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In the 2012 Presidential race the most pressing issues are jobs, the national debt, and economics in general. A recent Gallup poll shows that 48% of Americans believe that the most important issue for the next President should be the creation of good jobs, and third down the list is dealing with the national debt and deficit with 44% of Americans considering this an extremely important problem (Jones). The challenger, Governor Mitt Romney, would like nothing more than to make the election into a referendum on the economic record during President Barack Obama’s first term, but the President would rather the debate be about competing visions for the future and economic justice. A recent line of attack coming out the Romney camp is an out-of-context spin on a phrase from an Obama campaign speech in Roanoke, Virginia. The President said, “If you’ve got a business, you didn’t build that. Somebody else made that happen.”
The first thing to point out about this statement is that it has been de-contextualized, such that the two times Obama uses the word “that” are actually referring to something he was saying in an earlier part of his statement, words that are deliberately cut out of the GOP marketed version. The entire statement was, “If you were successful, somebody along the line gave you some help … Somebody helped to create this unbelievable American system that we have that allowed you to thrive. Somebody invested in roads and bridges. If you’ve got a business — you didn’t build that. Somebody else made that happen.” (Walter, Hartfield, Good ) The way that Obama put the sentence together was a moment to be seized upon by the Romney campaign, but anyone who is not determined to misunderstand the entire statement can see that “that” refers to the past investments in road, bridges, education, and the “unbelievable American system”. Nonetheless, Romney and the Republicans would like voters to believe that the President was telling small business owners that they did not build their own small businesses. If you believe that Obama was simply insulting business owners, then I can’t help you, you likely have a bias to view his statement as a confirmation of a truth you think you already know.
I have heard conservatives claim that they understand the President’s context, claim to have watched his entire Roanoke speech, but knowing the full context makes them even more convinced that Obama is a Socialist. From some in this group I have heard a counterargument that taxes pay for roads, bridges, and education, taxes that are contributed to the public coffers upon business activity. Since government is parasitic to free enterprise at its financial core, this means that technically business builds government and all that government builds. So the context of the entire speech makes Obama’s statements even more damning, at least according to Republican spin.
Obama is often called a socialist, communist, or Marxist by conservatives. This is incredible hyperbole, which I have also addressed in a previous article, ObamaCare, Tyranny, and Social Contracts. I don’t see anything in the President’s agenda which is out of the mainstream Democratic platform, so the socialist label is essentially an attack on liberalism more generally, an obtuse line of reasoning. While it is true that business activity generates the incomes that are taxed for the financing of government, the wider economic debate is over how government finances revenues, chooses spending outlays, and regulates commerce. Meaning that the notion that business pays for its own infrastructure through taxes, therefore your business built the roads and bridges is an attempt to abstract the practical role of public governance out of the economic system, or at most to reduce it to an irrelevant middle-man. The President’s very straightforward point is that government should be doing more to improve infrastructure, fund education, and assist innovation. A rebuttal to this vision that relies on the argument that government didn’t technically build those things because taxes collected from business financed them at root, is another example of obtuse reasoning.
Candidate Romney and the Republicans have framed a line of attack on President Obama’s economic philosophy as naive thinking from a lack of business experience, and these attacks have sometimes drifted into an insinuation that President Obama does not understand what made America a great economic power. Romney surrogate John Sununu controversially wished Obama “would learn how to be an American,” (Youngman) and Romney himself has said that “[t]he course we’re on right now is foreign to us, it changes America.” (Kohn) Is this really the case though? In my studies of American history, I find a great deal of support for the President’s vision. In the Roanoke speech President Obama made reference to the “unbelievable American system,” and it turns out that his articulation of American success and exceptionalism is much more in tune with America’s founding economic circumstances than the Romney-Ryan return to a fantasy era of laissez-faire opportunity through corporatism.
The Unbelievable American System
Early economics in colonial America fell under the mercantilist system of English dominion. In a way the distinction between political and economic governance did not exist during colonization. My family arrived in America in 1628, my ancestor John Endecott was the first Governor of Massachusetts Bay, but until 1630 when Governor John Winthrop arrived with the colony charter, the colony was the Massachusetts Bay Company and Endecott was one of five shareholders. A few years later, when Endecott was council leader in Salem town, he championed a couple of firsts in American political economy, an environmental conservation law in America for the purposes of a community shipbuilding strategy, and a tax on property owners to finance primary education of all the town’s children. I discuss the details of these lesser known American histories in my articles, The Lorax and the Endecott, and Thinking About Public Education respectively, if anyone is interested in reading about my family’s American legacy. For our purposes here, these examples illustrate that there were no theories of laissez-faire in America when the colonists first arrived.
The year 1776 contains the celebrated date of America’s independence from Britain, but it is also the year that the founding text of modern capitalism was published by the Scottish moral philosopher Adam Smith. An Inquiry into the Nature and Causes of the Wealth of Nations is a masterpiece of economics, elucidating the principles of free trade, specialization, efficiency, competition, and market mechanisms. The history of economic thought traces its origins to the Classical period of Adam Smith, David Ricardo, Thomas Malthus, and John Stuart Mill, a British domination of economic theory to rival their domination of the American political and economic system. Americans revolted against the British Parliament and Crown in the context of mercantile restrictions and taxation without representation, colonies of economic subjects for the select purpose of producing agricultural products for sale in Europe. So was Adam Smith’s idea’s about capitalism the guiding light for U.S. economic policy by the time George Washington was elected our first President?
Many advocates of free market philosophy in the present day point to the statements of Thomas Jefferson, conflating the general sentiments for limited government and individual liberty advocated by our third President, architect of the Declaration of Independence. When it comes to matters of economic consideration, and I want to find warrant for my argument in the ideas of the Founding Fathers, I tend to select Alexander Hamilton over Jefferson. I appreciate Jeffersonian ideals more when it comes to issues of ethics and general governance, notably the Declaration of Independence and his sentiments regarding religious freedom and egalitarianism. However, I find that Jefferson is a poor guide in economic matters, especially up against our first Treasury Secretary. Jefferson was opposed to industry writ large, arguing that building cities and centers of manufacturing would create concentrations of capital, would put Americans under servitude of their employers, which was to him as liberated as living under the old monarchy, as it represented a loss of independence and would perpetuate class distinctions between owners and workers (communist socialism?). He wanted an agrarian republic, an economic model that relied upon slave labor at the time, I might add. A realistic accounting of America’s economic history does not reveal much in the way of Jefferson’s vision, but the evidence of the realization of Hamilton’s American School is abundant.
If Thomas Jefferson is the architect of American Independence, and James Madison the architect of the U.S. Constitution, and George Washington the architect of the U.S. Presidency and military command, then Alexander Hamilton is the architect of the arguments for ratification of the Constitution, and architect of America’s economic system. In order to ensure ratification of the Constitution in his home state of New York, Hamilton contrived The Federalist Papers, written by him, James Madison, and Jon Jay, but all under the alias Publius. Alexander Hamilton wrote 60% of the 85 essays in The Federalist Papers, including many on the separation of powers and the various roles of the executive, judiciary, and legislative branches, as well as many arguments against the loose confederation regime in favor of a more energetic central government and union of states. Hamilton’s contributions to ratification also included articles on government financing, economy, and commerce, with a whole series on the need for general powers of taxation (The Federalist Papers).
Hamilton was a pragmatist who sought a workable plan for America’s security, and this was through a practical plan for economic development. While Jefferson dreamed of an agrarian utopia, Hamilton recognized the need for a doable strategy that would embrace the reality of human self-interest with a plan to channel those energies into building a first rate nation, an industrial and financial power. The alternative to this was that America remained economically subservient to British mercantile domination, likely to collapse from within politically and/or become re-conquered militarily. Hamilton’s desire for American ascendency through active government intervention in the national economy lay beneath the surface of his case for a stronger central government in The Federalist Papers, but his tenure as first Treasury Secretary brought the practical recommendations and steps that Alexander Hamilton devised to implement a successful American economic strategy.
Secretary Hamilton submitted the First Report on the Public Credit in January of 1790, per an earlier request from the House of Representatives. The report included an analysis of the current status of the finances of the new country, and recommendation of a debt assumption plan. The American Revolution has been financed through the issuance of bonds and paper currency, and both the domestic and the foreign lenders were to be paid back in full through the issuance of new federal debt. The debts of the individual states would be assumed by the federal government. Hamilton wanted to strengthen the new government by tying America’s financing elite to the national interest using bonds, and by maintaining a federal debt with a good credit standing the U.S would be able to transform into a financial center. The plan was very successful in its goals, but it was originally opposed by Jefferson and Madison and failed its first vote in the House. Hamilton was able to secure passage of the debt assumption arrangement after he met with Jefferson and Madison in New York City (the temporary site of the capital at the time) for the “dinner table compromise,” a deal that also resulted in a permanent capital in Washington D.C. being located on the Potomac River near Virginia. As you can see by some of Hamilton’s arguments in the report, it is hardly the sort of thing you would hear from a politician these days:
“To justify and preserve their confidence; to promote the encreasing respectability of the American name; to answer the calls of justice; to restore landed property to its due value; to furnish new resources both to agriculture and commerce; to cement more closely the union of the states; to add to their security against foreign attack; to establish public order on the basis of an upright and liberal policy. These are the great and invaluable ends to be secured, by a proper and adequate provision, at the present period, for the support of public credit….
…But there is a consequence of this, less obvious, though not less true, in which every other citizen is interested. It is a well known fact, that in countries in which the national debt is properly funded, and an object of established confidence, it answers most of the purposes of money. Transfers of stock or public debt are there equivalent to payments in specie; or in other words, stock, in the principal transactions of business, passes current as specie. The same thing would, in all probability happen here, under the like circumstances.
The benefits of this are various and obvious.
First. Trade is extended by it; because there is a larger capital to carry it on, and the merchant can at the same time, afford to trade for smaller profits; as his stock, which, when unemployed, brings him in an interest from the government, serves him also as money, when he has a call for it in his commercial operations.
Secondly. Agriculture and manufactures are also promoted by it: For the like reason, that more capital can be commanded to be employed in both; and because the merchant, whose enterprize in foreign trade, gives to them activity and extension, has greater means for enterprize.
Thirdly. The interest of money will be lowered by it; for this is always in a ratio, to the quantity of money, and to the quickness of circulation. This circumstance will enable both the public and individuals to borrow on easier and cheaper terms.
And from the combination of these effects, additional aids will be furnished to labour, to industry, and to arts of every kind….” (Hamilton Report on Public Credit)
The Second Report on the Public Credit was Hamilton’s even more controversial proposal to institute a banking system, including the First Bank of the United States, a hybrid creation of public-private partnership. Hamilton wanted a central bank for several important reasons. A banking system could issue bank notes that would circulate as a national paper currency, recognizing the necessary role of a system of financial intermediaries for the optimal utilization of financial capital in business ventures throughout the new country. A national bank would also facilitate the handling of government finances, like the collection of taxes, and would allow the extension of credit through loans to the business and the government sector. Hamilton presents compelling arguments for a central bank, expounding on the benefits of fractional reserve banking and an elastic money supply:
“The following are among the principal advantages of a Bank.
First. The augmentation of the active or productive capital of a country. Gold and Silver, when they are employed merely as the instruments of exchange and alienation, have been not improperly denominated dead Stock; but when deposited in Banks, to become the basis of a paper circulation, which takes their character and place, as the signs or representatives of value, they then acquire life, or, in other words, an active and productive quality…. It is evident, for instance, that the money which a merchant keeps in his chest, waiting for a favourable opportunity to employ it, produces nothing, ‘till that opportunity arrives. But if instead of locking it up in this manner, he either deposits it in a Bank, or invests it in the Stock of a Bank, it yields a profit, during the interval…. His money thus deposited or invested, is a fund, upon which himself and others can borrow to a much larger amount. It is a well established fact, that Banks in good credit can circulate a far greater sum, than the actual quantum of their capital in Gold and Silver….
The same circumstances illustrate the truth of the position, that it is one of the properties of Banks to increase the active capital of a country…. The money of one individual, while he is waiting for an opportunity to employ it by being either deposited in the Bank for safe keeping, or invested in its Stock, is in a condition to administer to the wants of others, without being put out of his own reach…. This yields an extra profit, arising from what is paid for the use of his money by others, when he could not himself make use of it, and keeps the money itself in a state of incessant activity…. This additional employment given to money, and the faculty of a bank to lend and circulate a greater sum than the amount of its stock in coin, are all to the purposes of trade and industry, an absolute increase of capital. Purchases and undertakings, in general, can be carried on by any given sum of bank paper or credit, as effectually as by an equal sum of gold and silver. And thus by contributing to enlarge the mass of industrious and commercial enterprise, banks become nurseries of national wealth….
Secondly. Greater facility to the Government in obtaining pecuniary aids, especially in sudden emergencies. This is another undisputed advantage of public banks, one which, as already remarked, has been realised in signal instances among ourselves….” (Hamilton “Report on a National Bank”)
As with the debt assumption plan, the plan for a national bank, and Federalist Party sentiments in general, were opposed by a new opposition party headed by Jefferson and Madison, the Democratic Republicans. It was contended that a national bank violated the Constitution, given that there was no enumerated power specifically granting the authority to create a central bank. Hamilton countered that there are powers implied by the Constitution, because the application of the enumerated powers requires an inference of additional authority for the exigent execution of the explicit duties. This was a reality that Hamilton argued was anticipated by the General Welfare Clause and the Necessary and Proper Clause of the Taxing and Spending Clause in Article I Section 8 of the Constitution, “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States; but all Duties, Imposts and Excises shall be uniform throughout the United States[.]” (U.S. Constitution) Hamilton interpreted America’s founding document as an elastic framework that did not unequivocally limit the federal government to only the exact words written within text. The Constitution does not say anything about express limitations, so inferences to practical context should not be constrained by literalism.
Hamilton was familiar with Adam Smith’s arguments about international free trade, but found disagreement with them (Muller). Let me say that again, America’s first Secretary of the Treasury, Alexander frickin’ Hamilton, the dude on our $10 Federal Reserve note, disagreed with the father of capitalism, Adam frickin’ Smith, about free trade. Hamilton believed that the U.S. needed to become a manufacturing power, and the only way to get out from underneath British dominance in this sector of the economy would be by government protection through import tariffs and the encouragement of internal improvements through financial incentives. Free trade alone would not produce wealth if the short term benefits of cheap imports dumped by Britain hindered the establishment of industry in its infancy. However, with protection and incubation the growth of manufacturing would grow the fledgling country’s economy faster and for the long term, and the adverse short term effect of higher consumer prices, which fell primarily on the agricultural States in the South, would be made up for in due time by the strategic development of markets within the U.S. through the amplification of internal commerce and trade.
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Hamilton’s third report to Congress as Treasury Secretary was the famous Report on Manufacturers in 1791, which laid out the theoretical arguments for proactive government support of industrial development, as well as concrete recommendations for tariffs and bounties. He argued that the growth of manufacturing would allow for the U.S. to dictate the terms of her own national defense, would promote efficiency and innovation through the division of labor and specialization, and the gains in technological expertise would further contribute to America’s capital stock. The diversification of trades and sectors would attract skilled immigrants with a spirit of enterprise and a sense of opportunity, and America’s increasingly productive and profitable industries would attract foreign capital investment (Muller) (Hamilton). These arguments are not so different than the ones President Obama is promoting in the Democrat’s platform of internal investments in infrastructure, education, scientific research, social insurance, and alternative energy.
Researcher Douglas Irwin has shown that while it is widely thought that Hamilton’s Report on Manufactures was rejected by the Congress, since in fact it was tabled upon arrival without debate, the individual recommendations in the report were basically all adopted by early 1792 in separate legislative initiatives. Even Hamilton’s recommendation of Cod fish bounties was adopted, a subsidy to encourage greater production. Jefferson and Madison argued that bounties are unconstitutional, but Hamilton defended the appropriations of money in support of industry as allowable under the prerogative of government’s duty to safeguard the general welfare. It’s also interesting to note, Hamilton structured the his tariffs recommendation so that they would not be protective in primary purpose, because he wanted primarily to earn revenue from tariffs, and this meant avoiding too significant a disincentive for imports (Irwin). Many libertarian and free market minded folks today would likely support Jefferson and Madison on the notion of limited federal powers, but Hamilton’s recommendations were those actually implemented and America grew to first world status upon his policy prescriptions.
When Thomas Jefferson was elected President in 1800 he characterized it as a revolution, and his party of Democratic-Republicans did trigger the end of Hamilton’s Federalist Party. Especially after Jefferson’s Vice President Aaron Burr shot and killed Hamilton in a duel in 1804. However, the Jeffersonian agenda of an agrarian society, as opposed to promotion of industry, in fact slowed the growth of manufacturing in America and left the country ill-prepared for another war with Britain in 1812 when President James Madison was in office. The Speaker of the House, Henry Clay of Kentucky, the great compromiser, was originally a Jeffersonian in the Democratic-Republican Party, but after the war he came to the realization that internal improvements and support for manufacturing were absolutely essential to America’s future viability as a free nation (Henry Clay). Clay, and like-minded Americans, created the Whig Party in response to the Jeffersonian platform of the Democrats, and although the party would only elect two Presidents, its economic policy platform would be adopted by President Abraham Lincoln and the new Republican Party in the middle of the 19th century.
Henry Clay, and fellow Whigs such as Daniel Webster and John C. Calhoun, became the most prominent proponents of a Neo-Hamiltonian economic platform that called for internal improvements like financing turnpikes and canals, high protective tariffs, and support for a national bank and currency. Clay dubbed this plan “The American System,” a furtherance of the policy theories endorsed by the late Secretary Hamilton and his “American School.” The Tariff of 1816 was passed by the Whigs, but strong opposition came from the Democrats and President Andrew Jackson, a strident Jeffersonian with an ironically tyrannical disposition. The American System was the economic philosophy that President Lincoln would later pursue, leading to such marvels as the Transcontinental Railroad.
The most notable American economist in the first half of the 19th century was Henry Charles Carey of the forgotten American School of Economics, who endorsed a Hamiltonian strategy in his 1852 book, Harmony of Interests. He would later become a top advisor to President Lincoln. The eminent Austrian economist Joseph Schumpeter in his voluminous survey, History of Economic Analysis, indicates that Henry Carey was the most significant American economist between 1790 and 1870. Schumpeter writes, “We need not like that protectionism and we need not like Carey’s whole vision…[t]his, however, is a matter of personal evaluation and does not excuse us from recognizing that Carey’s was a great vision and that, in most respects, this vision expressed adequately both the situation and the spirit of the country.” (Schumpeter 516) Carey argued against the laissez-faire British System in favor of the American System, claiming, “[p]rotection is needed…it operates in promoting the prosperity of, and harmony among, the various portions of society… the true, the profitable, and the only means of attaining perfect freedom of trade, is to be found in that efficient protection which shall fully and completely carry out the doctrine of Dr. Smith, in bringing the loom and the anvil to take their natural places by the side of the plow and the harrow.” (Carey Loc 52-53) These days we rarely discuss the early American economists, in favor of British and European theorists, which is unfortunate.
The German born economist Friedrich List lived in Pennsylvania for a time around 1825, where he owned a business and edited a newspaper, and studied the early ideas of the American School of Economics which he developed into the National School. He brought Hamiltonian economic theories back to Europe and Germany, where he advocated a national industrial development, and became an early inspiration to the thought of the German Historical School of Economics. List was very influential to early German economic development by advocating the removal of barriers to trade within the German states, creating an economic union, and then placing high protective tariffs on goods imported into this union. While List, like Hamilton, only recommended trade protection for infant industries, and free trade later, in more recent times, these protectionist arguments have been refined into the theories of strategic trade theory, the policies pursued by Japan and South Korea in the 1980s and 1990s to boost their exports and protect their strategic industries (Brue, Grant 199-201). I find some of Lists’ comments about the U.S. to be remarkable in regards to my thesis that America was not founded upon the economic doctrine of laissez-faire. In 1841 List had this to say:
“No nation has been so misconstrued and so misjudged as respects its future destiny and its national economy as the United States of North America, by theorists as well as practical men. Adam Smith and J. B. Say had laid it down that the United States were, ‘like Poland,’ destined for agriculture. This comparison was not very flattering for the union of some dozen of new, aspiring, youthful republics, and the prospect thus held out to them for the future not very encouraging. The above-mentioned theorists had demonstrated that Nature herself had singled out the people of the United States exclusively for agriculture, so long as the richest arable land was to be had in their country for a mere trifle. Great was the commendation which had been bestowed upon them for so willingly acquiescing in Nature’s ordinances, and thus supplying theorists with a beautiful example of the splendid working of the principle of free trade. The school, however, soon had to experience the mortification of losing this cogent proof of the correctness and applicability of their theories in practice, and had to endure the spectacle of the United States seeking their nation’s welfare in a direction exactly opposed to that of absolute freedom of trade.
As this youthful nation had previously been the very apple of the eye of the schoolmen, so she now became the object of the heaviest condemnation on the part of the theorists of every nation in Europe. It was said to be proof of the slight progress of the New World in political knowledge, that while the European nations were striving with the most honest zeal to render universal free trade possible, while England and France especially were actually engaged in endeavoring to make important advances towards this great philanthropic object, the United States of North America were seeking to promote their national prosperity by a return to that long-exploded mercantile system which had been clearly refuted by theory. A country like the United States, in which such measureless tracts of fruitful land still remained uncultivated and where wages ruled so high, could not utilise its material wealth and increase of population to better purpose than in agriculture; and when this should have reached complete development, then manufacturers would arise in the natural course of events without artificial forcing. But by an artificial development of manufacturers the United States would injure not only the countries which had long before enjoyed civilisation, but themselves most of all.
With the Americans, however, sound common sense, and the instinct of what was necessary for the nation, were more potent than a belief in theoretical positions. The arguments of the theorists were thoroughly investigated, and strong doubts entertained of the infallibility of a doctrine which its own disciples were not willing to put in practice.” (List Location 1727-1751)
I hope that the preceding history demonstrates that the unbelievable American System was established on a foundation of political economy that did not shy away from government intervention. Protectionism was not only a sentiment advocated by the first United States Treasury Secretary, it was a significant plank in the Whig political platform of Henry Clay, one the most celebrated House Speakers in our history. It was endorsed by Henry Carey, one of the most influential early American economists, and advisor to President Lincoln. American style protection of trade was lauded by Friedrich List, who advocated these policies back in Europe, and influenced subsequent generations of German political economy. As Schumpeter said, you don’t have to agree with protectionism, public works, or subsidized industry, but by now you should recognize that America’s ascension to economic and industrial dominance in the world did not happen under a regime of laissez-faire, and the counterfactual argument that the country would have grown even faster with free trade must forever remain a theoretical speculation.
The Laissez-Faire Fantasy
Laissez-faire is an economic philosophy that seeks minimal government intervention in the economy, the doctrine that business and commerce should be left alone, free of regulation and free of the tax burden. In laissez-faire, the only role for the state is the enforcement of property rights and contract rights. Market forces are the regulators in laissez-faire, like Adam Smith’s invisible hand, which channels competitive and self-interested human endeavors into optimal outcomes for society. In this view governments who abridge property rights or who tinker with market incentives are creating suboptimal outcomes. It should be noted that laissez-faire is a French phrase which in the modern age is endorsed most heavily by the Austrian School, and perhaps the product of Czarist Russian philosopher Ayn Rand. This begs the question, how American is laissez-faire?
The American era of laissez-faire, if there ever was such a time, was during the Gilded Age. A historical situation associated with industrialization, trusts and monopolies, railroads, Robber Barons, great inequality between the classes, labor movements, financial panics, and economic disruptions. Laissez-faire coincided with the emerging views of Social Darwinism, the idea that market competition establishes an economic meritocracy through unadulterated competition, rewarding winners and punishing losers. Americans responded to the Gilded Age with the era of progressivism, and critiques of the social and economic situation, such as Thorstein Veblen’s best seller The Theory of the Leisure Class. It turns out, upon closer inspection, that the time of big industry in America was never really about laissez-faire. It was not about leaving the economy alone, it was about government support of enterprise through economic intervention, in the form of high protective tariffs and taxes on imports, open immigration policies for maintaining a surplus of labor for low wages, state suppression of labor movements and strikes, patent protection, allowance of collusion and monopoly, land grants and subsidies to incentivize railroad construction and other internal improvements (Stoler). This last example is something I covered in more detail in the article, The American Railroads and the Panic of 1873:
“The financing needs of the railroads were also subsidized by the federal government. The precedent for federal involvement in transportation projects originates from legislation in 1802 that allocated 5% of the receipts from government land sales to finance public road construction (Atack, Passell 435). The government assisted the railroads, especially the transcontinental ones, with massive land grants. This allowed the railroads to finance construction from the proceeds of preferential real estate deals. The mortgage market was more developed than bond and equity markets at this time, so land grants were a useful way to obtain capital when returns from actual operation were years away. Between 1851 and 1871 the railroads received 131 million acres in free land (Atack, Passell 436). The justification for this massive government involvement in the economy was the social benefit that increased commerce would bring to the entire nation. For the Union Pacific alone the private return on investment was 11.6% while the social return was 29.9%, on average, in the years 1870 to 1879 (Atack, Passell 435). Other benefits, that are harder to measure, accrued to the public, such as rapid postage delivery and the increase in national security with the ability to transport large numbers of troops and cargo from one side of the continent to the other.” (Endicott)
The laissez-faire interpretation of the Constitution was a precedent set by the Supreme Court in the late 19th Century, a legal philosophy that lasted until President Franklin D. Roosevelt and the New Deal. I’ve encountered some conservatives and libertarians who believe that the 1930s Supreme Court reversed a precedent that had been in effect since the founding, with FDR upsetting America’s traditional political economy of strict non-intervention. As I have pointed out already, there never was such a time in American history, and although the Supreme Court did pass rulings during an era when they interpreted an austere theory of political economy into the Constitution, this only lasted from about 1880 to 1937.
The Supreme Court precedent that the public interest needed to be weighed against private interests was articulated at least as early as 1837 in the case of Proprietors of Charles River Bridge v. Proprietors of Warren Bridge, in which chief Justice Roger Taney wrote, “[w]hile the rights of private property are sacredly guarded, we must not forget that the community also have rights, and that the happiness and well-being of every citizen depends on their faithful preservation.” (Charles River Bridge) In 1877 the Supreme Court had yet to subscribe to the doctrine of laissez-faire. In the case of Munn v. Illinois, a majority on the Court upheld an Illinois law that regulated the grain storage business, by setting the industries prices at the behest of farmers. In this 7-2 decision, Chief Justice Morrison Waite claimed, “[p]roperty does become clothed with a public interest when used in a manner to make it of public consequence and affect the community at large. When, therefore, one devotes his property to a use in which the public has an interest, he, in effect, grants to the public an interest in that use, and must submit to be controlled by the public for the common good, to the extent of the interest he has thus created. He may withdraw his grant by discontinuing the use, but, so long as he maintains the use, he must submit to the control.” (Munn) This interpretation of constitutional provision brought a response from Justice Field who countered, “[t]he principle upon which the opinion of the majority proceeds is, in my judgment, subversive of the rights of private property, heretofore believed to be protected by constitutional guaranties against legislative interference, and is in conflict with the authorities cited in its support.” (Munn) The ruling in Munn created the impetus behind the formation of the Bar Association, an organization with the sole purpose of overturning this precedent (Finn).
The police powers doctrine indicates that states have the authority to pass and enforce laws that “regulate the health, safety, welfare, and morals of the community” (Finn). This doctrine derives from the Tenth Amendment, which reads, “The powers not delegated to the United States by the Constitution, nor prohibited by it to the States, are reserved to the States respectively, or to the people.” (U.S. Constitution) The federal government has additional jurisdiction over the regulation of interstate commerce, and ability to pass all necessary and proper laws toward that end. However, with a laissez-faire theory of the Constitution, the government needs extremely compelling reasons to abridge property rights and the liberty of contract. The Fourteenth Amendment’s Due Process Clause, that “[n]o State shall make or enforce any law which shall…deprive any person of life, liberty, or property, without due process of law,” (U.S. Constitution) afforded Court activists an opportunity to infer a broad liberty right that contravened state government’s police powers and the federal government’s power over commerce. This was the now defunct theory of Economic Due Process.
By 1880 the Supreme Court had become stocked with corporate lawyers after the appointments by Presidents Grover Cleveland and Benjamin Harrison. Chief Justice Melville Fuller consented with the majority in Chicago, Milwaukee, & St. Paul Railway v. Minnesota, finding that The Due Process Clause of the Fourteenth Amendment had been violated when Minnesota allowed a regulatory agency to set railroad rates. The majority opinion was written by Justice Blatchford, and set a precedent of judicial activism and Economic Due Process, “The question of the reasonableness of a rate of charge for transportation by a railroad company, involving, as it does, the element of reasonableness both as regards the company and as regards the public, is eminently a question for judicial investigation, requiring due process of law for its determination.” (Chicago) Justice Bradley wrote a dissent recognizing the problematic rejection of the earlier precedent set in Munn. A laissez-faire interpretation of the Constitution was not the norm before the Gilded Age, but it would come to dominate for some time.
The year 1895 brought three landmark cases in the realm of economics. In United States v. E. C. Knight Company, the Supreme Court, in an 8-1 decision, limited the government’s power to regulate monopolies vie the Sherman Anti-Trust Act. E.C. Knight Company’s virtual monopoly on the U.S. sugar trade was allowed to stand on the grounds that regulation of manufacture was not included in the power to regulate commerce, that commerce was subsequent to manufacture, never mind that the monopoly interest involved the shipment of sugar for ultimate sale across state lines. In Pollock v. Farmers’ Loan and Trust Company the Justices, in a closer 5-4 split, ruled that income taxes on interest, dividends, and rents were unconstitutional per the requirement that direct taxes be apportioned equally to the states. This gutted the Income Tax Act of 1894, but led to the adoption of the Sixteenth Amendment in 1913 which exempted income taxes from the apportionment constraint. The 1894 Pullman Strike, led by President of the American Railway Union Eugene Debs, was presented with a Federal injunction to cease the strike and return to work. Debs violated the injunction and appealed to the Supreme Court. In a unanimous decision the Court ruled that the injunction would remain based on the government’s commerce power and authority to promote the general welfare (Irons). So the same year that the Court said the government could not regulate a monopoly on sugar they also said that the government could break a strike. Taken together the laissez-faire principle appears to evaporate, leaving a legal system unbalanced in favor of big business.
In the landmark 1905 case Lochner v. New York the Supreme Court struck down a New York statute that regulated the working conditions of bakers, including the maximum weekly hours that they could be employed. The right to protect the health of its workers was justification for the regulation under the state’s police power. In a close and controversial 5-4 decision the Court found that the law violated the liberty of contract, a fundamental right that could not be abridged by the state’s concerns over worker health. Justice Peckham, writing for the majority, claimed that “[t]he general right to make a contract in relation to his business is part of the liberty protected by the Fourteenth Amendment, and this includes the right to purchase and sell labor, except as controlled by the State in the legitimate exercise of its police power…there is no reasonable ground, on the score of health, for interfering with the liberty of the person or the right of free contract…[n]or can a law limiting such hours be justified a[s] a health law…is not a legitimate exercise of the police power of the State, but an unreasonable, unnecessary and arbitrary interference with the right and liberty of the individual to contract in relation to labor, and, as such, it is in conflict with, and void under, the Federal Constitution.” This ruling represented a precedent for striking down economic regulations as unconstitutional under the doctrine of Economic Due Process and a new substantive interpretation of a liberty of contract implied by the Fourteenth Amendment.
There were two strong dissents written by Justice Harlan and Justice Holmes. Justice Harlan argued that the state interest at stake was not given its due weight, that the liberty of contract was not an absolute right free from regulation. The dissent from the celebrated Justice Oliver Wendell Holmes was very pointed. I want to elevate this dissent over Justice Peckham’s majority opinion in Lochner, because Holmes properly recognized the poorly thought out doctrine of Economic Due Process, and his sentiments are more reflective of our modern understanding of the Constitution. Holmes contended:
“This case is decided upon an economic theory which a large part of the country does not entertain. If it were a question whether I agreed with that theory, I should desire to study it further and long before making up my mind. But I do not conceive that to be my duty, because I strongly believe that my agreement or disagreement has nothing to do with the right of a majority to embody their opinions in law. It is settled by various decisions of this court that state constitutions and state laws may regulate life in many ways which we, as legislators, might think as injudicious, or, if you like, as tyrannical, as this, and which, equally with this, interfere with the liberty to contract…. The Fourteenth Amendment does not enact Mr. Herbert Spencer’s Social Statics…. [A] constitution is not intended to embody a particular economic theory, whether of paternalism and the organic relation of the citizen to the State or of laissez faire. It is made for people of fundamentally differing views, and the accident of our finding certain opinions natural and familiar or novel and even shocking ought not to conclude our judgment upon the question whether statutes embodying them conflict with the Constitution of the United States…. I think that the word liberty in the Fourteenth Amendment is perverted when it is held to prevent the natural outcome of a dominant opinion…” (Holmes Lochner)
The Fourteenth Amendment, intended originally to protect former African American slaves from racist State governments, was erroneously used to establish a completely unintended precedent of Economic Due Process and liberty of contract in America until 1937. The New Deal agenda being championed by President Franklin D. Roosevelt dealt directly with economic regulation, and in his first term the Court struck down signature legislation. Roosevelt then devised a controversial plan to pack the Court with new appointments if current Justices would not retire by a certain age. The Court packing plan was never realized, the two moderates on the Court flipped sides to reverse the Lochner precedent in West Coast Hotel v. Parish (1937), restoring the earlier precedent from Munn, and this removed the political impetus for expanding the Court’s bench. Roosevelt got many chances to appoint new Justices after that, and the Court naturally evolved away from the laissez-faire precedent, awoke from the laissez-faire fantasy.
The Lochner case is infamous to modern constitutional and legal scholars, as much of an historical embarrassment to the Supreme Court as Dred Scott v. Sanford (1857) and Plessy v. Fergusen (1896) are. It became a verb, to Lochnerize, which is the act of a Justice substituting his own judgment for that of the legislature, the ultimate sin on Constitutional interpretation (Finn). Today this is called “legislating from the bench.” The Constitution is not a laissez-faire document, no matter how much someone wants it to be, such as former Presidential candidate Ron Paul. The Fourteenth Amendment was not written in order to establish the liberty of contract. These notions are not in the text, nor in the intention of the text, rather they were projected into the Constitution by Justices who favored a particular economic theory. A return to laissez-faire legal doctrine needs a new Amendment to be legitimate.
To sum up my own sentiments on laissez-faire, I will employ two of my favorite quotes in economics. This first comes from Leon Walras in the 19th century, the founder of the Lausanne School of Economics, one of the early proponents of Marginalist explanations in value theory, contributed the notion of a circular flow in macroeconomics, the first economist to employ mathematical rigor to economic problems, and a major inspiration to Joseph Schumpeter. Walras once said, “laissez-faire is an economics that can be taught to a parrot in the morning using morsels of sugar.” (The Vision of Leon Walras) Lord John Maynard Keynes, the controversial founder of Keynesianism and depression economics said, “Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is past the ocean is flat again.” (John Maynard Keynes) The statements are not endorsements of socialism, but express my frustration with over simplistic imaginings of the marketplace.
Conclusion
As a moderate independent, with an education in economics and political science, I support capitalism and free enterprise, but I also desire things like national defense, public services, infrastructure investment, sensible regulations, and social insurance. The market is a wonderful institution, an American endeavor that cannot be separated from our great success as a nation. My arguments in this essay were not focused on the power of markets, or the benefits of free trade, these ideas do not need my defense right now, they are defended to a fault in America. Still, I want to be clear that I am not arguing against these things. What I want to demonstrate is that the history of American economic development was never a laissez-faire proposition. Federal taxes, national banks, protective tariffs, infrastructure investments, subsidies and bounties are not Socialist in origin, they are Hamiltonian. The closest America ever came to laissez-faire, were the elite decisions of a corporately stocked Supreme Court, which showed deference to big business, and disrespected the public interest in economic matters.
President Obama is not trying to take our country down a path of Marxism, a ridiculous straw man that conservatives love to hate. Read my article The Evolution of Terror in Peru: Conquest, Communism, and Cocaine if you want to understand what the attempt at real Marxist revolution looks like. The President is making an impassioned case for buttressing our “unbelievable American system,” affording it the resources it needs to promote opportunities for a greater number of citizens through progressive taxation. Obama desires to endow the country with internal improvement, investments in infrastructure, education, physical and human capital, science and research, and to promote infant industries such as the green energy sector. This is not the vision of Karl Marx, but that of America’s first Treasury Secretary Alexander Hamilton. A strategy called the American System and the American Way by its supporters in the 19th Century, such as House Speaker Henry Clay. I feel that President Barack Obama has a better vision for America’s economic future than Mitt Romney, who I believe would cede the public interest in economic matters to the machinations of big business, an unsurprising sentiment from a corporate executive, but a poor treatment of government’s role.
America is an amazing country, the most powerful engine of wealth in the history of the world. It is a truism that this could not have happened without the enterprising free spirits of America’s rugged and industrious individuals, yet it is also true that proactive government policy and support for the public good in economic matters cannot be unwound from this success either. The vision of Hamilton was in actuality implemented in America’s early years, sustained throughout the inappropriately named era of laissez-faire, and the regulation of commerce, including support for the working man, and was reintroduced into the normal functioning of American political economy since the New Deal. Whether you agree with the modern liberal economic philosophy, or not, does not change the fact that it is deeply rooted in the American tradition. After all, Welfare State Capitalism in America did not spring from Marxist philosophy, but originated from a dialectic of Jeffersonian ends met through Hamiltonian means, as articulated in 1909 by progressive Herbert Croley, founder of the New Republic Magazine (Herbert Croley). Just as President Obama is not a foreigner by birth, his economic philosophy is not foreign to America. I believe that when we demean President Obama’s economic vision, we demean the historical and traditional foundations of this greater country, this unbelievable American system.
Jared Roy Endicott
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