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Horrel, UK before wars, did victorian economy fail, capital exports

Were USA and Germany overtaking UK or were they catching up, by copying the system. Figures show that USA passed in 1880 GDP per capita, but Germany was not overtaking.

It may apply that other countries had more natural resources, or was there something wrong with the UK economy.

Was it:

1.   Complacency (failing)

2.   Limited resources

Growth accounting methods. In indrev we were looking at the changes in the technology that could improve efficiciency. In late victorians we also look at econmise of scale, better organisation of labour and production, production utilisation (shifts), increase int he factory production.

Mathew, Smee looked at the Britain growth of efficiency.

Growth acconting methods - explain growth in output, by looking at growth in inputs (LCLand, weigthed by their shares in national income). Any unexplained growth, r*, shows the growth of  efficiency. Q/Q=(K/K)+(L/L)+(T/T)+r*

The results they get are undebatable, they give the answer. Victorian Britain was suffering, there was a failure case.


1.      Measuring the output-declining older sectors and expanding new ones.

2.      Shifft from the family (self provisioning) and more is done in the market. Appears as a growth

3.      Change in quality

4.      errors will magnify the growth

5.      measuring labour is not accurate (hours of work, duality - more or less skilled, education). They are more important in victoiran era than in indrev

6.      Capital - how much is new and how much is replacement. How much is new technology

7.      alfa beeta, the shares are not easily measured

It assumes

1.      Capital and albour are homogeneous

2.      Markets are competitive and firms are profit maximisers

3.      Cobb-Douglas production function is the basis of equation. We ignore land, T. It assumes constant returns to scale

4.      Technical progress appears in r*, not capital


Anyway these does not devalidate the method.


Matthews found that:

They used 3 periods 1856-1873-1913, and looked aat GDP growth and GDP pere man. Both decline. Both decline after 1899.

Feinstein looked at the late victorian era of other industrial countrys. France, Italy, Japan, USA, Germany. Only Italy and Japan have lower growth rates before 1899, after that their productivity performance overtakes britain

There is evidence that other countries growth rates are converging, but Britain is diverging, because the output is not growing that fast.


1.   Labour

a.   Quantity

i.    Population - is increasing. People are living longer

ii.    Participation - not much altered

iii.   Unemployment - in unskilled higher unemployment and less in unionised skilled. So data is biased. There is not much changing, although Germany and USA have lower unempployment.

iv.  Hours of work falling - 1856 - 65h, 78 - 56h per week and after that static

Consequence - Labour force in the first period is not growing. On the second period is growing as fast as population.

b.   Quality

i.    Age sex distribution depends. More women, young - less quality. Less young people, so quality rises. Also proportion of Irish falls, so quality of labour force rises again, because lots of people emmigrate elsewhere. Imrovement is average 0.25% per annum.

ii.    Intensity of work - as working week is reduced quality increases. So intensity is increased. Employers will find ways for people to work harder. So the fall in the hours of work is completely ofset by the labour intensity and quality in the first period.

iii.   Education and training - very little knowledge and education. Less 1% going to university. Compulsory (primary) education up to 14 years. SO average amount increases. 0.3% growth in the first and 0.5% in the second

So quality causes most of the growth.

Proportion of salaries rises.

2.   Capital

There is a lot of work done, but she didnt go into.

Investment - 20 years cycles, peaks in 1877, 1900, down in 1886, 1914. ).9% per annum.

Property income abroad falls. Profits are stable, 25% of GDP.

Calculations for total factor productivity show only quantity. So productivity falls and is low. If you adjust this to quality there is no growth in productivity. This shows a serious problem. Most of the problem occurs in 1899-1913.

Failings occur in following sectors:

Based onthe output measure of GDP, which does nto show such a dramatic fall as income methods

Most of the sectors are doing badly. Specially

1.      Aggriculture

2.      Construction

Only transport and gas are doing well. Manufacturing is doing no worse than the average. 1899-1913 only 0.1% growth in productivity. It are actually falling in some sectors (wasting resources). So growth from inputs was actually higher than from the total factor productivity (TFP). Other countries and times I<TFP.

Productivity grows 1.6% in USA (0.5% in UK)

Vider view: Mccloskey said that evidence of other countries catching up is not evidence of failure, little utilisation of resources would be (next lecture).

Most thought there was a failure case. That made McCloskey suspicious. He thought that:

1.   Slugish home demand

2.   Too much money invested abroad

3.   Poor productivity due to inert entrepreneurship

Mccloskey tested these by using

1.   growth of output

2.   constraint of supply side factors (growth of capital and labour)


deficient demand=constraint of factor input+ (entrepreneurship+technology+ ingenuity(occasional inventions) +efficiency)

We want efficiency and get it by comparing different countries, you can net out ingenuity as all economies copy the invention.

He finds

1.      Sluggish demand - export demand decreased in the UK. If export would have remained the same as 1850-1873 then the rowth rates would have remained the same - growth rate of 3.71% instead of 1.69%. But Mccolskey said then there should be high rates of unemployed. There is little evidence. So Victorian economy is in full employment, so the constraint is the supply, not demand. To test this he used counterfactorial. If economy were to have this growth rate then labour must have double to 1907(little left in aggriculture, large emmigration abroad). Capital growth must be 6% (4x the actual). 42% of engilshmen incomes must have been saved. He assumed capital and labour are insubstitutable.

2.      Too much capital abroad. In order to assume that brittain would have been better off with capital left home,

1.      the investors must be rational - Investors could have got 10% at home, however he sent this money abroad to get 5%. So investors are irrational. McCloskey points of that this is not true. If you take risk into account (UK riskier) then returns are equal.

2.      no capital market bias. Investors are thus maximising national income (maximising their returns) - Mccolskey found no evidence of City being biased, but he does not produce much evidence.

You also need to show that there were places it could have been invested. In total you would have increased GDP 7.3% , which is not signifficant

3.      Total factor productivity - he looks at usa and found little work is done. 1-15,% in USA

So he thinks there is no failure, this growth rate was plausible. Edwardian economy did fail a bit, though. But McColskey asked whether 3.71 % is plausible. This is unreasonable. But if he would have asked if the economy coul have grown faster, the answer would have been yes.

Critics for McCloskey

1.      Methology used - growth accounting quite robbust. It assumes constant returns to scale and that the markets are competitive. This was not quite true for UK. Many industries had increasing returns and competitions was getting imperfect (oligopolies) and consentrated. If you take these into account then there could be failure.

2.      Is he right about no spare capacity and underutilised labour. Higher growth would mean higher education and research that would feed the growth. Unemployment, according to  Matthew, is high among unskilled (McCloskey used union data, so ignored unskilled). Also emmigration occured because no opportunities existed at home. McColskey said emmigration not important, only labour growth from 1 to 1.6%. But this is important, 1.6% would have given half the growth of labour needed.

3.      Capital markets are biased by Crafts. By 1911 more investment would have increased GDP per head by 25%. There were higher rates at home.

4.      Counterfactual arguments against - Craft points out that other countries should grow faster, but can't explain why Brittain does not develop modern industries (electricity).


Free trade

1.   backround was the revenue needed etc during indrev

2.   already were arguments for free trade from adam smith (lower prices, efficient allocations)

3.   1841-2 worst depression of century. Manufactures attacked protectionism and argued they can be better without.

4.   1846 Repeal of the corn law. 1849 navigation act repeal. 1860 free treaty with france

Other countries after initial free trade put up trade barriers. Germany was first. UK never put up tarifs agains.

Was free trade boosting exports

1.      Volume of exports is only a bit faster than during the indrev

2.      However the value of them goes up considerabley

3.      Growth of exports to europe but that could have happened anyway, because exports were coal etc and other growing economise would have wanted them anyway

4.      It did stimulate the domestic industry because food prices fell. UK was importing half of the food, consumers had more money for manufacturing

By 1880 manufactures realisse that free trade was not so beneficial to them.

1903 Joseph Chamberlain's Fair Trade Campaign for protectionism

Did free trade benefit (McCloskey)

1.      Terms of trade deteriorated (optimal tariff would have been moore beneficial)

2.      But maximum 4% of GDP lost trough the free trade

3.      Reduced reliance on aggriculture and more industry

Pattern of trade

1.      in 1846-1873 volume & value of exports are growing 5% a year. Very high.

2.      Metal goods and textiles retain their share. Things like machinery are also featuring.

3.      A lot to europe and to australia

4.      exports nearly 25% and 40% of total world export from brittain

5.      after 1873 value starts to stagnate as primary goods prices are reduced.Countries exporting raw had less moeny to demand british industrial goods.

6.      Complex pattern of trade with multilateral setlements

7.      Britain running an increasin deficit, not a very big problem

8.      Export was not paying for the imports. IndRev surplus may be, old story. Invisible earnings. At the end of the period even invisible is not covering. Now intersst and profit from capital invested abroad is paying.

Britain trade performance was poor because

1.      UK relyies on sof markets not developing new

2.      or exploiting comparative advantage (UK had in ld staples, USA in new industries)

3.      failure of entrepreneurs

Industrial countries balanceid their deficit by surplus with UK

Exports leading to decline

Capital exports

Either to economies

1.   Complementary - loand come back as demand for British goods, but in Edwardian economy link was not as strong anymore

2.   Competing

They were worth while. If yield is higher abroad that benefits the home country. There was probably no use for the investnement at home.

To show that capital markets failed

1.      Investors irrational - rational investors get highest returns on their investment. WE need to look at the rates of rreturn. Risk is problematic - high defaulting rates in abroad. There werent many more banrupcies in abroad than in the UK. Rate of return in UK 4.6%, in abroad 5,7%.Variation in asset pricees. Variations were also equal.  But if investors are rational, then why are the rates not equalised. If we look at the profitability of firms of home, empire and foreign. Depending on what time period you use one can prove anything. Wave llike movements show that investors are ratioonal (when returns higher investment increases).Profitability of firms wer 13% empire, 10.8% domestic and 9,4% foreign but 1880 onwards domestic 9% empire 7%. But when a default happened at home you keep the asset, but not so in abroad. Rates of returns to the society could thus be much hogher for home investment.

2.      Capital market bias

1.      How much were they biased - Bankers may not have provided adequate info about investing home. But industry was avoiding city as well. Looking at joint stock companies - only 6% issued prospectives, only 2% quoted on thhe stock exchange. But this could have just been specialisation.

2.      If they were, did it matter - little spare capacity at home. But there was unemployment, this  is doubtfull.Very small % of foreign investment could have wiped the employment.. Unemployment tends to follow or.investment cycles.

3.      Do private and social interest coincide

4.      Was there any profitable use for the capital at home

5.      What happens to the BoP (high inflows of Profits ID for the economy)

Most investment went into railways. Then government bonds and some to public utilities. Very little to manufacture It opens up  foreign counttries (food prices go down).Half of the investment was in the empire. There were high fluctuations in the foreign investment and occasionaly excceeded domestiv investment. 

1840 investment intorailways

1850 Indian railways with guaranteed 5% return.

1860 Argentina until

1890 Baring crises

1900 Canada and Australia

Push versus pull effects on investment

1.      Push factor - high levels of wealth and no profitable investment at home. Up to 1890 the psuh factors were dominating the investment to USA. After 1880 it is not so evident.

2.      Pull - very profitable investment abroad.. This may starve domestic investment. Quite a lot of writters have pointed out that pull was more important. Other countries have investment possibilities, so that it is unlikely they developed when Britain had excess wealth, so push factors unlikely. Pull factors dominated in Argentina. Even thouhg pull factors were not neccessary detremental to the economy.

Did foreign investment pay for the nation as well

Ie Indian government guaranteed loans, causing to much investment to go there and thus return for the nation was less than 5%.

Defence investment was very big to foreign countries and British subsidised that. Empire countries could thus have less tax, and firms had higher profits.

In Britain 1pound32 was paid per cappita for defence, other countries only 35p.

Net return from the empire investment

Minimum social costs=(British defence-other developed defence)/value of british investment.

If you include other subsidies it is two times.

In defence is accounted the return on investment in empire is 1-3% lower than nominal, so investment in empire is not worthwhile. So private and national interests do not coincide.

The reason is that tax payers and investors are different. Investors are only higher class, whereas tax payers also include middle class and industrialists.

We do not know how much the investment of 4 billion was in excess, we only no it was too much, but not how much more.

Potential harmful effects on interest profits dividends

By 1913 Britain is a net capital importer- dividends are higher than outward investment.

Britain had a very strong blance of payments. UK was earning a surplus in invisibles, and invisibles were growing. Britain couldnt run a large bop surplus, because it would create a shortage of sterling as most of the foresign trade is in sterling

Also surplus was going to provide problems in visible trade. Briatin was on gold standard - exchange rate couldnt change. So if exchange rate couldnt change then prices will go up and Britains exports become less competitive.

Two things aagainst that:

1.      Britain was probably in deficit in invisibles. SO profits for investment must have come from something else

2.      There is no evidence on prices causing negaitve effects and rising

Second effect besides price is the absorption effect(income effect)

Britain is earnings are high and can spend more that is produced locally.

You either have to reduce exports or increase imports - britain did the later.

Briitain could live only on its wealth - rentier economy.

One have to be caeful to deal with the wroong signals to manufacture, because people saw that and tried to hel (investment inhuman capital and R&D).

Britain did not have to have a strong industrial base before first world war.

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