The Third Pillar

by Raghuram Rajan

  If attracting people was so important, though, why did states continue to exclude women and minorities? One can only speculate here. Perhaps states felt that going against the prejudices of the time would attract fewer, not more of the favored settler, white men. Perhaps they thought women would follow with their husbands or fathers and few single women would migrate anyway. Perhaps they did not believe there were sufficient free blacks to attract. Nevertheless, even though the extension of the franchise was far from universal, and did not seem to rise above the prejudices of the time, the founders of new states were willing to extend the franchise, even without an agitation by the excluded.

  In contrast, in countries which were already well populated, where property inequality within the population was more significant, and the inequality aligned with racial or ethnic divisions, as in the plantation economies of Latin America, the right to vote was kept far more exclusive and for far longer. For instance, the literacy requirement in the Peruvian constitution was maintained till 1979. Exclusion may have served a dual purpose here. On the one hand, it prevented a rise in public spending, which would have to be funded by a tax on the privileged property owners. On the other, it kept a large part of the population uneducated (because of the absence, or poor quality, of public schools), which meant they would provide a docile labor force for the plantations and other menial jobs, even while they were kept from ever acquiring the learning to pass literacy tests and get the vote.33 Universal suffrage made a much later appearance in these countries, and the delay was not without costs.

  For a variety of reasons, therefore, the propertied extended the franchise, especially when they felt the extension would not jeopardize, and might even reinforce, their property rights. Democracy then offered a way for communities to express themselves on the national stage, to feed policies like worker rights and worker safety up rather than to accept top-down commands from the state. In fact, as we will now see, it was essential if market competition were to survive.

  POWER AND PERMANENCE

  Power prefers permanence. Unregulated markets tend toward concentration as the successful try and entrench themselves by pulling up behind them the ladder of competition that they themselves climbed. Equally, the politically powerful are tempted to suppress any competitive threat to their future posed by democracy. James Madison was persuaded that democracy would work in the United States because in a large country with many different competing political interests, it would be hard for any specific interest to dominate.34 Yet interests can coalesce.

  It is when the behemoth of monopoly enterprise consorts with the leviathan of the authoritarian state that both are likely to achieve permanence. History is strewn with examples of these collusive arrangements, some of which we have already encountered. Communism brought all business enterprise under government planning and control, with the state dominated by the Communist Party, the self-appointed representatives of the proletariat. Business and the state were united under the proletarians. Fascism was different only in the language of the dominant group and its stated aims, which was national supremacy instead of the communist paradise of the universal brotherhood of workers. In practice, fascism too involved permanent party dominance of the state, and state control of industry. Today, we have milder versions of these totalitarian regimes, with state-controlled capitalism in countries like China and Russia, and authoritarian capitalism in Turkey.

  While the nomenclatures vary, at the heart of such regimes is a pact between the cartelized market and the state, leaving little room for economic or political competition, or the community. Such arrangements are examples of what political economists Douglass North, John Wallis, and Barry Weingast call limited-access societies.35 In contrast, the liberal market democracies in developed countries are what they call open-access societies, combining free and open markets with vibrant democratic control over the government. Implicit in the work of a number of political scientists is the belief that open-access societies are the desirable pinnacle of social development, and they will not regress back to limited-access societies because of the strong institutions that protect them. They are probably right in believing that open-access societies are the best we can do for now, but they are mistaken in thinking that open-access societies cannot regress. To prevent regression, it is critical that the balance be maintained. As we will see now, communities of citizens, expressing their interests through democracy, played an important role in the United States in preventing a corrupt compact between the state and the markets.

  HOW THE UNITED STATES PRESERVED A COMPETITIVE MARKET

  In a recent study, Harvard economists Edward Glaeser and Claudia Goldin graphed the relative frequency of the appearance of the words “fraud” and “corruption” in the New York Times relative to the word “political” over time.36 They find a steady decline from the time of the notoriously corrupt Ulysses Grant presidency in the 1870s (not coincidentally, about the time of Rockefeller’s Cleveland Massacre) till about the time of the Nixon presidency in the early 1970s. They conclude that political corruption declined steadily in the United States, especially between the late 1870s and 1920s.

  Two great democratic reform movements date from around this time, first the Populists from the 1870s till the mid-1890s, then the Progressives from the mid-1890s till the end of World War I. The first movement was born out of adversity and anger, and the second was a middle-class movement, which flourished largely in a time of prosperity. As they fought against the privileged, and for the ordinary unconnected individual, these movements introduced a measure of restraint on political corruption and the associated creeping monopolization of American business. Both movements sought to constrain the unfettered market in order to make it work for the forgotten common man. While neither was entirely successful in its aims, together they provided a needed course correction for the United States.

  THE SOURCES OF CORRUPTION

  Political corruption was an issue from early on in US history. Most accusations centered on the close ties between big business and politicians.37 For example, legislatures could grant monopoly charters of incorporation to banks but also to infrastructure like pipelines and canals. Particularly problematic were the railways, which used their influence over legislatures to secure land grants, tax exemptions, municipal and state subsidies, and public loans. Historian John Hicks, in his classic, The Populist Revolt, asserts that entire legislatures and governments were bought by the railways, sometimes by the simple expedient of giving everyone who might be remotely useful a free and unlimited railway pass.38

  With high levels of corruption as the nineteenth century came to an end, the United States was in danger of turning into a plutocracy where large trusts and corporations like Standard Oil, United States Steel Corporation, or Consolidated Tobacco, coordinated by financiers like John Pierpont Morgan, controlled large swaths of the corporate landscape as well as government policy. The two successive reform movements helped arrest and reverse the drift toward crony capitalism.39

  THE POPULISTS

  In the United States, populism, then and now, is typically a movement that emphasizes the purity of the common people and their simple values, the self-interested, corrupt, and undemocratic behavior of the elite, and the need for the people to organize against the elite to effect change. In the last quarter of the nineteenth century, the Populist movement arose out of the discontentment of indebted small farmers. Farmers had been lured West by the expansion of railroads and the steady eviction of the Native Americans. As land became increasingly settled, unoccupied land was hard to find, and land prices went up.40 Unlike their predecessors who arrived when the West had not yet been settled, the new settlers took on significant amounts of debt as they purchased land. If harvests failed, they could not simply up stakes and move to new lands—there were no good lands left that were cheap. Moreover, they had the millstone of unpaid debt tying them to their farms.

  When, in 1879, the United Sta
tes returned to the gold standard, the debt the farmers owed was fixed to the steady dollar price of gold. The prices for their produce continued falling, though, in what is known as the Great Deflation between the 1870s and 1890s. The deflation was caused, in part, by the limited availability of gold, which caused everything else to fall in price relative to it (and the dollar). In the words of Populist leader William Jennings Bryan, with fixed payments on debt and falling revenues, farmers had been crucified by the Eastern financial establishment “on a cross of gold.”

  The situation of farmers worsened as droughts devastated the Great Plains in the late 1880s. Some returned to the East from whence they had come—one returning wagon bore the sign, “In God we trusted, in Kansas we busted.”41 Many tried to make a go of it, though, some because they had no alternative—they had given up their horses and wagons as collateral for loans and could not move, even if they wanted to. In addition to their concerns about financial injustice, the farmers had grievances: against monopolist railroads that had sold them overpriced land in the first place, and now arbitrarily increased freight rates for transporting their produce; against the elevator operators who charged them exorbitant rates for storing grain, as well as against Eastern manufacturers who lobbied for protective import tariffs that increased farmer input costs, even while resisting tariffs for farm produce.

  The farmers tried to make common cause with others who were aggrieved. The Populist platform of 1892 emphasized this broader coalition: “We meet in the midst of a nation brought to the verge of moral, political, and material ruin. Corruption dominates the ballot-box, the Legislatures, the Congress, and touches even the ermine of the bench . . . The newspapers are largely subsidized or muzzled, public opinion silenced, business prostrated, homes covered with mortgages, labor impoverished, and the land concentrating in the hands of the capitalists. The urban workmen are denied the right to organize for self-protection, imported pauperized labor beats down their wages . . . The fruits of the toil of millions are boldly stolen to build up colossal fortunes for a few . . . and the possessors of these, in turn, despise the Republic . . .”42

  The Populists wanted silver to be added to scarce gold in the monetary base so that farm produce prices would increase and farmer indebtedness (in terms of produce) would fall. They sought a program that would allow farmers to borrow money from the federal government to store their crops until prices rose enough for them to be profitable. And they wanted debt relief. In fact, the Populists were really asking for a safety net to replace the natural safety net that the wide-open frontier had provided earlier settlers. In addition, the Populists wanted to reduce the concentration of economic power through antitrust laws (they wanted to nationalize the railways) and a graduated income tax, and bring more political power to the people by making the ballot secret and giving them the right to elect senators directly.

  The movement largely ended soon after the 1896 presidential election. It probably petered out because growing farm prosperity from the mid-1890s on, coupled with inflation of farm produce prices as gold was found in Alaska, the Yukon, and South Africa, rendered farm debts more manageable. A bankruptcy code enacted in 1898 further relieved those who could not pay. The Populists were also not entirely ineffective in obtaining legislative responses to other grievances. Congress set up the Interstate Commerce Commission in 1887 to regulate railway freight rates, and passed the Sherman Antitrust Act in 1890 to prevent the creation of large monopoly trusts. While recent academic studies question the effectiveness of these legislative acts, they were symbolic blows for the principle that the market could not be left unfettered.43 Finally, the Populists did secure the secret ballot and direct elections of senators.

  More broadly, Populism was a cry from people who wanted more from their democracy, and whose geographically dispersed communities were brought together by widespread economic distress. The more universal themes of the Populist movement—that the market has to be saved from the anticompetitive actions of its strongest participants and that the federal government has some responsibility for public welfare—continue to resurface even today.

  THE PROGRESSIVES

  As the Populist movement petered out with rising prosperity, the Progressive movement gained strength. In contrast to the Populist farmers, the Progressives, many of whom came from solid middle-class urban backgrounds, were not so concerned about their own capacity to survive economically. Their worries had more to do with the shrinkage in economic opportunity for the small businessman as giant trusts colluded with corrupt politicians to dominate certain industries. They also were perturbed about relative decline. Growing inflation—which they believed was accelerated by monopoly prices—and the stupendous fortunes being accumulated by the rich, diminished their own comfortable positions by comparison. Paralleling today’s middle-class concerns about the “top one percent” earners, they were appalled by the incomes and uninhibited behavior of the rich “upper ten,” even as they feared the threats to their own way of life in cities that were exploding in size and diversity. They worried about the safety of the workplace, the quality of the food they ate, the temptations men faced from alcohol, prostitution, and gambling as they ventured out of the home, the second-class citizenship of women, and the quality of the education their children received. They were perturbed by growing class conflict such as the bloody Pullman Strike of 1894 and the United Metal Workers strike of 1902. They did not want to overthrow the system, they simply wanted to reform it to reflect middle-class values.

  The Progressives believed a level playing field created by transparent, well-enforced regulations would restore broad-based economic freedom. They also wanted these freedoms to be tempered by responsibility toward the family and the broader community. Such changes in human behavior could be effected gradually, through education and socialization, but that would take time. In the short run, therefore, the Progressives pushed for greater government involvement, as well as the professionalization of functions like teaching and medicine to force the change in behavior. Unfortunately, the federal and state governments were rarely content to stay confined to the precise areas identified by the Progressives, and usually the government bureaucracy, as well as the professional organizations such as teacher associations assumed much more power. In turn, this tended to usurp power from the communities, reducing local control as well as the customization of policies to local needs, leaving citizens less engaged. We will examine some of this in the next chapter.

  Opposition to the Progressive program mounted after the end of World War I, when people, having just emerged from a bloody war, became tired of Progressive sermonizing and government-imposed constraints on their behavior, such as Prohibition. Jazz and the Roaring Twenties were certainly not part of the Progressive agenda, and effectively marked the end of the movement.

  The Progressives nevertheless had an important, lasting, influence. They emphasized three ways short of socialism that big business could be contained, thus preserving competition in the market. The first was through antitrust legislation and judicial enforcement. The second was through regulation. The third was through taxation. All three are still with us.

  The most important was antitrust or competition law, which prohibited collusive practices in industry as well as the formation or continuation of corporate structures that might substantially reduce competition. In the choice between protecting property rights and preserving competition, antitrust law came down firmly on the side of competition.

  One of the biggest initial targets was Rockefeller’s Standard Oil. Between 1902 and 1904, Ida Tarbell, the daughter of one of the oil producers who had been squeezed by Rockefeller in Oil Creek, wrote nineteen articles in McClure’s Magazine exposing “The History of the Standard Oil Company.” Tarbell, a dedicated investigator who pierced through the mass of seemingly impenetrable corporate structures and deals, detailed how Standard Oil had achieved its dominance. Even though “there was not a lazy bone in the org
anization, not an incompetent hand, not a stupid head,” she concluded, “They had never played fair, and that ruined their greatness for me.”44 In 1906, responding in part to the public furor stemming from Tarbell’s articles, the federal government filed a suit under the Sherman Antitrust Act to dissolve Standard Oil, and in 1911 the Supreme Court finally upheld a verdict demanding its breakup.45 In 1914, the Clayton Act further clarified and barred anticompetitive practices and the Federal Trade Commission was set up to enforce antitrust legislation.

  An alternative to breaking up a monopoly, especially if it was in an industry that was more productively serviced by a single company (also termed a “natural monopoly”) was to regulate it. Regulation also made sense when the consumer could not discern product quality up front or had to rely on promises of responsible corporate behavior such as adequate after-sale service.

  Once again, the “muckraking” press played a role in energizing public opinion. Upton Sinclair’s The Jungle, published in serial form in 1905, was primarily about the exploitative conditions faced by immigrant factory workers in the United States, but public attention focused on the filthy, unhygienic practices the book detailed in the meatpacking industry. Perhaps most frightening and revolting was his account of workers accidentally falling into great lard vats and their bodies being ground up along with other animal parts into “Durham’s Pure Leaf Lard,” which was then sold for public consumption. Once again, public outrage prompted an inquiry, which substantiated many of Sinclair’s allegations about unsanitary and unsafe conditions in the meatpacking industry (though not the one about workers being ground up). In 1906, Congress passed the Meat Inspection Act as well as the Pure Food and Drug Act, which established the department that was later renamed the Food and Drug Administration in 1930.