Second Partial Economic History, Dispense di Storia Economica

Scarica Second Partial Economic History e più Dispense in PDF di Storia Economica solo su Docsity! ECONOMIC HISTORY – Second Partial Topic 6 – Economic Development after World War 1 Reading – Feinstein at al. – ‘The interwar economy’ | Lecture 14 – Interwar world economy 1789 to 1913: century of modernization and globalization. Period characterized by major episodes - how they affected the economy and what role did play the rise of the state. How can we characterize the 19th century: - Modernization: an unprecedented era of modernization. ▪ Political Revolution: Revolutions in Europe (French Revolution) and Americas. ▪ Industrial Revolution: mechanisation + steam power. ▪ Transport Revolution: steamships + railways. ▪ Communications Revolution: telegraph (the Internet of the 19 th century, but much more transformative than the latter invention – it allowed information to travel faster and to spread everywhere) + telephone. It fostered immigration, international finance, trade, and it had a great impact on diplomacy – diplomatic communication could be easily dispatched without the need for diplomatic to travel. - Globalization: first time we can speak for global division of labour. ▪ Global trade between core and periphery. ▪ Global capital flows and mass migration. ▪ International gold standard. ▪ Liberal international order: Pax Britannica. Liberal because it was promoted by a liberal ideology of interconnection and free trade at least in the major country at the time. What happens after question much of the foundation that the 19 th century lied on. The First Word War was a threshold between the long 19th century and the short 20th century. However, the “20th century” did not started with the turn of the century, both in history and in arts. In Italy, it did start with the death of Giuseppe Verdi (1900 film). Dramatic changes happened only a decade after the beginning of the 19th century, in 1914, with Word War I. The short 20th century was mainly characterized by conflicts: - 1914-1945: The ‘Second Thirty-Years War’ (Churchill) – The first 30-year war happened at the beginning of the 17 th century, a series of conflicts between the Protestant powers of Europe and Catholic powers of Europe. It laid the foundations of international terms in Europe until pretty much the French Revolution and the Napoleonic Wars. - 1917-1949: ‘European Civil War’ (Nolte) – these large interstate conflicts had a lot of motive in ethno- nationalism, but also more directly because there were many civil wars in this period as well. Not only interstate conflicts, but also intrastate conflict, starting with the Russian Civil War in 1917 and ending with the Greek Civil War. - 1947-1989: The Cold War. A very Eurocentric and older way of thinking about the 20th century. But if you open the gates of Europe, so to speak, you see much of the same story throughout the globe. Warfare dominated the 20th century, not only in Europe, but also globally, especially because in the non-European world, and especially the world that Europeans used to colonize, so most of the global South, warfare was exported during the Cold War from the West or from the North. The 20th century was also a century of calamities: global wars, global revolutions, global economic crises, and a global pandemic. World pandemic: - The Spanish Flu, the greatest pandemic of all time which characterized the beginning of the short 20th century. It is an Influenza pandemic caused by the H1N1 A virus. ▪ Up to 500 million infected worldwide in three waves (1918- 1920). Total mortality between 30 and 100 million. However, statistics are not accurate since the major waves happened in Asia, where not much data was collected. No statistical differences between the fighting countries and the one that were not fighting. In terms of deaths, it was very global. Half of the deaths were in India, but also China and Indonesia suffered a lot of deaths. ▪ In Europe known as the ‘Spanish’ flue. In West Africa known as the ‘Brazilian’ flue, in Brazil as the ‘German’ flu. In Spain, often referred to as the ‘Naples soldier’. Page 1 of 74 - Role of the war. Contagion spread by Allied armies. Naval forces and the celebration after the War worsened the contagion. Wartime censorship limited information and effective response. But mass mobilization (including doctors and the presence of military hospital) increased state capacity to the pandemic. A century of disintegration in the 1920s and 1930s, and especially after 1940s: de-globalization and de-colonization. The First World War marked the watershed between the 19th century and 20th century. Until 1914, the international payment system was based on the gold standard and was supervised by London, which could usually count on the cooperation of the major central banks. Factor of production, like labour and capital, enjoyed almost a perfect mobility, while commercial treaties and improving transport technologies favoured trade. In addition, before 1914, the role of the State was limited, providing for defence, foreign policy, and basic education. However, the war suddenly reversed this way of reasoning, obliging governments to shift resources in favour of war production, financing the war effort with borrowing and money printing. Governments organized for total war, creating dedicated war production offices to coordinate armament production and the allocation of resources. The Great War (1914-1918) was a global armed conflict: - Mostly fought on European soil but extended to colonies. - Larger than any previous war in size, scope, and destruction. The Great War had global repercussions that changed economic, social, political, even cultural. The interwar economy was characterized by a marked slowdown in the world’s real per capita growth between 1913 and 1950. Economic consequences: - Human casualties. As opposed to World War II and many modern wars, including some that we see today, military casualties still vastly outnumbered civilian casualties. In most countries, most of the casualties, most of the deaths, but also all the wounded were soldiers and sailors, some military men. In some countries like France or Italy, it may have meant up to 15%, 20% of the young and middle-aged male population. And that young and middle-aged male population was the traditional backbone of industrial workforce. Hence, for industrialized economies, simply losing all these men was an enormous shock after the war. This was also accompanied by the Spanish Flu. - The large empires of Eastern Europe, like the Russian and Austria-Hungary empire, were plagued by famines, given that farmers were reluctant to sell as there was little to trade for their products, resulting in social unrest and revolution. - In the international economy, the displacement of the agricultural sector in the belligerent countries led to the lifting of import duties to obtain cheap supplies from the Americas, where the agricultural sector expanded to exploit this comparative advantage. In addition, financial cooperation between the Entente was initially based on loans made by the United Kingdoms to the other powers, and later on loans made by the United States, all based on exchange rates temporarily pegged at politically acceptable levels. - Disruption of world trade. In the immediate years following the end of the war, international cooperation was made much harder by the endemic fighting in the Balkans and the deteriorating effects of the ill-devised peace treaties. - Crisis of global finance. - Peace settlements: redrawn borders, war reparations. The military outcomes: The victors: Allied Powers United Kingdom, France, Russia (until March 1918), Italy (from 1915), United States (from 1917) ... and many other country (really much of the world, both colonies and independent nations) joined the Allied Powers and contributed to the war effort in one way or the other. The defeated: Central Powers Germany, Austria-Hungary, Ottoman Empire (Turkey), Bulgaria (from 1915) It is common for scholars to refer to (quantitative “stylized facts”) the disruption of international trade and the sharp reduction in the cross- border movements of factors of production (capital and labour) as “globalization backlash”. Page 2 of 74 ▪ Eventually after the war, countries began to return to gold. First the United States in 1919 and then in Britain in 1925. It was a matter of prestige for Britain to return to the gold standard after the War. However, there was a lot of inflation. ▪ The pound sterling, the British currency, was overvalued relative to gold. In other words, there was not enough gold to back up the actual money supply. But it also meant that in international comparisons, the British pound became too expensive and British prices became too high. - International exchange rates ▪ The US also went back to gold on the pre-war parity, but there was much less inflation during the war in the US economy than in the British economy. ▪ Other western nations returned to gold after devaluation (e.g., Italy went back to gold after devaluation). - Keynes: ▪ Overvalued sterling raised production costs in foreign currency (British goods became too expensive to import). ▪ British industry lost competitiveness → rising imports + falling exports. ▪ Fall in aggregate demand (C + I + G + X - IM) → fall in domestic prices (deflation). ▪ Wages could not adjust enough to falling prices due to sticky wages. deflation → increased real wages → reduced demand for labour Countries that remained neutral during the First or both World Wars registered higher rates of growth, followed by the winners and then the losers. In addition, those who left the gold standard early resumed growth sooner, outperforming the Gold Bloc. The depth and persistence of the difficulties that arose after the First World War were caused by the changes in the composition supply and demand given by wartime disruption and the geopolitical shocks resulting from the peace treaties. The collapse in Eastern Europe of the Habsburg Empire, the Russian Empire, the German Empire, and the Ottoman Empire resulted in political fragmentation, with social uprising and political instability in the newly formed countries. The lack of international coordination and leadership in the interwar years can be summarized with the expression “no longer London, not yet Washington”. The diminished status and resources of the British empire meant that the United Kingdom was not able anymore to stand up as hegemon or lender of last resort in financial crises, while the United States was unwilling. Modern economic growth: - 1870 - 1913 ▪ Fast growth driven by globalization and technological progress. Divergence between the West and the East. - 1914 - 1950 - World wars and the Great Depression (The 1930s represented a much worse period than the 1920s): ▪ Slow growth in Europe and Asia. ▪ New global powers: United States and Soviet Union. ▪ In peacetime years, there was economic recovery and there was quite robust economic growth. But over the period, the impact of the two world wars really dampens the average growth rate. - 1950 - 1973 ▪ The ‘golden age’ of economic growth. - Post-1973 ▪ Slowdown in the West- Rise of the East. While unemployment rose, the productivity of those who kept their jobs continued to increase (divergence in the average annual growth). Plausible explanations: - Continuing technological progress (electrification & motorization were the GPT of the 2nd industrial revolution). - Improved human capital (expansion of public education) – limited by the high unemployment and failure of policies. - Layoffs tend to affect the least productive members of the workforce. The role of technology: - (Remember biased technical change) Growth after 1900 driven by new industrial technologies. New technologies were more capital and knowledge intensive (chemical and engineering invention - biased technical change towards both capital and knowledge). Hence, industrialised countries rich in capital and human capital grew faster. - General purpose technologies (U.S. lead): Page 5 of 74 ▪ Electrification:  Power supply  Fuel: electric motors, railways, trams  Lightening (around-the-clock production possible) ▪ Motorization:  Faster ships and diesel locomotives  New modes of transport: road and air Topic of the class: - World War I and the Spanish Flu - The main contours of the interwar economy Main messages to take away: - World War I was a watershed in modern economic history. - The interwar period was characterized by slow economic growth, retreat from global markets, and high unemployment. - But technological progress and productivity growth continued. Key concepts: globalization backlash (elements and its consequences), ‘sticky’ wages Topic 6 – Economic development after World War I Reading - Feinstein et al., ‘The legacy of the First World War’ | Lecture 15 – Europe after World War I Main questions to consider: 1. What were the economic consequences of WWI for Europe? 2. What was the impact of the reparations imposed on Germany? 3. What were the economic legacy of political disintegration? 1. The economic consequences of World War I for Europe were profound and multifaceted. The war led to significant disruptions in trade, production, and financial systems, causing long-lasting effects on the continent's economy. Some of the key economic consequences include: - Disruption of Trade and Production: The war resulted in the destruction of infrastructure, including transport networks, fields, houses, factories, and mines across various European countries. This widespread devastation had a significant impact on industrial output and agricultural production. - Redrawing of Political Boundaries: The post-war peace treaties, such as the Treaty of Versailles, led to the redrawing of political boundaries in central and eastern Europe. This restructuring disrupted long-standing economic relations and created new barriers to trade, affecting pre-1914 trading patterns and financial relations. - Loss of Fixed Assets: Many European countries, including France, Belgium, Italy, and Poland, suffered considerable loss of fixed assets during the war. The relocation of physical assets and labour to peacetime production posed significant challenges, and industries such as shipbuilding faced excess capacity. - Displacement of Agricultural Sector: The war led to the lifting of import duties in belligerent countries, which resulted in the expansion of agricultural production in the United States, Canada, Argentina, and Australia to supply European markets. This displacement affected the agricultural sector in Europe. - Social and Political Instability: The war's aftermath brought about social and political instability, both domestically and internationally. This instability contributed to the rise of new political movements and regimes, such as Mussolini in Italy and Hitler in Germany, as well as the October Revolution in Russia. - Disruption of International Relations: The war left a permanent scar on international relations, making economic cooperation more difficult for many years to come. The peace treaties, particularly the Treaty of Versailles, and the punitive nature of reparations imposed on Germany had momentous consequences for international economic relations. These consequences collectively contributed to a period of economic upheaval and adjustment for Europe in the aftermath of World War I, shaping the trajectory of the continent's economic development during the interwar period. 2. The impact of the reparations imposed on Germany following World War I was significant and had far-reaching consequences for both Germany and the broader international economic system. Some of the key impacts of the reparations include: - Economic Burden on Germany: The reparations imposed a substantial economic burden on Germany, requiring the country to make significant payments to the Allied powers as compensation for the damages caused during the war. These payments strained Germany's economy and financial resources, contributing to economic hardship and instability within the country. - Uncertainty and Acrimony: The issue of reparations injected a considerable amount of uncertainty and acrimony into the postwar economy. The reparations created additional challenges for Germany's economic recovery and contributed to a volatile international economic environment. - Political and Social Unrest: The burden of reparations fuelled political and social unrest within Germany, contributing to domestic instability and creating fertile ground for radical political movements. The economic strain Page 6 of 74 caused by reparations payments played a role in the social and political upheaval that characterized Germany during the interwar period. - International Relations: The issue of reparations strained international relations and created tensions between Germany and the Allied powers. The manner in which the problem of reparations was dealt with between 1918 and 1924 added an element of uncertainty to the postwar international economy and made international relations difficult and acrimonious. - Occupation of the Ruhr: Germany's failure to fulfil preliminary reparation payments led to the occupation of the Ruhr region by Allied troops in 1923. This occupation further exacerbated tensions and economic instability, contributing to a challenging environment for both Germany and the broader international community. Overall, the reparations imposed on Germany had a profound impact on the country's economy, political stability, and international relations, contributing to the complex and tumultuous economic landscape of the interwar period. The political disintegration that occurred in Europe during the interwar period had significant economic consequences, contributing to a challenging economic landscape for many countries. Some of the key economic legacies of political disintegration include: - Fragmentation of Markets: The creation of new nation-states and the redrawing of political boundaries disrupted long-standing economic relations and created new barriers to trade. This fragmentation of markets affected pre- 1914 trading patterns and financial relations, contributing to a challenging economic environment . - Protectionism: The imposition of tariffs and other trade barriers by newly created nation-states further restricted the scope for foreign trade. This protectionism contributed to a decline in international trade and a reduction in economic growth. - Loss of Fixed Assets: The political disintegration of Europe led to the loss of fixed assets, including transport networks, fields, houses, factories, and mines. This widespread devastation had a significant impact on industrial output and agricultural production. - Economic Instability: The political instability that characterized the interwar period contributed to economic instability, making it difficult for businesses and investors to plan for the future. This instability contributed to a volatile economic environment, characterized by fluctuations in exchange rates, interest rates, and commodity prices. - Social and Political Unrest: The political disintegration of Europe contributed to social and political unrest, creating fertile ground for radical political movements. This unrest contributed to a challenging economic environment, characterized by strikes, protests, and other forms of social and political disruption. Overall, the political disintegration of Europe during the interwar period had significant economic consequences, contributing to a challenging economic landscape characterized by fragmentation, protectionism, instability, and social and political unrest. Population grew only in the US, the only country where population growth could really increase. Here population increased by about 10%. Population stagnated in Italy and Britian and declined in France and particularly in Germany. In the case of France, this was partly due to very large human casualties, including civilian casualties because the Western Front concentrated for many years in French territory. And in the case of Germany, this is largely because Germany lost some territory after the war and indirectly through that lost population as well. Even in the country that registered stagnation, WWI has a very significant impact on population. GDP increased by about 20% in US, receiving a major boost from war production without having to open its own country as a front zone. In France and Germany, it is in decline. Central Government Debt as a % of GDP growth everywhere, all belligerent countries got enormously indebted. In US was nearly 0 before the War. Germany debt going to zero: in 1925, Germany observed hyperinflation. It could not borrow from Britain or the U.S. during the war because they were Germany’s enemies, it borrowed from its own population in its own currency. Since its own currency lost all its value in the hyperinflation savers, small savers, or big savers in Germany who held the German government debt also lost all their savings. This is just an artifact of inflation. Hyperinflation is a term to describe rapid, excessive, and out-of-control general price increases in an economy. While inflation measures the pace of rising prices for goods and services, hyperinflation is rapidly rising inflation, typically measuring more than 50% per month. Page 7 of 74 ▪ Wages and prices were fixed by collective bargaining during the war, a practice that persisted on the war ended due to the rising strength of trade unions. An increased level of government intervention in the economy as compared to pre-war levels further contributed to the stability of prices and incomes. As a result, monopolies and cartels (created by government to exploit economies of scale for war production) remained in place even after the end of the hostilities. ▪ Populist movements increased government spending. - Inflationary public finance: ▪ Extensive borrowing and excessive note issue. Very difficult for the government to exit from the habit of printing money to finance their needs. - Fragile international monetary system: ▪ The enormous borrowings taken by the belligerent nations to finance the war effort consisted of short-term debts to be repaid once the war was over, although a sufficient reduction in deficit spending to meet these payments was possible given the requirements for reconstruction and social welfare spending, resulting in a very fragile financial system. ▪ Gold payments had been suspended very soon after the start of the conflict, as the payment system was now based on inter-Allied loans, which ceased to exist right with the end of the conflict. ▪ Wartime suspension and delayed return to the Gold Standard. The only major economy to return immediately to the Gold Standard was the US, and this meant that the only currency that was accepted was the US dollar. With economic consequences, we also have political consequences which are of course not independent from one another. - Difficult return to peacetime governance: ▪ During the war, 30-50% of the belligerents’ GDP controlled by the state. ▪ Vested interest:  Firms and unions resisted demobilisation of labour and war industries.  Demobilization would reduce state bureaucracy and curb its powers. The increased government jobs created during the war feared the establishment of a pre-war government (because this would have meant job losses). - Social unrest ▪ Deep recession between 1920 and 1921  Demobilization closed plants in munitions industries → growing unemployment.  Wartime inflation → savings became worthless. This situation is quite paradoxical thinking about the Philips Curve, and as a policy maker this relationship is key since it allows you to fight one without making the other one worse. When inflation is high, unemployment is low, and vice versa. One of the major problems of this period was that the PC was breaking down, making the work of government policy very difficult – with a positive relationship or at least a coincidence between growing unemployment and in many cases runaway inflation. ▪ Rise of the working class: populist movements rising to power sometimes through democratic sometimes through violent means both on the extreme right and extreme left.  Growth of unions and labour parties during WWI.  Russian Revolution and populist movements in Europe. For many historians, peace treaties with the defeated powers worsened the already critical situation: ▪ 1919: Germany (Versailles), Austria (Saint-Germain), Bulgaria (Neuilly). ▪ 1920: Hungary (Trianon) and Turkey (Sèvres). - This had major economic consequences during the interval period between the wars: ▪ Disintegration: The redrawn political map of central and eastern Europe disrupted long-standing economic relations and created new barriers to trade. ▪ Destabilisation: Enormous reparations burden imposed on Germany became the prime cause of antagonism and economic discord. Territorial changes: - Pre-1914 trading patterns, communications, and financial relations disrupted by the new borders. ▪ The empires of eastern Europe were customs and monetary unions. - Creation of new nation states with nationalist ideology severed production networks and limited market access. ▪ Most territorial changes in the former Habsburg Empire.  Creation of Czechoslovakia, Poland, Yugoslavia  Enlargement of Romania Page 10 of 74  Huge territorial losses for Austria and Hungary ▪ Russian, German, and Ottoman Empires also lost territory. Political versus economic borders: - New borders guided by national self-determination, there coinciding (but often not) wit ethnic borders, increase of economic boarders: ▪ Quest for ethno-linguistic homogeneity disrupted trade networks. ▪ New borders imperfect: large ethnic minorities behind new borders. → separatism and revisionism - Each new state created its own new currencies (many of them unstable), and imposed tariffs to protect national industries, independent fiscal and monetary policies. ▪ No effective coordination and the pre-existing regional division of labour could not be rebuilt. ▪ Small markets undermined industrial progress (no economies of scale). - The sudden stop of financial aid from the United States to European nations, except for food imports, created chaos in currency markets. On average, the exchange rates of the victorious nations dropped by half, while the defeated powers faced hyperinflation. Volatility was amplified by uncertainty regarding economic recovery and reconstruction and war reparations payments. The most controversial issue in the peace with Germany were reparations, key to the political and economic crisis of the interwar period. Versailles Treaty Article 231 held Germany responsible for war: - Served as the legal ground for reparations, especially for Belgium, France and Italy which were war ground. - Supposed to cover all war-related material damage: ▪ Ambiguous on “war related material damages”. ▪ Reconstruction costs were undoubtedly included, controversy developed over the inclusion of compensation for personal losses (mainly pensions to widows and disabled men). - French political consensus built on “la Boche payera”. Keynes on reparations (1919) was among the first to condemn reparations as economical illogical and politically unwise [The Economic Consequences of the Peace – written as soon as the treaty was signed]: - Mistake to cripple Germany, as Europe’s welfare had depended on German economic growth. - Difficult to transfer real resources across borders given the uncertainty about international capital markets. - Reparations termed “vindictive,” “insane,” but mostly “unworkable”. “The important difference between the Versailles Treaty and the previous peace treaties providing for payment to the victors by the defeated power was that, on this occasion, no sum was fixed by the treaty itself.” E.H. Carr (1937), International Relations since the Peace Treaties The struggle to meet the demands: - Germany lost its gold reserves, most of merchant navy, and large stock of transport equipment. - German failure to fulfil first reparations demands prompted occupation of border towns by Allied troops in 1921. - Failure to meet reparations schedule again → occupation of Ruhr by French and Belgian troops in 1923 (paramount for heavy industrial resources like chemical, coal etc. and the core of the pre-War German economy). - Passive resistance from the Germany, including a general strike → the value of money became almost worthless, causing economic collapse and hyperinflation. The circle of debt: - During the war, the U.S. had become the main creditor, lending money to Allied powers to boost their war effort. - In 1919, U.S. recalled war debts: weakened European economies could only repay if they received reparations from Germany. - BUT German capacity to pay depended on ability to generate exports and thus to obtain gold. Hence, economic restrictions imposed by the Allies diminished German industrial and export potential. Dawes Plan (1924), awarded the Nobel Peace Prize in 1925: - Rescheduled German reparations with manageable annual payments. - Initial US loan to kick-start economic recovery. - Financial stabilisation under League of Nations oversight. - Specified sources of revenue for reparations payments. - Annual payments linked to ability to pay. Page 11 of 74 Between 1925 and 1929 Germany managed to pay, BUT not because of Dawes Plan. It was because of capital markets; Germany could borrow a lot of currency from US – thanks to its ability for capital exports. Financial instability: - Wartime inflation: ▪ Excess demand for consumer goods: industry was producing mainly for the war effort, therefore the consumer for good would shrink. ▪ Excessive note issue: war financing by printing money, purchasing power in the war increased. - Immediately after the armistice some commodity prices fell, but inflation resumed soon afterwards. Three distinct trends among European countries: ▪ Hyperinflation (e.g., Austria, Germany) – especially those who were defeated (at least four digits). Usually, hyperinflation is preceded by sustained levels of very high inflation, where the trust of market participants in the central bank and the government in general, the value of money is systematically destroyed. ▪ High and persistent inflation (e.g., France, Italy, Belgium) – especially the continental Europe but they were still damaged by the war (three digits). They could not control inflation fully until the mid-20s. ▪ High inflation eventually controlled (UK and the neutrals) – the best-case scenario was for those countries that did not fight in the war, or at least not directly involved, price began to fall after a short inflation. In countries like Denmark or Netherlands or Switzerland (hence advanced Western economies that were not fighting in World War I), consumer price index relative to 1914 almost doubled or doubled by the end of the war and continued to increase until 1920, but then prices were falling. In these countries, the situation for macroeconomic policy was easier, because from 1920 onwards, unemployment was high, but prices were already falling in this period (according to the PC). Hyperinflation: - Five countries were ravaged by hyperinflation after 1918: Austria, Hungary, Poland, Russia, and Germany. Poland was a country that re-merged on the European map and had to integrate three different regions that used to belong to three different economies in the post-World War. - To understand the origins of this hyperinflation, we can draw insight from one of the oldest and one of the most enduring theories in monetary economics. That's the Quantity Theory of Money: ▪ Price level depends on the money supply and the velocity of circulation (stock of money in the economy and the speed at which it is exchanged). ▪ Inflation can typically arise according to this theory in two ways.  When the economy is heating up, when business is very good, then obviously money exchange between agents is quick and the speed of circulation goes up.  If governments print money to finance their deficits, they cause inflation. - If you have something like the gold standard before World War I, where the money supply is limited by a fixed exchange rate between the stock of money and the reserves of gold or foreign exchange of the central bank, this is difficult to do. But once countries began to suspend the gold standard, they introduced something for the first time in history called fiat money: ▪ Money supply is independent of central bank reserves (before the war – fixed exchange based on the limited amount of gold). Once the countries started abandoning the Gold Standard, the money is not backed up by central bank. ▪ Money has no intrinsic value: its value is set by law. Therefore, for money to retain its value or maintain its value, agents in the economy have to trust the central bank. - However, in time of crises, governments have a very strong temptation to bring money to finance excess expenditure through inflation because these short-term priorities are more important than interest of long-term instability. When government listen to this temptation, inflation goes out of control. After WWI, monetary economist learned that the central banks should be independent, to make sure that it is not used to make the economy inflate just for short term objective that the government may have. Whether you were on the winning side or the losing side, Word War I was bad for economic development. However, at least on average, winners did better than losers. The post-war settlement that was imposed on the defeated powers made things even worse. Topic of the class: Page 12 of 74 ▪ Unemployment remained high in many countries. ▪ These undermined political radicalisations and growing international tensions. There were actually two bad days, Black Thursday and Black Tuesday. On a Tuesday in late October, the stock market crashed. What happened is that a stock market bubble emerged. The Rolling 20’s represents a great time for the American economy, even if business were “dirty”. But then it turns into a bubble and eventually, the bubble burst. Moreover, something else happened: the American bank crisis and things got worst. The actual Depression does not start until late ’29, when the bubble emerged in the summer months. Once the Depression really got going in 1930, it spread around the world: - 1929-1939: world manufacturing production fell by 36%. ▪ Most severe decline in the U.S. (46%) and Germany (39%) – the two largest industrial nations suffered the biggest shocks. ▪ Milder recessions in Japan (2% - arguably the only who did not had depression), Scandinavia (6-10%) and the UK (11%). - Industrial unemployment was high. - Collapse of world trade between 1929-1939 about 60%. Half of this collapse because volume dropped and the other half because the value of traded goods declined by a half. - The wholesale price index had a very steep decline – even if there was already a deflationary climate. General patterns of depression around the world: - United States – producer of a third of global GDP and the most affected by the crisis. ▪ Depression deeper and longer than elsewhere. domestic financial crisis (1930) → industrial depression (according to the traditional mainstream interpretations). - Once the U.S. was in depression, it began to import far less goods from the rest of the world as demand was shrinking. This hit very hard in Europe, countries that depended on industrial exports a lot: ▪ Germany, Austria, and Belgium (or Czechoslovakia) hit by falling demand for manufactures. ▪ Industrial depression → banking and currency crises – the largest banks were heavily exposed to lending in industry. This typically undermined the currency as well. - In other European countries: ▪ Recession more moderate, but still significant – even if unemployment was high. ▪ Banking sector remained relatively stable – no major bank runs and no major bank failures. - Global periphery: ▪ Primary exporters were hit very hard because they lost their export markets. It was usually in agricultural commodities that prices fell the most dramatically in the depression. This caused severe balance-of- payments problems (import surpluses) and currency crises [especially in Latin America]. The US banking crisis: - Causes ▪ Stock market crash of 1929 reduced investor confidence. This exposed many banks involved in mortgage lending – bad loans etc. ▪ Real-estate market collapsed in large cities. ▪ Banks that invested heavily in real estate failed.  Bank of United States (NY) December 1930  Chicago and NY banks in 1931/2 - Consequences ▪ Withdrawal of deposits reduced the money supply. Demand shock: reducing money supply reduces purchasing power in the economy, reducing aggregate demand. ▪ Bank failures raised the cost of financial intermediation. If the only one or two major banks failed, then many industrial firms lost their only financial partners available. Page 15 of 74 Supply shock: financial services in the modern economy are important inputs. This makes the supply side of the economy less flexible. The classic interpretation is the Monetaristic theory, established in 1960s in the US: - Large variations in money stock have large effect on prices and output. - Friedman’s rule: because of this, central banks should target a (small) constant rate of growth in the money supply. Friedman & Schwartz (1963), A Monetary History of the United States: ▪ The American central bank (Fed) deviated from Friedman’s rule during the Depression. When prices and output were falling, they should have added more liquidity into the economy. They should have increased the money supply to increase aggregate demand and therefore bring prices up. However, they did the opposite. ▪ Evidence shows that U.S. money supply was reduced by 30% between 1929 and 1933. ▪ Fed should have provided liquidity to counter deflation. However, monetary orthodoxy supported by Hoover and Glass-Steagall Act (1932). Peter Temin was the most famous critique of the monetarist view (1976): Did monetary policy in the US cause the Great Depression? He argued that the causation/sequence of events was actually the opposite: - Decline in money stock consequence, not cause, of Depression. Fall in output → lower demand for money (liquidity) → decline in money stock. - The 30% decline in the money supply that Friedman and Schwarz complained about was actually only M1 [M1 are all liquid assets that you can use for payment very quickly]: ▪ As the demand for cash and quickly liquid assets declined, people shifted their money into savings – less liquid assets. ▪ Banks did not fail because they were illiquid but because they were insolvent (due to irresponsible lending practices, especially mortgages in the late 1920s). ▪ Providing liquidity to insolvent banks would not have helped. Loans should have be reconstructed and bank structure should have been reconstructed. - Missing international perspective ▪ Friedman and Schwartz’s analysis is U.S. centred. ▪ They missed international prospective, where international payments played a key role in the global depression. Monetary policy had to be similar across the world. Currency crises in Central Europe: - ‘Twin’ crises: ▪ Failure of large banks provoked a bank run. ▪ Currency crisis and loss of gold reserves. - Contagion: both the Austrian and the German banking system was very highly concentrated – a few large universal banks dominated the system, both in commercial and investment banking. ▪ Largest Vienna bank, Credit-Anstalt, crashed in April 1931. ▪ This revealed weak portfolios in German banks – German investors became wary because they knew that there have been banks heavily exposed in industrial lending as well. - Government response ▪ Germany effectively left the gold standard in August 1931. ▪ However, Germany and other central countries introduced capital control – hence this exchange rate did not mean much. Austria, Germany, Hungary introduced foreign-exchange controls and moratoria on foreign loans to stop the outflow of gold – by restricting the servicing of foreign debt that was denominated in gold or US dollars, these countries aimed to retain these valuable assets within their borders.  Capital controls could include restrictions on the movement of money across borders, limitations on foreign- exchange transactions, and other measures to regulate the international flow of capital. Foreign-exchange controls could involve regulations on the buying and selling of foreign currencies. A moratorium is a temporary suspension or delay, in particular that these countries temporarily halted the repayment of foreign loans – thus conserve their financial resources and prevent the outflow of funds. The Sterling crisis: ▪ German suspension of gold payments put pressure on the pound. Page 16 of 74 ▪ Insufficient gold reserves of the Bank of England were exposed as well. Gold convertibility suspended on 20 September 1931 – the UK officially left the Gold Standard. - Balance of payments ▪ Current account (NX = X - IM): deficit due to strong pound (its good and services become relatively more expensive for other nations), loss of export markets, liquidation of overseas assets during WWI (countries often use or sell their foreign assets during wartime to finance military efforts). ▪ Capital account (record of the financial transactions with the rest of the world): large long-term liabilities offset by short-term credit. This could provide financial flexibility. ▪ The depression revealed the UK’s extreme dependence on world trade and growth in the periphery (economic growth in peripheral areas crucial for sustaining the UK’s economic). - New macroeconomic policy: ▪ Britain was still very dependent on international trade, on which they invested a lot. ▪ Expansion of liquidity through lower interest rate – free from the strict jacket of the Gold Standard (Keynes). ▪ Introduction of the General Tariff. Before WWI, the UK was the main protagonist of free trade. One of the central motives in Tanning's argument is deflation was not a US story, it was a global phenomenon: Monetary contraction took place in all countries, not just in the U.S. Why was monetary policy similar in all countries? - Gold Standard both caused and deepened the recession: ▪ Unlike the classical Gold Standard before 1914 that was growth promoting and promoted the growth of international trade, interwar Gold Standard became dysfunctional, and it promoted worldwide deflation. ▪ As long as countries were still in the Gold Standard, monetary and fiscal policy pushed for austerity instead of expanding aggregate demand. ▪ Recovery started when first Britain then U.S. left the Gold Standard. Why blame the Gold Standard when it worked well pre-1914? “Two gold standards” basically existed: - Before 1914 ▪ Gold-exchange system : Sterling was ‘just as good as Gold’, no actual shipment of bullion required. Everyone in the world trusted the exchange rate between sterling and Gold. ▪ Gold production grew rapidly, mostly from British dominions (South Africa and Australia), supporting a steady increase of the global money supply. ▪ Britain had huge current account surplus but exported capital. The world economy was flooded with this increasing supply of sterling. ▪ Major central banks cooperated to avoid running out of reserves when short crisis happened. For instance, this happened in 1907. - In the 1920s ▪ U.S. had huge current-account surplus, but sterilised it (= extra inflow of gold, was used just to increase Fed reserve but not the money supply). If a country receives payments in its own currency, the central bank might take steps to “sterilise”: this often involves selling domestic assets or issuing domestic debt. By selling assets or issuing debt, the central bank absorbs the excess domestic currency that entered the market due to the surplus, effectively preventing it from circulating more widely in the economy and influencing interest rates. ▪ Accumulation of gold reserves in U.S. and France caused a shortage of credit in the world economy: no effective gold-exchange system. ▪ Major central banks did not cooperate to alleviate gold hunger. What was the problem? 1. Incorrect exchange rates ▪ U.S. returned to gold (1919) at pre-war rate despite wartime inflation (much larger money supply in circulation) → Insufficient gold to back up the increased money supply → Fed sterilised current account surplus to increase the gold reserve and bring it in line with the money supply. ▪ Other countries returned to gold on too high (UK) or too low (France) parities, leading to large trade imbalances. 2. Misallocation of gold (Bernanke, Eichengreen): policies of the Fed and Banque de France led to a climate that at least helped the world get into the Depression and made it worse: ▪ Fed and Banque de France sterilised gold inflow to prevent inflation. Page 17 of 74 ▪ Ability of central banks to act as ‘lender of last resort’, in order to avoid further bank runs (help in times of crisis). - BUT British devaluation hurt other countries’ balance of payments, especially those that remained on gold. - To contrast this, countries began to introduce restrictions on imports: ▪ Increased tariff rates (custom revenue/imports). ▪ Supplemented by import quotas and exchange restrictions – set a maximum of volume that can be traded either total or of a specific good. ▪ Gold Bloc countries increased tariffs more than others . - Global protectionism contributed to decline the world trade, that already started with Great Depression. Even if government tried to increase aggregate demand, global demand remained low. Average rates of GDP growth in 1929-1938 of Scandinavian countries and UK performed vastly better and recovered much better than the Gold Bloc that tried to remain the Gold Standard for longer. European periphery (South Europe was not doing that bad): - Spain ▪ Only major European economy with flexible exchange rates in 1929 (did not restore Gold Standard). ▪ Government could boost aggregate demand during depression. ▪ Central bank could act as lender of last resort, and no bank failure. - Portugal and Greece had mild recessions (they did not have big industrial sector), no banking crises. - Italy and Poland ▪ Remained on gold standard until mid-1930s → severe depression. ▪ Universal banks exposed to poorly performing loans extended to industry and agriculture. ▪ Banking crises avoided by direct government intervention. ▪ Authoritarian government had unlimited political power and forcefully intervene even if they had to face conflict of interest in the economy. Global periphery: - Japan – only industrialized national that did not registered crisis. ▪ Restored gold standard after substantial devaluation. ▪ Unable to maintain parity during the depression, left gold late 1931. - Argentina: ▪ First country to go into depression in 1929. One of the biggest agricultural exporters. ▪ Therefore, it was forced off gold in December 1929. This became very useful during the depression, just when everyone was registered inflation and hence helped to recover. ▪ Managed to recover by 1935 and avoided default on foreign debt because of its early leave of the Gold Standard. - Africa and Asia – hit hardest: ▪ Primary exporters hurt by sharp fall in global agricultural prices. Investment stopped coming from the Western countries. ▪ Infant industries could not develop without foreign capital. ▪ Colonies could not conduct independent monetary policies. Topic of the class: - The Great Depression - The interwar gold standard Main messages to take away: - The Great Depression was a global phenomenon. - Domestic factors caused depression in the U.S., but it damaged other countries with weak balance of payments. - Governments and central banks could not combat deflation and boost aggregate demand while they maintained gold standard. Key concepts: monetarist theory, macroeconomic policy trilemma Page 20 of 74 Topic 7 – Depression and deglobalization Reading - Feinstein et al., ‘The fragmented world of the 1930s’ | Lecture 17 - Deglobalization Main questions to consider: 1. Why were attempts at international cooperation doomed to fail? 2. How did leaving the gold standard help recovery in Britain? 3. Why did the Gold Bloc recover more slowly than the Sterling Bloc? 1. Attempts at international cooperation during the 1930s were doomed to fail due to a combination of factors, including conflicting national interests, political considerations, and economic challenges. The lack of effective leadership and the absence of a shared vision for addressing the global economic crisis further contributed to the failure of international cooperation efforts. - Conflicting National Interests: Each country had its own agenda, economic priorities, and preferred solutions, leading to disharmony and rivalry among European nations and the United States at the World Economic Conference of 1933. The divergent interests of major powers, such as the United States, France, Germany, and the United Kingdom, made it difficult to reach consensus on critical issues such as reparations, war debts, and exchange rate stabilization. - Political Considerations: Domestic political factors, including impending elections in France and Germany, delayed the convening of international meetings and hindered the ability of governments to make concessions prior to elections. Additionally, President Hoover's refusal to postpone war-debt payments and the subsequent refusal of several European nations to pay their instalments further underscored the impact of political considerations on international economic cooperation. - Economic Challenges: The economic challenges faced by individual countries, such as the impact of currency devaluations, loss of competitiveness in foreign markets, and the need for economic assistance, created significant obstacles to cooperation. For example, Belgium's loss of competitiveness in British markets following the sterling devaluation in 1931 led to a desperate need for economic assistance, which was not adequately addressed by potential partners. - Lack of Effective Leadership: The absence of effective leadership and the failure to find necessary compromises to initiate international cooperation contributed to the breakdown of collaborative efforts. The failure of the World Economic Conference of 1933 is often attributed to the lack of conducive conditions for international economic cooperation, as major countries were entrenched in the defence of their own economic and political interests. - Currency and Trading Blocs: Instead of seeking necessary compromises for international cooperation, major industrial and financial powers became the centre of their own currency and trading blocs, further fragmenting the international economy. This fragmentation left countries outside of these blocs, such as many Latin American countries, to find domestic solutions, often resorting to protectionism. 2. Leaving the gold standard helped recovery in Britain by freeing macroeconomic policy from the "golden fetters" of the gold standard, which allowed the government to lower interest rates and expand the economy. Devaluation of the currency also stimulated exports and provided some protection from foreign competition. After 1932, a slight revaluation of the pound and its subsequent stabilization allowed for competitive import of raw material. By devaluing the pound, Britain made its exports cheaper and more competitive in foreign markets, which helped to increase demand for British goods and services. This, in turn, led to an increase in production and employment, which helped to reduce unemployment and stimulate economic growth. Additionally, leaving the gold standard allowed the British government to pursue expansionary monetary policies, such as lowering interest rates, which helped to stimulate domestic demand and investment. Overall, leaving the gold standard allowed Britain to pursue policies that were better suited to its economic needs and helped to promote recovery from the Great Depression. 3. The gold bloc recovered more slowly than the sterling bloc due to the stringent deflationary policies demanded by the gold standard, which made recovery from the depression of the early 1930s particularly slow. The gold bloc countries were constrained to follow these policies, which discouraged trading among the bloc's members and made it difficult for them to stimulate domestic demand and investment. In contrast, the sterling bloc was able to recover more quickly due to the flexibility provided by leaving the gold standard. By devaluing their currencies, the sterling bloc countries were able to stimulate exports and increase demand for their goods and services, which helped to increase production and employment. Additionally, leaving the gold standard allowed the sterling bloc countries to pursue expansionary monetary policies, such as lowering interest rates, which helped to stimulate domestic demand and investment. Furthermore, the sterling bloc was able to benefit from the protectionist policies of the British Empire, which helped to shield them from foreign competition and promote import substitution in manufacturing. This protectionism, combined with the flexibility provided by leaving the gold standard, allowed the sterling bloc to recover more quickly than the gold bloc. In summary, the gold bloc recovered more slowly than the sterling bloc due to the stringent deflationary policies demanded by the gold standard, which made it difficult for them to stimulate domestic Page 21 of 74 demand and investment. In contrast, the flexibility provided by leaving the gold standard allowed the sterling bloc to recover more quickly, along with the protectionist policies of the British Empire. Gold standard was a fixed exchange rate regime limited the room for expansionary monetary and fiscal policy. The solution to exit the trilemma was to restore independent monetary policy. Recovery from the depression was far better among those countries that abandoned the gold standard early and where able to boost their economies with devaluation and expansionary fiscal and monetary policy. In England, following the end of convertibility in September 1931, lower interest rates and devaluation stimulated investments and exports, while reducing imports. Failure of international cooperation: - Attempts to find a global solution: ▪ Lausanne Conference on Reparations (June 1932). In the late 1930, the German government suspended reparation payment for two years, they were allowed to do so to stabilize the German economy. In times of recession, Germany had the right temporarily suspend the payments – however, this was critical to countries like France or Belgium which were dependent of receiving German reparations. ▪ World Economic Conference in London (June - July 1933). In the next year, there was a major gathering of international powers in London to try to either restore the gold standard or a functioning alternative monetary regime to the gold standard. But this conference also broke down. - Initial political obstacles: Reparations, War debts. - New political obstacles: Roosevelt, Hitler. Both prevented effective international cooperation: both come to power at the beginning of the 1933, and both questioned very seriously the post-World War I international settlements. Moreover, both had a nation-centric policy for recovery after the Great Depression – we fix our own problems at home before we help the rest of the world. Recovery started in Britain (and in members of the Sterling bloc) very shortly after leaving the gold standard and devaluation: - Rebuilding competitiveness: ▪ Devaluation in September 1931 – helped gain competitiveness in the export industries. ▪ General Tariff in 1932 (10% on all goods) further improved competitiveness. - Preferential trade within the Sterling Bloc – distinguish between trade partners that trade either with countries that traded using Sterling as a trading currency, and also, in most cases, used Sterling as a reserve currency. - Freed from the “straightjacket” of the Gold Standard (Keynes). ▪ The Bank of England could lower interest rates to boost liquidity in the economy. Investors can borrow money cheaply. ▪ Low cost of borrowing caused housing boom, 1932-1935. - Unemployment only eliminated after the announcement of rearmament in 1937 – military spending created new demand for industrial goods. - No systematic anti-cyclical policy, even though this is what Keynes would have expected. The general theory of Keynes is still to this day very important. The Keynesian doctrine: - Basic assumption: output and employment depend on aggregate demand. The government can manage output and employment in the economy. - Demand management by the government: ▪ Need to moderate the ‘boom and bust’ cycle. The government should not let the economy overheat too much in the boom and neither let the economy fall too much during the bust. ▪ Fiscal and monetary policy needs to be anti-cyclical:  During the bust - , the finance ministries should spend more money than they take in revenue, so the deficit grow when the economy is doing bad to raise aggregate demand and fight unemployment. Deficit = G – T => higher government spending (fiscal policy) or lower interest rates (monetary policy).  During the booms + , they should the opposite. They should build a surplus, or reduce the deficit, in order to reduce aggregate demand and stop the economy from overheating. The easiest way is to lower interest rates to stop any inflationary pressure in the economy. Deficit = G – T => higher taxes (fiscal policy) or higher interest rates (monetary policy) - Government spending has multiplier effect. Often it is not efficient in generating higher aggregate demand as Keynes and other economists have argued. Page 22 of 74 particularly during a housing boom. Germany, facing a severe hit during the depression, saw accelerated recovery after the introduction of capital controls and increased monetary measures, especially post-1933. The U.S., on the other hand, faced a slower recovery due to delayed exit from the gold standard and ineffective fiscal policy measures, eventually experiencing a recession in 1937. France demonstrated a lack of recovery until 1936 when the election of the Popular Front led to changes in fiscal and monetary policies. The timing of leaving the gold standard played a crucial role in recovery, with earlier devaluation correlating with earlier recovery. Monetary policy, especially lowering interest rates, was a key factor in tackling the depression, evident in the steep increase in private investment in Britain from 1932 to 1935. Germany's recovery involved government-led construction projects, while the U.S. and France experienced delayed recoveries due to restrictive fiscal and monetary policies. Ultimately, countries that devalued early, such as those in Europe that departed from the gold standard in 1931, showed better economic growth, with Italy, a pre- emptive gold block departure, performing relatively well within the gold block. Topic of the class: - Recovery from the Great Depression - The end of the gold standard Main messages to take away: - The gold standard was the main obstacle to economic recovery. - Britain and the Sterling Area enjoyed rapid recovery because devaluation enabled expansionary monetary policies.3 - The Gold Bloc experienced slow recovery because it used high interest rates and fiscal austerity to maintain gold exchange rates. Topic 7 – Depression and deglobalization Reading - Feinstein et al., The fragmented world of the 1930s | Lecture 18 – Rise of the state Main questions to consider: 1. How did Nazi Germany transform her international trade? 2. Were monetary of fiscal policies responsible for economic recovery in the United States in the 1930s? 3. How did central planning in the Soviet Union generate rapid economic growth and industrialization? 1. Nazi Germany transformed her international trade through various policies and agreements aimed at reorienting trade patterns and promoting economic self-sufficiency. Some key transformations include: - Bilateral Trade Agreements: The Nazis initiated bilateral trade agreements, such as the private-compensation procedure and the bilateral-exchange clearing system, to balance imports and exports and ensure o setting trade.ff These agreements aimed to match private exporters and importers, as well as balance credits and debits on a national level, thereby promoting German exports and controlling trade. - Currency Controls and Administrative Measures: Nazi Germany formally maintained the gold value of the mark under the protection of administrative controls on conversion. The government implemented currency controls and trade controls to enforce compliance with economic policies, including exchange controls and trade barriers, which allowed for greater administrative control of trade. - Autarky and Import Substitution: The Nazis pursued policies aimed at achieving economic self-su ciencyffi (autarky) by restricting imports and promoting import substitution. This inward-looking approach aimed to reduce dependence on foreign trade and secure essential resources domestically, thereby transforming Germany's trade patterns and reducing reliance on international markets. - Expansion of Domestic Output: The inward-looking trade policies and focus on autarky proved e ective inff promoting the expansion of domestic output. Between 1932 and 1938, Germany's real GDP per person grew at a respectable rate, indicating the success of these policies in stimulating domestic production and economic growth. 2. The economic recovery in the United States during the 1930s was primarily driven by a combination of monetary and fiscal policies implemented as part of President Franklin D. Roosevelt's New Deal programs. - Monetary Policy: The abandonment of the gold standard in April 1933 and the subsequent expansion of the money stock as gold flowed into the United States were key components of the recovery. This expansionary monetary policy, facilitated by the appointment of a new head of the Federal Reserve System, allowed for increased liquidity and credit availability, which helped to stimulate economic activity. - Fiscal Policy: The New Deal programs introduced a range of fiscal policies aimed at addressing the economic crisis. These included measures such as the Agricultural Adjustment Act (AAA), which allowed the government to control the production of agricultural commodities to increase prices, and the National Industrial Recovery Act (NIRA), which provided incentives for employers and employees to negotiate agreements on wages and working conditions. Additionally, the New Deal included public works programs and direct government spending to create jobs and stimulate demand. Page 25 of 74 The combination of expansionary monetary policy and the implementation of various fiscal measures under the New Deal contributed to the economic recovery in the United States during the 1930s. These policies helped to increase liquidity, stabilize the financial system, stimulate demand, and create employment opportunities, ultimately leading to a gradual recovery from the depths of the Great Depression. 3. Central planning in the Soviet Union generated rapid economic growth and industrialization through several key mechanisms: - Forced Transfer of Labor and Capital: Central planning facilitated the forced transfer of labour and capital from agriculture to manufacturing and from consumer-goods production to investment-goods production. This reallocation of resources, though often wasteful, accelerated the transformation of the Soviet Union from an agrarian economy to an industrial economy. - Executed Planning: The central planning process, though often criticized for its inefficiencies, was executed with careful attention to industrialization goals. The Five-Year Plans, initiated under Stalin's leadership, set ambitious targets for industrial output, and provided a framework for directing resources toward specific sectors and projects to achieve rapid industrial growth. - State-Led Modernization: The state took on the task of modernizing and developing the economy, with Stalin initiating a major industrialization drive in the late 1920s. This state-led approach to economic development involved significant investment in heavy industry, infrastructure, and technological advancements, all of which contributed to rapid industrialization. - Emphasis on Economic Growth: Under central planning, economic growth became the primary focus, with all other considerations being subordinated to the goal of industrial expansion. This singular focus on growth, often at the expense of other social and humanitarian concerns, drove the rapid industrialization efforts in the Soviet Union. - Statistical Debate: While there is ongoing debate over the precise measurement of GDP growth in the Soviet Union during the 1930s, recent studies have indicated significant and rapid growth during this period. The Soviet Union experienced substantial increases in both output and exports, outpacing many other trading areas and demonstrating the success of its industrialization efforts. The German recovery: - Hitler came to power in January 1933. In the first years, Nazi government were very loud in words, but they did not change much in facts. ▪ Moratorium on all reparations (already suspended in late 1930). ▪ Public works programmes that began in 1932 under different government continued: drafting unemployed workers to infrastructure project, both funded by the state and government budget. - Capital controls that were introduced in the previous years and began to transform the international trade system with other countries, moving towards a model of clearing trade or bilateral exchange within Reichsmark Bloc: ▪ Fight against unemployment (successfully). They realized that rising unemployment in Germany was the most important source of dissatisfaction of working- and middle-class voters with previous governments. Therefore, it was one of the key factors to their success of rising to power. ▪ Building of national highways (Autobahn). ▪ Driving Jews and women forced out of employment. - In 1936, Hitler announced officially his rejection of the Versailles Peace Treaty. This meant the rejection of limitations on the size and the structure of the German armed forces. He reinstituted conscription, massively increased the size of the armed forces by personnel and began a program of war production in the German industry. Four Year Plan (1936): ▪ Rearmament to prepare Germany for new war (what reduced unemployment). German army forces were blocked by the Versailles Treaty. ▪ Allocated new investment to heavy industry, such as steel, machinery, chemicals. ▪ Financed largely through deficit spending. The German government was more Keynesian than the Great Britain. The German stabilisation: - The government could increase its deficit because the central bank was able to monetize its government debt since Germany effectively left the gold standard in July 1932. After the banking and currency crisis of the summer or 1931, Germany imposed: ▪ Exchange controls, foreign-exchange reserves limited to Reichsbank that could hold reserves of gold. This meant:  Owners of gold and hard currency had to sell them to Reichsbank at the official exchange rate and would receive the equivalent in the Reichsmark.  Reichsbank limited foreign exchange available to importers. Page 26 of 74  Exporters had to surrender foreign-exchange earnings to Reichsbank. ▪ Foreign deposits frozen in the country (this practically meant default in international debt or at least having a moratorium on servicing all forms of international debt both corporate debt and the debt of the government). - Expansionary policies and more independent monetary policy: ▪ Central bank interest rates reduced in summer of 1932. ▪ Work creation programmes financed by central government. The primary goals were to create more liquidity, without worrying about shortage of foreign exchange in the country. This meant two things:  Financing the central government deficit became crucial to sustain a fiscal policy increasingly more expansionary.  Monetary policy became more expansionary too. Lower interests helped private investment recover in the 1930s as well. The New Plan: - Hjalmar Schacht was the president of the Reichsbank, appointed as minister of finance in 1934. He introduced a new plan that was basically to restructure Germany international trade system. There was a general thinking was that the reason why German lost was economic reason, not military: before WWI, the country was too dependent on overseas import to produce critical product and to feed its population – the British naval blockade prevented Germany from maintaining the war effort. - One key objective was national autarchy – hence, reduce dependency: ▪ Import restrictions and export subsidies used to counteract impact of overvalued Reichsmark. ▪ An ‘extended economic space’ for Germany to provide secure supply of raw materials and food in time of war. - German exports became less competitive following the devaluation of the sterling and the dollar, therefore subsidies for exporters were introduced, while a board to oversee trade was instituted; later policies focused on rearmament. Bilateral trade agreements were introduced, like an exchange clearing system through the Reichsbank, which helped to balance exports and imports. These bilateral trading agreements came to account for as much as half of Germany’s trade, while its trade was reoriented versus Eastern and Southern Europe (although these regions never became Germany’s main trading partner): ▪ Private-compensation procedure was very ineffective. ▪ Bilateral exchange clearing system: trade agreement between two countries. Exchange refers to free exchange and clearing refers to the clearing of any existing imbalance in trade between the two countries. How does it work? The whole idea of bilateral exchange clearing mechanism is that only financial transaction that ever takes place between the two trading nations is the clearing of the imbalance in their trade. At the end of the agreed period, an assessment is made to determine the trade surplus or deficit for each country. If one country has exported more goods than it has imported, a trade imbalance exists. The financial transaction that occurs under the bilateral exchange clearing mechanism is the settlement of this imbalance. The primary objective was to maximize trade while minimizing the use of hard currency, as both nations faced shortages of gold and foreign exchange during that period. The brilliance of this mechanism lay in its ability to facilitate trade without the constant need for hard currency. It allowed both countries to manage their deficits and surpluses efficiently. The trade agreement outlined the goods each country would export to the other, setting a target trade volume of $100 million. Here's how the mechanism worked: German exporters, aiming for the $100 million target, sold merchandise to Italian importers. Instead of Italian importers paying in US dollars, they paid the equivalent in lira to the Bank of Italy. Simultaneously, German importers paid in Reichsmarks to the German Reichsbank. However, by the end of the year, trade imbalances became evident. Italian exporters exceeded the target by exporting $120 million worth of merchandise to Germany. The bilateral exchange clearing system ensured that the only transaction in hard currency occurred at the end of the year to settle the imbalance. In this case, the German Reichsbank would pay $20 million to the Bank of Italy. - By 1936, Germany concluded clearing agreements with most countries in central and southeast Europe. Page 27 of 74 - National Industrial Recovery Act (NIRA) – largely ineffective: ▪ Manufacturing firms encouraged to increase wages and expand employment by shortening the work week. ▪ In exchange for increasing costs, companies were allowed to raise prices. American recovery was much less successful in the early 1930s or until the mid-1930s than the other countries that we have spoken about so far. This was mainly due to unemployment. The Soviet industrial revolution: - While the rest of the World was recovering from Depression, it was the fastest growing economy in the world between 1929 and 1937. - The Soviet economy was turned into under a communist dictatorship. It was largely state-owned and centrally planned economy where both private ownership and market exchange were eliminated. - Forced industrialisation: ▪ Transfer of labour and resources from agriculture to manufacturing. ▪ Concentration of investment in modern industry: metals, machinery and equipment, chemicals. History – Socialism in Russia: - February 1917: bourgeois revolution started by women that marched on Valentine’s day. ▪ Constitutional monarchy with parliamentary rule. ▪ Provisional Government during the war. ▪ Radical parties increasingly powerful. - October 1917: Bolshevik coup d’état (colpo di stato). - 1918-1921: Russian Civil War. - 1922: Establishment of the Soviet Union (USSR): ▪ Formally a federal state of ‘independent’ republics. Theoretically, it was more democratic than the one in the US. ▪ In reality a single-party state, no republic was independent. ▪ Dictatorship of the Bolshevik Party (especially the Politburo). - 1924-1928: After death of Lenin, Stalin consolidated power. Stalin emerges as the winner from different leaders, and he consolidated his power in 1928. From 1929 onwards, Stalin turned the Soviet economy into a completely state managed and largely state owned where the force of markets was replaced by central planning: - Collectivisation of land: ▪ Industrialisation financed from expropriated farm surplus. ▪ To control surplus, the government had to take over: peasantry forced into collective farms. - Investment planning: ▪ Consumption was reduced to increase rate of investment in order to have more funds for investment. ▪ Priority of producer goods (heavy industry) in investment allocation. - Output maximisation: ▪ Modest plan targets in agriculture and light industry ▪ Ambitious plan targets in heavy industry, especially machinery Collectivisation: - Between 1928-1933 peasantry forced into collective farms. ▪ Achieve optimum farm size for mechanised production. ▪ Reallocate labour to urban industry. - Achievements disappointingly poor. ▪ Investment in agriculture insufficient for rapid mechanisation. ▪ Wealthy peasants protested by slaughtering (macellare) livestock and horses (this meant equalisation between relatively wealthy and relatively poor peasants) → K/L in agriculture reduced → sharp decline in productivity after 1930 → mass famine in the Ukraine and southern Russia → even more farm animals killed. Stalinism was the first developmental dictatorship. - Police state: ▪ State monitored all economic agents. Page 30 of 74 ▪ Sabotage of production was criminal offence. ▪ Anyone ‘opposed’ to super-industrialisation plan was liquidated. - Forced labour ▪ Farm labourers forced to join collective farms or resettle to new industrial cities and change occupations. ▪ Millions who refused were deported to labour camps. Actually, the size of the prison population was not significantly, but it demonstrates the use of terror. - Human cost: Total deaths to Stalin’s terror (including famine) about 10 million. - Militarisation of the economy: Stalin thought than in within ten year the URSS had to face foreign invasion (and he was right). ▪ Share of defence spending in GNP: 1% (1928) → 18% (1940). ▪ Share of war industries in total investment: from 3% to 30%. ▪ Military inspectors monitor quality standards. ▪ USSR became the largest munitions manufacturer in the world. Topic of the class: - Recovery from the Great Depression. - Economic development through state intervention. Main messages to take away: - Militarized dictatorships promoted economic recovery by boosting aggregate demand and creating preferential trade spheres. - The New Deal was a major departure point in U.S. macroeconomic policy, but it had mixed results in the recovery period. - The Soviet Union isolated itself from the world economy and adopted a completely state managed development model. Key concepts: exchange clearing, collectivization. Topic 8 – Economic development after World War II Reading - Eichengreen, ‘The postwar situation’ | Lecture 19 – Europe after World War II Main questions to consider: 1. What were the economic conditions in western Europe after 1945? 2. What factors limited economic recovery in post-war Europe? 3. What were the economic effects of the Marshall Plan? 1. After World War II, Western Europe faced significant economic challenges. The war had caused extensive damage to infrastructure, and the price mechanism as a means for allocating resources was largely in abeyance so long as governments continued to rely on rationing and price controls. Europe's trade had ground to a halt, and its capital markets remained inert. Governments depleted their reserves of dollars and gold, leaving them no means of financing imports from the United States. Banks drafted into the war effort had been forced to invest heavily in government bonds and now lacked the resources to resume normal peacetime lending. The future of the price system, the financial system, the trading system, and even the private property rights system was now fundamentally in doubt. However, the United States' Marshall Plan provided significant aid to Europe, which helped to relax the external constraint and sustain Europe's strategy of investment-led growth. 2. Several factors limited economic recovery in post-war Europe. These included: - Infrastructure Damage: The war had caused extensive damage to transportation and communication facilities, hindering the revival of economic activities. - Price Controls and Rationing: Wartime controls were retained to direct labor and raw materials, and prices were frozen below equilibrium levels, leading to shortages and reduced incentives for producers to bring goods to the market. - Capital Constraints: Depleted reserves of dollars and gold left European governments with limited means to finance imports, and banks lacked the resources to resume normal peacetime lending. - Trade Disruptions: Europe's trade had ground to a halt, and the continent faced challenges in rebuilding its trading system. 3. The Marshall Plan had several significant economic effects on post-war Europe, including: - Relaxing the External Constraint: The Marshall Plan provided significant aid to Europe, which helped to relax the external constraint and sustain Europe's strategy of investment-led growth - Decontrol of Prices: The Marshall Plan helped governments to decontrol prices and restore the operation of the price mechanism by reducing inflationary pressure. - Reduction of Belt-Tightening: Directly and indirectly, Marshall aid limited the belt-tightening to which the public had to agree in order to bring national budgets into balance and permit the relaxation of controls. Page 31 of 74 - Encouraging European Integration: American aid was contingent on agreement by the recipients on a collective strategy for using U.S. funds, which encouraged the formation of a "United States of Europe" whose close economic and political relations would make war unthinkable and which would constitute a united front against the Soviet Union. Important for the exam!! The professor cares about this Europe after 1945: - Economics of World War II - Post-war reconstruction: ▪ The legacies of the war ▪ Reconstruction efforts ▪ Obstacles to recovery - European recovery: the Marshall Plan World War II was a conflict in two theatres: - European war: 1939-1945. Started with the German invasion of Poland in September 1939. Ended when the Soviet Army marched into Berlin in late April/early May 1945. - Asian-Pacific war: 1937-1945. Started with the second final Japanese war in 1937, with the full force of Japan on eastern coast of China. Ended after the American nuclear bombs. ▪ The aggressors: Axis Powers (Nazi Germany, Fascist Italy, and the Japan Empire). ▪ The victors: Allied Powers (France, UK, USA, USSR, China - permanent members of UN Security Council in 1945). WWII was the largest armed conflict in history: the only truly global war and larger than any war in size, scope and destruction. Industrial warfare: - Manpower still important but secondary to firepower. - Military outcomes depended on industrial potential. This made the war the most destructive war ever: - Extensive battlefronts, especially in Eastern Europe and China. - Huge destruction behind enemy lines (aerial bombardment). - Civilian casualties equal or outnumber military casualties. One of the main differences between the two world conflicts was that in total, civilian casualties far outnumber the military casualties, and this was especially the case in both Eastern Europe and parts of East and Southeast Asia. Ethnic and religious cleansing, genocide. ▪ The human toll: total casualties, almost 60 million globally. Some estimate goes close to 100, but the critical country to estimate is China. Ca. 40 million in Europe and 26 million Soviet Citizens. ▪ Civilian casualties  Most in Eastern Europe and East Asia.  Result of extermination more than collateral damage.  Holocaust: 6 million. ▪ Military casualties  Concentrated on two fronts (Soviet and China).  Casualties overwhelmingly Soviet, Chinese, German, and Japanese. The economics of total war: - Total mobilization for war: ▪ Civilian production in metalworking and engineering shut down to produce weapons and ammunition. ▪ Handicraft productions sacrificed for large-scale industry. - Aim to destroy enemy’s economic potential: ▪ Submarine warfare. ▪ Strategic bombing. - Technological progress in certain industry: ▪ Mass production methods were adopted on a much larger scale in both Europe and Japan thanks to the spread of the American methods. ▪ Advancements in diesel motors, aerospace, communication technology (walk-talky). ▪ Spillovers in science (computers, nuclear energy, air-conditioning, radar, linear programming). Page 32 of 74 Disintegration of the economic system limited the recovery post-war. Wartime destruction: - Transport infrastructure could be rebuild relatively quickly: ▪ Destruction of railway track and key points e.g., bridges. ▪ Loss of railway equipment and of merchant marine. ▪ Major waterways blocked by wreckage. - Civilian infrastructure took more time to be repaired, but they were not essential to pump productive capacity: ▪ Huge destruction in residential housing and urban infrastructure, particularly in Western Europe and North Italy. ▪ Cities often cut off from other regions by transport bottlenecks. - Production capacity much larger even in defeated countries: ▪ Stock of industrial equipment enhanced during the war (despite destruction) by 20% in Germany, 30% in northern Italy. ▪ Power generating capacity larger than pre-war and needed little repair. Post-war reconstruction prioritized the most critical issues: - Collapse of industrial production: ▪ 40% of pre-war level in France and Benelux. ▪ 20% in defeated Germany and Italy. - Reconstruction priorities: ▪ Waterways reopened and railway tracks repaired within a year. ▪ Damaged industrial capacity repaired with imported American machinery and technical assistance. ▪ Railway equipment recovered and re-stocked by 1947. - Reconstruction bottlenecks: ▪ Germany and Italy had insufficient merchant marine capacity. ▪ Residential housing in cities remained insufficient, preventing their integration of displaced workers into the urban economy. The politics of reconstruction: - Reconstruction and economic revival seen as a national effort. ▪ Political consensus was built around reconstruction needs. ▪ Trade unions overwhelmingly supportive until 1948. - Swing to the left after WWII with extensive welfare: ▪ Britain: (Churchill) Labour Party came to power in 1945, introduced the welfare state but maintained warlike mobilization. ▪ France: socialists and communists gave priority to reconstruction over concessions to the working class. ▪ Italy: squads of ‘elite workers’ to encourage work intensity. - Focus on industrial revival resulted in uneven recovery. ▪ Industrial production reached pre-war levels in most countries by 1947, farm output recovered to only 80% (rural areas fell behind in the process of reconstruction). Post-war Germany (most dramatic): - Total defeat – total destruction. ▪ Allied bombers destroyed almost all German cities and the railways. ▪ Public utilities and communication lines became dysfunctional. - Post-war settlement made things worse. ▪ Postwar Germany divided into occupation zones, especially its agricultural food basket. ▪ Trade and transfer of resources between zones limited to minimum. ▪ Potsdam Agreement between US, Britian and Soviet Union demanded reparations from Germany to be met by dismantling industrial plant and equipment and transport these assets in other countries, not with money (as they learned from the 20s). - Allied occupation (country was divided into four zones, each occupied by one of the victorious powers): ▪ 1946 Level of Industry Plan limited manufacturing to half, machinery output to a tenth of pre-war production capacity. It had two aims:  Stop Germany from starting other WWII by removing its heavy industrial potential.  To do so, create enough surplus capacity can be dismantled as reparation goods. Page 35 of 74 ▪ Supply crisis in winter of 1946/7 enforced new occupation policy. At least in Western occupation zone, the reparations program was never fully implemented. The lack of food in 1947 and the advent of Cold war shifted American thinking on the role that Germany should play in postwar Europe. The limits of recovery: - Command economy (planned economy). Controls implemented during the war persisted, complicating the return of western European countries to functional market economies. The command economy: ▪ Wartime controls  Fixed prices and rationing to avoid inflation and shortages.  Wage control to avoid competition for workers and to allocate labour to high-priority industries. Government could allocate labour into the higher priority industry.  Price of essential commodities were frozen to prevent social unrest, while the labour market was diverted toward the production of essential goods. As long as prices were frozen at low levels, farmers had little incentive to sell their products to the market, resulting in a shortage of food. Workers had little incentive as well to work in factories. Firms basically produced only goods that could only be bartered with goods of other firms. In addition, as long as money printing inflation went on, the situation got worse. Allowing the market to function independently based on supply and demand was not easy, given popular resistance to price increases, which would happen as soon as price controls would be lifted.  Regulated bank lending to support industrial and public investment. Countries feared repeating what happened after WWI, so the banking sector was heavily regulated. ▪ Disabled markets  Under fixed prices and rationing, firms had no incentive to increase efficiency and, therefore, maximizing profits because they were not buying the materials they needed for production as they were rationed to them by central banks.  Market transactions were replaced by ‘compensation’ deals – firms exchanged supply needs between each other.  Wages had to be complemented by provisions in kind. ▪ Reluctance to liberalize driven by deep distrust of markets. - Dollar shortage. Another obstacle was the acute shortage of dollars and pounds sterling. Many western European countries lacked sufficient internationally tradable currency to import the essential goods required for successful reconstruction. The dollar shortage: ▪ Economic strategy: Investment-led growth model required the enhanced production of capital goods and/or machinery imports. ▪ External constraints  German steel and machinery production was insufficient to meet post-war demand for capital goods.  Europe depleted hard currency reserves during the war, so it could not import capital goods from Britain and the U.S.  Imports had to be paid for by exports, but to export more industrial production had to increase first. ▪ European economy could not revive without Germany, which was the biggest producer of capital goods and one of the biggest markets for many continental European countries. - Political uncertainty, not only about post-war settlements but also on the future political model in each country: ▪ New politics  Communists on the rise on France and Italy.  Labour government in Britain proposed nationalisation program.  Support of militant labour unions vital for government policy. ▪ German politics:  Until 1947, the Social Democrats were the largest party, in control of the Economic Administration, and supported nationalization.  Centre-right dominated by Christian Socialism (Ahlen Program), they tend to agree a lot of economic policy aims with the social democrats. ▪ Economic consequences:  Uncertainty about future property relations limited investment. Investors were very discouraged to invest.  Uncertainty about future of price and wage controls limited investment in skills and training. The Marshall Plan: Page 36 of 74 - Its official name is European Recovery Programme (1948-52), one of the most iconic international aid programs in modern history. ▪ Allocate in total about 13 billion dollars of U.S. government aid to European countries in exchange for trade liberalization and economic cooperation (only half of what was initially proposed). ▪ Technical Assistance Program to improve industrial productivity. European were invited to the Americas for them to learn about their technologies and management practises with the aim of improving productivity. - Motives of U.S. aid (not pure generosity!): ▪ Remove external constraints to European recovery. ▪ Expand market for U.S. industry after demobilisation. ▪ Contain Soviet expansion in Europe. - Three pillars: 1. Dollar aid to buy imports from the U.S. Firstly, countries received dollar aid from the U.S. Congress, designated exclusively for financing imports of U.S. goods and raw materials. Using Italy as an example, the Italian government paid American companies in dollars for imports, while domestic companies paid the equivalent in local currency. This dual mechanism not only eased dollar constraints but also generated counterpart funds at the disposal of recipient governments. 2. Counterpart funds to finance domestic investment, but also to subsidize private investment. These counterpart funds served a dual purpose. On one hand, they facilitated the payment for imports in domestic currency, effectively providing countries with American goods for free. On the other hand, the accumulated funds were utilized by governments to finance domestic investments, including infrastructure projects and subsidies for private industry. 3. Intra-European cooperation (OEEC). This collaboration aimed to coordinate investment strategies and allowed countries to use part of their dollar aid to fund imports from each other. This not only stimulated intra-European trade but also supported the economic recovery of individual nations. The next two are important for the exam!! Economic impact of the Marshall Plan: - External constraints ▪ Marshall Aid eliminated European trade deficit with the U.S. ▪ Imported materials and machinery boosted industrial growth. - Investment aid ▪ Investments by the counterpart funds provided additional resources to solve infrastructure and production bottlenecks. This facilitated economic development by channelling resources into critical areas. ▪ Eased tensions between investment needs and welfare. - Market incentives ▪ Marshall Aid was conditional on commitment to market economy. This finally removed political uncertainty, it was clear that the control would have been removed. ▪ Imported foodstuffs, fuel, and raw materials eased shortages. Political impact: - Political power to the centre. ▪ France: Coalition government between Republicans and Socialists, consolidating political power at the centre. ▪ Germany: Christian Democrats take over Economic Administration. ▪ Italy: Christian Democrats win 1948 election decisively and then for decades monopolize government in Italy. - Communists marginalised. ▪ Accepting a Marshall Plan implied commitment to capitalism. ▪ Refusal of the USSR and Soviet bloc to participate. - German rehabilitation. ▪ Marshall Aid to France and Benelux substitute for reparations. ▪ Revised Level of Industry Plan (1947) allowed for industrial expansion. ▪ Marshall Plan finalised the division of Germany. In 1949, two states were established (West Germany and East Germany). Topic of the class: - The economic consequences of World War II - European economic recovery Main messages to take away: - World War II did not destroy the economic foundations of western Europe, but it left behind legacies that limited recovery. - Economic recovery was limited by the collapse of foreign trade, the weakness of the German economy, and political uncertainties. Page 37 of 74 If we look at Western economic development, or to some extent global, since the Second World War, we have to distinguish between very different periods: - The Golden Age, 1950-1973. ▪ Growth acceleration in the western world, very high growth rates of GDP and GDP per capita: both income and productivity ventures between countries. Initially, relatively less developed economies within the Western world – like Italy or Japan – by comparison achieved slower growth. ▪ Cross-country convergence within Europe and across the Atlantic. Western countries throughout this period became more and more similar in terms of their level of income and productivity. - - Slowdown or normalisation, 1974-1989: ▪ Growth deceleration. ▪ Continental and Transatlantic convergence continued. - Globalisation and the New Economy, since 1990s ▪ Gap between U.S. and Europe grows again. ▪ Global inequality declines, end of the Great Divergence (‘rise of the Rest’). Examining fundamental indicators, such as the growth of total GDP, they provide a clear insight into the post-war golden age — undoubtedly an exceptional period in the history of economic development since the Industrial Revolution. During this era, total GDP exhibited a growth rate more than twice as fast, even in comparison to high- growth periods in the post-war years. The last quarter of the 20th century, despite challenges, outshone any achievements in Europe. The uniqueness of the golden age can be attributed to three primary factors: - Cross-country convergence (additional growth achieved by closing the efficiency gap with the US): ▪ Within Western countries, economic historians often highlight the ascendancy of Western nations during this period. Specifically, those Western industrialized countries that, pre-1950 had the lowest GDP per capita or comparatively modest levels of productivity, experienced remarkable growth, with the fastest-growing economies driving this progress. ▪ It required high returns on investment in capital and technology (which became a reality in the 1950s and 60s). This period was marked by substantial levels of investment, constituting a high share of GDP. - Macroeconomic stability: ▪ The golden age was characterized by exceptional macroeconomic conditions. In the 1950s and 1960s, many countries enjoyed near-full employment and low-cost conditions, eliminating the prevalent unemployment issues. The equilibrium of high growth, full employment, and significant investment contributed to an economic landscape where economies expanded rapidly, although with moderated growth compared to productivity. ▪ Wage moderation played a crucial role, ensuring profitability and resulting in two decades of low inflation and stable exchange rates. - Increased social equality: ▪ The golden age also signified a period of social progress in Western countries. The introduction of the welfare state after World War II marked a significant milestone. Welfare policies played a pivotal role in eradicating mass poverty by the early 1960s, a persistent issue in much of Western Europe. ▪ Full employment contributed to a reduction in income inequality, as women were integrated into the workforce, addressing gender disparities. Post-war ‘catch-up’ (reversing the loss of output and destruction of capacity): - Outlined in Derry Eichengreen's work, and referred to as "post-war catch-up," more commonly recognized as the reconstruction thesis. - The underlying concept is the notion of catching up to potential output disrupted by major impacts, such as a world war. ▪ This period is marked by a surge in actual output, aligning with both actual and potential trajectories. The aftermath of significant calamities, like world wars, results in the creation of substantial physical capital, including infrastructure and production plants. ▪ Post-war growth is achievable due to the reallocation of factors of production. Destruction during wartime misallocates these factors, either among industries or regions, prompting a return to more efficient use and ultimately fostering high production growth. Page 40 of 74 Two compelling pieces of evidence support this perspective (post-war growth miracles). ▪ Firstly, in the 1950s, the countries experiencing the fastest growth were those situated in the southern periphery, such as Greece, Portugal, and Spain. These nations had endured the Danish Civil War in the 1930s and the Greek Civil War in the late 1940s, leading to significantly low levels of output and productivity. The post-war period witnessed their rebound, with these countries exhibiting substantial growth. ▪ Secondly, the driving force behind growth during this period was substantial investment, underscoring the economic vigour prevalent at the time. European economies invested 15-20% of national income by the 1960s (without housing). The Growth theory - the Solow model: - This neoclassical model, attributed to Robert Solow, stands as a cornerstone in economics, contributing significantly to our understanding of economic growth. The Solow model serves as a fundamental growth model, addressing the dynamics of economic growth and population. This model, despite its simplicity, remained influential for much of the 20th century. Until recently, the Solow model was the starting point for macroeconomics worldwide. However, curricula have evolved, and while the Solow model may not be at the forefront of macroeconomic textbooks today, it still finds a place in economic history discussions, emphasizing its enduring significance. - At its core, the model relies on an aggregate production function, elucidating how factors of production contribute to output in an economy. It describes an economy with one homogeneous output, two factor inputs, labour and capital, and factor-augmenting technical change. ▪ Y = F (A, K, L) = AKαL1-α  where Y is output (value-added).  K and L are capital and labour; 0<α<1 the production function exhibits constant returns to scale overall but diminishing returns to each factor of production.  A is a technology determined and factor neutral. - But what exactly does constant returns to scale mean in this context? ▪ Constant returns to scale refer to a situation in which an increase in the scale or size of production leads to a proportional increase in output. ▪ In straightforward terms, it signifies that if we increase both the input of capital and labour by a certain percentage, let's say 10%, while holding technology constant, the output will also increase by the same percentage, in this case, 10%. ▪ This assumption simplifies the model, although more modern growth models acknowledge its limitations. - With constant returns to scale, the model presupposes diminishing returns to each factor of production. ▪ Diminishing returns to each factor of production occur when the increase in one input (factor of production) leads to a smaller increase in output, assuming other inputs are held constant. ▪ To illustrate, if we maintain technology and labour input constant, increasing the capital input by 10% would result in a less than proportionate increase in output. In the standard Solow model, assuming alpha to be either one-third or 0.3, scaling up capital by 10% while keeping everything else constant leads to an increase in output, while scaling up labour by 10% under the same conditions results in a 7% increase in output. - The final assumption revolves around the nature of technological progress, asserting that: ▪ It is exogenous: it occurs externally and is independent of other factors within the model. This implies that technological advancements are not influenced by the current state of the economy or the level of factors of production. ▪ It is factor neutral. This implies that when technological advancements occur, they enhance the productivity of both factors of production to an equal extent. In simpler terms, if technology improves the productivity of labour, it will also improve the productivity of capital.  If we plot labour productivity (denoted as y over l) against capital intensity (capital per unit of labour, denoted as small y or small k), the production function takes a specific shape due to these assumptions. Essentially, this implies that adding more capital - whether physical capital like machines and infrastructure or human capital - increases labour productivity. However, the rate of increase diminishes over time. To illustrate, consider the scenario where additional pieces of equipment are provided to a worker. Initially, productivity jumps significantly, but after a certain point, the curve becomes flatter because adding more capital per unit of labour ceases to significantly enhance labour productivity. Page 41 of 74 Page 42 of 74 ▪ Trade openness. International institutions fostering increased trade openness between countries play a significant role. Greater trade openness increases future product demand, further incentivizing firms to invest. Social contract: - Eichengreen: economic growth conditioned by social contract between firms and workers on how to redistribute profits. Workers, represented by unions, get a share of the company's profits. This arrangement involves a kind of negotiation, and economists use game theory, especially dynamic game theory, to understand the dynamics of these agreements. - In dynamic game theory, social contract is undermined by the time inconsistency of optimal plans. ▪ Workers have no incentive to support wage moderation if not certain that firms reinvest profits. ▪ Firms have no incentive to reinvest profits, if not sure that unions accept wage moderation. In the game of wage negotiation between firms and workers, there's a small-time inconsistency because firms might promise to reinvest profits from wage moderation, but workers can't be sure it will happen. Once profits are made and employment rises, workers may lose incentive for wage moderation in the future. Similarly, firms might not reinvest as promised. - After WWII, governments strong enough to force social partners to abide by their commitments, thus solving timing inconsistency, → High investment – high productivity – low wage equilibrium Domestic institutions - Forms of wage restraint in post-war Europe ▪ Broad social pacts (Belgium, Holland). ▪ Intervention by labour governments (Scandinavia). ▪ Institutionalised wage bargaining (Austria, Germany). - Cases of failure Countries at full employment and with militant craft unions experienced severe wage pressure and industrial action (France, Italy, UK). The failure of social contracts in certain Western European countries, notably the UK, was attributed to the lack of national-level coordination: high pre-existing tensions between employers and trade unions. Eichengreen attributes failure to the nature of labour unions, which remained specific to individual industries in these countries. Monitoring compliance: - Compliance must be monitored in order to be enforced. This is a role of the government. - Historically, firm compliance was key: reconstruction of capital had to be financed by initial wage restraint. - To ensure compliance from both parties, external and internal monitoring mechanisms were established. 1. External monitoring: disseminating information about firms within the same industry, highlighting any notorious non-compliance. 2. Internal monitoring: providing labour representatives with direct access to executive decisions. ▪ Co-determination in executive boards (Mitbestimmung, 1951). ▪ Advisory boards with labour reps. More informal way. ▪ Work councils in small. - Different countries employed various enforcement mechanisms, all aimed at creating strong incentives against breaking agreements: ▪ To make the social contract work, social partners must be ‘locked in’ the bargain. ▪ Enforcement mechanism: ‘bonds’ created to punish reneging.  Austria: subsidies linked to commitments, punitive taxes on non-compliers.  Germany: tax concessions on reinvested profits.  Sweden: deposited profits. An interventionist labour government introduced a unique solution where a portion of companies’ profits was held as collateral, refunded upon compliance within the year. ▪ Enforcement mechanism: devices to bond labour.  Welfare benefits conditional upon social contract.  Shortening of the workweek to compensate for wage restraint.  Swedish model: life-long learning opportunities, retraining schemes. Coordinating mechanisms: - To make the social contract effective, bargaining has to be coordinated across different sectors. - Externality : wage restraint in one sector might affect investment and thus future wage growth in other sectors. Page 45 of 74 - Two ways to internalize this externality: ▪ National level bargaining between ‘umbrella’ organisations: trade union congresses and chamber of industry. ▪ Government-mediated bargaining at industry level. If the firm or the trade union did not comply, the government stepped in. Institutional development: - What was the impact of WWII? ▪ ‘Clean slate’ (Olson):  In stable democracies, there was a tendency to accumulate ‘distributional coalitions’. Policymakers were influenced by special interest groups.  In Germany, or Japan, dictatorships dismantled these coalitions. Post-war interest groups more encompassing and more publicly controlled. ▪ Path dependency (Eichengreen)  Post-war institutional reforms were nuanced, with small changes depended on special historical circumstances.  Germany: corporatist model developed from 19th century.  Britain: governments were unable to dismantle craft trade unions. What have we learnt today? Topic of the class: - The neoclassical growth model. - The role of institutions in investment-led growth. Main messages to take away: - The golden age of the 1950s and 1960s stand out in the modern era for a unique growth acceleration. - Fast growth in western Europe and Japan was driven by post-war catch-up and technological convergence to the United States. - Both reconstruction and technological modernization required high investments, which were facilitated by the social contract. Key concepts: conditional convergence, social contract. Topic 8 – Economic development after World War II Reading - Eichengreen, ‘The mainsprings of growth’ | Lecture 21 – Postwar institutions Main questions to consider: 1. How dependent was post-war growth on post-war institutions? 2. Why did the golden age come to an end? 3. What was the impact of the oil shocks? 1. Post-war growth in Europe was significantly dependent on post-war institutions. The institutional foundations of the golden age, including government involvement in labor/management negotiations, bank-dominated financial systems, and collective strategies for using U.S. funds, played a crucial role in sustaining the high investment, rapid export growth, and wage moderation that characterized the period of exceptional growth from 1950 to 1973. These institutions were well-suited to the growth imperatives of the time and helped to address coordination problems that could not be solved at the level of individual firms or industries. They provided the necessary framework for economic stability, investment, and technological catch-up, which were essential for sustaining the post-war economic recovery and growth in Europe. 2. The golden age of post-war economic growth in Europe came to an end for several reasons: - Technological Change: The rapid technological change and the shift towards innovation-based growth made it more difficult for the existing institutions to sustain growth. The institutions that had played a positive role in the preceding years became obstacles to growth, as sustaining growth now involved investing in new products and unproven technologies, which was challenging for the existing institutional framework. - Macroeconomic Instability: The late 1960s saw a decline in the share of profits in national income, along with strikes, wage inflation, and a declining share of profits, which led to lower investment rates after 1973. The collapse of the Bretton Woods System in 1971–1973 also contributed to inflationary pressures and macroeconomic instability. - Feasibility Constraints: Ambitious modernization programs, such as the Monnet Plan in France, faced feasibility constraints as Europe produced limited amounts of the capital goods that were essential inputs into the Page 46 of 74 modernization process. This limited the ability to import large amounts of coal, intermediate inputs, and machinery, impacting the pace of growth. - Institutional Limitations: The institutional arrangements that had been conducive to growth and stability for a quarter century began to produce less satisfactory results. The rise of the capital–labor ratio toward steady-state levels and the limitations of the institutional arrangements in adapting to the changing technological imperatives contributed to the end of the golden age. 3. The oil shocks of 1973 and 1979 had a significant impact on the global economy, including Europe. These shocks led to a sharp increase in oil prices, which had several consequences: - Inflation: The oil shocks resulted in a period of generalized commodity price inflation. The increased cost of oil imports led to a broader inflationary impact on the European economy, contributing to macroeconomic instability and eroding purchasing power. - Balance of Payments Challenges: The increased cost of oil imports led to a significant increase in the trade deficit for European countries. This imbalance in trade contributed to challenges in the balance of payments, impacting the overall economic stability of the region. - Currency Depreciation: The oil shocks also contributed to a decline in the value of the European currency. The increased cost of oil imports and the trade imbalances led to a depreciation of the European currency, further exacerbating economic challenges. - Policy Response: In response to the oil shocks, there were attempts to manage aggregate demand through policy instruments. However, these attempts were not entirely successful, as evidenced by the need for sharp interest rate hikes in the United States and the United Kingdom to rein in inflation. Intra-European trade. - Export growth twice as fast as GDP: ▪ During the Golden Age, exports in Western Europe grew 9% p.a. ▪ By late 1960s, export intensity back to 1913 level, however this was not the same trade. Before, it was constituted exporting mainly to periphery. ▪ By the 1960, trade expansion driven by intra-industry trade, hence trade between industrialized nations. Countries found their comparative advantage relative to their partners, and increasingly similar products start be traded. - European Payments Union (1950-1958): like a good friend helping countries trade and deal with money problems. ▪ Clearing mechanism created by the OEEC, Organization for Economic Co-operation and Development - the institution of the Mashall Plan, so to speak. ▪ Working capital provided by the Marshall Plan. It allowed countries to import more goods from the US, and to rebuild trade between European countries. ▪ Member states could draw credit from EPU to finance temporary deficits, but drawing rights were conditional on trade liberalization. ▪ EPU reinvented a trick from the 1930s that is clearing trade. The idea of clearing trade is that you maximize the volume of trade by minimize the use of foreign trade. It is a multi-lateral trade mechanism. It allowed Western European Countries to increase volume of trade, in a period of shortage of dollar was a significant impediment to growth. ▪ Short-term founding for crisis. ▪ The Korean War was a massive war (very close to a WWIII). It sent global commodity market into chaos. In this period, this type of crisis founding was crucial. ▪ The first country to bail out was Germany. The German question: - The German dilemma: how and if to integrate Germany after WWII. ▪ Industrial base in steel and machinery had to be limited to reduce war potential (Morgenthau Plan). Otherwise, Germany could form any moment start another war. The best way to limit this power was de-industrialize Germany. ▪ BUT German capital goods exports were essential for European recovery. Without the rebuilding of the Germany economic and industrial potential, it would be difficult for other country to recover as well. Both the US and British administration supportive of German recovery and re-integrating Germany. France and Benelux were sceptical. - International control of the Ruhr made by representative of the Western power would control industrial production in this area. ▪ Production of strategic goods limited under Allied occupation, certain type of chemicals, airplanes etc. Page 47 of 74 ▪ Trade unions prevented real wage adjustment, while maintaining their efforts to shorten the working week. → low investment – high wage equilibrium (wages were growing faster than productivity). ▪ Loss of competitiveness versus East Asia. ▪ Many traditional industries found themself in crisis. Industry lobbyists acquired subsidies and prevented structural change (industry shutting down). The failure of Bretton Woods: - The system hinged too heavily on the U.S. dollar. ▪ Costly Vietnam War and high public investment (Great Society). ▪ A large part of its financing came from printing money. The rule of not financing government debt was not extended to the FED. - Eventually, the Fed could no longer support gold convertibility. ▪ In 1971, Nixon suspended convertibility. ▪ In 1973, the Articles of Agreement (IMF) were amended to allow floating (flexible) exchange rates, ending the fixed exchange rate. Ideally, we would want full capital mobility (easy movements of money between countries for investment), fixed exchange rate (steady values for currencies), and monetary autonomy (countries controlling their own money). However, the reality is that you can only have two out of three. The gold standard initially had full capital mobility and fixed exchange rates, but this caused problems during crisis because the central banks could not intervene effectively. - After the Gold Standard, Bretton Woods combined fixed exchange rates with monetary autonomy, and countries had to use capital controls. - Post-Bretton Woods, the world moved to a system with full capital mobility but floating exchange rates. This means exchange rates are determined by market forces based on the flows of foreign exchange. Stagflation is the coexistence of high inflation with rising unemployment: - The Arab League retaliated against western support for Israel in the Fourth Arab-Israeli War. ▪ Creation of the Organization of the Petroleum Exporting Countries (OPEC): international cartel of oil- exporting nations. The biggest oil exporting nations in the world decided to increase dramatically the price of crude oil. ▪ Oil is a necessity without substitutes → low price elasticity of demand. ▪ Dramatic increase of oil prices reduced purchasing power for all other goods and services. ▪ Lower aggregate demand reduced demand for labour. - Stagflation ▪ Rising commodity prices increased the general price level: inflation. ▪ At the same time aggregate demand shrank: stagnation. ▪ Inflation coexisted with high unemployment - PC curve is reversed. Very difficult to implement traditional macroeconomic policies. How does cartel function? By output, they act on prices. It is necessary to be a big player in the market and have very low-price elasticity. The consequences of stagflation: Page 50 of 74 - To stop high inflation, western central banks raised interest rates, which had a double effect: 1. Crowding out of domestic investment reduced aggregate demand. 2. High interest rates attracted hot money from oil-rich states, which caused either further inflation or exchange-rate appreciation. - Falling domestic demand and weakening competitiveness reduced demand for labour. Two results: ▪ Structural unemployment. ▪ Lower utilization of capital and labour slowed down TFP growth. Topic of the class - Post-war international institutions. - The end of the Golden Age. Main messages to take away: - Postwar stability hinged on multilateral institutions, which in depended too heavily on the United States. - Fast growth in western Europe and Japan slowed down as the sources of post-war growth were gradually exhausted. - The oil shocks were detrimental for growth as they generated high inflation and high unemployment at the same time. Key concept: accelerator principle, stagflation. Topic 9 – The new age of globalisation Reading - Amsden, ‘The rise of the Rest’ | Lecture 22 – New Age of Globalization Main questions to consider: 1. How did developing markets begin to modernize and catch up? 2. What has been the role of the developmental state? 3. How did globalization benefit emerging markets? 1. The rise of the rest, as described by Amsden, refers to the phenomenon of a handful of countries outside the North Atlantic, including those in Asia and Latin America, catching up to world-class competitors in mid-technology industries. Amsden's work highlights how these countries began to modernize and catch up through a process of late industrialization, characterized by the acquisition of knowledge-based assets and the development of manufacturing experience. Late industrialization was a case of pure learning, where countries initially depended on other countries' commercialized technology to establish modern industries. This process involved several key elements: - Acquisition of Knowledge: Developing markets began to modernize by attracting capital, both human and physical, out of rent-seeking and into manufacturing. This shift involved a transformation from a set of assets based on primary products, exploited by unskilled labour, to a set of assets based on knowledge, exploited by skilled labor. The development of knowledge-based assets played a crucial role in the modernization and catch-up process. - Manufacturing Experience: Amsden highlights that among backward countries, a great divide had already appeared by the end of World War II in the form of manufacturing experience. Countries that had acquired enough manufacturing experience in the production of basic goods were able to move into mid-technology and later high- technology sectors. This manufacturing experience provided the foundation for the modernization and catch-up process. - Industrial Diversification: The development of manufacturing experience allowed these countries to diversify their industrial base and move into more advanced sectors. This diversification was essential for modernization and catching up with world-class competitors in mid-technology industries. 2. The developmental state played a crucial role in the economic rise of the rest. The developmental state, as defined by Amsden, refers to a state that actively intervenes in the economy to promote industrialization and economic development. This intervention often takes the form of strategic policies aimed at fostering specific industries, promoting technological advancement, and guiding the allocation of resources to support long-term economic growth. The developmental state is characterized by its proactive role in shaping the direction of industrialization, often through targeted interventions such as subsidies, trade policies, and investment in infrastructure and human capital. Amsden emphasizes the importance of the developmental state in guiding the process of economic transformation and fostering the growth of strategic industries in late-industrializing economies. Amsden emphasizes that the developmental state in these late-industrializing economies was instrumental in guiding and promoting industrialization, often through strategic interventions in the economy. These states actively facilitated and directed the process of industrialization, often through policies such as import substitution, export promotion, and investment in strategic industries. The developmental state's role in fostering industrialization and economic growth is highlighted as a key factor in the rise of these economies to world-class competitiveness in various mid-technology industries. Page 51 of 74 3. Globalization benefited emerging markets in several ways. - Firstly, it provided access to larger markets, which allowed these economies to take advantage of economies of scale and scope, and to increase their exports. - Secondly, globalization facilitated the transfer of technology and knowledge from developed to developing countries, which helped to improve productivity and competitiveness. - Thirdly, globalization provided access to foreign investment, which helped to finance the development of infrastructure and industries in these economies. - Finally, globalization created opportunities for emerging markets to participate in global value chains, which allowed them to specialize in certain stages of production and to benefit from the resulting gains in efficiency and productivity. Post-war growth: - The Golden Age, 1950-1973. ▪ Growth acceleration in the western world. ▪ Cross-country convergence within Europe and across the Atlantic. - Slowdown or normalisation, 1974-1989. ▪ Growth deceleration. ▪ Continental and Transatlantic convergence continued. - Globalisation and the New Economy, since 1990s. ▪ Gap between U.S. and Europe grows again. ▪ Global inequality declines, end of the Great Divergence. The fundamental reason why we study economic growth and development in the long run is because it explains one of the most interesting aspects of economic development and that is the very large inequality that it has produced across countries in the word. In 1950, inequality was giant in both life expectancy and income. The United States were leaders on this trend, whereas China had lower income and lower life expectancy (UK had the same life expectancy at the beginning of the first Industrial Revolution). Most of the non-Western World had overall standards that the Western Europe had before the Industrialization. China during the last 20 year really accelerated growth. In 2022 we still see much less differences life expectancy, which means that exporting Western medical products by now eliminated most child mortality, but you still have large gap of income. Much strong gradient among countries. In 1990, China and India were still categorized as low country. The rise of the ‘Rest’ - End of the Great Divergence ▪ Until the mid-20th century, modern economic growth (driven by industrialization) only benefited Europe and the western offshoots (and Japan from). ▪ A new set of competitors in medium-tech from the 1960s onward. Until then, the industrialization in the periphery was limited only to industries like textiles. - Various names for these countries, one of the most common is Newly industrialised countries (NICs). ▪ In 1965, NICs produced 5% of world manufacturing output, by 1995 their share grew to 17% (and since then doubled). ▪ South Korea, Taiwan, Singapore, Hong Kong broke into the club of advanced economies. - What about the rest? Primary exporting countries ▪ Their (mixed) performance was determined exogenously, and their development was based on the commodities they exported, such as oil. The main drivers of late industrialization in these late developing economies were driven by four major factors (chronological order): - Demographic transition which, in this part of the world, took place much later than in Western Europe. Population growth (growth enhancing) created both a large enough markets for modern industries, but it also created the necessary labour force for industrialization. - Import substitution. They began to industrialize when, as a consequence of deglobalization, international trade was much lower than before. - The developmental state. As import substitution was reaching its limits, it became more and more important for these countries to integrate more successfully into the global economy and to be more competitive on external markets. For that, state intervention proved essential to make this successful transition. - Globalization. What really helped during this era of global convergence is a new era of globalization. Demographic movements: 1. Mortality decline Page 52 of 74 ▪ Innovation is a product. Innovation requires inputs like any other production (especially human capital). It is not something that comes from out of the production function innovation. Innovation is a product itself: innovators are producers for some perceived market demand, they expect returns and generate profits from their innovation. ▪ Ideas are non-rivalrous: not depleted by consumption. [Mokyr: useful knowledge] ▪ Technology is endogenous. The ability to innovate and implement new ideas relies heavily on the accumulation of human capital and the presence of skilled individuals who can generate and apply innovative concepts. The rate at which human capital is built up becomes a crucial determinant of the pace of technological progress. This aspect is particularly significant because in an economy where technology is endogenous, catching up becomes more challenging for nations that lack sufficient human capital. Education, being a long-term investment, plays a pivotal role in this process. - Directed technical change (Acemoglu). ▪ Increasing returns to scale (size matter!!): endogenous innovation depends on market size for several reasons, such as:  Innovation requires a lot of investments and risky investments. The larger the economy, the more is likely that you can find enough financing.  Large concentration of highly skilled and educate people with innovation capacity, they can innovate faster because they learn from each other as well. ▪ Innovation driven by large, advanced economies → new technology is capital and skill biased → inappropriate for poor countries. A larger economy where you can scale up much more quickly is easier to generate high profit. However, these technologies will be inappropriate for other countries since they do no have the same access to capital and human capital; these technologies are designed to economize on labour and not exploit cheap labour. Consequently, technological change is not factor neutral. Kumar and Russell, in their 2002 paper published in the American Economic Review, aimed to investigate the relationship between factor accumulation and productivity growth across countries. According to the Solow model, the expectation is that, at any given time, increasing capital intensity should result in growing labour productivity but at a decreasing rate. The curve representing this relationship may eventually become flat, indicating diminishing returns. This is precisely what was observed as they compared different countries in 1990. For instance, Luxembourg appeared to be more capital-intensive than the United States, yet the productivity of workers in both countries was comparable, highlighting the impact of diminishing returns. Looking back to 1965, the Solow model also predicts that economies can become more productive over time by developing new technologies. The productivity gain from these technologies is reflected in the distance between the production functions of different periods. Kumar and Russell's findings indicated that substantial productivity gains from technological change occurred, but notably, these gains primarily benefited countries with high capital per worker. Countries with lower capital per worker experienced minimal to no growth in productivity due to technical change. This evidence suggests a significant challenge for late-developing economies: catching up with advanced nations becomes more daunting when technological change is biased toward capital-intensive economies. The studies imply that, at least in the post-World War II era, technological advancements were strongly skewed in favour of countries with higher capital endowments. This bias poses a considerable hurdle for economies with fewer resources and capabilities in their pursuit of catching up with technologically advanced nations. The developmental state: - The challenge of late industrialization ▪ Inappropriate factor endowments. Being rich in cheap labour (instead of rich in capital) is going to make your economy inappropriate for the application of modern Western technologies, that are not going to be as profitable. ▪ Insufficient technical capabilities. Poor countries have insufficient skilled workforce to implement the best technology available. Additionally, they do not have enough scientific infrastructure and scientific capabilities to become more innovate themselves. - Gerschenkron (1962) argued that in backward economies, the state “substitutes for lacking prerequisites”. In these economies state intervention is needed to support capital accumulation to allocate additional resources for education, scientific and research to build infrastructure for both industry and innovation. - Amsden argued that export promotion: efficient production scale + learning. Import substitution, industrializing behind protective tariff walls, was criticized for allowing industrialization at lower levels of capital intensity and hindering catching up in productivity with advanced Western nations. Amsdell advocated for Page 55 of 74 export promotion as essential for learning in late-developing economies and achieving efficient production scales. Page 56 of 74 - Main challenge is that further growth depending on successful export promotion. The solution was what Amsden called ‘new control mechanism’ – what development economists like to call developmental state where the state alters market incentives or complements market incentives to make homegrown industries more competitive in international markets (chronological): ▪ Cost reduction. Low tech or some medium tech industry first where they could became competitive by lowering wage cost. ▪ Subsidized ‘learning’. Once a handful of industries and firms could successfully enter technologically advanced Western markets, learn through these activities both more successfully adapt new technologies but also new management practises. ▪ Institution building. Key if industry wants to transition from a growth model biased on industrialization to a more knowledge-based growth model. On the graph, productivity over output and wages over labour are measured to determine how much labour input is needed to produce one unit of output. Being closer to the origin indicates higher productivity, meaning fewer work hours to produce a unit of output, even with higher wages. In the early stages, advanced Western economies (the Incumbers) dominate world markets with high wages but very productive labour, resulting in relatively low unit labour costs. However, in the late 20 th or 21st century, efficient transport technology lowers the cost of shipping material inputs. This shifts the focus to unit labour cost for competitiveness. Amsden's challenge for other economies is to implement export promotion policies to match Western countries' unit labour costs and compete globally. The two strategies are either: ▪ reducing wages (maintaining productivity) to decrease unit labour costs or ▪ increasing worker productivity, which naturally lowers unit labour costs even without cutting wages. This is a period where Incumbents Western countries began to experience very rapid wage growth (social contracts), that did not necessarily corresponded to productivity growth. From the late 1960s onwards, South Korea, Taiwan, Thailand, and the Philippines, or later Indonesia, all of them were under authoritarian regimes that could use their power to repress wage demands and that is how they reduced costs relative to their competitors. The actual movement that happened historically is moving from a to b, and then to b to c – at least in the successful cases. Subsidized learning is a very important point. A critique of growth theories in general, which are too based on macroeconomy: - Industrialisation requires knowledge-based assets, three types: ▪ Production capabilities. How to make a certain product or apply a certain technology. ▪ Project execution capabilities. How to make or manage investment successfully, how to scale up. ▪ Innovation capabilities. Determine how successful you are adopting technology and how successful you are in innovating with new products, procedures etc. - This micro and firm level knowledge-based assets are difficult to access or build: ▪ Knowledge is firm-specific. ▪ Firms can generate rents (product differentiation). Firm has to acquire knowledge from their competitors, and they do not want to give away specific knowledge. Monopoly: - Knowledge-based assets constitute barriers to entry: ▪ Maintaining the barriers requires constant innovation. ▪ Market leaders have hardly changed in high and medium-tech. Monopolistic competition – market leaders, who are much more successful than others in differentiating their products, can price much higher than substitute products. Product cycle: - Theory: new industries locate in high wage economies because of: ▪ High human-capital needs to develop new technology and products. ▪ High returns to innovation in advanced markets. - As technology is standardized and not much innovation is needed anymore, comparative advantage shifts and industry migrates to lower wage economies. - As wages rise in NICs, they too become vulnerable to low-wage competition and must become more innovative. Page 57 of 74 advantage over Europe. Additionally, greater capital deepening, particularly in the form of higher levels of investment in ICT, has played a role in driving America's labour productivity growth advantage over Europe. Furthermore, the United States has excelled in the IT-producing sector, and its productivity advantage has been centred in sectors such as retail trade, wholesale trade, and financial services. These factors have collectively contributed to the United States' leadership in productivity growth relative to Europe. 3. In the new economy, technology plays a critical role in driving productivity growth and economic development. Information and communication technologies (ICT) have transformed the way businesses operate, enabling them to streamline processes, reduce costs, and improve efficiency. The widespread adoption of ICT has also facilitated the growth of new industries and business models, such as e-commerce and the sharing economy. Additionally, technology has enabled firms to access new markets and customers, both domestically and internationally, through the use of digital platforms and online marketing. The new economy is characterized by a greater emphasis on knowledge-based activities, such as research and development, innovation, and intellectual property creation, which are facilitated by advances in technology. Overall, technology has played a central role in shaping the new economy, enabling firms to operate more efficiently, access new markets, and create new products and services. The new age of globalisation: - Global trade boom since 1990 ▪ Transport & communications technology ▪ Reduced trade barriers (WTO) ▪ End of the Cold War - Capital flows ▪ Integrated capital markets ▪ Deregulation and financial innovation ▪ Multinationals, FDI - “This time is different” ▪ Trade-oriented firms become global → trade within the firm ▪ Specialization within product-chain Europe in the new global economy. - New Economy: ▪ The ICT revolution transformed production and trade, iconically starts with the opening of the WWW (1993). It introduced a set of new GPT (General Purpose Technology) such as the internet, smart communication, later AI, transformed production rate in different sectors of the economy transformed how we communicate. ▪ This had several consequences for industrialized economies. One is that production became much more skill and R&D intensive. Innovation is much faster, and start-ups became much more important in innovation. ▪ Service components became more important and flexible in Western economy. ▪ Institutional flexibility essential for innovation both in forms of financial instruments and financial services because start-ups are scaling so fast that services need to be adjusted to different stages of their development very quickly. - One of the fundamental consequences of this new economy was that EU (especially the “older” EU member stats) have been falling behind the U.S. Four main explanations on why this happened: ▪ Stricter regulation – especially in labour market regulations – which at least initially hamper the diffusion of ICT. ▪ U.S. lead in higher education especially in terms of quality. ▪ Europe had consistently higher taxation on working incomes, creating weaker incentives in working harder in Europe than U.S. ▪ Barriers to trade in services within the Single Market. For manufacturing goods it worked very well, but service market US are much more integrated than in Western Europe. Navigating the economic landscapes of the EU and U.S. has become quite a puzzle. These are high-wage economies where households enjoy substantial consumer surpluses, making traditional measures of economic performance less straightforward. When it comes to comparing income and productivity, it's no longer as simple as GDP per capita or per worker. High-wage economies introduce complexities like varying labour participation rates and differing perspectives on the value of leisure. In essence, how we measure productivity and income needs a fresh approach. Common claims, such as Page 60 of 74 excessive regulation hindering growth, face challenges. Despite a reduction in regulations over the past few decades, record growth has been achieved in Western economies. The notion that EU and North American institutions are starkly different also gets nuanced when viewed in a broader global context. The rise of the new economy since the 1990s, driven by information and communication technologies (ICT), brings its own set of questions. Defining the ICT sector becomes crucial – is it just about hardware and software, or does it extend to services that heavily use these technologies? Understanding how much this sector contributes to productivity growth and the diverging trend across Western countries adds another layer of complexity. In essence, evaluating economic performance in these modern economies requires a nuanced lens. It involves going beyond traditional metrics, considering the impact of technological shifts, and recognizing the intricate interplay of institutions in shaping economic trajectories. The complexities of these analyses mirror the intricacies of today's high-wage economies. GDP per capita between US and EU-15 – [The US is always one hundred] From mid-1970s, Western Europe maintained at least a 20% gap compared to the US. GDP per working hour –From the mid-1970s, European working hours declined leading to decline. By 1990s, the average Western European worker was putting in about 75% of the hours of their US counterpart. Since the late 1990s, a noticeable divergence in labour productivity emerges. France emerged as the most productive economy by the early 200s. Germany and Italy had a peculiar parallel, with workers being equally productive per hours since the 1970s. Productivity gap: - Decomposition of US-EU gap in GDP per capita ▪ 1/3 due to difference in labour participation. ▪ 1/3 due to difference in average hours worked. ▪ 1/3 due to productivity gap (per worker hour). - Why is has been labour participation lower in EU? ▪ Western Europe had much higher levels of unemployment than the US in most years since the 1990s. ▪ Since the 90s in many European countries, much lower rate participation among women due to tighter regulation that made the hiring and the firing of women more difficult in Europe than in US. But also because of much generous childcare benefits and tax concessions for children and non-working spouses in Europe. Is it a good or bad thing? ▪ Low rate among elderly. In US, no have a universal pension system. Is that a good thing? - Labour productivity (growth accounting: distinguish between different sources of labour productivity gap). ▪ Europe allocate labour to less productive sectors of the economy than in the US. ▪ US economy may be still more capital intensive. ▪ More efficient use of resources, and that has to do either with ICT technology or with something else. The other thing that needs to be explained is European unemployment: - Global divergence in labour expansion ▪ Sharp decline in labour input in Europe since the 1960s. ▪ Whereas the trade was reversed in the 1990s labour expansion in the US and in Asia as well. - Do European work too little? ▪ Employed labour force very productive, almost as productive as US. ▪ Unemployed mostly marginal workers i.e., much less productive, educated and skilled than the average workers. Including them in the economy may even disrupt the more productive workers. ▪ Leisure is a highly valuable commodity (also investment). Before, the main concern of worker what essentials. Now a middle-class family can cover their expenditure easily, but you want to earn money also to spend them during your leisure time. Investment meaning for example pick us a new language as a new skill. - What explains high unemployment (even if the problem is probably that this is long lasting) ▪ Labour market regulation (minimum national wage, work hours), especially in the low skilled industry. ▪ Structural unemployment. At the end of the Golden Age, Western European countries still employed relatively high share of the workforce in sectors that became declining industries - such as agriculture- that could be outsourced to other parts of the world or because of rapid mechanization. Most of the unemployed were laid off in 80s and 90s in these sectors. They remained unemployed for a long period of time. Why do Europeans work less? - “MIT school” ▪ Cultural preference: Europeans value leisure over extra pay. ▪ Preference for shorter hours accepted by political establishment. - “Minnesota school” focuses on regulations. ▪ Lower taxes in U.S. implies higher incentive to work. Page 61 of 74 ▪ 10% gap in average tax burden. ▪ Excessive tax burden in Europe makes people prefer leisure. - Empirical evidence ▪ Correlation weak within EU: e.g., Scandinavia has highest tax rates, but low unemployment and high labour participation for both men and women. ▪ Income taxes were very high during Golden Age. Both the US and EU had close to 90% marginal tax rate. ▪ Does not explain long-term unemployment that seems to be the biggest problem. Unemployment: - Unemployment is mostly structural. ▪ Concentrated in declining sectors like agricultural, construction, low skill services or outsourced from other countries. ▪ Limited occupational mobility relative to U.S. - Long-term unemployment ▪ Workers out of employment for years usually stay unemployed. ▪ Depreciation of human capital, especially in very fast development sectors. Once you are out of the labour market for long time, it is more difficult to catch up for technologies, practises etc. ▪ ‘De-learning by (not) doing’ (working skills, discipline). You lose working skill and basic working discipline. - Youth unemployment [now less of a problem than 10 years ago]. ▪ New phenomenon that includes people who are not in full-time education, who are seeking for a job but cannot find one. ▪ Large differences within the EU, even within countries between regions. ▪ Supply or demand? And to what extent one of the other. Is the economy not creating enough jobs, or do they not want certain type of jobs? How to reduce unemployment? Some of the older model: - Netherlands [unemployment rose in the early 1980s due to rising labour costs] ▪ Wassenaar Agreement (1982): freezing minimum wage and cut the unemployment benefits. New type of social contract, between the workers (or unions) and the government. ▪ Devaluation of guilder, strong dollar. ▪ Structural reforms: part-time work for women, cut the dole. - Ireland [unemployment rose by 1987, reflective the severity of the recession in Britain] ▪ Programme of National Recovery (1987/8): wage moderation to support investment and growth, in exchange for tax cuts - maintained the real household incomes with lower taxes. New type of social contract, between the workers (or unions) and the government. ▪ Successive devaluations. Employment rose drastically. ▪ Since the 1980s, return migration during a period of difficult time in the U.S. (young and educated). ▪ From of the poorest to one of the richest economy in Europe. - Germany-Austria ▪ Dual-track educational system: the relatively less educated in high school go to different types of vocational training, which involves two tracks education, which involves both practical and formal education. ▪ Subsidies for low-cost employment and regional mobility. [FULL SPECULATION:] Implications for Europe today: - What can Europe do to reduce unemployment? 1. Monetary policy ▪ Expansionary ECB can increase competitiveness. ▪ BUT, quantitative easing without fiscal austerity is inflationary. 2. Education ▪ Marketable skills: reduce mismatch between supply and demand. ▪ Become German: dual track. ▪ Transferable skills. 3. Internal differences in competitiveness difficult to reduce. 4. Demography might help ... or has already helped. Page 62 of 74 Topic 1: Economic Development after World War I - Economic consequences: ▪ disruption of world trade  larger peripheral economies began to invest in new manufacturing capacities to produce goods that hey used to import from Europe.  agricultural crisis in 1920s.  US and Japan limited further the market size for European exports ▪ end of mass migration ▪ collapse of the gold standard ▪ increasing government deficit and inflation  printing more money became the prime solution to finance wartime spending  high and persistent inflation  high inflation eventually controlled  hyperinflation: Germany, Poland, Russia, Hungary, and Austria.  Quantity Theory of Money (stock of money and velocity)  Fiat money: money has no intrinsic value ▪ unemployment  Neoclassical view: Benjamin and Kochin – Voluntary Army  Keynesian view – sticky wages ▪ productivity increase ▪ technology biased towards capital and knowledge ▪ reallocation of workforce in more relevant industrial sector  mass production; many small and medium sized enterprises went to bankruptcy ▪ increasing government regulation  vested interest: many industries received extra funding and favoured a slower and gradual approach to demobilization  deep recession after closing munitions industries; high unemployed + wartime inflation  populist movement increased government spending: wages and prices were fixed by collective bargaining - Political consequences: ▪ Demobilisation would reduce state bureaucracy ▪ Rise of the working class, with growth of unions and labour parties ▪ Peace treaties worsened the critical situation:  Disintegration and destabilisation  New boards based on self-determination - Reparations ▪ Germany could pay since it lacked gold ▪ US demanded repayment of war debt in 1919 ▪ Europe could only repay if Germany paid reparations => occupation of the border town and then of Ruhr ▪ Germany needed to generate export to obtain gold  Dawes Plan: initial kick start of US, financial stabilisation and specified sources of revenue for reparations payments, which were scheduled annually. Page 65 of 74 Topic 2: Depression and deglobalization - US ▪ Huge drop in stock prices and then stock market crash in 1929 ▪ Reduced investor confidence => real estate market collapsed => two major banks failed ▪ Many people started withdrawing their deposits to put them into savings => reduced money supply => reduced aggregate demand  Monetaristic theory (Friedman and Schwartz)  Money stock have a large effect on prices and output  They should have added more liquidity into the economy by increasing the money supply  Temin:  Decline in the stock market was a consequences of depression  Banks failed because insolvent  M.T. missed international prospective => deflation was a global phenomenon ▪ New Deal in 1933:  Abandoned gold standard in 1933  Federal Deposit Insurance  Glass-Steagall Act  AAA: raise agricultural prices to a level that would provide the same purchasing power as prewar  NIRA: encourage higher wages and short week - Central Europe ▪ Industrial depression => banking crisis => bank run and currency crisis => loss of gold reserves ▪ Largest Vienna bank failed => revealed weak portfolios in German banks  Germany left the gold standard in 1931  Austria, Germany, Hungary introduced foreign-exchange controls and moratoria on foreign loans to stop the outflow of gold  Hitler refused Versailles Peace Treaty: rearmament 1936  Four Year Plan  Exchange controls  Expansionary fiscal and monetary policy (independent)  New Plan:  National autarchy  Import restrictions  Bilateral trade agreements: Reichsmark bloc ▪ German suspension of gold payments put pressure on Britain => left the gold standard 1931  Deficit due to the strong pound, loss of export, liquidation of overseas assets during WWI  Britian devaluated => boosted aggregate demand => exports went up  Lower interest rates => boost liquidity => housing boom  Increased tariffs, import quotas and exchange restrictions: preferential trade with the Sterling Bloc [Commonwealth conference in Ottawa]  The sterling area left the gold standard and held reserves in sterling  Stable exchange rate allowed country to stabilized their currencies  India was an exception  Primary exporter, hit by falling raw material prices  Should have devaluated  As a British colony, it had to stay pegged to sterling - Other European countries ▪ France and the Gold Bloc maintained the Gold Standard [Gold Bloc (Latin Monetary Union + smn) was only a symbolic organisation  No devaluation led to high tariffs to protect their current account and avoid pressure on the currency  Mantignon Accords: increase wages => consumption  Ended deflation but no devaluation => loss of gold reserves  Tripartite Agreement: full gold convertibility => devaluation ▪ Spain did not restore gold standard after the war ▪ Portugal and Greece had mild recession ▪ Italy and Poland maintained gold until 1935 => severe depression Page 66 of 74  Authoritarian regimes intervene to avoid banking crises  In Italy, Mussolini tried to deflate in 1931 => outflow of gold reserves  Capital controls  Only recovered with rearmament - Global periphery ▪ Japan: practically no depression  Devalued yen  Militarist industrialization with the invasion of northern China  Dual economy ▪ Latin America: they could easily leave the gold standard  Devaluation increased external debt  They defaulted on external debt => more government spending for domestic investment  Import-substituting industrialisation  Argentina left G.S. in 1929 ▪ Africa and Asia (primary exporters): hit hard by fall in global agricultural prices ▪ URSS:  Fastest growing economy  Central planning  Collectivisation of land: not efficient  Investment planning  Output maximization  Development dictatorship Failure of international cooperation: - Lausanne Conference on Reparations - World Economic Conference in London Gold standard (full capital mobility and fixed exchange rate) - Two different ▪ Before 1914 ▪ In the 1920s  Dysfunctional and promoted worldwide deflation  Tight monetary policy, needed to maintain gold standard => deflation  Deflation => rising real wages (due to sticky wages) => fall in employment and output  Industrial nations buy less raw materials  Primary exporters reduced demand for manufactures, they are the first to go into depression  Decline of industrial exports  Either leave the gold standard  Or devalue, since reserves go down - Problems: ▪ Incorrect exchange rates: retuned at gold exchange at too high or too low parities ▪ Misallocation of gold (Bernanke and Eichengreen)  US and France sterilized current account surpluses: no effective gold-exchange system - Keynesian doctrine: ▪ Output and demand depend on aggregate demand ▪ Fiscal and monetary policy should be anti-cyclical  During the burst, government should spend more than they take in revenue  During the boom, government should decrease deficit in order to stop the economy from overheating ▪ Problems:  G is not that efficient  Hard to forecast burst Page 67 of 74 - Main sources of post-war growth potential exhausted - Institutional Sclerosis (Olson) ▪ Special interest prevented much needed economic reforms ▪ Productivity slow down => wages were growing faster - Oil shocks: stagflation (inflation + unemployment) ▪ OPEC: the arab league retailed aagainst western support for israel in the fourth arab-israeli war ▪ Increase in oil price => reduced purchasing power => lower aggregate demand => reduced demand for labour  To stop it higher interest rates  Reduced aggregate demand  Further inflation  Reduced demand for labour led to structural unemployment  Slowed down TFP growth Topic 4: The new age of globalisation: - New growth theory ▪ Endogenous technology (Romer) and it relies on accumulation of human capital ▪ Directed technical change (Acemoglu): increasing returns to scale  Kumar and Russel o substantial productivity gains from technological change occurred, but notably, these gains primarily benefited countries with high capital per worker - The main drivers of late industrialization in NICS: ▪ Demographic transition ▪ ISI  Protectionism led to building their own manufacturing industries to substitute home production for imported manufacturers  Pre-modern, émigré, colonial  Limitation:  Limited market size  Limited exposure to advanced markets ▪ Globalisation:  Transport  Communication  Reduced trade barriers  Capital flows:  Integrated capital market  Global value chains: full range of activities that firms and workers perform to produce. It often involves multiple countries and firms with each contributing with different value- added components  Outsource production  Comparative advantage within the firm  Most of the trade happens intra-industry  Multinational and FDI ▪ Developmental state: a state that actively intervenes in the economy to promote industrialization and economic development  Challenges for late industrialization:  Inappropriate factor endowments  Insufficient technical capabilities o Gerschenkron: the state is fundamental to support lacking prerequisites o Amsden: export promotion is essential for learning and achieving efficient production scales  New control mechanisms:  Cost reduction Page 70 of 74  Subsidized learning o Industrializaation requires knowledge-based assets  Production, project execution, and innovation capabilities  This are difficult to achieve and obtain; can lead to above normal profits and earning the owner monopoly rent  Institution building o Product cycle:  New industries locate in high wage economies because of:  High human capital  High return to innovation  When standardized, it can be shifted to lower wage economies  As wages rise in NICs, they are vulnerable to low-wage competition  They need to innovate too - Emerging market New Economy: - A new set of GPT ▪ Production is much more skill and R&D intensive ▪ Start-ups are much more important in innovation ▪ Institutional flexibility essential - US ▪ Higher quality of higher education ▪ Lower taxation ▪ Still more capital intensive ▪ Labour productivity driven by market services ▪ ICT:  Rapid diffusion  Increased capital intensity - EU ▪ Stricter regulation, especially in labour market ▪ Barrier to trade in services within the Single Market  Higher unemployment in EU  Mostly structural  Long term unemployment  Young unemployment Successful cases:  Netherlands: Wassenaar Agreement  Freezing minimum wages, part time for women  Ireland: Programme of National Recovery  Wage moderation in exchange for tax cuts  Germany-Austria: Dual track  Subsidies for low-cost employment and regional mobility  Lower participation of women  Lower participation of elderly ▪ Sharp decline in labour input in Europe since the 1960s ▪ Very productive employed  Unemployed are only marginal workers ▪ Leisure is high valuable  MIT school: cultural preferences  Minnesota school: lower taxes in US implies higher incentives to work  Weak empirical evidence ▪ EU KLEMS:  Kapital, Labour, Education, Materials, Services Page 71 of 74 KEY WORDS - Globalization backlash refers to the phenomenon of disruption of international trade and the halt of cross-border movement of factors of production. Before 1914, the world experienced the first globalization with mass migration and almost full capital mobility. However, even before the WWI this trend was reversed, and the war worsened the situation. Almost every country in the world had introduced quotas and immigration became mainly unvoluntary and forced. “Doors to immigrants closed gradually”. Moreover, the collapse of the Gold Standard further limited intranational trade. This attitude from political forces outweighed the positive impact that technology brought during the WWI, with communication and transport technology that continued to improve for the war needs. - Sticky wages are a macroeconomic concept introduced by Keynes. Until 1914, unemployment was always a relatively small issue and limited to a single sector or industry. Keynes proposed an explanation to what happened specifically in UK, starting from the assumption of sticky wages, unvoluntary unemployment and necessary government intervention in the economy. In 1925, UK returned to Gold Standard at pre-war parity, despite the wartime inflation. British goods became more expensive for foreigners, and imports to rise and export to fall. This led to a decrease in the aggregate demand and consequently to a decrease of prices. However, being wages sticky due to the rising of power of unions, real wages could not adjust and hence, demand for labour decreased (and unemployment rose). The government had to intervene to increase aggregate demand. This view contrasts the neoclassical view, which poses its basis on the classical view with flexible labour market, voluntary unemployment (anyone who seeks for a job finds one) and self-adjusting nature of markets. According to Benjamin and Kochin, the increasing unemployment in UK can be explained by the Unemployment Recovery Act which created a “Voluntary Army” (of unemployed). This regulation provided for 11 million of workers with unemployment benefits; individuals started preferring not working at all rather than taking low-paying jobs because of the generous dole. - Hyperinflation is a phenomenon of rapid, excessive, and out-of-control price increase in an economy. It is usually preceded by a period of rapid rising inflation that then reaches more than 50% of price increase each month. After WWI, three distinct trends appeared in the European economy, after the extensive printing of money and issuing of notes during wartime. High inflation was eventually controlled in countries like Britain, or in the Netherlands (here high inflation coexisted with low unemployment). High and persistent inflation occurred especially in wartime zones like Italy, France, or Belgium. Five countries experienced hyperinflation: Germany, Austria, Russia, Poland, and Hungary. This phenomenon can be explained with the Quantity Theory of Money according to which price levels depends on stock of money supply or its velocity of circulation. Increase in prices can either happen with an increase speed of circulation (i.e. an economic boom) or with an increase of money stock. The latter describes what happened in those five countries, who experienced for the first time in history the introduction of “fiat money”: money with no intrinsic value. Agents in the economy have to trust the central bank for money to retain its value. - ‘Circle of debt’ describes an economic dynamic in which an individual takes more debt than is able to repay. During the WWI, US became the main creditor, lending money to Allied powers to boost their war effort. Once the war ended, US recalled its war debts in 1919. However, the critical European economy could not sustain the burden of repaying them, since their recovery depended mainly on reparations that were asked to Germany. In fact, the latter was held responsible for the war in Article 231 of the Versailles Treaty and was forced to repay for the damages created. After the first failure of repayment the Allied troops occupied German borders towns (1921) and after the second failure the Ruhr valley (core of German production) was occupied by Belgium and French troops (1923). However, for Germany to pay its reparations increase in production was needed and especially revive its ability to export in order to rebuild its reserves of gold. The Dawes Plan tried to solve the reserves dilemma, rescheduling Germany payments in annual instalments, boosting the economy with an initial kickstart of the US. Then, production was supervised by the League of Nations and specific sources of repayment should have been pointed. From 1925 to 1929, Germany managed to pay its reparations, not thanks to the Dawes Plan, but through the international capital markets from whom Germany could borrow. - Developmental state is refers to a state that actively intervenes in the economy to promote industrialization and economic development. This often takes the form of strategic policies aimed at fostering long-term economic growth. Amsden emphasizes that the developmental state is a key instrument for late industrialized countries in order to catch up and converge to the advanced economies. According to her, promotion of export is essential to learning and achieving an efficient scale production. The first step for these countries is cost reduction: in Page 72 of 74