Lecture 6

A New View of the Industrial Revolution – and the Conditions for

Sustained Economic Leadership

Was there an Industrial Revolution in Britain?

• Recent research in economic history says No, but…

• The classical period of the I R 1780-1830 was ’…a period of incubation in which the groundwork to future growth was laid’ (Joel Mokyr) meaning that

• Intellectual and institutional preconditions were created

Old school view

• The Industrial Revolution marked a radical break with the past

• Low or insignificant growth rates were replaced by substantially higher rates in many (all?) sectors

• A large number of sectors became part of the modern economy

• Science became increasingly important as a source of technological change

New view

• Growth rates were (just a little) higher than in the past but initially only moderately higher

• The modern sector was limited to a few initially small dynamic sectors, such as the cotton industry

• Water mills remained an important energy source in industry

• Science played a minor role in the advancement of technological knowledge until mid 19th century but the knowledge-base increased

• Innovations relied on skilled workers and mechanics

Old (Deane & Cole) and new view compared

Why do new and old estimates differ?

• It’s the index number problem, stupid• We need to estimate the growth in constant

prices• To do so we need quantities of goods produced

and prices • Choice of base year affects results • Fast growing sectors usually experience falling

relative prices• As a consequence early base year implies

higher growth than later base year

Cotton and beer

• Cotton grows from 10 to 100 units between 1770 to 1800

• Beer from 25 to 50 units• Cotton price falls from 1 to 0.5• Beer price is constant at 1• Increase in output in 1770 prices is 150/35

=4.3 times• Increase in output in 1800 prices is 100/30

=3.3 times

Lock at panel b for the British case!

Modern sector grows as a fraction of total industry

• Deane and Cole first estimated growth rates of individual sectors

• To aggregate to national income you also need sector weights, that is the relative value added of different sectors of total value added

• Using end of period year weights, say 1801 or 1831, will generate higher growth rates than using 1770 sectoral weights, because fast growing sectors increase their share in total value added, see panel a

A beer and cotton sector example

• Assume the cotton industry output increases by 150 percent between 1780 and 1830 and that beer output increases by 75 percent.

• Assume furthermore that the weight of cotton in total output is 30 per cent in 1780 and 75 percent in 1830.

• With 1830 sector weights total output grows with

0.75*150 +0.25*75 = 131 per cent, but with 1780 weights only by 97 per cent (0.3*150 + 0.7*75)

And now to the Angus Maddison text

• Angus Maddison is a Scottish economic historian at Groningen and former OECD economist who has devoted his life to establish comparative historical national accounts.

• His work is very useful as a source in studies of why growth rate differs among nations and over time.

The meaning of economic leadership

• Economic leadership is defined by GDP per man-hour or GDP per employed (including self-employed)

• The basis for leadership is relative technological sophistication, that is high productivity, high capital/labour ratios, human capital formation, and good government and institutions

• Leadership is hard to attain but easily lost

The First Modern Economy- The Dutch Republic (Netherlands)

• Markets for commodities and factors of production, no bonded, un-free labour.

• Well defined property rights including intellectual• Financial innovations, discounting of bills,

served trade and industry• Good government, once free from the

Habsburgs (c.1600)• Religious tolerance attracted immigrants with

(human) capital• Mentalities were marked by the urge of rational

use of labour, knowledge and resources

Land scarcity was solved by land reclamation

A 18th century model economy

Contemporary observers from all over Europe, and Britain in particular, looked at the Dutch republic as the economy to imitate.

But it was the institutions and technologies which stand out – because the Dutch Republic was not richly endowed with resources.

It has been called ‘the industrious revolution’(Jan de Vries)

Skilled Dutch workers were very mobile diffusing the knowledge in other parts of Europe

Why did the Netherlands decline?

• Monopolistic profits in trade could not be maintained. British navy ruled the seas by the end of 18th century.

• The manufacturing sector had high wage costs, and downward rigidity of nominal wages and other production costs despite increasing international competition.

• Innovative activity declined as witnessed by falling patent applications.

Patent applications took the wrong turn

Britain takes the lead

Why Britain?

UK:s income lead was eroded by slow growth

And why did Britain not keep its industrial leadership?

• Low domestic investments in human and physical capital

• Low total factor productivity growth

• Relatively high interest rates were hurting manufacturing but service sector did well

• Financial institutions might have neglected profit opportunities in new technologies? (compare previous lecture)

UK investments ratios do not catch up until after WWII

The dynamic disadvantage of an Empire

• UK had favourable access to colonies and dominions

• Most of the empire was composed of low income economies with weak demand for sophisticated new products

• British industry was not compelled to enter into new fast growing product industries

• UK Export/Import ratio low (high) in dynamic (traditional) new sectors (= R.C.A)

Revealed comparative advantage

Growth rates of capital stock and TFP are correlated

Is leadership always associated with a small agrarian sector?

• This relationship holds strictly only in a closed economy

• US had a large agricultural sector when it gained leadership and was a net exporter

• US agriculture had high output per worker because land resources were abundant

• Labour shortage stimulated mechanization in agriculture

• Agriculture has experienced as high or higher TFP growth as the industrial sector

KGP:s mantra

• It is not what you do

•but how you do it, that matters

Agriculture vs. industry

Britain replaced Netherlands and then US stepped in as leading economy

Why US took and kept the leading position

• Hight investments and high productivity growth

• High spending on education (human capital)

• Large homogenous market made it possible for industry to exploit economies of scale by standardized (similar) products

• Labour shortage directed innovations to labour saving technologies

Few secrets in economic leadership

• In next table a sample of nations are ranked relative to US performance

• For example, the number 80 for UK in Educational level means that UK educational level is 80 per cent of the US

• US lead in all indicators except trade and modernity of capital stock, but scale and trade are substitutes

Scale of the economy matters a lot!

But scale and trade are substitutes

• Small economies must trade more to reap the economies of scale and exploit comparative advantages

• As a consequence trade/GDP ratios are much higher for small economies (and as a rule in favour of free trade)

• US had an advantage of a huge market where consumer preferences were homogenous permitting gains from domestic scale economies (and protectionist forces were/are stronger)

Modern growth relies on the three K:s

• High investment in

• ’Das human Kapital’

• K, that is non-residential capital

• Knowledge, that is Research and Development

Conclusion: the keys to success

• The historical record suggests• High investments in capital, human capital and Research

and Development• Resource endowments of greater importance in the past

when transport costs were high enough to impede trade• Trade is a substitute to large size of the domestic

economy which is why small nations are often more inclined to free trade than large

• Good government and appropriate institutions (contracts are honoured, markets for goods and factors of production, low corruption)