Great Britain and Laissez Not-so-Faire Economics

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I recently finished State, Economy, and the Great Divergence by Peer Vries. It’s a comparison of the activities of the state in Great Britain and China in the period running up to and including the Industrial Revolution, roughly 1650-1850.

Vries critiques the standard view on the role of the state and the divergence between these two places, encapsulating that view in the following:

In the Smithian interpretation of British economic history, that fits in quite neatly with the Whig interpretation of Britains overall history, the primacy of Britain and its industrialization are by and large regarded as the culmination of a long process in which Britains economy increasingly became characterized by free and fair competition and in which government increasingly tended to behave according to Smithian logics.
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For those who endorse them, the predicament of imperial China, that it did not industrialize, has always been quite easy to explain. They only need to refer to the fact that China was characterized by some kind of oriental despotism. This notion has a long pedigree whose beginnings can be traced back at least to Marco Polo.

The alternative that Vries proposes is that China is far more “Smithian” than Great Britain in this period, in the sense that it operated a very hands-off government that mainly served to provide some subsistence insurance to its population, while Great Britain had a relatively large, intrusive, and active government managing its economy and actively interfering in the process of industrialization. With regards to the idea that Great Britain enjoyed a meaningful advantage in institutions (re: property rights) after the Glorious Revolution, Vries has this to say:

I, moreover, see no concrete direct links between changes in property rights and the emergence of modern economic growth during industrialization in Britain, or rather I do not see any major changes in that respect just before and during take off. In several respects property rights in Britain after 1688 were not better protected, as a strengthened central government had acquired more power to interfere with them on the basis of national interest. More in general, one has to realize that, as will be discussed later on, the history of Western Europe was not exactly lacking examples of expropriation and that well protected, entrenched property rights including patents can also be an obstacle to growth.

Vries then spends a good portion of the rest of the book laying out the evidence on government expenditures, taxes, employment, and transfer payments to support the idea that Great Britain had a much more intrusive state than China in this period.

I’ll leave you to the book for the full details, but here are some essential highlights. Taxes per capita in Great Britain were approximately 20 times higher than in China. As a percent of GDP, the figure depends on exactly your preferred source for GDP data, but taxes were again much higher in Great Britain (3-5 times higher depending on the measure). Further, taxes were rising in both per capita and percent of GDP terms over this entire period in Great Britain, while they were essentially flat in China. Finally, the government in China never ran deficits in this entire period. If you are familiar with the history of Great Britain, then you know that government debt as a percent of GDP was essentially zero in 1689, right after the Glorious Revolution. From there it rose steadily, reaching a peak of almost 250% of GDP after the Napoleonic wars. It wasn’t until after 1850 that debt fell back below 100% of GDP. In terms of the number of government officials, Vries cites data that China had between 20,000 and 30,000 civil servants in the 18th century. Great Britain had an equal amount, for a population roughly 30 times smaller. Great Britain spent a much larger fraction of GDP on welfare and poor relief than China ever did.

Drawing on the excellent War, Wine, and Taxes by John Nye, Vries also talks about the attitude of Britain towards free trade:

In the 1820s, for example, the average tariff rate for imported manufactured goods was between 45 and 55 per cent. It was only after 1850, and even then only quite temporarily, that Britain really became a free-trading nation. Overall, its tariffs in the first half of the nineteenth century were so high, higher for example than in France, and continued to be high for so long that any explanation of the first industrial revolution by reference to the existence or emergence of a free-trade economy is extremely improbable. When Britains economy took off, the country definitely was not a free trader in matters of international trade.

Compared to Britain, China was much closer to a free trade nation, declining to interfere or promote imports or exports actively.

Vries wraps up his argument with

This book maintains that the historical evidence now is so heavily in favour of industrial and military policies successfully encouraging long-term economic development in England, admittedly through far more complex means than simply setting tariffs to encourage domestic manufactures, that the burden of proof falls on neoclassical economics, not on the historic record.

Mercantilism, as practiced throughout this period in Great Britain, was not simply a fascination with collecting gold. The British government actively looked to strengthen manufacturing (of imported raw materials) and used military and naval power to open markets with that purpose in mind. To do this it taxed heavily, borrowed heavily, and spent heavily.

What to make of this? There is no necessary link between strict laissez-faire policies and growth. The first industrial nation in the world was anything but laissez-faire, and it intervened far more deeply into its economy than China, which functioned in some sense as the idealized “night watchman” state of Adam Smith. There is little to no evidence that government “just getting out of the way” leads to development. The interventions Great Britain did make certainly resulted in massive monopoly rents to small groups of people at times. So let’s not go overboard in the other direction and conclude that massive state interventions are necessary or optimal. But it is valuable knowing just how un-laissez-faire Britain was during this period.

Why did Britain take off even with all this government interference? Vries doesn’t say this explicitly, but I think his answer is partly that large-scale industrialization has big fixed costs. I want two things before I undertake big fixed investments: a large market and low risk. The British government used the high taxes to fund a military that could ensure large markets around the world, and could ensure that those markets remained open so I could earn enough to pay off my fixed cost. That military (directly or by proxy) could also actively ensure that other markets did not develop competitive industries, again ensuring that I could earn enough to make the fixed costs worth it. Without the market size and low risk, maybe British capitalists are not willing to create the large-scale industries that drove the IR. In that sense, the large size of government was necessary to the industrialization of Britain.

Empirics and Institutions

I just completed a section in class on institutions and growth. This had led me to re-read several papers, including Acemoglu, Johnson, and Robinson (2005) on “The Rise of Europe: Atlantic Trade, Institutional Change, and Economic Growth.” The idea in the paper is that the places that grew most quickly in Europe were those that could (1) take advantage of Atlantic trade and (2) had good initial institutions around 1500 AD.

The point of the paper is section II, called “Our Hypothesis”. It is this:

In countries with easy access to the Atlantic and without a strong absolutist monarchy, Atlantic trade provided substantial profits and political power for commercial interests outside the royal circle. This group could then demand and obtain significant institutional reforms protecting their property rights. With their newly gained power and property rights, they took advantage of the growth opportunities offered by Atlantic trade invested more, traded more, and fueled the First Great Divergence.

This is a fine hypothesis. It seems plausible, and my guess is that one could make a solid historical case for it. In essence, Spain and France were not able to take advantage of Atlantic trade because their monarchies were too rigid/absolutist/powerful, and England and the Netherlands did take advantage because their monarchies were already relatively weak.

AJR undertake an empirical study in this paper meant to bolster their hypothesis. But the more I read through it, the less convinced I am that this empirical exercise really tells us anything useful. In particular, it doesn’t do anything to convince me that their hypothesis is right.

To do this empirical exercise, they construct an index of initial institutions around the year 1500, coded from 1 to 3, that is supposed to measure the constraints on executives. 1 is few constraints (bad) and 3 is some constraint (good). They assign a value of 1–3 to each European country. To be clear, I’m not making an Albouy-like claim about the assignment itself. I’m willing to stipulate that “institutions” in the Netherlands at the time were a 3, while those in Spain were a 1, and France somewhere in between with a 2. That’s not the issue.

Their empirical work is based on comparing the effect of initial institutions on subsequent economic outcomes among Atlantic traders. In practical terms, this means that they are looking at variation across five countries (England, France, Netherlands, Spain, and Portugal) with meaningful Atlantic trade. This is a small enough group to immediately see how things are going to come out. The Netherlands has a 3 for institutions in 1500, England a 2, France a 2, Spain a 1.5, and Portugal a 1. Already, this index is closely correlated to income per capita in these countries in subsequent years they analyze (1600, 1700, 1820). The index is almost exactly colinear with income per capita around 1700. The real issue is that later on (by 1820), England takes a lead over France in income per capita, so that doesn’t correlate with their institutional measure. However, if you weight the institutional index by the amount of Atlantic trade a country does (i.e. number of voyages), then England looks better than France.

One issue is that it doesn’t seem necessary at all to run their regressions. Their table 7 presents a series of 30(!) regressions showing that having a big value of the initial institutional index (once you weight it by the volume of trade) is correlated with urbanization, GDP per capita, and future values of the institutional index. But a (not even careful) reading of history would lead you to same correlations. Their section II, in fact, is just such a reading of history. What does it matter that the coefficient they estimate is 0.21? What does that mean?

Further, the statistical significance and coefficient estimates are arbitrary. As there are no natural units for the index, there is no meaning to going from a 2 to a 3. Are institutions in the Netherlands 33% better than in France? While the ranking is informative, the numbers themselves are not. Imagine that I re-indexed the institutions in the AJR paper as Netherlands = 5, France and England = 4, Spain = 1.5, and Portugal = 1. I haven’t rescaled the entire index, I’ve just added 2 to the Dutch, French, and English scores. This preserves the rank ordering, but changes the spread. This will affect both the slope estimate and the standard error. If I fiddle just right with the index (e.g. adding 3 rather than 2, or giving Portugal a 0) then I can make the slope and standard error come out however I want.

Last, the regressions do not even necessarily confirm their historical intuition. They may have coded the index based on institutions, but that index picks up anything that varies widely between the Netherlands and Portugal, with England and France as some sort of intermediate case. The propensity for enjoying tulips? The prevalence of dairy farming? The inverse of average February temperatures? Just because you call it an index of institutions doesn’t mean that it will only pick up variation in institutions (And no, country fixed effects do not necessarily wash out my silly examples, for the same reason that FE don’t wash out the institutions index – they’re continuous measures).

The really frustrating part is that this veneer of empiricial support is completely unnecessary. AJR have a perfectly plausible explanation for the general historical facts. It’s a pretty compelling story, from my perspective. But there is not ever going to be a rock-solid empirical identification strategy for this kind of work. It’s worth remembering that lacking identification is not the same thing as rejecting a theory. For this kind of historical hypothesis, we have to get comfortable with ambiguity.

Growth in Sea Transportation

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I saw these incredibly cool images of shipping routes over time (original source is assistant professor Ben Schmidt from Northeastern). They map actual voyages taken, ship by ship, so you can see not just the routes but the density of usage.

First, one showing routes from mid-19th century

Second, here is the same map done with data from 1980-1997.

Very nice, quick summaries of the expansion in trade over a century. Shows the expansion of Asia, in particular, in this time period.