Economic History Lecture 1

Why study Economic history?

1) Economic data typically non-experimental, history offers natural experiments

2) Economic data can be scarce, history offers more observations for rare events

3) Economic Data can be path dependent (to understand present, history has to be studied)

Example: What are effects of money supply changes?

Observation: Expansionary monetary policy is correlated with low GDP growth

Can we now say that Expansionary monetary policy causes low GDP growth? No, because of the identification problem: monetary policy reacts to past, present, and expected future economic conditions.

Soon after 1492 Columbian voyage to America the Spanish started to exploit the rich silver deposits in New World. This initiated a 300 year period during which silver coins were shipped from the New World to Spain => Spain’s money supply is subject to the vagaries of the sea.

More than 30 maritime disasters with substantial silver money losses occurred => Repeated natural experiments allows for measurement of the effects of money supply changes.

Effects of maritime disaster losses in Spanish Empire

Prices adjusted slowly, because of price rigidity.

Real output contracted by around 1% for every 1% reduction in money arrivals (short-run money neutrality)

What is a caveat regarding natural experiments?

External validity and how applicable the results are to other countries and periods.

Important phenomena that happend rarely:

Pandemics

Wars

Financial crises

Consequences of Pandemics on K and L? (and w and r)

Labor scarcity, because people get sick. So less people who can do the work, so wage increases.

Abundant capital per worker, which will make the return on capital lower, so r will go down.

Consequences of War on K and L? (and w and r)

Both L and K drop. Exact net situation depends on the proportion changes in K/L.

Findings consistent with Standard Neoclassical Growth Model

Pandemics → K/L up, w up and r down.

Wars → Led to capital scarcity and lack of capital per worker (K/L down) => r increases. Every investment in K will give a lot for workers who after the war have little capital.

How long do post-war economic recoveries take?

Even after severe destruction of proximate causes of economic growth, GDP per capita returns to pre-war trend within less than 2 decades.

If war results in destruction of fundamental causes of growth, long-term growth can suffer.

Proximate causes of economic growth (Short-run)

Capital inputs

Labor inputs

Fundamental causes of economic growth (Long-run)

Technology access, institutions, geography

Relatively fast post WW2 economic recoveries

GDP per capita returned to pre-war trends within 2 decades.

Recovery of destroyed cities

Long-run city growth remarkably resilient to destruction.

Fundamental vs proximate causes of growth

Regions subject to more fundamental institutional and policies changes can experience long-run effects.

Income losses in financial crises versus normal recessions

In financial crises a lot worse than normal recessions.

Economic consequences of financial crises

Normal recessions: Temporary (1-2 years), and 1-2% fall in real gdp per capita.

Financial crisis recession: more persistent for many years and more than 5% decline of real GDP per capita.

Many important economic variables exhibit long salient cycles. Salient long-cycles:

International capital and goods market integration

Inequality

Debt/GDP-ratios

Also, distant past can be more relevant than close past. History does not repeat, it rhymes.

Example: Great Recession - Great Depression Parallels

Kumhof et al. (2015) highlight 3 parallels between Great Recession after 2008 and Great Depression in 1930s.

1) Preceded by rising top income shares.

2) Preceded by rising Debt/GDP-ratios

3) Accompanied by financial crises.

They propose a model that links all 3 phenomena:

a) Rich households have lower marginal propensity to consume.

b) Higher top income share → more savings → lower natural rate.

c) More borrowing → higher debt/GDP-ratios → more crisis risk.

U.S. economy was crisis prone in both 1929 and 2008.

Examples of path dependency, initial conditions and the persistent effects

QWERTY keyboard

Railway track gauge

Example: Why did the Industrial Revolution start in C18th England?

According to induced innovation thesis the British Industrial revolution was a path dependent process that origined in mid C18th England’s unique factor price combination. Initial condition, was the unique combination of factor prices:

1) Wages relatively high

2) Energy (coal) cheap

3) Capital cheap (interest rates low)

=> Entrepreneurs have incentive to develop and improve energy-intensive and labor-substituting machines (steam engine, Spinning Jenny)

Persistent effect: Onset of modern economic growth.

Factor Price and technology choice in textile manufacturing. Spinning jennies in 1790 in England around 20000, in France only 900. Why the difference?

Spinning jennies not cost-effective in France, given lower French-wages, cost minimization in France implied employing more workers with old-fashioned spinning wheels rather than investing in new novel spinning jennies.

What explains the initial conditions?

Why was coal cheap? Geographical luck.

Why were wages high? - C14th plague and Commercial Revolution and Atlantic trade.

Why didn’t the Plague lead to an equal wage increase everywhere?

Why didn’t the Atlantic trade equally benefit Portugal and Spain?

Path-dependent system: No steady state from where to start and to which to return.

In a path-dependent world disruptive events can push the world economy into a new path:

Technological changes: Improvements in ship design & discovery of sea route around Africa (1497).

Geopolitics: WW1 and the Russian Revolution.

Climate change: e.g. Late Antique Little Ice Age.

Epidemics: e.g. 14th century Plague.