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Phases in Economic Growth in a European Perspective, 1870-1995. Lennart Schön Department of Economic History Lund University [email protected] Paper for the conference “Economic Integration in Europe: New Directions in Swedish Research” in Mölle, May 23-26, 2000. Very preliminary paper – please do not quote!

Introduction This is mainly a discussion paper on some aspects of European growth from 1870 to the mid-1990s. In this paper, basic traits in two predominating theoretical approaches will be compared with a third perspective, derived from a structural analysis of growth as a historical process. Furthermore, the different perspectives will be discussed in relation to phases of European growth since 1870. The discussion leads to a proposal of a periodisation of growth in line with the structural analysis. The discussion draws mainly upon data that have been available internationally (Maddison 1995, Williamson 1995). It should be emphasised from the beginning, though, that “theory has run ahead of measurement, especially with regard to examining differences within the advanced countries”. (Crafts/Toniolo, 1996 p. 16) Three perspectives on growth In the last decade, perspectives on growth from two different branches of economic theory have had a decisive impact upon economic history – one perspective is focussed on the mechanisms of convergence and the other on growth as an endogenous process. These two strands of thought give to a large extent very different perspectives on growth and a different understanding of the process. They will be compared and discussed in relation to a structural analysis of growth that originates in research at Economic History in Lund. Convergence in history Convergence of income levels and relative prices is a main characteristic in analyses of market integration or globalisation in history - notably by Williamson/O’Rourke (1994) and Williamson (1995,1996). Their analysis is based upon standard neoclassical Economics with a Solow-model with diminishing returns to the accumulation of factors of production. Growth is not the direct object of study, but convergence and growth run largely parallel. There are mainly two sources of growth. One is technical change that is exogenous to the model. The other is the reallocation of resources to more productive ends. That is the central mechanism in

2 this analysis. According to Jeffrey Williamson the interaction between labour, capital and commodity markets should be in focus of studies in economic growth. Economic historians “should attack these issues first before elevating international technological transfer to the status of prime mover, a thesis so ably argued by Gerschenkron that it has dominated the convergence debate ever since.” (1995, p 162) When markets widen through integration of different national economies (in the process of globalisation), relative prices will change in a systematic way. In a given economy, prices of factors that prior to integration were relatively abundant will rise and consequently prices of scarce factors will fall. Thus, globalisation will favour labour in labour-abundant economies and capital in capital-abundant economies. Through the flow of goods, labour and capital, prices and relative income levels will converge within a globalised economy. This is of course the mechanism of factor price equalisation put forward by Eli Heckscher and Bertil Ohlin, based upon experience in the late 19th century and early 20th century. The first world war and the breakdown of international institutions put very effectively an end to that process of globalisation and convergence that was to recur after the second world war. Thus, modern history has witnessed two periods of globalisation and convergence according to Williamson et.al. – from 1870 up to the First World War and the period after the Second World War. Endogenous growth The new growth theory that was launched within Economics in the 1980s (notably Romer 1986) gives a very different perspective on the growth process and its outcome. Through the accumulation of “broad capital” that includes knowledge, human capital and innovations, growth was made endogenous to the process. Thus, knowledge was produced as any other investment good by the calculated use of labour and capital. The inclusion of knowledge as a key factor and asset had further consequences. While other factors had diminishing returns and were consumed in the production process, knowledge grew when it was used. Furthermore, through externalities including spillovers and complementarities the accumulation of knowledge was endowed with increasing returns. New complementarities arose through the advance of knowledge in different areas and new complementarities were created between human capital and technology. Convergence between economies at different income levels is not the logical outcome of a theory with increasing returns, externalities and complementarities. Rather it predicts divergence since initial differences are enlarged in an endogenously determined growth process with such characteristics. There are of course modifications and qualifications of the basic models that diminish the gulf between them. The concept of social capability (Abramovitz 1986) emphasises that there are decisive socially determined differences in the ability to integrate productivity-increasing methods and to transform structures and thus differences in the ability to join convergence clubs at certain historical points of time. Furthermore, in the augmented Solow-model the concept of capital is broadened to include knowledge. (Mankiw et.al. 1992) Basically, however, there are two very

3 different propositions of the “normal” outcome of the growth process – one of convergence and one of divergence. Analysis of structural change Analysis of historical growth performance gives, however, ground for another position (developed from a structural model presented in e.g. Krantz/Schön 1983, Schön 1994, 1998, 2000). Convergence and divergence have been components in that process in a quite logical manner; i.e. different periods have been characterised by convergence and divergence respectively not because of shortcomings in the external conditions but because of qualities inherent in growth. Furthermore, this variation between convergence and divergence in growth rates and income levels has followed a certain regularity that may be expressed in a model of the historical process that combines aspects from both bodies of theory. Inventions may appear and knowledge accumulate at a rather constant pace, but their impact upon the economy vary very much over time due to properties such as complementarity and externality. Radical innovations that create important and farreaching new complementarities as the steam-engine, the railway, the electrical motor and the combustion engine, the motor-car, the micro-processor, the Internet are rare and their diffusion spread over long periods. With a Swedish Schumpeterian concept the complementarities around innovations form development blocks that are at the centre of the growth process. (Dahmén 1950, 1988) The creation of new complementarities within a development block changes the relative price structure – as does market integration but with another logic. In central areas of innovation relative output prices will generally fall that intensifies competition against old combinations of production factors. The expansion of activities in the innovating areas will, however, increase demand for inputs of goods and services and for complementary production that are supplied less elastically and for these, prices will rise. Within the development block remuneration to the factors of production will increase either as a consequence of increased productivity (supply push) or as a consequence of increased prices (demand push). Within old blocks remuneration will decrease. Furthermore, complementarities around radical innovations appear suddenly and unexpectedly, despite the fact that the breakthrough has been preceded by a long period of innovative activity. The wider repercussions of the innovation that forms the development block make a new turn of events. Such was the case with the electronic revolution (the third industrial revolution) following the advent of the microprocessor or with the second industrial revolution following upon the accumulation of engineering and scientific knowledge at the end of the 19th century. In such periods of more rapid transformation, regions and nations react differently. There are clearly leading regions and nations, since innovations appear from the existence of geographically confined complementarities and externalities. Diffusion is more rapid to regions and nations that are favoured by new demands – due to their resource endowments, their institutional characteristics and their social capability. For the same reasons, the new turn of growth direction is unfavourable to other regions and nations. They may be firmly attached to old combinations and/or have

4 endowments that are less advantageous under new circumstances. In those conditions divergence will follow. Over time however (due to investments) competencies, infrastructures and institutions will be more generally adapted to the new complementarities. Hence the development blocks will be more widely diffused. Since further innovate activity (i.e. economic use of potentially available new combinations from the accumulation of knowledge) is restricted by the structure of complementarities and interests created (i.e. by path-dependency), the accumulation of broad capital will be captured within the confinements of diminishing returns. Further growth will be more determined by diffusion of the new technology and by the working of the market mechanism. In that diffusion process, the favourable position of the leaders is undermined while laggards will improve their position. Thus, divergence in growth rates and income levels will turn into convergence (among countries involved in this process). Diminishing returns will however shift relative profitability between established and emerging complementarities that pave the way for crisis and new structural transformation. Thus, from this perspective the growth process may be periodised in two parts. The first period is characterised by radical transformation of structures when development in a geographical context is uneven with growth accelerating in small nuclei. The second period is characterised by rationalisation when gaps are being levelled and the economy is made more homogenous with growth accelerating (to a certain point) in a wider context. Hence, convergence and divergence put their imprint on different phases and the traditional and the new growth theory evolve around properties that have characterised growth alternately.

Phases of growth As Nicholas Crafts and Gianni Toniolo stated in their survey of post-war European growth: “It is useful to think in terms of epochs of growth”. (1996, p. 32) There is a well-established periodisation of European economic development since 1870 that is as follows: 1870-1914 – the era of the classical Gold Standard 1914-1950 – the period of wars and reconstruction 1950-1973 – the post-war Golden Age of high growth rates 1973– deceleration and restructuring into “a new economy” This periodisation appears very clearly in figure 1 and table 1 that depicts a measure of an aggregated European GDP per capita calculated from 14 countries and with a single PPP-benchmark in 1990. Although the construction of GDP series in individual European countries have progressed immensely in the last decades, there are still a number of problems and difficulties in these long-term cross country constructions that are far from solved and are being addressed by a number of European economic historians. (See for instance Prados 2000) In the present context, however, focus will be on some rather well established trends.

5 Figure 1. GDP per capita in 14 European countries 1870-1994. 1990 Gheary-Khamis Dollars. 20000 16000 12000 8000

4000

1880

1900

1920

1940

1960

1980

Note and sources: See table 1.

Table 1. Growth rates in GDP per capita in Europe. Average of 14 countries. Period 1870-1914 1914-1950 1950-1973 1973-1994 1870-1994

Annual growth rate of GDP per capita 1,2 0,9 3,8 1,8 1,7

Note: The countries are Austria, Belgium, Denmark, Finland, France, Germany, Italy, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK. Sources: Maddison (1995); GDP for Sweden constructed from Krantz (1986, 1987a, 1987b, 1991), Schön (1988, 1995), Johansson (1967).

The two post-war periods There was not only a shift from high to low growth rates in the 1970s. There was also a shift from strong convergence to weak convergence or even divergence from the second half of the 1970s at least within the industrial world – particularly so in the relation between the United States and Europe. (Crafts/Toniolo, p 4 ff) Lower growth rates and weaker convergence are problematic to theories of endogenous growth and of convergence respectively. The shift to weaker convergence or divergence is problematic to a theory on globalisation and convergence since there was no breakdown of international integration comparable to that of the interwar period. On the contrary, globalisation rather gained strength. The shift is not emphasised by Williamson who treats the period from 1950 to the late 1980s as a homogenous one from the perspective of convergence and globalisation. (1996) It ought to be a problem to the new growth theory that growth decelerated at a time

6 when knowledge became more intensively used in most production processes. There is of course a reply to the latter objection by referring to the extraordinary character of the 1950s and 1960s in Europe. When compared with long run growth 1870-1950, the post-1973 record is not disappointing at all. However, Eichengreen (1996) formulated an explanation to both these trend-breaks. The high European growth rates as well the strong convergence were driven by a double catch-up process that formed post-war European institutions but eventually, in the 1970s, the process eroded its own basis. The double catch-up was a result of “the gaps that had opened up vis-à-vis both the United States and Europe’s own prewar trend” in the two decades of depression and war since 1930. (p. 38) With such possibilities to catch-up, institutions and social arrangements were constructed conducive to rapid and foreseeable growth; i.e. wage moderation enabled high levels of investment that were directed into clearly defined areas. When catch-up possibilities dwindled, the institutional framework of wage moderation broke down. These conclusions on the European post-war development can be put in a more general framework of the dynamics of uneven development. When new complementarities and development blocks have arisen in regions that have forged ahead, the divergence gives rise to differences in productivity and profitability that become the driving force both in market integration and in a catch-up process that produces convergence but eventually erode its basis. The long-run dynamics disappear either if new complementarities or development blocks fail to arise in the ensuing crisis (no imbalances) or if market integration fails (no catch-up). In the history of European growth the first failure has not occurred as yet while the second failure marred the 1910s. The double catch up may be phrased in another way, in the framework of structural analysis. It was not only a catch-up in relation to USA and to some “mystical growth trend” but a catch-up in relation to two sets of complementarities that had arisen in earlier decades and that Europe to a large extent had been unable to implement and diffuse. One set was the new technologies that arose in the second industrial revolution from the 1890s including sophisticate engineering and chemistry and above all tayloristic methods of mass-production including the use of new motive power. These had developed up to 1910 primarily in the US and Germany and to some extent in Sweden, and could have been diffused more widely in Europe in the 1910s and 1920s but for the First World War and the following institutional shortcomings. The second set of complementarities involved a proper infrastructure built upon electrical motors and combustion engines as well as social arrangements for the industrial society widening participation in both economic and political terms. In this transformation, Sweden was a progressive country with new trends from the 1930s, whereas most of Europe was drawn into another long and violent conflict. From the early 1950s institutions were created both internationally and within Europe that facilitated the double catch-up process – a diffusion that created strong growth and convergence within Europe as well as globally but with diminishing returns and profit squeezes that eventually ended in crisis in the 1970s. From that time the electronic revolution and the IT-revolution grew in momentum with an end to the strong convergence and with new elements of divergence infused.

7 The era of the classical Gold Standard 1870-1914. In their work on globalisation, Williamson et.al. treat the decades of the Gold Standard from 1870 to the First World War as a homogenous period of convergence. The flows of capital and labour were particularly important in the process of global factor price equalisation. That equalisation occurred both within Europe and in the Atlantic Economy. Overall convergence was, however, very much a result of growth and factor price development in the Scandinavian countries and the United States, which is apparent from Williamson’s data but also assert itself in table 1. According to figures from Williamson and Maddison, the relative change of factor prices in Sweden was extraordinary but the change was almost as strong in Denmark and Norway. (On the importance of capital imports in Sweden, see Schön 1989, 1997) Increases in real wages clearly outstripped a fairly rapid growth in GDP per capita. In the highwage economy of the United States development was the opposite. Growth of wages was sluggish while GDP grew quite rapidly. In low-wage Latin Europe (the Iberian and Apennine peninsulas) GDP growth was weak but wage growth was even weaker. Thus, the Scandinavian countries clearly formed a convergence club at the end of the 19th century that joined in modern economic growth, while Latin Europe generally did not. Table 2. Annual growth in indexes of real wages and in GDP per capita in European countries and the United States 1870-1910. Country Sweden Denmark and Norway France, Germany and UK USA Italy, Portugal and Spain

Annual growth of real wages 1870-1910 2,8 2,6 1,1 1,1 0,6

Annual growth of GDP per capita 1870-1910 1,7 1,3 1,2 1,6 1,0

Sources: Wages from Williamson (1995); GDP, see table 1.

However, the classical Gold Standard era was not a very homogenous period. There was a decisive turning point around 1890. In the period 1870-1890 convergence was much more pervasive and growth rates much more even among countries – also in a Scandinavian/Latin European comparison. (Table 3) That was a period characterised by the decisive market integration that took place after the introduction of new institutions at mid-19th century as well as the creation of a new infrastructure of railways, steam-ships and telegraph cables. It was an expansion built upon innovations of the first industrial revolution and the ensuing infrastructure development and upon the complementarity between an industrial centre and a largely raw-material producing periphery. From 1890 development changed character, however. While growth of GDP and wages accelerated in Scandinavia (as in the United States), it decelerated in Latin Europe (and stagnated in the United Kingdom). Development diverged both in the European periphery and in the Atlantic core countries. There was divergence also within Latin Europe. The economies of Spain and Portugal stagnated almost completely, while there was a strong industrial

8 spurt in Italy from around the turn of the century that served to increase the diversity between northern and southern Italy even more. Table 3. Annual growth rates of GDP per capita in Europe and the United States 1870–1910. Land Scandinavia United Kingdom Spain, Portugal Italy Continental Europe United States

1870–1890 0,9 0,9 0,9 1,0 1,9

1890–1910 2,0 0,9 0,7 2,1 1,3 2,2

Note: Continental Europe = Austria, Belgium, France, Germany, the Netherlands and Switzerland. Sources: see table 1.

The diverging growth rates from 1890 reflect different reactions to the new basis that was created for growth with the so-called second industrial revolution. Manufacturing industry became more sophisticated with a more central role to engineering and science. Abramovitz and David (1973) stated that this decade meant a new basis for growth in the United States. In the 19th century, and particularly 1850-1890, American growth could by and large be explained by the accumulation of the traditional factors of production – of land, labour and capital. Capital accumulation was of particular importance in enabling a growing labour force to take into use the abundant resources of land. But from 1890 the importance of that accumulation diminished. From this point of time human capital became all the more important to the increase in growth rates and to a sustained increase in the productivity of the traditional factors (i.e. in total factor productivity). Thus, the centre of industrialisation shifted from the building of railways, factories, and residential constructions to the development of competent labour and management. The returns from investments in knowledge and education increased. A similar new turn was recently pointed out by Goldin and Katz (1996) that found a new complementarity between capital and skills arising in the US in combination with the first wave of electrification. At the other extreme, United Kingdom failed to accelerate in the second industrial revolution. According to Crafts (1985) British capitalists behaved quite rationally when they accommodated to comparative advantages established from the first industrial revolution with comparatively high productivity within low-skilled manufacturing industries. The failure to adopt new technologies has also been attributed to the high degree of British integration in the world markets, particularly in the financial market that gave weak linkages between risk capitalists and British industry. (Kennedy 1987) In continental Europe there was a western group consisting of France, Belgium and the Netherlands with “close-to-UK” growth rates and only weak acceleration from the 1890s and a central group of Germany, Austria and Switzerland with “close-toScandinavian” growth from 1890. Thus, we find a sphere of western Europe from UK down to Spain and Portugal with weak performance in the second industrial

9 revolution 1890-1910, and a strong central axis from Scandinavia (particularly Sweden with the new engineering industries) down to northern Italy – with Sweden and Italy matching US growth rates. This paper will not go further into the background of the differing European reactions to this industrial revolution. It will only emphasise that the classical Gold Standard era holds two distinct periods that may not show up in aggregate growth rates. It also emphasises that the reactions to the second industrial revolution were strongly diverging among European countries, creating scope for a new convergence at a higher level than that of 1870-1890 – a convergence that was to be delayed due to war and disintegration. Conclusion The idea of this paper is mainly two-folded. Firstly, processes of convergence and divergence, that logically follow from neo-classical theory and new-growth theory respectively, characterise different phases of the growth process. Their alternations constitute a pattern that is part of a rhythm of transformation and rationalisation of structures behind growth. Secondly, those processes could form a new periodisation of growth. While convergence apparently was strong 1870-1890 (built upon the new institutions and infrastructures developed in the 1860s and 1870s), the second industrial revolution introduced new forces of divergence from the 1890s. The outbreak of war in the 1910s and the dismantling of market integration obstructed a possible convergence with the diffusion of these new development blocks in the decades 1910-1930. From the 1930s up to the early 1950s a second set of complementarities evolved very unevenly and were diffused together with technologies from the second industrial revolution in the Golden Ages of growth and convergence 1950-1973. With the third industrial revolution, gaining momentum in the second half of the 1970s, forces of divergence and transformation of structures were released once more. What appears is a pattern where the strength of convergence and divergence alternates, if institutions let them do so, in a periodisation of a long swing character in European growth.

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