A Possible Perspective on Growth and Stagnation over the Past 200 Years

The previous section gave a brief summary of the most important ideas highlighted in this book. I now discuss how some of these ideas might be useful in shedding light on the process of world economic growth and cross-country divergence that have motivated our investigation starting in Chapter 1.

(1) Why did the world economy not experience sustained growth before 1800?

(2) Why did economic takeoff start in 1800 and in Western Europe?

(3) Why did some societies manage to benefit from the new technologies and organiza­tional forms that emerged starting in 1800, while others steadfastly refused or failed to do so?

I will now offer a narrative that provides some tentative answers to these three questions. While certain parts of the mechanisms I will propose have been investigated econometrically and certain other parts receive support from historical evidence, the reader should view these as a first attempt at providing a coherent answers to these central questions. Two aspects of these answers are noteworthy. First, they build on the theoretical insights that the models in this book generate. Second, in the spirit of the discussion in Chapter 4, they 1100

link the proximate causes of economic phenomena to fundamental causes, and in particular to institutions. And here, I take a shortcut. Although I emphasized in Chapter 23 that there are no perfect political institutions and that each set of different political arrangements is likely to favor some groups at the expense of others, I will simplify the discussion here by making a core distinction between two sets of institutional arrangements. The first, which I will refer to as authoritarian political systems, encompasses absolutist monarchies, dictatorships, autocracies and various types of oligarchies that concentrate power in the hands of a small minority and pursue economic policies that are favorable to the interests of this minority.

Armed with the economic models we have seen so far in the distinction between authori­tarian and participatory regimes, we are now ready to discuss some tentative answers to the central questions outlined above.

Why did the world not experience sustained growth before 1800? While sus­tained growth is a recent phenomenon, growth and improvements in living standards certainly 1101

did occur many times in the past. The human history is also full of major technological break­throughs. Even before the Neolithic Revolution, many technological innovations increased the productivity of hunter gatherers. The transition to farming after about 9000BC is perhaps the most major technological revolution of all times; it led to increased agricultural productivity and to the development of socially and politically more complex societies. Archaeologists have also documented various instances of economic growth in pre-modern periods. Histo­rians estimate that consumption per-capita doubled during the great flowering of Ancient Greek society from 800BC to 50BC (Morris, 2005). Similar improvements in living standards were experienced by the Roman Republic and Empire after 400BC (Hopkins, 1980), and appear to have been experienced by pre-Columbian civilizations in South America, especially by the Olmec, the Maya, and even perhaps the Inca (Mann, 2004, Webster, 2003). Although data on these ancient growth experiences are limited, the available evidence suggests that the basic models we have seen, where growth relies on physical capital accumulation and some technological change, provide a good first description of the developments in these ancient economies (see, for example, Morris, 2005, on capital accumulation and limited technological change in Ancient Greece).

Importantly, however, these growth experiences were qualitatively different from those that the world experienced after its takeoff starting in the late 18th century. Four factors appear to have been particularly important and set these growth episodes apart from modern economic growth.

Why did these growth episodes not turn into a process of takeoff, ultimately leading to sustained growth? My main answer is related to that offered in Section 23.3 in Chapter 23. Growth under authoritarian regimes is possible. Entrepreneurs and workers can become better at what they do, achieve better division of labor, and improve the technologies they work with by tinkering and learning-by-doing. Moreover, those with political power and their allies do have the necessary security of property rights to undertake investments. And some technological breakthroughs can always happen by chance.

Let me focus on the political economy aspect and provide a few examples may be useful to illustrate the main limits to growth under authoritarian regimes. The Chinese Empire has been technologically innovative during many distinct phases of its history. Productivity in the Chinese economy, especially in the Yangtze Delta and other fertile lands, has been high enough to support a high density of population. But the Chinese economy never came close to sustained growth. Authoritarian political institutions regulated economic activity tightly for most of Chinese history. The society has typically been hierarchical, with a clear distinction between the elite and the masses. This system did not allow free entry into business by new entrepreneurs that would adopt and exploit new technologies and unleash the powers of creative destruction.

The Ancient Greek and Roman civilizations are often viewed as the first democratic societies. One might therefore be tempted to count them as participatory regimes that should have achieved sustained economic growth. But this is not necessarily the case. First, participatory regimes do not guarantee sustained economic growth when other preconditions have not been met. But more importantly, these societies were democratic only in comparison to others at the time. Both societies were representative only for a small fraction of the population. Production relied on slavery and coercion. Moreover, despite certain democratic practices, there was a clear distinction between a small elite, which monopolized economic and political power, and the masses, which consisted of both free plebs and slaves. Economic growth in both Greece and Rome did not rely on continuous innovation. Both societies managed to achieve high levels of productivity in agriculture, but without changing the organization of production in a radical manner. Both societies benefited from their military superiority for a while, and challenges to their military power were also important factors in their decline.

The Ottoman Empire provides another example of a society that was successful for an extended period of time but never transitioned into sustained growth. The Ottoman Empire, especially during the 14th, 15th and 16th centuries, achieved relative prosperity and great military strength. Agricultural productivity was high in many parts of the empire and mil­itary tribute contributed to state coffers and generated revenues to be distributed to parts of the population. But the state elite, controlling decision-making within the empire, never encouraged broad-based economic growth. There was no private property in land, trade was encouraged as long as it was consistent with the state’s objectives, but always tightly con­trolled, and any new technology that could destabilize the power of the state was steadfastly blocked. Like China, Greece and Rome, the Ottoman growth first tapered off and then turned into decline (Pamuk, 2007).

The final example I will mention is the Spanish monarchy. By the beginning of the 16th century, the Spanish crown had achieved both political control of its own lands under Ferdi­nand and Isabella and control of the large overseas empire through its colonial enterprises. Many parts of greater Spain, including the South that was recently reconquered from the Moors and the lands of Aragon, were already prosperous in the 15th century. The whole of Spain became much wealthier with the transfer of gold, silver and other resources from the colonies in the 16th century. But this wealth did not translate into sustained growth. The colonial experiment was managed under a highly authoritarian regime set up by Ferdinand and Isabella, and the most lucrative businesses were allocated to the allies of the crown. The greater revenues generated from the colonies only helped to tighten the grip of the crown on

the rest of the society and the economy. Instead of abating, absolutism increased. Trade and industry remained highly regulated, and groups not directly allied to the crown were viewed suspiciously and discriminated against. The most extreme example of this, the persecution of Jews that had started under the Inquisition, continued and spilled over to other independent merchants. Spain enjoyed the transfer of wealth from the colonies, but then experience a very lengthy of stagnation, with economic and political decline (Elliott, 1963).

It is also remarkable that in none of these cases did complementary economic institutions develop. Financial institutions were always rudimentary. The Roman Republic developed a precursor to the modern corporation and allowed some contracts between free citizens, but by and large, economic prosperity was built on traditional economic activities that did not necessitate complex relationships among producers and between firms and workers. Conse­quently, the structural transformations that accompany economic growth never took place in these societies. Life was largely rural, social relations were dominated by the state and community enforcement, and financial markets were rudimentary or nonexistent. Perhaps more important, there was little investment in human capital, except for the elite for whom education was often not a means towards higher productivity.

I suspect that these patterns were not coincidences. Economic life under authoritarian political regimes must have many of these features. Growth relying on practices that increase the productivity of the elite in traditional activities can secure growth for a while. But it will never engender creative destruction. Growth will go hand-in-hand with the political domination of the elite and thus with entry barriers protecting the status and the power of the elite. Therefore, the answer to the question of why not before 1800 is twofold. First, no society before 1800 invested in human capital, allowed new firms to bring new technology, and generally unleashed the powers of creative destruction. This might have been partly due to the difficulty of undertaking broad-based human capital investments in societies without the printing press and with only limited communication technologies. But it was also related to the reward structures for workers and firms. An important consequence of this pattern of growth is that no society experienced the sweeping structural transformations that are an essential part of modern economic growth (recall Chapter 21). Second, no society achieved these crucial steps toward sustained growth because all these societies lived under authori­tarian political regimes.

Why did economic takeoff start in 1800 and in Western Europe? Before devel­oping an answer to this question, let me take a slight digression. Faced with the patterns documented so far, one can adopt one of two distinct approaches. Either we can think that stagnation is the usual state of mankind and that something quite unusual, perhaps unlikely, needs to happen in order to break the cycle and lead to economic takeoff (Brenner, 1966). 1105

If this perspective is correct, there is no reason to expect that a similar takeoff would hap­pen in other societies unless they were subject to similar, and similarly unusual, shocks or some other process of intervention or change that induced them to undergo similar changes. Alternatively, one might suppose that the impetus for growth is ever present and is kept in check by certain non-growth-enhancing institutions or market failures (Jones, 1988). Once the growth process starts, it is likely to continue and spread. Then the question is pinpointing what the growth-blocking institutions and market failures are. My perspective is a mixture of these two views.

The division of labor emphasized by Adam Smith and capital accumulation always present growth opportunities to societies. Furthermore, human ingenuity is strong enough to create room for ma jor technological breakthroughs in almost any environment. Thus, consistent with the second perspective, there is always a growth impetus in human societies. Neverthe­less, this growth impetus may only be latent because it lives within the context of a set of political (economic) institutions. When these institutions are not encouraging growth—when they do not provide the right kind of reward structure, punish rather than reward innovators and investors—we do not expect the growth impetus to lead to sustained growth. Even in such environments, economic growth is possible and this is why China, Greece, Rome and other empires experienced growth for part of their history. But this prosperity did not exploit the full growth impetus. In fact, such prosperity relied on political regimes that, by their nature, had to control the growth impetus, because the growth impetus would ultimately bring these same regimes down. Therefore, growth under authoritarian political institutions must be growth despite the reward structures, not because of them.

West European growth starting in the late 18th century was different because Western Europe underwent three important structural transformations starting in the late Middle Ages. These structural transformations created an environment in which the latent growth impetus could turn into an engine of sustained growth.

The first was the collapse of one of the pillars of the ancient regime, with the decline of feudal relations in Western Europe. Starting in the 13th century and especially after the Black Death during the mid-14th century, the feudal economic relations crumbled in many parts of Western Europe. Serfs were freed from their feudal dues either by default (because the relationship collapsed) or by fleeing to the already expanding city centers (Postan, 1966). This heralded the beginning of an important social transformation; urbanization and changes in social relations. But perhaps more importantly, it created a labor force ready to work at cheap wages in industrial and commercial activities. It also removed one of the greatest sources of conflict between existing elites and new entrepreneurs—competition in the labor market (recall from the analysis in Chapter 22 how competition in factor markets can be the source of a range of distortionary policies). The decline of the feudal order also weakened the power base of the European authoritarian regimes that were largely unchallenged until the end of the Middle Ages (Pirenne, 1937).

The second structural transformation was related. With the decline in population, real incomes increased in much of Europe, and many cities created sufficiently large markets for merchants to seek new imports and for industrialists to seek new products (recall the im­pact of a decline in population on income per capita in the Solow or the neoclassical growth model, Chapters 2 and 8, or in the Malthusian model of Section 21.2 in Chapter 21, and the evidence in Chapter 4; recall also the importance of aggregate demand in jumpstarting industrialization emphasized in Section 21.5 in Chapter 21). During the Middle Ages, a range of important technologies in metallurgy, armaments, agriculture and basic industry, such as textiles, were already perfected (White, 1978, Mokyr, 1991, 2002). Thus the European econ­omy had reached a certain level of technological maturity and perhaps created a platform for entrepreneurial activity in a range of areas and sufficient income levels to generate investment in physical capital and technology necessary for new production relations.

The more important change, however, was the political one. The late Middle Ages also witnessed the start of a political process that inexorably led to the collapse of abso­lutist monarchies and to the rise of constitutional regimes. The constitutional regimes that emerged in the 16th and 17th centuries in Western Europe were the first examples of par­ticipatory regimes, because they shifted political power to a large group of individuals that were previously “outsiders” to political power, including the gentry, small merchants, proto­industrialists as well as overseas traders and financiers (Section 23.3 in Chapter 23). These regimes then provided secure property rights and growth-enhancing institutions for a broad cross-section of society. These institutional changes created the environment necessary for new investments and technological changes and the beginning of sustained growth, which would culminate in the Commercial Revolution in the Netherlands and Britain during the 17th century and in the British Industrial Revolution at the end of the 18th century. By 19th century, industry and commerce had spread to much of Western Europe (North and Thomas, 1973, Chapter 4).

It is noteworthy to emphasize that constitutional monarchies were not democracies as we understand them today. There was no one-person one-vote and the distinction between the rich and the poor was quite palpable. Nevertheless, these regimes where responses to the demands by the merchants, industrialists, and those with the resources who wished to participate in economic activity. More importantly, these constitutional regimes not only reformed the political institutions of Western Europe, but undertook a series of economic reforms facilitating modern capitalist growth. Internal tariffs and regulations were lifted. Entry into domestic businesses and foreign trade was greatly facilitated. With the founding of the Bank of England and other financial reforms, the process of financial development got underway.

These constitutional regimes that emerged, first in Britain and the Netherlands, then in France and other parts of Western Europe, paved the way for sustained economic growth based on property rights for a broad cross-section of society, investment in contract enforce­ment, law and order, and infrastructure, and free entry into existing and new business lines. According to the theoretical perspective developed in earlier chapters, these improved condi­tions should have led to greater investments in physical capital, human capital and technology (Chapters 4 and 22). This is indeed what happened and the process of modern economic growth, unprecedented for the world economy, started. Economic relations now relied on new businesses investing in industry and commerce and on the formation of complex organi­zational form and production relations. Growth did not immediately accelerate. Economic growth was present but modest during the 17th and 18th centuries (Maddison, 2001). But these institutional changes laid the foundations of the more rapid growth that was soon to come. Financial institutions developed, the urban areas expanded further, new technolo­gies were invented, and markets became the primary arena for transactions and competition (North and Thomas, 1973). By 1800, the process of technological change and investment had progressed enough that many historians now viewed this as the beginning of the Industrial Revolution (Ashton, 1968, Mokyr, 1989). The first phase of the Industrial Revolution was followed by the production of yet newer technologies, more complex organizations, greater reliance on skills and human capital in the production process and increasing globalization of the world economy. By the second half of the 19th century, Western Europe had reached growth levels that were unprecedented.

Naturally, a complete answer to the question above requires an explanation for why the constitutional regimes that were so important for modern economic growth emerged in West­ern Europe starting in the late 16th and 17th centuries. These institutions had their roots in the late medieval aristocratic parliaments in Europe, but more importantly, they were the outcome of radical reform resulting from the change in the political balance of power in Europe starting in the 16th century (Ertman, 1997). The 16th century witnessed a ma­jor economic transformation of Europe following the increase in international trade due to the discovery of the New World and the rounding of the Cape of Good Hope (Davis, 1973, Acemoglu, Johnson and Robinson, 2005a). Together with increased overseas trade came greater commercial activity within Europe. These changes led to a modest increase in living standards and more importantly, increased economic and political power of a new group of merchants, traders and industrialists. These new men were not the traditional allies of the European monarchies. They therefore demanded, and often were powerful enough to obtain, changes in political institutions that provided them with greater security of property rights

and state action to help them in their economic endeavors. By this time, with the collapse of the feudal order, the foundations of the authoritarian regimes that were in place in the the Middle Ages were already weak. Nevertheless, the changes leading to the constitutional regimes did not come easy. The Dutch had to fight the Hapsburg monarchy to gain their independence as a republic. Britain had to endure the Civil War and the Glorious Revolu­tion. France had to go through the Revolution of 1789 (Acemoglu, Johnson and Robinson, 2005a). But in all cases, the ancien regime gave way to more representative institutions, with greater checks on absolute power and greater participation by merchants, industrialists and entrepreneurs. It was important that the social changes led to a new set of political institutions, not simply to concessions. This is related to the theoretical ideas emphasized in Chapter 23; the nascent groups demanded long-term guarantees for the protection of their property rights and their participation in economic life, and this was most easily delivered by changes in political institutions, not by short-term concessions.

These changes created the set of political institutions that would then enable the creation of the economic institutions mentioned above. The collapse of the authoritarian political regimes and the rise of the first participatory regimes then opened the way for modern economic growth.

Why did some societies manage to benefit from the new technologies while others failed? The economic takeoff started in Western Europe, but quickly spread to cer­tain other parts of the world. The chief importer of economic institutions and economic growth was the United States. The United States already had participatory political insti­tutions, founded by settler colonists, who had just defeated the British crown to gain their independence and set up a smallholder society. This was a society built by the people who would live in it, and they were particularly keen on creating checks and balances to prevent a strong political or economic elite. This environment turned out to be a perfect conduit for modern economic growth. The lack of a strong political and economic elite meant that a broad cross-section of society could take part in economic activity, import technologies from Western Europe and then build their own technologies to quickly become the major industrial power in the world (Galenson, 1996, Engerman and Sokoloff, 1997, Keyssar, 2000, Acemoglu, Johnson and Robinson, 2002). In the context of this example, the importance of technology adoption from the world technology frontier is in line with the emphasis in Chapter 18, while the growth-promoting effects of a lack of elite creating entry barriers is consistent with the approach in Section 23.3 in Chapter 23.

Similar processes took place in other West European offshoots, for example, in Canada. Yet in other parts of the world, adoption of new technologies and the process of economic growth came as part of a movement towards defensive modernization. Japan started its 1109

economic and political modernization with the Meiji restoration (or perhaps even before) and a central element of this modernization effort was the importation of new technologies.

But these attitudes to new technologies were by no means universal. New technologies were not adopted, they were in fact resisted, in many parts of the world. This included most of Eastern Europe, for example Russia and Austria-Hungary, where the existing land­based elites saw the technologies as a threat both to their economic interests, because they would lead to the end of the feudal relations that still continued in this part of Europe, and to their political interests, which relied on limiting the power of new merchants and slowing down the process of peasants migrating to cities to become the new working class (see Freudenberger, 1967, and Mosse, 1992, for evidence and Chapter 22 for a theoretical perspective). Similarly, the previously-prosperous plantation economies in the Caribbean had no interest in introducing new technologies and allowing free entry by entrepreneurs. These societies continued to rely on their agricultural staples; industrialization, competition in free labor markets and workers investing in their human capital were seen as potential threats to the economic and political powers of the elite. The newly independent nations in Latin America were also dominated by a political elite, which continued the tradition of the colonial elites and showed little interest in industrialization. Much of South East Asia, the Indian subcontinent, and almost all of sub-Saharan Africa were still West European colonies, and were run under authoritarian and repressive regimes (often as producers of raw materials for the rapidly industrializing West European nations or as sources of tribute income). Free labor markets, factor mobility, entrepreneurial spirit, creative destruction and new technologies did not feature in the colonial political trajectories of these countries (Chapter 4).

Thus the 19th century, the age of industrialization, was only to see the industrialization of a few select places. Modern economic growth did not start in much of the world until early 20th century. By the 20th century, however, more and more nations that started importing some of the technologies that had been developed and used in Western Europe. The process of technology transfer pulling all of the countries integrated in the global economy towards greater income levels, as emphasized and studied in Chapter 19, thus started by the 20th century, but still not for all nations. Many more had to wait for their independence from their colonial masters, and even then, the end of colonialism led to a period of instability and infighting among would-be elites. Once some degree of political stability was achieved and economic institutions that encourage growth were put in place, growth started. For example, growth in Australia and New Zealand was followed by Hong Kong, then by South Korea, then by the rest of South Asia and finally by India. In each of these cases, as emphasized in Chapters 20 and 21, growth went hand-in-hand with structural transformations. Once the structural transformations were under way, they facilitated further growth. Consistent with the picture in Chapter 19, societies integrated into the global economy started importing technologies and achieved average growth rates in line with the growth of the world technology frontier (and often exceeding those during their initial phase of catch-up). In most cases, this meant growth for the new members of the global economy, but not necessarily the disappearance of the income gap between these new members and the earlier industrializers.

In the meantime, many parts of the world continued to suffer political instability dis­couraging investment in capital and new technology, or even exhibited overt hostility to new technologies. These included parts of sub-Saharan Africa and until recently much of Central America. Returning to some of the examples discussed in Chapter 1, Nigeria and Guatemala, for example, failed to create incentives for its entrepreneurs or workers both during its colonial period and after independence. Both of these countries also experienced significant political instability and economically disastrous civil wars in the postwar era (recall the discussion of the implications of political instability in Chapter 23). Brazil managed to achieve some degree of growth, but this was mostly based on investment by large, heavily protected corporations and not on a sustained process of technological change and creative destruction (thus more similar to the oligarchic growth in terms of the model of Section 23.3 in Chapter 23). In these cases and others, policies that failed to provide secure property rights to new entrepreneurs and those that blocked the adoption of new technologies, as well as political instability and infighting among the elites, seem to have played an important role in the failure to join the world economy and its growth process. Overall, these areas fell behind the world average in the 19th century and continued to do so for most of the 20th century. Many nations in sub-Saharan Africa, such as Congo, Liberia, Sudan and Zimbabwe, are still amidst political turmoil and fail to offer even the most basic security of property rights to their entrepreneurs. Consequently, many are still falling further behind the world average.

24.3.