What Were the Real Growth Penalties of Britain’s

Early Start?

Nicholas Crafts

Keynote Lecture, Maddison Memorial Conference, Amsterdam, November 6, 2010

Long-Run British Economic Growth• Aim is to understand the relative economic

decline of the first industrial nation

• Basic proposition: history matters for growth performance

• Policies and institutions matter greatly but are not always easy to reform; yesterday’s solutions may be tomorrow’s problems

Angus Maddison’s Legacy

• Evaluating British economic performance requires long-run international and inter-temporal comparisons of productivity

• Growth accounting is a key ingredient; but we have to consider both the proximate and the ultimate sources of growth

• Angus’s work facilitated a transformation in the terms of this discourse enabling the notions of catching-up, falling behind, and forging ahead to be quantified

• The huge debt that we owe him will be obvious as this lecture proceeds

Source: Crafts and Toniolo (2008)

Real GDP/Person

UK/USAUK/West Germany

UK/France

1870 130 173 170

1913 93 135 141

1950 73 162 132

1979 70 86 88

2007 75 109 104

Penalties of the Early Start• Is sometimes argued that being the pioneer impaired

later growth performance; if so, how and when?

• ‘Path dependence’ is the obvious way to make this claim; going beyond QWERTY!

• Possibilities include

• Dutch disease (over-commitment)

• Institutional legacy

• Constraints on policy

• Is it pre WWI or post WWII?

Relative Economic Decline (1)• Quite apparent from the 1870s through the

1930s; catch-up by Europe, catch-up and then overtaking by USA

• Acceleration in US TFP growth after 1890 not matched by UK

• Idiosyncratic technological progress, intangible-capital-based endogenous innovation central to US productivity growth

• Unique American advantages or British failure?

Growth of Real GDP/Hour Worked (% per year) (Huberman & Minns, 2007; Maddison, 2003)

UK USA

1870-1890 1.28 1.45

1890-1913 0.79 2.06

1913-1929 1.88 3.19

1929-1938 1.21 3.00

Crude TFP Growth (% per year)Abramovitz & David (2000); Crafts (2004)

UK

1856-1889 0.6

1889-1913 0.4

1924-1937 0.8

USA

1855-1890 0.4

1890-1905 1.3

1905-1927 1.3

1929-1948 1.5

Late-Victorian Britain

• Choices of technique basically correct

• Foreign investment profitable, portfolio diversification valuable, banking not so bad after all

• Emulation of USA not feasible in non-neoclassical world (non-universal technology, different geography) but this is not really a problem of the early start

• BUT could better economic policy have made a difference?

Did Late-Victorian Britain Fail?

• New Economic History said NO!; subsequent research says this is a bit too strong

• Competition in a very open economy was central to the NEH argument (McCloskey &

Sandberg, 1971); if correct, implies Golden-Age UK much more susceptible to failure

• But examples skewed to tradeables; look at a sector where competition and shareholders are both weak and productivity performance is much more questionable

Late-Victorian Railways (Crafts et al., 2008)

• Cost inefficiency in late 1890s substantial; 10% for median company, cost 1% GDP

• Subsequent elimination of much of this inefficiency as profits fell to unacceptable levels suggests managerial satisficing; action taken when fall out of comfort zone

• Foreshadows much more general problem that surfaced in Golden-Age UK

Productivity in ServicesBroadberry (2006)

• Growth of productivity in services more important than in manufacturing for American overtaking

• ‘Industrialization’ of services, where high-volume, low-margin business based on hierarchical management realized economies of scale based on new technology, lagged in UK

• Demand, education, competition all played a part

Labour Productivity Growth, 1870-1910 (% per year) (Broadberry, 2006)

UK USA

Manufacturing 1.1 1.3

Services 0.4 1.1Transport & Communication 0.7 2.5

Distribution -0.3 1.3

Finance & Other 0.9 1.4

The Over-Commitment Hypothesis

• Richardson (1965): pre-WWI UK skewed to low productivity-growth sectors (old industries); a ‘lock-in’ based on comparative advantage in a free-trade economy

• Protectionist policies needed to counter the hangover of the early start; problem solved in interwar period when new industries deliver economic revival

• Economic structure is the problem; government intervention is the solution

Structure of UK Trade

• Revealed Comparative Advantage looks very different from USA, is persistent and unlike 20th century leader

• UK RCA strong in old industries, weak in R & D-intensive sectors

• Agglomeration benefits explain some of this

Revealed Comparative Advantage Rankings (Crafts, 1989)

UK 1913 UK 1937 US 1913 US 1937

Agricultural Equipment 10 16 2 1

Cars and Aircraft 12 11 4 2

Industrial Equipment 5 7 3 3

Electricals 8 5 5 4

Iron and Steel 3 9 9 5

Non-Ferrous Metals 16 15 1 6

Book and Film 13 8 10 7

Chemicals 11 12 12 8

Metal Manufactures 7 13 6 9

Brick and Glass 14 10 11 10

Wood and Leather 15 14 7 11

Rail and Ship 1 3 8 12

Fancy Goods 9 4 13 13

Apparel 6 6 14 14

Alcohol and Tobacco 4 1 15 15

Textiles 2 2 16 16

Would It Have Been Better to Abandon Free Trade?• Free trade unusual and a legacy of the early

start

• Shift-share analysis says difference between UK and US is overwhelmingly is intra-sectoral productivity growth not structure

• Does not address slow productivity growth in services or incentives to innovative effort

• Chamberlain tariff would have shifted employment further away from structure that Kennedy and Richardson want (Thomas, 1984)

Interwar Tariffs

• Richardson thought that WWI and 1920s tariffs were a good infant-industry policy

• Kitson & Solomou (1990) found that productivity growth accelerated in newly- protected but not in non-newly protected industries in the early 1930s

• Doubtful that protection improved productivity performance either in the short or the long run (Broadberry & Crafts, 2011)

Difference-In-Differences Analysis of Productivity Growth Revisited

1930/5 – 1924/30 =

0.733 + 1.321 Additional - 0.974 Early(1.026) (1.384) (-0.762)

1935/48 – 1924/35 =

-1.228 + 0.109 Additional - 1.843 Early(-2.993) (0.200) (-2.584)

The 1930s: Onward and Upward?

• Trend growth did not increase (Greasley & Oxley, 1996; Mills, 1991)

• Correctly measured, the labour productivity gap with the US widened further

• TFP growth remained modest and investment stayed low

• This is not the optimistic picture that the over-commitment school painted

US Real GDP per hour worked in manufacturing (UK = 100) (De Jong & Woltjer, 2009)

150 160 170 180 190 200 210 220 230 240 250 260 270 280 290

Longer-Term Implications of the 19th Century Development Path

• UK exceptionally vulnerable to interwar ‘globalization backlash’

• World-market share of export staples unsustainable

• ‘Outer Britain’ depended on exports of staples

• Labour market adjustments required by changes in world economy extremely difficult

Insured Unemployment in Interwar Britain (%) (Beck, 1951)

June 1929 June 1932 June 1937

South East 4.4 12.3 4.9

East Anglia 5.8 15.4 6.9

South West 7.7 16.1 6.5

West Midlands 9.0 22.0 6.2

North 15.2 36.4 16.8

North West 12.7 25.3 12.7

Scotland 11.0 26.8 14.0

Wales 18.2 37.4 20.7

The ‘Managed Economy’ Strategy of the 1930s

• Post-1932 dirty floating, cartels, tariffs understandably seen as damage limitation and a way to restore profitability

• This implied a major reduction in competition which lasted well into the post-war period

• The reduction in competition reduced productivity growth both before and after WWII (Broadberry & Crafts, 1992, 1996)

• The claim that the 1930s represents an antidote to Victorian failure is seriously misleading

Malign Implications of the Interwar Period• Loss of faith in the market economy to deliver

full employment

• Future competition for votes would have to address this issue

• Shocks had adverse long-term effects both direct and indirect

• The episode was especially unfortunate for UK because future policy was constrained and the new policy framework interacted badly with the institutional legacies of the early start

Hypothesis

• The problems of the early start were not Dutch Disease and an inability to protect new industries before World War I

• The key transmission mechanism was the persistence of institutions together with the policy framework resulting from the severe interwar problems to which the early start exposed us

• The real penalties of the early start were felt after World War II

Institutional Legacies (1)

• By the later 20th century, the UK was characterized by an unusual degree of separation of ownership and control (Cheffins, 2008)

• Relatively few large firms had a dominant external shareholder; principal-agent problems a big concern, especially when competition was weak

• UK followed a path from 19th-century origins to ‘Anglo-American’ (rather than German) capitalism promoted by revisions to company law, taxation, transition from personal to institutional investors

Institutional Legacies (2)

• The early start produced a distinctive and persistent ‘British system of industrial relations’

• Characteristics include craft control, legal immunities, multi-unionism, TUC rather than LO, effort bargains that influenced technical choice

• E.g., the ‘British system of mass production’ (Lewchuk, 1987)

• 19th-century organizational structures became dysfunctional but employers did not find it worthwhile to pay the price/take the risk to abolish them

Institutions Differ• West Germany vs. UK: industrial

relations and capital markets

• UK firms more exposed to hold-up problems given multiple unions (Bean & Crafts, 1996)

• UK firms more exposed to agency problems especially given weaker competition (Crafts & Mills, 2005)

Competition and Productivity Growth

• Absence of competition allows managers to be sleepy if ineffective control/monitoring by shareholders

• Competition is strongly positive for productivity outcomes in UK firms without dominant shareholder (Nickell et al., 1997)

• Competition promotes better management practices (Bloom and van Reenen, 2007)

• Patenting performance of UK firms suggests inverted U-shaped relationship with price-cost margin which peaks at about 20% (Aghion et al., 2005)

Relative Economic Decline (2):UK in the Golden Age• Does deserve to be analyzed; it can be seen in

the data even if it is also a notion constructed for political purposes

• UK was overtaken; growth appreciably lower than it could have been

• Reflects adverse incentive structures

• Happened in a period of protectionism and weak competition

Source: Crafts and Toniolo (2008)

Levels and Rates of Growth of Real GDP/Person 1950-1973 ($1990GK and % per year)

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Levels of GDP/Person and GDP/Hour Worked ($1990GK) (The Conference Board,2008)

1950 Y/P

1973 Y/P1950

Y/HW1973

Y/HW

France 5271 13114 5.00 15.72

West Germany 4281 13153 4.36 16.05

UK 6939 12025 7.35 14.05

Competition in Golden-Age UK

• Undermined by nationalization, protectionism and largely ineffective competition policy

• Price-Cost Margins much higher than in West Germany or post-1970 UK (Crafts & Mills, 2005, 2011)

• Tariffs remained at 1930s levels through the mid 1960s; when trade costs fell, mark-ups collapsed; median tariff twice West German level in late 1950s (PEP, 1962)

• UK strongly exposed to agency-problem firms: emphasis on industrial rather than competition policy a serious error (cf. Aghion et al., 1997)

Restrictive Practices Act (1956)

• The one competition-policy reform during the Golden Age with teeth

• Had significant impact on productivity

• 1954-63 compared with 1964-73: productivity increase in non-colluding sectors unchanged but in formerly-colluding sectors rose by 1.8% per year (Symeonidis, 2008)

Trade Costs Index (Jacks et al., 2009)

UK-France

UK-Germany

1929 100 99

1938 121 122

1950 122 142

1960 122 115

1970 110 105

1980 74 66

Trade Costs and the Mark-Up(Crafts & Mills, 2011)

0.2

0.4

0.6

0.8

1.0

1.2

1.4

1950 1955 1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Manufacturing markupTrade costs: UK-FranceTrade costs: UK-Germany

After the Golden Age: Competition and Productivity Performance

• Increases in competition correlated with 1980s productivity growth at sectoral level (Haskel, 1991)

• Openness and TFP growth strongly correlated across manufacturing sectors post-1970 (Proudman & Redding, 1998)

• Post-1980, restructuring and divestment replaced diversification and conglomeration that had prevailed under inadequate corporate governance (Toms & Wright, 2002)

Industrial Relations• The legacy has big costs in this period including

not achieving the Eichengreen co-operative equilibrium

• Craft control was increasingly costly as American mass-production methods improved further

• Multi- (relative to single-) unionism implied a reduction of 0.75 percentage points per year in TFP growth for affected sectors (Bean & Crafts, 1996)

• Effort bargaining was bad for TFP: “underemployment of labour is one of the major scandals of the British economy” (Clegg, 1964)

Increased Competition:Effects via Industrial Relations

• Weak competition in product markets generates rents that can be partly appropriated by unions with bargaining power into higher wages and lower effort

• During the 1980s and 1990s, increased competition reduced union membership, union wage mark-ups and union effects on productivity (Brown et al., 2008; Metcalf, 2002)

• Multiple unionism in an industry reduced TFP growth by 0.75pp from the 1950s through the 1970s but had no effect in the 1980s (Bean and Crafts, 1996)

Traditional Criticisms of Postwar British Industry

• Weak and incompetent management

• Difficult industrial relations

• Seriously inefficient use of inputs

• NB: these were all nurtured by inadequate competition in product markets interacting with the historical legacy

Conclusions

• The problems of the early start were not Dutch Disease and an inability to protect new industries before World War I

• The key transmission mechanism was the persistence of institutions together with the policy framework resulting from the severe interwar problems to which the early start exposed the UK

• The real penalties of the early start were felt after World War II