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The Silent Revolution: Analyzing the Impact of the Telegraph on US Market Structure

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Department of Economics

University of Victoria

ECON 327: Economic History of North American

Dr. Alan Chaffe

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Abstract

This paper uses the Technical Efficiency/Agency Efficiency model to analyze why the telegraph

affected some industries differently than others in 19th century America. Before the introduction

of the telegraph, the US markets were inefficient and had poor information flow which made

integration rare. The telegraph was a revolutionary invention that reduced information costs and

expanded economies of scale. With the introduction of the telegraph some industries became

more competitive and others became more consolidated. The model presented shows that

whether an industry became more consolidated or more competitive depended on the level of

asset-specificity in the market. As examples, this paper uses the model to explain why wheat

became more competitive while meatpacking became more consolidated. The general framework

presented can be applied to the majority of the industries in the time period.

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The Silent Revolution: Analyzing the Impact of the Telegraph on US Market Structure

The transportation revolution has long been cited as the principal cause of economic

growth in mid 19th century America, and while significant, it often overshadows another major

innovation. The invention of the telegraph transformed the very fabric of the US economy and

made coordination and communication possible at a higher level than ever before. This “silent

revolution” impacted almost every industry in the US economy. It expanded markets and sparked

waves of industry consolidation. The paradoxical nature of the telegraph may be one of the

reasons it is often skimmed over in studies of economic history. In some industries, it spurred an

increase in competition, in others it led to mass consolidation. The Technical Efficiency/Agency

Efficiency model provides a simple framework to analyze the impact of the telegraph on the

market structure of industries in the 19th century US economy.

This paper will first analyze the condition of US markets before the telegraph and give a

brief narrative of its invention. Next, the paper will explore the telegraph’s paradoxical impacts

under the lens of the Technical Efficiency/Agency Efficiency model. Finally, the paper will

show how this model can be applied to various industries to explain why they responded

differently to the introduction of the telegraph.

Market Structures Before the Telegraph

To fully appreciate the impact of the telegraph, it is important to understand the state of

the economy before its introduction. In general, it was characterized by small family firms

operating in regional markets. Farmers sold most of their produce to local merchants and

shopkeepers. The story of an Iowa merchant demonstrates the inefficiencies of this economy.

John Burrows was a merchant who bought and sold potatoes. Based on the news that prices in

New Orleans were a high $2/bushel, John travelled there to sell his 2,500 bushels. Along the

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way, he was offered $0.50/bushel but turned it down in hopes of higher prices. Unfortunately,

John found upon arriving in New Orleans that the market had been saturated by other merchants.

John eventually sold the potatoes in exchange for coffee to a Bermuda ship captain for only

$0.08/bushel (Cronon, 1991). This story demonstrates the problem of poor communications

technology in the pre-telegraph economy. It was not irregular for merchants to travel long

distances based on uncertain prices.

Although in 1840 the economy remained primarily agricultural, with over 63% of the

labour force on farms, change was occurring rapidly. The proportion of the labour force in

manufacturing, though still at the low end of 9%, had tripled since 1810 (Boff, 1980). Urban

growth occurred in the same time frame, with an increased clustering into city sub-districts.

Although pre-industrial, the economy was ready for a change. As Boff (1980) states,

“The logic of business expansion was prodding firms to reach out for larger markets… [but this]

behaviour was constrained by the costs of establishing wider ranges of commercial contact” (p.

460). Despite the demand, the infrastructure in place was insufficient. In-land transportation was

slow and costly, done primarily on dirt roads. Communication relied on horse and stagecoaches.

This meant it took almost as long to send a message as it did to ship goods. The economy was

ready for the communication revolution.

The Invention of the Telegraph

While the transportation revolution of the mid 19th century has been widely documented,

the parallel communication revolution has received less notice. The invention of the railroad has

overshadowed the telegraph despite the fact that the benefits of one were only realized because

of the other. Although the railroad made it possible to ship goods quickly across the United

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States, the levels of coordination needed for production on a nationwide scale would not have

been possible without the telegraph (Boff, 1980).

Chadler (2002) presents a compelling timeline of the rapid movements in the telegraph

industry. In 1844, the communication revolution started with Congress granting Samuel Morse

$30,000 to build an experimental telegraph line from Washington to Baltimore. This initiative

was a success, and the government passed the responsibility of further development onto the Post

Office in 1845. Due to financing issues in the next years, the projects were turned over to private

developers. This shift helped to expand the industry, and by 1852 23,000 miles had been laid.

Although the industry had low barriers to entry (due to minimal capital outlays), other factors led

to a consolidation. The firms quickly found there were significant returns to coordination, and

worked out cooperative arrangements to send messages across each other’s lines. This greatly

expanded their reach. In August 1857, the six leading telegraph companies signed a treaty that

divided the nation into six regions, but even this division posed problems and the industry soon

consolidated into three companies. Finally, in 1866, the three merged into the Western Union,

making it the first multi-union modern business enterprise in the US.

The example of the telegraph industry demonstrates a shift to monopolization that is

counter-intuitive for those well-versed in basic economic theory. The industry had low barriers to

entry and a business climate characterized by the free flow of information. Despite this, the

industry moved from a competitive market to a monopoly. Similar behaviour was mirrored by

many other industries. Now that the history has been presented, this paper will introduce some

relevant economic principles that can be used to explain why this occurred.

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Economic Principles of Market Structures and Integration

To fully understand the impact of the telegraph on US industries, the reader must have a

basic knowledge of the factors that lead to industry consolidation. For the non-technical reader,

this presentation will be relatively general, with little reliance on mathematical formulas and

equations.

Yates (1986) applied market structure principles in her analysis of the telegraph. She

explained how industries with high asset specificity and complex product descriptions are more

likely to become integrated. Yates also discussed the trade-offs between the organizational forms

of the efficient market and integrated firms, citing high production costs and vulnerability costs

as characteristics of firms, and high coordination costs as characteristics of the market. This

analysis can be simplified using the Technical Efficiency/Agency Efficiency Trade-off model

described by Besanko, Dranove, Shanley, & Schaefer (2016).

The Technical Efficiency/Agency Efficiency model describes the trade-offs of

integration. Technical efficiency is a firm’s ability to minimize production costs. Agency

efficiency is a firm’s ability to minimize coordination and transaction costs. In general, markets

have higher technical efficiency and integrated firms have higher agency efficiency. To

determine whether firms will integrate, one must examine this trade-off. As Yates (1986)

described, the result of the trade-off ultimately depends on asset specificity.

Figure 1 collects this information into three curves. ΔT represents the minimum cost of

production by integrated firms minus the minimum cost of production in the market. ΔA

represents the minimum transaction costs for integrated firms minus the minimum transaction

costs in the market. ΔC is the sum of ΔT and ΔA and represents the cost difference between

integrated firms and the efficient market. When ΔC is positive the costs of integrated firms are

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higher than the costs of the market and the market will prevail. When ΔC is negative, the costs of

integration are less than the costs of the market and integration will occur. ΔT and ΔA both fall

as asset specificity rises, increasing the appeal of integration. This model shows that whether an

industry will be characterized by integrated firms or a competitive market depends on asset

specificity.

The Impacts of the Telegraph

The telegraph enabled near instantaneous communication unlike anything seen before.

This technological breakthrough made both markets and integrated firms more efficient. Favoring

markets, the telegraph brought dramatic reductions in intermarket price differentials, information

costs, and transaction costs (Yates, 1986). This ushered in an era of near-perfect information.

Although this reduction in coordination costs also benefited integrated firms, it had a

proportionally greater effect on communication-intensive markets. Favouring integrated firms, the

Figure 1. Technical Efficiency/Agency Efficiency Model

Source: Besanko, Dranove, Shanley, & Schaefer (2016)

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telegraph helped to expand market areas, creating economies of scale that allowed firms to

drastically decrease production costs.

Since these two effects are opposing, it is initially unclear how the telegraph would affect

the market structure of an industry. We can use the Technical Efficiency/Agency Efficiency

model to identify which change is more significant. Since the telegraph changed communication

and production costs, the ΔT and ΔA curves will both shift. To examine the final impact, one

could look at an industry’s Technical and Agency Efficiency before and after the telegraph. A

simplified interpretation of these changes is that the post-telegraph era was the first-time firms

could seriously consider integration. The ability of an integrated firm to coordinate its operations

before the telegraph was near impossible, resulting in a ΔC so large it would almost never fall

below zero. This interpretation falls in line with Boff’s (1980) claim that “it makes little sense to

state that the telegraph ‘improved’ communication: one may as well contend that electricity

moves faster than railroads and horses” (p. 461). Under this simplification, we can make the

judgement that the more asset specific the industry, the more likely consolidation would occur. A

further study could calculate actual changes in the Technical and Agency Efficiency to determine

the extent of integration, but this would require significant data on the costs in each industry. In

this paper, we will adhere to the simplified analysis and show how it can be applied to two key

industries.

Industries that Remained Competitive: Wheat

By applying the presented model, the astute reader will recognize that the wheat industry,

with low asset specificity, had more to gain from the market-positive effects of the telegraph.

This means the telegraph would increase competitiveness in this industry. In the Technical

Efficiency/Agency Efficiency model, the wheat industry would be at a point to the left of k**

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where the costs of integrated firms are higher than the cost of the market. Whereas in the

example presented by John Burrows there was considerable uncertainty around prices, the

telegraph gave traders throughout the country knowledge of the prevailing market prices. A

uniform grading system made it possible for buyers to distinguish quality (Yates, 1986).

Although local events used to be the primary influencers of prices, national and international

shocks became the driving factors. If local shocks forced up prices in one region, merchants

would go elsewhere. This would effectively decrease the demand and bring the regional price

back in-line with the market. The result was a nearly perfectly competitive market, with many

buyers and sellers and little differentiation between the goods.

Industries that Consolidated: Meat Packing

The meatpacking industry is an excellent example of how the telegraph impacted

industries with higher asset specificity. Although meat became considerably undifferentiated

with the introduction of a standardized grading system, its perishability made it time specific. If

the movement of a meat shipment was interrupted it could spoil. In our model, this is

characterized by a low ΔA curve, as the market was a very inefficient means to coordinate

complex movements. Yates (1986) stated that “[t]he telegraph ultimately played a significant

role in coordinating the integrated meat packing companies and, we can assume, in coordinating

any time specific product” (p. 160). The industry ultimately consolidated into a few major

players such as Swift and Armour. In the Technical Efficiency/Agency Efficiency model, this

industry would be at a point to the right of k** where the costs of integrated firms are lower than

the cost of the market. Given that Swift and Armour spent over $200,000 on telegraphic

communication a year, the importance of the telegraph for this industry was undeniable

(Chandler, 2002).

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This application of the Technical Efficiency/Agency Efficiency model for the wheat and

meatpacking industries can be repeated to understand the impact of the telegraph on the many

industries of the 19th century US economy. This model helps simplify the seemingly paradoxical

effects of the telegraph.

Conclusion

The telegraph was one of the most influential innovations of its time. It rapidly changed

the majority of the industries in the US economy with the introduction of near instantaneous

communication. While expanding markets and reducing communication barriers, it’s effect on

US market structure ultimately depends on the industry in question. The Technical

Efficiency/Agency Efficiency Model can be applied to help understand its seemingly paradoxical

impacts. For future research, there is a need for a data-driven analysis of the telegraphs impact on

GDP, economic growth, and market structure using metrics like the Herfindahl’s index to

quantify the analysis in this paper. It is time that the silent communication revolution gets the

attention it deserves, and that the confusion surrounding the telegraph’s impact on market

structure is dispelled with simple economic analysis.

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References

Besanko, D., Dranove, D., Shanley, M., & Schaefer, M. (2016). Economics of strategy.

Hoboken, NJ: Wiley.

Boff, R. B. (1980). demand and the development of the telegraph in the United

States, 1844–1860. History Review, 54, 459-479.

Chandler, A. D. (2002). The visible hand: The managerial revolution in American business.

Cambridge, MA: Belknap Press.

Cronon, W. (1991). Nature’s metropolis: Chicago and the great west. New York,

NY: Norton.

Network effects. (2009, December 19). The Economist. Retrieved from

http://www.economist.com/node/15108618.

Yates, J. (1986). The telegraph’s effect on nineteenth century markets and firms. and

Economic History, 15, 149-163.

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