The Gains from Improved Market Efficiency: Trade Before and After the Transatlantic Telegraph

This paper looks at the gains from improved market efficiency in long-distance grain trade in the second half of the 19th century when violations of the law of one price were reduced due to improved information transmission. Two markets, a major export centre, Chicago, and a major importer, Liverpool, are analyzed. We show that there was a law of one price equilibrium throughout the period but that markets displayed spells of demand- or supply-constrained trade when the law of one price was violated. Over time adjustments back to equilibrium, as measured by the half-life of a shock, become faster, violations of the law of one price become smaller and hence less persistent. There were also significant gains from improved market efficiency but that improvement took place after the information ‘regime’ shifted from pre-telegraphic communication to a regime with swift transmission of information in an era which developed a sophisticated commercial press and telegraphic communication. Improved market efficiency probably stimulated trade more than falling transport costs.