Men Who Made The Rules

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One of the more amusing moments in recent American history came in 1978, when Alfred E. Kahn, the flamboyant head of President Carter’s Council on Wage and Price Stability, made the mistake of suggesting that the nation might face a deep depression if inflation were not brought under control. When a spokesman for the President protested the use of the word depression , Kahn promptly offered a substitute: banana .

Kahn will be remembered for more than his quick wit, however. Along with Charles Francis Adams, Jr., Louis D. Brandeis, and James M. Landis, he is the subject of a fascinating book by Thomas K. McCraw, a professor at the Harvard Business School with a special interest in government regulation of business.

Prophets of Regulation (Harvard University Press, 1984), the winner of the 1985 Pulitzer Prize in history, explores a century of regulation by focusing on four key figures. McCraw calls these people “prophets,” rather than “architects or innovators,” because the term expresses “the unusual combination each one represents of both theorizing about regulation and actually doing it. . . .”

Charles Francis Adams, Jr., the great-grandson of John Adams, the grandson of John Quincy Adams, and the brother of the historian Henry Adams, was not crippled by that great affliction— the family name. Of the four brothers in his generation, McCraw asserts, “it was Charles who made the most interesting attempt to weave the Adams tradition of public service into the harsh realities of the Gilded Age.”

As a young man, Adams tells us in his autobiography, he “fixed on the railroad system as the most developing force and largest field of the day, and determined to attach myself to it.” To break into the field, he used the one weapon every Adams commanded: his pen. In a series of brilliant articles he demonstrated a command of the economics of railroading that none of his contemporaries could match.

Railroads, Adams argued, were natural monopolies. It was idiotic to force them to compete, because if they were allowed to operate as monopolies, they were subject to economies of scale that made it possible to drive down costs. Massachusetts lawmakers who tried to enforce competition were making a giant mistake. They “saw only that a monopoly existed,” Adams wrote. “They failed wholly to realize that it was far easier and far cheaper to regulate than to destroy it.”

In 1869, at thirty-four, Adams was appointed to the new Massachusetts Board of Railroad Commissioners. That same year he published “the hardest piece of work I ever did”—a dazzling account of the battle for control of the Erie Railroad that raged among Daniel Drew, Jay Gould, Jim Fisk, and Cornelius Vanderbilt in 1868.

The Massachusetts Railroad Commission was the outstanding early example of the “sunshine” approach to regulation. As Adams wrote in 1879, “The Commissioners have no power except to recommend and report. Their only appeal is to publicity.” Adams did not add, but certainly knew, that the appeal to publicity could be a formidable weapon in a democracy.

Having left the Massachusetts commission in 1879, Adams became the president of the Union Pacific Railroad in 1884, only to be forced out by his old enemy Jay Gould in 1890. Adams was “the first modern regulator,” McCraw concludes, “and one of the best ever to serve on a state commission.” But in his old age he “watched helplessly from the sidelines as his beloved ‘public interest’ broke apart among dozens of quarreling economic and ethnic constituencies.”

With the establishment of the Interstate Commerce Commission in 1887, the primary responsibility for the regulation of business shifted from the states to the federal government. At about the same time, giant corporations emerged in many sectors of the economy. These developments set the stage for the second of McCraw’s prophets, Louis D. Brandeis.

Born in 1856, Brandeis graduated from the Harvard Law School at twenty with a record that remains unmatched to this day. He went on to have an extraordinary career, culminating in twenty-three years on the Supreme Court (1916-39). In light of Brandeis’s reputation, many readers will be startled to find McCraw arguing—persuasively, in my view—that “Brandeis offered regulatory solutions grounded on a set of economic assumptions that were fundamentally wrong.”

Brandeis spelled out those assumptions in “the longest and most memorable piece of muckraking he ever did,” a series of articles published in Harper’s Weekly in 1913 and reprinted as a book entitled Other People’s Money and How the Bankers Use It .

The title of one chapter, “A Curse of Bigness,” gives Brandeis’s economic philosophy in a nutshell. He believed that bigness in business was always bad. Today, McCraw points out, most business historians believe that bigness works well in a small number of “center” industries and that it cannot possibly work in a large number of “peripheral” industries. Brandeis never grasped this distinction. History itself has provided “a step-by-step demolition of the Brandeis brief against bigness.”

Brandeis’s reputation as the “people’s lawyer” has obscured the extent of his indifference to the welfare of consumers. At one point he even led a campaign on behalf of “resale price maintenance,” a form of price-fixing. The supposed champion of the common man was actually suggesting, McCraw observes, “that small retailers be exempted from the antitrust laws and permitted, in concert with each other, to fix the prices of consumer goods.”

The third of McCraw’s prophets, James M. Landis, began his career as clerk to Justice Brandeis in 1925. Landis had graduated first in his class from both Princeton and Harvard Law School.

In 1933 Felix Frankfurter asked him to come to Washington to join the team that was drafting federal securities regulations. Three protégés of Frankfurter—Landis, Thomas Corcoran, and Benjamin Cohen—became known as Frankfurter’s “Happy Hot Dogs.” They worked together on three key pieces of New Deal legislation—the Securities Act of 1933, the Securities Exchange Act of 1934, and the Public Utility Holding Company Act of 1935.

In striking contrast to Brandeis in his design of the Federal Trade Commission, Landis developed a philosophy of “participatory regulation” that emphasized “a careful shaping and bending of the incentive structures, so that each of the major players would voluntarily carry out SEC policies.” The result, McCraw argues, was that the Securities and Exchange Commission became “the most successful of all federal regulatory agencies.”

Landis succeeded Joseph P. Kennedy as chairman of the SEC in 1935 and was succeeded himself by the future Supreme Court justice William O. Douglas in 1937, when Landis accepted an invitation to become dean of the Harvard Law School. A year later, drawing on his experience in Washington, he published a landmark study, The Administrative Process —“the most forceful argument ever written in favor of regulation.”

Brandeis’s reputation as the “people’s lawyer” has obscured the extent of his indifference to the welfare of consumers.

In his forties Landis began to drink heavily, and his family life fell apart. He eventually resigned his Harvard deanship and married his secretary, and in the early 1960s he was sentenced to thirty days in prison for an evasion of taxes that seems truly to have been unintentional. Only a few years before, he had produced for President-elect Kennedy a brilliant and devastating report on the state of the federal regulatory agencies. But his brilliance could not save him. Accidental death by drowning was the coroner’s ruling when he was found dead in his backyard swimming pool in 1964.

McCraw’s fourth prophet, Alfred E. Kahn, was born in Paterson, New Jersey, in 1917, the son of a Russian Jewish immigrant. He graduated from high school at fifteen and, at eighteen, graduated summa cum laude and first in his class from New York University. A doctorate from Yale was followed by an impressive academic career that culminated with the publication of a two-volume masterpiece, The Economics of Regulation , in 1970 and 1971.

In 1974 Kahn was appointed chairman of the New York Public Service Commission. Over the next few years he revolutionized utility rate structures in New York. Kahn insisted that rate structures must reflect true costs. That meant, for instance, that telephone companies must charge less for calls made during off-peak hours and that consumers must pay more for calls made during peak hours. This was “marginal-cost pricing.” Under any other system, Kahn argued, consumers made the wrong decisions—made too many high-cost calls during peak hours and not enough low-cost calls during off-peak hours.

From New York Kahn moved to Washington, where, as chairman of the Civil Aeronautics Board in 1977 and 1978, he presided over the first major deregulation of an entire American industry and became a media favorite. No government official had ever talked to executives quite the way Kahn did. “I really don’t know one plane from the other,” he told Frank Borman of Eastern Airlines. “To me they are all marginal costs with wings.”

To McCraw, Kahn represents “the economist’s hour in the history of regulation"—a refreshing change from the “notably different hours during which the muckraker and the lawyer alternately held center stage.”

In general, business executives feel about regulation the way children feel about rules that limit their consumption of ice cream. The rules that irritate executives, however, are not always as rational as the rules that frustrate the appetites of children. Nor do the rules always secure the good they intend. Prophets of Regulation is a provocative, tightly argued work that illuminates the past and should help guide public policy in the future.