The First Industrial Revolution: a Puzzle for Growth Economists

Nick Crafts and Larry Neal

The Holy Grail

• To explain the sustained acceleration in economic growth in Britain during the Industrial Revolution

• The Good News: the explicandum is better described

• The Bad News: endogenous growth theory does not yet have a persuasive model that fits the facts

British Industrial Revolution

• Modest growth

• Escape from ‘Malthusian Trap’

• Large structural change

• No take-off but TFP growth increases significantly

Growth in Britain (% per year)

1780-1801 1801-31 1831-73

GDP 1.3 1.9 2.4

Population 1.0 1.4 1.2

Industry 2.0 2.8 3.2

TFP 0.1 0.4 0.8

Malthusian Model Crafts & Mills (2007)

LogW = α - βLogPop + ρt

Trend growth of W is zero till 1800 while ‘Iron Law’ of wages allows population growth at ρ/β =0.5% pre-1800, = 2% post-1800 based on higher ρ

English population in 1800 was 3 x 1550 population but no sign of positive feedback from population to technological progress

The key feature of the industrial revolution is the dog that didn’t bark – rapid population growth was sustained without a collapse in real wages

Employment Composition (%)

1760 1800 1840

Agriculture 52.8 40.8 28.6

Industry 23.8 29.5 47.3

Urbanization 21.0 33.9 48.3

Agricultural/Total Employment at British 1840 Income Level (%)

Belgium 44.4

Britain 22.2

France 44.1

Germany 39.9

Italy 55.4

Netherlands 37.4

Family to Capitalist Farming

• Disappearance of small farms

• Release of surplus labour

• Promotes industrialization

• ‘Explains’ British divergence from ‘European Norm’

Simulated 1841 EconomyCrafts & Harley (2004)

Actual 2/3

Peasant

Agricultural Output 100 105

Industrial Output 100 69

Agricultural Employment (%) 22 47

Industrial Employment (%) 41 28

Institutions, Theory

• “Rules of the game” set incentives and constraints for “play” by economic agents.

• “Winners” become incumbents, resist institutional change

• “Losers” adapt, exit, or revolt

Institutions are persistent

• New rules emerge in response to external shocks; they do not evolve gradually

• New institutions are conditioned by adaptations of past losers

• New institutions are fragile; reversals are typical. Legitimacy is hard to establish

Institutions Matter

• Modern economic growth associated with modern institutions:

nation statesecularismconstitutional governmentextension of the franchise

Institutions Matter

• Issue of causality confounded by advantages of backwardness for followers, who can:

substitute capital skip learning stagesadopt most advanced technologyimport capital, skills, institutions

Slow TFP Growth

• Uneven technological progress

• Slow incremental improvements and diffusion of well-known inventions, e.g. steam power

• Disincentives to innovative activity

• Confirmed by growth of wages (Clark, 2005)

TFP Growth

• Much slower and less pervasive than ‘old-hat view’ believed

• Sustained acceleration from 2nd quarter of 19th century indicates new era of growth

• Note the (delayed) impact of steam

Source: Crafts (2003): includes railway, steamships, steam engines

Total Steam Contribution to Growth of Labour Productivity (% per year)

0

0.05

0.1

0.15

0.2

0.25

0.3

0.35

0.4

0.45

1760-1800 1800-30 1830-50 1850-70 1870-1910

1780-1860: Ingenuity or Abstention ?Crafts (2004b)

• TFP growth accounted for less than 30% of GDP growth

• TFP growth accounted for 70% of labour productivity growth

• TFP growth and new varieties of capital goods accounted for 87% of labour productivity growth

Sources of Labour Productivity Growth, 1780-1860 (Crafts, 2005) (% per year)

Capital Deepening 0.22

Modernized Sectors 0.12

Agriculture -0.03

Other 0.13

TFP 0.56

Modernized Sectors 0.34

Agriculture 0.19

Other 0.03

Labour Productivity Growth 0.78

Why Was Britain First ?

• Timing of acceleration in TFP growth much harder to explain than structural change

• Search but success not guaranteed

• Inventions and market demand

• The Peso Problem

• Macro-inventions

• NEG and agglomerations

Endogenous Innovation Models

• Expected technological progress is faster if

appropriability of returns improves

productivity of R & D inputs goes up

markets get bigger

Endogenous GrowthSchumpeter relationship (high λ)

Schumpeter (low λ)

Solow (high s)

Solow steady-state relationship (low s)

x

k^

Growth Potential

• In later 18th century quite probable that growth potential higher in Britain than in France or 16th_century Britain (cf. Crafts, 1995)

• Britain better at micro-inventions but what does that tell us about the ex-ante probability of making the decisive inventions in cotton and getting ahead in the key sector ?

Implications for Unified Growth Theory

• Industrial revolution is more than a scale effect of bigger population (cf. Kremer, 1993)

• Period of sustained demographic pressure is prolonged and escape from Malthusian Trap involves substantial increase in TFP growth (cf. Galor & Weil, 2000)

• Understanding the acceleration of technological progress is central; the ‘national innovation system’ (cf Mokyr, 2002) not the size of the population is the heart of the matter

Role of Markets: Land, Labor, Capital, Entrepreneurs

• Markets allocate resources more efficiently than alternative methods: Command economies

Custom in traditional economies

• Hicks’ dilemma:Command is usual response to shocksCustom emerges in absence of shocks

Role of Finance: Mobilize Resources

• Hicks’ resolution of dilemma:European invention of city-states governed by merchant elites committed to maintenance of markets

• Neal’s resolution of dilemma:Governments that use debt markets to respond to shocks committed to use labor and capital markets as well

Tales of Two Institutions

Tales of Two InstitutionsBritish National Debt, 1694-1815

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Market Value

Tales of Two Revolutions

• Bordo-White compare UK & France during Napoleonic Wars

• UK wins, despite flexible exchange rates, fiat currency, and tax shocks.Why? Credible commitment for debt

• France loses, despite fixed exchange rates, and balanced budget.Why? Napoleon’s defeat in Russia.

Neal’s Tale of Two Revolutions

• Capital flight initiated by French revolution elimination of feudal rights

• Capital fled to merchant centers throughout Europe, using private trade credit circuits

• British war finance resumes on 18th c. model, fails with fall of Amsterdam, leads to paper pound

Neal’s Tale of French Revolution

• Flexible exchange rate of pound “locks in” foreign capital in London’s capital market

• Continental Blockade destroys UK system of war finance, as intended

• Napoleon’s capital levies throughout conquered Europe increase flight capital to London

Tale of Two Revolutions

• France: establishes property rights, rule of law, constitutional monarchy, and funded government debt by end of 1815.

• New institutions constantly under threat and revised periodically through 1871.

• Lesson: Institutions matter, but hard to legitimate and incorporate in new setting

Tale of Two Revolutions• Great Britain: switches capital formation to

capital goods industry, reducing relative cost of capital permanently (cf. Hicks)

• Key to success is arms-length financial markets maintained by government throughout conflicts with France

• Postwar settlement difficult: Corn Laws, repatriation of capital, de-mobilization,

• TFP resumes rise by 1830, accelerates after 1850