The First Industrial Revolution: a Puzzle for Growth Economists

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The First Industrial Revolution a Puzzle for
Growth Economists

• Nick Crafts and Larry Neal

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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

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British Industrial Revolution

• Modest growth
• Escape from Malthusian Trap
• Large structural change
• No take-off but TFP growth increases significantly

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Growth in Britain ( per year)
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Malthusian Model Crafts Mills (2007)

• LogW a - ßLogPop
  ?tTrend growth of W is zero till 1800 while
  Iron Law of wages allows population growth at
  ?/ß 0.5 pre-1800, 2 post-1800 based on
  higher ?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 didnt bark rapid population
  growth was sustained without a collapse in real
  wages

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Employment Composition ()
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Agricultural/Total Employment at British 1840
Income Level ()
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Family to Capitalist Farming

• Disappearance of small farms
• Release of surplus labour
• Promotes industrialization
• Explains British divergence from European Norm

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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
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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

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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

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Institutions Matter

• Modern economic growth associated with modern
  institutions nation state secularism constitut
  ional government extension of the franchise

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Institutions Matter

• Issue of causality confounded by advantages of
  backwardness for followers, who can substitute
  capital skip learning stages adopt most
  advanced technology import capital, skills,
  institutions

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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)

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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

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

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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
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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

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Endogenous Innovation Models

• Expected technological progress is faster if
  appropriability of returns improves
  productivity of R D inputs goes up
  markets get bigger

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Endogenous Growth
Schumpeter relationship (high ?)
x
Schumpeter (low ?)
Solow (high s)
Solow steady-state relationship (low s)
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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 ?

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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

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Role of Markets Land, Labor, Capital,
Entrepreneurs

• Markets allocate resources more efficiently than
  alternative methods Command
  economies Custom in traditional economies
• Hicks dilemmaCommand is usual response to
  shocksCustom emerges in absence of shocks

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Role of Finance Mobilize Resources

• Hicks resolution of dilemmaEuropean invention
  of city-states governed by merchant elites
  committed to maintenance of markets
• Neals resolution of dilemmaGovernments that
  use debt markets to respond to shocks committed
  to use labor and capital markets as well

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Tales of Two Institutions
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Tales of Two Institutions
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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? Napoleons defeat in Russia.

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Neals 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

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Neals Tale of French Revolution

• Flexible exchange rate of pound locks in
  foreign capital in Londons capital market
• Continental Blockade destroys UK system of war
  finance, as intended
• Napoleons capital levies throughout conquered
  Europe increase flight capital to London

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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

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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