The Decline and Fall of Economic Freedom

How the Supreme Court reversed itself on economic regulation.

As hard as it may be for the present generation to envision, there was a period in our history when the US Supreme Court was a leading opponent of social and economic regulation. This was the era, between 1897 and 1937, of "economic due process." The Fifth and Fourteenth Amendments specified that neither the federal government nor any state shall deprive any person "of life, liberty, or property, without due process of law." And the justices interpreted these prohibitions to mean that government could not, except in specified or extraordinary circumstances, prevent individuals or corporations from freely engaging in the production and distribution of goods and services.

If economic freedom is to be limited, maintained the Court, Congress and the state legislatures must carry the burden of justifying such regulation, much as they are now required to do when they pass laws restricting freedom of expression. In the belief that the framers of the original Constitution and of relevant amendments sought to protect economic activity from government restraint, the justices struck down a considerable amount of economic and social legislation.

In 1934, however, the Court began to change direction, relaxing the high standards by which it had measured arguments seeking to justify such legislation. Three cases—challenging limitations on entry into business and on the setting of prices and wages—illustrate the trend. The thinking of the justices who stood in the path of economic regulation would soon be found only in the Court's dissenting opinions; deference to legislative "wisdom" eventually carried the day.

In 1932, in New State Ice Co. v. Liebmann, the Supreme Court stood firmly on its interpretation of constitutional guarantees of free economic activity, but a lengthy dissent foreshadowed the shape of things to come. The New State Ice Co. case concerned a 1925 Oklahoma statute declaring that the manufacture of ice for sale and distribution is a "public business" requiring a certificate of public convenience and necessity from the Oklahoma Corporation Commission. (Under such a requirement, a firm wishing to enter into a business must prove that its proposed service will benefit the public and is not already being adequately provided by another firm.)

Liebmann commenced construction of an ice plant without applying for a certificate; New State, an established firm, sued to enjoin his operation. Liebmann won in both the federal district and appeals courts. New State appealed to the US Supreme Court, where two philosophical opponents squared off: Justice George Sutherland for the majority of six, and Justice Louis D. Brandeis, long a champion of economic regulation, for the minority of two (one justice not participating).

The majority, applying the standards of economic due process, held that Oklahoma had not presented justification to warrant infringing Liebmann's liberty to enter the market. The ice business, wrote Sutherland, was not a "public business" (for which the Court had earlier sanctioned regulation) but was essentially as private in nature as most others on which the community is dependent. The practical effect of the restrictions was to shut out new enterprises and thus to foster monopoly.

The aim is not to encourage competition, but to prevent it; not to regulate the business, but to preclude persons from engaging in it.…There is nothing in the product that we can perceive on which to rest a distinction, in respect of this attempted control, from other products in common use which enter into free competition, subject, of course to reasonable regulations prescribed for the protection of the public and applied with appropriate impartiality.

Sutherland was willing to accept some regulation when public health and safety were concerned—but not the restrictions embodied in the challenged statute. And he rejected Oklahoma's suggestion that it should be allowed to experiment to ascertain the desirability of the law: "There are certain essentials of liberty with which the state is not entitled to dispense in the interest of experiments."

Brandeis's lengthy dissent, which outweighed (31 versus 10 pages) and outpointed (55 versus no footnotes) his opponent's, constitutes an engaging explanation of the regulatory process. Those who want to learn about the rationale for airline or trucking regulation will find few better sources.

Brandeis was not concerned that competition would be eliminated. He contended that conditions of natural monopoly prevailed in the ice-making business, that it was therefore not subject to economic competition, that "the relative ease and cheapness with which an ice plant may be constructed exposes the industry to destructive and frequently ruinous competition."

But the notion that competition among ice producers would result in a single monopolistic firm had no basis in fact. Eight plants then existed in Oklahoma City and Tulsa, capable of producing daily more than 200 tons of ice for sale. Brandeis seemed oblivious to a phenomenon evident in many industries. Competitive industries are frequently highly fluid, with companies constantly entering and leaving. The most efficient survive; and with the passage of time, relative stability often results. Bars on entry into an industry protect companies from competitive forces that operate to restrain price increases and reduce inefficiency. Whatever monopolistic tendencies were present in Oklahoma ice making were perhaps not attributable solely to marketplace dynamics but to the 17 years of limited regulation that had preceded the 1925 statute. (In communities in which a company enjoyed a "virtual monopoly" of the ice business, the Corporation Commission had fixed or approved prices, required "equitable distribution," and stipulated business and sanitary practices. Such regulation could well inhibit investment.)

Brandeis conceded that regulation might promote monopoly. But if so, he argued, its results would be economically beneficial and legally harmless:

Where, as here, there is reasonable ground for the legislative conclusion that in order to secure a necessary service at reasonable rates, it may be necessary to curtail the right to enter the calling, it is, in my opinion, consistent with the due process clause to do so, whatever the nature of the business.

Despite the extensiveness of his inquiry, Brandeis did not question the legislature's conclusion that regulation would provide greater service at more reasonable rates. At the time he wrote, the country had little experience with economic regulation, and theory had to substitute for practice. Theory argued that regulation would stabilize the industry by limiting competition and would provide services that the market does not offer. Generally, however, only the first objective can be realized; cost considerations tend to limit the second.

When New State Ice Co. arose, competition among ice producers was very keen in some areas of the state and limited or nonexistent in others. While Oklahoma could reduce competition, the state could not demand that the ice makers serve the entire population, for the expense involved would be too great. They would be required to sell only within designated areas, probably not much larger than the areas previously served by the unregulated market. Consumers in those areas would have to pay a greater than competitive price because competition was restricted, and they would also be charged for the cost of expanding services.

The ice industry favored regulation—a fact which Brandeis marshaled in support of his arguments. He might have done better to include, among the authorities he consulted, Adam Smith, who had long before warned about support for regulation from this sector:

To widen the market and to narrow the competition, is always the interest of the dealers. To widen the market may frequently be agreeable enough to the interest of the public, but to narrow the competition must always be against it. The proposal of any new law or regulation of commerce which comes from this order, ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention.

Considering the Oklahoma statute in the light of present understanding, one would have to conclude that most of its beneficiaries would be wealthy companies and individuals; consumers and prospective entrants would be disadvantaged, and neither public health nor safety would be augmented. Given the narrow rewards of the statute, the state had little reason to deny Liebmann a liberty basic to a private enterprise society.

Brandeis wrote his New State Ice Co. dissent during the Depression, and his comments reflect a disillusionment with economic competition characteristic of the time. To him, the law seemed neither arbitrary nor unreasonable and therefore, he argued, not unconstitutional. His remark, however, that "the reasonableness of every regulation is dependent upon the relevant facts" suggests that, had he better comprehended the consequences of the Oklahoma statute, he might have voted with the majority.

Within two years of the New State Ice Co. case, the Depression-inspired anti-competition pressures that influenced Brandeis's dissent prevailed. The barrier of economic due process, so long held in place by the Supreme Court, began to crumble.

During 1931 and 1932, milk prices in New York declined drastically, to a point below the cost of production. Amid farmers' strikes and violence, the state legislature conducted an investigation and adopted a statute establishing a milk control board to regulate the industry and set prices at the retail level. The legislation was tailored to satisfy the large milk dealers and farm representatives; largely unrepresented in the legislative hearings and conferences were proprietors of small retail stores.

Nebbia, who owned a small store in Rochester, was convicted of selling two bottles of milk and a loaf of bread for eighteen cents, thus undercutting the fixed price of nine cents per quart. When Nebbia v. New York reached the US Supreme Court in 1934, the justices, in a 5-to-4 decision, upheld his conviction against a challenge that the setting of minimum milk prices violated the seller's rights under the Fourteenth Amendment's due process clause.

Rejecting the standard that had previously applied, the majority, through Justice Owen J. Roberts, held that the due process guarantee demands only that the law not be unreasonable or arbitrary and that it have a substantial relation to the legislature's objective. The justices repudiated the Court's long-standing position that legislation could be exempted from the requirements of economic due process only when it pertained to businesses affected with a public interest. The new rule called for much more limited scrutiny of legislative action in economic matters. Without probing the effectiveness of the law, the majority ruled, that under existing circumstances, it was not unreasonable for New York to enact legislation that deprived Nebbia of the liberty to sell milk at a price of his own choosing.

The dissenters totally rejected this standard of review. Justice James C. McReynolds, writing the minority opinion, contended that the only question was whether justification existed—either because of emergency conditions or because of the public nature of the industry in question—for depriving Nebbia of his rights under the Fourteenth Amendment. He found no such justification. The milk industry was a private calling not affected with a public interest.

As to the presence of an emergency whose magnitude justified the law, the legislative findings and report should not be deemed conclusive: "Are federal rights subject to extinction by reports of committees? Heretofore they have not been." In fact, argued McReynolds,

The exigency is of the kind which inevitably arises when one set of men continue to produce more than all others can buy. The distressing result to the producer followed his ill-advised but voluntary efforts. Similar situations occur in almost every business. If here we have an emergency sufficient to empower the Legislature to fix sales prices, then whenever there is too much or too little of an essential thing—whether of milk or grain or pork or coal or shoes or clothes—constitutional provisions may be declared inoperative.

Even had there been an emergency, said McReynolds, the means proposed would not achieve the legislative purpose—to increase farmers' income. Economic analysis tends to support him. While the precise impact of fixing minimum prices depends on the severity of the controls and the responsiveness of demand to prices, increasing prices is likely to cause a reduction in consumption, thereby exacerbating, not alleviating, the producers' woes. The farmers had nothing to gain by this restraint on Nebbia's liberty.

It was primarily the large retailers who supported the setting of minimum prices. Their existence was threatened by price cutting, they claimed, and if they were forced out of business, milk distribution would be disastrously impaired, to the serious detriment of milk producers. Such assertions are difficult to accept, for these are inevitable risks in a competitive society, which has generally demonstrated its ability to withstand them. In any case, the fact that changes in economic conditions may affect entrepreneurs differently does not usually justify preserving the existence or profits of those adversely affected.

For legislation that would compound rather than relieve the problem of excessive production, the public was being forced to assume a heavy burden, noted Justice McReynolds:

To him with less than nine cents it says—You cannot procure a quart of milk from the grocer although he is anxious to accept what you can pay and the demands of your household are urgent! A superabundance; but no child can purchase from a willing storekeeper below the figure appointed by three men at headquarters!

McReynolds concluded:

The Legislature cannot lawfully destroy guaranteed rights of one man with the prime purpose of enriching another, even if for the moment, this may seem advantageous to the public. The ultimate welfare of the producer, like that of every class, requires dominance of the Constitution. And zealously to uphold this in all its parts is the highest duty entrusted to the courts.

The Nebbia case had all the trappings of radical drama: powerful interests, depression, exploitation, excessive milk prices, and criminal sanctions. McReynolds's opinion ably speaks to these issues: "A superabundance: but no child can purchase from a willing storekeeper below the figure appointed by three men at headquarters!" Still, it has received no recognition from those who condemn economic due process as a wicked tool of laissez-faire capitalism. Surely McReynolds's dissent would have been described as powerful, eloquent, and moving in a setting more to the liking of the critics. His prose is scarcely in keeping with the image of old-guard reactionaries and those who tread on the rights of the masses. And it should be very provocative: Why have so many legal commentators and historians missed the point of economic due process?

If Nebbia signaled the approaching end of economic due process, West Coast Hotel v. Parrish, decided by the Supreme Court in 1937, marks its formal termination. Employing the Nebbia standard, the 5-to-4 majority determined that a Washington state statute establishing minimum wages for women and minors was a reasonable exercise of legislative discretion.

They thus overruled a 1923 decision, Adkins v. Children's Hospital, in which the 5-to-3 majority, per Justice Sutherland, had held unconstitutional a similar congressional statute for the District of Columbia. Sutherland had used the old standard, that only exceptional circumstances warrant abridgment of freedom of contract, and he found none. He had rejected the position that women require restrictions that could not lawfully be imposed on men under similar circumstances. And to the contention that the law would serve the public interest, Sutherland had replied eloquently:

To sustain the individual freedom of action contemplated by the Constitution, is not to strike down the common good but to exalt it; for surely the good of society as a whole cannot be better served than by the preservation against arbitrary restraint of the liberties of its constituent members.

Were an appropriate challenge to be instituted at this time against a law establishing a minimum wage for women, the primary legal issue would be whether the statutory classification by sex meets the equal protection requirements of the Fifth and Fourteenth Amendments. To withstand constitutional attack, the Court has held, classification by sex must serve "important governmental objectives and must be substantially related to the achievement of those objectives." In the light of this recent terminology, the present Court, were it ruling on the matter for the first time, probably would agree with the result in Adkins and not with that in Parrish.

Contemporary economic understanding, too, would support such a ruling. Laws that elevate the minimum wage above market will elevate some workers' pay, but they also will cause employers to fire or not to hire workers, thus creating and maintaining unemployment. Studies published in recent years conclude that general wage minimums have reduced employment for the marginally employed, those who would otherwise earn lower wages. Limiting such a law to women will not therefore achieve the legislative end of improving their condition because it will reduce the level of their employment. Moreover, as Justice Butler observed in a 1936 opinion upholding Adkins, "prescribing of minimum wages for women alone would unreasonably restrain them in competition with men and tend arbitrarily to deprive them of employment and a fair chance to find work."

Special working conditions for women have not always been advocated solely for their protection. In a book published in 1905, Florence Kelley, head of the National Consumers League, concluded:

In many cases, men who saw their own occupations threatened by unwelcome competitors, demanded restrictions upon the hours of work of those competitors for the purpose of rendering women less desirable as employees. In other cases, men who wished reduced hours of work for themselves, which the courts denied them, obtained the desired statutory reduction by the indirect method of restrictions upon the hours of labor of the women and children whose work interlocked with their own.

Many feminists in the 1920s decried such legislation as another instance of the paternalism that for centuries had "protected" and harmed them. The Women's Party had filed a brief in Adkins urging the Court to strike down the Washington, D.C., law. An odd coalition of radical feminists and libertarian-conservative justices triumphed, for a short time and in a small area, over the combined forces of liberals and unions. Today, equal rights advocates appear to agree that laws limiting a woman's hours and types of work act to narrow her employment opportunities, one of her most important liberties.

Indeed, the comments of Chief Justice Charles E. Hughes in the Parrish decision stand the the concept of liberty on its head:

The liberty safeguarded is liberty in a social organization which requires the protection of law against the evils which menace the health, safety, morals and welfare of the people. Liberty under the Constitution is thus necessarily subject to the restraints of due process, and regulation which is reasonable in relation to its subject and is adopted in the interests of the community is due process.

These remarks are at variance with a fundamental idea of our society, that the State's power over people is limited. American constitutional tradition—and, as we have seen, much contemporary economic understanding—supports instead Sutherland's opinion, in Adkins, that "the good of society as a whole cannot be better served than by the preservation against arbitrary restraint of the liberties of its constituent members."

Bernard H. Siegan is a professor of law at the University of San Diego School of Law. This article is adapted from Economic Liberties and the Constitution, just published by the University of Chicago Press. Copyright © 1980 by Bernard H. Siegan