Category Archives: Economic history

Prices, property rights, profits … and ice?

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Lynne Kiesling

The history of the commercialization of the ice market is a multi-layered case study in market processes. Who knew? This Freeman article from David Hebert, an economics graduate student at George Mason University, tells the economic history of the origins of the long-distance ice industry in the U.S. in the early 19th century:

In 1806 Frederic Tudor sailed a ship full of ice from Boston to the Bahamas. Two years earlier Tudor had begun experimenting with insulation with the goal of bringing ice to the Bahamas.  When he was ready to set sail, he found that the ship captains refused to carry his cargo for fear of damaging their vessels. So he bought his own brig, the Favorite, and set sail February 10, 1806. He arrived in Martinique with a large quantity of ice still intact and began selling. The Bahamians loved the ice, which they had never seen before. Yet that first year Tudor lost a substantial sum of money, although he proved that ice could be shipped to the Bahamas. Now the objective became doing it at a profit.  Convinced his idea would be wildly successful, he continued his attempts to drive down costs and increase demand.

How he does so is a tale of property rights over ice on a lake, how users of a common-pool resource established a system of use rights, and technological innovation to reduce costs while improving product quality. Highly recommended reading.

Rob Bradley’s Edison to Enron

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Lynne Kiesling

Consider the preconceptions that surface in your mind when you read the name “Enron”. What are they? Chances are that they are negative, and not particularly nuanced — fraudulent business activity, tarnishing the idea of free markets by trying to manipulate them using the political process, and so on. If that’s true for you, then you are probably in a pretty similar mental space to mine when I started reading Rob Bradley’s Edison to Enron: Energy Markets and Political Strategies. Rob’s detailed and thoroughly researched book is a well-told analysis of the valuable and interesting regulatory and business history that formed the backdrop of Enron’s spectacular failure.

The name of the book is somewhat misleading, because the first third of the book focuses not on Thomas Edison but on Samuel Insull. Insull, the oldest son of a working class family in Victorian England, emigrated to the US after several years of a successful financial career in London. He brought, and sharpened, his business acumen to complement Edison’s inventive creativity, and it was Insull’s business genius that accelerated the electrification of the country. Rob tells Insull’s story extremely well, and provides extensive links to supporting material that illustrates how important Insull’s contributions were to Edison’s success individually and as a business/set of businesses. With his analysis Rob also argues that Insull’s business skill generated substantial social value (i.e., consumer surplus as well as profit). That point is incontrovertible, but the story is not told often enough or well enough, and Rob has done so here. I appreciated this part of the book in particular because although I am familiar with Insull’s biography, I did not realized that his business model advocacy had shaped our modern electricity industry so dramatically; for example, Insull consistently pursued acquisitions and consolidation that led to reduced costs through economies of scale, but always advocated for pairing those moves with reductions in retail prices to consumers. The companies he headed that followed this strategy profited while charging lower prices, in the absence of formal economic regulation. Insull was, though, always an advocate for regulation, largely because he worried that rising debt service costs would make it difficult to pursue this model.

Insull’s career and life ended tragically, with him exercising unusual poor business judgment while simultaneously being too optimistic about economic prospects in the US in the early 1930s. His earlier career had been characterized by an emphasis on hard work, self-help, provision of quality service at affordable prices, and provision of a healthy working environment in return for the hard work of employers. His career ended with a successful defense against a federal lawsuit, which combined with the wealth effects of the stock market crash and Depression to leave him bankrupt.

Rob uses Insull’s history as a foil for Ken Lay’s story. The remainder of the book digs into the origins of the natural gas long-distance pipeline and local distribution industries, the mergers and acquisitions that would create Williams Energy and Enron, and Ken Lay’s role in this progression from the 1960s through the mid-1980s. Rob’s narrative combines business history with biography as he traces the individual and corporate interactions, personalities, and changes. Lay’s background as a Ph.D. economist, an academic, and a policy adviser in Washington, DC meant that he brought a diverse range of skills and experience to the natural gas industry. Given his experience of working closely with Lay, Rob can also attest to his temperament and his management style and how those combined with his experience to help him transform the natural gas industry.

The point at which Lay’s story stops here parallels Insull’s business and personal success, and in the next volume Rob will pick up the tale and finish the parallel by relating his personal experience of Enron’s demise and the extent to which Lay exercised unusually poor judgment. I look forward to reading the sequel to this analysis.

Another valuable aspect of Rob’s work in this volume is the book’s long epilogue, which pulls back and analyzes the period he’s covered (1881-1984) through the lens of what Rob calls “political capitalism”. Conveniently, Capitalism at Work was the first volume in this “Political Capitalism” trilogy. The epilogue here draws on the theoretical political economy framework Rob constructed in that first volume, a synthesis of energy economics, Austrian economics, and public choice theory. Rob uses this framework to “differentiate market capitalism from political capitalism”, an analysis that’s very timely and relevant today as we debate the role of politics in business and the unsustainable proliferation of cronyism in the economy.

Edison to Enron synthesizes business history, economic history, biography, and political economy to tell a compelling tale of innovation and new value creation in two energy industries, as well as increasing regulation and political capitalism in them. If you teach an energy economics class, the epilogue can be a useful reading to get your class thinking about the history of innovation and regulation and their implications in energy industries. The volume does have an unfinished feel to it, as you would expect from the second book in a trilogy, but it does not detract from the detailed analysis presented here.

Skwire at Cato Unbound: “Bonfire of the Clichés”

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Michael Giberson

We ought not let Sarah Skwire’s second hit-and-run posting here at Knowledge Problem slip by without mentioning that she is also lead-off essayist in the current month’s Cato Unbound. The teaser from Cato:

Literary scholar Sarah Skwire asks us to revisit the western canon’s portrayal of business and commerce. Mainstream scholars and libertarians both seem to agree that these works portray business in a negative light, but Skwire finds the evidence for this contention to be thin. She proposes a much more nuanced view, in which critiques of the market stand side by side with favorable depictions and even sound, encouraging advice for would-be businessmen. It’s time to get beyond the clichés about literature and commerce.

Skwire begins her essay, “There is a problem with the relationship between literature and business. But it’s not the one you think.” Go read the rest of it. All good, but for the instruction to read more (and more broadly, and more deeply); I already want to read more than I have time for, so now the trade-offs will only become tougher!

As is the Cato Unbound practice, several invited responses to the lead essay will be posted in the next few days, Skwire will respond, further interaction, etc. Enjoy.

Book review: A Genius For Money

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Lynne Kiesling

Today’s Wall Street Journal has a review, King of the Shopkeepers, of a new biography from Caroline Dakers. A Genius For Money tells of the rags-to-riches life of James Morrison, a Victorian innovator of retailing and banking in England. I can already tell that I am going to order the book as soon as I’m done writing this post:

Morrison was not an inventor-capitalist but a retailing genius, more Sam Walton than Steve Jobs. He catered to England’s growing consumer class by diversifying his wares and, in his ever-growing network of shops, introducing luxurious showrooms. He was a disciple of volume, seeking “high turnover, small profits, and quick returns.” He sent his traveling men not to find buyers, as was typical, but to find the best suppliers. Advantageously purchased in bulk, goods would sell themselves. Morrison’s buyers were specialists, anticipating the practices of later department stores. He kept his finger on the pulse of fashion and on “market making” events. Legendarily, he was never caught short of black crepe when a member of the royal family was ill. “The Duke of York has died most conveniently,” he once quipped while tallying profits.

Entrepreneurs like Morrison and Josiah Wedgwood transformed the everyday lives of so many people, and changed how we view work, consumption, and beauty. They also made markets work more efficiently, Morrison through banking and Wedgwood through infrastructure investment (he was a driving pioneer in the construction of canals in England). In that sense, innovators like Morrison and Wedgwood are equilibrating entrepreneurs in the way that Kirzner describes. The review of Dakers’ book also suggests that it raises themes that Deirdre McCloskey raises in The Bourgeois Virtues and Bourgeois Dignity, and that we have discussed here in the past.

I have not talked here much about Wedgwood, but I have had plans to for a long time, so this book may be the catalyst.

Michael Graetz’s “The End of Energy” surveys 40 years of energy policy making. It isn’t pretty.

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Michael Giberson

Michael J. Graetz, "The End of Energy." (Book cover)

Michael J. Graetz, "The End of Energy," MIT Press, 2011.

Michael Graetz’s The End of Energy is a fascinating run through 40 years of U.S. energy policy making. Engaging and at times even entertaining if you are at all interested in energy issues. In Graetz’s telling it is mostly a story of 40 years of failure, though he notes a few successes along the way.

I absolutely loved that the first chapter began with President Nixon’s decision to impose wage and price controls on August 15, 1971. If you think that wasn’t energy-policy relevant, then read that chapter (the publisher will let you read it free). Just note that the Arab oil embargo just over two years later caused barely a hiccup in U.S. oil imports; the gas lines and shortages were mostly due to the remaining Nixon oil price regulations. (Yet, 40 years later we still blame OPEC!)

Graetz proceeds to pull us through the swamp of 1970′s energy policy. President Ford joined Congress in giving us automobile fuel economy regulations. President Carter pushed an astounding range of proposals, succeeded on some but failed on others,  and lectured Americans for their supposed consumerist excesses. The book does a good job of surveying the problems created by interstate natural gas price regulation and the difficult politics of casting off that burden.

Reagan’s presidency doesn’t get much attention. Oil and gas price decontrol seemed to work, but these policies were initiated by Carter. After Reagan comes a decade and a half of relatively low energy prices, but for the spike around the Iraqi invasion of Kuwait in 1990. Not much to report, Graetz suggests, as the urge for new energy policy rises and falls with energy prices.

Energy prices pick up again in the mid-2000s, and after a few words on the Energy Policy Act of 1992 we find ourselves in the middle of climate change discussions and the massive difficulties that come with finding reasonable policy. Graetz devotes a late chapter to Congress and the attempted making of a cap-and-trade law. It is enough, perhaps, to turn the most die hard advocate of cap-and-trade into a carbon tax proponent (excepting that, had Waxman-Markey pushed a carbon tax, then a look into the sausage factory likely would have produced the opposite impulse). The book winds down contemplating the BP oil spill in the Gulf of Mexico and the Obama administration’s efforts in response.

The book mostly covers domestic federal coal, oil and gas, environmental and some nuclear power issues. Relatively little attention goes to electric power beyond nuclear or to  international issues, except when discussing climate change politics. Not much on ethanol and just a little on solar and wind power. Still – coal, oil and gas, the environment – these are where the big money is and so that is where the politics have focused. One lesson of the book seems to be that lobbying expenditure is a product of policymaker ambition and the size of government, and not the other way around.

The hazard of writing a current events-type book is that the book must end even as events continue. So Graetz laments that 40 years of energy policy making hasn’t put a dent in our “energy dependence,” and practically at the same time we have begun importing less oil for the first time in decades. Domestic oil and gas production is up in recent years, and what is more, it is a development that has come about mostly without the attention of federal energy policy makers. (Or perhaps in part due to their lack of attention, even admitting some federal R&D support for oil and gas drilling technology.)

Well, we can’t blame Graetz because history continued after his book ended. It is a strength of his book that is gives us some idea of what to expect of the next few years, as the politicians and regulators in Washington DC begin to take notice of this domestic energy development. I wouldn’t score all of the wins and losses quite the way he does, and I’m not sure where his interest in more grand energy policy comes from given the fairly damning assessment of the federal energy policy system. Still, the book offers its readers a fair view of and deeper insight into the last 40 years of federal energy policy.

Does a public good argument justify subsidizing private energy production?

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Michael Giberson

Yesterday I disputed the analysis by which the Breakthough Institute wanted to claim credit on behalf of the federal government for the shale gas boom; today I dispute their claimed broader implications for federal energy R&D policy.

Late in their op-ed, the Breakthrough folks shift emphasis from a narrow drilling technology story to a broader examination of energy R&D policy:

Giving the federal government credit where it is due takes nothing away from Mitchell, who was determined and tenacious. But the lesson of the shale gas revolution is that we should not be so quick to judge government investments in energy technology. Between 1978 and 2007, the Energy Department spent $24 billion on fossil energy research. Billions more were spent through the Gas Research Institute and non-conventional gas tax credits. Those investments were widely panned as a failure during the ’80s and early ’90s, when gas was plentiful and cheap.

Whatever one thinks about shale gas today — we worry about its environmental consequences — there’s no denying the extraordinary economic return on taxpayer investments.

This last point is interesting, but undeveloped in the article. If one were to calculate the “economic return on taxpayer investments,” would one have to conclude they were extraordinary?

The essay ultimately wants to argue against claims that the Solyndra episode proves governments can’t pick winners and the shale gas boom proves private enterprise can. Defenders of subsidies for solar power projects claim critics are too focused on a single failure, Solyndra, when reasonably critics should be assessing the overall portfolio of projects supported. It is a fair observation, but it may turn against their conclusion. If we are to consider the return on “taxpayer investments” in energy R&D, we’d reasonably need to survey the full portfolio of energy technology concepts funded by the federal government. We’d have to count the winners and losers both, based on the best current understanding, and again (as yesterday) we’d want to work out some idea of what would have happened in the energy technology space without federal government intervention. Further, we wouldn’t just worry about the environmental consequences, we’d have to compute some estimate of the costs and include it in the analysis.

The article goes nowhere close to presenting the relevant case. Near the end of the article they claim federal credit for “nuclear power, natural gas turbines, solar panels, and wind turbines — pretty much every significant energy technology since World War II.” Hmmm, notice they don’t mention the other big selectively-cited-by-critics failure: the Carter-era launch of an$88 billion effort to make oil from coal. Like the Solyndra and Synfuels Corp. complainers, the Breakthrough Institute wants to draw policy implications for an uncertain future based on a selective invocation of history.

It is further a kind of mistake to invoke Solyndra in an essay all about energy R&D policy. Much recent taxpayer-extracted support for energy shows up in the production tax credit, the investment tax credits, the Section 1603 Treasury grants and miscellaneous other subsidies that are directed to help promote the fortunes of companies building renewable power components or producing power via renewable sources. While some of these companies are pursuing technological developments, these subsidies are not tied to research in any substantial way and yield very little in the way of publicly available research results. Try gathering detailed data on production from a wind farm or solar power plant benefiting from millions of dollars in taxpayer-supported subsidies – their lawyers will likely tell you it is commercially-sensitive information and not publicly available. And by the way it isn’t just renewable energy, the lawyers for subsidized production from low-output oil and gas wells will likely say the same thing.

There is a respectable public good argument that can be made in support of subsidizing at least some research. The “extraordinary economic return” that the Breakthrough Institute wants to claim on behalf of government subsidized research into oil and gas drilling technology is this kind of an argument. If Breakthrough wants to drag Solyndra and the full range of energy production subsidies into this argument, an economist looking for a respectable public good argument has got to ask: where is the public good in subsidizing private energy production from projects that hide publicly useful information from public review?

Did the federal government invent the shale gas boom?

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Michael Giberson

In the Washington Post the folks at the Breakthrough Institute try to learn us some history about the shale gas boom. Maybe you think the shale gas boom was some big surprise suddenly made real after the decades-long work of a hard-headed oil and gas guy – George Mitchell – willing to spend millions of dollars on the crazy idea that hydrocarbons stuck in a rock could be produced economically, once the right mix of technologies could be brought to bear.

Wrong, says the Breakthrough Institute, credit the shale gas boom to the federal government.

They have their reasons:

  • “Slick-water fracking, the technology that Mitchell used to crack the shale gas code, was adapted from massive hydraulic fracturing, a technology first demonstrated by the Energy Department in 1977.”
  • “Mitchell learned of shale’s potential from the Eastern Gas Shales Project, a partnership begun in 1976 between the Energy Department’s Morgantown Energy Research Center and dozens of companies and universities ….”
  • “Mitchell’s success depended on a revolution in monitoring and mapping technologies driven largely by government labs.”
  • In 1991, Mitchell asked the publicly funded Gas Research Institute, then funded by a tax on gas production, and the Energy Department for help.”
  • “Sandia National Labs provided Mitchell with many critical microseismic tools.”
  • “Mitchell also benefited from 3-D imaging, which the Energy Department had long supported.”
  • “The third critical technology was horizontal drilling and well installation …. In 1976, two government engineers … patented an early-stage directional drilling technology that became the precursor to horizontal drilling.”
  • “A joint venture between the Energy Department and industry drilled the first horizontal Devonian shale well….

There are a few more similar points. The article pursues a larger goal – some statement concerning current energy policy support – but today I just want to consider how to assess the credit for technological advancement. (See tomorrow for part II.)

A fair analysis of credit and blame requires more than just a recounting of history, such as provided in the article, we need also to construct a counterfactual history for comparison. Should we reasonably believe that but-for the energy technology programs of the Department of Energy, we’d be unable to produce natural gas from shale? It would be difficult to do this analysis well, and the authors don’t attempt it here, but a full assessment calls for it.

A sketch of technology developments may be helpful. Note that fracturing as a well-stimulation technology started in Pennsylvania in the early 1860s. A few clever folk discovered dropping gunpowder down a well, later liquid nitroglycerin,  often brought marvelous returns. Edward A. L. Roberts submitted a patent application for the process in 1864. Hydraulic fracturing technology was first developed by Standard Oil (Indiana) in the late 1940s.  In the 1960s, Project Gasbuggy had the federal government collaborating with the oil and gas industry to test a nuclear-weapon based fracturing technology on federal land in New Mexico. The Breakthrough Institute’s story picks up in the 1970s, but what the backstory reveals is a history of efforts to develop fracturing technology, funded privately in some cases and publicly in others. Department of Energy involvement may have shaped the direction of research, but I suspect its pool of research funds was merely convenient to technological advancement and not necessary. (More recently, GasFrac Energy Services of Alberta has pioneered a propane-based fracturing technology.)

Directional drilling, a precursor to horizontal drilling, first became practiced in the industry in the 1920s – well before “two government engineers … patented an early-stage directional drilling technology” in 1976. (See “Slanted Oil Wells,” published in Popular Science magazine in 1931.) As with hydraulic fracturing,  the industry found the technology quite useful in application and companies pursued technological advancements. Taxpayer funding may have been convenient support for the oil and gas industry, government research involvement may have shaped the direction of directional-drilling research, but the industry would have pursued the technology in any case.

So possibly the federal government’s involvement advanced by a few years the technologies that were finally blended in a sufficiently promising mix by George Mitchell. Even if we grant as much, it isn’t the whole of the shale gas boom that federal involvement gains credit for, just the added value that comes from shifting shale gas production forward by a few years. Of course possibly the whole of the federal government’s involvement in the industry – tax policies, regulatory policies, antitrust policies, federal lands policy, and so on – could reasonably be counted as delaying technological advancement when compared against what would have happened under some more rational regime.

Admittedly, they were just writing an op-ed and I’m complaining that they didn’t do a dissertation’s worth of work to support it. Maybe my complaints are a little unfair.

Okay, here is an offer: I’ll admit my complaints are unfair if they admit that their analysis was insufficient to justify their conclusions.

Why did water utilities in the U.S. become mostly publicly owned?

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Michael Giberson

Among U.S. water utilities, some are publicly owned and some are privately owned. Same thing for gas utilities and electric utilities. But unlike in the gas and electric power industries, the water business has become predominantly organized by publicly-owned utilities. Scott Masten explores why it was that public utility ownership became dominant among water utilities in an article, “Public Utility Ownership in 19th-Century America: The ‘Aberrant’ Case of Water,”  appearing in the October 2011 issue of the Journal of Law, Economics, and Organization.

I would have guessed that the large up-front costs with low salvage value (termed “relationship-specific assets”) created a large potential for post-investment opportunism (i.e., like the “competition over infra-marginal rents” story that John Neufeld says help explain the rise of state electric power regulation). After all, seems like there are few better examples of sunk costs than the networks of underground pipes that make up a municipal water supply system.

Masten discusses the idea that relationship-specific asset related problems favored municipalization, but finds no evidence in his data to suggest that water utilities will larger investments were more likely to be publicly owned. And yet his favored explanation is related: he finds strong support for the idea that frictions between city governments and private water utilities was a key contributor to municipalization. Friction was often over city-demanded expansions that were resisted by private water utilities, mostly because contracts negotiated between cities and private utilities didn’t provide efficient incentives for expansions and occasionally cities reneged on promised subsidy arrangements to induce expansion. This is, as Masten explains at pp. 621-625, is a fight over infra-marginal rents, so I’m not sure why Masten favors a “relational friction” story over a “relationship-specific assets” story. In any case public ownership, by integrating city and water utility, eliminates the costly conflict that would otherwise undermine the efficiency of private operations.

While his data and analysis mostly revolve around the late 19th century, he notes the issue is of more than historical interest. From the conclusion (notes omitted):

The World Bank has recently been actively studying privatization of waterworks as a way of addressing severe water problems in developing countries.The dominance of public ownership of water and sanitation services in the United States should, at a minimum, give policymakers pause: If, despite an institutional environment conducive to private ownership, American water and sanitation systems are overwhelmingly publicly owned and operated, is it reasonable to expect privatization to yield long-term gains in developing countries where the environment for private enterprise may be much less hospitable? Understanding the determinants of variations in waterworks ownership both over time and between communities may help inform whether privatization of water systems in developing countries makes sense .

Public ownership does eliminate costly fighting between city and private utility over infra-marginal rents, but it doesn’t eliminate the rents and so likely won’t eliminate the competition to capture them. Masten’s suggestion for further research are useful, but also needed are complementary studies of the efficiency of publicly owned water utilities in countries “where the environment for private enterprise may be much less hospitable.” The question in terms of generalized economic growth seems to be under which system are more of the rents yielded to consumers.

Masten’s abstract:

Unlike other public utilities, most water in the United States is supplied by publicly owned and operated waterworks. The predominance of the public sector in the supply of water was not always the case, however; private firms dominated US water supply throughout most of the 19th century. This article analyzes the puzzle of why water and sanitation systems were the only major utilities to become predominantly public by, first, reexamining historical accounts of the problems of contracting for water services in light of modern theories of economic organization and, then, evaluating hypotheses derived from those accounts using data on 373 waterworks serving US municipalities with populations over 10,000 in 1890. Among other results, municipal ownership is found to be related to the distribution of population and commerce within a city in ways that suggest that frictions between cities and private companies over system extensions and improvements played a significant role in the shift to municipal ownership.

Boulton & Watt on new £50 note

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Lynne Kiesling

Industrial revolutionaries, rejoice! The Bank of England is honoring one of the most fruitful and enterprising inventor-entrepreneur partnerships in economic history, Matthew Boulton and James Watt, by putting their images on the new £50 note.

You are probably familiar with James Watt as the inventor of the double-acting steam engine and other accompanying improvements that enabled mechanization and the ultimate replacement of animate, water, and wind power for the industrial transformations of the 19th century. Watt’s hard work and vision created a power source that enabled a dramatic increase in productivity, innovation, living standards, and transformational economic growth.

But Watt was also an irascible inventor who did not relish the customer-facing aspect of commercializing his inventions, which was where Matthew Boulton came in. Boulton’s background in manufacturing metal products, combined with his business sense and his “people skills”, made the partnership of Boulton and Watt a commercial success and the firm of Boulton & Watt one of the most profitable and influential pioneers of mechanization and industrialization. They truly changed the world for the better.

HT: Boing Boing

Smil’s brief list of the pioneering creators of electric systems

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Michael Giberson

In the process of explaining why Steve Jobs, though talented, is no Thomas Edison, Vaclav Smil name-drops a “brief list of the pioneering creators of electric systems”:

This fundamental innovation [the electric power system] was created during a remarkably short period of time—most of it between the late 1870s and the beginning of the 20th century—by a surprisingly small number of inventors, engineers, and scientists. In order to avoid the most obvious exclusionary injustice, even a brief list of the pioneering creators of electric systems must include the names of Charles Clarke, Sebastian Ferranti, Lucien Gaulard, John Gibbs, Zénobe-Théophile Gramme, Edward Johnson, Irving Langmuir, Charles Parsons, Emil Rathenau, Werner Siemens, William Stanley, Charles Steinmetz, Joseph Swan, Nikola Tesla, Elihu Thomson, Francis Upton, and George Westinghouse. But, justly, one name stands above them all, that of Thomas Alva Edison.

I thought I knew a bit about this period, but I credit myself for recognizing only 6 of the 18 names mentioned (Siemens, Swan, Tesla, Thomson, Westinghouse, and Edison).

How well do you know your early electric power industry history?