Sintesi in lingua INGLESE di tutto il libro, capitolo per capitolo, Sintesi del corso di Storia Economica

Scarica Sintesi in lingua INGLESE di tutto il libro, capitolo per capitolo e più Sintesi del corso in PDF di Storia Economica solo su Docsity! Chapter 1: The making of Europe The geo-economic continuity of Europe • How do we define ‘Europe’? The formation of Europe was a long historical process. If we define Europe by the borders of the European Union, the great historical paradox is that despite disruptive political forces Europe remained as a unit of cultural and institutional homogeneity thanks to cohesive forces, with trade being the most important. • 80% of population of the Roman Empire in 100 CE lived within the borders of the present EU • Carolingian Empire around 850 CE saw restoration of order after the disintegration of the Roman Empire, but note the continuity in borders up until the EU Nations and borders • Nations and unions of nations defined by borders • Borders represent the limit of political authority and state capacity • State is better suited than markets in providing non-excludable services and public goods such as defense, law and order. • Nations form because they offer economies of scale when providing these public goods The Gravity Model • The gravity model demonstrates that the volume of trade between 2 countries is determined by: – Size of the economies as measured by national incomes – Distance between them • Larger countries trade more and the larger the combined size of two economies the larger the volume of trade, but trade declines with geographical distance • There are also border effects (Henri Pirenne) – Cultural, religious, and jurisdictional differences reduce trade similarly to geographical distance The commercial revolution • The fundamental problem of exchange: – How to get strangers to trust and trade with each other • From the first half of the second millennium, trade increased over space and time • How was this possible? • Trade evolved from taking place within families to between strangers due in part to the use of formal contract enforcement mechanisms (institutional framework) so as to enhance trust beyond the confines of family and ethnic group Henri Pirenne and border effects • Henri Pirenne (1862-1935) sought to understand why the Northern African countries traded so little with Europe after the Arab conquest (8th and 9th centuries) • His argument rested on what later became known as border effects – Cultural and religious divide: trust is easier to build if people share common beliefs and a common code of conduct that develops into common rules of contract enforcement • More recent research suggests that it was mostly the poverty (because of the Roman empire fell) of Europe which led to the decline in trade • Lack of trade reinforced these border effects The role of distance in history • In the past long-distance transport costs were prohibitively high for anything except luxury goods – E.g., silk and spices • Land transport costs were particularly high, so most goods shipped by water, but this added mileage • Then ships became larger, insurance mechanisms improved – Modern insurance with the merchant paying a fee developed in the fourteenth century with rates around 10–15 % of value of cargo, compared to 1–2 % in late-nineteenth- century trade. This dramatic fall over time reflects safer ships and the extinction of pirating at sea and robbery of transport on land. The commercial revolution • One of the first signs was the Champagne fairs southeast of Paris in the medieval Europe • Merchants (and moneychangers) from all over Western Europe met to trade since the location was convenient for them – Contractual disputes could be solved by legal services such as the threat of exclusion from these fairs • As trade moved onto the sea, permanent trading emporia with financial and more formalized contract enforcement services emerged and substituted the periodical fairs importance of proximity and similarity • Proximity means lower transport costs • Similarity in economic culture is a synonym of standardization, and is stimulated by trade – Standardization of weights, volumes, qualities and legal procedures • For long distance trade, it must be possible to describe commodities using a terminology understood by both trading partners • Allows complete contracts, in turn promotes standardization of legal procedures Trade and standardization • Trade generates standardization of measures, law and preferences; it also erodes border effects • Early examples are maritime law, now codified as the Hague-Visby rules • The 19th century was a breakthrough for the metric system (born in France during the end of 18th century) • Britain did not follow continental Europe because it was focused on trading within the commonwealth (British colonies) • US still not have a mandatory metric system because international trade is a much smaller share of national income than in Europe – Industries such as the pharmaceutic one uses the metric system since scientists are required to confront and work with colleagues from all around the world and hence need a standard measuring system Common language • Promotes diffusion of ideas and goods, and exercise of authority • 10th century Europe much more heterogeneous than Roman Empire • But Roman alphabet gradually replaced local alphabets in Western Europe • Regionally uniform languages adopted: – German in Baltic Sea area, Latin promoted by the Church – French from the 18th century, then English The east-west divide • All trading nations will become closer culturally (preferences, law) over time – Cultural ‘distance’ falls but at different rates depending on the volume of trade – Faster growth of trade means faster erosion of cultural differences • Groups of nations that become relatively closer culturally and pass a “cultural homogeneity threshold’ will form clusters, normally called regions, or unions of nations, such as the EU What about Russia? • The Roman Empire never touched the Russian heartland • Russian isolation imposed by poverty, distance (high transportation costs) and policy (isolationism of the socialist republic born in 1917) – Initial lack of similarity not broken down by trade • Falls in demand can also reverse this since learning by doing requires a continuity of production Virtuous and vicious processes in technological progress/regress The efficiency of labour, measured as “output per worker” on the Y - axis, is positively linked to the degree of division of labour, as measured on the X - axis and represented by the K schedule. K represents a given technological knowledge. Virtuous process (starting at dl A): Imagine an increase in demand, which permits a further subdivision of labour to dl B, which will enhance output per worker at B. It is likely that the more sophisticated division of labour will increase learning by doing and the development of specific tools, so there will be a shift in the technological or knowledge level to K’, which implies an increase in output per labourer. Specialized tools represent fixed costs and require a minimum level of production to be profitably used. This is one of the reasons why there is the spectre of technological regress due to a shock to demand. Historical example: The falling population and per capita income linked to the decline of the Roman Empire caused a fall in the demand for new housing and buildings. Consequently a technological regress in building technology set in, which was not reversed until the end of the Middle Ages. The economic renaissance of the 9th to 15th centuries • Slow transition to a modern economy: social order, population growth, transport networks, markets and money are prerequisites for the growth of the extension of the market • Population growth is essential since it induces division of labour and urbanization • Money extends trade from barter to market exchange • But Europe lagged behind China, Byzantine Empire, Muslim world in terms of welfare, technology and learning • Money supply not constant: direct and balanced bilateral barter of goods was the only mean of exhange alternative to money • Markets imperfect: information flowed slowly • Took first half of second millennium for Europe to catch up Measuring income per head over time • Income per head can be expressed as constant prices or multiples of subsistence income (SI) • In constant 1990 prices subsistence income defined as 355 $PPP (1990) • Estimates of pre-industrial maximum incomes range between ca. 800$PPP and 2000$PPP • Income fell after the collapse of the Roman Empire, but Byzantium probably had around 80% of Roman income Per capita income compared ($PPP → Costant prices; SI → Subsistence income) • Rome: Estimates range from 2 to 4 SI or 813 $PPP to 1742 $PPP (it could be underestimated: modern underdeveloped economies with a similar inequality profile typically have income per capita above 1000$PPP) • Byzantium: 700 $PPP in year 1000 • England: 550 $PPP (1044); 1134 $PPP (1500); 1540 $PPP (1700) • Holland: 1320 $PPP (1500); 2130 $PPP (1700) • Italy: 1644 $PPP (1500); 1398 $PPP (1700) • Denmark: 1767 $PPP (1850); 23,010 $PPP (2000) Population • 6th to 8th centuries saw population decline in former Roman Empire but it is difficult to assess its exact magnitude • Epidemics and invasions from the north • Movements of people carried diseases • “Extent of the market” declined • Then from 9th century until the Black Death in the 14th century population expanded, from around 20 million to 60 million The restoration of a monetary system • Monetary system disintegrated after the collapse of the Roman Empire, limiting long-distance trade • Carolingian Empire from the 8th to the 9th century introduced monetary system based on silver – A unified system is that it reduces uncertainty regarding the value of the means of payment • Gold coins from the 13th century, expansion of mints and denominations – Practically every market town of importance had or got a mint in the first centuries of the second millennium • Money markets became increasingly well integrated over time. – Law of one price: the currencies in use should be exchanged so that the same silver/gold price ratio prevails in all markets • The increased demand of money increased the ruler’s gain from seignorage (profit made by issuing currency, especially the difference between the face value of coins and their production costs) – Debasement of coins: the precious metal content og a given coin was reduced • Token coins (fiat money) limited for small trade • Bills of exchange developed for long distance trade during the 13th and 14th century – Clearing debt and credit bills locally, merchants and bankers could minimize the use of specie, which greatly reduced the risk of theft apart from the cost of transporting bullion between long-distance markets. • Money broking (the business of arranging transactions between buyers and sellers) became a specialized occupation Transport and trade routes • Roman Empire left an extensive road network – Mostly used for valuable goods such as slaves • Bulk transport (i.e., grain and wine) usually by coast and rivers – Shipping technology improved – N.B. economies of scale in shipbuilding • Major roads toll free, bridges usually not • Trade from the merchant and financial centres in northern Italy carried by river, then coast to northern Europe, where trading posts emerged Shipbuilding exploits scale effects • Maritime trade from second millennium between the Mediterranean and Atlantic coast of Europe and the Baltic relied on larger ships (from ca. 50 t to 500 t) • Shipbuilding is a clear case of economies of scale: – A container of 4m times 4m times 4m has a volume of 64 cubic metres (total surface of 96 square metres) – With 8m times 8m times 8m the volume will be 512 cubic metres (total surface of 384 square metres) – Fourfold increase of building material (surface) → eightfold increase in volume Merchant communications in the early centuries of revival Urbanization • Ratio of non-food producers to total population is a guide to per capita income: – If non-food producers increasing, means that demand for non-necessities increasing • Income elasticity of demand for food lower than for non-food items: Engel’s law • De-urbanization and de-specilization after collapse of Roman Empire, recovery from eighth century (but expecially in the 10th) with the foundation of new urban centers because of the growth of long “emporia” • Allowed for specialization Increasing division of labour as measured by no. of occupations urban population as a percentage of total population The Malthusian theory • Population growth is positively correlated with income per head, but population growth will reduce income and population growth will then come to a halt. • There are physical limits to the amount of cultivable land • As population increases the land available for agriculture per head will fall which will lead to falling income (diminishing returns: + population → - income) and ultimately to a subsistence income associated with stagnating population • Malthus assumed implicitly that there was no technological progress in agriculture Malthus graphically speaking Initially income per head is above subsistence because land constraint is not binding. Hence population growth is positive (birth rate > death rate). However, as population increases the land- to-labor ratio (or the quality of marginal land) will fall. That will lead to diminishing returns from labor, and income and population growth will fall. In the long run the economy will finally settle in the Malthusian equilibrium with zero population growth. If there is a permanent positive rate of technological progress, it will balance or counteract the diminishing returns Is the Malthusian theory (diminishing returns) testable? • Population has increased constantly except for exogenous shocks (outside the Malthusian model) • Technological progress can explain population growth in the Malthusian model, but not increases in income • Decline in real wages in England from the 16th century (after the positive pop growth due to the end of the black death) has been considered evidence of diminishing returns, but might also be due to climate • Formal testing usually shows evidence for preventive check (When income falls young people marry later and this reduces the number of pregnancies per marriage), but not other Malthusian features Real farm wages and temperature 1560-1880 In pre-industrial societies a decrease in mean temperature had a negative impact on output. That impact might spill over into effects on rural wages (note: the fall in mean temperature at the end of the 16th century is associated with the fall in real wages; A century-long rise in wages set in by the end of the 17th century, which was initially accompanied by a rise in temperature). Unified Growth Theory • Developed by Oded Galor and others • Suggests economic growth goes through three phases – Malthusian stagnation (very slow technological progress with land being a fixed factor of production), all economies near subsistence. – Post-Malthusian era with higher rates of population growth and moderate income growth (typical of 19th century Europe) – Modern growth era: sustained high growth with a demographic transition to low fertility and investment in the education of children • Møller and Sharp pushed back the onset of “post-Malthusian” growth to 16th century Is land a limiting resource? • A hectare of land is a poor predictor of the yield of that land in the long run • Crop ratio (number of crops per year and per unit of land) has increased from 0.05 in primitive agriculture to around 2 • In agriculture, experience was linked to the management of soil fertility which depends on the choice and rotation of crops and the extent of fallow • Yields increased: better fertilizer, crop varieties, etc. • The knowledge gained from learning by doing has no scientific basis: primitive agriculture did not understand i.e., the role of nitrogen or genetics, but trial and error gave results! • Technological progress is land augmenting • Malthus focused on limited land supply, neglecting the fact that output per unit of land is dependent on crop ratios and yields which change over time Understanding fertility strategies • Malthus believed in natural instincts and excessive procreation • Modern economists, unlike Malthus, consider the optimizing behavior of the household – Conflict between quantity and quality of children • Given income constraint, can choose to have more or better educated / healthier children • Preferences changed over time: Given income constraint an increase in the quality of children (education and better nutrition) will affect the resources spent on the number of children as well as income spent on consumption of other goods negatively: an increase in income does not necessarily lead to an increase in the number of children but can lead to a permanent increase in the consumption of other goods and/or in more resources spent on the quality of children Could households control fertility? • Malthus assumed not • But was possible before modern contraception! – Delay marriage – Coitus interruptus – Extended period of breastfeeding – Abortions • No society has fertility levels at the biological maximum • There is evidence that fertility depended on economic conditions Fertility in a Tuscan village 1650-1950 The demographic transition • Until the end of the 18th century: high fertility, high mortality (1/3 before the age of 10), low rate of population increase • Demographic transition (from a family size of 4 children to the prevailing 2 children family): mortality and fertility declined, again low rate of population increase • Where mortality declined first, there were large increases in population • It is difficult to determine the timing of the demographic transition because conventional demographic concepts like crude death and birth rates are too ambiguous: crude birth rates are determined by several factors such as the size of the fertile cohorts in the total population and the fraction of these cohorts being married. Crude birth rates can increase even though the number of children per married woman falls because the fraction of women that marry increases and/or the fraction of fertile women in total population grows. A better measure is cohort fertility which measures the number of children per woman in a specific birth cohort • Decline in fertility began in France, around rest of Europe later from mid-19th century into 20th century Old and new fertility regimes The convex curve is an iso-growth curve of population at 0.1–0.4 per cent per year. Why the demographic transition? • Decline in mortality maybe due to better nutrition for women, maybe less aggressive disease environment, immunity (still don’t know) • Falls in mortality in the 20th century due to better medical care • Decline in fertility began before modern contraceptives • Coincided with early urbanization, industrialization, increasing income • Imagine a predominantly agrarian economy. The sum of wages and rents is the total income of that sector and must, by definition, equal the value of the value added or output of that same sector. If the sum of the rent per unit of land and real wage per worker increases from one year to another then land and/or workers are being used more efficiently, since any income increase per unit of inputs must correspond to an increase in output. The average worker with a given amount of land is producing more, and this is revealed by an increase in the income of landowners and farm workers. Example: TFP in French agriculture 1522-1789 (Ancien Régime), % / year • P. Hoffman, notes periods of growth and stagnation and large regional differences. o Paris, expected to be the most dynamic region, is surpassed by the southeast of France which is equally densely populated and close to Mediterranean ports. o The TFP growth of Paris averaged around 0.13% per year and increased to 0.31% in the late 18th century. o The West region had negative growth o Normandy characterized by stagnation during the Ancien Régime ▪ Hoffman argues that exogenous shocks, religious wars and disorder interrupted the growth process and resulted in the low long-term averages Validating TFP estimates • Estimates of pre-industrial TFP in agriculture show could reach 0.1-0.2 % / year • Great regional differences: growth not shared by all (same as in the modern world) • But these estimates are very uncertain • verify by looking at urbanization rates: + urban population implies + productivity in agrarian sector, i.e., fewer farmers feed more people → Indirect estimation (Wrigley) • But must also consider food imports and relative wages • If the portion of workers in urban industry increases, it might be due to an increase of industrial exports against imported food, and if so, the relative size increase of the urban sector doesn’t reveal a productivity gain in the domestic agricultural sector • Urban growth might be because wages and agrarian consumption in cities are declining, in which case the inference that urban growth always implies agrarian productivity growth is not correct variation in agricultural productivity in Europe • R.C. Allen looked at 14th-19th century period • Different growth patterns in different regions • Belgium early leader, ends with negative growth: stifling political domination and religious intolerance of the Spanish crown (17th century) harmed growth. i.e., Belgian skilled workers migrated to Netherlands because of religious persecution • Spain and Italy initially leaders (up to 16th century), then fell in relative terms • Netherlands grew after independence from Spain around 1600: first modern economy: political stability + religious tolerance + welcoming attitude to low-skilled immigrants + growth-promoting institutions • First industrial economy, England, had similar institutions to Netherlands and saw strong growth 1650-1800: 1650-1800 doubled agricultural output per worker • N.B. importance of institutions Wages and income distribution • Real wages commonly used to infer income and productivity growth • The most urbanized areas of Europe, well supplied of skilled workers, had the highest wage levels (16th-18th century wages in London and Amsterdam were about as twice the level in warsaw) • Real wages of urban workers generally present a gloomy picture of the 17th and 18th centuries • But must be careful in interpreting them as indicator of national income o National income composed of wage income and income from capital (profit) and land (rent) • So national income can increase even with stagnant real wages Real wages over time • Peaked first in the mid-15th century, driven by labor shortages after the Black Death o Workers negotiated higher (day) wages, shorter hours, and larger numbers of holidays, they also enjoyed lower agricultural prices • Labor shortages end, real (day) wages fell from 1450-1600 o Mostly because prices increased, nominal wages did not o Probably workers adjusted by changing diet (not accounted for by real wages, with constant consumption basket: the commodity composition of the real wage deflator is fixed) o The fell is difficult to reconcile with a positive rate of TFP unless there were shifts in income distribution away from workers. household income might increase despite stagnating wages because of more hours and increasing labor force participation of women and children • No. of days worked increased until the Industrial Revolution, maybe because of “consumer revolution”? o The increased yearly income enjoyed by working more days brought a surplus income to be spent on goods other than necessities, which is part of the reason for a demand- driven increase in the goods made by urban producers. • This explanation is consistent with the observed increase in urban occupations relative to food-producing workers The Great Divergence • When did Europe forge ahead? • Why did the Industrial Revolution happen in Western Europe and not elsewhere? • California school: Importance of coal deposits? Allowed Europe to escape “Malthusian” land constraint • Eased energy constraint since the alternative was to use scares land to grow fuel from timber • Increased industrial productivity so west-Europe relied on exporting manufactured goods and imported food and agricultural raw materials from the Americas • Newer research has revealed large regional differences within Europe and Asia at the eve of the industrial revolution Europe vs. Asia • As late as 1750 India was the largest producer and exporter of textiles in the world and China had large and sophisticated industrial centers • In 18th century Europe mercantilistic governments subsidized domestic manufacturing imitating Chinese porcelain and Indian cotton prints • But when did Europe diverge from China, Japan, and India? • There is evidence from real wages: beginning of the Great Divergence late in the medieval and Early Modern period • It was believed to occur just before the Industrial Revolution because real wages in manufacturing areas in Asia and Europe did not differ much in the Early Modern period → Problems in comparing real wages Problems with using real wages to compare Europe and Asia • How do we choose the deflator so as to transform nominal wages to relative ones? Should be equivalent consumption baskets in each country / region → But we don’t have prices of everything • Grain wages (nominal wage divided by the price of grain): large component of daily consumption, but not traded internationally (at that time) • Silver wages: traded internationally • Non-traded goods have lower prices in poorer countries because they are not traded internationally and are not subject to the “law of one price”: • Unlike traded commodities they are not sold at (about) the same price in all markets • The combination of quite equal grain wages and inferior silver wages around 1550–99 only means that grain prices and nominal wages were low in China and India while grain prices and nominal wages were high in England. And what was true for England was true also for other advanced parts of Western Europe. Solution: Historical national accounts estimates There was a small difference in income levels around 1500 between England and China but the gap was larger relative to Italy and the Netherlands. Even though income per head stagnated at a high level in Italy the gap with Asia increased because income fell in China and India over the following centuries. The gap relative to England increased even more. Why did Asia fall behind? • Late marriages in Europe reduced fertility • Europe practiced family planning within marriage: these practices might have made diminishing returns less of a problem in Europe • European quest to control nature through systematic inquiry, not subject to religious and political authorities • Openness to technological change contributed to swifter adoption of useful knowledge – Solution was to restrict mobility: not being a serf allows to move away, to negotiate a better contract. As a consequence, the land rent would converge to zero as long as the liberty of laborers was not denied. • Decline of serfdom when labor shortage replaced by land shortage after centuries of uninterrupted population growth – When labor shortage was chasing land shortage, and marginal output on open fields had declined sufficiently, land rents could be expected to rise: Landlords could rely on market forces to extract rents from labor rather than on restricting individual rights. Geography and timing of serfdom • No direct link with Roman empire decline, and slavery • Gained momentum in ninth century, but not all Europe – Core between the rivers Loire and Rhine (former Carolingian empire) – Spread eastwards, but weak or absent in southern France, Scandinavia, and Eastern Europe – Mixed in Italy and England • Manor was never the dominant source of agricultural output (instead, Peasant households were) Conditions for serfdom • Labor shortage (population decline after the collapse of the Roman Empire) • Small and declining independent peasantry • High concentration of land in the hands of lay and ecclesiastical landowners • A state which cooperated with the aristocracy • Landlords offered lighter burden in areas with higher opportunity income for runaway serfs Decline of serfdom • Consensual and driven by market forces • After Black Death landlords were competing for scarce labor and could not agree on enforcing uniformly low wages • Growing incentives to defect to cities, other estates, areas of land reclamation → gradual relaxation of labor services • Earliest decline in the Low Countries (Paesi Bassi lol → BeNeLux) • Led to development of sophisticated land and labor markets (later industrialization) Open field System • Agricultural reforms led to growing importance of small household-based farms • The open field system – Farmers had small plots scattered over a wide area – Allowed or forced farmers to co-operate in ploughing, sowing, weeding, and harvesting • Difficult to find an efficiency-enhancing characteristic – Perhaps having plots in different areas reduced risks from local harvest shocks (McCloskey) – Villages were built on mutual assistance, and the co-operation enforced by the field layout enabled members to monitor the efforts of others in order to maximize the output of all Farms vs. firms • In agriculture the worker is the residual claimant (who receives the residual income when all expenses including rent have been met) – Output determined by nature, difficult to separate from effort: Agricultural workers will neither be fully rewarded for their effort nor be fully punished for shirking – Owners cannot cheat on themselves • In industry the factory owner is the residual claimant – Production constrained by human ingenuity (and not by nature) → economies of scale – Systems of reward and control of work effort – In principle workers could borrow capital to set up labor-managed firms, but capital markets were imperfect: • Early industrial entrepreneurs borrowed from family and friends, and bank managers were likely to be friends of the rich rather than the poor → less credit constraints • Managing firms is inherently risky and the rich can endure risk better than the poor, because the richer you are the more you can diversify your investments Why are firms still usually capitalist? • Path dependency (the tendency of institutions to develop in an established way based on their historical conditions, and the consequent exclusion of more efficient alternative paths) given previous capital market imperfections and risk aversion • Capitalist firms more adaptive, because only aim was to maximize returns for the owners • Labor-managed firms would e.g., also aim not to dismiss owners, delaying the introduction of labor-saving machinery • Exceptions in services where quality of work difficult to monitor: legal services, advertisement, architecture Co-operatives • From late-19th century capitalist firms challenged by cooperatives: supplier-managed firms • Famous example the Danish dairy cooperatives – Often considered the main reason for Danish success as agricultural exporter • Other examples: sawmills, paper producers, meat producers, wineries • But not e.g., car manufacturers or steel producers Dairy co-operatives and hold-up • Milk is perishable, so firms relied on critical mass of suppliers from limited geographical area → Difficulty in exerting a credible threat to punish farmers who cheated on quality • Hold-up power of suppliers: – Firm “locked in” by investment in fixed capital with no alternative uses – Farmers could switch to alternative production • Solution: vertical integration via contracts (late 19th century) – But relied on ability to enforce these: The problem of opportunistic behavior was solved by severe punishment for those detected breaking quality requirements, and co- operatives used informants to monitor members’ behavior • Since members were the residual claimant, they had an interest in monitoring the other members and reporting misconduct Sharecropping • Was common for peasants to lease land by “paying” a share of the output, rather than a fixed rent • A share contract reduced work effort (since only received a share of the marginal output), so how can this be efficient? – Some claims that sharecropping reduced the risk for the tenant farmer because in a bad harvest season rents would be reduced automatically, since only a fixed share of the output was paid rather than a fixed rent • It was common practice to allow tenants under fixed rent contracts to postpone rent payments until an abundant harvest came: it is not obvious that over an extended period of time the fixed rent tenant needed to pay more rent than the sharecropper – Some claims that it stopped tenants from over-exploiting the land • Over-exploitation occurred only if the lease was a short-term contract. If the landowner extended it, tenants would not be tempted to obtain short-term gains which had long-term negative consequences. Tenants often obtained hereditary rights toa lease, giving them incentives to improve their land. Asymmetric information and self-enforcing contracts • Long-distance trade means delayed payment and delivery: problem of trust • Merchants typically used agents to complete an exchange → principal-agent problem – The agent can exploit asymmetries in information in his own interests against those of the principal (merchant) • Ideal contracts should be self-monitoring, i.e., in agent’s own interest to be honest – Reputation has to matter, cheating detected – Merchants joined forces to report misconduct • Networks often based around ethnic groups Science and Entrepreneurship • Many 19th century investors had poor formal training, but had a scientific mind (they conducted trials and experiments and communicated their results to colleagues) • Many investors more skilled as entrepreneurs than researchers o Alfred Nobel: commercialized dynamite which transformed the mining industry and helped the building of railways, tunnels and roads o Guglielmo Marconi: Nobel for physics, made wireless communication commercially successful (many researchers failed to see its commercial potential) obtaining the first patent in the field • Accidental discoveries attracted scientists searching for explanations, e.g., Louis Pasteur and why canning food under heat helped in preserving it Brains replace muscles • The new technologies of the late 18th and 19th centuries developed production processes for known commodities (paper and steel), but also for entirely new products (electricity) • General characteristics of technological progress in the 18th and 19th centuries: 1. Resource saving 2. Lessened constraints of nature, especially human and animal energy 3. Improved the quality of commodities 4. Developed new products and services 5. Widened the resource base for industrial use Saving resources and lessening natural constraints (1-2) • Conserving the resources and freeing mankind from the constraints imposed by nature are the defining characteristics of technological progress throughout time, but in the 18th and 19th centuries speed rate increased • 18th century innovations in spinning and weaving were labor saving o But improvements in steel production were both labor and energy (coal) saving o Steam turbine, electrification, and internal combustion engine saved human and animal energy, allowed more flexible location of production Quality improvement and differentiation (3) • Arts and Crafts movement deplored machine-made products. Luxury goods were not suited to the mass production, but sometimes cheap products make sense e.g., paper for newspapers • How to measure welfare gains from technological change? Real wages (nominal w./cost of living index) rely on constant bundle of goods which are assumed not to change in terms of quality • How then to take account of changes in quality, e.g., for light, candles to electric bulbs? o W. NordHaus: Light can be measured by lumen hours, but price indices for light do not involve any serious quality control • Quality changes underreported → underestimation of real income levels • Attempts to measure the overall impact of this finding have been made for the US economy and land at an overestimation of inflation of about 1.1 % per year, if we apply that number to an average European economy in the second half of the 20th century, and recalculate real wage improvements, set at 2 per cent per year using conventional estimates, the true real wage growth would be about 70 % higher New products and production processes (4) • 19th century inventions still dominate our lives: o Mechanized textile production, electrical motors and household appliances, electrical light, combustion engines and cars, wireless communication, the telephone, cheap paper, plastic, reinforced concrete, steel, etc. o In agriculture, industrial production of nitrates (fertilizers) o Even the jet engine (20th century) is made possible by the internal combustion engine Widening the resource base (5) • Increased demand for paper difficult to meet with conventional raw materials (rags, hemp, and straw). Wood was in abundant supply but advances in chemistry were necessary to make it a suitable source of raw material – Mechanical method for producing paper from wood invented around 1850 but in 1870 US, Germany and Sweden invented the sulphate process which produced the so-called kraft paper (strong but hard to bleach) • The environmental drawbacks of this method – water pollution – were not adequately addressed until the second half of the 20th century • New ways to extract iron from phosphorous-rich iron ore (Thomas and Gilchrist, around 1870) – Phosphorous reclaimed as waste in the process could be used as fertilizer for agriculture Twentieth century innovations • Many built on work from 19th century – E.g., internal combustion engine, telephone, gramophone, cameras, radio, calculators (computers), etc. • Centre of gravity of innovation moved to the United States – Higher income per head and the share of GDP spent on education and research – Rationalization of production starting from the second half of 19th century: “Fordism” (division of labor in which each worker did a limited number of simple tasks repeatedly) – United States enjoyed internal economies of scale which Europe did not • The huge standardized (people had the same preferences in terms of products) domestic market allowed the mass production to lower the average costs of production as the total output increased Technology transfer and catch-up • Knowledge is a non-rival good (↑use does not lead to ↓units of knowledge) – Even if technologies were patented, they were in the public domain and could be improved • By end of 19th century most nations in Europe had people who followed and participated in R&D • Europe had the necessary institutional requirements for technology transfer – Part of the public literate in science and technology – Minimum level of education – Banking system to support entrepreneurs – General institutional characteristics of a modern economy • European managers studied American industrial technologies in the interwar period, but they were not transferred to European industries until after the WW II, and in some nations this so- called scientific management was fiercely resisted by trade unions. The “advantage of backwardness” (Gerschenkron) • Income per head gives rough approximation of technological level • With technology transfer, it should be possible for less sophisticated countries to grow faster. the larger the technology or knowledge gap, the more knowledge there is out there which can be transferred and hence the faster the country could grow if it implements those technologies: “catch up” • Because of: 1. Technology transfer 2. Structural change, e.g., agriculture to industry • In a comparative perspective, the advanced economies tend to have small shares of the old-style sectors while relatively poor ones initially harbor large traditional sectors. As a consequence, the relatively poor economies will catch up with the advanced simply by relocating labor and other resources from the traditional to the modern sectors. 3. R. Solow: Lower K/L in poorer countries causes them to save and invest more, richer countries see diminishing returns to capital: in this way, backward economies will approach the income and growth of the leading economies • The actions of governments in providing R&D spending may generate different growth paths and the assumption of diminishing returns has been questioned. Annual rate of growth of GDP per capita • Annual percentage growth in per capita income, on the vertical axis, is plotted against initial income, GDP per capita in 1990 constant $, on the horizontal axis. • The three periods are: o The first European industrialization before the First World War ▪ the first era of free trade in European history even though tariffs were not altogether absent ▪ International mobility of people, an era of mass migration, which meant mobility of brains and ideas ▪ Great capital mobility o The World Wars and interwar period ▪ Trade restrictions ▪ Mobility restrictions (closed borders) o The so-called Golden Age of European growth, 1950–1973 ▪ Reduction in trade restrictions ▪ Massive American investments in Europe ▪ High mobility of people • Since initially less developed economies have more scope for technology catch-up, we should expect them to grow faster o Furthermore, less developed economies have less K/L and there are therefore better prospects for profitable investment, that is higher rates of return on capital. o High rates of investment stimulate economic growth and it turns out that all the economies which converged on or overtook the UK had higher investment ratios. • We can notice a positive correlation across nations and periods and between investments and the rate of TFP o The explanation is that investments are linked to the introduction of new technologies o The less developed economies in Europe also would see more gains from structural relocation of the labor force from the traditional, low-productivity sector to the high- productivity modern sector • These factors suggest that there is a negative relationship between initial income and subsequent growth o This expectation is met for the pre-First World War and post-Second World War periods. The downward sloping line is generated by a linear regression. Initially rich, the United Kingdom (GB) did not grow as fast as, for example, the less rich Scandinavian (SE, NO, DK) nations in the pre-First World War period, or as southern Europe (IT, ES, PT) in the post-Second World War era. • The World-Wars-and-interwar period was different. The regression suggests a positive relationship: the higher the initial GDP per head, the higher the growth rate of GDP per capita in the subsequent period • The difference is explained by the fact that 1914-1950 period lacked the mechanisms necessary for technology transfer: openness to trade, capital and people • The regression lines represent the expected growth in GDP per capita given a certain initial income. If a nation falls below that line, it is an underperformer; If it is located above it is an over- performer • Scandinavia o Growth pattern similar to that of Germany and France except for the Great Depression of the 1930s, when the Scandinavian economies did quite well, relatively speaking. ▪ Convergence only in the Golden Age (1950–1973) after which the income differential remains stable • That the income gap just after the Second World War is large represents a potential for Scandinavian catch-up, which was indeed exploited • US’ lead is linked to its superiority in knowledge and technology generation Log GDP per capita in Germany, Ireland, Czechoslovakia & Italy • Germany o Early catch-up industrializer, leads thanks to new technologies and products o High growth in the golden age thanks to low initial income levels imposed after the war which were similar to those in 1914 ▪ Reconstruction effects and the potential for technological catch-up stimulated high investment ratios leading to higher TFP but the growth rate pace couldn’t be sustained: • The gains from adopting best-practice technology had already been exploited and the high rate of investments lowered returns on capital, which slowed down investment • Italy o Follows Germany • Ireland o Starting from a similar income level to Italy’s in 1950 it lagged until the late twentieth century: Ireland’s catch-up did not start until the country opened up to free trade at the end of the Golden Age • Czechoslovakia o It was one of the most advanced of the economies that ventured into socialist planning after 1945 and had a growth potential ▪ It traced Ireland’s performance until the middle of the 1970s, when the contradictions of socialist planning were starting to constrain growth even more Log GDP per capita in France, Spain & the UK • France o Ignoring the wartime shocks to income, it is possible to discern a long-term convergence on Britain: France overtook the UK by the end of the Golden Age ▪ Growth after the WW II: France regained its long-term trend in less than five years. That was possible despite the destruction of physical capital because the social capital, the human capital and the institutions remained and made for a quick return to normality • Spain o The Civil War of the 1930s and the authoritarian nationalist government that ruled Spain ended the brief period of openness in the 1920s ▪ No trace of convergence until well into the Golden Age, when the economy opened up allowing the catch up: inequality decreased, foreign trade and investments brought new technologies • As late as 1950 Spain and Portugal had almost half their labor force in agriculture. The labor-saving technologies released under-employed labor for industrial occupation and triggered structural convergence. o The exodus of labor from low-productivity jobs in agriculture to manufacturing increases average labor productivity Why is Europe not catching up with the US? • Persistent gap in income per head and productivity between Europe and the US, even after “Golden Age” • Initial differences due to investment in labor-saving technologies thanks to the availability of natural resources; large US market favored mass production and economies of scale • Makes a difference if we define productivity as GDP per hour worked • Europe continued to close the gap to the USA even after the Golden Age and until the mid-1990s but between 1960 and 2010 GDP per hour fell by 35%. Why? • Europeans have a stronger preference for leisure! • Slow adoption of ICTs (information and communication technologies): Service production was using ICT heavily in the USA and the contribution to productivity growth was substantial. So, for Europe about two-thirds of the productivity difference stems from a few lagging service sectors. Can we explain this pattern? • In many European nations service production is surrounded by barriers to entry which might be retarding productivity change. Chapter 7: Money, credit and banking The origins of money • Occupational diversification (division of labor) increases productivity in pre-industrial economies when regions and nations exploit their comparative advantages – But these gains require exchange between specialized producers • Money, as means of exchange, developed alongside specialization • First money 5 or 6,000 years ago was standardized ingots of metal, not stamped coins • Why is money so important? – Barter (direct bilateral exchange) requires coincidence of wants • Time consuming: matching process • Reduce volume of trade: trade must be balanced • Prices not transparent – Money solves the problem of non-coincidence of wants Evolution of wheat as money with no coincidence of wants Start from Mr. Farmer Commodity money • For most of history money has been commodity money – Money made of commodities with alternative uses, an intrinsic value – E.g., gold, silver, pearls, shells • Some commodities are better than others – Non-perishable – Low price volatility – High value-to-weight ratio for easy storage • Favored silver and gold • Should be: – Means of payment – Store of value – Unit of account Coins and bills of exchange • After Roman Empire, Europe lost its monetary system • Revival with Carolingian Empire, based on silver – 1.7g of silver = 1 penny • Could take silver to the mint to get it minted, although mint took a 5-10 % fee – Seigniorage fee: the fee covering minting costs, brassage • Also a way to raise income for the government • Governments debased coins to fund expenditure – Less gold/silver in coins but same declared value – Full-bodied coins went out of circulation – Inflation raised because debasement increased the amount of commodity money necessary for buying a certain good • After Carolingian Empire local mints spread (cities and monasteries) The impact of banks on economic growth • Impact on the saving ratio (savings as share of national income) – Increased opportunity cost of hoarding “store of value” goods (gold and silver) • It is more convenient to deposit savings in banks in exchange for interest rates • Impact on efficiency of use of savings – Match savers and borrowers • Importance of savings banks for low-middle income earners • Cash constraints were impediments for investments • Monetarization (Bank of England) had a strong impact on industrial production (1730-1850) • Increased monetarization (↑MS) of the economy – Fractional reserve banking increased the money supply Financial and banking crises • Liquidity crisis – The bank is solvent, but cannot meet customers’ demand for cash (result of fractional reserve banking) – Solved by lenders of last resort, central banks • Solvency crisis – Usually after financial bubbles, shocks to the value of assets – Has been solved by nationalizing then privatizing banks • One often leads to the other Transaction banking vs. relationship banking • Transaction banking (UK): discount of bills, provision of short-term credit, etc. • Relationship banking (Germany): as above, but also investment banking, mortgage lending, some with close relationship with firms, “universal banks” • Have been seen as reason for the rapid German catch-up – German banks invested in firms at technological frontier • There is some evidence that UK banks did not invest optimally Banks vs. stock markets • Stock markets introduced in late 19th century • Similar functions to banks, but different means – Savers can diversify risk, have liquid assets (equity, shares or stocks) which are long- term commitment for borrowers • Mutual funds allow savers to diversify and enjoy economies of scale in information which single savers cannot gather on their own. – Buying shares in mutual funds is less attractive to risk-averse savers • Mutual funds cannot promise a positive return on shares, nor can they guarantee the nominal value of the original deposit Chapter 8: Trade, tariffs and growth Comparative advantage • David Ricardo (1772-1823): countries trade to gain from their comparative advantages • In his model (developed looking at the Corn Laws which regulated the import of grain into Britain until 1846) countries only differ by labor productivity, and should export goods they are relatively efficient at producing • Implication: countries should trade even if they don’t have an absolute advantage in production, due to opportunity costs • Trade → greater extent of the market → specialization → growth • Comparative advantage: producing a good diverts labor from producing other goods, which are lost (the opportunity cost). Without trade it is necessary to produce all goods. With trade it is best for a country to focus on the goods it produces relatively well, because by so doing it can produce most. This extra output can then be traded for the goods it is relatively poor at producing and hence enhance the level of consumer welfare. Hecksher & Ohlin and winners and losers from trade • In the early 20th century they developed Ricardo’s theory • Hecksher-Ohlin theorem: Comparative advantage is based on relative abundance of factors of production (not on differences in labor productivity). – E.g., land-abundant countries will export land-intensive goods, agricultural products • But trade patterns in history were often not governed purely by the market and comparative advantages because of, for example, tariffs imposed by governments. Why they do that if there are gains from trade? – Stolper-Samuelson: Trade increases return to owners of the abundant resources, while it lowers return to owners of the scarce one • E.g., owners of land will gain from exporting agricultural produce from land- abundant country • Winners and losers from trade → trade policy important! Trade in the 19th century • Hecksher-Ohlin based their model on 19th century trade – largely intersectoral: goods traded between countries from different sectors and industries • Exceptions to Hecksher-Ohlin model such as US due to trade policy – E.g., US protected industrial production Merchandise trade patterns in the UK and the US 1880-1913 • US, Canada, and many developing countries, exported raw materials and food and imported machinery and other manufactured goods from the European core and the UK in particular. This was completely in line with the predictions of the Heckscher–Ohlin model: the United States was a land abundant country, giving it a comparative advantage in agriculture o US and Canada did not import a particularly high proportion of manufactured goods (Just around 30%) because both protected their manufacturing. Trade in the 20th century • Trade became increasingly intrasectoral: countries exported similar goods to those they imported • Paul Krugman’s New Trade Theory, monopolistic competition: economies of scale at the level of the firm lead to imperfect competition between varieties of goods o Free trade gives both cheaper goods and more variety • But comparative advantage is still relevant, especially for trade between industrial and lesser developed countries (intersectoral trade) Merchandise trade patterns in Western Europe 1963-1999 Trade and growth • Trade implies a welfare improvement as previously inefficiently allocated resources will become more efficiently used through international specialization and production will increase – Also impacts on growth through technological change • Technological knowledge travels because it is embedded in capital equipment • New growth theory considers knowledge to be non-rival: if one country learns a new technology from another, it does not prevent it to use that technology • Warning: More competition with trade implies less profit, so less for firms to invest in R&D because since any competitive advantage they receive as a result of their new technology will be eroded as their competitors take advantage of its non-exclusiveness An argument for protection • Infant industry protection, e.g., in the US of industry – Might pay to protect until an industry is of a sufficient size to compete internationally • If technological progress aided by learning by doing and dynamic economies of scale • Problems: – How to identify industries with potential – Protection might make industries less competitive – Might be politically difficult to remove protection again The infant-industry argument for protection • Point 1: UK is the producer of machines and is producing quantity Q1 at which point demand, D, is satisfied at a given level of average costs. • The cost of producing each unit of production (shown by the AC curve) is falling with the level of production. o This can be due to learning by doing or economies of scale • At this level of production, the UK’s average cost per unit is equal to P1, which is the price at which it sells each machine. • Although the USA’s average cost curve is lower than the UK’s, when they start producing they cannot offer a price below C0, and the nascent industry will be outcompeted by the UK. • If the US protect its industry, as output expands, its average costs will fall, outcompeting the UK • Protection will no longer be necessary, and the quantities and prices will be at point 2 Mercantilism • Mercantilism until the beginning of the 19th century – Policy aimed at gathering international reserves needed in risky environment where international conflicts were endemic Tariffs and growth • Difficult to test relationship between tariffs and growth – How to measure protection? The most common approach is to measure a nation’s trade policy by its tariff revenue divided by the value of its dutiable imports • Very unsatisfactory indicator: • Country A imposes a 20% ad valorem tariff on all commodities. ▪ This will be given a 20% value for protection • Country B allows free imports of all goods but imposes a 50% ad valorem tariff on wine ▪ This will be considered to have a value of 505 for protection, and be considered more protectionist • ‘Tariff-growth paradox”: tariffs good for growth before WW2, bad afterwards! – Reason: depends on how tariffs are used • Which sectors are protected? E.g., industrial protection might foster industrialization Chapter 9: International monetary regimes in history Why is an international monetary system necessary? • An international monetary system means currencies can be converted and facilitates international trade – Otherwise, trade restricted to balanced bilateral trade • E.g., if Denmark wants 10 billion kroner worth of goods from Norway, but Norway only wants 5 billion kroner of goods from Denmark, then trade is restricted to 5 billion kroner • Cannot fully realize gains from trade and specialization – Also means domestic savings = domestic investment • Foreign investment impossible: • Y=C+I+G+NX where S=Y−C–G → NX=S–I. If there is no international monetary system, and trade is balanced, then net exports are equal to zero, and domestic investment is constrained by domestic saving (S = I). • Foreign investment is desirable if the return to investments differs at home and abroad How do policymakers choose the international monetary regime? • Was long believed that commodity currencies and fixed exchange rates were necessary for a well- functioning international monetary regime – Commodity money’s value is fixed to a particular commodity. Currencies based on the same commodity were fixed in value in relation to each other • Late 20th century movement to fiat currencies and floating exchange rates – Today the 5 major currencies (US dollar, Euro, Yen, Pound and Swiss franc) are all floating against each other – Floating exchange rates dominate today because of changing priorities of policymakers • Fixed exchange rate – No unexpected changes in the exchange rate – Ineffective monetary policy (the interest rate can’t be used to regulate money demand) • Available choices have been termed the open economy trilemma 3 desirable policy goals 1. Fixed exchange rates – Less uncertainty for international traders 2. Unrestricted capital mobility – More trade and foreign investment 3. Monetary autonomy – Use of interest rate as macroeconomic tool (to raise investments and GDP) The trilemma (Obstefeld) • Pick two policy goals 1. Fixed exchange rates and unrestricted capital mobility – Monetary policy cannot be used 2. Fixed exchange rates and monetary autonomy – Capital controls must be imposed 3. Unrestricted capital mobility and monetary autonomy – Exchange rate uncertainty for international traders Why can’t you combine all three policy goals? • With unrestricted capital mobility and fixed exchange rates monetary policy is limited! – Why? Arbitrage: an attempt to lower interest rates lowers the return to domestic capital • Assets will move out of the country • Downward pressure on the exchange rate • Central bank must raise interest rates again to attract investments and not to depreciate History of international monetary regimes in a nutshell: The open economy trilemma • From second half of 19th century to First World War – International Gold Standard • Fixed exchange rates and unrestricted capital mobility • From Second World War until 1970s – Bretton Woods System • Fixed exchange rates and capital controls • From 1970s until today – Post-Bretton Woods System • Floating exchange rates and unrestricted capital mobility The International Gold Standard c. 1870-1914 • Gold used as money since ancient times • Gold Standard as an institution has origins in Britain’s Resumption Act of 1819 • Spread through Europe, replacing bimetallism, based on gold and silver – When countries fixed currencies against gold (by the end of 19th century), their currencies automatically became fixed against each other • Implied fixed exchange rate, and some countries also introduced international monetary unions – Latin Monetary Union of 1865 (European countries) based on bimetallic standard – Scandinavian Monetary Union of 1875 • These unions ended straight after the first world war: when the monetary union was threatened, there was no central institutional structure to fall back on ‘Rules of the game’ of the International Gold Standard • Most important rules: 1. Currency freely convertible to gold at a set price (“mint parity”) 2. No barriers to capital and gold flows between countries 3. Money convertible on request to gold, and thus backed by gold reserves Why was the gold standard a fixed exchange rate system? • E.g., US mint parity $20.646 / ounce; UK £4.252 / ounce • Exchange rate must be 20.646 / 4.252 = $4.856/£ • REASON: Any other exchange rate gives the possibility of arbitrage (given rules 1-3) • Currency traders would be able to convert the cheap currency to gold, exchange the gold for the expensive currency and make a profit on the foreign exchange markets • In reality small deviations possible due to gold points: • Because of transport and transaction costs involved in shipping gold between countries, arbitrage take place only if gains > costs • Exchange rates fluctuated within bands based on the cost of transporting gold Deviations from the ‘Rules of the Game’ • Most governments took a laissez faire attitude (did not interfere) towards economic policy – Why? Hume (1752) described price-specie-flow mechanism • Gold (specie) standard automatically ensures balance of payments equilibrium: if country A has gold inflows, its prices will be higher than that of other countries. Hence, in country A, there will be increasing demand for foreign (cheapest) products leading to gold outflow, forcing prices to decrease, causing exports to increase and restoring equilibrium • This mechanism works also for paper money and bills: country A enjoys trade surplus and traders accumulate foreign currency which they mint at foreign banks for gold, raising gold reserves of country A by • Prices diverged after Bretton Woods collapse, countries lost interest since floating exchange rates proved to be compatible with increasing world trade The Optimal Currency Area Criteria • OCA criteria give conditions under which countries might form a currency union – When does it make sense to have a common monetary policy? – When asymmetric shocks are less likely, so when the participants are similar in terms of economic and political criteria • Economic criteria: Labor mobility, similar structure of trade, openness to trade • Political criteria: Countries put common interests before national interests → fiscal transfers given shocks • In the European Monetary System (EMS) Germany was the conductor of monetary policy as the US in Bretton Woods, and other countries pegged their currencies to the German mark aiming at lower inflation. After collapse of Exchange Rate Mechanism in 1992, EU implemented common currency: the euro The Eurozone crisis in the light of the historical experience • European Economic and Monetary Union (EMU) differs from previous monetary unions since combines a single currency with a single central bank: the ECB, as in national monetary unions • 2007/8 financial crisis was an asymmetric shock – How could the ECB set monetary policy for countries in very different economic situations? – Badly affected countries forced to implement austerity measures, need deflation • The euro “trap” (Paul Krugman) left countries with levels of prices and wages that were too high after the years of easy money, and without the possibility of devaluation for the necessity of deflating their economies. As described in the Great Depression, this is a deeply painful process, bringing recession and unemployment. Exchange rate systems Chapter 10: The era of political economy: from the minimal state to the Welfare State in the 20th century Economy and politics at the close of the 19th century • A number of west-European countries started to catch up with Britain o Phase of modern economic growth • Minimal state era: o Government expenditure 10% of GDP o Governments did not care much about people’s opinions o Role of the state ▪ Guarantee property rights ▪ Enforce contract laws ▪ Defend the gains from trade • Money supply was left to the banking system and ultimately to the central banks • Economy as a self-regulating entity (economic orthodoxy) o The gold standard mechanism was thought to be able to absorb shocks to economy through changes in nominal prices and wages ▪ No expected real effects even in the short to medium term Changings in the 20th century: The First world war • Trade routes disrupted • Gold standard suspended after 50 years o Price levels diverged among Europe o Free-floating exchange rates • Introduction of full parliamentary democracy o Exception: nation which switched to left or right-wing authoritarian rule • Trade unions strengthened and social-democrat parties gained wide electoral base The long farewell to economic orthodoxy: the response to the Great Depression • After the war, the economic orthodoxy of prices and wages being flexible nurtured the idea that a return to pre-war nominal exchange rates and gold parities was desirable, possible and rapid o Keynes’ thinking helped broking the orthodoxy in 1930s o In economies with uncontrolled inflation (i.e., France) the magnitude of the adjustment necessary to restore pre-war gold parity competitiveness wasn’t conceivable ▪ Solution: return to gold at a lower parity • Nations under orthodoxy (Scandinavians and Britain) competitive disadvantage relative to economies like France because of higher prices and wages o Deflationary policies less likely: ▪ Trade unions not willing to negotiate wage cuts even if ↑unemployment ▪ Industrial goods prices less flexible because large firms imposed their own price • The Great Depression (1929) o Fall in prices while nominal wages remained at their pre-crisis level. Real wages and product wages increased worsening profitability and threatening companies’ survival o First truly international growth disaster o Originated in the USA spread to the rest of the world o Causes: ▪ Policy errors ▪ Absence of policy responses o Negative shock to consumption and investment following the stock-market bubble burst (1929) which shattered business confidence and reduced wealth ▪ People lost confidence in the banking system ▪ Industrial output declined • Food and primary product prices fell dramatically, and raw material producers lack of export income to pay industrial imports from Europe o USA ceased international capital lend in 1930 → Protectionism ▪ Rest of the world followed: 1929-1933 world trade fell to a third of its value at 1929 prices ▪ Nominal interest rates were very low, but deflation kept real interest rates high enough to prevent a recovery of investment ▪ Britain, Scandinavia and other nations left gold standard in 1931: recovery • Devaluation led to mild inflation • High unemployment reduced product wages not allowing to negotiate higher nominal wages • Inflation reduced real interest rate and stimulated investments • Domestic industry gained competitiveness (imported goods became more expensive) and falling prices increased exports ▪ Continental Europe sticked to economic orthodoxy • France left gold standard in 1936 • Germany: political disaster Germany: The Great Depression • Germany entered interwar period politically weak, humiliated by military defeat and facing hyperinflation o After stabilization entered gold standard and enjoyed US and foreign capital inflows which offset Reparation payments o Great depression constrained export and foreign debt + Reparation payments led to current account deficit • Austerity measures reduced economic activity, imports and sent unemployment to 25% (like USA) o 1933 A. Hitler (NSDAP party) gathered >40% votes exploiting the economic decline Macroeconomic management in the second half of the twentieth century: full employment targeting • “Keynesian” macroeconomic doctrines are commonly associated with deficit spending (spending financed by government debt) o Deficit spending occurs in periods of war or in preparation for war (E.g., Hitler’s rise) o Keynesians showed that an increase in deficit spending led to a potential “larger-than- spending” effect on national income, by applying the fiscal multiplier theory ▪ The fiscal multiplier is the ratio of change in national income and change in government spending. An initial rise in expenditure can therefore result in a greater rise in GDP o Keynesian principles were not universally accepted after the WW II, and when they were, fiscal policy was not used consistently over the business cycle • Macroeconomic Keynesian management in the immediate post-war aimed at “full employment” by reducing tax or increasing public spending (demand management) o Germany initially reluctant o France tried a different path with state intervention but without socialist-type planning • Average unemployment in Europe 1950-1960s, about a third of the level in the interwar period Net welfare state balance of a typical household over its life cycle • Simplified inter-temporal lifecycle redistribution of consumption possibilities. Welfare state provides transfers and services helping households to smooth (avoid shocks) consumption possibilities over their life cycle o Net welfare balance: difference between household’s contribution to the funding of Welfare State (i.e., taxes) and the monetary value of the household’s use of Welfare State. o Lifecycle phases: ▪ Family-formation phase: high income needs because of family size, schooling and reduced earnings (child-related constraints on labor) • Net receiver: The sum of Welfare-State-related taxes it pays is smaller than the welfare contribution (subsidized education, parental leave, childcare and child allowance) ▪ As children leave school households become net contributors • Transitory welfare benefits (sick leave insurance and temporary unemployment benefit) are lower than the paid Welfare-State-related taxes ▪ Old age: net receiver • households become public health consumers and beneficiaries of publicly funded pensions • The life-cycle transfer is an implicit contract between generations: net contributors will become net receivers and vice versa • Why have citizens delegated the life-cycle redistribution of consumption possibilities to politicians and not to the market (by borrowing at an early stage before becoming net savers and ending up with negative saving in old age)? o 4 reasons: ▪ Market solutions’ distributional effects violate common preferences for equal access to some essential services • Studies show that human beings aren’t only motivated by self-interest and admit the need for income redistribution ▪ Externalities and coordination problems would make the market solution inefficient • Example: schooling. Education brings positive externalities, and the usefulness of the generated knowledge is enhanced if others have the corresponding knowledge. Coordination problem: private decisions to invest in schooling will depend on others’ actions since being the only schooled won’t bring any benefit ▪ Capital market imperfections are not compatible with universal access to inter- temporal smoothing of income • Banks would lend only to low-risk households ▪ Time inconsistent preferences make people under-invest in pension saving as well as sick leave and unemployment insurance Chapter 11: Inequality among and within nations: past, present, future Why is there inequality? • Inequality: unequal access to welfare (consumption, health, life expectancy and schooling). • Usually linked to inequality of income o The major sources of income are work, acquired or inherited wealth and, from the 20th century, transfers such as pensions o Excluding property income, the income inequality we observe is related to skills acquired through formal education and on-the-job training • The poor in poor nations are usually much poorer than the poor in rich nations, while the rich in poor nations are almost as rich as the rich in rich nations o Poor nations remain poor because they lack the ability, in terms of institutions (corruption and low public governance quality) and education, to exploit modern technology but poverty in itself is a barrier to the escape from poverty because the resources needed to invest in education and infrastructure are hard to mobilize Colonialism as source of poverty • Many poor nations have been subject to colonial rule • Colonized regions lacked strong local governments and colonial powers exploited them: o They acquired property rights in land and mineral resources and trade agreements with terms unfavorable to indigenous people ▪ Colonial expansion of trade left many colonies with a heavy concentration on a few commodities from extractive industries which are subject to wide price fluctuation • Trade volatility has a direct and strong effect on fluctuations in government revenues and economic growth Measuring inequality • The “Gini Coefficient” is an inequality and income dispersion measure which estimate the extent of inequality relative to an ideal of equal income distribution (all individuals/households earn the same). It takes values from 0 (perfect income equality) to 1 (only theoretically, because the maximum inequality possible for a sustainable society must permit to earn a feed-subsistence income) • On the horizontal axis, we measure the cumulative percentage of households in the population ranked according to income (low to high) and on the vertical axis the cumulative percentage of total income. o Straight line: perfect equality, in which X% of households acquire X% of the income o Lorenz curves: The more the curve departs from the straight line, the more unequal the income distribution will be and the higher the value taken by the Gini coefficient • The Gini coefficient does not track inequality over time: o The Roman mean income is about twice the subsistence income, and the related Lorenz curve is similar to the one linked to England and Wales 1600 years later, where the mean income is 3 to 4 times the subsistence income o Brank Milanovic (World Bank economist) introduced Maximum feasible inequality: The higher the average income is the higher the maximum inequality as measured by the Gini coefficient ▪ If the average income in a poor modern economy is 400$ (subsistence income), the society cannot be sustained if not perfectly egalitarian → i.e., Hunter- Gatherer line • How can we understand and track inequality over time? o Estimate the actual Gini coefficient as a percentage of the maximum Gini coefficient possible given the per capita income ▪ Gini coefficients for Rome in year 14 and the USA in year 2000 were around 0.40. Did they have the same inequality score? No: • Roman empire maximum coefficient: 0.55 → Rome was almost as unequal as it possibly could be given the low income per head • USA maximum coefficient: 0.98 • The graph on the side shows the growth rate of the ratio between the actual relative and the maximum Gini coefficients for economies over time o The ratio first increases: actual inequality follows maximum potential inequality as income per head increases ▪ Early civilizations (Roman Empire or Byzantium) characterized by large inequalities in the distribution of property and skills. As larger sections of the population got the skills and access to other resources, they raised their income above subsistence o From the Early Modern period the increase ends and falls in the 20th century ▪ The march towards a less unequal society can be explained by the rise of mass education during the 20th century which allowed people to specialize and improve their skills, hence narrowing wage gaps Gender inequality • Little evidence of gender-specific wage or income inequality before 19th century • There is reason to believe that females on average were paid less than males also before: When work was demanding in terms of physical strength, pay differentials reflected the gender- specific physical demands of the job o Pay differential are still present even if physical strength is less relevant because production technology has replaced muscles with machines • The gender gap today varies between 30-10 % and a substantial part of it is due to differences in occupations, education and job experience • What is the role of discrimination (pay differential not explained by differences in skills)? o The gap tends to increase with increasing age, which reflects the fact that females do not obtain the same on-the-job training as males. Before the middle of the 20th century, it was normal for females to leave the labor market at marriage or after the birth of the first child, which gave employers no incentive to invest in training for females ▪ As female attachment to the labor market became more permanent in the second half of the 20th century, the differential started to decline o Differentials that we cannot ascribe to observed background factors still persist: Studies estimate a 5 -10 % pay disadvantage of females relative to men with identical skills, job history and training ▪ Claudia Goldin (Harvard): employers fail to register the true attributes of individuals and stick to average attributes of men and females because the assessment of individuals is costly • Example: the average length of on-the-job training of men is greater than for women, because an average woman’s job history is interrupted by giving birth. However, there are females with a longer work experience than some men o Critics argue that traditional job choices and occupational strategies endorsed by social conventions direct women into low-paid occupations Chapter 12: Globalization and its challenge to Europe Globalization and the law of one price • Globalization is market integration on a world scale o Not an entirely new phase of economic development ▪ First wave: half 19th century until WW I, Great Depression and WW II ▪ Second wave: 1970-80s o Product of intensified trade, capital mobility and migration • Domestic markets increasingly depend on international markets o Prices, interest rates and – with time lag – wages, reflect global rather than local demand and supply conditions and converge to react faster to international shocks • Market integration operates through trade and arbitrage and the ultimate manifestation of a fully integrated market is the law of one price o Arbitrage: simultaneous purchase and sale of the same asset in different markets so as to profit from tiny differences in the asset's price ▪ In efficient markets arbitrage opportunities are hard to come by o Law of one price: the price of identical goods that are traded is the same in all geographical locations (if transportation costs are 0) ▪ For commodities a more adequate formulation of the law of one price is that the price difference between identical goods in two geographically separated market should be strictly equal to transport and transaction costs • If the price difference is smaller than transport cost, it does not pay to trade ▪ Implications • Price convergence: the price difference between identical goods traded in geographically separated markets will decline as transport and transaction costs and tariffs fall • Deviation from the law of one price will prompt faster price adjustments so that the law is restored • Obstacles to the operation of the Law of one price and to market integration o Tariffs o High transportation costs o Unreliability and slowness of information transmission What drives globalization? • Politics o Tariff policy o Financial market deregulation o Immigration policy • Technological factors which lowered transport and transaction costs o Transport costs fell in the 19th century especially the USA domestic railways ones o Information transmission costs fell from the 19th century thanks to the increased speed of information brought by the telegraph, hence increasing market efficiency The phases of globalization • Capital markets o Currency markets existed in a Europe since early medieval times (moneychangers in major trading spots) and Bill of exchange became mean of credit. Were markets arbitrage-efficient? o L. Neal: London and Amsterdam leading financial centers (17-18th century) with efficient connections and no unexplained price differences between the two markets for identical assets (arbitrage-efficient market) ▪ We cannot assume that smaller and peripheral financial markets were as well integrated o Telegraph (1860-70s) created the pre-conditions for global capital markets o International capital inflows advantage: ▪ Domestic investments not constrained by domestic savings • Nations with large investment needs but low income and savings can borrow in order to invest o Economies before 1914 were permitted to run current account deficits for long periods (Scandinavia, Russia) • Economies don’t incur in the potentially harmful effect of insufficient savings on growth o In a global market, capitals should flow to where rewards are higher ▪ Evidence shows that the link between domestic saving and domestic investment remained strong: home bias in investment behavior • Information asymmetry: domestic investors are better informed about home market than about foreign markets, so they invest in the first o At present, nations typically have foreign liabilities as well as foreign assets o Periods of capital market integration ▪ International Gold Standard period (1860-1914) ▪ Post Bretton Woods system period (1970- onwards) o Does capital market integration coincide with capital market efficiency? ▪ Efficiency is based on arbitrage and if capital mobility is restricted we expect high interest rate differences between nations • The graph shows USA–UK interest rate differences as well as the standard deviation (measure of variance) from 1870 to 2000, and a similar pattern is found within European capital market o In an efficient capital market the interest rate difference should be zero. The graph confirms that the interest rate differential was converging on zero before 1914 and after 1970 • Commodity markets o Commodity market globalization can be measured by price convergence and by the speed of price adjustments ▪ Commodity trade involves high transport costs and tariffs • Price differentials don’t converge on zero o Price differences between geographically distant strongly converge during the 19th century but tended to diverge in the 20th century. Why? ▪ Transportation costs fell and tariffs (trade policies) on certain products (i.e., agricultural commodities) raised • Rationale: avoid a situation where public sector wage explosions trigger wage rises in the sectors exposed to international competition, which would ruin their competitiveness • Labor Market o The real wages convergence mechanism concerns migration of labor from nations with excess labor and low wages to nations with excess demand and high wages ▪ Limit: A significant part of wage differences across nations is related to differences in labor productivity o The wage differential between receiving and sending nations is a determinant of the size of migration flows, but there are a number of barriers to migration ▪ Home Culture bias: workers tend not to move to nations where there are not many previous immigrants from their own country ▪ Before 1850 (start of mass migration) moving costs were too high for those who were likely to benefit from migrating across the Atlantic • After the decline of the slave trade (first quarter of 19th century), Europe became the major source of emigrants for the New World o Forced migration (especially because of religious persecution) often included skilled workers and professionals ▪ I.e., expulsion of the Jews from Spain, end of 14th century, or of Protestants from France in 17th century) ▪ European financial institutions’ history is linked to migration of Italians and Jews o Mass migration reached its highest levels before WW I ▪ European migration never picked up again, partly due to immigration barriers erected in the USA (to avoid the arrival of low-skilled workers) and subsequently by most other nations in the New World o The fall in European migration (internal and external) was due to the fell in the wage gap between potential host country and country of origin, caused by mass migration Globalization and divergence • The gap in real wages and GDP per head between the leading European economies and the developing world started around 1500 but after 1850 divergence increased at a dramatic rate • This increasing gap between poor and rich nations occurred as world economy became globalized o Divergence occurred when Europe increased the rate of growth of GDP per head from some 0.1– 0.2 % per year to between 1 and 2.5 % per year during the 19th century, while the rest of the world remained at the low pre-industrial growth rates • The trade pattern of 19th century erased Indian dominance in textiles both in Asia, and in British markets o At the eve of the Industrial Revolution the price (in silver) of British cotton fabrics in London was three times that of good Indian substitutes traded in Mumbai while in London Indian cotton was sold at the same price as British’ ▪ Over the next 75 years British cotton prices converged to the Indian ones on the Indian market and finally conquered a large market share by lowering prices o From being an exporter of manufactured goods India became an importer ▪ Trade stimulated exports in agricultural goods and raw materials • Agricultural sector declined as a share of the total economy in countries which experienced fast economic growth, but this is the result of a combination of a low domestic income elasticity of demand for agricultural goods and very fast total factor productivity growth o Fewer and more productive rural workers can satisfy domestic demand for food o Many economies which might have been constrained by slow growth of domestic demand were able to grow fast focusing on exports of food and raw materials in the 19- 20th centuries