(1) Economic History

The History of Economic Thought (Economic Ideas and Thinkers)


Fifty years ago, the question was ‘why did the Industrial Revolution happen in England rather than France?’ Research on China, India, and the Middle East has emphasized the inherent dynamism of the world’s great civilizations, so today we must ask why economic growth took off in Europe rather than Asia or Africa. Data on incomes in the distant past are not robust, but it looks as though the differences in prosperity between countries in 1500 were small. The present division between rich and poor largely emerged since Vasco da Gama sailed to India and Columbus discovered the Americas.

We can divide the last 500 years into three periods. The first, which lasted from 1500 to about 1800, was the mercantilist era. It began with the voyages of Columbus and da Gama, which led to an integrated global economy, and ended with the Industrial Revolution. The Americas were settled and exported silver, sugar, and tobacco; Africans were shipped as slaves to the Americas to produce these goods; and Asia sent spices, textiles, and porcelain to Europe. The leading European countries sought to increase their trade by acquiring colonies and using tariffs and war to prevent other countries from trading with them. European manufacturing was promoted at the expense of the colonies, but economic development, as such, was not the objective.

This changed in the second period of catch-up in the 19th century. By the time Napoleon was defeated at Waterloo in 1815; Britain had established a lead in industry and was out-competing other countries. Western Europe and the USA made economic development a priority and tried to achieve it with a standard set of four policies: creation of a unified national market by eliminating internal tariffs and building transportation infrastructure; the erection of an external tariff to protect their industries from British competition; the chartering of banks to stabilize the currency and finance industrial investment; and the establishment of mass education to upgrade the labour force. These policies were successful in Western Europe and North America, and the countries in these regions joined Britain to form today’s club of rich nations. Some Latin American countries adopted these policies incompletely and without great success. British competition de-industrialized most of Asia, and Africa exported palm oil, cocoa, and minerals once the British slave trade was ended in 1807.

In the 20th century, the policies that had worked in Western Europe, especially in Germany, and the USA proved less effective in countries that had not yet developed. Most technology is invented in rich countries, and they develop technologies that use more and more capital to increase the productivity of their ever more expensive labour. Much of this new technology is not cost-effective in low-wage countries, but it is what they need in order to catch up to the West. Most countries have adopted modern technology to some degree, but not rapidly enough to overtake the rich countries. The countries that have closed the gap with the West in the 20th century have done so with a Big Push that has used planning and investment coordination to jump ahead.

Before we can learn how some countries became rich, we must establish when they became rich. Between 1500 and 1800, today’s rich countries forged a small lead that can be measured in terms of GDP (gross domestic product) per person. In 1820, Europe was already the richest continent. GDP per head was twice that of much of the world. The most prosperous country was the Netherlands, with an average income (GDP) of $1,838 per person. The Low Countries had boomed in the 17th century, and the main question of economic policy elsewhere was how to catch up with the Dutch. The British were doing that. The Industrial Revolution had been under way for two generations, and Great Britain was the second richest economy, with an income of $1,706 in 1820. Western Europe and Britain’s offshoots (Canada, Australia, New Zealand, and the USA) had incomes of between $1,100 and $1,200. The rest of the world lagged behind, with per capita incomes between $500 and $700. Africa was the poorest continent at $415.

Between 1820 and the present, the income gaps have expanded with only a few exceptions. The countries that were richest in 1820 have grown the most. Today’s rich countries have average incomes of $25,000–$30,000, much of Asia and Latin America average $5,000–$10,000, while sub-Saharan Africa has reached only $1,387. The phenomenon of divergence in which the regions plotted towards the right with higher incomes in 1820 had the greatest income growth factors, and the regions on the left with lower initial incomes had smaller growth factors. Europe and the British offshoots realized income gains of 17- to 25-fold. Eastern Europe and much of Asia started with lower incomes and realized increases of 10-fold. South Asia, the Middle East, and much of sub-Saharan Africa were less fortunate, being both poorer in 1820 and achieving income gains of only 3-to 6-fold. They have fallen even further behind the West. The ‘divergence equation’ summarizes this pattern.


GDP measures the total output of goods and services in an economy as well as the total income generated by it. In this table, GDP is valued in 1990 US dollars so the volume of production (real income) can be compared over time and across space. Note: Great Britain includes Northern Ireland from 1940


The great divergence


There are exceptions to income divergence. East Asia is the most important, for it is the one region that bucked the trend and improved its position. Japan was the greatest success of the 20th century, for it was indubitably a poor country in 1820 and yet managed to close the income gap with the West.

Equally dramatic has been the growth of South Korea and Taiwan. The Soviet Union was another, although less complete, success. China may be repeating the trick today. Industrialization and de-industrialization have been major causes of the divergence in world incomes. In 1750, most of the world’s manufacturing took place in China (33% of the world total) and the Indian subcontinent (25%). Production per person was lower in Asia than in the richer countries of Western Europe, but the differentials were comparatively small. By 1913, the world had been transformed. The Chinese and Indian shares of world manufacturing had dropped to 4% and 1% respectively. The UK, the USA, and Europe accounted for three-quarters of the total. Manufacturing output per head in the UK was 38 times that in China and 58 times that in India. Not only had British output grown enormously, but manufacturing had declined absolutely in China and India as their textile and metallurgical industries were driven out of business by mechanized producers in the West.

In the 19th century, Asia was transformed from the world’s manufacturing centre into classic underdeveloped countries specialized in the production and export of agricultural commodities.


Distribution of world manufacturing


From 1750 to 1880, the British Industrial Revolution was the major event. In this period, Britain’s share of world manufacturing increased from 2% to 23%, and it was British competition that destroyed traditional manufacturing in Asia. The period from 1880 to the Second World War was marked by the industrialization of the USA and continental Europe including Germany, in particular. Their shares reached 33% and 24%, respectively, in 1938. Britain lost ground to these competitors, and its share dropped to 13%. Since the Second World War, the USSR’s share of world manufacturing output rose sharply until the 1980s and then crashed precipitously as the post-Soviet countries went into economic decline. The East Asian miracle saw a rise in the share of world manufacturing in Japan, Taiwan, and South Korea to 17%. China has also been industrializing since 1980, and produced 9% of world manufactures in 2006. If China catches up to the West, the world will have come full circle.


Real wages


GDP is not an adequate measure of wellbeing. It leaves out many factors such as health, life expectancy, and educational attainment. In addition, absence of data often makes GDP hard to compute, and, in any event, it may be misleading because it averages the incomes of the rich with the poor. These problems can be finessed by calculating ‘real wages’, that is, the standard of living that can be bought with one’s earnings. Real wages tell us much about the standard of living of the average person and help explain the origins and spread of modern industry, for the incentive to increase the amount of machinery used by each worker is greatest where labour is dearest.

I focus on labourers. To measure their standard of living, their wages must be compared to the prices of consumer goods, and those prices must be averaged to calculate a consumer price index. My index is the cost of maintaining a man at ‘bare-bones subsistence’ (the least-cost way of staying alive). The diet is quasi-vegetarian. Boiled grain or unleavened bread provides most of the calories, legumes are a protein-rich complement, and butter or vegetable oil provides a little fat. This was typical fare around the world in 1500. Francisco Pelsaert, a Dutch merchant who visited India in the early 17th century, observed that the people near Delhi ‘have nothing but a little kitchery [kedgeree] made of green pulse mixed with rice … eaten with butter in the evening, in the day time they munch a little parched pulse or other grain’. The workmen ‘know little of the taste of meat’. Indeed, most meats were taboo.

The diet is based on the cheapest grain available in each part of the world – oats in northwestern Europe, maize in Mexico, millet in northern India, rice in coastal China, and so on. The quantity of the grain is chosen, so that the diet yields 1,940 calories per day. Non-food spending is restricted to scraps of cloth, a bit of fuel, and the odd candle. Most spending is on food, and, indeed, on the carbohydrate at the core of the diet.

The fundamental standard of living question is whether a fully employed labourer earned enough to support a family at bare-bones subsistence. Figure 3 shows the ratio of full-time earnings to the family’s cost of subsistence. Today, living standards are similar across Europe. The 15th century was the last time that was true. Living standards then were also high: labourers earned about four times bare-bones subsistence. By the 18th century, however, a great divergence had occurred in Europe. The standard of living on the continent collapsed, and labourers earned only enough to purchase food. In the Middle Ages, Florentine workers ate bread, but by the 18th century they could afford only polenta made from maize, newly introduced from the Americas.


Subsistence ratio for labourers


In contrast, labourers in Amsterdam and London still earned four times bare-bones subsistence. Workers in London in 1750 did not, however, eat four times the oatmeal. Instead, they upgraded their diet to white bread, beef, and beer. It was only on the Celtic fringe that the British ate oats. As Doctor Johnson remarked, oats are ‘a grain which in England is generally given to horses but in Scotland supports the people’. The workers of southern England also had the income to purchase the luxuries of the 18th century such as the odd book, a mirror, sugar, or tea.

Real wages have diverged as dramatically as GDP per head. In 1820, the London real wage was already four times subsistence, and the ratio has grown to fifty – mainly since 1870.




In the poor countries of the world, however, real wages are still at bare-bones subsistence. In 1990, the World Bank defined a world poverty line at $1 per day (since raised to $1.25 due to inflation). This figure, which is based on the poverty lines of present-day poor countries, corresponds to bare-bones Subsistence. Those baskets averaged $1.30 per person per day when priced in 2010. More than one billion people (15% of the world’s population) live below that line today, and the proportion was far higher in 1500. Labourers in Beijing were this poor in the 19th century. China’s remarkable growth in recent decades has boosted the labourer’s standard of living to only six times subsistence – a level that British workers realized 150 years ago.

We can now appreciate the low incomes for 1820. They are expressed in 1990 dollars, and, at that time, bare-bones subsistence cost $1 per day or $365 per year. Average income in sub-Saharan Africa in 1820 was $415 – only 15% more than bare-bones subsistence, which was the standard of living of the vast majority. In most of Asia and Eastern Europe, which had more capital-intensive farming systems and hierarchical societies, the average incomes were only $500–$700. Most people lived at subsistence, and the surplus was extracted by the state, the aristocracy, and the rich merchants. Northwestern Europe and the USA had incomes four to six times subsistence. Only in these societies did workers live above bare-bones subsistence. These economies were sufficiently productive to also support aristocracies and merchants. Bare-bones subsistence has further implications for social wellbeing and economic progress. First, people living on the bare-bones diet are short. The average height of Italians who enlisted in the Habsburg army fell from 167 cm to 162 cm as their diet shifted from bread to polenta. In contrast, English soldiers in the 18th century averaged 172 cm due to their better nutrition. (Today, the average man is 176–8 cm tall in the USA, UK, and Italy, while the Dutch are 184 cm tall.) When people’s heights are stunted for lack of food, their life expectation is also cut, and their health in general declines. Second, people living at subsistence are less well educated. Sir Frederick Eden, who surveyed labourers’ incomes and spending patterns in England in the 1790s, described a London gardener who spent 6 pence per week sending two of his children to school. The family bought wheat bread, meat, beer, sugar, and tea, and his earnings (£37.75 per year) were about four times subsistence (just under £10). If their income were suddenly cut to subsistence, vast economies would have had to be made, and who can doubt that the children would have been removed from school? High wages contributed to economic growth by sustaining good health and supporting widespread education.


Finally, and most paradoxically, bare-bones subsistence removes the economic motivation for a country to develop economically. The need for more output from a day’s work is great, but labour is so cheap that businesses have no incentive to invent or adopt machinery to raise productivity. Barebones subsistence is a poverty trap. The Industrial Revolution was the result of high wages – and not just their cause.




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