45-855 Railroads, The First Big Business: Topic 3

3. How Business Was Conducted Before the Railroads
   
   
1. The Basics



1. Land Tenure and Private Property Rights – Why did the British North American colonies evolve into highly successful economies of ever rising real per capita wealth and those of Spain stagnate? The answer can be found in the work of Douglass North and Robert Thomas: The Rise of the Western World . A necessary (but perhaps not sufficient) condition for real long-run per-capita income growth is a system of private property rights and a system of enforcement of those rights. The English and their colonists became successful economically not because they spoke English or any inherent "superiority" of English culture, they succeeded because of a series of historical "accidents" that led to the development of private property rights in England. Without private property rights and the enforcement of those rights by government, people do not have the incentive to create surpluses or invent useful tools. People must be allowed to profit from their creations for society as whole to become better off.
   
   
1. Definition: Land Tenure. The manner in which, and the period for which, rights in land are held. Legally it is not the land you "own", it’s the bundle of rights in land that are yours. In the United States today the most common form of ownership is known as title in fee simple or fee simple title. This evolved from a medieval form of land tenure known as:
   
   
2. Free and Common Socage: The most important rights were (are):


1. It was perpetual
2. It could be inherited (under fee tail tenure the property reverted back to who you bought it from on your death!)
3. It could be passed to heirs in a Will. This was legalized by Henry VIII in 1540. Note that a Will in essence overrides primogenitor!
4. Obligations were fixed and certain. In other words, the Lord higher than you in the hierarchy could no longer show up and demand your military services for an indefinite period of time. You paid a fixed fee and were free of all other obligations to your Lord. This fixed fee was known as a quitrent which is what we now call a property tax.
5. Right to waste. You can "use up" the land – cut down the trees, dig the minerals out of the ground, etc. This right is now considerable circumscribed by government regulations.
6. Freely alienable. You could sell the land.
   
   
3. Since this was, for practical reasons, the only land tenure introduced into British North America, the result was that very early on land ownership and personal freedom became closely linked. Land became a commodity to be bought and sold for profit in contrast to a family estate that was kept for posterity. Indeed, one of the most important professions in the 17^th and 18^th Centuries in British North America was surveying. George Washington, for example, was a surveyor and a land speculator.
   
   
2. Market Overt and Fair Days – We take for granted the simple right to buy and sell things to each other whenever we want to. This is a relatively recent development historically. In the Middle Ages property could only be legally transferred from one person to another at a government sanctioned market (a market overt) under the supervision of a clerk of the market.
   
   
1. Market Overt – A legally sanctioned market. Certain towns were designated as market towns and certain days were designated as market or fair days (hence the origin of the county fair!).
   
   
2. Not surprisingly this system slowed down the pace of economic transactions! Consequently, the rising merchant classes pressed to expand the number of market overts and market days. By the 18^th Century all the shops in London were market overts and every day of the year was a market day.
   
   
3. By the end of the 17^th Century, by 1700, New England farmers were allowed to sell directly to customers on their farms. The vast physical expanse of the New World made such restrictions as market days impractical. Transactions had to take place wherever buyers and sellers met on the frontier.
   
   
4. Caveat Emptor – Latin for "let the buyer beware". In an open market, if the buyer had a fair chance to examine the goods, then the buyer assumed responsibility for the quality of the commodity once the property right in it had been transferred by sale. This is a widely misunderstood and misinterpreted concept in business history. Under Roman Law the seller was liable for all latent defects – an implied warranty in every contract of sale. Under English Common Law, the buyers could always sue sellers in civil courts for damages.
   
   
3. Police Power of Government – These powers are closely related to the old concept of clerk of the market. These mostly concern health and safety issues – regulation of food quality and so on. But they also cover the blue laws which regulated when businesses could be open (the most common restriction was a prohibition against doing business on Sundays).
   
   
2. Wholesalers and Retailers Before the Railroads
   
   
1. Suppose you are a dry goods dealer in Pittsburgh in the period before the railroads. Every six months you must travel to New York City to buy goods from wholesalers. You personally inspect the goods – caveat emptor – after which you could not (for the most part) complain. How did you pay for the goods? There was no national currency after 1836 save for gold and silver coins and there was no national bank. Consequently, you paid with some form of promissory note equal to the value of the goods purchased plus interest (reflecting the risk taken by the wholesaler that you might not be able to pay the note when it was due).
   
   
2. There are three means of payment available to merchants: barter, cash, and deferred payment. There are two means of deferred payment – letters obligatory which evolved into commercial paper and promissory notes, and bills of exchange.
   
   
1. Letters obligatory originated in the Dutch market center of Antwerp. Initially they were literally an IOU and were a written promise to pay an individual or company a certain amount of money on a future date. The amount was equal to the price of whatever was being purchased plus interest/risk factor.
   
   
2. These quickly evolved into an I.O. [Payable to Bearer] so they could be used in a 2^nd transaction. For example, I buy a good from person B and give him an IOPTB for the price of the good plus a premium. The IOPTB gives a date after which I am obligated to pay the face value of the IOPTB to the bearer of the note upon presentation. Person B can use my IOPTB to purchase a good from Person C but note that Person C will insist upon discounting the note to reflect the risk. That is, the face value of the IOPTB might be $1100 payable on 1 January 1825 but Person C will only sell Person B $1000 worth of goods in exchange for the good.
   
   
3. Eventually the IOPTB winds its way back to me and I pay the current bearer of the note. However, suppose I were to say to the bearer that I was bankrupt and could not pay! As a legal matter, in order to make this system work the government has to legalize endorsement. That is, Person B has to sign the back of the IOPTB when he passes it to Person C. His signature obligates him to repay Person C should I fail to pay the bearer of the note. This law is necessary so that IOPTBs can be freely used as money! By 1537 it became law in the Netherlands and it was still standard business practice in the 1800s (it survives to this day when you sign the back of a check you deposit into your checking account!).
   
   

4. Bills of Exchange – These are very similar to letters obligatory and were invented by the Italian traders around the 15^th Century. These were the medium of foreign exchange during the Colonial era. For example, a representative of a British tobacco merchant travels to the Chesapeake Bay region and buys tobacco directly from the planters. The factor buys the tobacco with a Sterling Bill of Exchange that is, in effect, a receipt for gold. Upon presentation at the merchant’s place of business in London, you were paid in gold on the spot.
   
   
5. These bills of exchange were the way international trade was financed because once the trading firm’s reputation was established, they were literally as good as gold. This quickly led to the development of deposit banking. Smaller merchants place funds on deposit with larger and more famous firms and in exchange for a small fee, were able to draw bills of exchange on the larger firm. This considerably increased the efficiency of trade.
   
   

3. The Banking and Financial System in the Early Railroad Period
   
   

1. In 1860, just before the outbreak of the Civil War, the U.S. banking system consisted of about 1500 State chartered banks. There was no national bank after 1836 and, aside from gold and silver coins, there was no national currency in the U.S. The only other circulating medium was state bank notes – paper money.
   
   

2. Suppose you owned a saw mill, business was good, and you wanted to expand production for which you needed some capital. What you did is go to your local bank and exchange a promissory note for say, $1000, for $950 worth of the bank’s notes (the discount rate is 5 percent in this example). You then used these notes to buy the goods and services you needed to expand the sawmill.
   
   
3. Note that as long as everyone accepts the bank notes, they are indistinguishable from modern paper money and perform the same task. Technically the bank notes were redeemable in specie but there was no way to prevent an unscrupulous bank from issuing loans in excess of its deposits.
   
   
4. The bank is creating money! Indeed, the sovereign and banks are the only institutions that issue (or create) money! Note that what makes this work is the belief by the holders of the bank notes that if they took the notes to the bank then they would receive specie (just is in modern banks, if you believe you could withdraw your deposits if you wanted to), then the system works.
   
   
5. Note that if there is slack in the economy, then these banking activities will create real growth. When the bank notes are injected into the local economy there is an increase in demand so there will be some inflation. But if there is slack, real growth results. For example, suppose you are a wagon/carriage maker and you and your workers have enough work to keep you busy 8-9 hours a day. Suddenly more people have money and want fancier carriages. What happens? Well, you can work 10-14 hours a day (depending upon available light). More carriages and wagons are produced. You make more money and your workers make more money.
   
   

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