EH Lecture 4

The Great Divergence

Industrial revolution begins in C18th Britain. In some world regions transition to modern economic growth occurs soon thereafter (Western Europe, North America). In many other regions it’s delayed by many decades and even centuries => Great divergence.

The ascent of the rich

After Britain, Western Europe and North America are the first regions to transition to modern economic growth.

Standard model of development

Like Britain, Western Europe and North America had accessible coal and relatively high wages. They could thus profitably adopt Britain’s new labor-saving technologies after micro-innovations had improved their efficiency.

In addition, countries made a deliberate effort to catch  up with Britain by employing the standard model of development:

1)     Railways: integration of domestic market

2)     Schools: promotion of mass education

3)     Banks: finance industrialization

4)     Tariffs: protection of domestic industry

Changes in in C19th, C20th

In mid 1800s Germany’s railway system is still fragmentary

By 1880 Germany's railway network has caught up with Britain’s

Europe-China comparison: early C20th railway networks

Mass education quickly spread in the West.

Tariffs were comparatively high in the West.

Why was Tariff protection a peculiar Western characteristic?

Tax systems of eastern empires predominantly land-based, not trade-based as in Europe.

-        Europe: small countries -> high external trade-ratios

-        Eastern empires: large empires -> low external trade-ratios

-        Mercantilist tradition in Europe

Military imbalance emerges in the C19th

-        Asymmetric free trade treaties in exchange for military support

-        Free trade militarily imposed

-        Gunboat diplomacy

Colonial empires: colonies had no tariff autonomy.

Important competition and deindustrialization

Industrial revolution arrives in form of import competition, rather than through diffusion of modern production technologies.

-        In contrast to the West, little tariff protection for domestic prot-industries.

-        Geographic misfortune: distance between pre-modern manufacturing centers and coal.

While Industrial Revolution spreads within West, de-industrialization becomes the dominant force in many other parts of the world.

Cotton textile industry: Anglo-Indian comparison

In 1680:

-        British cotton textiles cost 2x as much as Indian cotton textiles

-        And British wages were 4x higher than Indian wages

=> British cotton textile industry was uncompetitive, but survived behind protective tariffs.

By 1820:

-        British cotton textiles cost half the price of Indian cotton textiles

-        Although British wages were 5x higher than Indian wages

=> Most of this reversal was due to a 3-fold increase in British TFP

Western textiles begin to dominate world markets

=> East’s comparative advantage shifts to primary goods production.

Great Specialization, Deindustrialization, Great Divergence

New Economic Geography (NEG) models explain the joint occurrence of trade specialization and income divergence through increasing returns to scale and agglomeration effects.

Core-periphery pattern: If region A specializes in production with increasing returns and region B in constant returns production, region A will grow faster than region B (which deindustrializes).

C19th transportation costs plummet => great specialization => Great Divergence begins.

Caveats to Deindustrialization thesis

Counterexamples: several regions transitioned to modern economic growth while specializing in primary production.

Terms of trade effects: Manufacturing growth in the industrial core regions could become an engine for growth to many primary goods exporters.

-        Rising global raw material demand increased raw material prices.

-        Glut of manufacturing goods churned out by European factories led to a decline in the price of manufactures.

Timing: per capita incomes in China and India had been trending downward centuries before Western important competition began.

Long-run decline in China and India of GDP.

Terms of trade effect benefitted primary good exporters

=> Periphery could tap into global commodity demand boom.

Examples of primary producers transitioning to modern growth

But China and India were no frontier economies: ecologically badly positioned to benefit from primary goods demand boom.

Technology transfer challenges: Japanese agriculture

Japan only East Asian economy to transition to modern economic growth in C19th

-        It applies the standard model of economic development

-        But: not tariff autonomy due to U.S. gunboat diplomacy

Meiji Restoration (1868): Japan makes deliberate effort to modernize

-        Imports U.S. agricultural technology -> failure

-        U.S. technology ill-adapted to Japan’s low land-labor ratio

Why was U.S. agricultural technology not very useful in Japan?

C19th U.S.: high land-labor ratio

=> High wages induce labor-saving mechanization, i.e. big farming machines (habbakuk thesis)

=> These machines work best on large tracts of plain fields

Japan’s next trial: land-saving biological and chemical innovations

-        Fertilizers and improved plant varieties => success. Per capita agricultural output rises.

Hayami-Ruttan thesis

Hayami-Ruttan: different endowments require different technologies. Output per capita can be increased in different ways:

Y/L = Y/A * A/L

Land-abundant U.S.: machines increased Y/L by increasing the land area each worker could farm, A/L

Land-scarce Japan: bio-chemical technology increased Y/L by increasing the output per hectare, Y/A

Differences in initial factor endowments can give rise to multiple paths of technological development. Transition to modern economic growth often requires the capacity to innovative, rather than copying of existing technologies.

Institutional transfer challenges

Likewise, simply copying existing institutions may not work.

Djankov et al 2003: institutions are endogenous choice that a society makes to navigate between 2 undesirable extremes

-        Anarchy: High private expropriation risk (gangs kunnen overrulen)

-        Despotism: High state expropriation risk (overheid kan overrulen)

A society’s trade-off between these 2 extremes depends on its institutional possibility frontier (IPF)

Factors determining a societies IPF: civil society/social capital, conflict resolution capacity, ethnic polarization etc.

Institutional possibility frontier and optimal institution choice

e.g. Land use disputes.

Private orderings: citizens settle disputes themselves.

Anarchy risk: disputes can turn violent leading to anarchy.

Despotism risk: absent strong state, no state expropriation risk.

State ownership: government official adjudicates disputes.

Anarchy risk: strong state squashes private anarchy.

Despotism risk: citizens can be expelled from land based on autocratic caprice.

 

Different societal fundamentals => different institutions minimize social losses due to private and state expropriation.

E.g. Rwanda: steep IPF due to history of ethnic conflict. Independent judges may increase expropriation risk if judges manifest a preference for their own ethnic group.

Caveats: how fundamental is the anarchy-despotism trade-off? => why not focus on measures that shift IPF inwards? E.g. foster broader ethnic identities. Can be misused to interpret any despotic government as optimal.

Increasing returns and multiple equilibria

Poverty traps can delay the transition to modern economic growth

Poverty traps and Big Push Policies

Examples of poverty traps:

-        No infrastructure <=> no economic activity

-        No steel mill <=> No coal mine

Transition to modern economic growth may require a Big Push

-        Gerschenkron thesis: late-industrializers may require greater state initiative to overcome missing prerequisites.

-        Heavy government involvement in C20th East Asian industrialization often interpreted in this way.

Big push policies

After the Big Push rapid transitory growth kicks in.

East Asian Convergence

Sudden transition to rapid catch-up grown after 1950.

Caveats

Kraay & Mckenzie (2014): since 1950s poverty traps are rare in practice -> remaining poverty has deeper roots (geography, institutions,…)

Big push policies often rely on close informal relations between government, banks, and firms -> corruption risk

Relation-based system difficult to maintain as economy grows

=> Transition from relation-based system to rule-based system.

Soviet Union and the limits of central planning

-        Central Planning could cope with mass production technologies

-        But failed to keep up with frontier developments in late C20th: mass customization, application of ICT.

Examples of Big Pushes gone wrong: Stalinist industrialization (USSR, 1920s-1930s), Great Leap Forward (China, 1958-62)

Soviet TFP flatlines in 1970s.

Back to deep roots of economic growth

To extent that deep root factors are determinants of transition to modern economic growth they might also help us to better understand the Great Divergence.

Deficiencies in one or more of deep roots may have contributed to delaying the onset of modern economic growth in some regions.

European deep root peculiarities may have facilitated the onset of modern economic growth there.

Which regional differences in geographic endownments, institutions, culture, … can explain the Great Divergence?

Geography: California school

California school argues that leading regions in China and Europe were very similar except for 2 geographic pecularities.

Europe

-        Abundant supply of accessible coal

-        New World resources: complement European Industry

China

-        Yangzi valley very far from coal

-        No access to periphery resources to complement its industry

-        Ecological constraint in China itself already binding

=> Europe industrializes, China does not.

New world windfall shifts Europe’s endowment to E^eu. Perfect complements: Industrial production IP only gets going with the complementary New World resource.

Caveats: Lower Yangzi imported similar amounts of cotton from India as Britain did from America. Europe sourced raw materials from elsewhere too. How crucial were colonial goods to Industrial revolution?

Disease environment: TseTse fly and African development

TseTse fly transmits parasite that causes sleeping sickness in humans and is deadly to livestock => lack of animals for transport, plowing, and manure.

Alsan (2015): TseTse linked to..

-        More slavery

-        Lower population density & less political centralization

=> Developmental headwinds

Institutional legacy effects: different colonization policies

Extractive states in regions with high European morality rates

-        No checks and balances, little protection of property rights

=> Bad for long-run growth (e.g. Africa, Latin America)

Neo-Europes in regions more hospitable to settlement

-        Checks and balances, protection of property rights

=> Good for long-run growth (e.g. Australia, North America)

These institutional differences persisted and partly account for income differences in modern times.

Caveats of different colonization policies

Modest degree of institutional persistence over C20th. (corr = 0.2)

European settlers did not just bring their institutions with them: Hard to clearly identify institutional effects and separate them from cultural factors and human capital effects.

Bad disease environments also affects native populations: some geographies come with higher disease burden than others.

-        Sachs(2003): when accounting for present-day Malaria risk the size of institutional effect estimate by AJR (2001) halves.

Reliability of settler mortality data? (>20% extrapolations)

Institutions: Late adoptions of business law in islamic world

Middle East and North Africa adopted corporations only very late:

-        1851: first joint stock company founded in Ottoman Empire

-        1908: first corporate law passed

Traditional Islamic contract law only recognized natural persons

=> No legal standing for corporations, no commercial courts

Available economic partnerships became null and void at the withdrawal, incapacitation, or death of even a single partner => Discouraged investment in large and long-lasting ventures.

A European Deep root peculiarity: early corporations

Traditionally: kinship groups solved many economic problems (e.g. social safety net, education, conflict resolution, pooling resources for business)

Western Church discouraged emergence of kinship groups (e.g. discouraged polygamy, divorce and remarriage, cousin marriage)

Demand for corporations:

=> By late medieval period nuclear families were dominant

=> Need for new institutions to solve old economic problems

Supply of corporations:

Roman/Germanic legal heritage had corporation precedents. In C11th: papacy formulated corporate law on this basis (no royal permissions required, right to set rules for its members, i.e. self-governing)

=> Europe’s family structure and legal heritage conducive to early proliferation of corporations (recap Commercial Revolution).

(e.g. incorporated cities, mutual-insurance guilds, universities, monestaries, firms)

Church exposure, kin networks, and institutional development

Communes: city with local administration in which at least part of citizens participated.

Extended prohibitions: prohibitions of marriages between higher order cousins.

Geography meets institutions: The Engerman-Sokoloff thesis

Latin America’s geography suitable for plantation crops for which scale economies favor large slave plantations

=> Inequality in wealth, education, and political power

=> Exclusive institutions restrict commercial and political opportunities to small elite

North America’s geography more suitable for grain farming for which scale economies are less important.

=> More egalitarian outcomes

=> Inclusive institutions

Example: regional governments in latin America dominated by landed interests unwilling to fund public primary schooling well into the C20th => low literacy rates.

Cultural and Institutional legacy effects: African slave trades

Ethnic groups that were more severely affected by the Atlantic and Indian Ocean slave trades (C15th-C19th) today still have lower levels of trust in relatives/neighbors/local officials and lower incomes.

Enslavement through:

1)     Tricking & selling

2)     Raiding & capturing

3)     Instrumentalized judiciary

=> Trust lowered, transactions costs went up, development went down.

Low trust is transmitted across generations internally (e.g. family norms, a bit more than 50%) and externally (e.g. institutions, a bit less than 50%) and can explain income differences today.

Low versus high slave export countries’ GDP growth

=> Low slave export countries do a lot better than high slave export countries.

A European Deep root peculiarity: high impersonal trust

Recap: In Europe church family policies and roman/Germanic legal heritage had brought about an early proliferation of corporations.

Cultural effect: loosening of intensive kinship norms and emergence of WEIRD psychology.

Intensive kinship norms: conformity, obedience, in-group loyalty & trust => facilitates intra-group cooperation.

Loose kinship norms (WEIRD): individualism, independence, impersonal fairness & trust => facilitates nonskin cooperation across kinship groups. (BETER, want meer network)

Cultural barriers to knowledge diffusion in India?

Roy (2008) argues that informal institutions in C19th India were hindering knowledge diffusion across social groups.

Artisanal knowledge was controlled by kin-based collectives with strong barriers to entry.

Little communication occurred across occupational groups -> insular knowledge

Example: Would have been uncommon for master carpenters to directly interact with weavers to construct custom-made new loom.