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This page intentionally left blank AnEconomicHistoryofEurope This concise and accessible introduction to European economic history focusses on the interplay between the development of institutions and the generation and diffu- sion of knowledge-based technologies.The author challenges the view that European economic history before the Industrial Revolution was constrained by population growthoutstrippingavailableresources.Hearguesinsteadthatthelimitingfactorwas the knowledge needed for technological progress,but also that Europe was unique in developing a scientific culture and institutions which were the basis for the unprece- dented technological progress and economic growth of the nineteenth and twentieth centuries. Simple explanatory concepts are used to explain growth and stagnation as well as the convergence of income over time whilst text boxes, figures, an extensive glossaryandonlineexercisesenablestudentstodevelopacomprehensiveunderstand- ingof thesubject.ThisistheonlytextbookstudentswillneedtounderstandEurope’s uniqueeconomicdevelopmentanditsglobalcontext. k a r l g u n n a r perssois a professor in the Department of Economics at the University of Copenhagen, where he has been teaching comparative economic his- tory and the history of globalization over the last thirty years.He is the author of Pre- Industrial Economic Growth: Social Organization and Technological Progress in Europe (1988)andGrainMarketsinEurope1500–1900:IntegrationandDeregulation(1999). newapproachestoeconomicandsocialhistory EditedfortheEconomicHistorySocietyby nigelgoose, UniversityofHertfordshire larryneal, UniversityofIllinois,Urbana-Champaign New Approaches to Economic and Social History is an important new textbook series published in association with the Economic History Society. It provides concise but authoritativesurveysofmajorthemesandissuesinworldeconomicandsocialhistory from the post-Roman recovery to the present day. Books in the series are by recog- nized authorities operating at the cutting edge of their field with an ability to write clearlyandsuccinctly.Theseriesconsistsprincipallyofsingle-authorworks–academ- ically rigorous and groundbreaking – which offer comprehensive,analytical guides at alengthandlevelaccessibletoadvancedschoolstudentsandundergraduatehistorians andeconomists. AnEconomicHistoryofEurope Knowledge,institutionsandgrowth,600tothepresent KaRl GUnnaR P ERSSon CAMBRIDGE UNIVERSITY PRESS Cambridge, New York, Melbourne, Madrid, Cape Town, Singapore, São Paulo, Delhi, Dubai, Tokyo Cambridge University Press The Edinburgh Building, Cambridge CB2 8RU, UK Published in the United States of America by Cambridge University Press, New York www.cambridge.org Information on this title: www.cambridge.org/9780521840095 © Karl Gunnar Persson 2010 This publication is in copyright. Subject to statutory exception and to the provision of relevant collective licensing agreements, no reproduction of any part may take place without the written permission of Cambridge University Press. 2010 First published in print format ISBN-13 978-0-511-67745-8 eBook (NetLibrary) ISBN-13 978-0-521-84009-5 Hardback ISBN-13 978-0-521-54940-0 Paperback Cambridge University Press has no responsibility for the persistence or accuracy of urls for external or third-party internet websites referred to in this publication, and does not guarantee that any content on such websites is, or will remain, accurate or appropriate. Contents list of tables page x listof figures xi listof maps xiii listof boxes xiv Foreword xv Introduction:Whatiseconomichistory? 1 Efficiencyintheuseof resourcesshapesthewealthof nations 1 outlineof thechapters 4 1 ThemakingofEurope 10 1.1 Thegeo-economiccontinuityof Europe 10 1.2 Europetrades,thereforeitis! 14 1.3 Fromgeo-economicstogeo-politics:theEuropeanUnion 18 2 Europefromobscuritytoeconomicrecovery 21 2.1 lightintheDarkages 21 2.2 Gainsfromdivisionof labour:adamSmithrevisited 22 2.3 Divisionof labourisconstrainedbyinsufficientdemand 24 2.4 Divisionof labourpromotestechnologicalchange 26 2.5 afterthepost-Romancrisis:theeconomicrenaissance of theninthtofifteenthcenturies 28 2.6 Population 29 v vi Contents 2.7 Therestorationof amonetarysystem 30 2.8 Transportandtraderoutes 31 2.9 Urbanization 32 2.10 Productionandtechnology 36 3 Population,economicgrowthandresourceconstraints 42 3.1 Historicaltrendsinpopulationgrowth 42 3.2 TheMalthusiantheoryof populationgrowthandstagnation 45 3.3 IstheMalthusiantheorytestable? 47 3.4 Thesecretsof agriculturalprogress 49 3.5 Understandingfertilitystrategies 52 3.6 Thedemographictransition 54 4 Thenatureandextentofeconomicgrowth inthepre-industrialepoch 60 4.1 Understandingpre-industrialgrowth 60 4.2 accountingforpre-industrialproductivitygrowth 62 4.3 Wagesandincomedistribution 67 4.4 WhendidEuropeforgeahead? 68 appendix:Thedualapproachtototalfactorproductivitymeasurement 71 5 Institutionsandgrowth 74 5.1 Institutionsandefficiency 74 5.2 Thepeculiarityof institutionalexplanations 76 5.3 Thecharacteristicsof amoderneconomy 77 5.4 Marketperformanceinhistory 79 5.5 Theevolutionof labourmarkets:theriseanddeclineof serfdom 81 5.6 Firmsandfarms 82 5.7 Co-operativesandhold-up 85 5.8 Contracts,risksandcontractenforcement 87 5.9 asymmetricinformation,reputationandself-enforcing contracts 89 vii Contents 6 Knowledge,technologytransferandconvergence 92 6.1 IndustrialRevolution,IndustriousRevolutionand IndustrialEnlightenment 92 6.2 Scienceandentrepreneurship 99 6.3 Theimpactof newknowledge:brainsreplacemuscles 100 6.4 Thelastingimpactof nineteenth-centurydiscoveriesand twentieth-centuryaccomplishments 107 6.5 Technologytransferandcatch-up 110 6.5.1 WhywasGermanyalateindustrialnation...andwhydid itgrowfasterthanBritainonceitstartedtogrow? 117 6.5.2 Humanandcapitalinvestment 118 6.5.3 ResearchandDevelopment 120 6.5.4 Industrialrelations 120 6.6 Convergenceinthelongrun:threestories 121 7 Money,creditandbanking 129 7.1 Theoriginsof money 129 7.2 Therevivalof themonetarysysteminEurope: coinsandbillsof exchange 131 7.3 Usuryandinterestratesinthelongrun 135 7.4 Theemergenceof papermoney 136 7.5 Whatdobanksdo? 140 7.6 Theimpactof banksoneconomicgrowth 142 7.7 Banksversusstockmarkets 147 appendix:Thebillof exchangefurtherexplored 151 8 Trade,tariffsandgrowth byKarlGunnarPerssonandPaulSharp 154 8.1 Thecomparativeadvantageargumentforfreetradeandits consequences 154 8.2 Tradepatternsinhistory:thedifferencebetweennineteenthand twentieth-centurytrade 156 8.3 Tradepolicyandgrowth 158 viii Contents 8.4 lessonsfromhistory 160 8.4.1 Frommercantilismtofreetrade 160 8.4.2 Thedisintegrationof internationaltradeintheinterwar period 163 8.4.3 Therestorationof thefree-traderegimeaftertheSecond WorldWar 164 8.4.4 Empiricalinvestigations 165 appendix:Comparativeadvantage 167 9 Internationalmonetaryregimesinhistory byKarlGunnarPerssonandPaulSharp 171 9.1 Whyisaninternationalmonetarysystemnecessary? 171 9.2 Howdopolicymakerschoosetheinternationalmonetary regime? 172 9.3 Internationalmonetaryregimesinhistory 175 9.3.1 TheInternationalGoldStandardc.1870–1914 175 9.3.2 Theinterwaryears 178 9.3.3 TheBrettonWoodsSystem 179 9.3.4 Theworldof floatingexchangerates 181 10 Theeraofpoliticaleconomy:fromtheminimal statetotheWelfareStateinthetwentiethcentury 185 10.1 Economyandpoliticsatthecloseof thenineteenthcentury 185 10.2 Thelongfarewelltoeconomicorthodoxy:theresponsetotheGreat Depression 186 10.3 Successesandfailuresof macroeconomicmanagementinthe secondhalf of thetwentiethcentury:fromfullemployment toinflationtargeting 190 10.4 KarlMarx’strap:theriseandfallof thesocialist economiesinEurope 195 10.5 amarketfailuretheoryof theWelfareState 199 ix Contents 11 Inequalityamongandwithinnations:past,present,future 206 11.1 Whyisthereinequality? 206 11.2 Measuringinequality 207 11.3 Genderinequality 212 11.4 Worldincomedistribution 214 11.5 Towardsabroaderconceptof welfare 216 11.6 Speculationsaboutfuturetrendsinincomeinequality 217 12 GlobalizationanditschallengetoEurope 221 12.1 Globalizationandthelawof oneprice 221 12.2 Whatdrivesglobalization? 224 12.3 Thephasesof globalization 226 12.3.1 Capitalmarkets 226 12.3.2 Commoditymarkets 230 12.3.3 labourmarkets 232 12.4 Globalizationbacklash:threecases 234 12.4.1 Tradeopennessandmigration 234 12.4.2 Theretreatfromtheworldeconomy 235 12.4.3 Thetaleof thetwinfarmprotests 237 appendix:Freightratesandglobalization 239 GlossarybyKarlGunnarPerssonandMarcP.B.Klemp 242 Index 250 Tables 1.1 Intra-EuropeantradeandtradewithRoW(Restof theWorld), in 2005. Percentage of total trapage 18 2.1 Increasingdivisionof labourasmeasuredbynumber of occupations 35 3.1 numberof livebirthspermarriedwoman,ageatmarriageandsurvival chancesof children,1650–1950 53 4.1 TotalfactorproductivityinFrenchagriculture,1522–1789. Percentperyear 64 6.1 TFPgrowthandnewandoldestimatesof nationalproduct growthinBritainduringtheIndustrialRevolution.Percentperyear 95 10.1 GDPpercapitaintheUSa,RussiaandEasternEuroperelative toWesternEurope1950–90.WesternEurope=1 199 10.2 Theusesof localandcentralgovernmentspendinginEuropein2005. Percentageof total 200 x Figures 1.1 The impact of distance and border effects on trade page 16 2.1 Mutualgainsfromspecialization 23 2.2 Virtuousandviciousprocessesintechnologicalprogress/regress 27 2.3 UrbanizationinEuropeandChina:urbanpopulationasapercentage of totalpopulation 36 2.4 anapproximationof metalproductioninthenorthernhemisphereas revealedbyleademissionsfoundintheGreenlandicecap 37 3.1 Europeanpopulation400BCEto2000CE.Millions 44 3.2 Malthusgraphicallyspeaking 46 3.3 RealfarmwagesinEnglandandfluctuationsinnorthernhemisphere temperature,1560–1880 48 3.4 oldandnewtotalfertilityregimesrelativetoapopulationgrowth isoquantof 0.1–0.4percentperyear 54 3.5 Fertilityandmortalityinthedemographictransition 55 4.1 MalthusianandSmithianforcesineconomicgrowth 61 4.2 Silver,grainandrealwagesinBritain,ChinaandIndia,1550–1850. Wagesasapercentageof Englishwages 70 6.1 PatentapplicationsperyearinvariousEuropeannations,1860–1916. Per1000inhabitants 98 6.2 annualrateof growthof GDPpercapita1870–1914andGDP perheadin1870.Constant1990$ 112 6.3 annualrateof growthof GDPpercapita1914–50andGDP perheadin1914.Constant1990$ 113 6.4 annualrateof growthof GDPpercapita1950–75andGDP perheadin1950.Constant1990$ 113 6.5 logGDPpercapita1860–2000inargentina,Scandinavia andtheUSa.1990$ 122 6.6 logGDPpercapita1860–2000inGermany,Ireland,Czechoslovakia andItaly.1990$ 122 6.7 logGDPpercapita1860–2000inFrance,Spainand UnitedKingdom.1990$ 123 xi xii Listoffigures 7.1 Spontaneousevolutionof wheatasmoneywhenthereisno coincidenceof wants 130 7.2 Paymentsystemsreducecostandriskovertime 150 7.3 Thebillof exchange 152 8.1 Theinfant-industryargumentforprotection 159 8.2 Thefirstfree-tradeerainEurope 162 9.1 The(obstfeld–Taylor)openeconomytrilemma:picktwopolicy goals,onlytwobutanytwo 174 10.1 Unemploymentpavesthewayforadolf Hitler 189 10.2 netwelfarestatebalanceof atypicalhouseholdoveritslifecycle 201 11.1 Ginidistributionsineconomiesfrom10,000BCEtothepresent 208 11.2 TheactualGinicoefficientasashareof themaximumGiniovertime 210 11.3 HDIandGDPperhead,1870–2000 217 12.1 Globalizationmeansastrongerinverselinkbetweendomestic productioncostsandemployment 223 12.2 Realdomestic(USarail)andtransatlanticfreightrates,1850–1990 (1884=1) 225 12.3 nominalinterestratedifferentialsbetweenUSaandUKonsimilar assets,1870–2000 229 12.4 PriceconvergencebetweentheUKandUSa1800–1975.Priceof wheatinUKrelativetopriceinChicagoandnewYork 231 12.5 opennessandlabourstandardsin1913 236 12.6 Freightratereductionsextendthefrontierandincreaseprice andincomefornon-frontierfarmers 240 Maps 1.1 The Roman Empire around 200 CEpage 11 1.2 TheCarolingianEmpirearound850CE 12 1.3 TheEuropeanUnion2010 13 2.1 Merchantcommunicationsintheearlycenturiesof Europeanrevival33 xiii Boxes 2.1 Income levels and division of labour in the pre-industrial era page 28 3.1 Somebasicdemographicconcepts 46 3.2 anexampleof increasingproductivity:moregrainfromlessland 51 4.1 Totalfactorproductivitygrowthinpre-plagueEnglishagriculture 63 4.2 Urbanizationmeanshigherlabourproductivity 65 5.1 Whysharecroppingreducesworkandoutput 88 7.1 Whatbanksdo 140 7.2 Theanatomyof financialcrises 142 8.1 TheEuropeantraderegimes 167 9.1 Example:Whywasthegoldstandardafixedexchangeratesystem? 176 9.2 Exchangeratesystems 183 10.1 GrowthdisastersandtheGreatDepression 190 xiv Foreword This book evolved over the years from the lectures I have given and give to my students at the Department of Economics in Copenhagen. I have, how- ever, attempted to write a book for a wider audience who are searching for a very concise introduction to European economic history which is in tune with recent research. I make use of a few basic and simple economic tools which turn out to be very effective in the interpretation of history. The book offersapanoramicviewratherthanclose-ups.However,theanalyticalframe- work will be useful in further studies of the specialized literature.For readers with little background knowledge in economics I provide a glossary defining key concepts, which are marked by italics and an asterisk, for example bar- ter*.Economicideasdemandingmoreattentionareexplainedinthetextorin appendices. This is a work of synthesis, but it attempts to give challenging and new insights. I am indebted to generations of economic historians as well as to a greatmanyof mycontemporaries.Thatnormallyshowsitself inendlessfoot- notes, which not only interrupt the narrative flow but also drown the gen- eral historical trends amidst all the details.Instead,I have chosen to end each chapter with a selective list of references which is also a suggestion for further reading. authors I am particularly influenced by are referred to in the main text. a large number of colleagues have guided me. Cormac o’Gràda has as usual been a very stimulating critic and Paul Sharp has not only saved me from embarrassing grammatical errors but is also the co-author of two chap- ters. I would also like to thank Carl-Johan Dalgaard, Bodil Ejrnæs, Giovanni Federico, Christian Groth, Tim Guinnane, Ingrid Henriksen, Derek Keene, Markus lampe, Barbro nedstam and Jacob Weisdorf for helpful comments andsuggestions. Mette Bjarnholt was my research assistant during the initial phase of the project and Marc Klemp and Mekdim D. Regassa in the final stage and they haveallbeenenthusiasticandgoodtohavearound. xv Introduction:Whatiseconomic history? Efficiencyintheuseofresourcesshapesthewealthofnations Economic history is concerned with how well mankind, over time, has used resources to create wealth, food and shelter, bread and roses. nature pro- videsresourcesandmantransformstheseresourcesintogoodsandservicesto meet human needs. Some resources remain in fixed supply, such as land, but the fertility of land can and must be restored after harvest.over thousands of yearsof agriculture,mankindlearnedhowanimaldung,rotationof cropsand the introduction of nitrogen-fixing crops could increase the yearly harvest. natural resources such as coal, oil and iron ore are, however, non-renewable. other resources are made by mankind.Capital,for example factory buildings and machinery and tools,is therefore renewable. labour,finally,is a resource whose supply relies on how well mankind uses the other resources at hand. But labour has been in increasing supply since the transition from hunter- gatherer technology to agriculture about ten thousand years ago.The skills of labour, so-called human capital, were primarily based on learning by doing, anditisonlysincethenineteenthcenturythatformaleducationhasplayedan importantrole. Efficiencyisdeterminedbythetechnologyofproductionandbytheinstitu- tionsthatgiveaccesstotheuseof resources. Institutions can be understood as the rules of the game for economic life. Institutions or principles such as the Rights of Man matter because if labour is notfreetomoveitisunlikelythatlabourwillfinditsmostproductiveemploy- ment.Workers who are not properly rewarded will have every reason to shirk, thatis,nottooffersufficienteffort.ownersofcapitalneedassurancesfromrul- ingelitesthattheirpropertywillnotbearbitrarilyexpropriatedbeforetheywill be willing to invest.Inequalities in the distribution of income and wealth tend totriggeroff distributionalconflictsinnations,whichhampergrowthbecause politicalconflictscreateuncertaintyabouttherulesof thegameinthefuture. 1 2 Introduction:Whatiseconomichistory? Economic history traces the efficiency characteristics of institutions by studying the development of commodity and labour markets,financial inter- mediaries (banks), the legal framework of contract enforcement, property rights,openness to trade and international capital flows.Property rights over resourcescanbemoreorlesswelldefinedandtheyimpactontheuseanddis- tribution of resources. Markets can be more or less efficient depending on their competitive nature and the speed at which new information about sup- ply and demand conditions is spread. Markets can be thin, that is trade can be infrequent and engage few participants at a time; or thick, which means that markets are almost continuous and involve a large number of traders.In history, markets have tended to become thicker and more efficient over time. Money facilitates trade and exchange and banks can help savers with incom- plete knowledge to find good investment opportunities. High risks can deter peoplefromtrade,butinsurancecanreducetheserisks.opennesstotradeand factor flows has varied dramatically throughout history. Even though there is evidence that openness tends to increase efficiency in the use of resources, therearelosersaswellaswinnerswithinanynationsfromthepracticeofinter- nationaltrade.althoughthelong-runhistoricaltrendhasbeenoneofincreas- ingopenness,therearesignificantsetbacksinthisprocessdrivenbythosewho fear to or actually do lose from free trade.openness can increase risk because open economies are more exposed to shocks originating in the world econ- omy.Itispossiblethatopennessisthereforelinkedtotheevolutionof specific institutions, such as the Welfare State, that alleviate these effects of openness. Governmentsetstherulesof thegame,andtriestoupholdlawandorder.But since governments have a monopoly of force, good and accountable govern- ment is far from the rule. Corruption and bad government is a major reason whyeconomiesfail. Technology is knowledge about how to use resources in the production of goodsandservices.Theabilitytomakeironoutof ironoreisbasedonknow- ledgeoriginallyderivedfromtrialanderror.Withoutthatknowledgeironore wouldbeuseless,asitwasthroughoutmostofthehistoryofmankind.Modern technologies differ from pre-nineteenth-century technologies mainly by the fact that they are developed from theoretical and scientific inquiry about the world,which over the span of just 200 years has expanded the knowledge baseatanever-increasingrate. oftensuchknowledgewillbe‘embedded’inparticularpiecesofproduction equipmentandtools.ThinkofamodernPC.Itisausefultoolinawidevariety of operations,andalargeamountof priorknowledgeisembeddedinitinthe sensethattheoperationsyoucanperformwiththecomputerrelyontheprior knowledgeneededtoconstructthecomputeranditssoftware. 3 Efficientuseofresourcesshapesthewealthofnations althoughsomenaturalresourcesmayhavebeendepletedovertime,suchas oil and minerals,there has been an increase in the efficiency of their use.The general technological trend in history has been that the amount of resources you need to produce a given amount of output has declined.late nineteenth- century economists all agreed that coal deposits would be exhausted in the near future,which would put an end to prosperity.It did not happen because another non-renewable resource, oil, and renewable energy sources such as hydroelectricity,replaced coal as a major source of energy.In the long run oil resources will be exhausted if no alternative energy resources, renewable or non-renewable,areexploited. Material resources, such as capital equipment, land and natural resources, arewhatwecancallrivalgoods.Youcannotbothusethecoalandkeepit.Your use of a particular machine hinders others from its use. However, the factors thatgenerateefficiency,thatistechnologyandinstitutions,arenon-rival.Your useof commonknowledgetoconstructanewefficienttooldoesnotpreclude others from using the same knowledge. It is true that some knowledge is not immediately and freely accessible to all because of patent protection. Such protection is an institutional mechanism to stimulate research spending, but patents expire, after which private knowledge becomes common knowledge. Knowledge of a new institutional mechanism– say a change in corporate tax- ation*, which gives investors incentives to invest in sophisticated production technology – can be imitated in any nation. The non-rival nature of know- ledgeabouttechnologiesandinstitutionsgivesitanalmostlimitlesspotential tochangetheefficiencyof production. In recent years,climate change has come to the forefront in the political and economicdebate.Whatrole,ifany,hasclimateintheframeworksketchedhere? Climate is best seen as a factor, along with technology and institutions, which determines the degree of efficiency with which resources can be used.Climate change is certainly not new to economic historians, but neither the extent of these changes nor their effects have been sufficiently explored. The so-called littleIceage,intheEarlyModernperiod(1450–1650),isaccordingtooneline of researchresponsibleforadeclineinoutputproducedbygivenresourcesand technology.as a contrast,the contemporary discussion focusses on the poten- tial increasing costs of production from global warming, although the impact maydiffersignificantlyamongregionsandsectorsintheworld. Resourceendowmentsofnationsasfaraslandandmineraldepositsarecon- cernedhavenotchangedovertime.Thedramaticchangesthateconomichisto- riansfocusonarehowhumancapital,technologiesandinstitutionsdevelopover timetofacilitatetheaccesstoandefficientuseof resourcesthatpermitincome and wealth to grow. Initial resource endowments matter, but it is increased 4 Introduction:Whatiseconomichistory? efficiency in their use which has permitted economies to enjoy increasing wealth throughout the course of history. at this stage we can formulate a strongpropositionwhichwillbecorroboratedinthesubsequentchapters: Proposition1:Economiesthatarerichlyendowedwithresourcesarenot necessarilyrichbuteconomieswhichuseresourcesefficientlyarealmostalways richirrespectiveoftheirresourceendowment. Outlineofthechapters our story begins at a time when the first European civilization, the Roman Empire, had declined. Chapter 1 examines the surprising geo-political continuity of Europe despite the endemic political and territorial conflicts. onequestionaskediswhatshapesregionalentitiessuchasEurope.Thegravity theory of trade notes that trade is stimulated by proximity and similarity and stresses the gravitational attraction of large core economies. The chapter advancestheideathattradehasbeenamajorforceof integration,notonlyeco- nomic but also cultural and political. Initial barriers to trade tend to develop intotrade-inhibitingbordereffectswhichdefinethelimitsof regionalentities. Proposition2:Europetrades,thereforeitis! Before the nineteenth century technological progress was very slow and rested on a thin base of knowledge which was mainly derived from experi- enceacquiredfromlearningbydoingandthedivisionof labour.Thedivision of labour was the primary source of efficiency gains in production and trig- gered the development of institutions,markets,money and contract enforce- ment rules, which facilitated exchange.Without the exchange of services and goodstherewasnoscopeforpeopletospecializeinseparateskills.InChapter2 I develop a simple explanation of the rise and fall of economies stressing the upsanddownsoforderlymarkets,urbansettlementsandtradenodesanddiv- ision of labour. The positive effects of population growth are stressed when the declining trend in the aftermath of the decline of the Roman Empire is reversed.ThedeclineoftheRomanEmpireisastoryofinstitutionalandpolit- icalbreakdownwithsevereconsequencesforeconomicwelfare.aninteresting question arises here:are modern economies immune to institutional failures? aswewillseeinsubsequentchapters,theanswerisno! Proposition3:Theforcesthatstimulatedivisionoflabour(specialization),that ispoliticalorder,populationgrowth,moneysupplyandexchange,wereessential 5 Outlineofthechapters fortherevivaloftheEuropeaneconomyintheearlyMiddleAgesandstarteda processofslowgrowthofwelfarebasedonskillperfectionandlearningbydoing. Economics and economic history tell us,first,that more resources per pro- ducer generally increase output and income. Second, and more interestingly, evenwithintheconstraintsofresourceswhichareinfixedsupply,suchasland, output and income per person will increase if a person learns how to increase efficiencyinheruseof resources.Forexample,theyieldof wheatperyearfrom a hectare of land has increased continuously and dramatically in the course of history. In Chapter 3 I focus on how the fixed supply of land can constrain growth,butonlyinsofarastechnologyisstagnating. Proposition4:Technologicalprogressisessentiallyresourcesaving,whichmakes explanationsrelyingonbindingresourceconstraintsinsufficientandoften inappropriateforhistoricalanalysisexceptwithregardtoeconomiesthatare characterizedbytechnologicalstagnation. Thelessonfromhistoryisthattechnologicalchangecanrelievetheeconomy oftheconstraintsofaresourceinfixedsupply.Moreparadoxically,wefindthat an increase in population can stimulate both technological change and div- isionoflabour,therebycounteractingtheimpactofdiminishingreturnswhen land resources per producer fall. In Chapter 4 I explore this finding further. The pre-industrial economies differed in their capacity to balance negative andpositiveeffectsfrompopulationincrease.Theoutcomeisnotdeterminis- tic: some regions and nations experience slow economic growth while others haveperiodsof growthfollowedbystagnation. Proposition5:Populationgrowthtendstoincreasedemandandhencedivisionof labouraswellastechnologicalprogress(Pepys’rule). We often take institutions as given, but in a historical analysis, we cannot and should not do so. Institutions develop spontaneously or by design; they regulate use of and access to resources and the conditions for exchange. It is useful to look for efficiency characteristics in institutions. In the absence of contract enforcement mechanisms, exchange which involves future delivery will be severely restricted, for example. However, institutions which regulate theaccesstoresources,thatispropertyrights,haveanimpactonthedistribu- tionof welfare,andpersistentinstitutionsmaysurviveonlybecausetheyserve powerfulelites.InChapter5Idiscusstheinterpretationandimpactof institu- tions and note that there is often a bewildering variety of institutional solu- tions to the same economic problem. I ask questions like the following: why 6 Introduction:Whatiseconomichistory? are farms generally small and managed by those who work there, whereas industrialfirmsarelargeandmanagedbythosewhoownthefirmratherthan thosewhoprovidelabourservices?Itturnsoutthatinsomecasesinstitutions failbecausetheyareinefficient,buthistoryalsotellsusthatinefficientinstitu- tionsmaysurvivebecausetheyservevestedinterestsandpowerfulelites. Proposition6:Efficientinstitutionsareoftenstable,butstableinstitutionsarenot necessarilyefficient. The industrial revolution in the eighteenth and nineteenth centuries was foundedonasetofmoderninstitutionsaswellasnewmechanismsservingthe growth of science. Chapter 6 explores the foundations of modern economic growthandtheconditionsfortechnologytransfer.Duringmostof thehistory of mankind technology has been based on knowledge derived from experi- ence in production, which is learning by doing. Such knowledge can develop bychanceorbydeliberatetrialanderror.However,thesetechnologiesarenot based on theoretical or scientific understanding. The great leap forward in technological development is associated with the breakthrough in the nine- teenthcenturyofknowledgegainedthroughtheoreticalandscientificinquiry. This industrial enlightenment,as it has been called,has its roots in preceding centuriesbutbecomesadecisiveforceonlyinthesecondhalfofthenineteenth century.From being slow,technological progress became the prime mover of economic growth by the end of the nineteenth century. It turns out that the vastmajorityofproductsandproductionprocessesthatcametodominatethe twentiethcenturywereinventedinthenineteenthcentury.Sincetechnologyis essentially the useful application of knowledge and ideas,which are non-rival in nature (i.e. your use of knowledge does not reduce the availability of it), we would expect transfer of best-practice technology among nations to lead to convergence in the levels of technology and income across nations.We do indeedobservethisconvergence,butitisnotuniversal.ThisisaparadoxsinceI amarguingthatwhatmattersisafactor–ideasandknowledge–whichisnon- rival.However,beinginthepublicdomaindoesnotimplybeingeasilyaccess- ible or easily applied.We need to know whysome nations were not able to use available knowledge of superior technologies and develop institutions which helped the efficient use of resources. It turns out that technology transfer is dependent on institutional and educational pre-conditions which, if absent, willmaketransferimperfect. Proposition7:ScienceandR&D(ResearchandDevelopment*)arerecent phenomenaintechnologicaldevelopment.Fasttechnologytransferafter1850 7 Outlineofthechapters ledtoconvergencebasedoncatch-upamongeconomiesthathadanappropriate educationalandinstitutionalinfrastructure. over thousands of years money developed into an increasingly efficient instrument of credit and payment. Banks are a more recent phenomenon, emerging only in the late medieval period and not reaching maturity until the nineteenth century. Banks are intermediaries between savers and inves- tors (spenders).They reconcile the savers’desire to hold liquid assets with the investors’need for long-term finance,and they reduce risks by holding diver- sifiedassetportfoliosbeyondthereachof individualsavers.Despitetheinher- entlyriskynatureofbankingandfinance,itispossibletoshowhowbanksover time reducedriskandcostsintransactions.Furthermore,thedevelopmentof banksincreasedsavingsandinvestment.Thebreakdownof afinancialsystem intwelfth-centuryEuropewouldhaveeffectsontrade,butinthepresentworld it threatens all economic activities.The evolution of money,credit and bank- ingisexploredinChapter7. Proposition8:Bankshavedevelopedasintermediariesbetweensaversand investorsbyreducingriskinsaving,bysolvinginformationalasymmetriesandby monitoringborrowersmoreefficientlythansaverswouldbeabletoontheirown. BeforetheIndustrialRevolution,internationalcapitalflowsandinternational trade were limited; the first wave of globalization occurred in the nineteenth century. The institutional foundations of a functioning international trading system and monetary regime are explored inChapters8 and9.although there are net gains for nations that trade, there are winners and losers within each nation. Sometimes the losers dictate trade policy and the result will be trade restrictions and a globalization backlash, as in the interwar period (1920–40). Whileitiseasytounderstandthatamajorityof loserscandictateprotectionist policies,likelandownersinEuropeintheclosingdecadesofthenineteenthcen- tury,we also face the paradox that small minority groups,such as farmers,can lobbysuccessfullyfortariff protection100yearslater.Explainthat! Proposition9:Netgainsfromtradedonotprecludewinnersandlosers.The protectionistparadoxisthatbothlargeandsmallgroupscansuccessfully lobbyforprotectionism*andwin,butfordifferentreasons.Badtimesfoster protectionism,butgoodtimeshelpfreetradeforces. International monetary regimes, discussed in Chapter 9, have varied sig- nificantly throughout history. The relative merits of fixed exchange rates vs. 8 Introduction:Whatiseconomichistory? floating exchange rates cannot be determined in a straightforward way. The advantages of fixed exchange rates in stimulating trade and capital mobility were noted in the nineteenth century, but these phenomena have also been present in the floating exchange rate regimes emerging since the mid-1970s. Fixed exchange rates tend to restrict the ability of policymakers to impact on domesticeconomies,andfloatingexchangeratesarethereforefavouredwhen there is a demand for an activist domestic economic policy, as emerged after the breakthrough of democracy in Europe in the early twentieth century. although economic orthodoxy led Europe back to the Gold Standard,a fixed exchangerateregime,ithadneithertheequilibratingmechanismsnorthelon- gevity of the classical Gold Standard of the period before the FirstWorldWar. Thelessonsfromtheinterwarperiodwereappliedintheexchangerateregime introducedaftertheSecondWorldWar,givingnationsmoresayoverdomestic monetarypolicyattheexpenseof freecapitalmobility.Butasystemwithfixed exchange rates in the short run and adjustable exchange rates in the long run fell victim to its own contradictions.The twentieth century was not made for fixedexchangerates. Proposition10:Thehistoricalrecordsuggeststhatwidespreaddemocracyseems tobedifficulttoreconcilewithafixedexchangeratepolicybecausesuchapolicy constrainsdomesticeconomicpolicyoptions. Chapter10exploreseconomicgrowthandeconomicpolicyinthetwentieth century.Thatcenturycanbedescribedastheeraof politicaleconomybecause it witnessed the transformation of the minimal state to the activist state. The balance between politics and markets differed and the‘over-politicized’econ- omies of the Socialist bloc ultimately failed because they did not deliver the goodspromised.Themixedapproachfavouredintherestof Europewasmore successfulinthecombinationof competitivemarketsandextensiveinsurance schemesprovidedbytheWelfareState.WeinterpretWelfareStateprovisionsas a response to market failures in insurance and the need for life-cycle smooth- ingof income. The book illustrates the fragility of free trade policies and fixed exchange rates under pressure from an international crisis. But I also demonstrate the powerofeconomicpoliciesinrevivinggrowthinadepression,andthetragedy of erroneous policy responses, as in Germany leading to the ascent of adolf Hitler. The interwar period paved the way for a new economic policy regime characterizedbymoreactivefiscalandmonetarypoliciesofKeynesianpersua- sion.Ishallchronicleitsbirth,near-deathandresurrection. 9 Outlineofthechapters Proposition11:Theideathattheeconomywasaself-regulatingand equilibratingprocesswaskilledbytheGreatDepression,andaftertheSecond WorldWarEuropeworkedoutanewbalancebetweenpoliticsandeconomics, pavingthewayforactivistfiscalandmonetarypolicies.TheWelfareStateis primarilyaninter-temporalredistributioninstitutionwhichisexplainedby marketfailuresandhumanlackofself-control. Chapter11discussesinequality,pastandpresent.WhileEuropeconverged, the income gap between the rich industrialized countries and the rest of the world increased dramatically from around 1800 and has gone on increasing uptothepresent.Thedevelopingnationsarepoormainlybecausetheyarenot capableofcreatingtheinstitutionalandeducationalconditionsfortechnology transfer.Thespectaculargrowthinrecentdecadesof economiesinSouthEast asia indicates the power of institutional change. Industrialization and mod- ernizationusuallyincreaseinequalitywithinnationsbecauseofbottlenecksin the supply of skilled people.But by expanding human capital investment and easing access to higher education inequality will be reduced, as in Europe in the twentieth century.However,there are persistent wage differences between menandwomenthatarebasedondiscrimination. Proposition12:Worldincomeinequalityhasprobablypeakedafter200yearsof increasedincomegaps.Moreequalityaheadneednotbejustwishfulthinking butwillbetheresultofanincreasingnumberofnationsgettingtheinstitutional infrastructureneededfortechnologytransfer. Chapter 12 deals with the challenge and opportunities of globalization. Iarguethat,onbalance,globalizationbringsnetbenefitstotheworldeconomy. Buttherearelosersandwinners.anumberofquestionswillbeaddressed.Will globalization put downward pressure on (unskilled) wages in the rich coun- tries? Will wages in poor and rich countries converge? Will there be a‘race to thebottom’asregards‘labourstandards’,thatishoursandconditionsofwork? The preliminary answer to the first two questions is yes,but it is no to the last question – if we are allowed to judge from the experience of the first era of globalization. Proposition13:TheworldeconomyjustbeforetheFirstWorldWarwasas globalizedastheworldeconomytoday.Therewasconvergenceofwagesinthe firsterabutnotaracetothebottomin‘labourstandards’. ThemakingofEurope 1 1.1 Thegeo-economiccontinuityofEurope TheformationofEuropewasalonghistoricalprocesswhichinvolvedpolitical, culturalandeconomicforces.Themoststrikingfactisthegeo-economicper- sistence and continuity of Europe during the last two millennia.We will deal with the integrative impact of trade as well as its border-maintaining effect in shaping and maintaining Europe.Trade was the cohesive force when political andmilitaryconflictsthreatenedtotearEuropeapart. If we let the core of Europe be defined by the borders of the European Union,wecantracebacktheoriginsof thatgeographicalentitytotheRoman andCarolingianempires,thelatteremergingintheninthcentury,severalcen- turies after the collapse of the Roman Empire. (See Maps 1.1–1.3). about 80 percentof thetotalpopulationof theRomanEmpirearoundtheyear100aD lived within the present (2010) borders of the European Union. It stretched from the atlantic coast to the Black Sea. Ireland, the northern periphery of Europe, Scandinavia and Russia were touched by neither the Roman nor the Carolingian rulers. Russia’s relationship to Europe has remained ambivalent throughoutitshistory,withperiodsof self-imposedisolationaswellasenthu- siastic embracing of European ideals, and Scandinavia was late in joining the European Union; in fact norway is still making up its mind whether to join ornot. The Carolingian Empire represented the revival of political order after the disintegration of the Roman Empire, and also the emergence on the polit- ical scene of Germanic peoples, who amalgamated their own traditions with the adopted culture, law and language of their Roman predecessors in their southandwestwardpush.Germanictribesalsoadvancedtowardstheeast,but kept their own language and pushed the Slavic languages back eastward when theysubjectedtheindigenouspeoplesandtheirland.Ittookcenturies,infact a millennium of conflicts, for the present map of nation states forming the 10 750 miles 1000 km 750 500 500 250 RomBaurdadyhf hentuyAnDEmpire 250 0 0 Rome AN EMPIRE M RO TheRomanEmpirearound200CE Map1.1 400 miles 600 km 500 300 400 200 300 BodundioisstfyhfierdhretfeeADby 200 100 Prague 100 Rome 0 0 Augsburg Venice Genoa Aix-la-ChapeVerdun ons Ly s ri Toulouse Pa itiers Po CAROLINGIAN EMPIRE TheCarolingianEmpirearound850CE Map1.2 Iran Azerbaijan EuroC paandiUantoncountry Kazakhstan Iraq Armenia Georgia a Syri rey Tu Russia va Ukraineldo an d Belarus F i l Estonia Bulgaria Latvia Romania a bia k S er MacidonGreece Lithuania v Alban ne land lS de w Hungary S Po Bosnia- Croatia Montenegro Rep. Herzegovina ay Czech Austriaa any Slov Italy Norw Denmark Germ Liechtenstein Tunisia Neltahnedr-s Switzerland UnKiegddom Belgium Monaco Luxeancerg Fr Algeria Andorra Iceland Spain Ireland lag utro P 750 miles Morocco 1000 km 500 750 500 TheEuropeanUnionyear2010 250 250 Canary Islands 0 0 Madeira Map1.3 14 1ThemakingofEurope European Union to emerge, and it is worth noting that the heartland of the RomanEmpire,thatisItaly,wasnotagainanationstateuntilinthelatenine- teenth century.after Rome and after the partition of the Carolingian Empire the new nations remained smaller. at one extreme we have the prosperous merchantcitystatesof Italy,forexampleVenice,emergingintheeleventhcen- tury, and at the other extreme a large nation state emerging in France as the westernpartof thedisintegratingCarolingianEmpire.Theageof empireswas not to appear again until the European colonial expansion of the nineteenth century. We delineate a nation or a union of nations by borders because borders representthelimitofpoliticalauthorityandthecapacityofthestatetotaxand spend on roads and public goods*, such as defence and law and order institu- tions. nations form because they offer economies of scale* in providing these publicgoods.Thesizedistributionofnationshasvarieddramaticallythrough- out history,but the reason for that has probably more to do with politics than with economics. Since the breakdown of the unified Carolingian Empire, nationalbordershavebeenredrawnrepeatedlyafterbitterandcostlyconflicts. The great historical paradox is that despite disruptive political forces Europe remainedasaunitofculturalandinstitutionalhomogeneitybecauseofstrong cohesiveforces,of whichtradewasthemostimportant. 1.2 Europetrades,thereforeitis! Throughout history, the intensity of trade has been stimulated by the prox- imity and similarity of nations. nations close to each other trade more with eachotherthanwitheconomiesfaraway.Whentradeexpands,itdoessomore with those nations already part of the trading network than with those on the fringe of that network. This is true today but was even truer in the past, whenlandtransportcostswereoftenprohibitivelyhighforcommoditiesother than luxury goods: silk was transported over long distances, but bulky com- modities like grain were not. over land a commodity like grain was not nor- mally transported more than 100 km, but since the cost of sea transport was only about 10 to 25 per cent that of land transport, grain could be and was shipped over longer distances by sea,for example from the Baltic coast to the atlantic ports in Europe. Dried cod (stoccafisso), was shipped from norway to the Mediterranean in the late medieval period. a large economy will typ- ically stimulate trade with the surrounding economies very much like a force of gravity. Trade transmits goods, but also common languages, commercial law,culture,preferences and technology.Intense trade makes economies with 15 1.2 Europetrades,thereforeitis! initialdifferencesmoresimilarinalltherespectslistedabove.Economiescome tosharesimilartechnologiesand,asaconsequence,similarincomelevelsthat will also stimulate trade.However,if trade was stimulated by proximity alone we would not see the evolution of regional entities like Europe,because there are always nations at the margin or limit which are close to some neighbours. nations at the margin would therefore tend to extend the limit successively. Whydidthatnothappen?Thereasonwas‘traderesistance’duetolackofsimi- larity of nations at the geographical margins as well as the distance from the largetrade-generatingcoreeconomiesof Europe. although empire building like that of the Romans tended to create homo- geneity in language and law, there were limits to the extension of empire. These limits were set by the mounting costs of policing frontier areas as well as the falling revenues from populations at a lower level of income. at the geographicalmargin,theforcesof gravityfromthelargecoreeconomieswere too weak to generate sufficient trade. Furthermore, the neighbouring econ- omies differed in income levels and technology, in culture and preferences, in language and law,and these differences remained because they constituted a barrier to trade. When technology and income levels differ among trading partners, trade volumes will be low irrespective of proximity. Relatively rich nations find the export prospects of poor nations too small. a lack of com- monlyacceptedcurrencyunitsmadetransactionsdifficultorbasedonbarter,* which also reduced the volume of trade. as a consequence the initial lack of similarity was broken down in the proximity of a core economy – but only in the proximity. For areas further away heterogeneity was maintained or increased when the frontier area started to adopt the institutions – say the money or contract resolution institutions – of the core economy. The impli- cation is that if the periphery is initially poor it may remain poor because it is left untouched by the knowledge, commodities and institutions that trade is bringing.Wecalltheseforcesbordereffects*.Youcanthinkof abordereffectas a high transaction cost imposed on trade which is not present in trade within theregionorempirewhichhasacommonlegalandmonetarysystemandlan- guage.Bordereffectsreducetradeandthereforemaintainthelackofsimilarity between neighbouring economies in the border areas.a telling illustration of bordereffectsisthediffusionof lateRomanpotteryfromaparticularproduc- tion site in southern France.The pottery was shipped as far as Hadrian’sWall in Britain, north africa and all over the Empire, but there are practically no finds north of the River Rhine, as indicated in Map 1.1. So the border of the Empireconstitutedaformidableobstacleforthistypeof commodity. The impact of border effects on trade is illustrated in Figure 1.1, which demonstrates the trade and trading costs of an economy (C as in Core), with 16 1ThemakingofEurope Trade with core economy, trade costs Trade costs Trade C Distance from core Figure1.1 Theimpactofdistanceandbordereffectsontrade trading partners scattered along the vertical axis at increasing distance from the C economy. Trading costs, mostly transport costs, increase with distance fromtheexportingnation.owingtoincreasingtransportcosts,theproximity effect,andthefactthatthesimilarityof nationstendtodecreasewithdistance, trade will diminish with increasing distance from the C economy. a border effect represents an upward shift in the trade cost curve and will be associated withadownwardshiftinthevolumeof tradeschedule. Wecanilluminatetheargumentbyanexamplefromhistory.Thearabcon- quest in the eighth and ninth centuries of northern africa and the Iberian peninsula, once part of the Roman Empire, created a cultural and religious barrier to trade in the Mediterranean. The core of Europe moved away from theMediterraneanworldtowardswesternandcentralEurope.HenriPirenne, aBelgianeconomichistorian(1862–1935),focussedonwhatwerelatercalled border effects, in this case the negative effects on trade of a cultural and reli- gious divide, in analysing the decline in Mediterranean trade and imports to northern and western Europe after the arab conquest. Why would religious andculturaldifferencesaffecttradenegatively?Inthecontextof longdistance tradeexportersandimportersneedtotrusteachother.Trustisneededbecause atraderinGenoacannoteasilyverifythattheimporterinalexandriaisrightin claimingthattheshipmentfromGenoahasbeendamagedduringthepassage. Different cultures, which also have different procedures for settling disputes, 17 1.2 Europetrades,thereforeitis! might discriminate against strangers. By and large trust is easier to build if people share common beliefs and a common code of conduct that develops into common rules of contract enforcement.Within Europe a fairly uniform setof rulesandinstitutionsemergedastradepickedupinthemedievalperiod to assist in settling contractual disagreements, honouring promises and pro- tectingforeignmerchantsfromarbitraryactionsbylocalmerchants. Recent research based on the ample finds of arab coins in Western Europe suggests that the trade between the arab and European nations probably did not decline as much as maintained by Pirenne; part of the reason for the low tradingactivitywasprobablythefactthatEuropewasjustrecoveringfromthe decline following the demise of the Roman Empire. Poor nations simply do not trade much.To the arabs Europe was a backwater.However,Pirenne was right in focussing on border effects and pointing out that previously flourish- ing trade relations deteriorated as a consequence of a cultural and religious divide.Buttherewereotherculturaldivides. The diffusion of ideas and goods and the exercise of authority are helped by a common language. Most of the Germanic tribes which flowed into the Roman Empire were fast learning the language and the law of their hosts,but in the rest of Europe, the local languages remained. Compared to the Roman Empire,tenth-centuryEuropewasmuchlesshomogenousinlinguisticterms. Manytongueswerespoken,buttradersandmerchantsoftenadoptedaregion- ally uniform language in transactions.For example,varieties of German were generally spoken in the Baltic area, since trade was dominated by Germans. However, with the advance of the Christian faith which also gradually pen- etratedtheBalticarea–oftencommercialandspiritualmissionswenthandin hand – a universal language,latin,was used all over Europe since the Church insisted on its liturgical use. It was also standardized by the Church, but was usednotonlybytheclergybutbythesecularelitesaswell.asaconsequencethe elites were united culturally by one language,and the schools and universities which emerged from the twelfth century,teaching law and theology,attracted students from all over Europe. For example, the early thirteenth-century bishopandersSuneseninlund(southernSweden),whichwasontheperiph- eryof Europeatthistime,waseducatedinFrance,ItalyandEngland.Muchof higher learning relied on results already obtained inantiquity,and when that learningwasforgottenandneglectedinEuropeitsurvivedamonglearnedmen in the Muslim world and was then rediscovered in Europe. Algebra, alchemy and algorithm are words borrowed fromarabic,and with the words came the learning. Similarity, proximity and the absence of (strong) border effects stimulates trade.Isthatpredictioncorroboratedbythedata?Table1.1conveystheanswer 18 1ThemakingofEurope Table1.1 Intra-European trade and trade with ROW (Rest of the World), in 2005. Percentage of total trade Importing EU25 Denmark France Germany Italy Netherlands Spain Sweden UnitROW country Norway Kingdom Exporting Switzerland country Denmark 76% 5% 18% 3% 5% 3% 13% 9% 24% France 67% 1% 15% 9% 4% 10% 1% 8% 33% Germany 72% 2% 11% 7% 4% 5% 2% 8% 28% Italy 65% 1% 13% 14% 2% 8% 1% 7% 35% netherlands 82% 2% 9% 25% 6% 4% 2% 9% 18% Spain 76% 1% 20% 12% 9% 3% 1% 9% 24% Sweden 72% 7% 5% 11% 4% 5% 3% 8% 28% United 67% 1% 10% 12% 5% 7% 6% 2% 33% Kingdom Source:Totaltradedata:Eurostat:Europeinfigures,Yearbook2005–2006:epp.eurostat.ec.europa.eu/cache/ITY_ oFFPUB/KS-CD-06-001/En/KS-CD-06-001-En.PDF EU25consistsof:Belgium,CzechRepublic,Denmark,Germany,Estonia,Greece,Spain,France,Ireland,Italy,Cyprus, latvia,lithuania,luxemburg,Hungary,Malta,netherlands,austria,Poland,Portugal,Slovenia,Slovakia,Finland, Sweden,UnitedKingdom for present-day Europe. The table indicates that about three-quarters of the tradeof individualEUnationsiswithintheEUplusnorwayandSwitzerland. Wealsonotethatforeachnationsimilarity,presumablyinlanguageandpref- erences,mattersalot.Denmarkhasalargershareof itstradewithacompara- tively small economy,Sweden,than with much larger economies,the UK and France. But proximity might explain part of the difference. Denmark’s trade with Germany is three times larger than its combined trade with Spain and Italy. European trade as a share of income was smaller in the past but it has alway
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