Inequality & the First Globalisation

A follow-up to my previous post, “Did inequality cause WW1? Contra Hobson-Lenin-Milanovic“, elaborating on the inequality=>capital exports link in Branko Milanovic’s overall inequality=>ww1 claim.

In the earlier post, two commenters took issue with my treatment of the inequality=>capital exports linkage. Of course I did acknowledge that high domestic inequality did probably contribute to Europe’s capital exports, in the sense that lower inequality implies higher aggregate consumption and therefore less capital exported. But I also argued that other structural factors (demographics and diminishing returns to capital) should not be underrated.

Yet even IF inequality had been the most important cause of capital exports, then what it helped achieve indirectly was the rapid development of the world’s settler regions and the consolidation of social democracy in Europe.

(1)

Commenter Gaffers suggested that low aggregate demand due to inequality might have lowered the domestic rate of return for British and European investors. That’s an empirical question, but I’m sceptical there could have been so much underutilisation of productive capacity as implied by that suggestion.

In the short-run, domestic and foreign investment tended to fluctuate more or less inversely in the capital-exporting countries. For the UK:

[Source: Edelstein in Floud & Johnson 2004; Top: national savings; middle: domestic investment; bottom: foreign investment]

The swings in the investment cycle were largely driven by differences between domestic and foreign rates of return. Sometimes there would be a big overseas investment boom (in North America, especially), but when overseas rates of return fell, British savings “stayed home”. But what was the balance of the push and pull factors ?

The United States and Latin America offered pretty high rates of return. The gap with the UK (as a long-run average) seems just too large to make ‘domestic underconsumption’ a an important explanation.

(2)

Jo Michell, an economist at UWE Bristol, posted a comment which allows me to clarify something:

The first issue you highlight is that higher consumption [due to a hypothetical income redistribution from British savers to British consumers] would lead to higher imports and lower net exports. But this doesn’t undermine the Hobson thesis: all else equal, lower net exports will also mean diminished requirements for foreign lending….

My observation about extra import demand is connected to the subsequent observation that Britain (as well as, later on, France and Germany) were not trade surplus countries in terms of physical goods. Rather, their current account surpluses were driven by the so-called ‘invisibles’, what today we would call the balance of trade in services and net foreign factor income (NFFI). In other words, Britain, France, and Germany were not producing more (physical goods) than they were consuming at home.

I think this is a problem for any variant of the Hobson-Lenin thesis — if the source of your “excess savings” is actually overseas, and not domestic.

Another issue is the composition of the merchandise trade balance and the pattern of trade which is neglected by purely macroeconomic reasoning about external balances. Britain exported manufactures, and imported food and raw materials. The “Hobson counterfactual” (a large income redistribution from savers to consumers) would have required more food for any year we might be talking about.

But earlier the counterfactual begins, the more the pattern of British specialisation would have been altered. A portion of any extra food demand would have been met by imports, but a portion would have been met through domestic production. Britain’s actual food import requirement was pretty hefty. In 1850, ~25% of calories available per capita were imported, and by 1913 it was <60%. And that’s just the average: lower down the income distribution, caloric consumption would have been lower and the activity level (from unskilled labour) would have been much higher compared to today’s energy requirement.

It’s difficult to speculate off the cuff about the general equilibrium implications of a higher domestic demand for food. But under plausibly reasonable assumptions, that might have:

• slowed Britain’s structural transformation out of lower-productivity agriculture into higher-productivity manufacturing; and
• moderated the improvement in the UK terms of trade (the imports you can buy with your exports). {edit} British TOT underwent an improvement of 30% in the period after 1860, which coincides with the arrival of food from the Americas, etc. {edit}

Both — structural transformation and terms-of-trade improvement — surely had welfare-improving effects in the long run, even holding politics and institutions constant.

I’m not arguing that such secondary effects would have been large enough to offset the effects of direct redistribution of income from savers to consumers in the “Hobson counterfactual”. Surely the direct effect would predominate. But….

(3)

The tendency for domestic production would have been reinforced if the Corn Laws had never been repealed and Britain had continued to protect its agriculture after the 1840s. And I venture to guess, politically, Britain would have stayed protectionist, had it been a more egalitarian country in terms of wealth and asset distribution.

There’s no mystery about why Germany stayed protectionist: despite its powerful industrialists, Germany was politically controlled by an agrarian-military elite of “East Elbian” Prussian Junkers.

Democratic France pandered to the agricultural interest, because the land reforms of the French Revolution had divided up the great aristocratic estates and created a large class of small land holders. In the long run, this may have slowed industrialisation in France, since, even as late as 1945, France was much more agricultural than the UK or Germany.

( Agricultural protection did not seem to slow down the growth of the manufacturing sector in Germany, but it did impede the development of the service sector. As pointed out by Broadberry (1998), US labour productivity converged with Britain’s in the late 19th century not via manufacturing, but via services. In Germany, however, the service sector remained atrophied until after 1945, and its agricultural sector remained large and unproductive relative to the USA and the UK. [Broadberry 2005] )

In plutocratic Britain, the distributive political conflict was between the ascendant northern manufacturers and the traditional landed aristocracy. The aristocracy lost this conflict, and the value of agricultural land slowly eroded over time. But to some extent the agrarian interest was compensated because the landed magnates integrated socially and economically with the global services industry based in the City.

Had Britain been a more democratic country in the 18th and early 19th centuries, and a more egalitarian country in terms of land holdings, the balance of political power might have favoured the agricultural interest. Then we can take much more seriously the idea that greater equality (earlier in the 19th century) might have retarded Britain’s subsequent development.

(4)

Another consideration: by how much would wages not have risen in a counterfactual Britain (and Europe) which did not export the capital to develop the agricultural potential of the settler frontiers? Even as late 1913 French and German unskilled urban labour was paid less than the British equivalent. (See the wage gap for various European countries 1850-1913.)

In the long run, British and European capital exports financed the development of the food exporting sectors of North America, Australasia, Argentina/Uruguay, and Russia-Ukraine. The incredibly cheap food from these sources, as we know from Hoffman et al. (2002), helped lower inequality after 1870 in Europe. Between 1867 and 1910, the cost of living for the bottom 40% of the British population fell nearly 25% on account of lower food prices from agricultural globalisation.

However the effect was considerably more muted in France, which protected its agriculture:

European capital exports, then, should be viewed as an extension of European direct investment in domestic food production. Not having net exports of capital would have slowed down the development of the settler frontiers and checked one of the great equality-promoting forces of the late 19th century.

(5)

And remember, the capital-importing / food-exporting economies of the 19th century were populated by European migrants. British exports of capital and people look almost synchronous in the time series !

[Source: Floud, Johnson, & Humphries (2014); also see the emigration rates per 1000 per decade of other European countries.]

Basically it amounts to this: Northwest Europe’s specialisation in manufacturing entailed a dependence on imported food and raw materials. Demography and industrialisation had produced by mid-century a large supply of young footloose urban workers. In parallel, there were large land-abundant settler-frontiers with a scarcity of labour and capital, high dependency ratios, and a potential for huge agricultural and raw material production. The “first globalisation” connected the two processes — European workers emigrated en masse and European capital chased them en masse. As O’Rourke & Williamson (1999) argue, Europe’s capital exports “during the age of high imperialism can be viewed, at least partially, as an intergenerational transfer” amongst Europeans.

Hatton & Williamson (1998), probably the most comprehensive treatment of the economics of mass migration in 1870-1914, finds that along with demographics (as an independent variable), the most important factor explaining emigration was the gap in real wages between sending and receiving countries. So we might speculate, if there had been less inequality in Europe on the eve of the Great War, not only would there have been less capital export, but also fewer people exported. Yet people exports were important in the long run to the development of Europe’s egalitarian and social democratic institutions.

One simple way of conceptualising the path of income inequality in the course of industrialisation is the Lewis Turning Point, named after the development economist and Nobelist Arthur Lewis. In the early stages of industrialisation, because agriculture is becoming less important as an employer, there is urban-rural migration and the supply of workers rises faster than the urban demand for workers especially in manufacturing.

The Lewis turning point is where migration into the cities decelerates, and employers start bidding up wages, as labour bargaining power is strengthened. (It’s basically the point where the labour supply curve switches from being horizontal to ‘normal’ and upward-sloping.) Before the LTP, wages grow more slowly than labour productivity, and the labour share of income falls; after the LTP, wages grow at the same rate as labour productivity and the labour share rises.

Emigration helped accelerate the coming of the Lewis Turning Point in 1870-1914, especially for Sweden, Norway, Italy, and Ireland, where emigration really thinned the ranks of labour.

How much did emigration, by itself, contribute to wage growth in the people-exporting countries of Europe? In various simulations, Hatton & Williamson conclude

• roughly, wage growth due to emigration for 1870-1910: Denmark 11%, the UK 9%, Italy 33%, Norway 15%,  Sweden 12%;
• for Ireland 1851-1911: “roughly 40 to 50 percent of the observed growth [in non-farm wages] can be attributed to emigration”; and the lower bound for the estimate on farm wages is 25%

Emigration may also have contributed to egalitarian institutions more indirectly. Recent evidence from Sweden suggests that having an “exit option” via emigration emboldened labour activists in the period 1867-1920 and ultimately increased membership in trades unions. Since labour agitation carried the risk of sacking, intimidation, and blacklisting, the option to emigrate reduced the cost of social activism. Scandinavia’s famous social democracy was made possible, at least in part, by emigration — or rather the “first globalisation”.

§ § § § §

The overall point I’m trying to make is that even if inequality drove the export of capital and people, the latter two also contributed to lowering inequality in the long run through the development of the neo-Europes and the relief of demographic pressure in old Europe.

Postscript

There are many echoes of economic history in the recent comeback of ‘underconsumption’ as an idea in the debate about the recession, inequality, and “secular stagnation”.

• Like Keynes but unlike Hobson, Stiglitz argues inequality makes the recovery more sluggish and incomplete.
• Like many historians (now mostly discredited) who blamed capital exports for Britain’s industrial decline, Hobson believed the domestic economy was “capable of indefinite expansion” — which I interpet as a point about long-run growth, not business cycles.
• I pay little attention to contemporary politics but I recently discovered that a minor storm had erupted over the heterodox economist Gerald Friedman. He assumed in his analysis of the economic proposals of the US presidential candidate Bernie Sanders that lowering inequality and increasing aggregate consumption would double the growth rate of productivity in the US economy. Friedman apparently argues not merely that inequality causes GDP to remain below potential, but that inequality lowers potential GDP, something which is not well supported by mainstream economics.
• Friedman appeals to Verdoorn’s Law as justification — something which has been cited in historiographic debates about (a) the supposed harm done in the 19th century to the British economy by exporting so much capital; and (b) the supposed harm done by the erosion of Britain’s share of the world’s export markets after the Great War.
• Finally, there’s a crazy article claiming or implying that the Industrial Revolution was driven by consumption and demand (it was not).