Economic History.docx

7/27/2019 Economic History.docx

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5Outline for today

a) What are economic growth and economic development? b)Why is it useful to look at the past?(the rich were once poor, too) c) What drives economic growth? An exploration of factors of production,

technology, markets

6How to measure an economy

Gross Domestic Product (GDP; output): the size of an economy (total marketvalue added produced within a specific territory, e.g., Spain, during a period oftime)

GDP (output) per capita: the same, divided by the number of inhabitants proxy

for living standard (how much can we all consume? only if this increases we are

better off)

GDP (output) per worker (or per hour worked): a proxy for productivity (howmuch does everyone produce?) Market value added produced: Market value = valued with market prices; valueadded = intermediate products not double-counted; produced = not second hand) GDP includes all residents in a country. GNP includes all Nationals of a country,incl. those abroad.7

Real GDP and PPPs

If we compare countries, official exchangerates are not a good indicator for the pricedifferences between countries. Often, labour-

intensive non-traded goods (haircuts, bread)are cheaper in countries with lower wages;http://www.expatistan.com/cost-of-living/comparison/madrid/copenhagen We need to establish a common consumption basket and use the value of thisbasket in every country as exchange rates; the technical term is Purchasing Power

Parity (PPP) We say real because it indicates whether higher incomes really can buy morestuff, in other places and compared to the past (as with the 1990 Gheary-Khamisdollars).8

Economic growth, development, progress Economic growth is when (real) output increases, which might be because ofmore inputs (land, labour, capital, etc.) or because of their more efficient use To make sure that income increases for the average person (and not just becausethere are more people working) it is a good idea to measure economic growth inper capita (per head) terms Development is a wider concept which includes a structural and/ororganizational transformation of the economy (structural change, marketeconomy, etc.) Modern economic growth is then the (relatively) rapid, permanent and

continuous increase in productivity and living standards

If you think this is positive, you can call it progress


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Modern economic growth

It is not clear whether there was no substained increase in income before c. 1800(as Clark suggests) or slow, but steady growth since at least the 15th century,especially in Western Europe (Maddison and others, cant use Allen for that, he justhas labour income!)

This is because of data problems: GDP (per capita) can only be guesstimated forpast periods However, if we believe in these exercises, we have now on average a 10 to 16times higher income than our ancestors in 1700 or 1800 (and, if you are a labourerin London, 50 times what you need to just survive). So, on average we produce and can consume now 10 to 16 times more real stufflike food, clothing, housing, education, etc., than our ancestors in 1700 or 1800 (orbefore) But of course, we do not eat 22.5 kg of grain per day (that, is 50 times the Londoncheapest food according to Bob Allen).

But there is even more! If we account for innovations like air travel, television, internet, penicillin, etc.,the variety and quality of goods we can consume with an average income, is evenhigher Take the example of lighting (Nordhaus 1996): While it took the people paintingthe Altamira caves in 12000 BC 50 hours of work to collect the sticks (andflintstones) to generate 1000 lumen of light, and people in 1800 still had to work 5hours to pay the candles, in 1992 0.00012 hours were necessary to get nice electriclight (this is 1/417000 of the effort of the Altamira painters) this is not included inthe calculations of real GDP On the other hand, we might be able to buy 16 times more chairs, and even better

ones, but we do not enjoy 16 times more chair-sitting pleasure (diminishingmarginal utility).

Growth, development and possibilities

What we can measure are possibilities and capabilities, and there are somethings that might matter beyond GDP per capita and thus, consumptionpossibilities One of them is literacy, because it allows to access education, which enhances thepossibilities of self- development (what you can do in life) Another is life expectancy, because if you can expect to live a longer life than youwould have in 1800, you have more time to explore your possibilities These three are included in the so-called Human Development Index (HDI)elaborated by the United Nations Development Programme

Some countries are poorer than othersHDI from Human Development Report for 2010, graph from Wikipedia Greenerand darker meens more human development. Red and dark, less

Gaps in income and development The country with the highest HDI (Norway) had in 2012 (data link) a GDP/cap. of 48,688 2005-US$ a live expectancy of 81.3 years

a literacy rate of nearly 100% and12.6 years of schooling per adult


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Niger had (data link) a GDP/cap. of 701 USD a live expectancy of 55.1 years a literacy rate of 28.7% and 1.4years of schooling per adult

According to Angus Maddison, Spain in 1820 had a GDP/cap. of ca. 1595 2005international PPP US$, Norway 1359 US$ and Niger maybe 500 (DR Congo wouldeven be below that today).

18Over time

Differences are getting bigger, not smaller Difference in income per capita between UK and India in1500 was maybe 30 % (1.3:1). Difference between poorest and richest country in 1960 was 30 to 1 In 1990 it was 70 to 1 (the ratio of Norway to Zimbabwe today is 69:1, Norway toDR Congo (319$) is 153:1). Most countries that are rich today, were already rich in 1800 or even 1500

(Western Europe). Japan, first, then East Asia, and now China and India becameand are becoming exceptions.19

Why are some nations rich and others poor?

Easily speaking: because they produce more stuff per head - which means, they have higher productivity perworker, probably because of the most advanced stuff they produce with the most

advanced technology have higher literacy rates - which should be the result of a better educationalsystem enable their population to live longer lives - because of better nutrition, healthcare systems, sanitary conditions and/or disease environments But why is this, and why is it that the poor arent rich? That s what this course isabout!

Production factors, technology, markets

Demographic behaviorEducationLABOR Inputs LANDBLACK BOXOUTPUTCAPITALAVAILABLE TECHNOLOGIES

Labour (and Land)

Thats us everyone who produces Until c. 11,000 BC that is for 99% of human history humans were nomadichunter-gatherers, that means collected or killed the resources of a large plot of

land (c. 8-200 km2 per head, depending on climate)


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In the neolithic revolution man started to become a food producer (agriculture

and livestock breeding); until at least the 17th Century (in most cases muchlonger) the vast majority of humans worked in agriculture Changes in the number of people (due to higher or lower birth or death rates)affect the resources (land!) per person, and therefore their productivity

Different composition of the population (age distribution, life expectancy andactivity rate) are also important

Human capital (education)

Is the sacrifice of consumption today to increase production in the future, so itsan investment. It depends on the costs and benefits to be obtained; skill-premium and subjectivediscount rate: if life expectancy is low, a year of education might mean much moreforgone earnings (and hence be more expensive) than if life expectancy is high Also referred to as labour quality Does not only include formal education (schooling), but also other factors, fromhealth via experience to learning by doing and other informal ways of study23

Physical capital

Is the sacrifice of consumption today to increase production in the future(another investment) It can be savings (in money) or production time invested to make tools, etc.yourself (not so common today) Again it depends on cost and benefits Includes formally buildings, non-residential capital(machines, tools, other equipment) and inventory stock

Technological change often is transmitted by renewing the stock of capital (e.g.,use of better machines) Residential capital (and also land) became less important as history moved on,equipment becomes more important

Technological progress

Is everything that increases the productivity of the other factors of production(land, labour, capital) It is not only (better) machines, but also better organization of the production

process, more effient institutions governing production, and also betterorganization of markets It is the only factor that allows for long run economic growth (intensive growthvs. extensive growth, which is more output just because of more inputs) In the short-term, we can take tastes, institutions and technologies as constant,but in the long run (economic history!) they become the major variables

The production possibility frontier

Technological progress allows to produce more of both goods with the sameamount of resources. That is why some (e.g.,Mokyr) call it a free lunch.27

Outward movement of the frontier


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Extensive growth and the law of diminishing returns

If we increase the quantity of each factor of production by a some number ofunits, the total output increases less then the increase in inputs.

Technological progress allows to escape the law of diminishing returns an

increase in the quantities of inputs leads to a more than proportional increase in

output Without technological and institutional innovations a society stops to develop,might decrease income per capita, etc.

So, what does ultimately determine economic growth?

An obvious candidate is the number (and importance) of inventions andinnovations, which leads to better techniques of production Today, this mainly depends on investment in research and development, that isscience and its application, and in general the education of the population But in the past (until maybe 1850), the most important inventions (like the

mouldboard plough, wind and water mills, blast furnaces, steam engine, thespinning jenny) were invented not by scientists, but through trial-and-error The Greek and the Romans produced few technological progress, but had a lot oftheoretical knowledge The Middle Ages introduced many new technologies, but are seen as the Dark

Ages for human knowledge So, there might be something behind the innovative capacity of a society...

So, what does ultimately determine economic growth?

Culture, values and institutions

System of shared beliefs, values, customs, behaviours, that the members of a

society use to cope with the world and with one another and that are transmittedgeneration through generation. They serve to integrate a society, they provide elements of continuity and

stability, without which societies would disintegrate, but may also serve asbarriers to change One example might be religion, others are specific values or forms oforganization We may call this more broadly the socioeconomic and institutional matrix of asociety Note that many of these aspects are interconnected!

The socioeconomic matrix of a society

Includes demographic, economic, cultural and sociological factors like Age distribution, family structure, population mix and life expectancy of thepopulation Fluidity of social classes (social mobility) Education and Health (human capital, which not only serves to produce better,but might as a spill-over create new inventions) Geography (soil fertility, climate, species, availability of resources and naturaltransport ways) Religious or ideological proclivities of the dominant groups or classes and masses

(openness to change, gender equality, attitudes towards minorities) Infrastructure, e.g. for transport, trade, and communication


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Political and legal system, property rights Openness to trade and competition Prevailing standard of living and income distribution (poverty, nutrition)

Example I: Geography

Access to the sea makestransport easier; this widensthe extent of the market, and hence allows for more trade and specialization.This might on the one hand lead to more efficient use of existing technology(smithian growth) and on the other hand to contact with different people andideas, which help to develop new technologies Land-locked countries have higher transport costs and more difficult access tomain markets (Niger!, Mali, Burkina Faso, Afghanistan, Laos, Mongolia, Bolivia,Paraguay, but also Switzerland!) Deposits of minerals and fuels might help development, since the use of mineralfuels (coal, oil) gives much more and cheaper energy than organic fuels (be ithuman and animal labour or wood, etc.), but without adequate technology they are(almost) useless

Example II: Religion

Mokyr (1990) argues that in generalthe attitudes of religions towardschange are not very different, but inthe long run small differences can lead to large divergence Judeo-christian religions believe that God created Man to be the center of theuniverse, and to manipulate and to utilize the earths resources. This mightexplain

why knowledge slowly, but constantly accumulated in Europe. Weber thesis: The protestant ethic and the spirit of Capitalism: Protestantismfavours individual freedom and responsibility, this promotes literacy, educationand entrepreneurship (see also the Cistercians, who promoted hard work andconstructed watermills) In change, hinduism and its classification of men into varna (caste) sustained

that promotion from one class into another only was possible after reincarnationthrough an obedient and austere life, which does not exactly promote change insociety But of course, religion is not the factor behind growth, in part because theadoption of religions also depends on economic, political, social, military factors

Example III: Property rights

and the state North and Thomas (1973): Efficienteconomic organization is the key togrowth. It entails the establishment ofinstitutional arrangements and propertyrights that create the incentive to channel individual economic effort into activitiesthat bring the private rate of return close to the social rate of return ... if a societydoes not grow it is because no incentives are provided for economic inititative.


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This means that if you own something you must be able to assure that you candecide what to do with it and earn the profits it creates (on markets); the same istrue for inventions According to institutional analysis main threat are the rulers. They mightbestrong enough to protect property rights, but also have the force to confiscate

resources (which causes insecurity!)

Conclusions

Relationships between institutions (culture, values, state), technology, resources

and population are complex, interdependent and potentially unpredictable The biggest question in economics (Why some countries are rich and otherspoor?) has not yet been answered definitely This is good news! The question is still open and attracts the best minds in theprofession...

Executive summary

The standard of living can be measured (in real PPP adjusted GDP per capita) There are rich and poor countries, and in the past, most people were poor, by

modern standards Today, rich countries produce more (per person) and have higher incomes thanpoor countries for several reasons The course will explore their development and by that chooses an historical

approach to the understanding of economic development


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Summing up: explaining growthThe mistery of growth: normally the ouput growth rate is higher than what we canexplain with the increases in factor inputsCAPITALThis is the unexplained part (the part of output growth that exceeds increase in

inputs)

Change in L (labour)Change in K (capital and land)Unexplained part (Solow residual) or total factor productivity growth (TFP)

Growth accounting

(if we divide everything by labour we get the increase in labour productivity,which is what we are most interested in)Change in Y (production)The Solow residual (TFP growth) The Solow residual (Robert Solow invented the growth decomposition method)is that part of output growth which cannot be explained by the increase in thequantity of individual factors of production These increses can be attributed to external forces (like better weather thatgenerates better harvests), an increase in the average level of technology used orhigher overall efficiency in the economy (for example thanks to macroinventionslike railways, electricity, information technology, etc.) In principle, we can also account for better quality of individual productionfactors (human capital, technological age of capital stock). This makes the residualsmaller, but does not make it disappear accouting for better labour and capital

quality is not so easy as we will see in a moment. Economists generally relate the increase in total factor productivity totechnological progress in production (although both are not the same), linked forexample to the level of research and development, human capital, and in general creativity in a society This is why increases in inputs and TFP are called proximate causes of growth,because we still have to search for the ultimate causes explaining capitalaccumulation, increase in hours worked and education and TFP growth, etc.

Doing the math is secondary... In future classes, we will come back to this to see how exactly we can calculate

the contributions to economic growth from more capital, more labour, more land,more human capital, etc. Now it is important to see that technological progress (or TFP growth) is whatwe are really interested in Asking for its determinants is searching for ultimate causes of growth (while

measuring contribution of capital, land, etc., is discussing proximate causes) ->what makes economies more efficient and technologically advanced (and morecapital/land/labour/human capital intensive)

Some numbers (Maddison 2004)

In the las millenium, world population multiplied by 23, GDP per person by 14,and GDP by more than 300


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Between 1000 and 1820, growth was extensive, this means that most of the

increase in GDP was used to sustain a population that multiplied by factor 4. In Western Europe, population multiplied by 5 and income per capita by 3. In 1000, life expectancy at birth was 24 years, in 1820 it was 36 in Westerncountries, but not much more than 24 in the rest of the world.

GDP per capita for the world grew on average 1.2% per year since 1820, which is24 times the average growth rate in 1000-1820. In the West, the growth rate wasmuch higher, around 1.7% (1.9% since 1870) in other parts of the world it waslower.

Between 1000 and 1820 Preindustrial economies operated with a very small basis of knowledge,education and capital Because their income per capita was low, saving was dificult, and hence theaccumulation of capital Extensive growth means that the increase in total production is mainly used tosustain more persons, and to a small extent to make each person better off But having more persons increases the extent of the market (aggregate demand),which allows more specialization and accumulation of best practice (and maybelearning by doing)

Since then Many societies have experienced industrial revolutions (and more) and the startof modern economic growth Lets have a look at which were the productivity (and growth) leaders (inEurope) since 1300 and why Later we have a look at the sources of growth in a more systematic way25

GDP per capita, 1300-1820 (international Dollars of 1990)Black=Italy, Red=United Kingdom, Blue=Netherlands, Green=USA26

10.0001.000GDP per capita, 1820-2008 (international Dollars of 1990)Italy Netherlands United Kingdom United States27

1820 1827 1834 1841 1848 1855 1862 1869 1876 1883 1890 1897 1904 19111918 1925 1932 1939 1946 1953 1960 1967 1974 1981 1988 1995 2002

Maddisons stylized graph

Three cases of economic leadership(a run-through of the whole course!) Holland/The Netherlands (c. 1590-1780/1820) England/United Kingdom (1820-1890) USA (1890-)

Netherlands: Reasons for success

Modern institutions


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Most of the land was in the hands of the farmers themselves (fewfeudalism/manorialism), land could be used to obtain loans (mortgage), sold etc.(property rights) An important part of the political power was held by urban elites (bourgeoisie),not by traditional elites

Few obstacles to the creation of capitalist enterprices (like trading companies,e.g. Dutch East India Company); modern financial institutions (the Amsterdamstock exchange) Recent settlement on land recovered from the sea (especially in Holland),Faustian sense of domination Refugees: Protestantes and Jews (for example from Antwerp) Geography Rivers (Rhine) give access to markets in europe (Germany, Switzerland, etc.) andallow cheap internal water transport (market integration) Possibilities for ocean ports (Amsterdam, etc.), convenient location inNorthwestern Europe Energy from peat and wind Strengthened through investment in canals (also for drainage) and wind-mills Activecommercialpolicy Mercantilism: governmental stimulus regarding the development of industries ina world of limited markets (beggar thy neighbour) Military struggles in the name of trade Blockade of the port of Antwerp (1585-1795), with the trade also textileindustries move to Holland (finishing of woolen and linen textiles) Successful struggle with Portugal over the control of trade with Asia (and in partLatin America)

Netherlands: Reasons for loss of leadership Lossoftradeprivileges(monopolies)becauseof less successful conflicts withFrance and England The financial sector becomes very sucessful (large investments in colonies, etc.,

generating rents of 8% of GDP) contributes to a overvalued currency which makesexports of national production less competitive (high wages and unemployment) Nevertheless,thedeclineoftheNetherlandsisvery relative, although in the late18th/19th Century we observe less immigration and a certain disurbanization

England: Reasons for success

Copied (and improved) the Dutch model regarding institutions, agriculture,

technology, canals, maritime transport, banking and international specialization(woolen textiles, later cottons); the new governmental institutions allowedeconomic change, agricultural reform and favoured scientific/enlighted actitudes Technological progress was fast in industry (especially textiles and iron andsteel, using steam engines and coal, and later railways); this lead to structuralchange and transformation of production (from manufacture to machinofacture) Geography: Access to the sea and large deposits of coal Leadership in world trade, won thanks to military, esp. naval power, this allowsto protect domestic trade interests (wars against the Netherlands), openness totrade and international competition in the 19th Century

England: Reasons for loss of leadership


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Comparatively low levels of investment in domestic manufacturing (high level ofinvestment in foreign countries and the Empire), but services at a very high level(City of London) Comparatively low public investments in education, research and human capitalin general

Industrial relations (workers/industrialists) did not necessarily help theabsorption of new technologies in production Maybe the financial institutions lost opportunities of investment in newtechnologies The currency was overvalued since about 1850; this contributed to a decline incompetitiveness of industrial exports (but was positive for the status of thefinancial sector) Possibly the colonial administration crowded out talent that might have servedthe economy more efficiently in private enterprises Nevertheless, the UK remained the leader in Europe during decades after the riseof the US

USA: Reasons for success

Geography: Large empty zones with arable land; many natural resources (coal,oil, iron ore, etc.) Enormous levels of investment in the construction of cities, canals, railways,telegraph network, etc. Domestic market: very big (and growing thanks to immigration and highfertility), and ever more integrated thanks to better transport (railways) Economies of scale and innovations in production, marketing, advertisement,distribution, consumer credits, etc. transformation of production and

consumption Institutionalization of the process of research and development (new products,new techniques) Advantages in the two world wars, which increase demand,but did not cause mayor damages to US capital stock

Lessons from History?

Common reasons for success Geography (waterways, mineral deposits, engery Modern institutions and attitudes Important position in world trade (and access to large markets) Common reasons for loss of leadership Loss of privileges/trade monopolies Loss of competitiveness because of overvalued currencies (and a very advancedbanking sector and large foreign investments) Underinvestment in human capital (UK) 40


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Calculating population growth

Crude Birth Rate (CBR) = Births/Population*1000 (Babies per 1000) Crude Death Rate (CDR) = Deaths/Population*1000 (Burials per 1000) If CBR exceeds CDR, then population grows (we look at a closed population,that is, there is no immigration or emigration)

If CDR exceeds CBR, population shrinks P/P=CBR-CDR (divided by 10 if you want it in percent) Variables explaining the growth potential of population:- TFR (total fertility rate)=Births/Woman15-49 : a measure of reproduction- E0 (life expectancy at birth): a measure of survival

Why did population grow faster than income per capita, and can the latterhave grown at all?

Why did he say that?

Malthus wanted to argue that poverty was not caused by bad government but anatural condition reforms and revolutions were unnecessary and pointless Malthus wrote also against helping the poor: they would increase poors fertility,

thus lowering their real wages and worsening (not improving) their livingstandard philanthropy was also ill-advised Bad or good institutions either were bad, or did not make any difference to livingstandard However, since he died in 1836 world population increased to about six billion,food production has increased about ten times, and per capita production of foodhas almost doubled in 200 years modern economic growth defeated Malthusianpessimism.

His view proved wrong about the future. Was he right about the past? 8Some believe that his view explains all of human history

One of them is Greg Clark. In his book A Farewell to Alms he presents andintuitive model in the Mathusian tradition and argues thatthe average person before 1800 was no better off than the average person of100,000 BC. Indeed in 1800 the bulk of the worlds population was poorer thantheir remote ancestors. The lucky denizens of wealthy societies such as eighteenth-century England or the Netherlands managed a material lifestyle equivalent to thatof the Stone Age. (Many people, e.g., in China and Japan, were actually poorer thancavemen)The quality of life also failed to improve on any other observable dimension. Lifeexpectancy was no higher in 1800 than for hunter- gatherers: thirty to thirty-fiveyears. Stature, a measure both of the quality of diet and of childrens exposure todiseases, was higher in the Stone Age than in 1800. He also argues that war, violence, disorder, harvest failures, collapsed publicinfrastructures, bad sanitation were good, because they reduced populationpressures and increased material living standardsCan this be true? Lets first look at the model and then at whether it explains reality, or whetherreality can explained with other models also He uses three assumptions:

1) Birth rates differ across societies because of cultural reasons,but increase with living standards


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2) Death rates decline as living standards increase 3) Material living standards decline if population increases One implication, if a society has a stagnating population (CBR=CDR), then lifeexpectancy is the inverse of death rates. That is, if 33/1000 of all people die eachyear, the life expectancy is around 30 (if 1/3 dies on average, people get c. 3.33

years old) If you live in a stagnating society, you have to restrict births to live long; this iswhat Malthus called a preventive check, otherwise nature with positive checkswill increase mortality and thereby reduce population (see below)Subsistence income, allows the population to reproduce itself, at higher incomelevels, population increases because birth rates rise and death rates fall.

Why should this happen? Because of diminishing marginal returns of labour Initially land per worker is high High income means high CBR and lowCDR As population increases, the land/worker ratio falls (or worse land has to becultivated) Income per head is falling (diminishing returns), causing CBR to fall and CDR to

increase Lower income per head leads to worse nutrional status higher risk for diseasesand exposure to epidemics. Finally the economy settles at an equilibrium with constant population12

Population size and income per head

The graph is equivalent to that on the last slide in the lower right corner, except

thatit does not depict marginal product (output), but average product (income perhead),which falls with diminishing marginal returns as the amount of inputs (here:population, i.e. labour) increases, but not as fast as the marginal product (since it isthe average productivity of all amounts of input, not the additional contribution ofthe last additional unit of input)See also here: http://en.wikipedia.org/wiki/Diminishing_returns

PopulationBirth rate, death rate

Preventive and positive checks

Restricting fertility (by marrying late, detaining a share of the population fromgetting married and imposing in-marriage only reproduction) was what Malthuscalled preventive checks (more about that in a second) It avoids that societies fall back to bare-bone subsistence where nature takescare of reducing population (positive checks) However, by restricting the birth rate level still populations have to adapt toMalthusian forces, that is In good times ,people marry more and earlier, fertility increases In bad times,

people marry later and less, fertility decreases


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If not, population growth will depress real wages in the long run because of

diminishing returns and leads to population stagnation. How? Through positive checks increasing mortality due to famines and spread ofcontagious disease. So, the preventive check helps to avoid positive checks

The European marriage pattern and fertility

The European fertility pattern (summary) We do observe lower CBRs in Europe than in other parts of the world, societiesseem to have targeted little more than 2 children per woman Consquences: Higher income per capita Relatively less intensive subsistence crisis Slower population growth, relatively smaller population, and higher lifeexpectancy at birth

If the death rate schedule decreases, for any income there will less deaths; incomeper person in equilibrium decreases (if that is sustainable). On the other hand,everything that increases death rates (war, disorder, desease), is helpful for livingstandards, while improving sanitary conditions is harmful in a material sense

Better technology means that the same resourcesproduce more, and make more consumption possible. But, increase in incomemeans more births, and more birth depress income, so that in the long run, onlypopulation increases (extensive growth)

Nikola Koepke/Jo rg Baten, The biological standard of living in Europe during thelast two millennia. European Review of Economic History 9 (2005), pp. 61-95.

But? According to Angus Maddison (last class!) GDP per capita increased by factor 3between 1000 and 1820 in Western Europe that is roughly 0.13% per year (andpopulation grew!) Clark says, the numbers for 1000 or 1500 are inventions by Maddison with verylittle basis; he guessed them too low, thereby creating non- existing growth before1800 Apparently, Maddisons figures were too low, but we also find that there was

growth (0.2%/year until 1700, then 0.5% until 1870) in England, as well as in theNetherlands and other places. GDP levels were far higher than subistence level (ca.350$)

Are there really decreasing marginal returns?

Sceptics about Malthusian theory (like Persson 2010, ch. 3) have argued thatactually the land constraint behind the diminishing returns populations growthhas never become effective They argue that maybe using more land means that marginal lands of inferiorquality have to be used, but that what we observe is that the amount of harvests

per year as well as the yield per harvest have increased along history, this means


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that Malthusian forces are not irrelevant, but technological progress was alwaysfaster than Malthusian checks If the rate of technological progress (translating into higher labour productivity)exceeds (with given land) the rate of population growth, income per person willrise; this seems to have been the case at least since 1500 in the most advanced

parts of Europe (The Black Death of the 14th Century might have been exogenous, aswere many wars; and between 1550 and 1650 climate deteriorated, etc.)

Vital RatesThe historical record after c. 1500-income above subsistence and rising, though slowly -positive population growth.Malthusian Equilibrium? Income per capitaSource: See Persson (2010), p. 46 (the axes are turned around in comparison withformer graphs).cbr = crude birth ratecdr = crude death rate28

If there are no diminishing returns, so what?

An anti-Malthusian view:Increase in population leads to innovation in agriculture!Population growth is the motor of developmentInvestment in infrastructure requires a critical mass of resources that cannot beraised by small groups

The Boserup Model Forces societies to adopt more intensive techniques In sparsely populated areas we observe technological regress (like after declineof Rome)This leads to larger markets, more trade, more division of labour andspecialization, better communication (forces of Smithian growth) Urbanization:Functionalspecializationincontrolanddefense,needs agriculturalexcess production Since about the 10th Century we find increasing technological change (fertilizers,

mouldboard plough, crop rotation, etc., but slowly) Innovations only made sense if excess production can be exchanged for othergoods. Innovation and investment are endogenous to opportunities ofcommercialization 30

Persson Malthus predicted that increasing population density would depress real wages

population growth would eventually come to a halt However, technological progress in agriculture techniques kept real wages at aconstant or slowly increasing level despite continuing population growth in pre-industrial economies. Positive checks were mostly exogenous (epidemics, wars) rather then

endogenous Episodes of falling real wages also exogenous (climate, not shown in this class)


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Population growth and urbanization stimulated technological progress and

specialization.

Some conclusions

Malthusian theory can give some guidance to understand preindustrial, agrarian

economies However, it is dificult to say up to which point it is empirically observable (Clarkvs. Maddison, Persson, etc.) and valid in the long run This is because the effects of different factors like sufficiently rapid technologicalchange, wars, etc., might be difficult to separate from Malthusian mechanisms We observe that in the long run world population and incomes increased (at leastif we do not follow Clark). This might be because of higher population density (ifwe believe in Boserup and Smithian growth)

Until now

Stilized facts of a race between population, resources and (slow) technologicalprogress If population grows faster than labour productivity (or TFP, both have the samegrowth rates if capital and education per person is the same), all technologicalchange leads to higher populations only and living standards are low [notnecessary to understand this now, its the same as bullet point 1 as can be seen onthe next slide] (Y/Y- L/L) K (K/K- L/L) + HK (HK/HK- L/L) + TFP/TFP So, an important question is why technological progress was so low inpreindustrial economies For Malthus, population was the problem


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Main question

Why did Amsterdam and London (and with them Holland and England) grow,while others did not? Today we will look at two kinds of explanations: Institutionalists (or New Institutional Economics): Douglass North, Daron

Acemoglu and others argue that institutions are very important, since they arehuman-designed (social choices) and in part the outcome of geography, culture,politics and economic factors Smithian growth (division of labour through trade and market integration)10

North and Thomas (1973), pp. 2-3

Efficient economic organization is the key to growth, the development of anefficient economic organization in Western Europe accounts for the rise of theWest. Efficient organization entails the establishment of institutionalarrangements and property rights that create the incentive to channel individualeconomic effort into activities that bring the private rate of return close to thesocial rate of return ... if a society does not grow it is because no incentives areprovided for economic inititative.

Normally, the market provides efficient solutions (added)However, there are all sorts of problems

Trade costs cause problems for perfect arbitrage Transaction costs (finding a partner, making sure he pays,etc.) Transport costs (moving goods in space, infrastructure) Financing trade (volume of trade > capital in the hands of merchant)

What matters today are Market failures The consequences of the market exchange (and production and consumptionthat go with it) affect the wellbeing of more than just the contract partners (->externality) this means: private benefits/costs social benefits/costs 13

Negative externalities

Positive externalities

Historical buildingsPositive externalityEmissions from motor cars (or factories)Negative externalityScientific researchPositive externality (next slide)BotellonNegative externality

Institutions

...are the rules, regulations, laws and policies written and informal that effecteconomic incentives and hence the incentives to invest in capital, human capital

and technology That is, they define and influence the opportunities and choices of individuals


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Individuals will only take actions that are economically rewarded; whether this isthe case or not depends on the institutional framework Hence, if institutions and therefore incentives are not working correctly, theexpansion of productive potential (necessary to overcome diminishing returnsfrom current factor endowments and technologies) can be slowed down

This is inefficient organisation of the economy, that hinders itsfunctioning and therefore growth

Acemoglu and Robinson (2012), ch. 3

All economic institutions are created by society. (...) Politics is the process bywhich a society chooses the rules that will govern it. Politics surrounds institutionsfor the simple reason that while inclusive institutions may be good for theeconomic prosperity of a nation, some people or groups (...) will be much better offby setting institutions that are extractive. (...) When there is conflict overinstitutions, what happens depends on which people or group wins out in thegame of politics who can get more support, obtain additional resources, and formmore effective alliances. In short, who wins depends on the distribution of politicalpower in society. To be inclusive, economic institutions must feature secure private property, anunbiased system of law, and a system of public services that provides a levelplaying field in which people can exchange and contract; it also must permit theentry of new businesses and allow people to choose their careers. (...) Such rightsmust exist not just for the elite, but for a broad cross-section of society. (...)Inclusive economic institutions need and use the state. Extractive political institutions concentrate power in the hands of a narrow eliteand place few constraints on the exercise of power. Economic institutions are then

often structured by this elite to extract resources from the rest of society.18Or in one simple graph

Inclusive political institutions: pluralism, broad political participation, governmentis subject to the lawExtractive political institutions: concentration in the hands of few,absolutism/despotism, no rule of law

A set of definitions

Institutions: any form of organization and regulation of individual and collective

behavior (a set of rules) Incentive: any factor that enables or motivates a particular course of action, or

counts as a reason for preferring one choice to the alternatives. Property rights: the ability to exercise legal control over a resource (an item of

value, incl. the persons labour supply) including the right to attach a price to it, orprofit from its use. Markets: institutions that allow economic agents to set prices and transferproperty rights through contracts. Transaction costs: the costs that parties incur in the process of agreeing andfollowing through a bargaininformation asymmetriesnegotiation,intermediation, monitoring, enforcement costs

Institutional change and (in)efficiency Since they are social choices, institutions can be changed


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Theory in its most simple form suggests that, under conditions ofcompetition, more efficient institutions will replace inefficient ones Nevertheless, change has costs: winners from a new situation have to be able tooverrule potential losers that benefit (extract rents) from current arrangments

(vested interests) in a political process (the field of political institutions where

economic institutions are made). The political process does not always follow theeconomic logic of competition and efficiency (but one of relative power). If constraints on the exercise of power of the old elite were weak, the newelite might not necessarily converte extractive into inclusive institutions. Therefore, inefficient institutions can exist and persist (e.g. arbitraryexpropriation, forced taxation by a strong government, privileges for minoritieswith strong influence [and lack of competition in markets], lackof equality of opportunities and access to public services)

Did preindustrial economies grow so slow because of bad

institutions?

There exists an endemic conflict between the own interest of the government andeconomic efficiencya strong state is necessary to guarantee social order (prevent free riding bycitizens and and provide public goods) but it can also extract a large share of thesurplus generated by the economy (for example by not repaying debts) for its ownconsumption, thus limiting growth potential How to constrain the Leviathan?The frontispiece of the Leviathan 22 by Thomas Hobbes (1651)

England Institutional set-up: after the death of Elisabeth I Tudor, permanent conflict

between the Crown and representative bodies (Parliament, common law courts)on taxation and allocation of property rights (chartered monopolies) Absolutism with high concentration of power in the Crown: quasi-legislativepowers (Royal Prerogative superior toParliamentary acts)full control of the government acts (no need for Parliamentsapproval or authorization for issuing or renegotiating debt) judges salaried bythe Crown; King could remove disloyaljudges. Events: Civil War and execution of Charles I Stuart (1649)Commonwealth (Republic based on military rule in the name of Parliamentarysupremacy) under Oliver CromwellRoyal restoration under Stuarts(1660)political conflict (Whigs vs. Tories)William III Orange (a Dutchstadtholder) invited by the Parliament to become King: the Glorious Revolution(1688).

Constitutional monarchy under the Bill of Rights of 1689

1. Parliamentary supremacy 6.established sovereigntyshared. Common Law prerogative2. The Crown cannot disband Parliament at discretion 7.

courts were abolished3. Parliament gains central role in financial matters (taxation)


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Judges independent from Crownthey could only be removed if convicted ofcriminal offence or by the two chambers of Parliament4. The Crown s independent sources of income limited by Parliament.8. Political rights were regarded as a key element in the protection againstarbitrary violations of economic rights

5. Parliamentary power to oversee how government spends veto power overexpenditures voted in ParliamentPrerogative power curtailedand subordinated to

Consequences

The new institutional balance made the governments commitment to secureproperty rights more credible, by ruling out expropriation by a predatory state andincreasing the cost of rent-seekinga constrained government is also a more predictable government. How did this contribute to prepare the ground for the transition to highergrowth? According to North and Weingast (1990): By reducing the costof capital: afterthe Revolution, rise in the volume and decline in the cost of borrowing by theEnglish government = reduced risk premiumreduced also the cost of capital raised in private capital markets.

Government finance before the Revolution: forced loans with systematic defaulthigh risk = high interest rate

After the Revolution: increased public expenditure, access to credit and pricestability

In international perspective

North and others suggest that in all countries that did not grow (Spain, France,etc.) the problem was the same, and England (or the Netherlands) was the firstcountry to escape it. However, authors like Epstein (2000) have argued that also the Northern Italiancity states were republics that went into decline at the same time Greg Clark (2007, ch. 9) shows that actually the problem of high interest rateswas only one of the English state, not of private individuals in England. For theminterest rates (on land) had been falling since about 1300, because the risk ofexpropiation was far less problematic than North claims Epstein additionally argues that what made interest rates for the English Crownhigh before 1688 was not so much the uncontrolled government, but the backwardway of organizing government finances29

Interest rates on public debt, 1300-1750, all over Europe(Private) rate of return on farmland and rent charges in England, 1170-2003Epstein (2000), Figure 2.1: the English Crown in the 15th and 16th Century paidhigher interest rates than other European Monarchies because of its backwardsystem of managing public debt (which was in part a result of not having to fight

many wars after 1066)Rate of return on farmland and rent charges, Clark (2007), Figure 9.1.


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(Because of ursury laws interest rates on private loans are difficult to assess, landcould be rented out because it literally brought fruits and therefore interestpayments were justified; muchland was held by the church itself)

So there were other problems Interest rates for the Crown in England were high because they did not developregular financing instruments (a consolidated debt), because they did not needmuch revenue (since only few wars had to be fought since 1066) England could solve the problem quickly, because the national market andnational politics were actually integrated and united (as a consequence of absenceof wars and good natural infrastructure) In other countries, like France or Spain, the government was actually weakerthan absolutism makes us believe (because there were many traditionalfreedoms for regions or people of status that limited tax revenues), similarproblems ocurred (for different reasons in many city republics and in Poland, thatadditionally were very small), which made it difficult for them to survive wars orprotect their commercial routes That is, a strong state can be a problem if not controlled, but a weakstate and one that is too controlled (so it cannot actually act) is alsoproblematic, since sometimes markets and private institutions need thestate

Limitation to taxation

Source: Bogart et al. (2010), pp. 78, 79Overall fiscal (state) revenue is the product of revenue (or tax pressure) per capita

and the size of the population. High overall revenue means, among other things,that a government can sustain large armies and navies.Tax pressure per capita means how much a government (local, regional ornational) was able to raiseper capita. While taxes per capita were highest in the Netherlands, overall incomefrom taxes was highest in France in the 18th Century, since it had the highestpopulation. However, the capacity to increase taxes inFrance seems to have been limited (tax pressure per capita is about 1/3 that of theDutch and less than half that of England in the second half of the 18th Century.

But does this mean that constraining the Leviathan is unnecessary?

No, because, if this leads to inclusive economic institutions via a more pluralistic

parliament, constraints on the executive, the end of Royal Prerogative and more

independent judges it is not just capital costs that matter

Monopolies could be dismantled and reduced, decision-making was not justbased on landed interests, but also on those of merchants. Creativity and creative

destruction become little by little more likely society reinforces its move fromextractive economic institutions (feudalism, etc.) towards inclusive economicinstitutions. In this sense, Acemoglu and Johnson (2012) also see 1688 as one of the criticaljunctures, which would pave the way for the industrial revolution


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A second, not necessarily incompatible explanation: Smithian growth

As already heard, if surplus of production can be exchanged on the market, it isuseful to specialize according to individual comparative advantage to assignresources more efficiently Via this, we can actually have increase in incomes without much technological

advance (although remember the learning-by-doing idea by Persson) This exchange might happen at the level of a village (farmers, weavers,carpenters, smith, etc.), at the level of a country (rural regions and cities providingoverhead services such as markets, financial institutions, etc.) and at aninternational level (different countries specializing relatively in the production ofdifferent goods) However, the essential problems in a world with small surplus and thinmarkets are (a) transport is costly and insecure, (b) finding transactionpartners is difficult, (c) property rights might not be respected and difficultto ensure

Adam Smith and economic history

In the 16th to 18th Century domestic markets in the Netherlands and in England

were integrating into a national economy, large parts of the population lived inand moved to cities like Amsterdam and London Their international trade in all kinds of goods (first only very valuable ones, lateralso wood, wheat, etc.) was also increasing This went together with institutional advances (fairs, banking, accounting,trading companies, VOC/EIC, etc.) Incomes were rising, although it is not clear if Smithian forces actually led tosustained growth (in the Netherlands in the 18th Century income levels stagnate at

a high level, in England the industrial revolution happens, which might or mightnot have to do with division of labour)

Summing up

Non-defined and insecure property rights and inefficient (extractive)institutions are a problem for economic growth, because they work against allincentives for individual action in favour of productivity growth The state can provide security of property rights and thereby increase efficiency(lower transaction costs) and give incentives to innovation, but it needs to becontrolled itself (North) But in the first place the state needs to be able to act in a uniform way for all

regions and people he is ruling over (political integration, Epstein) Market integration also makes division oflabour possible (Smith) and lowers therisks associated with specialization, but requires institutitions and infrastructure In view of that preindustrial or premodern institutions (like the Manor) might beinefficient in welfare terms, but they might have served the needs of the time(which made them efficient for contemporaries)

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Economic History.docx