Chicago

An economic history

John F. McDonald

• Publisher: Routledge
• Year: 2015
• Print ISBN: 9780367873660
• eBook ISBN: 9781317418818
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

Chicago went from nothing in 1830 to become the second-largest city in the nation in 1900, while the Midwest developed to become one of the world's foremost urban areas. This book is an economic history of the Chicago metropolitan area from the 1820s to the present. It examines the city in its Midwestern region and compares it to the other major cities of the North. This book uses theories of the economics of location and other economic models to explain much of Chicago's history.

Chicago maintained its status as the second-largest city through the first decades of the 20th century, but rapid growth shifted to the Sunbelt following World War II. Since the 1950s the city's history can be divided into four distinct periods; growth with suburbanization (1950-1970), absence of growth, continued suburbanization, and central city crisis (1970-1990), rebound in the 1990s, and financial crisis and deep recession after 2000. Through it all Chicago has maintained its position as the economic capital of the Midwest. The book is a synthesis of available literature and public data, and stands as an example of using economics to understand much of the history of Chicago.

This book is intended for the college classroom, urban scholars, and for those interested in the history of one of world's foremost urban areas.

1 Some useful economic models in prose

DOI: 10.4324/9781315687667-1

Introduction: Chicago as an economic phenomenon

This book is an economic history of Chicago. Cities have been formed for a variety of reasons—civic, defensive, cultural, economic, and so on. In my view Chicago can be considered to be primarily an economic phenomenon. The actors involved had economic motives. The recent death of the Nobel Prize economist Gary Becker reminds us of the economic approach to human behavior (1976), which consists of maximizing behavior, market equilibrium, and stable preferences. Maximizing behavior means that firms try to maximize profits (given the limits of technology and market opportunities) and consumers try to maximize their satisfaction given their money and time resources. Government actors are more complicated, but often act to provide public goods and services that provide economic benefit. Market equilibrium means that markets exist to coordinate the actions of the various participants. And stable preferences mean that economists do not explain economic changes by tautologically saying that tastes changed. For example, the long-run development of an economy is considered to be a function of the creation of new products and services and changes in production technology, and these innovations are often in response to perceived economic benefit.

This chapter is an introduction to the economic models pertaining to urban areas that are used in this book to explain the economic history of Chicago. Each model is a different version of the economic approach to human behavior as outlined above. The chapter also is an introduction to how economists think. I do not imagine that all readers will become conversant with all of the models in this chapter upon first reading. That is not a problem. Keep reading the book. The models will come up again, and you will recognize when they do. You may wish to refer back to this chapter now and then. All of the models are presented in prose form, but one model is supplemented by an equation (which can be skipped). The discussion of each model in this chapter includes an example of the model as applied to the economic history of Chicago.

The rest of the book (Chapters 2 through 8) divides the history of Chicago into discreet time periods. Each of these chapters makes use of some of the economic models presented in this chapter. The choices of the models utilized in a particular chapter are my judgment about the models that can help to explain best the most important economic outcomes in that time period. The models are not being subjected to formal empirical tests. Rather, evidence is provided to show that the economic outcomes for Chicago corresponded to implications of the model. Also, along the way, some historical events and facts about Chicago are included that are not necessarily important for an economic model.

Transportation costs

Throughout the book it is presumed that firms and households are motivated by transportation costs, which involve both time and money (and time is money, as they say). The period covered by the book includes all of the major changes in transportation technology that have occurred since the early 1800s. Chicago went from the horse and wagon era to the canal era to the railroad era to the internal combustion era to the airplane era. And it is not just these changes in the technology of moving people and freight that matter. The telegraph, telephone, radio, television, and internet are changes in the method for transmitting information that had great impact. These changes in transportation technology and costs shaped economic growth and economic geography. Transportation has always been at the heart of the Chicago economy and is the primary theme in Chapter 2 on nineteenth-century Chicago.

Consider the simplest model of where to locate production activity. Suppose that a firm uses one resource located at one location and provides its output to the market at another location. The firm has to pay the transportation cost for either shipping the input to the market (locating production at the market), or shipping the output to the market (locating production at the site of the resource), or locating somewhere in between. The model says that the choice of location is made to minimize transportation costs. If only one mode of transportation is needed so that either the input or the output can be shipped directly, then the answer is to locate at the market or at the site of the resource—not in between. Why? Either shipping input or output is cheaper per mile, so the firm chooses the cheaper option for the entire distance. Goods produced at the market are called “market oriented,” and goods produced at the site of the resource are called “resource oriented.”

Here is a simple example. Suppose your firm supplies firewood to people in the city by cutting down trees in the north woods. Do you ship the trees or the firewood? Shipping is done by truck. Where do you cut the trees into firewood? The answer is—cut the trees into firewood at the forest because shipping firewood is much easier, neater, and cheaper than shipping trees.

What if you cannot use the same mode of transportation to move your input or output? You are a firm that buys wheat from farmers in farm country to be consumed as flour in the city. But the transportation route requires moving freight over land (by railroad, let us say) and then over water (by ship). Where do you locate the plant that turns wheat into flour—in farm country, in the city, or at the point where the freight must be moved from train to ship? Each of these is a possibility depending on the transportation costs of shipping wheat and flour, and on any economies of scale in the production of flour. The place where freight is moved from train to ship is called a transshipment point. Chicago was and is a big transshipment point—one of the very biggest. One solution is to load wheat on trains as the train moves through farm country, and then build a large flour mill at the transshipment point (hello General Mills in Minneapolis). The initial solution in Chicago was to move wheat by train to Chicago and to transport the wheat by ship from Chicago’s huge grain elevators—after the wheat had been sorted into quality grades.

What if your customers are located in a number of locations? Assume here that your input is found anywhere, so you are not resource oriented. Your job is to produce output somewhere and distribute it to your customers. As it happens, if at least 50.1 percent of your customers are located in one place, you produce at that location and ship the other 49.9 percent of your output from there. This is the Principle of Median Location. You locate next to your median customer. You find the median customer in terms of location, and locate production next to that customer. Consider any other location. If you move away from the median customer you can at best get closer to less than half of your customers and farther away from more than half of your customers. Here is a very simple example. Suppose you must schedule a face-to-face meeting for seven people, and four of them are located in one place. You choose to meet where these four are located to minimize transportation costs (assuming all have the same cost of transportation). If one of the people is the boss, and this person is not one of the four, then the meeting may have to be where the boss is located. You might say, “… but, but consider transportation costs.” Maybe not.

Here is an important example that combines some of these location principles. Cronon (1991) provided data to show that half of the customers of the lumber companies in Chicago in the latter half of the nineteenth century were located in the Chicago urban area, and the other half were located around the Midwest. Raw lumber (not trees) was transported from the north woods to Chicago down Lake Michigan by ship, and then turned into usable lumber by the companies in Chicago. From there lumber was delivered to customers outside of Chicago by rail.

Now consider another more realistic example. Suppose that your customers are along three rail lines (north, west, and south) that all meet at a central point. You have a few customers at the central point, but the rest of the customers are along those three lines. You locate production at the central point because any other location along one of the three rail lines would mean higher transportation costs. Chicago is that central point, the major node in the transportation system. Economic historian Louis Cain (1985) has emphasized the importance of the creation of Chicago as the most prominent transportation node in the Midwest prior to the Civil War.

Here is a recent example. The largest mail sorting facility operated by the U.S. Postal Service is located in Chicago. Mail is transported in from a wide area around the Midwest, is sorted, and shipped out to the rest of the world. Likewise, mail from the rest of the world comes to Chicago, is sorted, and shipped out to destinations in that wide area around the Midwest.

As a final example, suppose that you must assemble several bulky inputs, and that they are shipped by different modes of transportation. Consider the basic steel industry, which must assemble iron ore, coal, and limestone. Iron ore comes from the Mesabi Range in Minnesota (discovered in 1866) and is moved by ship, while coal and limestone come by rail. The Chicago urban area (including Gary, Indiana) became the nation’s largest producer of basic steel in the early twentieth century. The southern end of Lake Michigan was the point at which the three inputs could be assembled most cheaply—iron ore from Minnesota, anthracite coal from Pennsylvania (by rail), and limestone from Indiana and other more local sources (by rail). Indeed, Gary was founded in 1906 on an empty beach and a town was built expressly for the purpose of producing steel.

Economic base: Export and local goods

An urban area prospers by providing goods and services to people and firms located outside the urban area—export goods. I do not mean only goods exported to other countries, but all goods and services sent outside the urban area for which payment is received. Export goods provide employment (wages) and profits for the urban area, and the money earned is spent on goods and services produced locally and on goods and services imported from outside the urban area. A great deal of that money is spent on local goods such as housing, haircuts, medical care, restaurant meals, and so on. Other goods such as foodstuffs and many manufactured goods primarily are imported. An urban economy can pump itself up by expanding exports, or by replacing imports with goods and services produced locally. This is the urban version of the basic Keynesian model of the multiplier. Exports earn money, which turns into more income for the urban economy as local goods are produced and sold.

This simple idea is well understood by the general public—perhaps too well. You have all seen the TV reporter who is reporting on a plant closing down. The reporter goes across the street to ask the bar owner what will happen, and the bar owner says that business will drop. Of course. Plant closings are bad news for a local economy. Local merchants lose business, unemployment rises, property values fall, and so on. All of this is not really “news.” The fact that Chicago was heavily dependent on manufacturing exports in the 1920s meant that the depression of the 1930s had an impact on Chicago that was larger than in many other local economies. On the other side of the coin, the positive multiplier effects of expanding exports often are exaggerated. Urban economies are called “open” economies because exports and imports are large in relation to total income. A big propensity to import from an increase in income limits the local multiplier effect. A basic rule of thumb is that an expansion of exports of $100 may produce about an additional $50 in local income. In other words, the local multiplier effect is about 1.5, not four or five.

Drivers of regional and urban growth: Then and now

Exports drive the regional and urban economy, but what determines the demand for exports? And what determines the ability to supply exports? Growth in the demand for exports from a particular urban area depends upon economic growth in the areas within the “economic reach” of that urban area, and upon the ability of the urban area to expand its economic reach. Chicago of the last half of the nineteenth century benefited greatly from both factors. The Midwest was growing rapidly, and Chicago’s ability to supply goods to a wide area was created by its becoming the railroad capital.

On the supply side, the ability of an urban area (or any economy) to respond to the demand for exports depends upon:

• availability of critical natural resources,
• private capital,
• public capital (infrastructure),
• labor quantity and quality,
• technical change,
• entrepreneurship, and
• agglomeration economies.

Natural resources provide basic inputs into production. Chicago was blessed by being located adjacent to a large area of fertile farmland, and other basic resources such as iron ore, lumber, and coal were nearby. Private capital directly provides the buildings and equipment needed for the production of goods and services, and public capital (infrastructure) provides the facilities that make the urban area function. Some of the public capital is provided by government (public buildings, streets and highways, water and sewer systems, ports, and so on), while other portions of the public capital are provided by private firms under license from the government (telephone, rail lines, electricity, etc.). Labor has both the quantity and quality dimensions. In the late nineteenth and early twentieth centuries, a time in which the economy of Chicago was dominated by manufacturing industry, the quantity of the labor force was critical. Immigrants were drawn to Chicago by the prospect of jobs that did not require much formal education. However, as time passed the quality of the labor force in terms of formal education became more and more important. Indeed, numerous studies of the growth of urban areas in the U.S. after 1980 show that the one variable that consistently emerges as an important factor in growth over a decade is the percentage of the adult population with college degrees at the beginning of the decade.

Technical change in the economic sense means innovation—new products, changes in production methods that reduce costs, and changes in products that make them better for the user. New products and new methods make for Schumpeter’s “wave of creative destruction.” But assembling the capital and the labor force, and taking advantage of new products or methods, requires entrepreneurship. Chicago’s entrepreneurs are legendary—McCormick, Ward, Armour, Pullman, and the many who came after. Chapter 8 includes a more detailed discussion of the modern model of innovation and economic growth as it pertains to metropolitan areas and metropolitan Chicago in particular.

The last factor on the list—agglomeration economies—requires some explanation. The general idea of agglomeration economies is that more economic activity in one location makes for higher productivity (lower costs). This can happen within an individual industry or group of related industries, an effect called localization economies. Alfred Marshall (1920, p. 225) famously wrote:

When an industry has thus chosen a locality for itself, it is likely to stay there long: so great are the advantages which people following the same skilled trade get from near neighborhood to one another. The mysteries of the trade become no mysteries; but are as it were in the air, and children learn many of them unconsciously. Good work is rightly appreciated, inventions and improvements in machinery, in process and the general organization of the business, have their merits promptly discussed: if one man starts a new idea, it is taken up by others and combined with suggestions of their own; and thus it becomes the sources of further new ideas. And presently subsidiary trades grow up in the neighborhood, supplying it with implements and materials, organizing its traffic, and in many ways conducing to the economy of its material.

Agglomeration economies can also exist at the level of the entire urban area—urbanization economies. An urban area becomes the railroad capital, with many lines going in every possible direction. This system redounds to the benefit of every business in the urban area. An urban area contains a large and diverse population, which means that businesses can recruit workers from a large and deep labor market pool.

Urban economists have devoted a great deal of effort to document the existence of localization and urbanization economies. Industrial districts do generate benefits for individual firms. Innovation happens. The right workers can be found easily. Examples include: Silicon Valley in modern times, Detroit and the auto industry in the first decades of the twentieth century, and so on. Urban areas have tried to replicate these. But can the positive effects of industrial districts get reversed? Suppose an industrial district with some positive external features starts to decline. The demand for the particular products made there declines, foreign competition chips away at sales, technological change dictates a different location choice (one-story plants versus the old multi-story plants, for example), workers are required with different skills. Do the positive external effects of the industrial district start to decline, and does this accelerate the decline of the district itself? I think so, and we have seen this in the manufacturing sector in Chicago in roughly the last 40 years.

New technologies and shifts in the demand for goods and services have changed the list of important growth factors. In the nineteenth and early twentieth centuries it was the rail system, later it was the highway system, and now it includes the air transportation system and the internet backbone. Now it is not just quantity, but the quality of the labor force, and the education and training facilities. Now it is the ability to attract high-quality labor with an excellent “quality of life,” i.e. opportunities for education, recreation, and entertainment. Before it was good water and sewer systems and public transit (and it still is), but now it is also good cable TV service, internet service, wireless telephone service, air travel service, medical care, and so on. But the same basic list of supply factors still applies. The trick for the actors in the local economy is to figure out how to enhance those factors.

Congestion, network, and other externalities

Agglomeration economies produce benefits to firms or households for which no direct payment is made. Andreu Mas-Colell, Michael Whinston, and Jerry Green (1995, p. 352) provide a very general definition: “An externality is present whenever the well being of a consumer or the production possibilities of a firm are directly affected by the actions of another age...

Table of contents

• Cover Page
• Half Title Page
• Series
• Title Page
• Copyright Page
• Contents
• List of figures and tables
• Preface
• Introduction
• 1 Some useful economic models in prose
• 2 Chicago and the development of the Old Northwest
• 3 The second city 1900–1930
• 4 Depression and war
• 5 Chicago in 1950, and a look ahead
• 6 Postwar growth and suburbanization 1950–1970
• 7 The decades of urban crisis
• 8 The old century ends on a high note, and a new century begins
• References
• Index