Economic HistoryLecture 1

Pablo Martinelli pablo.martinelli@uc3m.es Office:

18.2.C.11Office Hours: Monday, 18:00-

19:00

OUTLINE

• Presentation and Rules of the Game• What is this course all about:

– Modern Economic Growth: the Big Picture– Proximate causes of growth– Ultimate causes: Macroexplanations

Rules of the Game (I)• Assessment: “Continuous Evaluation”

• 50% Final Exam• 50% Weekly Tutorials. Further details: Wednesday

• Attendance to Tutorials is compulsory!• ≤ 4 unjustified* absences: each one counts as 0 in the

relevant activity• >4 (i.e., 5 or more): no “continuous evaluation”

• Missing “continuous evaluation” Final grade = 60% of the final exam mark.

* “unjustified” means “without medical certificate”

Rules of the Game (II)• Silence is compulsory• If questions, ask• If doubts persist, come to office hours (but

always write before and/or arrange an appointment).

• Lecture slides will be online. Suggestedreadings at the end

• Weekly readings for tutorials are compulsory

Rules of the Game (III)• No textbook• Most subjects in some of the following:

• Rondo Cameron and Larry Neal (2002, 4th ed.) A Concise EconomicHistory of the World

• Robert C. Allen (2011), Global Economic History. A Very Short Introduction

• Karl G. Persson (2010) An Economic History of Europe• Broadberry and O’Rourke (eds., 2010, 2 vols.) The

CambridgeEconomic History of Modern Europe.

• Eichengreen (2008, 2nd ed.) Globalizing Capital• Eichengreen (2007) The European Economy since 1945

• For specific topics, I will tell you in the correspondingclass.

TODAY:INTRODUCTION TO

MODERN ECONOMIC GROWTH

Modern Economic Growth: Definition• “A country's economic growth may be

defined as a long-term rise in capacity to supply increasingly diverse economic goods to its population” (Nobel laureate Simon Kuznets, 1971)

• That is, MEG is a sustained increase in income/output per capita and means:– More of the same goods available– New goods available

World Economic History (according to Clark)

MEG (data from Maddison)

Btw, subsistence is about here (5.6 =ln(275) 1990 $)

Not much room for improvement since100.000 BP!

Modern Economic GrowthFeature #1:

Very Recent Phenomenon• Stagnation and income at subsistence not sure

before 1800 (or 1500), but extremely slowgrowth (if any)

• Human economies experienced several radical transformations (Upper Palaeolithic explosion, the Neolithic revolution), but no steady growth

GDP p.c. (1990 GK int. $): A closer look...

Modern economic growthFeature #2: Divergence

• Differences are getting bigger, not smaller.• Difference in income per capita between UK

and India:– in 1500, only 30 %.– in 2010, over 700%.

• Difference between poorest and richest country– 1960: 30 to 1– 1990: 70 to 1

• The rise of China may be changing this

Modern economic growth Feature #3: Persistence

• Most countries that are rich today, were already rich in 1800 or even 1500 (Western Europe).

• Japan, first, then East Asia and now Chinaand India are the exceptions.

Modern economic growthFeature #4:

Conditional Convergence• MEG started in NW Europe and eventually

spread to some countries All rich now• Some poor countries converge towards

rich ones, provided something else happens

• What? The Holy Grail of Economics!

Money matters for living standards!

UK 1800

UK 2000

Modern Economic Growth: Questions

• Proximate causes– Why does it happen?

• Ultimate causes– Why did it start in UK around 1800?– Why did it spread to some countries and not to

others? Why are some countries so rich and others so poor?

Modern Economic Growth:Proximate causes

• What are we measuring?– Economic growth: the change of the total output

produced by an economy in a given time interval• Why does this happen?

– Remind the production function! Either you• use more inputs or• use them more efficiently (i.e. Technological

progress)

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Production factors, technology, markets

BLACK BOXCAPITA

L

Inputs(Entradas) OUTPUT

(Salidas)

AVAILABLE TECHNOLOGIES

Demographicbehavior Education

Saving

LABOR

LAND

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Changes in Y

Changes in L

Changes in K

Solow residual

Unexplained part of growth

The Solow Model• Production (Y) is obtained by combining labour (L)

and capital (K) into a production function (F), with a given level of technical efficiency (A or “Total Factor Productivity”, TFP)

• Y=F(A, L, K)• If F is “well behaved”, you get “diminishing returns

toeither L or K”

• In terms of welfare, production per capita is the relevant variable. Hence, it is convenient to express everything in terms of labour units: Y/L=F(A,K/L)

Solow Model: more ingredients• Capital is accumulated by saving a portion s of

income and investing it (I)• Every year, population grows at rate n.• Hence, new capital has to be allocated to new

individuals if K/L is to remain constant• Moreover capital depreciates at rate d (machines

broke after a certain period of use, etc).• Hence, new capital has to be allocated to replace the

depreciated capital.

Solow in a nutshell

k=K/L

y=Y/L

I0=sy0

y0=F(TFP0,k)

(d+n)*k

Steady state k 0

Steady state y0

K/L

y=Y/L

y0=F(TFP0,k)

(d+n)*k

I1=sy1

I0=sy0

y1=F(TFP1,k)Technical Change shifts upwards the Production Function

K/L

y=Y/L

y0=F(TFP0,k)

(d+n)*k

I1=sy1

I0=sy0

y1=F(TFP1,k)Steady state y1

K/L

y0=F(TFP0,k)

(d+n)*k

I1=sy1

I0=sy0

y1=F(TFP1,k)Steady state y1

y=Y/L

Contr. ofΔk

Contr.ofΔA

In words:• In a Solow world, growth by mere K accumulation has limits:

the steady state.• Changes in technology shift upwards the PF and allow

furthergrowth.

• Hence both TFP and K accumulation are the main proximate causes of growth.

• How do we measure the contribution of each factor?– i) We try to find the form production function with statistical

techniques– ii) We decompose output growth in its “measurable”

components (K and L).– iii) The residual is attributed to changes in TFP (“Solow

residual” – “the measure of our ignorance”)

“Residual” very important in the 20th century.Contribution of residual to overall growth

1873-1913

1913-1950

1950-1973

1973-1992

UK 26 % 31% 40% 44%

US 47% 41% 8%

Germany 23 % 55 % 65 %

Japan 39% 26%

What causes Technological Progress?• A) First models: “Is exogenous” (i.e., we don’t really know).• B) “Endogenous Growth Theories”: it is another production

factor (Human K), with no diminishing returns. But, then, why did growth start so late in history?

• C) “Unified Growth Theories”: similar to EGT, but incorporates demography in order to explain the delay in HK accumulation, secular stagnation, the demographic transition and sudden growth

• Most of these macroeconomic models focus on how countries grow once MEG starts; some (UGT) even explain why it should start at some point in human history…

• …but none explains why are some countries that adopt MEGwhile other don’t, as well as the timing of adoption and delay!

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Ultimate causes. Big theories, explaining who was rich in 1500 or 1800• Non-human made

– Geography – Jeffrey Sachs– Ecology (“Sophisticated geographical hypothesis”) –

Jared Diamond– Natural resources, coal, position

• Human made– Imperialism– Culture – Landes, Weber– Scientific revolution and the Enlightment – Mokyr– Institutions – North & Thomas, Acemoglu

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Geography: the direct effect• Distance to equator is positively correlated with

development (Jeffrey Sachs)• Many parts of Africa have high prevalence of

malariaand other diseases, also poor soils

• Land-locked countries have higher transport costs and more difficult access to main markets

• Many of the poorest countries in the world are landlocked (no access to sea): Mali, Burkina-Fasso, Afghanistan, Laos, Mongolia, Bolivia, Paraguay

• Being close to the main markets is also good for exports (although the effect of distance is fading over time).

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GDP p.c. (PPP) today

Population density 1918

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Geography (2)• Limitations:• Nogales (Mexico) and Santa Cruz county (New Mexico,

US) are a few kilometres away: Nogales has an income per capita of 10,000$ and Santa Cruz of 30,000 $. Geography alone cannot explain this difference

• Haiti and the Dominican Republic: same island but Haiti income per capita in 2007 of 1,155 $ and Dominican Republic of 6,705 $.

• Some remote economies are among the richest of theplanet (Australia)

• Does not explain income differences at similar latitudes

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Ecology• Jared Diamond: Guns, Germs and Steel• European or Asian empires in the 15th

and 16th centuries• Eurasian superiority: shipping, military

technological superiority (powder, iron, horses etc), contagious diseases

Ecology - 2• Eurasia develops first because

– Europe and Asia go from West to East as opposedfrom North to South (like Africa or America)

– Easier to transfer crops– Greater preponderance of plants with high ratios of

grains to plant/tree (wheat, rice) (means plants grow fast, making agriculture possible) (wheat, rice also superior to corn or yams)

– Got lucky in the domestication of big mammals (cowsand pigs as opposed to buffalos or elephants)

– Proximity to large domesticated mammals – greater immunity to flu, tuberculosis, etc (reason why European diseases killed millions of indians)

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Ecology (3)• These cumulative effects made the Neolithic

Revolution begin earlier in Eurasia than in any other independent origin of agriculture

• Surplus food production allowed larger sedentary and stratified societies, with specialists non engaged in food production technological and military superiority

• Hence, Eurasia conquers the world and notthe other way around

Ecology-3• Limitations

– Does not explain superiority of Europe over Asia until late 20th and 21st century

– Does not explain large differences among European countries (Spain vs UK for example)

– Does not explain decline (Italy after 1600,Spain after 1600 etc)

– Does not explain the “Reversal of Fortunes”

Imperialism• Earliest capitalist institutions appear in the

colonial trade (East India Company, etc)• Primitive accumulation• Cheap raw materials• Captive markets for metropolitan exports

But (and without endorsing imperialism!)• Huge empires did not benefit Spain or Portugal, which started

to decline in the 16-17th centuries.• US: massive success without empire.• Colonial trade is tiny part of aggregate 18th century economy,

although London and Amsterdam• Not as good a business as we think (lots of risk and high

costs)• Capital flows in the 19th century go to the empire (railroads in

India for example) not the other way round. Further investment in guaranteeing order, infrastructure, and administration. It is not clear that a cost-benefit analysis of empires throws a positive number.

• Not the best market for European exports: low incomes, and slow growth.

Culture• Concept is difficult to define.• 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 transmitted generation through generation.

• Entrepreneurship, hard work, social capital (trust), risk taking are important for development

• Corrupt practices need no to be permanent: US verycorrupt in the early 20th century.

• To what extent are corruption and poor institutional quality related to culture?

Culture: Fertility and development

• “European marriage pattern” vs the traditional marriage pattern– Increases age of marriage (to about 25

years old)– Many women remain single– Reduces fertility rate by about 40 %.

• But is the fertility transition a universal phenomenon?

52

I am not sure there aredifferent cultural patterns…

Culture: Religion• Max Weber thesis (The Protestant Ethic and

the Spirit of Capitalism, 1905):– Original version: Protestantism favours individual freedom

and responsibility, hardworking etc.– Modified version: Promotes literacy and education good

for growth (Becker and Woeßmann, QJE 2009)

• In Muslim countries: rights of women, high fertility rates (may distort resource allocation).

• More generally, Landes: Judeo-Christian beliefs are anthropocentric favour modifying nature and scientific inquiry

How strong correlated after MEG steps in?

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Culture: Limitations• East Asia Fast growth after decades of stagnation,

keeping same cultural traits• Religion does not account for income differences among

(Jamaica vs Canada) or within (Italy, Germany) countries, nor for the timing or spread of MEG

• The adoption of religions also depends on economic, political, social, military factors

• Is culture immutable?• Huge differences in economic outcomes for countries close

from each other sharing the same culture and geo- environment. Example: North and South Korea.

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Institutions

• Almost all human-made explanations collapse towards “institutions”: incentive mechanisms explaining why some behavioural scheme is adopted

• Explain North vs South Korea• Haiti vs Dominican Republic• Central idea: incentives matter,

incentivesto specialise, trade, invest, innovate.

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Institutions 2: Definition• Douglas C. North (1993 Nobel prize in

economics) “Institutions are the humanly devised constraints that structure political, economic and social interaction. They consist of both informal constraints (sanctions, taboos, customs, traditions, and codes of conduct) and formal rules (constitutions, laws, property rights). Throughout history, institutions have been devised by human beings to create orderand reduce uncertainty in exchange.”

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Institutions 3• North, a leading figure in “New Institutional

Economics” Institutions central to MEG• An institution is “efficient” (in the NIE

sense) when it brings the private benefits of an economic activity closer to the social (public) net benefits by reducing– Externalities

• Negative (pollution): producers win, society loses• Positive (invention): producers lose, society gains

– Transaction costs

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Institutions 4. Transaction coststime needed to set up a business, World Development Report

2005, World Bank

-50

300

250

200

150

100

50

00 5000 10000 15000 20000 25000 30000 35000 40000 45000 50000 55000 60000

GNI per capita 2005

days

to s

tart

a

busi

ness

61

0.0

20.0

40.0

60.0

80.0

100.0

5. Judicial / Legal Effectiveness. Source: World Bank

120.0

0 10,000 20,000 40,000 50,000 60,00030,000

GNI per capita, 2005 $

judi

cial

ef

fect

iven

ess

Investor protection index, 2005

0

2

4

6

8

10

12

0 5000 10000 15000 20000 2500030000

35000 40000 45000 50000 5500060000

62GNI per capita

inve

stor

pro

tect

ion

0.0

20.0

40.0

60.0

80.0

100.0

4. Public Sector Ethics Index (PSEI) source: World Bank (2005).

120.0

0 10,000 20,000 40,000 50,000 60,000

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30,000GNI per capita (2005 $)

inde

x of

pub

lic s

ecto

r et

hics

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Good institutions are good for growth …• But what is cause and what is effect?• For example better paid and better trained

judiciary can appear because a country is now richer

• Better paid public servants are less corrupt (policemen in Mexico City vs policemen in Madrid)

• A literate and richer population is easier to tax

Institutions 5Acemoglu & Robison (2012)

• 2 kinds of institutions:– Economic institutions: determine economic

incentives of individuals– Political institutions: set the economic

institutions• 2 possibilities:

– Extractive or inclusive institutions

• Extractive economic institutions: rent seeking, privileges for few (monopolies, guilds, etc), no free entrance

• Inclusive economic institutions: allowpeople to freely allocate their resources

• Political exclusive institutions: closed elite has the power.

• Political inclusive institutions: political power widely distributed and pluralistic (with a certain degree of state centralisation)

• Inclusive economic institutions are the key to MEG

• They allow “creative destruction”• Innovators invest and implement their

innovations without fear to be expropriated• Economic losers from innovation have no

way to prevent failure but to innovate themselves

• In the long run, only inclusive political and economic institutions can sustain MEG

EXTRACTIVE POLITICAL INSTITUTIONS

INCLUSIVE POLITICAL INSTITUTIONS

EXTRACTIVE ECONOMIC

INSTITUTIONS

INCLUSIVE ECONOMIC

INSTITUTIONS

UNSTABLE EQUILIBRIUM

UNSTABLEEQUILIBRIUM

EXTRACTIVE POLITICAL INSTITUTIONS

INCLUSIVE POLITICAL INSTITUTIONS

EXTRACTIVE ECONOMIC

INSTITUTIONS

Rulers extract rents from the economy with help of the state, which is put in charge of avoiding the emergence of alternative

Political power widely distributed makes rent extraction insecure:•Economic elites incentives to overthrow existing institutions

sources of economic power •Economic privileges eroded

INCLUSIVE ECONOMIC

INSTITUTIONS

Political power concentrated and freedom to allocate resources:• Political elites incentives to

close economic institutions (fearing to be overthrown)

• Emerging economic power incentives to:

• a) capture political power for themselves

• b) turn to inclusive political institutions

Political power widely distributed and freedom to allocate resources incentives to MEG

OK, but how did we get here?• Acemoglu: It’s politics• Basically, interaction between economic

and political institutions is not predictable• At some point in history, “something”

happens (“critical junctures”) that reshapes the existing political-economic equilibrium

• Then there is a chance to end up with bothinclusive ec&pol insitutions

• Not strong predictive power...

If chance is so important, keep trying!

• Maybe Europeans get institutions right simplybecause they had more trials

• Dense sedentary societies but politically fragmented continent:– Institutional competition among polities

• Why fragmentation?– Difficult to keep unified, difficult to conquer;

several physical barriers, different environments, lots of coast and rivers, etc (Jones).

They all failed...

But then...

• A) We end up with a complex interaction between non-human and human made factors!

• B) Why some countries adopt “right” institutions while other don’t?

• We really need to further deepen on this

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Yet, against long run determinants, there are cases of successful adoption

• Meiji Japan in the late 19th century• Other East Asian countries in second half

of XXth century• China?

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Conclusions• The biggest question in economics (Why

some countries are rich and others poor?) has not yet a definitive answer

• This is good news! The question is still open and attracts the best minds in the profession…

Key books about some important issues in this class• Basic readings:

– Jared Diamond, 1997, “Guns, Germs and Steel”. Have a look at Chapter 4(Farmer Power), though the whole book is worth reading.

– Daron Acemoglu and James A. Robinson, 2012, “Why Nations Fail. The Origins of Power, Prosperity and Poverty”. Interesting book that has become a bestseller. Theoretical and general insights are much more worth reading than some of its applications. Have a look at Ch. 3 and 4, where their main point is made.

• Further readings:– Eric Jones, 1981, “The European Miracle. Environments, Economies and Geopolitics in the

History of Europe and Asia”. One of the most authoritative assertor of the thesis of Europe’s “optimal degree of fragmentation”.

– Douglass North and Robert Thomas, 1973, “The Rise of the Western World: A New Economic History”. Their main points are made in ch. 1 and 2.

– Joel Mokyr, 1990, “The Lever of Riches: Technological Creativity and Economic Progress”.

– David Landes, 1998, “The Wealth and Poverty of Nations”. A modern classic, advocates fora key role of values.