Cyclopædia of Political Science, Political Economy, and the Political History of the United States

Edited by: Lalor, John J.
(?-1899)
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First Pub. Date
1881
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New York: Maynard, Merrill, and Co.
Pub. Date
1899
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Includes articles by Frédéric Bastiat, Gustave de Molinari, Henry George, J. B. Say, Francis A. Walker, and more.
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OVER-PRODUCTION

III.23.1

OVER-PRODUCTION. Over-production is a term which is clear and simple as each man applies it in his own business, but which is liable to be misunderstood when applied to the business of the community. This combination of apparent clearness and real doubt has caused much confusion and unnecessary argument; so that we must begin with a careful analysis of its meaning in various aspects. It is defined by Malthus as occurring "when the production of anything is carried beyond the point where it ceases to be remunerative." For instance: a manufacturer owns his plant, but depends upon credit for the purchase of raw materials and the means of paying wages. Now if his product brings the expected price, it compensates him for all these advances, and gives him his business profit in addition. But a slight fall in the price of his product, from whatever cause it arises, will sweep away his business profit. This is the point where production ceases to be remunerative. A further fall will not only leave him without business profit, but also without compensation for the wages he has advanced, or without the means of paying for his raw material; so that the more he has manufactured the poorer he is for it. To him, then, all production on these terms is over-production. And to him the result is the same in its main features, whatever be the reason for the fall in price. He could have avoided the worst of the trouble to himself, had he but curtailed his production in time.

III.23.2

—But if we go one step back, and look for the causes which occasion this fall in price, we find that it may be due to any one of three things: 1. A disproportionate production of this particular article; 2. A hindrance of any kind which prevents placing goods in the most advantageous market; 3. A general fall in prices. As regards its relation to the general business of the community, the first of these causes acts in a very different way from the second and third; and it is to the first of these causes that the name over-production is most properly applied. The mistakes of Sismondi, Chalmers and even Malthus in this connection arose from their supposing that it meant the same thing in the second and third causes as in the first. They said that depression in individual branches of trade arose from over-production in those branches, and inferred that when phenomena of the same kind were seen everywhere there was the same kind of over-production everywhere. But this is by no means the case. Disproportionate production is one thing; failure to sell at the expected price may be quite another. It may look like the same thing to the individual producer, and yet mean very different things respecting the past and future of the business community. Disproportionate production is liable to occur at any time in individual branches of trade. It is only when it becomes much more serious than usual, and is combined with other causes, that it is followed by a commercial crisis. But the so-called general over-production does not ordinarily occur except in connection with a crisis, and there it is a result rather than a cause. By keeping this distinction in mind we shall avoid confusing the real partial over-production which usually precedes commercial crises, with the apparent general over-production which is characteristic of their advanced stages. It is with the former of these that this article mainly deals.

III.23.3

—Disproportionate production on a small scale, such as constantly occurs in one or another branch of industry, readjusts itself so easily as to occasion no harm except a temporary one to a few individual producers in that line. The capitalists see their mistake the moment their business profits are swept away, and use less capital in their business; the excess of supply is quickly consumed, prices recover, and the business goes on as before. But special circumstances may aggravate the trouble to the extent of a public calamity, and special lines of production are particularly liable to such misfortune. When large amounts have been invested in fixed capital, such as machinery, public works, or, above all, railroads, such excess of supply can not be quickly consumed, but exerts its depressing influence for a long time to come. And, on the other hand, when special lines of production have been stimulated by a temporary demand at abnormally high prices, as was the case in the iron business in 1873, and is liable to be the case to a less marked extent in almost any other line of manufacture, it will be found that after the excess is worked off and consumed, prices still do not recover anything like their former figures. We thus have two types of business liable to over-production; one because the excess of supply is permanent, the other because the high price is abnormal. The history of railroad building on the one hand, and of iron production on the other, furnishes the most striking instances of these results, as well as the most complete statistics for our purpose.

III.23.4

—Ever since the invention of railroads excessive railroad building has been a leading symptom of an approaching crisis. In 1837, it is true, the system of railroads was not yet far enough advanced to be an important factor, yet here we had the same kind of extravagance in building roads and canals on borrowed capital, and the same effects from it. It was in England in the years preceding the crisis of 1847 that the railroad first assumed its importance as a subject of speculative production. Of the workings of a railroad system capitalists knew very little, but they went into the business with the same blind confidence that their ancestors had gone into South sea bubbles. And this reckless investment of capital was encouraged by the blind belief of legislators in unchecked railway competition as an unmixed benefit to the public. 678 companies—for the most part, it must be said, with ridiculously short lines—applied for incorporation in the year 1845 alone; and of these 136 were actually incorporated, 65 receiving the royal assent in a single day. And this at a time when the system was in its infancy. By the end of the year 1847 the estimated value of the railways incorporated was more than a thousand million dollars, and a large part of this sum had been actually expended, while most of the work was too incomplete to bring in returns that could be used in payment of interest. There is no need, for our present purpose, of going into the further history of the crisis of 1847; in a community which had been investing its capital thus recklessly, any economic shock must needs produce the most serious results. The crisis of 1857 is not so distinctly an instance in point. There was indeed in many cases a sudden shrinkage of railroad earnings and a marked decrease in railroad building—3,647 miles being added in the United States in 1836, 2,647 in 1857, 2,465 in 1858, and only 1,821 in 1859. But this was hardly over-production in its truest sense. The shrinkage came elsewhere even more than here. There had been speculation and extravagance everywhere, and much property changed hands as values settled down to a truer basis. But there was no useless mass of lingeringly insolvent capital, almost no disproportionate production that could not be made use of in some way beneficial to the community.

III.23.5

—Not so in 1873. For five years men had been building railroads to an extent hitherto unheard of. High wages and prices had made the real cost of construction great, and the extravagant spirit of those years had added other items of expense. Only an abnormally stimulated trade could enable them to meet their obligations and furnish profit besides. But the panic of 1873 left trade abnormally depressed; and many roads were in no condition to meet their obligations. Sooner or later they had to reorganize; but before this could be done they succeeded in doing a great deal of harm to other people's property as well as their own. Once regarding themselves as insolvent, they felt exempt from a number of responsibilities that had hampered them. If they could not get business at a paying price they would get it at a price that did not pay, and force competing solvent roads into non-paying rates. Hence arose the railroad wars culminating in 1876, when the Grand Trunk and the Erie, then insolvent roads, swept away the profits of the Pennsylvania and the Baltimore & Ohio, and for the time greatly reduced investors' confidence in the New York Central. This is the typical effect of over-production: the surplus is not only in itself unprofitable, but as long as it lasts will depress values of everything with which it competes. And the continued existence of such masses of undisposable surplus may be regarded as a leading difference between the long crisis of 1873 and the shorter one of 1857.

III.23.6

—The extent to which railroad over-production was carried is shown by the figures in Poor's Manual. In 1869 there were built in the United States 4,615 miles of railway; in 1870, 6,070; in 1871, 7,379; in 1872, 5,878; and in 1873, 4,107: an average for five years of over 5,600 miles. In 1874 the number fell to 2,105, and in 1875 to 1,712; for the five years succeeding 1873 the average was less than 2,300, or only about two-fifths the previous. The figures for France and Germany about the same time tell a similar story. Not less striking are the figures illustrating shrinkage of value. The "Railroad Gazette" of Sept. 27, 1878, furnishes statistics on this point concerning forty-five roads dealt in by the New York stock exchange, and in soundness presumably above the average of those in the country. The aggregate value of these roads, at their highest prices in 1873 (reduced to a gold basis), was $567,000,000; at the lowest prices of the same year it had fallen to $380,000,000; while in September, 1878, it was still only $460,000,000. Still more to the purpose are the figures concerning foreclosures furnished at the beginning of each year by the "Railway Age." In 1876 there were sold under foreclosure, (this term being apparently used in a rather wide sense), 3,846 miles of road, representing $218,000,000 of capital; and in the four years succeeding, 3,875, 3,902, 4,909, 3,775, miles of road, representing investments of $199,000,000, $312,000,000, $243,000,000 and $264,000,000, respectively. One-fifth of the railway investment of the country sold under foreclosure in these five years of settlement! Whether this has taught us its lesson remains to be seen. Men have lost faith in unlimited railway competition; but a specially pernicious form of overproduction is developed in the case of parallel roads, built to sell rather than to operate; for the sake, that is, of forcing the old road to buy a controlling interest to avoid a railroad war. The enormous increase of railways in recent years (4,721 miles in 1879, 7,174 in 1880, 9,358 in 1881, 11,343 (?) in 1882) gives ground for apprehension, even though this rate of building is not likely to continue.

III.23.7

—In looking at over production in the iron industry, variations in price are even more striking than variations in production. In January, 1871, the average Philadelphia price of No. 1 pig iron was $30,50 per gross ton. From this time it steadily increased till, in September, 1872, the month's average was $53.87. In December, 1874, it had declined to $24, a loss of more than one-half in a little over two years; and this decline on the whole continued till November, 1878, when the price was $16.50, scarcely one-third of what it had been in 1872, even if we make allowance for the gold premium. In Great Britain the same change was still more marked. Scotch pig, which in 1870 had sold as low as 49¾s., rose in 1870 to 145s., and in 1878 had fallen to 42¼s., less than three-tenths of what it had brought five years before. A similar change was seen in America at the beginning of 1880, when iron, which in July, 1879, was selling at $19.25, rose to $40 and $41, only to fall, three months later, to $23.

III.23.8

—The reason for these extraordinary changes is to be found in the character of the demand for iron. A demand for iron at all often means a demand at any price, whether it be for a railroad that can make no money till its tracks are laid, or a factory that can make none without new machinery. But the demand that forces up the price is moderate in quantity; and though the high rates may be submitted to by the immediate demand, they may cheek the future demand. Thus, those who have gone into the iron business under the stimulus of high rates find that the pressure was only temporary; the extra supply, by the time they are ready with it, no longer wanted; and in place of the readiness to buy at any price, however high, comes an unwillingness to buy at any price, however low. Just this course of events is indicated by the statistics of iron production. The American pig iron product, which in 1870 had been about 1,859,000 net tons, and in 1871 about 1,905,000, rose under the stimulus of high prices in 1872 to 2,855,000, and in 1873 to 2,868,000 tons. But by this time the fall in prices had been so marked that the iron men checked production as best they might. In 1874 they reduced their product to 2,689,000 tons; but in spite of this reduction and of the further fall in prices there remained at the end of the year 796,000 tons unsold in the producers' hands. The further course of events is shown in the following table, compiled from figures in the report for 1881 of the secretary of the American iron and steel association:

Table.  Click to enlarge in new window.

III.23.9

From this it appears that in spite of diminished production and prices it was not until 1877 that they were able to reduce materially the proportion of their product unsold. As soon as they began to do this they were on a sounder basis; but what this involved may be inferred from the fact that out of 700 furnaces in the United States only about 250 were in blast in the year 1877; and that in the whole iron industry there was probably not a branch worked up to half the capacity which its fixed capital would admit. (For the statistics of the same general depression throughout the world, see "Economist," Com. Hist. and Rev. of 1878, supplement to March 5, 1879.) A repetition of some of these phenomena has been seen in the last four years; notably in the case of steel rails, whose price increased from $42 per gross ton in May, 1879, to $85 in February, 1880, but at the end of the year 1882 had fallen to $39. There was the same reckless investment of capital to meet a temporary demand at high prices, and the same impossibility of maintaining anything like those prices when the extra supply was thrown on the market.

III.23.10

—Railroad production and iron production furnish types of the two causes which render disproportionate production a source of lasting evil: in the former case, because the increase of supply is permanent; in the latter, because the high demand is only momentary. The introduction of machinery is apt to produce effects of the former character; the supply of articles of fashion and luxury is subject to the latter. It was the combination of these two that had a large share in causing the English crises of 1818 and 1825. Agricultural produce is less liable to these disturbances than anything else, the exception in the case of cotton in 1837 and 1839 being only apparent; the evil was due to speculation on the part of cotton producers rather than to disproportionate production of cotton. So in England in 1847, when an exceptionally good harvest was the occasion of a crisis, it was not because there was more food than people had been in the habit of demanding, but because to certain individuals, who had speculated in the price of grain, normal production meant ruin. Results like these may occur when any combination makes a speculative attempt to control production and prices both. When such a combination is powerful enough to form a monopoly, there is no doubt that a check to production generally increases their returns, the prices rising more rapidly than the quantity diminishes. And, conversely, an increase of production, even under their own hands, actually diminishes the gross returns. If an individual extends his production his gross returns are commonly increased. If a monopoly extends its production the opposite effect is quite as common.

III.23.11

—We have hitherto spoken of over-production only in the sense of disproportionate production. It was shown at the outset that the same effect upon individual producers might result from a failure to reach the right market, or from a general fall in prices. The first may be due to transportation difficulties, or to tariff legislation; the second, to a contraction of the currency; but by far the commonest cause of both is a commercial crisis. It renders the credit system so far inoperative that it is impossible to place goods where they are the most needed; and it so far increases the demand for ready money instead of credit documents that it has the same effect upon prices as currency contraction. It may thus happen that the appearance of over-production will occur as the result of a crisis even in those lines where there has been no abnormal production, merely in consequence of difficulty in doing business and in paying debts. This is what has given rise to the name and idea of general over-production.

III.23.12

—For more extended theoretical discussion of certain points, which the limits of this article do not allow, see Roscher, Political Economy, § 215-217; J. S. Mill, Principles of Political Economy, bk. iii., ch. xiv.; Francis A. Walker, Political Economy, § 214-224; George Chesney, Fortnightly Review, September, 1881.

ARTHUR T. HADLEY.

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