This question is about the relative decline of British economy when compared to Germany and USA in the late 19th century. It is true that the British economy grew slower than her competitors at the end of the 18th century and at the beginning of the 19th century. British economy did grow with the rate comparable to the previous periods, but competitor economies were growing faster. But Britain's trade cycle was more violent and it had more unemployment at later years, so it was not only the growth that counted for the suggestion of the UK failure. Several reasons have been suggested for this decline. Most writers, with the notable exception of McCloskey, thought that there was something inherent about the British economy, that it was not only the foreign industrials that were copying and catching up, or the insufficiency of demand, that there was something wrong with the British industry.
First criticisms on British industry were not based on very strong empirical evidence at all. Most of them could be accused of data mining or for using individual examples of failures, that had become famous, and automatically assuming these failures were common to the whole economy (aggregating failures). In 1902 McKenzie said: "In spite of all recent warnings, there is a solid conservatism which seems irremovable. Even great houses ... decline to look into new improvements." So basically there was thought to be little technical change. This led to inefficient and obsolete production techniques. Several reasons have been put forwards, most notably the lack of entrepreneurship by British entrepreneurs, lack of scientific education for British students and the difficulties to obtain finance for small scale or new industries in the City, mainly because of its short-termism and bias towards overseas investment.
I shall start with the entrepreneurship, and with some examples of failing to adopt to new technologies, which resulted in Britain importing too much and not exporting enough. It was thought that steel industry in the UK was using wrong types of technology, which required British firms to import iron ore that was free from phosphoric contamination, but more expensive. The Liverpool's ore was left unused. At the same time competitors were using Bessemer acidic process that lead to lower average costs. But surely if the absolute costs of production (mainly the variable ones) were that much higher then, given that there was free trade, the British steel industry should have bankrupted. In fact it only grew slower. So there must be other explanations for not using acidic process. One reason was the need to invent slag removal technique for Liverpool ore and when it was invented by Talbot in 1890 change occurred to new technology. Also Britain had accumulated a large capital and concentration in steel, so it would have been irrational to discard the machinery while it was still useable.
Many accusations that entrepreneurs were with short term views were thrown. They were said to refuse the use of new technology when it was not immediately profitable, compared with "passionate" USA and Germany businessmen who had technical education and were invention prone. So British industry became uncompetitive in export markets. But again one can find several examples of this behaviours (United alkali retaining Leblanc process, cotton spinning used mule process and coal did not introduce mechanical cutting), but these can be justified (coal having geological constraints, and cotton having abundance of skilled workers that made mule more attractive) or did not matter much in aggregates (the whole chemical industry lost only £0.9-£1.9m between 1890-1914, so it was relatively small industry). But these numerous examples do not tell anything about the aggregates, so this evidence is not very strong.
Another bit of evidence is the reluctance to introduce mass production and thus economies of scale were not used. Firms had too many technical specifications. It is argued that Britain should have adopted more capital intensive production techniques of mass production as it had abundant capital. But the UK also had an abundance of skilled workers that mass production was designed to replace. And the law was inhibiting the limited liability needed for large scale production during most part of the 19th century. So it was not only the entrepreneurs who did not want to grow larger. Much more important was the extensive links that the businesses had back to the family which led to over-conservative policies. This had the advantage of unifying control and ownership, but financing (as I later show) was much harder to obtain. When industries did grow, they had very large boards of directors of the individual factories that had unified. So the momentum of change was very low and management ineffective. Most of the investment was still just to replace the old technology, so despite new ring-spinning technology was introduced in textiles, still British firms bought 3/4 of their new machinery for mule-spinning, but they did it for partially other reasons than customs (better quality cotton produces etc.).
Wiener has a thesis that the entrepreneurship failed because leaders had elitist attitudes towards industry. But Rubenstein has pointed out that this reasoning does not explain the attitudes in industrial towns and the rational preferences for services. There is also a pretty doubtful idea about third generation industrialists (grandsons inheriting firms) taking over and not caring about the firm and taking as much money out of them as possible. But there were successful 3rd generation firms like Lipton and only about 17% of the firms remained in existence until the third generation. So in general empirical evidence, mainly found by McCloskey, does not support the rather logical blame to the top people for the industrial failing. Furthermore the records of the firms that have survived are strongly biased, as they are predominantly of those concerns that "were sufficiently successful to have created conditions favourable for untypical longevity."(Payne) Yet another problem of measuring the missed opportunities is the absence of any model economy during the Victorian period, with which UK economy could be compared to. It was much easier to compare the performance of Germany against Britain, but not vice-versa.
Firms were also arguably too complacent with their current position. They could easily manage to survive with existing clients, although with inefficient techniques, as the demand existed. This was especially true before 1870 when international competition in heavy industries had not developed. But other countries allowed it to develop under increasingly protective conditions, so soon this complacency hurt English entrepreneur strongly by decreasing export. The extensive product differentiation had similar effects - ineffective firms could survive for much longer if their good was branded.
Similar empirical evidence can be used to find evidence on the thesis that Britain was stuck with the old and obsolete technology. Here the conclusion is similar to the old industries - yes they were using older technology, but that was rational and cost effective at the time, because the initial investment was done. But new industries, like electricity, were also not developed during the time. Most notable being the electricity that was invented a long time ago. Edelstain points out that the electricity supply is hindered by the existence of effective gas monopolies and the absence of regulation of uniform voltage. This decreased the possibilities for a strong electrical industry to emerge. This can definitely be accounted as a penalty for an early start with much empirical evidence.
Education is another issue. Britain had traditionally strong grammar schools and universities, but science was not a subject they taught. Britain did not have the need for education during industrial revolution, but the need arose in the Victorian economy as new developments were needed in chemistry and in other new industries. Germany wanted to catch up with England, so much state expenditure went to education and for developing direct links between industry and education. People noticed that in 1852 World Exhibition England excelled, but in 1872 UK had only 10 of 90 marks of excellence in different categories. Individual industries failed a lot because little education about managerial techniques and industrial processes. Companies were largely joint stock with unlimited liability, so it was hard to involve a managerially educated person into the running of the firm without him bearing any risks. UK had many inventions, but people did not start using them in practice. Innovations by entrepreneurs, that had been abundant in industrial revolution, were missing now.
Several commissions were set up to look at education. They found numerous faults. Primary education was poor, grammar schools concentrated on classics. Nobody studied industry in University and there was little compulsory education. So to cure that failing, primary education was made compulsory in 1870 and public schools were made to teach science and build laboratories. Developments also occurred in the City. Firms put money into education and established central exams, technical schools and colleges and introduced teacher grants. But this was not much help. Main experience was acquired in work and there were still number of closed shops restricting the number of apprentices taken. Germany at the time also had pure grammar schools. But it also had real schools teaching science. 1859 nine year science schools and thus German entrepreneur was much more scientifically educated. Employers were not investing to education and were not aware of the benefits of R&D. That might be reasonable, because they thought others will benefit from their investment to education, it was much cheaper to watch and copy the other industry. But there was no link between the success of industry and availability of education. Furthermore the service income grew steadily and tertiary sector did not need that much scientific education.
Third point I like to make is about the availability of capital to new industries and the possibility of stock market floatation. First let me look at the assumption that too much capital went abroad. So I am now dealing with the supply side of capital - writers have suggested that it was not sufficient.
In order to assume that Britain would have been better off with capital left home the investment decision abroad must have been irrational. If investors could have got 10% at home, however he sent this money abroad to get 5% they would have been irrational. McCloskey points of that this is not true. If you take risk into account then returns are equal. Investment in UK was riskier, the returns abroad were safer with for example India guaranteeing 5% return on railways. McCloskey also found no evidence of City being biased towards home industry, but he does not produce much evidence. That means investors were not favouring investment abroad just for the sake of it, as some writers suggest, they ware thus maximising national income by maximising their returns in investing abroad. Craft, however, points out that capital markets were biased. By 1911 more investment would have increased GDP per head by 25%. The evidence in this point is not very good, there are different statistics available and it is very hard to judge the actual risk. There were not many more bankruptcies in abroad than in the UK. Rate of return in UK 4.6%, in abroad 5,7%. Variations in asset prices 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, then depending on what time period is used one can prove anything. It is true that wave like movements show that investors are rational, when rates of returns grow abroad investment follows. Profitability of firms was 13% empire, 10.8% domestic and 9,4% foreign before 1880, but 1880 onwards domestic 9% empire 7%. So these figures are widely fluctuating, non predictable and it is hard to draw any conclusions. But when a default happens at home nation can keep the asset, but not so in abroad. Rates of returns to the society could thus be much higher for home investment. About capital market bias, bankers might not have provided adequate information about investing home. Britain had a complex bank structure. There were many small private banks. Joint stock banks were allowed in 1824 and banks started to get larger, especially when limited liability was allowed. By 1914 there were only 3 big banks that controlled most of the banking. But did these banks provide the funds needed in industry? Answer compared to Germany is not very much. Banking ethos was that you should get your money back immediately so they were not involved in long-term loaning. On the other hand many bankers were local and gave overdrafts to local industrialists long term. In 1850's banks move away from the industry. By the Edwardian period banks were abstaining from the industry altogether as banks' head offices were in London and thus their lending policies became cautious and inflexible. But there is evidence of industry avoiding the City as well. Looking at joint stock companies - only 6% issued prospectuses, only 2% quoted on the stock exchange. This leads me to the next point - the demand for investment. Was there sufficient demand for investment to maintain industrial growth?
In order to answer that one must show that there were places one could have invested money domestically. Clearly there were not as many opportunities as abroad. It is argued that there was little spare capacity at home. But as there was unemployment, this is doubtful. Very small percentage of foreign investment redirected to domestic uses could have wiped the unemployment. Smaller firms were difficult to get floated on the Stock Exchange because investment firms only floated million plus firms, commission was 6%, minimum 20 000 pounds. Medium size firms were expected to offer were very high returns short term that were detrimental to their health. But there were provincial stock exchanges as well that could have dealt with smaller firms. But they were not very effective and channel much investors money to London instead of investing it locally. Kennedy has investigated the neglecting of opportunities by the City and has found a lot of interesting evidence. Professional promoters, who were involved in marketing, were managing launches initially. Most of the money went to promoters or initial owners. So industrial launch was very risky business and City learned by experience and did not invest domestically anymore.
Same was not true for Germany, mainly because of the investment banks that were allowing much closer links between firms and finances and helped to run the business. They overcame informational asymmetries, because they had technical expertise and usually had long-term relationship with firms. Same things happen to USA as well. But investment banks accounted only for 25% of the total assets, so were not very important and there were other disadvantages. Also if Britain would have wanted they could have used German investment banks.
So clearly Britain grew slower than its competitors. Partly because decreased demand for British products and other exogenous factors, but partly because of endogenous failings, mainly the inability to develop new industries and inflexibilities in leading the industry. Early start was not that much of a real penalty. It exaggerated statistics on productivity and economic growth decrease as productivity and GDP were historically high and thus could not grow much further without any extra inventions. There were also some location problems for industry (like shipyards) pointed out by Saul that were a reminder of old days. There is also some weak evidence to suggest that entrepreneurs were too complacent, because they had used to the old good times.
Much more of a failure was the persistence in set ways, witch could be extended to include too high specialisation in export markets (McCloskey) and low marketing efforts there. Structure of industries was also of the old style - when firms grew they just multiplied themselves and did not adopt new leadership strategies. Education problems, old machinery problems and reluctance to new industries were also failings classified under this heading. So there is a case of endogenous failure to be answered, although not as big as was thought at the beginning of this century. Failing is not that big because Britain was developing services and remained dominant in major key industries (steel and textiles) and when using a comparative advantage theory there was no apparent reason for Britain to develop an advantage in new industries when it already had an advantage in old industries.
This question is hard to answer due to lack of empirical work and the suggested reasons offered in this essay are likely to change in the near future when more research is done.