July/August 1994 | Volume 45, Issue 4
When the government manipulated and misused the robber barons
Economists from Adam Smith on have written about the evils and dislocations that monopolies bring to an economy. What has been much less written about over the years, however, are the evils of monopsony.
In the interest of saving wear and tear on three hundred thousand dictionaries, let me hasten to offer a definition. A monopoly is any entity that effectively controls the supply of a commodity. A monopsony, on the other hand, controls the total demand for a commodity.
Obviously monopsonies are much rarer than monopolies. The only one I ever enjoyed happened years ago when I was traveling in Greece. A photographer, quite unasked, snapped pictures of the members of a tour I was on, and the next morning he went from table to table in the hotel dining room, offering eight-by-ten glossies at outrageous prices and doing a brisk business.
When he came to me, however, I told him I’d give him one-tenth his asking price for the photos he had taken of me. He indignantly refused, so I suggested he call up the newspapers and see what they would pay for pictures of an utterly unfamous college student walking around Delphi with a guidebook in his hand. He took the money I offered him and said something in Greek that would probably lose nothing in translation. The same to you, buddy, and welcome to the world of market forces.
But monopsonies can have largescale pernicious effects for much the same reasons as monopolies: they prevent the determination of real prices while their possessors invariably come to abuse their power. And like most monopolies nowadays, monopsonies tend strongly to be government ones—state textbook boards are one example—and the greatest of them are military in nature.
After all, how many customers are there for, say, nuclear-missile submarines? Mercifully, perhaps, there is only one, and Electric Boat sells to the Navy or it doesn’t sell at all.
These military monopsonies are nothing new. A hundred years ago, when battleships, not nuclear submarines, were the measure of naval power, the government had a thirty-year dispute with the country’s steelmakers over armor plate. It’s an instructive tale.
The battle between the Monitor and the Merrimack in 1862 had spelled the doom of wooden navies. By the 188Os the monitor form had evolved into the battleship, armed with the biggest guns afloat and protected by belts of armor plate. The U.S. Navy, however, had quickly shriveled to insignificance after the Civil War and bought what little armor plate it required from abroad. Then the Arthur administration decided to expand the Navy and wanted domestic sources to assure supply in case of war.
The steel manufacturers were not interested in building highly specialized plants that could make only armor. Why should they have been? Demand was subject to the vagaries of politics, the Navy would be virtually the only customer, and the technology was very difficult to handle. Because of inevitable variations in the distribution of impurities and in cooling, each batch of armor plate varied considerably in thickness, tensile strength, and resistance to penetration.
Nevertheless, both Andrew Carnegie and the Bethlehem Iron Company, under government prodding, began to construct armor plants. Carnegie, however, suspended constructions when Navy bureaucrats insisted that government inspectors be present during every phase of manufacturing and that rigid specifications for the very factors that were inherently difficult or impossible to control be adhered to. Carnegie thought, quite correctly, that the only thing that really mattered was the armor’s resistance to gunfire and therefore that a ballistics test should be the sole criterion by which the Navy should judge his armor plates.
Bethlehem continued to construct its armor plant but, with far smaller resources than Carnegie, soon ran into financial trouble. So President Benjamin Harrison personally appealed to Carnegie to resume construction of his armor-plate mill at the Homestead Works, and he did so.
By 1892 it was in operation, but the great Homestead strike of that year ended production for a time, and when it resumed, after the strike had failed, disaffection among the workers was, understandably, intense.
The following year an attorney representing four of the workers went to Carnegie’s partner, Henry Clay Frick, whose actions had been mainly responsible for the strike, and offered to sell him “evidence” of fraud on the part of the company in fulfilling its armor contracts. Frick—the very opposite of a wuss—sent the lawyer for what he called the “vermillion-hued” workers packing. But the lawyer then went to the government, which agreed to give the men 25 percent of any fines levied on the basis of their evidence.
The government proceeded to name a board of inquiry, which investigated the matter using only the information supplied by the informants, and not surprisingly submitted a report finding the company guilty. The first that the Carnegie Steel Company knew of this was when Frick was summoned to Washington to be told that the Navy intended to levy a fine equal to 15 percent of the value of the contract.
It was, of course, a classic starchamber proceeding, and both Frick and Carnegie were outraged. They appealed to President Cleveland. Cleveland, a Democrat, did not want to seem to be supporting the company responsible for the Homestead strike against his own Secretary of the Navy. But as a lawyer himself he realized that the company had gotten nothing resembling justice. He reduced the fine to 10 percent, but that still amounted to $140,484.94.
The nub of the Navy’s case was that although only three of the plates thus far delivered had been below specifications and therefore rejected, most of the rest had been 5 percent better than specified and a few were 20 percent above grade. In the Navy’s logic, if that is the word, since some of the plates were 20 percent above what the contract called for, all of the plates should have been that good.
Only a bureaucrat profoundly ignorant of the difficulties of making uniform armor plate could have decided this was fraud. And much that might appear to have been genuine fraud was, in fact, only an attempt—an extremely ill-advised one, to be sure—to protect the Navy from itself.
For instance, the contract called for armor plate with no blowholes, holes caused by uneven cooling. In congressional hearings Charles Schwab, then the superintendent of the Homestead Works, testified that blowholes were inevitable in first-class armor plate and that while they could be easily prevented by adding silicon to the metal, that would have weakened the whole plate. What did the Navy want, he asked in effect, strong armor with blowholes or weak armor with none? He pointed out that the German firm Krupp, one of the leading armor manufacturers in the world, had exhibited its very best armor plates in Chicago at the World’s Columbian Exposition of 1893 and they had been full of blowholes.
Charles Schwab was a man much given to getting the job done now and worrying about nitpicking rules later. To give the Navy the best armor plate, but without blowholes, he had simply patched them when the government inspectors had not been around to object.
The Carnegie company could have gone to court, and might have won. But Carnegie and Frick, all too aware of the government’s monopsony power, knew that any delay in paying the fine might be grounds for the Navy’s canceling the contract, leaving them with masses of armor plate and no one to sell it to. They swallowed their pride and paid the fine.
Matters returned to normal, and the Carnegie Steel Company, becoming in 1901 part of U.S. Steel, got its share of armor contracts from the government as the country built itself into a worldclass naval power.
But when the Wilson administration came to office in 1913, it was perturbed by the fact that the bids for contracts by the handful of companies that could produce armor plate were often nearly identical. The reason was simple enough. The Navy was afraid that if it awarded an entire contract to the lowest bidder, less efficient companies might drop out of the armor-plate business and the country would not have an adequate supply in wartime. So it made a practice of giving all the companies an equal share of any large contract, provided they met the lowest price. With no incentive to bid low, no company did so.
Josephus Daniels, Wilson’s Secretary of the Navy, thought the solution was a government armor plant. Congress appropriated the money after a Navy report estimated that a plant with a yearly ten-thousand-ton capacity could be built for $8,446,000 and could produce armor for only $314 a ton, while the steel manufacturers were then being paid $454 a ton.
The steel companies, hardly happy about the idea of the government, already a monopsony for armor plate, becoming a competitor as well, fought the project. But they needn’t have worried. When the plant was finally finished, three years after World War I ended, it was millions over budget and could not produce armor for less than nearly double what the steel companies charged. The plant was shut down after producing one batch of armor plates and never reopened.
For almost a century leftist historians have been regularly dredging up the “armor-plate scandal” as an example of capitalist greed at its worst. What it really is, of course, is one more example of government incompetence both as a customer and as a manufacturer.