Category Archives: Economics

England and the only bootstrapped Industrial Revolution

Of all the social changes which have occurred in human  history, none has been so profound as the process of  industrialisation. The two previous great general amendments  to human life – farming and urbanisation – pale into  insignificance. Before industrialisation, man lived primarily from the land and animals whether from farming, husbandry or  hunter-gathering. Even in the most advanced civilisations, the vast majority of populations lived outside large towns and cities. In England, the most advanced state, a majority of the population derived their living directly from the land as late as the 1830s. France did not become a predominantly urban nation until the 1930s.

With industrialisation came not merely a change in the material circumstances, but profound social alteration. There  arose vastly greater opportunity to move from the small world of the village. The massive increase in wealth  eventually made even the poor rich enough to have aspirations. Sufficient numbers of the wealthier classes  became guilty enough about abject poverty existing beside great wealth that the condition of the poor was further  mitigated by greater educational opportunity, welfare provision and legislation regulating the abuse of workers by employers. Political horizons were expanded by the extension  of the franchise.

The industrial revolution altered the balance of power throughout the world. David Landes “In the wealth and Poverty of Nations” describes the effect succinctly: “The industrial revolution made some countries richer, others (relatively)  poorer; or more accurately, some countries made an industrial revolution and became rich; and others did not and stayed  poor.” (p168). Prior to industrialisation, the disparity in wealth between states, regions and even continents was relatively  small. Come the Industrial Revolution and massive disparities begin to appear. For Dr Landes, it is to the success or otherwise in industrialising which is the primary cause of  present disparities in national wealth.

All of this tremendous amendment to human existence occurred because the one and only bootstrapped Industrial Revolution took place in England. Indeed, without England the world might have had no Industrial Revolution. Those who would scoff at such a proposition should consider the cold facts:  even with England and Britain’s example to follow no other nation matched her industrial development until the 1870′s and then the first country to do so was a state ultimately derived from England, namely the USA. Moreover, England and eventually Britain did not merely produce an industrial revolution, they actively exported and financed it throughout the world. For example, most of the European railway building of the years 1840-70 was the result of British engineers and money.

Some may point to scientific advance in Europe from 1600 onwards as reason to believe that industrialisation would  have been achieved without England. It is true that Europe advanced scientifically in the seventeenth and eighteenth  centuries, but scientific knowledge is no guarantee of technological progress. Moreover, a good deal of that scientific advance came from England. Nor does scientific knowledge have any natural connection with the severe social upheaval required for a transformation from the land dominated pre-industrial state to capitalism. Indeed, the  landowners of pre-industrial Europe had a vested interest in not promoting industrial advance. Moreover, in many parts of  Europe, particularly the East, feudal burdens became greater not less after 1500. This was so even in as advanced a  country as France. Consequently, the widespread social mobility which historians have generally thought necessary to promote a bootstrapped industrial revolution simply did not exist in Europe at the beginning of the British  Industrial revolution. Even the country most like England in its commercial development, the Netherlands, became socially and politically ossified in the Eighteenth century, with a bourgeoise developing into an aristocracy and representative government narrowed to what was in effect a parliament of nobles.

There will be those – Scots in particular – who will chafe at  the idea that the British industrial revolution was dependent upon England. The facts are against them.

Scotland before the union with England (1707) was a remarkably poor state. Nor, despite its much vaunted  educational system – supposedly much the superior of England – had it produced many men of international importance. Read  a general history of Europe, either old or modern, and you will find precious few Scots mentioned on their own account.  The names John Eringa and Duns Scotus with perhaps a nod to John Knox are the best the reader may hope for, and the former two had to leave Scotland to make their names. If any other Scotsman who lived before the union is mentioned, he will be noticed only because of his connection with another country, most commonly England. It required the union with England to give Scots a larger platform to act upon. Without  the union, the likes of David Hume, Adam Smith and even James Watt would in all probability have been roses which bloomed unseen in the desert air. That is not to decry the talents or contributions of Scots, which are considerable, merely to describe a necessary sociological condition for their full display.

Let us suppose that the union had never occurred. What then? All the evidence suggests that the first industrial  revolution would still have occurred when it did, perhaps slightly slower or with a different emphasis.

Let me demonstrate how much of an English enterprise the Industrial Revolution was by taking the Dragnet approach  (“Just the facts, Ma’am, just the facts”). Take steam power. It is the epitome of the industrial revolution. Contrary to  many a schoolboy’s imagining, James Watt did not invent the steam engine. That was the province of Englishmen, The  Marquess of Worcester may have produced a working steam engine on his estates in 1663. James Savery certainly did by 1698. This was improved by another Englishman, Thomas Newcomen. Their machines were crude beam engines, but the technological Rubicon had been crossed.

It is true that the Scotchman, Watt’s, improvements to the steam engine – the conversion of linear to rotary action and   the introduction of a separate condenser – were profoundly important and provided the means to extend the use of steam  engines from their limited applications in pumping water from mines. But it should be noted that he had to come to England to achieve his improvements through the patronage of an Englishman, Mathew Boulton, who in his Soho works in Birmingham had probably the best engineering facilities then in the world. Moreover, within a generation of Watt’s improvements, the English engineer, Richard Trevithick had greatly improved on Watt by producing a non-condensing high pressure steam engine,

But before steam could play its full role there had to be a revolution in iron production. This was accomplished by Englishmen. Until Abraham Darby began smelting iron with coke made from coal in the early 1700s, iron making was an  expensive and uncertain business carried on in small foundries using charcoal to fire the kilns (an ironmaker  named Dudley claimed to have used coal successfully for smelting as early as 1619 but died without establishing a  business to carry the work on). Compared with coal, charcoal was in short supply. Worse, it did not produce the same  intensity of heat as coal converted into coke. Darby and his son solved the basic problem of smelting with coke made from coal. Henry Cort’s puddling process allowed cast-iron to be refined to remove the brittleness. A little later Benjamin Huntsman improved steel making. In the middle of the next century the Bessemer revolutionised steel production to such a degree that its price fell dramatically enough to make steel no longer a luxury but the common material of construction. All these advances were made by Englishmen.

 If a ready and cheaper supply of iron was a necessary condition for the industrial revolution, so was the very idea  of large scale manufactories using machines. Undertakings employing hundreds of men on one site were not unknown before the 18th century – a clothier named Jack of Newbury had a factory employing 500 in Tudor times – but they very rare.  In 18th century England such enterprises became if not commonplace, at least not extraordinary. By the next century they were the norm. Industry became for the first time geared to a mass market. Nor was this new method of   manufacturing confined to the necessities and banalities of  life. Factories such as Josiah Wedgewood’s at Etruria manufactured high quality and imaginative china directed deliberately at the growing middle classes. All the most  successful 18 century machines for mass production were developed by Englishmen. Arkwright’s water frame, Crompton’s  mule, James Hargreaves spinning jenny.

Once the first blast of the industrial revolution had passed, the fundamental fine tuning was undertaken by Englishmen,  with men such as Whitworth leading the way with machine tools and new standards of exactness in measurement and industrial cutting and finishing. All very boring to most, but utterly essential for the foundation of a successful  industrial society.

Many vital industries since have originated in England. To take a few. George Stephenson produced the first practical  railway (the railway probably did more than anything to drive the Industrial Revolution because it allowed a true national market to operate within England), Brunel issued in the age of the ocean going steamship. William Perkins laid the foundation for a vast part of the chemical industry by discovering the first synthetic dye. The first electronic  computer was designed in Britain, after theoretical  conception by the Englishman, Alan Turing. In the previous  century another Englishman, Charles Babbage, designed but did not finished building the first programmable computer.

For much of the nineteenth century Britain remained utterly dominant as an industrial power in a way that no nation, not even the USA, has been since (the nearest approach was America’s position in the immediate post war years). To give an example: in the mid 19 century Britain produced two and a half times the iron produced in the rest of Europe. Even when Britain’s predominate position had gone she still dominated certain industries and trades massively. She built two thirds of the world’s shipping between 1890-1914 and possessed fifty per cent of the world’s carrying trade  between 1890-1914

Along side the development of manufacturing ran that of agriculture at which England became the leader during the  eighteenth century. The enclosure movement was already well advanced by 1700. By the middle of the nineteenth century  it was effectively finished. Not merely feudalism but the peasantry were gone. The old, inefficient open-field system was a dead letter. With enclosure came agricultural innovation. In the eighteenth century we have Jethro Tull,  whose seed drill greatly reduced the amount of seed needed for sowing, Robert Bakewell whose selective breeding  greatly increased the size of sheep and cattle and “Turmip” Townsend who greatly increased crop efficiency by various  means such as the marling of sandy soil. The importance of  such developments cannot be overestimated because the population of Britain rose so dramatically in the next century.

Why did the first Industrial Revolution occur in England and not elsewhere? The short answer is that no one knows. The explanations given by historians comprise a melange of social development, scientific discovery, legal development, political stability, geographical position, historical circumstances and commercial advance. But the problem is that any of the circumstances can be found in other countries. Obviously it was a confluence of developments which made England unusual. For myself, I give greatest weight to intangibles such as intellectual development, political maturity, legally enforced respect for private property and a sound system of money and credit for without those state underwritten assurances, it is difficult to see how human beings may begin to build the necessary structures for a sophisticated commercial and industrial system.

David Landes  sees the historical process of industrialisation as twofold. First,  comes a pre-industrial preparatory period in which irrationality of thought is gradually replaced by scientific method and what he calls “autonomy of intellectual inquiry” (p 219), that is,  thought divorced from unquestioned reliance on authority, irrationality, especially superstition. At the same time technology begins to be something more than by-guess-and-by-God. This gives birth to industrialisation by creating both the intellectual climate and the acquired  knowledge, both scientific and technological, necessary for the transformation from traditional to modern society. It is  as good a general explanation as any and fits the flow of England’s historical development.

Quantitative Easing 2

I initially planned to post this in November. However the economic outlook was confused at the time, typical of a turn in the economy, and since I wanted to encourage readers to make their own decision I decided to wait a couple of months.

The Bank of England helpfully provide a pamphlet to explain Quantitative Easing (Q.E.) http://www.bankofengland.co.uk/monetarypolicy/assetpurchases.htm#

In this the Bank explains that its approach to Q.E. is to purchase assets from private sector institutions, banks, pension funds, insurance companies and non-financial firms, for example. They do this to ensure that the risk of banks holding on to the money is ameliorated. If the Bank buys gilts from a commercial bank the money will end up as reserves of that bank and is capable of being lent on, subject to the bank’s desired reserve ratio. If the Bank buys its gilts from a non-financial firm or a pension fund the money will eventually end up in a deposit account in a bank, where it is available for lending on, subject to the bank’s required reserve ratio. The money supply effect will therefore be similar.

In its pamphlet the Bank describes it monitoring process. It will monitor

  1. The terms and conditions offered on loans?
  2. Are corporate debt markets easier for companies to borrow in?
  3. What is happening to asset prices (such as shares and house prices)?
  4. Are banks lending again?
  5. What is happening to the supply of money?
  6. Is household spending increasing?
  7. Is company expenditure increasing?
  8. What is trend in inflation?

Whilst the Central Bank is buying government securities and lowering the interest rate, the government, struggling to deal with reduced tax revenue as a result of the recession, will be selling government securities and finding it is helped by the central bank buying them in. This is called ‘monetizing’ the government’s debt.

In effect the government is printing money to buy its own debt. There is a risk that the government will become addicted to monetizing its debt, pimping its central bank to buy more and more. The classic case is, of course, Zimbabwe where things went so far that in the end the currency had to be junked. In truth many Central Banks are up to it.

But this is not the only economic stimulation in the UK. There is the matter of the governments deficit budget spending. Currently in excess of £175 bn in the current financial year this provides a huge stimulus. Moreover Prime Minister Gorden Brown is driven not by financial prudence, but by a constant concern for his image and by his reckless desire for reelection  at any cost, to anyone. As a result we are told that this stimulation will go on for years. This season should remind us that after the gifts of the kings there followed the slaughter of the innocents!

This gives the chancellor and the Bank three choices. The first is to stop or reverse Q.E. whilst continuing with the budgetary stimulus. The second is to continue or stop Q.E. whilst reducing the budget deficit by a material amount. The third is a mixture of the two. For example this could mean stopping Q.E. whilst making some adjustment to the deficit by increasing taxes generally or cutting government expenditure. A start on the latter has been made by the recent increase in VAT back to its original 17.5%.

If Q.E. is not reversed there are two key risks. The first is that there will be a large stock of bonds in the Bank’s hands “overhanging” the market. This is likely to lead to higher volatility and possibly higher interest rates as a result. The second risk is inflation, possibly severe inflation, and a return to a credit boom. The risk of cutting budgetary expenditure is increased unemployment and reduced demand in the economy.  It seems that you are dammed if you do and dammed if you don’t!

So, let us get back to basics and see what is happening to the eight indicators of the Bank of England.

  1. Loan terms. A recent report in the International Financial Review was entitled “From Famine to Feast – a review of the corporate bond market”. The bond markets were open for the entire investment grade spread
  2. In Europe certainly corporate borrowing appears easier.
  3. Asset prices are increasing
  4. Banks are lending but the government has had to increase its support for SMEs
  5. The liquidity preference of corporations and individuals is still high
  6. We have seen record retail spending this Christmas
  7. The trend of company expenditure is not yet clear.
  8. Inflation is increasing.

So, what should the Bank of England do? Is it time to reverse Q.E. or are the hints of the Chancellor, that there will be budget cuts, sufficient to dissuade them from this action?

Why not make your own choice and take part in the polls on the sidebar?

Next post will be on climate and weather and how the government and local authorities could have made better forecasts of the chance of cold weather than they appear to have done. There really is no place for the string of excuses we have been treated to!

Quantitative Easing 1

Quantitative Easing (QE). Now there’s a phrase to ruminate about. It was created by Dr Richard Werner, Professor of International Banking at the School of Management, University of Southampton. He used this phrase in order to propose a new form of monetary stimulation policy by the central bank that did not rely rely on traditional methods of stimulating the economy which appeared to have failed in Japan.

When you make a deposit into the bank, the bank will lend out that fraction of the deposit that will leave it with its desired or regulated reserve ratio. So if the reserve ratio is 10% the bank will lend out up to 90% or £90 out of every £100 you deposit.

The bank into which the £90 loan is deposited will in turn lend out 90% or £81 of this deposit. The money merrygoround continues until the banks have lent out £1000. Your £100 represents the 10% reserve ratio. This represents an increase in the money supply since all depositors can access the £1000. But if there are many hundreds of thousands of depositors the chance of this happening at the same time is very low, unless there is a run on the banks. Banks therefore depend on the average of all deposits and withdrawals  in a day netting out to almost zero.

This simple analysis is, in fact, not quite correct. If the £100 you deposit has been withdrawn from another UK bank then that bank will have had to reduce its loans setting up a merrygoround in the opposite direction. So in this case there will be no net change in deposits. For this reason it is possible to treat all UK banks as one when doing this sort of analysis.

The Money that comes from central banks, however, is new money. When it is deposited in a commercial bank it can be lent out and start the money merrygoround without any corresponding opposite reaction.

When a crisis hits the banks they have a problem of knowing which of the loans or investments they have made are sound. Because of this they will all decide to hold more cash, perhaps 30% more, so that their desired reserve ratio is now 40%. If the banks had £1000 of loans and £100 of cash they will now wish to call in any loans they can, like overdrafts, so that they now have £250 in loans and £100 in cash in order to meet their, new, desired reserve ratio. This 75% reduction in loans would, if allowed to happen, cause havoc in the economy.

The solution is to give the commercial banks sufficient money to stop this happening. In this case deposits would have to increase by £300 to have the desired effect. Now with £400 a loan base of £1000 can be supported.

To do this the Central Bank buys government securities and perhaps high grade corporate bonds from the banks using new money created for the purpose. This gives the banks more money, so allowing them to increase their deposits to the desired £400 required to stop the loan recalls.

Buying in the government securities from the banks causes their price to increase and this means that, happily, interest rates drop. Just what you want in a crisis!

If you now do nothing the crisis will abate and banks will now increase lending so as to get back to their 10% ratio. But they now hold £400 to act as reserves. This means that deposits, and hence money supply, will increase to £4000 compared to the original £1000. So much money going into the economy so quickly will lead to massive inflation. What can be done?

Well the central bank will now try to sell the securities and bonds back to the banks in return for the excess cash. The bankers will protest. After all they are lending to companies and people just as the government wanted them to. But, eventually, they will sell the securities back, not of course at the high price the central bank originally paid, but at a much lower price. This will give the banks a(nother) good profit and interest rates will as a result of the lower price go up, so helping to choke of any incipient inflation.

Of course the Central Bank must commence selling the securities back to the banks at the correct moment. Too early and any recession is extended, too late and rapid inflation occurs.

What could possibly go wrong? Next week the grizzly story!