Saturday, June 9, 2012

What you know about economic history is bunk

Back to Deirdre McCloskey's book, Bourgeois Dignity: Why Economics Can't Explain the Modern World. Her main question is what caused the extraordinary sixteen-fold leap in income of the industrial revolution?I discussed the causes of the industrial revolution before in connection with Joel Mokyr's book, the Gifts of Athena. I said:

It is of course perhaps the most significant question in economic history, but the precise sequencing and details is of more limited general interest.
But I find McCloskey's points are of much broader interest. She persuasively argues that many of the conventional ways we think about growth and development are wrong when it comes to explaining the biggest surge in growth of them all.


For one thing, "competitiveness" appeals to many in journalism because it's like a horse race. And a horse race is a story. And stories sell newspapers. It is also a staple of politics and business schools. She takes issue with Michael Porter's book Competitive Advantage of Nations:

Howard Davies and Paul Ellis, though, put their finger on the central confusion underlying Porter's book-it confuses "`competitiveness' construed as productivity and 'competitiveness' construed as the market share held by a sub-set of industries." Being productive, producing a great deal with few inputs, is certainly a good idea. No one would dispute that. It is called Getting Rich By Being Smart. But getting a large market share has little to do with getting rich, or being smart.
And the cost of being less competitive are not so serious in a world where possibilities are going supernova. Take Britain's relative loss of competitiveness in the twentieth century, for example.

The prize for merely second place, or tenth place, was not poverty, or even loss of political hegemony. "Beaten' Britain is still the eighth-largest economy in the world, the second-largest source of direct foreign investment, and a permanent member of the United Nations Security Council; and London is the second-largest financial center in the world.
The familiar business world of differentiation and barriers to entry and first-mover advantage can help explain the distribution of the pie, but not the size of the pie.


Nor was the industrial revolution caused by thrift, saving, investment or accumulation. (Micawber exaggerated.) There had been high savings rates in many other times and places - extremely high, if you count peasants having to save a fourth of one low-yielding crop as seed for the next year.

Thrift or prudence did not increase in the childhood of modernity. Actual saving stood high before modern times, and did not change much at the time of modern innovation. It changed only after the innovation had given us new opportunities to invest.
The professionalization of history in the twentieth century has led to discovery that many previous arguments are simply wrong (and I take her at her word on this.)

The history of thrift was revolutionized around 1960, in other words, when economists and economic historians realized with a jolt that thriftiness and savings could not explain the Industrial Revolution. The economists such as Abramowitz, Kendrick, and Solow discovered that only a smallish fraction of recent economic growth can be explained by routine thrift and miserly accumulation (and even that fraction depended, I say again, largely upon innovations pushing out the productivity of capital accumulation).


And so it turns out that many nineteenth century thinkers, including Marx, were wrong about the facts. This is particularly interesting. I wasn't aware of the more recent historical change of mind.

For all Marx's brilliance-anyone who does not think he was the greatest social scientist of the nineteenth century has not read enough Marx, or is blinded by ideology or by the appalling effects of Marxian writings on the politics of the twentieth century-he got the history wrong... another of the discoveries of the 1960s by economic historians was that the savings demanded by England's heroic age of mechanization were quite modest, nothing like the eventually massive offspring of the "original accumulation of capital" that Marxist theory posits. Early cotton factories were not capital-intensive.
That is a little annoying if you have written a three-volume book called, er, Capital. There is a silver lining to this, however. If prosperity was not caused by capital accumulation, it means there is less potential damage from diminishing returns to capital.

During the 1930s and early 1940s the prospect of diminishing returns deeply alarmed economists such as the British economist John Maynard Keynes and the American follower of Keynes at Minnesota and Harvard, Alvin Hansen. They believed that the technology of electricity and the automobile were exhausted, and that sharply diminishing returns to capital were at hand, especially in view of declining birthrates. People would save more than could be profitably invested, the "stagnationists" believed, and the advanced economies would fall into chronic unemployment.Stagnationism proved false.' Instead, world income per head grew faster from 1950 to 1974 than at any time in history, and the liberal countries boomed. That is, innovation prevented the return to capital from declining.
This is of more than contemporary interest, given the "search for yield" in the years running up to the financial crisis. Not to mention the fact that US Treasuries have negative real yields along most of the curve, and, as we saw recently, the zero returns of most venture capital firms in the last ten years. The returns to capital are becoming increasingly mediocre. But that does not necessarily mean anything for the returns to innovation. You just can't count on being a rentier and living off risk-free government bonds. (And ask holders of Spanish bonds about that, too.)

Primitive Accummulation

Marx and his followers since have also been wrong in believing that there had to be some kind of original sin in capital accumulation.

The original accumulation was necessary (Marx averred) because masses of savings were necessary, and "conquest, enslavement, robbery, murder, briefly, force, play the greater part." He instanced enclosure in England during the sixteenth century (which has been overturned by historical findings that such enclosure was economically minor) and in the eighteenth (which has been overturned by findings that the labor driven off the land by enclosure was a tiny source of the industrial proletariat) and enclosure happened then mainly in the south and east where in fact little of the new sort of industrialization was going on, and where agricultural employment in newly enclosed villages in fact increased).'
Not only does Marx not explain what happened in England. The theory does not explain why the frequent murder, conquest and slavery through the rest of recorded history did not produce an industrial revolution. The West is not rich because the developing countries are poor, either.

Modern economic growth has not depended on saving, and therefore has not depended on stealing to get the saving, or any other form of original accumulation.

Education and human capital

Nor was the industrial revolution a consequence of education or knowledge in isolation. After all Chinese mandarins had been superbly educated for millennia. It mattered what kind of knowledge and eduction and attitudes people had. In fact, the wrong kind of education could kill off innovation.

Yet education without the new bourgeois rhetoric is merely a desirable human ornament, not the way to human riches. It makes for a clerisy that may in fact be hostile to bourgeois values, and very willing to be of professional service to the antieconomic projects.Without a liberalized attitude toward innovation, however, such sophisticates would have worked at keeping their country impoverished. The educated Chinese elite did. The educated Spanish elite did.
She keeps coming back to her core argument: Innovation is the key. And innovation requires living with the consequences of change. And that requires respect for bourgeois dignity rather than aristocratic or traditional status. Of course, it's possible that the causes of the industrial revolution two centuries ago may have little to tell us about the prospects or dilemmas which confront us now. But all of these argument have substantial relevance to contemporary policy debate. For example, I'll have to think a bit harder about the rationale for lower capital gains taxes (much as I like their effect on my portfolio.) And the arguments about primitive accumulation have huge implications for many left-wing projects. There was no original guilt. She says near the end:

The Marxist and the reactionary views of economic history-in many ways they are the same view-have poisoned our political lives for a century and a half. If we're going to have a future, it is desirable that we know what really happened, and listen to the lessons derived from the really-happened, and not go on and on getting inspiration for our politics from historical fairy tales of left or right.
I'll be interested to see if other economic historians dispute some of her historic points. But the logic seems sound to me, at least as presented here. And that is a matter of some importance. And there's quite a bit of ground left to cover in coming posts, too.


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