EH.net is owned and operated by the Economic History Association
with the support of other sponsoring organizations.

A Monetary History of the United States, 1867-1960

Author(s):Friedman, Milton
Schwartz, Anna Jacobson
Reviewer(s):Rockoff, Hugh

Milton Friedman and Anna Jacobson Schwartz, A Monetary History of the United States, 1867-1960. Princeton: Princeton University Press (for the National Bureau of Economic Research), 1963. xxiv + 860 pp.

Review Essay by Hugh Rockoff, Department of Economics, Rutgers University. rockoff@econ.rutgers.edu

On Monetarist Economics and the Economics of a Monetary History

A Monetary History of the United States, 1867-1960 by Milton Friedman and Anna J. Schwartz is surely one of the most important books in economic history, and indeed, in all of economics, written in the twentieth century. It has had a profound impact on the way economists think about monetary theory and policy. And it is still one of the most frequently cited books in economics. To some extent, it has suffered the fate of most classics: it is often cited, but seldom read. In the course of preparing this review essay, I have been repeatedly struck by the difference between what people think Friedman and Schwartz say, and what they actually say. Below I try to set out some of the reasons for the enormous impact of A Monetary History, and some of the reasons why there is such a large gap between (to subvert the title of Axel Leijonhufvud’s fine book on Keynes) “Monetarist Economics and the Economics of A Monetary History.”

The main point of A Monetary History is that “money matters: ” The quantity of money is an independent and controllable force that strongly influences the economy. This view, which is now accepted, at least in some measure, by most economists is very different from the view that prevailed when A Monetary History was published. At that time the professional consensus considered monetary policy ineffective. The job of central bankers was to keep interest rates as low as possible as long as unemployment was a problem. Following this policy would mean, however, only that investment might be bit higher than it would otherwise be and unemployment a bit lower. And although inflation might be countered with higher interest rates, the presumption was that monetary policy would have little impact. The rate of unemployment and the behavior of costs, particularly wage rates, largely determined the rate of inflation. Controlling labor unions was important for controlling inflation; monetary policy was at best a secondary consideration. The main tool for keeping the economy on an even keel was fiscal policy. It was a development in the real world, of course, the growing problem of inflation in the 1960s and 1970s, that was the main factor overturning the Keynesian orthodoxy. But A Monetary History was a powerful voice for restoring to monetary policy some of its former prestige. How did Friedman and Schwartz persuade the majority of the profession that money matters? The basic methodology of A Monetary History is to highlight “natural experiments,” occasions when the stock of money changed for reasons unrelated to the current state of the economy, so that we can then attribute the corresponding changes in the economy to changes in money.

Friedman and Schwartz offer an impressive array of case studies. To convey a sense of their approach, let me cite three of their most famous examples: (1) the contrast between 1879-1896 and 1896-1914 in terms of the behavior of the price level; (2) the contrast between World War I and World War II in terms of the behavior of the price level; and (3) the impact of restrictive actions taken by the Federal Reserve system in 1937.

(1) Prices (the NNP deflator) fell -0.93 percent per year between 1879, when the United States returned to the gold standard, and 1896, when the deflation came to an end, and then rose 2.08 percent per year between 1897 and 1914. The stock of money behaved in a similar way. Money per unit of output (money divided by real NNP) rose 2.99 percent per year from 1879 to 1896, and then rose 4.23 percent per year between 1897 and 1914. The acceleration in money growth was the result of the flow of new gold, much of it from the mines of South Africa. (High-powered money rose 3.49 percent per year between 1879 and 1896 and 4.83 percent per year between 1897 and 1914.) To be sure, the intense searches for new gold mines and new ways of refining gold ore that were rewarded when the mines of the Rand became productive and the cyanide process for refining it had been perfected, had been encouraged by rising real price of gold before 1896. But these events long preceded the post-1896 inflation. The correlation between rising money supplies and rising prices after 1896, Friedman and Schwartz argue, must be chance or must reflect a causal connection running from money to prices.

(2) Surprisingly, prices rose more in World War I than in World War II, and by about the same magnitude in World War I as in, to go outside the strict boundaries of A Monetary History, the Civil War. Yet measured in almost any conventional way (length of war, casualties, government deficits, etc.) World War I was a much smaller war for the United States than the Civil War or World War II. The monetary facts, however, are roughly in line with the inflation facts. From 1914 to 1920 money per unit of output rose 8.45 percent per year while the price level rose 10.84 percent per year. From 1939 to 1948 money per unit of output rose 7.90 percent per year while the price level rose 6.65 percent per year.

As these figures indicate, money cannot explain everything. The difference in inflation in the two wars exceeds the difference in the rate of growth of money per unit of output. Nevertheless, the striking fact is that the rate of inflation and the rate of growth of money per unit of output were broadly similar in the two wars. One would have expected, based on the degree of mobilization, far more money growth and inflation in World War II.

Part of the reason that the United States could “get away with” slower monetary growth in World War II was that the deposit-reserve ratio of the banking system was lower during World War II. The government, therefore, received a larger share of the revenues produced by increases in the stock of money. High-powered money, the main channel through which the government acquires seigniorage, rose 10.78 percent per year in World War II compared with 12.25 percent per year in World War I. Friedman and Schwartz conclude that the correlation between prices and money per unit of output suggests causation running from money to prices, rather than the common effect of some third factor, such as the intensity of the mobilization.

(3) One of the most famous and most hotly debated examples offered by Friedman and Schwartz is the 1937-1938 recession. In early 1937 the Federal Reserve doubled the required reserve ratios of the banking system with the purpose of immobilizing reserves and preventing future inflation. After some months, this action was followed by declines in the stock of money and real output. Money fell -0.37 percent between 1937 and 1938 while prices fell -0.50 percent, and real output fell -8.23 percent. High-powered money, responding to other forces, rose by 7.95 percent during the same year. Friedman and Schwartz conclude that the correlation between the decline in the stock of money and the decline in economic activity must have resulted from chance or from causation running from money to economic activity.

These case studies, I should note, arose in three different institutional regimes. In case (1) the United States was on the gold standard, and there was no central bank. In case (2) the Federal Reserve was constrained by the need to finance large wartime government deficits, and had to follow the Treasury’s lead. In case (3) the Federal Reserve was relatively independent, and could follow its own judgments about appropriate monetary policy. Drawing examples from different institutional environments strengthens the argument. In each case there is a rough correlation between monetary changes and changes in the economy, yet the factors determining the supply of money are very different. This suggests that the proposition “money matters,” represents a fundamental economic relationship, and is not the adventitious result of some particular set of institutional arrangements.

None of these “natural experiments” or the many others cited in A Monetary History, was conducted in a laboratory. Many variables were changing, and it is always possible, although not always easy, to construct an alternative explanation based on some other key factor. An extensive literature, for example, has grown up elaborating and contesting the Friedman-Schwartz interpretation of case (3), and attributing the 1937 downturn to other factors, such as fiscal policy. But for someone seeking to overturn A Monetary History, contesting one of these explanations is only the beginning. What gives weight to Friedman and Schwartz’s argument is the multiplicity of examples. So far, I would argue, none of Friedman and Schwartz’s critics has been able to forge an alternative explanation – whether based on fiscal policy, or labor union militancy, or technological change, or whatever – that fits all of the examples explored in A Monetary History. Indeed, to my way of thinking, the major advances since A Monetary History, have been the attempts by Brunner and Meltzer, Bernanke, and others to enrich the picture of how disturbances in the financial sector, and in particular the banking sector, affect the rest of the economy, rather than attempts to explain macroeconomic events from totally different perspectives.

Perhaps the greatest mystery is not that the Friedman-Schwartz methodology was persuasive, but rather that despite the enormous impact of A Monetary History, few economists use its methodology. Typically, when an economist attempts to persuade other economists, the first step is to feed the numbers through the computer and in the process strip away the historical circumstances that adhere to them.

Friedman and Schwartz’s interpretation of the Great Depression is both figuratively and literally at the heart of their book. The detailed discussion occupies about 30 percent of the total, and the episode is referred to by way of contrast in discussions of other episodes. Princeton University Press later issued this section as a separate volume, The Great Contraction.

Their point, as most college students of economics now know (or should know), is that the Great Depression could have been greatly ameliorated by better monetary policy. Today, only a few dyed-in-the-wool Keynesians reject any causal role for monetary policy, although many economic historians would place the major blame for the Depression on other factors, and relegate bad monetary policy to a secondary role. The Friedman-Schwartz interpretation of the Depression was crucial, moreover, to the revival of confidence in market-based economics. The Great Depression, and the way it was interpreted by Keynesian economists, convinced a generation of American intellectuals that only socialism (or near-socialism) could save the American economy from periodic economic meltdowns. If Great Depressions could be prevented through timely actions by the monetary authority (or by a monetary rule), as Friedman and Schwartz contended, then the case for market economies was measurably stronger.

It has been objected that Friedman and Schwartz don’t prove that monetary forces caused the Great Depression. They merely describe the Great Depression in great detail as if monetary forces were the causal factor. This objection is true, but not as decisive as it might seem at first glance. From the point of view of proving the importance of money, the Depression is merely another period, although a particularly revealing one, in which to search for natural experiments. It provides additional evidence, such as the case of the doubling of required reserve ratios in 1937 discussed above, and other episodes, but this one short period by itself cannot prove anything.

Friedman and Schwartz are doctors writing up the results of a detailed clinical examination of a patient who entered the hospital on the verge of death. Their observation that the patient was suffering from a bacterial infection is not by itself proof that the infection caused the patient’s illness. The fact that other patients with the same symptoms and the same infection have been seen at other hospitals in other places and at other times is what makes their argument persuasive. And it is the evidence taken as a whole that makes the prescription offered by Drs. Friedman and Schwartz, that the patient should have been given a strong dose of antibiotics (high-powered money), appear so sensible.

Perhaps the most misunderstood aspect of A Monetary History is the way that Friedman and Schwartz treat Nonmonetary factors. Their approach is to assume a “real” business cycle, which is then pushed a pulled by monetary factors. I use the term “real” with some trepidation. What Friedman and Schwartz have in mind is the sort of cycle described by Wesley C. Mitchell, Arthur Burns, and other scholars at the National Bureau of Economic Research in work that preceded A Monetary History, rather than what now goes by the name “real business cycle.” Yet there is a family resemblance worth stressing. Friedman and Schwartz, unfortunately for us, say little about the sources of this cycle, although at times they make some interesting observations about the tendency of good harvests in the United States to occur at the same time as bad harvests in Europe, and a few other factors. Nevertheless, it is clear that various supply-side shocks including technological shocks that now appear important to macroeconomists would fit easily into the Nonmonetary cycle that forms the backdrop for Friedman and Schwartz’s analysis.

The real cycles in which Friedman and Schwartz impound other factors are often forgotten when economic historians recount “monetarist” interpretations of historical episodes. I have heard economic historians claim that Friedman and Schwartz “say” that the recession of 1937 was caused by the doubling of reserve requirements in 1937. In fact, they write the following.

“Consideration of the effects of monetary policy [the increase in required reserve ratios] on the stock of money certainly strengthens the case for attributing an important role to monetary changes as a factor that significantly intensified the severity of the decline and also probably caused it to occur earlier than otherwise” (p. 544).

Similarly, I have heard economic historians claim that Friedman and Schwartz say that money caused the Great Depression, or that the stock market crash did not cause the Great Depression. In fact their statements on both points are more circumspect, and assume a Nonmonetary contraction of some magnitude. Of the stock-market crash Friedman and Schwartz write that “… its [the stock market crash’s] occurrence must have helped to deepen the contraction in economic activity. It changed the atmosphere within which businessmen and others were making their plans, and spread uncertainty where dazzling hopes of a new era had prevailed” (p. 306).

The crucial turning point in the Depression, according to Friedman and Schwartz, was late 1930 or early 1931, when they thought the contraction might have come to an end in the absence of the banking crises. But they acknowledge that even so, the contraction of the early 1930s “would have ranked as one of the more severe contractions on record” (p. 306).

In their counterfactual discussion of the effects of an open market purchase of $1 billion, they conclude that if undertaken between January 1930 and October 1930 the open market purchase would have “reduced the magnitude of any crisis that did occur and hence the magnitude of its aftereffects” (p.393). If undertaken between September 1931 and January 1932, the open market purchase would have produced a change in the monetary tide and as a result “the economic situation could hardly have deteriorated so rapidly and sharply as it did” (p. 399).

In discussing the banking panic of 1907, to give an earlier example, Friedman and Schwartz conclude that “There can be little doubt that the banking panic served to intensify and deepen the contraction: its occurrence coincides with a notable change in both the statistical indicators and the qualitative comment. If it had been completely avoided, the contraction would almost surely have been milder” (p. 163).

In short, Friedman and Schwartz tried to show that good monetary policy – best of all, as Friedman argued elsewhere, a monetary rule – would make the world a better place; they never promised a rose garden.

Although the central thesis is “money matters,” Friedman and Schwartz follow a large number of closely related threads. These range from the determinants of the greenback price of gold after the Civil War, to the relative effects of mild inflation and mild deflation on long-term economic growth, to the effects of deposit insurance on the stability of the banking system, and so on. Their discussions of these episodes are invariably intelligent, and often at variance with what was the conventional wisdom at the time they wrote. Not only do these discussions help us to understand these particular episodes; they also increase our confidence in their central thesis. They convince us that we are reading economic historians of outstanding ability who have explored every nook and cranny of American monetary history.

As most readers of A Monetary History recognize the book also succeeds in part because of how well it is written. Friedman and Schwartz employ a style that might be called high-NBER. It is written for the intelligent lay person. No special knowledge of statistics is required to read it, and no equations appear in the text, although there is an appendix on the determinants of the stock of money that uses equations. The quantity theory of money never appears in algebraic form. The sentences flow in magisterial fashion, and yet one is aware that the authors have thought about what they are discussing and are eager to make sure that the reader understands. In many ways their book, with its myriad of examples and its telling analogies, is the most similar, among all the classics of economics, to The Wealth of Nations. One can’t help but feel that the former lecturer on rhetoric would have approved of Friedman and Schwartz’s polished yet straightforward style.

For all these reasons, my choice for the most significant book in the field of economic history in the twentieth century is A Monetary History of the United States, 1867-1960 by Milton Friedman and Anna J. Schwartz.

Annotated References:

There is a large and growing literature on A Monetary History. Here I will mention just a few sources that I have found particularly useful.

Bernanke, Ben S., Nonmonetary Effects of the Financial Crisis in Propagation of the Great Depression. American Economic Review. Vol. 73 (3): 257-76, June 1983.

Bordo, Michael D., editor, Money, History, and International Finance: Essays in Honor of Anna J. Schwartz. National Bureau of Economic Research Conference Report series. Chicago: University of Chicago Press, 1989. (This volume, a Festschrift for Anna J. Schwartz, contains a number of relevant essays, including one by Bordo that focuses explicitly on the contributions of A Monetary History.)

Brunner, Karl and Allan H. Meltzer, “Money and Credit in the Monetary Transmission Process.” American Economic Review. Vol. 78 (2): 446-51, May 1988.

Hammond, J. Daniel, Theory and Measurement: Causality Issues in Milton Friedman’s Monetary Economics. Cambridge: Cambridge University Press. 1996. (Hammond discusses all of the Friedman-Schwartz work on money focussing on methodological issues and the large volume of criticism their work generated).

Leijonhufvud, Axel, On Keynesian Economics and the Economics of Keynes: A Study in Monetary Theory. New York: Oxford University Press, 1968.

Lucas, Robert E, Jr., “Review of Milton Friedman and Anna J. Schwartz’s A Monetary History of the United States, 1867-1960.” Journal of Monetary Economics. Vol. 34 (1): 5-16, August 1994. (Lucas lays out what he considers the most important contributions of A Monetary History.)

Miron, Jeffrey A., “Empirical Methodology in Macroeconomics: Explaining the Success of Friedman and Schwartz’s A Monetary History of the United States, 1867-1960. Journal of Monetary Economics. Vol. 34 (1): 17-25, August 1994. (Miron explains why members of the younger generation of macroeconomists, even those not trained at Chicago, found A Monetary History so persuasive.)

Steindl, Frank G., Monetary Interpretations of the Great Depression. Ann Arbor: University of Michigan Press, 1995. (Steindl provides a useful overview, which compares and contrasts the Friedman-Schwartz interpretation of the Great Depression with the interpretations offered by other monetary historians.)

Temin, Peter, Did Monetary Forces Cause the Great Depression? New York: Norton, 1976 and Temin, Peter, Lessons from the Great Depression. Cambridge, MA: MIT Press, 1989. (Temin presents a detailed and extremely skeptical reading of the Friedman-Schwartz interpretation of the Great Depression.)

Subject(s):Macroeconomics and Fluctuations
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

The Second Bank of the United States: “Central” Banker in an Era of Nation-Building, 1816-1836

Author(s):Knodell, Jane Ellen
Reviewer(s):Brennecke, Claire

Published by EH.Net (May 2018)

Jane Ellen Knodell, The Second Bank of the United States: “Central” Banker in an Era of Nation-Building, 1816-1836. New York: Routledge, 2017. xiii + 188 pp. $110 (hardback), ISBN: 978-1-138-78662-2.

Reviewed for EH.Net by Claire Brennecke, Federal Deposit Insurance Corporation.

 
Many economic historians have analyzed the Second Bank of the United States through the lens of modern central banking. In The Second Bank of the United States: ‘Central’ Banker in an Era of Nation-Building, 1816-1836, Jane Knodell builds on this literature with a unique and nuanced view of the institution. Knodell argues that the Second Bank of the United States did not act as a modern central bank, as it did not provide services to state banks: the Bank did not act as a lender of last resort or issue high powered money for state banks to use as a reserve currency. But neither was the Bank purely a profit-maximizing commercial bank. The Bank acted in the national interest when it took on the role of a fiscal agent for the federal government and when it maintained monetary stability through specie market operations. Knodell draws on a variety of sources to present this case including contemporary accounts, state bank balance sheet data, and Second Bank branch geography.

Knodell begins, in the second chapter, by pointing out that the Second Bank was never intended to explicitly support state banks. Congress chartered the Bank to address specific challenges that the United States government faced in the early nineteenth century. The federal government was more concerned with the possibility of a public finance crisis rather than a banking crisis. The Second Bank was founded in order to create a uniform currency for the national government and transfer public funds around the country. The Bank placed many of its branches to help achieve this goal, as well as placing branches to provide a place to deposit custom duties. It also exploited its monopoly on interstate branching to profit by placing other branches in locations with few state banks and more growth potential.

Modern central banks produce monetary stability in part by issuing high-powered money for commercial banks to use as reserves and by acting as a lender of last resort (LOLR) for banks. Knodell uses state bank balance sheet data to show that those banks never considered Second Bank notes high-powered money. Moreover, the Bank did not even allow state banks to use the Second Bank’s large-denomination notes for interbank payments (p. 104). Neither did the Second Bank create stability by acting as a LOLR to state banks during the crisis of 1825-26.

However, the Second Bank did act to create monetary stability in ways possibly unfamiliar to scholars of modern central banking. Primarily, the Bank managed the monetary system through specie market operations. As discussed in Chapter 4, the Bank accumulated significant specie reserves through its trade in the domestic and foreign bills of exchange markets. These specie reserves allowed the Bank to conduct specie market operations that stabilized the money markets and suppressed private arbitrage. Through these operations, the Bank both earned profit and acted in the national interest.

In this book, Knodell makes a convincing case that the Second Bank of the United States was neither a conventional modern central bank nor a purely profit-motivated commercial bank. Furthermore, she makes excellent use of a variety of data sources to clearly lay out her argument. However, she misses an opportunity to discuss what the history of the Second Bank can tell us about a) the purpose of a central bank and b) the American economy in the early nineteenth century. Modern central banks affect the economy primarily through their interactions with commercial banks. However, the importance of a central bank comes from its impact on the economy, not the specific policies. The book could have gone further to consider how the Second Bank compares to modern central banks in its motives rather than just its policies. Furthermore, the policies of the Bank were specific to the early nineteenth century U.S. economy. The book could have explored what these policies reveal about how the economy functioned historically relative to how it does today. For example, the Second Bank arguably did create high-powered money for merchants even if it did not do so for banks, and so provided a useful service in creating currency for exchange. The Bank allowed non-bank members of the public, but not banks, to redeem notes for specie at par at all bank branches (p. 127). The book could have discussed the goal of the policy, what that goal tells us about central banking, and what the decision to use this policy to achieve that goal tells us about the broader economy. Overall, this book is an important contribution to the understanding of the Second Bank of the United States and an excellent point of reference for scholars of early American economic and political history.

 
Claire Brennecke is a financial economist with the Federal Deposit Insurance Corporation. Any opinions, findings, conclusions, and recommendations expressed above are those of the author and do not necessarily reflect the views of the Federal Deposit Insurance Corporation. She is the author of “Information Acquisition in Antebellum U.S. Credit Markets: Evidence from Nineteenth-Century Credit Reports,” FDIC Center for Financial Research Working Paper No. 2016-04.

Copyright (c) 2018 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (May 2018). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):19th Century

The Oxford Handbook of Banking and Financial History

Editor(s):Cassis, Youssef
Grossman, Richard S.
Schenk, Catherine R.
Reviewer(s):Neal, Larry

Published by EH.Net (July 2017)

Youssef Cassis, Richard S. Grossman, and Catherine R. Schenk, editors, The Oxford Handbook of Banking and Financial History. Oxford: Oxford University Press, 2016. xviii + 537 pp., $160 (hardcover), ISBN: 978-0-19-965862-6.

Reviewed for EH.Net by Larry Neal, Department of Economics, University of Illinois at Urbana-Champaign (emeritus).

The global financial crisis that began in 2007-08 and continued to rattle the Eurozone countries after 2010 has certainly been good for the market for financial history.  The Oxford Handbook of Banking and Financial History is clearly a response to these events.  In their introductory chapter, the editors set out their ambitious agenda, which is to deal with the individual parts of our modern complex financial system and trace how each has evolved over time.  Each chapter ends with some insight into how the current turmoil in global banking and finance might affect part of the global financial system. This broad-ranging approach is very much in keeping with current analysis by policy economists, who have become very sensitive to how our financial system intertwines banks, which specialize in particular niches of the economy; shadow banks, which innovate to find new niches; money markets, which deal with short-term finance; capital markets, which provide long-term finance; and regulators, who attempt to oversee the operation of the financial system for the interest of the public (or the government).  The editors’ goal is to provide anyone concerned with a particular aspect of the financial system an authoritative treatment by an acknowledged expert that is clearly written for the non-specialist combined with a useful bibliography to follow up particular aspects.

The Oxford Handbook is organized into four parts: Part I, Thematic Issues, deals explicitly with the problems that the editors confronted at the outset: how have historians approached the issues in financial history (Youssef Cassis); how have economists dealt with the issues that interest them (John D. Turner); and how have policy makers tried to apply lessons from history for promoting economic development (Gerard Caprio, Jr.).  To pay due attention to historical contingency, economic analysis, and policy relevance in each of the following chapters is, indeed, a daunting task for each author.

Part II, Financial Institutions, takes up these challenges by separating out several categories of distinctly different institutions, a useful distinction too often overlooked in practice and one that illustrates nicely the complexity of any financial system.  Youssef Cassis’s “Private Banks and Private Banking” begins with the initial role models for banks, from their origins in kinship networks in Renaissance Italy to today’s Swiss managers of private wealth.  Gararda Westerhuis’s “Commercial Banking: Changing Interactions between Banks, Markets, Industry, and State” follows by dealing with the nineteenth-century spread of industrialization globally, which led to the rise of universal banks.  By the end of the twentieth century, however, it appeared that commercial banks might be in “a state of terminal decline.” (See Raghuram Rajan, 1998, “The Past and Future of Commercial Banking Viewed through an Incomplete Contracts Lens,” Journal of Money, Credit, and Banking. 30(3), 524.)  The financial crisis of 2008 led many observers to push for a separation of investment and commercial banking once again in the interest of financial stability.  Westerhuis goes on to distinguish the motives for establishing market-based systems (U.S. and England) versus bank-based systems (Germany and Japan).  She posits that the two paths diverged early on due to the differences in government control over banks and then the role played by banks in financing industrialization for follower countries, such as Germany and Japan.  Oddly missing from her overview is any consideration of the experience of Scottish banking, which developed joint-stock banks with national branches early in the eighteenth century.  Only after the financial crisis of 1825 did the English care to look seriously at the Scottish example for improving their commercial banking system!  Further, joint-stock banks did not disappear in the U.S. during the “free banking” period as she asserts. While they were confined within state boundaries, limitations on branching within a state varied considerably.  The wide range of experiments undertaken by various states has stimulated a growing and interesting literature among U.S. scholars, largely omitted from her bibliography.

Caroline Fohlin’s “A Brief History of Investment Banking from Medieval Times to the Present” takes up the most challenging role of banks, how to transform short-term liabilities into long-term assets.  Rather than taking specific organizational forms, she prefers to analyze investment banks as a set of services that help finance the long-term capital needs of business and governments. After briefly looking at merchant banks from medieval times to the early nineteenth century, this loose definition requires her to take up individual countries one by one during the nineteenth century.  Sections follow that deal with England, the European continent, Belgium and the Netherlands, France, Germany, Austria and Switzerland, Italy, Japan, and the United States. Each section highlights the differences in organizational structures created to accomplish basically the same goals, helping governments promote industrialization.  The twentieth century presents more interesting differences, essentially due to the ways various governments regulated, deregulated, and then re-regulated from the 1920s to the present.  She concludes, “even well-known investment banking names that have endured over the centuries bear little resemblance to their ancestors” (p. 159).

Christopher Kobrak’s “From Multinational to Transnational Banking” takes up the complex transformations of the world’s leading banks by size as they successively internalized their international operations.  The availability of huge advances in information technology combined with increasing opportunities for re-allocating domestic savings across foreign investments provided the basis for the growth of today’s megabanks.  Oddly, however, Kobrak takes as archetypes of the new transnational bank two of the worst performers after 2008 — Deutsche Bank and Citibank.  Relying on their respective annual reports in 2007-2010, he touts each of them as “market players” rather than staid fiduciary agents, lauding their scale and scope of activities that are only vaguely related to financial intermediation associated with banks “lending long, while borrowing short.” He dispassionately notes that three-quarters of Deutsche Bank’s two trillion euros in assets in 2007 were securities held for trading, and 40 percent were financial derivatives (p. 183), without disparaging the obvious omission of fiduciary responsibility. Citibank, similarly, by 2007 had “invested huge resources in creating an internal market, in essence warehousing securities and derivatives to build hedged positions and for future sale” (p. 182). All these intra-bank holdings of assets and liabilities enabled such banks to make a lot of money by proprietary trading that remained unobserved by regulators or by publicly accessible financial markets.  He refrains from criticizing the model developed by these two megabanks, each of which has suffered huge losses and justified public acrimony since 2008, confining himself to the anodyne remark that “megabanks may be forced, as they have many times in the past, to find an intertwined institutional and organizational adaptation more sustainable in the modern social order” (p. 185)!

R. Daniel Wadhwani’s “Small-Scale Credit Institutions: Historical Perspectives on Diversity in Financial Intermediation” concludes Part II by lumping together a motley assortment of credit cooperatives, savings banks, industrial banks, pawn shops, and savings and loans associations.  Wadhwani argues their cumulative size makes their impact on their respective economics arguably as great or greater than that made by the commercial, investment, and public banks dealt with in the previous chapters.  Their common origin across many cultures and through past millennia he finds in the ubiquitous presence of ROSCAs (rotating savings and credit associations).  Beginning with small kinship groups desiring to pool their limited resources to enable individual members to acquire a desired goal, perhaps a piece of land, a dwelling, livestock, or even the means to migrate somewhere else for employment, ROSCAs often provide a basis for transition to the more modern forms of intermediation.  These include savings banks, credit cooperatives, and savings and loans, with each evolving quite differently depending on local circumstances.  Critical to their evolution historically is the role of government, whether as regulator (restricting competition), competitor (postal savings banks), or customer (providing sovereign debt as risk-free asset).  The theoretical economic bases for their evolution and persistence are robust, both for their monitoring capability and for their local knowledge of investment possibilities.  Nevertheless, Wadhwani calls attention to more post-modern “theories” that favor the creation of supportive narratives when cultures confront changes in economic regimes.

Part III, Financial Markets, begins with Stefano Battilossi’s “Money Markets,” which emphasizes the importance of access to outside liquidity for banks when they face unanticipated shocks either for increased loans or increased withdrawals of deposits.  Further, Battilossi argues that a key lesson learned by banking theorists and practitioners in the nineteenth century, namely that money markets are essential for a smooth working of the economy but are inherently unstable, was lost over the course of the twentieth century.  The success of the Bank of England in stabilizing the money market at the center of the global economy of the nineteenth century, he argues, was due to a complex combination of close monitoring by the Bank of England and cartel complicity by the major joint-stock banks, each with extensive branching networks domestically and overseas.  U.S. efforts to imitate the British example after creation of the Federal Reserve System in 1913 failed due to irreconcilable differences in institutional structures between the two banking systems and their respective central banks.  It took over a century and a half for the Bank of England to learn how to avoid being a dealer of last resort, a role that the Federal Reserve System in the U.S. had to undertake in the 2008 crisis, and which it has not yet been able to relinquish.  Readers are left to draw the implications for the future of the global financial system for themselves!

Ranald C. Michie’s “Securities Markets” lays out convincingly and clearly the importance of securities markets for a successful financial system.  Divisibility and transferability of a security expands greatly the potential customer base, adding the virtue of diversity in demands for liquidity among the creditors as well.   He distinguishes clearly between “Primary Securities Markets” and “Secondary Securities Markets,” showing their interdependence in layman’s terms.  “Stock Exchanges” provide the effective linkage between the two levels of markets, but fall prey in turn to problems either of monopoly pricing or government repression. His exposition of the underlying theory of securities markets provides the structure for his narrative that follows. From “Early Developments in Securities Markets,” which only mentions briefly the roles of informal markets in the speculative booms of 1720, Michie insists on focusing on the nineteenth century, starting with the London Stock Exchange in 1801.  It’s unfortunate that he ignores recent work on the Amsterdam stock market, (e.g., Lodewijk Petram, The World’s First Stock Exchange, New York: Columbia University Press, 2014), or early work by this reviewer on the precedents for the London Stock Exchange (Larry Neal, The Rise of Financial Capitalism, New York: Cambridge University Press, 1990).  Committed to the importance of formal structures for modern stock exchanges, however, Michie takes up their rise in the advanced capitalist economies of the nineteenth century and then their eclipse from 1914 to 1975.  Thanks to the exigencies of war finance from World War I through the Cold War, stock markets seemed to “appear somewhat irrelevant in a world dominated by governments and banks” (p. 253)  “The Era of Global Banks” did not come to an end in 2008, however, but what had ended was the “self-regulation that had contributed so much to the attractions of stocks and bonds to governments, businesses, and investors through the reduction or elimination of counterparty risk and price manipulation and the certainty that sales and purchases could be made as and when required” (p. 258).  Big banks are bad once again!

Moritz Schularick’s “International Capital Flows” is the most quantitative and instructive of the chapters, as he summarizes succinctly in nine brief tables and one graph, the levels of international capital flows over the nineteenth and twentieth centuries, their size relative to Gross Domestic Product, and the main sending countries and main receiving countries over time.  In sum, rich countries invested in poor countries in the nineteenth century, when international capital flows were highest relative to GDP, and the rich continued to invest in poor countries even when capital flows were severely constrained during the period 1914-1975.  But after the collapse of Bretton Woods, when international capital flows rose sharply once again, the result has been for poor countries to invest in rich countries.  Further, when capital does flow suddenly to emerging economies, financial crises often follow when the flow tapers off, undoing whatever economic advance may have occurred.

Youssef Cassis’s “International Financial Centres” concludes the coverage of financial markets by analyzing the recurring features of international financial centers that lead to their persistence over time.  The physical layout of the dominant cities, the combination of functions they perform (government, communications, education, as well as trade and finance), and their organization may change as the technology of transport, communications, and information change, but, Cassis argues, the network externalities created by the concentration of so much expertise in one location make the existing centers hard to replace.

Part IV, Financial Regulation, takes up the most vexing questions for policy makers, starting with Angela Redish’s “Monetary Systems.”  Redish begins with the complexity of metallic currencies with coins minted in varying combinations of copper, silver, and gold in early modern Europe, and deftly reviews the causes that concerned European policy makers as they sought to maintain coins with fixed legal tender values, whether minted in any or a combination of the three precious metals.  Basically, their concerns were the same as today, “whether nominal change can have real consequence for the balance of trade or level of economic activity?” (p. 327).  Redish goes on to trace out the academic literature that has dealt with the Emergence of the Gold Standard, the Latin Monetary Union, the Cross of Gold, the Classical Gold Standard, and the Good Housekeeping Seal of Approval, highlighting the controversies that have arisen under each rubric.  Next, she divides the End of the Gold Standard into the First World War and the Interwar Period, Bretton Woods and European Monetary Arrangements, and the End of Bretton Woods and the Rise of the Euro.  Reproducing faithfully the graph produced by Eichengreen and Sachs to show that countries that stayed committed to the gold standard after 1929 suffered in terms of industrial production relative to those that devalued, she doesn’t point out that the outliers of Germany and Belgium are readily explained by mistaking their formal exchange rate regimes with the ones they followed in practice (Germany using bilateral trade agreements to increase industrial exports while keeping the nominal exchange rate fixed, and Belgium reducing its nominal exchange rate while being forced to maintain existing trade agreements with France).  She concludes with a brief discussion of both inflation targeting under fiat currency regimes and the rise of crypto currencies such as Bitcoin, Her conclusion is merely that “money is information, a method to enable multilateral clearing of myriad transactions.  It would be surprising if the digital revolution did not lead to a revolution in how this information is managed” (p. 339).

Forrest Capie’s “Central Banking” takes up the baton passed on by Redish to provide a brief synopsis of the issues confronting central banks as they have increasingly taken control of the supply of money over the past two or more centuries.  Monetary stability, their prime responsibility, can be assessed in terms of price stability, but financial stability, which has become a major concern, he notes is more difficult to assess, much less to sustain.  Central bank independence, however defined, does seem to correlate with monetary and price stability, which shows that policy lessons have been learned successfully on that score.  Continued independence of central banks, however, hinges very much on attaining and then sustaining financial stability.  This task, very much underway now among the world’s central banks, 174 at last count, may require expanding their role to include financial regulation as well as oversight of the banking system.

Harold James’s “International Cooperation and Central Banks” makes an interesting argument that central banks in their pursuit of the goal of monetary stability naturally tend to cooperate with other central banks internationally, but without need for formal mechanisms.  Cooperation can then be merely discursive, as it was during the classical gold standard.  Financial crises, however, often do call for international cooperation, but cooperation is difficult, perhaps impossible, to sustain given the priority of strictly national policy concerns.  Large countries, needed to make cooperative efforts successful, are the most reluctant to join in cooperative efforts.  His examples cover episodes during the classical gold standard, the interwar period, the brief Bretton Woods period, and the ongoing travail of the euro-system, which he concludes is “the global test case for both the possibilities and the limits of central bank action” (p. 391). In an interesting aside, he explains why the Bank for International Settlements was resuscitated to manage the European Payments Union in the 1950s.  Top U.S. officials were wary of using the newly-established International Monetary Fund because its staff were largely protégés of Harry Dexter White, then under suspicion as a possible Russian agent!

Catherine Schenk and Emmanuel Mourlon-Droul’s “Bank Regulation and Supervision” develops a sub-theme to the arguments presented by Harold James, namely the recurring problems of regulatory competition, moral hazard, and regulatory capture.   Essentially, “[r]eputation and private information are key bank assets in a market with information asymmetry, but this complicates the ability to engage in transparent prudential supervision” (p. 396).  The U.S. stands out for having the most complicated and unwieldy array of conflicted regulatory agencies, summarized in Table 17.1.  The authors conclude, as do Charles Calomiris and Stephen Haber (Fragile by Design: The Political Origins of Banking Crises and Scarce Credit, Princeton, NJ: 2014), that it is no accident that Canada and the UK, with more coherent approaches to bank regulation have had fewer banking crises.  Much of the remaining chapter focuses on China and the successive efforts of China’s rulers to establish, then regulate, a banking system to enable industrialization and modernization, concluding, perhaps prematurely, that China managed to reduce the problem of non-performing loans after their peak in 2000.  The difficulties of deciding where to locate the regulator of the banking system are highlighted by tracing the successive efforts of the U.S., then the UK to find an ex post regulatory solution to the problems of recurring financial crises.  The efforts of the Basel Committee, established after the collapse of the Bretton Woods System, are described in the context of the European Union’s efforts to move toward regulatory cooperation within a more limited scope of international cooperation.  Prospects for success on that score are still very much in doubt.

Laure Quennouelle-Corre’s “State and Finance” takes a step back to look at the origins of the ongoing dilemma for the Eurozone of the interaction between governments’ sovereign debt and financial fragility of their banks.  The recurring differences between France and the other members of the European Union form the backdrop for his rambling notes on the interactions of private and public financial institutions, ending with the observation that France alone has had to deal with the European Union’s pro-market ideology versus the French tradition of state intervention.

Part V, Financial Crises, opens with Richard Grossman’s “Banking Crises,” which reprises the standard story of boom-bust cycles, exacerbated when new opportunities for speculative investments open up (first globalization after 1848; second globalization after 1979; post-war adjustments after WWI) but then moderated under strict regulation (capital controls, interest rate restrictions from 1945-71).  In his perspective, the Eurozone crisis fits the boom-bust pattern first described by D. Morier Evans in 1859 (The History of the Commercial Crisis, 1857-58, and the Stock Exchange Panic of 1859, New York: Augustus M. Kelley, 1969).

Peter Temin’s “Currency Crises: From Andrew Jackson to Angela Merkel” takes up the international aspect of the boom-bust paradigm by extending it into national decisions about setting the exchange rate with foreign trading partners and possible investors. To bolster his long-standing conviction that most, if not all, banking crises are really currency crises at heart, he lays out in detail the open macro-economy model developed by Trevor Swan. Swan’s diagram relates a country’s domestic level of production to its real exchange rate.  Internal balance is maintained if production rises with the real exchange rate, while external balance requires the real exchange rate to fall when production increases. The model leads to dire consequences for a country if it does not succeed in maintaining both internal balance (matching domestic investment with domestic supplies of savings) and external balance (matching capital account flows with offsetting trade balances) simultaneously.  Either excessive inflation or long-term unemployment occurs whenever imbalances are sustained due to misguided government policy.  Banking crises then arise as the necessary outcome of such policy failures by governments. The historical evidence to support Temin’s argument starts with Andrew Jackson and the crisis of 1837 in the U.S., continues through the Great Depression in the U.S. in the 1930s, not to mention the concurrent crisis in Germany, and concludes with the ongoing Eurozone crisis, all basically due to misguided political leaders, as named in his sub-title.

Juan H. Flores Zendejas’s “Capital Markets and Sovereign Defaults: A Historical Perspective” concludes the Oxford Handbook.  The first global financial market, arising with the collapse of the Spanish Empire in Latin America after the Napoleonic Wars, saw various devices to cope with the recurring problem of governments defaulting on the sovereign bonds they issued for whatever reason, usually to fight a war or quell a revolution.  Flores recounts the success of the London Stock Exchange in bringing governments to heel if they wanted access to British savers. The monitoring capabilities of the leading merchant bankers, especially the Barings and Rothschilds, put their imprimatur on bonds issued through their firms.  Twentieth century regulatory restrictions on these leading investment banks by their host governments, however, have limited the effectiveness of their “branding” and their intrusive follow-up in monitoring the finances of their customer governments.  Flores casts some doubt as well on the effectiveness of the Council of Foreign Bondholders in the nineteenth century.  He could also have challenged the effectiveness of international financial control committees that served as the model for the League of Nations Financial Commission after World War I if he had cited the recent work of Coskun Tuncer (Sovereign Debt and International Financial Control, The Middle East and the Balkans, 1870-1914, London: Palgrave Macmillan, 2015).  Flores concludes in general that governments that avoided defaulting in times of general crisis did so because they had been excluded from the earlier expansion of international credit.

All in all, the editors did get the compilation in print still in time to be useful for anyone concerned with how the ongoing financial crisis of the early twenty-first century will play out.  Specialists in each topic, however, may be disappointed in the necessary brevity of treatment, not to mention absence of references to their own work, particularly if they worry most about the future of the U.S. financial system.

Larry Neal is the author of A Concise History of International Finance: From Babylon to Bernanke, Cambridge: Cambridge University Press, 2015

Copyright (c) 2017 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (July 2017). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
Time Period(s):18th Century
19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

Current Federal Reserve Policy under the Lens of Economic History: Essays to Commemorate the Federal Reserve System’s Centennial

Editor(s):Humpage, Owen F.
Reviewer(s):Hausman, Joshua K.

Published by EH.Net (September 2016)

Owen F. Humpage, editor, Current Federal Reserve Policy under the Lens of Economic History: Essays to Commemorate the Federal Reserve System’s Centennial. New York: Cambridge University Press, 2015. xxi + 386 pp. $110 (hardback), ISBN: 978-1-107-09909-8.

Reviewed for EH.Net by Joshua K. Hausman, School of Public Policy, University of Michigan.

This volume is a festschrift for Michael Bordo; it contains sixteen papers presented in December 2012 at the Federal Reserve Bank of Cleveland. The conference, organized with the help of Barry Eichengreen, Hugh Rockoff, and Eugene N. White, celebrated both Michael Bordo’s work and the Federal Reserve System’s centennial. It brought together leading economic historians and macroeconomists, and they produced a collection of fascinating papers.

The volume is made more than a collection of papers by the introduction, the first chapter, and the last two chapters. The substantial introduction by Owen F. Humpage (the book’s editor and senior economic advisor in the research department at the Federal Reserve Bank of Cleveland) summarizes each of the papers in the volume and draws out their common themes. (For further summary of the work in this volume, see Williamson 2016.) The first chapter by Barry Eichengreen, “The Uses and Misuses of Economic History,” argues for both the usefulness and potential limitations of historical analogies for informing public policy. It is an ideal first chapter, since the relevance of history to current macroeconomic policy is a more or less explicit theme of all the papers in this collection.

The second-to-last chapter, “Monetary Regimes and Policy on a Global Scale: The Oeuvre of Michael D. Bordo,” by Hugh Rockoff and Eugene N. White summarizes Michael Bordo’s lifetime of work. It is a testament to Bordo’s work that this summary doubles as a review of the causes of the Great Depression, the proper role(s) of a central bank, the operation of the Gold Standard and Bretton Woods system, and the changing frequency of financial crises. Rockoff and White do a particularly nice job of reminding readers of Bordo’s work on the history of economic thought. They make a persuasive argument that Bordo’s attention to past generations of economists was often fruitful; for instance, Bordo’s important 1980 Journal of Political Economy paper on the determinants of price responses to monetary policy shocks grew out of earlier work on the thinking of John Elliot Cairnes (Bordo 1975).

The book fittingly concludes with a short essay by Bordo, “Reflections on the History and Future of Central Banking.” Bordo argues that central banks should confine the use of monetary policy tools to targeting the traditional, pre-2008, goals of low inflation and short-run macroeconomic stability. In the event of a financial crisis, central banks should act as a lender-of-last resort, but should not engage in bailouts of insolvent institutions. Other financial stability concerns, in particular asset prices, are best addressed with different tools. This argument is grounded in history: Bordo argues that macroeconomic outcomes have been best when central banks have acted in this way.

The body of the book contains twelve academic papers. The first, by Marvin Goodfriend (“Federal Reserve Policy Today in Historical Perspective”) traces both the development of transparency in Federal Reserve communication and the Federal Reserve’s focus on inflation. Relatedly, the second paper, by Allan H. Meltzer (“How and Why the Fed Must Change in Its Second Century”), marshals history to argue in favor of rules-based monetary policy.

The next two papers consider the lender-of-last-resort aspect of monetary policy. Mark A. Carlson and David C. Wheelock (“The Lender of Last Resort: Lessons from the Fed’s First 100 Years”) review the history of the Fed as a lender of a last resort; most novel may be the discussion of Fed actions between 1970 and 2000, and the ways in which these foreshadowed those during the 2008 financial crisis. Jon Moen and Ellis Tallman (“Close but Not a Central Bank: The New York Clearing House and Issues of Clearing House Loan Certificates”) reevaluate the effectiveness of clearing house loan certificates for liquidity provision during the pre-Fed National Banking Era (1863-1913). They argue that the New York Clearing House and its clearing house loan certificates were unable to provide the liquidity necessary to effectively address banking crises.

Forrest Capie and Geoffrey Wood (“Central Bank Independence: Can It Survive a Crisis?”) consider how the inevitable strains of a crisis affect central bank independence. Their conclusion is pessimistic. In reviewing the recent history of the Bank of England and the Federal Reserve, they conclude that the 2008 crisis has reduced monetary policy independence.

The next two papers by Peter L. Rousseau (“Politics on the Road to the U.S. Monetary Union”) and Harold James (“U.S. Precedents for Europe”) consider the long and often messy process through which the U.S. achieved political, fiscal, and monetary union. Rousseau draws an optimistic lesson from this history for Europe today, arguing that forces like those that brought about union in the U.S. are at work in Europe. By contrast, James is pessimistic, concluding that “American history shows how difficult and obstacle-filled is the path to federalism” (p. 192).

Christopher M. Meissner in his paper “The Limits of Bimetallism” is also interested in historical parallels to Europe’s current problems. He makes the intriguing — and convincing — argument that France’s transition from bimetallism to the Gold Standard was an example of policymakers’ mistaken belief in the sustainability of the status quo. He concludes that for analogous reasons “European Monetary Union as established in 1999 is very likely to face the fate of bimetallism” (p. 214).

In their essay “The Reserve Pyramid and Interbank Contagion during the Great Depression,” Kris James Mitchener and Gary Richardson consider an often-ignored aspect of the early 1930s financial crisis: interbank deposit flows. Using a remarkable new dataset, they show that in the early 1930s these deposit flows transmitted shocks to financial centers.

John Landon-Lane in his paper “Would Large-Scale Asset Purchases Have Helped in the 1930s? An Investigation of the Responsiveness of Bond Yields from the 1930s to Changes in Debt Levels” considers a counterfactual question: suppose that the Fed had undertaken quantitative easing in the 1930s; what would the effects have been? To answer this question, Landon-Lane examines the relationship between interest rates and large changes in outstanding debt. He concludes that the effect on interest rates of quantitative easing in the 1930s would have been similar to the effect of quantitative easing in recent years.

The final two academic papers relate to an important strand of Michael Bordo’s work: comparison of the U.S. and Canada. Ehsan U. Choudhri and Lawrence L. Schembri’s contribution (“A Tale of Two Countries and Two Booms, Canada and the United States in the 1920s and 2000s: The Roles of Monetary and Financial Stability Policies”) compares U.S. and Canadian monetary policy in the 1920s and 2000s. The description of Canadian monetary policy in the 1920s before there was a central bank will be useful for many. Angela Redish (“It Is History but It’s No Accident: Differences in Residential Mortgage Markets in Canada and the United States”) traces the current large differences between the U.S. and Canadian mortgage markets to differing institutional responses to the Great Depression.

This very brief review of the papers in this volume illustrates the diversity of topics considered. The diversity of methods is also noteworthy, ranging from a formal monetary model to cross-sectional econometrics and narrative evidence. This volume thus serves not only as a superb review of current lessons from monetary history, but also as an introduction to methods used by macroeconomic historians. This will be useful to students and practitioners alike.

References:

Bordo, Michael David. 1975. “John E. Cairnes on the Effects of the Australian Gold Discoveries, 1851-73: An Early Application of the Methodology of Positive Economics,” History of Political Economy, 7:3, pp. 337-359.

Bordo, Michael David. 1980. “The Effects of Monetary Change on Relative Commodity Prices and the Role of Long-Term Contracts,” Journal of Political Economy, 88:6, pp. 1088-1109.

Williamson, Stephen D. 2016. “Current Federal Reserve Policy under the Lens of Economic History: A Review Essay,” Journal of Economic Literature, 54:3, pp. 922-934.

Joshua K. Hausman is assistant professor of public policy and economics at the University of Michigan. He is currently working on understanding the role of agriculture in the initial recovery from the Great Depression.

Copyright (c) 2016 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (September 2016). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):19th Century
20th Century: Pre WWII
20th Century: WWII and post-WWII

The Economic History of Mexico

The Economic History of Mexico

Richard Salvucci, Trinity University

 

Preface[1]

This article is a brief interpretive survey of some of the major features of the economic history of Mexico from pre-conquest to the present. I begin with the pre-capitalist economy of Mesoamerica. The colonial period is divided into the Habsburg and Bourbon regimes, although the focus is not really political: the emphasis is instead on the consequences of demographic and fiscal changes that colonialism brought.  Next I analyze the economic impact of independence and its accompanying conflict. A tentative effort to reconstruct secular patterns of growth in the nineteenth century follows, as well as an account of the effects of foreign intervention, war, and the so-called “dictatorship” of Porfirio Diaz.  I then examine the economic consequences of the Mexican Revolution down through the presidency of Lázaro Cárdenas, before considering the effects of the Great Depression and World War II. This is followed by an examination of the so-called Mexican Miracle, the period of import-substitution industrialization after World War II. The end of the “miracle” and the rise of economic instability in the 1970s and 1980s are discussed in some detail. I conclude with structural reforms in the 1990s, the North American Free Trade Agreement (NAFTA), and slow growth in Mexico since then. It is impossible to be comprehensive and the references appearing in the citations are highly selective and biased (where possible) in favor of English-language works, although Spanish is a must for getting beyond the basics. This is especially true in economic history, where some of the most innovative and revisionist work is being done, as it should be, by historians and economists in Mexico.[2]

 

Where (and What) is Mexico?

For most of its long history, Mexico’s boundaries have been shifting, albeit broadly stable. Colonial Mexico basically stretched from Guatemala, across what is now California and the Southwestern United States, and vaguely into the Pacific Northwest.  There matters stood for more than three centuries[3]. The big shock came at the end of the War of 1847 (“the Mexican-American War” in U.S. history). The Treaty of Guadalupe Hidalgo (1848) ended the war, but in so doing, ceded half of Mexico’s former territory to the United States—recall Texas had been lost in 1836. The northern boundary now ran on a line beginning with the Rio Grande to El Paso, and thence more or less west to the Pacific Ocean south of San Diego. With one major adjustment in 1853 (the Gadsden Purchase or Treaty of the Mesilla) and minor ones thereafter, because of the shifting of the Rio Grande, there it has remained.

Prior to the arrival of the Europeans, Mexico was a congeries of ethnic and city states whose own boundaries were unstable. Prior to the emergence of the most powerful of these states in the fifteenth century, the so-called Triple Alliance (popularly “Aztec Empire”), Mesoamerica consisted of cultural regions determined by political elites and spheres of influence that were dominated by large ceremonial centers such as La Venta, Teotihuacan, and Tula.

While such regions may have been dominant at different times, they were never “economically” independent of one another. At Teotihuacan, there were living quarters given over to Olmec residents from the Veracruz region, presumably merchants. Mesoamerica was connected, if not unified, by an ongoing trade in luxury goods and valuable stones such as jade, turquoise and precious feathers. This was not, however, trade driven primarily by factor endowments and relative costs. Climate and resource endowments did differ significantly over the widely diverse regions and microclimates of Mesoamerica. Yet trade was also political and ritualized in religious belief. For example, calling the shipment of turquoise from the (U.S.) Southwest to Central Mexico the outcome of market activity is an anachronism. In the very long run, such prehistorical exchange facilitated the later emergence of trade routes, roads, and more technologically advanced forms of transport. But arbitrage does not appear to have figured importantly in it.[4]

In sum, what we call “Mexico” in a modern sense is not of much use to the economic historian with an interest in the country before 1870, which is to say, the great bulk of its history. In these years, specificity of time and place, sometimes reaching to the village level, is an indispensable prerequisite for meaningful discussion. At the very least, it is usually advisable to be aware of substantial regional differences which reflect the ethnic and linguistic diversity of the country both before and after the arrival of the Europeans. There are fully ten language families in Mexico, and two of them, Nahuatl and Quiché, number over a million speakers each.[5]

 

Trade and Tribute before the Europeans

In the codices or deerskin folded paintings the Europeans examined (or actually commissioned), they soon became aware of a prominent form of Mesoamerican economic activity: tribute, or taxation in kind, or even labor services. In the absence of anything that served as money, tribute was forced exchange. Tribute has been interpreted as a means of redistribution in a nonmonetary economy. Social and political units formed a basis for assessment, and the goods collected included maize, beans, chile and cotton cloth. It was through the tribute the indigenous “empires” mobilized labor and resources. There is little or no evidence for the existence of labor or land markets to do so, for these were a European import, although marketplaces for goods existed in profusion.

To an extent, the preconquest reliance on barter economies and the absence of money largely accounts for the ubiquity of tribute. The absence of money is much more difficult to explain and was surely an obstacle to the growth of productivity in the indigenous economies.

The tribute was a near-universal attribute of Mesoamerican ceremonial centers and political empires. The city of Teotihuacan (ca. 600 CE, with a population of 125,000 or more) in central Mexico depended on tribute to support an upper stratum of priests and nobles while the tributary population itself lived at subsistence. Tlatelolco (ca 1520, with a population ranging from 50 to 100 thousand) drew maize, cotton, cacao, beans and precious feathers from a wide swath of territory that broadly extended from the Pacific to Gulf coasts that supported an upper stratum of priests, warriors, nobles, and merchants. It was this urban complex that sat atop the lagoons that filled the Valley of Mexico that so awed the arriving conquerors.

While the characterization of tribute as both a corvée and a tax in kind to support nonproductive populations is surely correct, its persistence in altered (i.e., monetized) form under colonial rule does suggest an important question. The tributary area of the Mexica (“Aztec” is a political term, not an ethnic one) broadly comprised a Pacific slope, a central valley, and a Gulf slope. These embrace a wide range of geographic features ranging from rugged volcanic highlands (and even higher snow-capped volcanoes) to marshy, humid coastal plains. Even today, travel through these regions is challenging. Lacking both the wheel and draught animals, the indigenous peoples relied on human transport, or, where possible, waterborne exchange. However we measure the costs of transportation, they were high. In the colonial period, they typically circumscribed the subsistence radius of markets to 25 to 35 miles. Under the circumstances, it is not easy to imagine that voluntary exchange, particularly between the coastal lowlands and the temperate to cold highlands and mountains, would be profitable for all but the most highly valued goods. In some parts of Mexico–as in the Andean region—linkages of family and kinship bound different regions together in a cult of reciprocal economic obligations. Yet absent such connections, it is not hard to imagine, for example, transporting woven cottons from the coastal lowlands to the population centers of the highlands could become a political obligation rather than a matter of profitable, voluntary exchange. The relatively ambiguous role of markets in both labor and goods that persisted into the nineteenth century may perhaps derive from just this combination of climatic and geographical characteristics. It is what made voluntary exchange under capitalistic markets such a puzzlingly problematic answer to the ordinary demands of economic activity.

 

[See the relief map below for the principal physical features of Mexico.]

image1

http://www.igeograf.unam.mx/sigg/publicaciones/atlas/anm-2007/muestra_mapa.php?cual_mapa=MG_I_1.jpg

[See the political map below for Mexican states and state capitals.]

image2

 

 

Used by permission of the University of Texas Libraries, The University of Texas at Austin.

 

“New Spain” or Colonial Mexico: The First Phase

Mexico was established by military conquest and civil war. In the process, a civilization with its own institutions and complex culture was profoundly modified and altered, if not precisely destroyed, by the European invaders. The catastrophic elements of conquest, including the sharp decline of the existing indigenous population, from perhaps 25 million to fewer than a million within a century due to warfare, disease, social disorganization and the imposition of demands for labor and resources should nevertheless not preclude some assessment, however tentative, of its economic level in 1519, when the Europeans arrived.[6]

Recent thinking suggests that Spain was far from poor when it began its overseas expansion. If this were so, the implications of the Europeans’ reactions to what they found on the mainland of Mexico (not, significantly in the Caribbean, and, especially, in Cuba, where they were first established) is important. We have several accounts of the conquest of Mexico by the European participants, of which Bernal Díaz del Castillo is the best known, but not the only one. The reaction of the Europeans was almost uniformly astonishment by the apparent material wealth of Tenochtitlan. The public buildings, spacious residences of the temple precinct, the causeways linking the island to the shore, and the fantastic array of goods available in the marketplace evoked comparisons to Venice, Constantinople, and other wealthy centers of European civilization. While it is true that this was a view of the indigenous elite, the beneficiaries of the wealth accumulated from numerous tributaries, it hardly suggests anything other than a kind of storied opulence. Of course, the peasant commoners lived at subsistence and enjoyed no such privileges, but then so did the peasants of the society from which Bernal Díaz, Cortés, Pedro de Alvarado and the other conquerors were drawn. It is hard to imagine that the average standard of living in Mexico was any lower than that of the Iberian Peninsula. The conquerors remarked on the physical size and apparent robust health of the people whom they met, and from this, scholars such as Woodrow Borah and Sherburne Cook concluded that the physical size of the Europeans and the Mexicans was about the same. Borah and Cook surmised that caloric intake per individual in Central Mexico was around 1,900 calories per day, which certainly seems comparable to European levels.[7]

Certainly, the technological differences with Europe hampered commercial exchange, such as the absence of the wheel for transportation, metallurgy that did not include iron, and the exclusive reliance on pictographic writing systems. Yet by the same token, Mesoamerican agricultural technology was richly diverse and especially oriented toward labor-intensive techniques, well suited to pre-conquest Mexico’s factor endowments. As Gene Wilken points out, Bernardo de Sahagún explained in his General History of the Things of New Spain that the Nahua farmer recognized two dozen soil types related to origin, source, color, texture, smell, consistency and organic content.  They were expert at soil management.[8] So it is possible not only to misspecify, but to mistake the technological “backwardness” of Mesoamerica relative to Europe, and historians routinely have.

The essentially political and clan-based nature of economic activity made the distribution of output somewhat different from standard neoclassical models. Although no one seriously maintains that indigenous civilization did not include private property and, in fact, property rights in humans, the distribution of product tended to emphasize average rather than marginal product. If responsibility for tribute was collective, it is logical to suppose that there was some element of redistribution and collective claim on output by the basic social groups of indigenous society, the clans or calpulli.[9] Whatever the case, it seems clear that viewing indigenous society and economy as strained by population growth to the point of collapse, as the so-called “Berkeley school” did in the 1950s, is no longer tenable. It is more likely that the tensions exploited by the Europeans to divide and conquer their native hosts and so erect a colonial state on pre-existing native entities were mainly political rather than socioeconomic. It was through the assistance of native allies such as the Tlaxcalans, as well as with the help of previously unknown diseases such as smallpox that ravaged the indigenous peoples, that the Europeans were able to place a weakened Tenochtitlan under siege and finally defeat it.

 

Colonialism and Economic Adjustment to Population Decline

With the subjection first of Tenochtitlan and Tlatelolco and then of other polities and peoples, a process that would ultimately stretch well into the nineteenth century and was never really completed, the Europeans turned their attention to making colonialism pay. The process had several components: the modification or introduction of institutions of rule and appropriation; the introduction of new flora and fauna that could be turned to economic use; the reorientation of a previously autarkic and precapitalist economy to the demands of trade and commercial exploitation; and the implementation of European fiscal sovereignty. These processes were complex, required much time, and were, in many cases, only partly successful. There is considerable speculation regarding how long it took before Spain (arguably a relevant term by the mid-sixteenth century) made colonialism pay. The best we can do is present a schematic view of what occurred. Regional variations were enormous: a “typical” outcome or institution of colonialism may well have been an outcome visible in central Mexico. Moreover, all generalizations are fragile, rest on limited quantitative evidence, and will no doubt be substantially modified eventually. The message is simple: proceed with caution.

The Europeans did not seek to take Mesoamerica as a tabula rasa. In some ways, they would have been happy to simply become the latest in a long line of ruling dynasties established by decapitating native elites and assuming control. The initial demand of the conquerors for access to native labor in the so-called encomienda was precisely that, with the actual task of governing be left to the surviving and collaborating elite: the principle of “indirect rule.”[10] There were two problems with this strategy: the natives resisted and the natives died. They died in such large numbers as to make the original strategy impracticable.

The number of people who lived in Mesoamerica has long been a subject of controversy, but there is no point in spelling it out once again. The numbers are unknowable and, in an economic sense, not really important. The population of Tenochtitlan has been variously estimated between 50 and 200 thousand individuals, depending on the instruments of estimation.  As previously mentioned, some estimates of the Central Mexican population range as high as 25 million on the eve of the European conquest, and virtually no serious student accepts the small population estimates based on the work of Angel Rosenblatt. The point is that labor was abundant relative to land, and that the small surpluses of a large tributary population must have supported the opulent elite that Bernal Díaz and his companions described.

By 1620, or thereabouts, the indigenous population had fallen to less than a million according to Cook and Borah. This is not just the quantitative speculation of modern historical demographers. Contemporaries such as Jerónimo de Mendieta in his Historia eclesiástica Indiana (1596) spoke of towns formerly densely populated now witness to “the palaces of those former Lords ruined or on the verge of. The homes of the commoners mostly empty, roads and streets deserted, churches empty on feast days, the few Indians who populate the towns in Spanish farms and factories.” Mendieta was an eyewitness to the catastrophic toll that European microbes and warfare took on the native population. There was a smallpox epidemic in 1519-20 when 5 to 8 million died. The epidemic of hemorrhagic fever in 1545 to 1548 was one of the worst demographic catastrophes in human history, killing 5 to 15 million people. And then again in 1576 to 1578, when 2 to 2.5 million people died, we have clear evidence that land prices in the Valley of Mexico (Coyoacán, a village outside Mexico City, as the reconstructed Tenochtitlán was called) collapsed. The death toll was staggering. Lesser outbreaks were registered in 1559, 1566, 1587, 1592, 1601, 1604, 1606, 1613, 1624, and 1642. The larger point is that the intensive use of native labor, such as the encomienda, had to come to an end, whatever its legal status had become by virtue of the New Laws (1542). The encomienda or the simple exploitation of massive numbers of indigenous workers was no longer possible. There were too few “Indians” by the end of the sixteenth century.[11]

As a result, the institutions and methods of economic appropriation were forced to change. The Europeans introduced pastoral agriculture – the herding of cattle and sheep – and the use of now abundant land and scarce labor in the form of the hacienda while the remaining natives were brought together in “villages” whose origins were not essentially pre- but post-conquest, the so-called congregaciones, at the same time that the titles to now-vacant lands were created, regularized and “composed.”[12] (Land titles were a European innovation as well). Sheep and cattle, which the Europeans introduced, became part of the new institutional backbone of the colony. The natives would continue to rely on maize for the better part of their subsistence, but the Europeans introduced wheat, olives (oil), grapes (wine) and even chickens, which the natives rapidly adopted. On the whole, the results of these alterations were complex. Some scholars argue that the native diet improved even in the face of their diminishing numbers, a consequence of increased land per person and of greater variety of foodstuffs, and that the agricultural potential of the colony now called New Spain was enhanced. By the beginning of the seventeenth century, the combined indigenous, European immigrant, and new mixed blood populations could largely survive on the basis of their own production. The introduction of sheep lead to the introduction and manufacture of woolens in what were called obrajes or manufactories in Puebla, Querétaro, and Coyoacán. The native peoples continued to produce cottons (a domestic crop) under the stimulus of European organization, lending, and marketing. Extensive pastoralism, the cultivation of cereals and even the incorporation of native labor then characterized the emergence of the great estates or haciendas, which became a characteristic rural institution through the twentieth century, when the Mexican Revolution put an end to many of them. Thus the colony of New Spain continued to feed, clothe and house itself independent of metropolitan Spain’s direction. Certainly, Mexico before the Conquest was self-sufficient. The extent to which the immigrant and American Spaniard or creole population depended on imports of wine, oil and other foodstuffs and textiles in the decades immediately following the conquest is much less clear.

At the same time, other profound changes accompanied the introduction of Europeans, their crops and their diseases into what they termed the “kingdom” (not colony, for constitutional reasons) of New Spain.[13] Prior to the conquest, land and labor had been commoditized, but not to any significant extent, although there was a distinction recognized between possession and ownership.  Scholars who have closely examined the emergence of land markets after the conquest—mainly in the Valley of Mexico—are virtually unanimous in this conclusion. To the extent that markets in labor and commodities had emerged, it took until the 1630s (and later elsewhere in New Spain) for the development to reach maturity. Even older mechanisms of allocation of labor by administrative means (repartimiento) or by outright coercion persisted. Purely economic incentives in the form of money wages and prices never seemed adequate to the job of mobilizing resources and those with access to political power were reluctant to pay a competitive wage. In New Spain, the use of some sort of political power or rent-seeking nearly always accompanied labor recruitment. It was, quite simply, an attempt to evade the implications of relative scarcity, and renders the entire notion of “capitalism” as a driving economic force in colonial Mexico quite inexact.

 

Why the Settlers Resisted the Implications of Scarce Labor

The reasons behind this development are complex and varied. The evidence we have for the Valley of Mexico demonstrates that the relative price of labor rose while the relative price of land fell even when nominal movements of one or the other remained fairly limited. For instance, the table constructed below demonstrates that from 1570-75 through 1591-1606, the price of unskilled labor in the Valley of Mexico nearly tripled while the price of land in the Valley (Coyoacán) fell by nearly two thirds. On the whole, the price of labor relative to land increased by nearly 800 percent. The evolution of relative prices would have inevitably worked against the demanders of labor (Europeans and increasingly, creoles or Americans of largely European ancestry) and in favor of the supplier (native labor, or people of mixed race generically termed mestizo). This was not of course what the Europeans had in mind and by capture of legal institutions (local magistrates, in particularly), frequently sought to substitute compulsion for what would have been costly “free labor.” What has been termed the “depression” of the seventeenth century may well represent one of the consequences of this evolution: an abundance of land, a scarcity of labor, and the attempt of the new rulers to adjust to changing relative prices. There were repeated royal prohibitions on the use of forced indigenous labor in both public and private works, and thus a reduction in the supply of labor. All highly speculative, no doubt, but the adjustment came during the central decades of the seventeenth century, when New Spain increasingly produced its own woolens and cottons, and largely assumed the tasks of providing itself with foodstuffs and was thus required to save and invest more.  No doubt, the new rulers felt the strain of trying to do more with less.[14]

 

Years Land Price Index Labor Price Index (Labor/Land) Index
1570-1575 100 100 100
1576-1590 50 143 286
1591-1606 33 286 867

 

Source: Calculated from Rebecca Horn, Postconquest Coyoacan: Nahua-Spanish Relations in Central Mexico, 1519-1650 (Stanford: Stanford University Press, 1997), p. 208 and José Ignacio Urquiola Permisan, “Salarios y precios en la industria manufacturer textile de la lana en Nueva España, 1570-1635,” in Virginia García Acosta, (ed.), Los precios de alimentos y manufacturas novohispanos (México, DF: CIESAS, 1995), p. 206.

 

The overall role of Mexico within the Hapsburg Empire was in flux as well. Nothing signals the change as much as the emergence of silver mining as the principal source of Mexican exportables in the second half of the sixteenth century. While Mexico would soon be eclipsed by Peru as the most productive center of silver mining—at least until the eighteenth century—the discovery of significant silver mines in Zacatecas in the 1540s transformed the economy of the Spanish empire and the character of New Spain’s as well.

 

 

 

Silver Mining

While silver mining and smelting was practiced before the conquest, it was never a focal point of indigenous activity. But for the Europeans, Mexico was largely about silver mining. From the mid- sixteenth century onward, it was explicitly understood by the viceroys that they were to do all in their power to “favor the mines,” as one memorable royal instruction enjoined. Again, there has been much controversy of the precise amounts of silver that Mexico sent to the Iberian Peninsula. What we do know certainly is that Mexico (and the Spanish Empire) became the leading source of silver, monetary reserves, and thus, of high-powered money. Over the course of the colonial period, most sources agree that Mexico provided nearly 2 billion pesos (dollars) or roughly 1.6 billion troy ounces to the world economy. The graph below provides a picture of the remissions of all Mexican silver to both Spain and to the Philippines taken from the work of John TePaske.[15]

page16

Since the population of Mexico under Spanish rule was at most 6 million people by the end of the colonial period, the kingdom’s silver output could only be considered astronomical.

This production has to be considered in both its domestic and international dimensions. From a domestic perspective, the mines were what a later generation of economists would call “growth poles.” They were markets in which inputs were transformed into tradable outputs at a much higher rate of productivity (because of mining’s relatively advanced technology) than Mexico’s other activities. Silver thus became Mexico’s principal exportable good, and remained so well into the late nineteenth century.  The residual claimants on silver production were many and varied.  There were, of course the silver miners themselves in Mexico and their merchant financiers and suppliers. They ranged from some of the wealthiest people in the world at the time, such as the Count of Regla (1710-1781), who donated warships to Spain in the eighteenth century, to individual natives in Zacatecas smelting their own stocks of silver ore.[16] While the conditions of labor in Mexico’s silver mines were almost uniformly bad, the compensation ranged from above market wages paid to free labor in the prosperous larger mines  of the Bajío and the North to the use of forced village  labor drafts in more marginal (and presumably less profitable) sites such as Taxco. In the Iberian Peninsula, income from American silver mines ultimately supported not only a class of merchant entrepreneurs in the large port cities, but virtually the core of the Spanish political nation, including monarchs, royal officials, churchmen, the military and more. And finally, silver flowed to those who valued it most highly throughout the world. It is generally estimated that 40 percent of Spain’s American (not just Mexican, but Peruvian as well) silver production ended up in hoards in China.

Within New Spain, mining centers such as Guanajuato, San Luis Potosí, and Zacatecas became places where economic growth took place rapidly, in which labor markets more readily evolved, and in which the standard of living became obviously higher than in neighboring regions. Mining centers tended to crowd out growth elsewhere because the rate of return for successful mines exceeded what could be gotten in commerce, agriculture and manufacturing. Because silver was the numeraire for Mexican prices—Mexico was effectively on a silver standard—variations in silver production could and did have substantial effects on real economic activity elsewhere in New Spain. There is considerable evidence that silver mining saddled Mexico with an early case of “Dutch disease” in which irreducible costs imposed by the silver standard ultimately rendered manufacturing and the production of other tradable goods in New Spain uncompetitive. For this reason, the expansion of Mexican silver production in the years after 1750 was never unambiguously accompanied by overall, as opposed to localized prosperity. Silver mining tended to absorb a disproportional quantity of resources and to keep New Spain’s price level high, even when the business cycle slowed down—a fact that was to impress visitors to Mexico well into the nineteenth century. Mexican silver accounted for well over three-quarters of exports by value into the nineteenth century as well. The estimates vary widely, for silver was by no means the only, or even the most important source of revenue to the Crown, but by the end of the colonial era, the Kingdom of New Spain probably accounted for 25 percent of the Crown’s imperial income.[17] That is why reformist proposals circulating in governing circles in Madrid in the late eighteenth century fixed on Mexico. If there was any threat to the American Empire, royal officials thought that Mexico, and increasingly, Cuba, were worth holding on to. From a fiscal standpoint, Mexico had become just that important.[18]

 

“New Spain”: The Second Phase                of the Bourbon “Reforms”

In 1700, the last of the Spanish Hapsburgs died and a disputed succession followed. The ensuring conflict, known as the War of Spanish Succession, came to an end in 1714. The grandson of French king Louis XIV came to the Spanish throne as King Philip V. The dynasty he represented was known as the Bourbons. For the next century of so, they were to determine the fortunes of New Spain. Traditionally, the Bourbons, especially the later ones, have been associated with an effort to “renationalize” the Spanish empire in America after it had been thoroughly penetrated by French, Dutch, and lastly, British commercial interests.[19]

There were at least two areas in which the Bourbon dynasty, “reformist” or no, affected the Mexican economy. One of them dealt with raising revenue and the other was the international position of the imperial economy, specifically, the volume and value of trade. A series of statistics calculated by Richard Garner shows that the share of Mexican output or estimated GDP taken by taxes grew by 167 percent between 1700 and 1800. The number of taxes collected by the Royal Treasury increased from 34 to 112 between 1760 and 1810. This increase, sometimes labelled as a Bourbon “reconquest” of Mexico after a century and a half of drift under the Hapsburgs, occurred because of Spain’s need to finance increasingly frequent and costly wars of empire in the eighteenth century. An entire array of new taxes and fiscal placemen came to Mexico. They affected (and alienated) everyone, from the wealthiest merchant to the humblest villager. If they did nothing else, the Bourbons proved to be expert tax collectors.[20]

The second and equally consequential change in imperial management lay in the revision and “deregulation” of New Spain’s international trade, or the evolution from a “fleet” system to a regime of independent sailings, and then, finally, of voyages to and from a far larger variety of metropolitan and colonial ports. From the mid-sixteenth century onwards, ocean-going trade between Spain and the Americas was, in theory, at least, closely regulated and supervised. Ships in convoy (flota) sailed together annually under license from the monarchy and returned together as well. Since so much silver specie was carried, the system made sense, even if the flotas made a tempting target and the problem of contraband was immense. The point of departure was Seville and later, Cadiz. Under pressure from other outports in the late eighteenth century, the system was finally relaxed. As a consequence, the volume and value of trade to Mexico increased as the price of importables fell. Import-competing industries in Mexico, especially textiles, suffered under competition and established merchants complained that the new system of trade was too loose. But to no avail. There is no measure of the barter terms of trade for the eighteenth century, but anecdotal evidence suggests they improved for Mexico. Nevertheless, it is doubtful that these gains could have come anywhere close to offsetting the financial cost of Spain’s “reconquest” of Mexico.[21]

On the other hand, the few accounts of per capita real income growth in the eighteenth century that exist suggest little more than stagnation, the result of population growth and a rising price level. Admittedly, looking for modern economic growth in Mexico in the eighteenth century is an anachronism, although there is at least anecdotal evidence of technological change in silver mining, especially in the use of gunpowder for blasting and excavating, and of some productivity increase in silver mining. So even though the share of international trade outside of goods such as cochineal and silver was quite small, at the margin, changes in the trade regime were important. There is also some indication that asset income rose and labor income fell, which fueled growing social tensions in New Spain. In the last analysis, the growing fiscal pressure of the Spanish empire came when the standard of living for most people in Mexico—the native and mixed blood population—was stagnating. During periodic subsistence crisis, especially those propagated by drought and epidemic disease, and mostly in the 1780s, living standards fell. Many historians think of late colonial Mexico as something of a powder keg waiting to explode. When it did, in 1810, the explosion was the result of a political crisis at home and a dynastic failure abroad. What New Spain had negotiated during the Wars of Spanish Succession—regime change– provide impossible to surmount during the Napoleonic Wars (1794-1815). This may well be the most sensitive indicator of how economic conditions changed in New Spain under the heavy, not to say clumsy hand, of the Bourbon “reforms.”[22]

 

The War for Independence, the Insurgency, and Their Legacy

The abdication of the Bourbon monarchy to Napoleon Bonaparte in 1808 produced a series of events that ultimately resulted in the independence of New Spain. The rupture was accompanied by a violent peasant rebellion headed by the clerics Miguel Hidalgo and José Morelos that, one way or another, carried off 10 percent of the population between 1810 and 1820. Internal commerce was largely paralyzed. Silver mining essentially collapsed between 1810 and 1812 and a full recovery of mining output was delayed until the 1840s. The mines located in zones of heavy combat, such as Guanajuato and Querétaro, were abandoned by fleeing workers. Thus neglected, they quickly flooded.

At the same time, the fiscal and human costs of this period, the Insurgency, were even greater.[23] The heavy borrowings in which the Bourbons engaged to finance their military alliances left Mexico with a considerable legacy of internal debt, estimated at £16 million at Independence. The damage to the fiscal, bureaucratic and administrative structure of New Spain in the face of the continuing threat of Spanish reinvasion (Spain did not recognize the Independence of Mexico (1821)) in the 1820s drove the independent governments into foreign borrowing on the London market to the tune of £6.4 million in order to finance continuing heavy military outlays. With a reduced fiscal capacity, in part the legacy of the Insurgency and in part the deliberate effort of Mexican elites to resist any repetition Bourbon-style taxation, Mexico defaulted on its foreign debt in 1827. For the next sixty years, through a serpentine history of moratoria, restructuring and repudiation (1867), it took until 1884 for the government to regain access to international capital markets, at what cost can only be imagined. Private sector borrowing and lending continued, although to what extent is currently unknown. What is clear is that the total (internal plus external) indebtedness of Mexico relative to late colonial GDP was somewhere in the range of 47 to 56 percent.[24]

This was, perhaps, not an insubstantial amount for a country whose mechanisms of public finance were in what could be mildly termed chaotic condition in the 1820s and 1830s as the form, philosophy, and mechanics of government oscillated from federalist to centralist and back into the 1850s.  Leaving aside simple questions of uncertainty, there is the very real matter that the national government—whatever the state of private wealth—lacked the capacity to service debt because national and regional elites denied it the means to do so. This issue would bedevil successive regimes into the late nineteenth century, and, indeed, into the twentieth.[25]

At the same time, the demographic effects of the Insurgency exacted a cost in terms of lost output from the 1810s through the 1840s. Gaping holes in the labor force emerged, especially in the fertile agricultural plains of the Bajío that created further obstacles to the growth of output. It is simply impossible to generalize about the fortunes of the Mexican economy in this period because of the dramatic regional variations in the Republic’s economy. A rough estimate of output per head in the late colonial period was perhaps 40 pesos (dollars).[26] After a sharp contraction in the 1810s, income remained in that neighborhood well into the 1840s, at least until the eve of the war with the United States in 1846. By the time United States troops crossed the Rio Grande, a recovery had been under way, but the war arrested it. Further political turmoil and civil war in the 1850s and 1860s represented setbacks as well. In this way, a half century or so of potential economic growth was sacrificed from the 1810s through the 1870s. This was not an uncommon experience in Latin America in the nineteenth century, and the period has even been called The Stage of the Great Delay.[27] Whatever the exact rate of real per capita income growth was, it is hard to imagine it ever exceeded two percent, if indeed it reached much more than half that.

 

Agricultural Recovery and War

On the other hand, it is clear that there was a recovery in agriculture in the central regions of the country, most notably in the staple maize crop and in wheat. The famines of the late colonial era, especially of 1785-86, when massive numbers perished, were not repeated. There were years of scarcity and periodic corresponding outbreaks of epidemic disease—the cholera epidemic of 1832 affected Mexico as it did so many other places—but by and large, the dramatic human wastage of the colonial period ceased, and the death rate does appear to have begun to fall. Very good series on wheat deliveries and retail sales taxes for the city of Puebla southeast of Mexico City show a similarly strong recovery in the 1830s and early 1840s, punctuated only by the cholera epidemic whose effects were felt everywhere.[28]

Ironically, while the Panic of 1837 appears to have at least hit the financial economy in Mexico hard with a dramatic fall in public borrowing (and private lending), especially in the capital,[29] an incipient recovery of the real economy was ended by war with the United States. It is not possible to put numbers on the cost of the war to Mexico, which lasted intermittently from 1846 to 1848, but the loss of what had been the Southwest under Mexico is most often emphasized. This may or may not be accurate. Certainly, the loss of California, where gold was discovered in January 1848, weighs heavily on the historical imaginations of modern Mexicans. There is also the sense that the indemnity paid by the United States–$15 million—was wholly inadequate, which seems at least understandable when one considers that Andrew Jackson offered $5 million to purchase Texas alone in 1829.

It has been estimated that the agricultural output of the Mexican “cession” as it was called in 1900, was nearly $64 million, and that the value of livestock in the territory was over $100 million. The value of gold and silver produced was about $35 million. Whether it is reasonable to employ the numbers in estimating the present value of output relative to the indemnity paid is at least debatable as a counterfactual, unless one chooses to regard this as the annuitized value on a perpetuity “purchased” from Mexico at gunpoint, which seems more like robbery than exchange.  In the long run, the loss may have been staggering, but in the short run, much less so. The northern territories Mexico lost had really yielded very little up until the War. In fact, the balance of costs and revenues to the Mexican government may well have been negative.[30]

Whatever the case, the decades following the war with the United States until the beginning of the administration of Porfirio Díaz (1876) are typically regarded as a step backward. The reasons are several. In 1850, the government essentially went broke. While it is true that its financial position had disintegrated since the mid-1830s, 1850 marked a turning point. The entire indemnity payment from the United States was consumed in debt service, but this made no appreciable dent in the outstanding principal, which hovered around 50 million pesos (dollars).  The limits of debt sustainability had been reached: governing was turned into a wild search for resources, which proved fruitless. Mexico continued to sell of parts of its territory, such as the Treaty of the Mesilla (1853), or Gadsden Purchase, whose proceeds largely ended up in the hands of domestic financiers rather than foreign creditors’.[31] Political divisions, if anything, terrible before the war with the United States, turned catastrophic. A series of internal revolts, uprisings and military pronouncements segued into yet another violent civil war between liberals and conservatives—now a formal party—the so-called Three Years’ War (1856-58). In 1862, frustrated by Mexico’s suspension of foreign debt service, Great Britain, Spain and France seized Veracruz. A Hapsburg prince, Maximilian, was installed as Mexico’s second “emperor.” (Agustín de Iturbide was the first). While only the French actively prosecuted the war within Mexico, and while they never controlled more than a very small part of the country, the disruption was substantial. By 1867, with Maximillian deposed and the French army withdrawn, the country required serious reconstruction. [32]

 

Juárez, Díaz and the Porfiriato: authoritarian development.

To be sure, the origins of authoritarian development in nineteenth century Mexico were not with Porfirio Díaz, as is often asserted. Their beginnings actually went back several decades earlier, to the last presidency of Santa Anna, generally known as the Dictatorship (1853-54). But Santa Anna was overthrown too quickly, and now for the last time, for much to have actually occurred. A ministry for development (Fomento) had been created, but the Liberal revolution of Ayutla swept Santa Anna and his clique away for good. Serious reform seems to have begun around 1870, when the Finance Minister was Matías Romero. Romero was intent on providing Mexico with a modern Treasury, and on ending the hand-to- mouth financing that had mostly characterized the country’s government since Independence, or at least since the mid-1830s. So it is appropriate to pick up with the story here. Where did Mexico stand in 1870?[33]

The most revealing data that we have on the state of economic development come from various anthropometric and cost of living studies by Amilcar Challu, Aurora Gómez Galvarriato, and Moramay López Alonso.[34] Their research overlaps in part, and gives a fascinating picture of Mexico in the long run, from 1735 to 1940. For the moment, let us look at the period leading up to 1867, when the French withdrew from Mexico. If we look at the heights of the “literate” population, Challu’s research suggests that the standard of living stagnated between 1750 and 1840. If we look at the “illiterate” population, there was a consistent decline until 1850. Since the share of the illiterate population was clearly larger, we might infer that living standards for most Mexicans declined after 1750, however we interpret other quantitative and anecdotal evidence.

López Alonso confines her work to the period after the 1840s. From 1850 through 1890, her work generally corroborates Challu’s. The period after the Mexican War was clearly a difficult one for most Mexicans, and the challenge that both Juárez and Díaz faced was a macroeconomy in frank contraction after 1850. The regimes after 1867 were faced with stagnation.

The real wage study of by Amilcar Challu and Aurora Gómez Galvarriato, when combined with the existing anthropometric work, offers a pretty clear correlation between movements in real wages (down) and height (falling). [35]

It would then appear growth from the 1850s through the 1870s was slow—if there was any at all—and perhaps inferior to what had come between the 1820s and the 1840s. Given the growth of import substitution during the Napoleonic Wars, roughly 1790-1810, coupled with the commercial opening brought by the Bourbons’   post-1789 extension of “free trade” to Mexico, we might well see a pattern of mixed performance (1790-1810), sharp contraction (the 1810s), rebound and recovery, with a sharp financial shocks coming in the mid-1820s and mid -1830s (1820s-1840s), and stagnation once more (1850s-1870s). Real per capita output oscillated, sometimes sharply, around an underlying growth rate of perhaps one percent; changes in the distribution of income and wealth are more or less impossible to identify consistently, because studies conflict.

Far less speculative is that the foundations for modern economic growth were laid down in Mexico during the era of Benito Juárez. Its key elements were the creation of a secular, bourgeois state and secular institutions embedded in the Constitution of 1857. The titanic ideological struggles between liberals and conservatives were ultimately resolved in favor of a liberal, but nevertheless centralizing form of government under Porfirio Diáz. This was the beginning of the end of the Ancien Regime. Under Juárez, corporate lands of the Church and native villages were privatized in favor of individual holdings and their former owners compensated in bonds. This was effectively the largest transfer of land title since the late sixteenth century (not including the war with the United States) and it cemented the idea of individual property rights. With the expulsion of the French and the outright repudiation of the French debt, the Treasury was reorganized along more modern lines. The country got additional breathing room by the suspension of debt service to Great Britain until the terms of the 1825 loans were renegotiated under the Dublán Convention (1884). Equally, if not more important, Mexico now entered the railroad age in 1876, nearly forty years after the first tracks were laid in Cuba in 1837. The educational system was expanded in an attempt to create at least a core of literate citizens who could adopt the tools of modern finance and technology. Literacy still remained in the neighborhood of 20 percent, and life expectancy at birth scarcely reached 40 years of age, if that. Yet by the end of the Restored Republic (1876), Mexico had turned a corner. There would be regressions, but the nineteenth century had finally arrived, aptly if brutally signified by Juárez’ execution of Maximilian in Querétaro in 1867.[36]

Porfirian Mexico

Yet when Díaz came to power, Mexico was, in many ways, much as it had been a century earlier. It was a rural, agrarian nation whose primary agricultural output per person was maize, followed by wheat and beans. These were produced on haciendas and ranchos in Jalisco, Guanajuato, Michoacán, Mexico, Puebla as well as Oaxaca, Veracruz, Aguascalientes, Chihuahua and Sonora. Cotton, which with great difficulty had begun to supply a mechanized factory regime (first in spinning, then weaving) was produced in Oaxaca, Yucatán, Guerrero and Chiapas as well as in parts of Durango and Coahuila. Domestic production of raw cotton rarely sufficed to supply factories in Michoacán, Querétaro, Puebla and Veracruz, so imports from the Southern United States were common. For the most part, the indigenous population lived on maize, beans, and chile, producing its own subsistence on small, scattered plots known as milpas. Perhaps 75 percent of the population was rural, with the remainder to be found in cities like Mexico, Guadalajara, San Luis Potosí, and later, Monterrey. Population growth in the Southern and Eastern parts of the country had been relatively slow in the nineteenth century. The North and the center North grew more rapidly.  The Center of the country, less so. Immigration from abroad had been of no consequence.[37]

It is a commonplace to see the presidency of Porfirio Díaz (1876-1910) as a critical juncture in Mexican history, and this would be no less true of economic or commercial history as well. By 1910, when the Díaz government fell and Mexico descended into two decades of revolution, the first one extremely violent, the face of the country had been changed for good. The nature and effect of these changes remain not only controversial, but essential for understanding the subsequent evolution of the country, so we should pause here to consider some of their essential features.

While mining and especially, silver mining, had long held a privileged place in the economy, the nineteenth century had witnessed a number of significant changes. Until about 1889, the coinage of gold, silver, and copper—a very rough proxy for production given how much silver had been illegally exported—continued on a steadily upward track. In 1822, coinage was about 10 million pesos. By 1846, it had reached roughly 15 million pesos. There was something of a structural break after the war with the United States (its origins are unclear), and coinage continued upward to about 25 million pesos in 1888. Then, the falling international price of silver, brought on by large increases in supply elsewhere, drove the trend after 1889 sharply downward. By 1909-10, coinage had collapsed to levels previously unrecorded since the 1820s, although in 1904 and 1905, it had skyrocketed to nearly 45 million pesos.[38]

It comes as no surprise that these variations in production corresponded to sharp changes in international relative prices. For example, the market price of silver declined sharply relative to lead, which in turn encountered a large increase in Mexican production and a diversification into other metals including zinc, antinomy, and copper. Mexico left the silver standard (for international transactions, but continued to use silver domestically) in 1905, which contributed to the eclipse of this one crucial industry, which would never again have the status it had when Díaz became president in 1876, when precious metals represented 75 percent of Mexican exports by value. By the time he had decamped in exile to Paris, precious metals accounted for less than half of all exports.

The reason for this relative decline was the diversification of agricultural exports that had been slowly occurring since the 1870s. Coffee, cotton, sugar, sisal and vanilla were the principal crops, and some regions of the country such as Yucatán (henequen) and Durango and Tamaulipas (cotton) supplied new export crops.

 

Railroads and Infrastructure

None of be of this would have occurred without the massive changes in land tenure that had begun in the 1850s, but most of all, without the construction of railroads financed by the migration of foreign capital to Mexico under Díaz. At one level, it is a well-known story of social savings, which were substantial in Mexico because the terrain was difficult and the alternative modes of carriage few. One way or another, transportation has always been viewed as an “obstacle” to Mexican economic development. That must be true at some level, although recent studies (especially by Sandra Kuntz) have raised important qualifications. Railroads may not have been gateways to foreign dependency, as historians once argued, but there were limits to their ability to effect economic change, even internally. They tended to enlarge the internal market for some commodities more than others. The peculiarities of rate-making produced other distortions, while markets for some commodities were inevitably concentrated in major cities or transshipment points which afforded some monopoly power to distributors even as a national market in basic commodities became more of a reality. Yet, in general, the changes were far reaching.[39]

Conventional figures confirm conventional wisdom. When Díaz assumed the presidency, there were 660 km (410 miles) of track. In 1910, there were 19,280 km (about 12,000 miles). Seven major lines linked the cities of Mexico, Veracruz, Acapulco, Juárez, Laredo, Puebla, Oaxaca. Monterrey and Tampico in 1892. The lines were built by foreign capital (e.g., the Central Mexicano was built by the Atchison, Topeka and Santa Fe), which is why resolving the long-standing questions of foreign debt service were critical. Large government subsidies on the order of 3,500 to 8,000 pesos per km were granted, and financing the subsidies amounted to over 30 million pesos by 1890. While the railroads were successful in creating more of a national market, especially in the North, their finances were badly affected by the depreciation of the silver peso, given that foreign liabilities had to be liquidated in gold.

As a result, the government nationalized the railroads in 1903. At the same time, it undertook an enormous effort to construct infrastructure such as drainage and ports, virtually all of which were financed by British capital and managed by “Don Porfirio’s contactor,” Sir Weetman Pearson.  Between railroads, ports, drainage works and irrigation facilities, the Mexican government borrowed 157 million pesos to finance costs.[40]

The expansion of the railroads, the build-out of infrastructure and the expansion of trade would have normally increased output per capita. Any data we have prior to 1930 are problematic, and before 1895, strictly speaking, we have no official measures of output per capita at all. Most scholars shy away from using levels of GDP in any form, other than for illustrative purposes.  Aside from the usual problems attending national income accounting, Mexico presents a few exceptional challenges. In peasant families, where women were entrusted with converting maize into tortilla, no small job, the omission of their value added from GDP must constitute a sizeable defect in measured output. Moreover, as the commercial radius of Mexican agriculture expanded rapidly as railroads, roads, and later, highways spread extensively, growth rates represented increased commercialization rather than increased growth. We have no idea how important this phenomenon was, but it is worth keeping in mind when we look at very rapid growth rates after 1940.

There are various measures of cumulative growth during the Porfiriato. By and large, the figure from 1900 through 1910 is around 23 percent, which is certainly higher than rates achieved during the nineteenth century, but nothing like what was recorded after 1940. In light of declining real wages, one can only assume that the bulk of “progress” flowed to the recipients of property income. This may well have represented a reversal of trends in the nineteenth century, when some argue that property income contracted in the wake of the Insurgency[41].

There was also significant industrialization in Mexico during the Porfiriato. Some industry, especially textiles, had its origins in the 1840s, but its size, scale and location altered dramatically by the end of the nineteenth century. For example, the cotton textile industry saw the number of workers, spindles and looms more than double from the late 1870s to the first decade of the nineteenth century. Brewing and its associated industry, glassmaking, became well established in Monterrey during the 1890s. The country’s first iron and steel mill, Fundidora Monterrey, was established there as well in 1903. Other industries, such as papermaking and cigarettes followed suit. By the end of the Porfiriato, over 10 percent of Mexico’s output was certainly industrial.[42]

 

From Revolution to “Miracle”

The Mexican Revolution (1910-1940) began as a political upheaval provoked by a crisis in the presidential succession when Porfirio Díaz refused to leave office in the wake of electoral defeat after signaling his willingness to do so in a famous pubic interview of 1908.[43] It was also the result of an agrarian uprising and the insistent demand of Mexico’s growing industrial proletariat for a share of political power. Finally, there was a small (fewer than 10 percent of all households) but upwardly mobile urban middle class created by economic development under Díaz whose access to political power had been effectively blocked by the regime’s mechanics of political control. Precisely how “revolutionary” were the results of the armed revolt—which persisted largely through the 1910s and peaked in a civil war in 1914-1915—has long been contentious, but is only tangentially relevant as a matter of economic history. The Mexican Revolution was no Bolshevik movement (of course, it predated Bolshevism by seven years) but it was not a purely bourgeois constitutional movement either, although it did contain substantial elements of both.

From a macroeconomic standpoint, it has become fashionable to argue that the Revolution had few, if any, profound economic consequences. It seems as if the principal reason was that revolutionary factions were interested in appropriating rather than destroying the means of production. For example, the production of crude oil peaked in Mexico in 1915—at the height of the Revolution—because crude oil could be used as a source of income to the group controlling the wells in Veracruz state. This was a powerful consideration.[44]

Yet in another sense, the conclusion that the Revolution had slight economic effects is not only facile, but obviously wrong. As the demographic historian Robert McCaa showed, the excess mortality occasioned by the Revolution was larger than any similar event in Mexican history other than the conquest in the sixteenth century. There has been no attempt made to measure the output lost by the demographic wastage (including births that never occurred), yet even the effect on the population cohort born between 1910 and 1920 is plain to see in later demographic studies.  [45]

There is also a subtler question that some scholars have raised. The Revolution increased labor mobility and the labor supply by abolishing constraints on the rural population such as debt peonage and even outright slavery. Moreover, the Revolution, by encouraging and ultimately setting into motion a massive redistribution of previously privatized land, contributed to an enlarged supply of that factor of production as well. The true impact of these developments was realized in the 1940s and 1950s, when rapid economic growth began, the so-called Mexican Miracle, which was characterized by rates of real growth of as much as 6 percent per year (1955-1966). Whatever the connection between the Revolution and the Miracle, it will require a serious examination on empirical grounds and not simply a dogmatic dismissal of what is now regarded as unfashionable development thinking: import substitution and inward-oriented growth.[46]

The other major consequence of the Revolution, the agrarian reform and the creation of the ejido, or land granted by the Mexican state to rural population under the authority provided it by the revolutionary Constitution on 1917 took considerable time to coalesce, and were arguably not even high on one of the Revolution’s principal instigators, Francisco Madero’s, list of priorities. The redistribution of land to the peasantry in the form of possession if not ownership – a kind of return to real or fictitious preconquest and colonial forms of land tenure – did peak during the avowedly reformist, and even modestly radical presidency of Lázaro Cárdenas (1934-1940) after making only halting progress under his predecessors since the 1920s. From 1940 to 1965, the cultivated area in Mexico grew at 3.7 percent per year and the rise in productivity in basic food crops was 2.8 percent per year.

Nevertheless, the long-run effects of the agrarian reform and land redistribution have been predictably controversial. Under the presidency of Carlos Salinas (1988-1994) the reform was officially declared over, with no further land redistribution to be undertaken and the legal status of the ejido definitively changed. The principal criticism of the ejido was that, in the long run, it encouraged inefficiently small landholding per farmer and, by virtue of its limitations on property rights, made agricultural credit difficult for peasants to obtain.[47]

There is no doubt these are justifiable criticisms, but they have to be placed in context. Cárdenas’ predecessors in office, Alvaro Obregón (1924-1928) and Plutarco Elías Calles (1928-1932) may well have preferred a more commercial model of agriculture with larger, irrigated holdings. But it is worth recalling that one of the original agrarian leaders of the Revolution, Emiliano Zapata, had an uneasy relationship with Madero, who saw the Revolution in mostly political terms, from the start and quickly rejected Madero’s leadership in favor of restoring peasant lands in his native state of Morelos.  Cárdenas, who was in the midst of several major maneuvers that would require widespread popular support—such as the expropriation of foreign oil companies operating in Mexico in March 1938—was undoubtedly sensitive to the need to mobilize the peasantry on his behalf. The agrarian reform of his presidency, which surpassed that of any other, needs to be considered in those terms as well as in terms of economic efficiency.[48]

Cárdenas’ presidency also coincided with the continuation of the Great Depression. Like other countries in Latin America, Mexico was hard hit by the Great Depression, at least through the early 1930s.  All sorts of consumer goods became scarcer, and the depreciation of the peso raised the relative price of imports. As had happened previously in Mexican history (1790-1810, during the Napoleonic Wars and the disruption of the Atlantic trade), in the medium term domestic industry was nevertheless given a stimulus and import substitution, the subsequent core of Mexico’s industrialization program after World War II, was given a decisive boost. On the other hand, Mexico also experienced the forced “repatriation” of people of Mexican descent, mostly from California, of whom 60 percent were United States citizens. The effects of this movement—the emigration of the Revolution in reverse—has never been properly analyzed. The general consensus is that World War II helped Mexico to prosper. Demand for labor and materials from the United States, to which Mexico was allied, raised real wages and incomes, and thus boosted aggregate demand. From 1939 through 1946, real output in Mexico grew by approximately 50 percent. The growth in population accelerated as well as the country began to move into the later stages of the demographic transition, with a falling death rate, while birth rates remained high.[49]

 

From Miracle to Meltdown: 1950-1982  

The history of import substitution manufacturing did not begin with postwar Mexico, but few countries (especially in Latin America) became as identified with the policy in the 1950s, and with what Mexicans termed the emergence of “stabilizing development.” There was never anything resembling a formal policy announcement, although Raúl Prebisch’s 1949 manifesto, “The Economic Development of Latin America and its Principal Problems” might be regarded as supplying one. Prebisch’s argument, that a directed change in the composition of imports toward capital goods to facilitate domestic industrialization was, in essence, the basis of the policy that Mexico followed. Mexico stabilized the nominal exchange rate at 12.5 pesos to the dollar in 1954, but further movement in the real exchange rate (until the 1970s) were unimportant. The substantive bias of import substitution in Mexico was a high effective rate of protection to both capital and consumer goods. Jaime Ros has calculated these rates in 1960 ranged between 47 and 85 percent, and between 33 and 109 percent in 1980. The result, in the short to intermediate run, was very rapid rates of economic growth, averaging 6.5 percent in 1950 through 1973. Other than Brazil, which also followed an import substitution regime, no country in Latin America experienced higher rates of growth. Mexico’s was substantially above the regional average. [50]

[See the historical graph of population growth in Mexico through 2000 below]

page39

Source: Essentially, Estadísticas Históricas de México (various editions since 1999; the most recent is 2014)

http://dgcnesyp.inegi.org.mx/ehm/ehm.htm (Accessed July 20, 2016)

 

But there were unexpected results as well. The contribution of labor to GDP growth was 14 percent. Capital’s contribution was 53 percent, and the remainder, total factor productivity (TFP) 28 percent.[51] As a consequence, while Mexico’s growth occurred through the accumulation of capital, the distribution of income became extremely skewed. The ratio of the top 10 percent of household income to the bottom 40 percent was 7 in 1960, and 6 in 1968. Even supporters of Mexico’s development program, such as Carlos Tello, conceded that it probable that it was the organized peasants and workers experienced an effective improvement of their relative position. The fruits of the Revolution were unevenly distributed, even among the working class.[52]

By “organized” one means such groups as the most important labor union in the country, the CTM (Confederation of Mexican Workers) or the nationally recognized peasant union, the CNC, both of which formed two of the three organized sectors of the official government party, the PRI, or Party of the Institutional Revolution that was organized in 1946. The CTM in particular was instrumental in supporting the official policy of import substitution, and thus benefited from government wage setting and political support. The leaders of these organizations became important political figures in their own right. One, Fidel Velázquez, as both a federal senator and the head of the CTM from 1941 to his death in 1997. The incorporation of these labor and peasant groups into the political system offered the government both a means of control and a guarantee of electoral support. They became pillars of what the Peruvian writer Mario Vargas Llosa famously called “the perfect dictatorship” of the PRI from 1946 to 2000, during which the PRI held a monopoly of the presidency and the important offices of state. In a sense, import substitution was the economic ideology of the PRI.[53]

Labor and economic development during the years of rapid growth is, like many others, a debated subject. While some have found strong wage growth, others, looking mostly at Mexico City, have found declining real wages. Beyond that, there is the question of informality and a segmented labor market. Were workers in the CTM the real beneficiaries of economic growth, while others in the informal sector (defined as receiving no social security payments, meaning roughly two-thirds of Mexican workers) did far less well? Obviously, the attraction of a segmented labor market model can address one obvious puzzle: why would industry substitute capital for labor, as it obviously did, if real wages were not rising? Postulating an informal sector that absorbed the rapid influx of rural migrants and thus held nominal wages steady while organized labor in the CTM got the benefit of higher negotiated wages, but in so doing, limited their employment is an attractive hypothesis, but would not command universal agreement. Nothing has been resolved, at least for the period of the “Miracle.” After Mexico entered a prolonged series of economic crises in the 1980s—here labelled as “meltdown”—the discussion must change, because many hold that the key to relative political stability and the failure of open unemployment to rise sharply can be explained by falling real wages.

The fiscal basis on which the years of the Miracle were constructed was conventional, not to say conservative.[54] A stable nominal exchange rate, balanced budgets, limited public borrowing, and a predictable monetary policy were all predicated on the notion that the private sector would react positively to favorable incentives. By and large, it did. Until the late 1960s, foreign borrowing was considered inconsequential, even if there was some concern on the horizon that it was starting to rise. No one foresaw serious macroeconomic instability. It is worth consulting a brief memorandum from Secretary of State Dean Rusk to President Lyndon Johnson (Washington, December 11, 1968) –to get some insight into how informed contemporaries viewed Mexico. The instability that existed was seen as a consequence of heavy-handedness on the part of the PRI and overreaction in the security forces. Informed observers did not view Mexico’s embrace of import-substitution industrialization as a train wreck waiting to happen. Historical actors are rarely so prescient.[55]

 

Slowing of the Miracle and Echeverría

The most obvious problems in Mexico were political. They stemmed from the increasing awareness that the limits of the “institutional revolution” had been reached, particularly regarding the growing democratic demands of the urban middle classes. The economic problem, which was far from obvious, was that import substitution had concentrated income in the upper 10 per cent of the population, so that domestic demand had begun to stagnate. Initially at least, public sector borrowing could support a variety of consumption subsidies to the population, and there were also efforts to transfer resources out of agriculture via domestic prices for staples such as maize. Yet Mexico’s population was also growing at the rate of nearly 3 percent per year, so that the long term prospects for any of these measures were cloudy.

At the same time, growing political pressures on the PRI, mostly dramatically manifest in the army’s violent repression of student demonstrators at Tlatelolco in 1968 just prior to the Olympics, had convinced some elements in the PRI, people like Carlos Madrazo, to argue for more radical change. The emergence of an incipient guerilla movement in the state of Guerrero had much the same effect. The new president, Luis Echeverría (1970-76), openly pushed for changes in the distribution of income and wealth, incited agrarian discontent for political purposes, dramatically increased government spending and borrowing, and alienated what had typically been a complaisant, if not especially friendly private sector.

The country’s macroeconomic performance began to deteriorate dramatically. Inflation, normally in the range of about 5 percent, rose into the low 20 percent range in the early 1970s. The public sector deficit, fueled by increasing social spending, rose from 2 to 7 percent of GDP. Money supply growth now averaged about 14 percent per year. Real GDP growth had begun to slip after 1968 and in the early 1970s, in deteriorated more, if unevenly. There had been clear convergence of regional economies in Mexico between 1930 and 1980 because of changing patterns of industrialization in the northern and central regions of the country.  After 1980, that process stalled and regional inequality again widened. [56]

While there is a tendency to blame Luis Echeverria for all or most of these developments, this forgets that his administration coincided with the First OPEC oil shock (1973) and rapidly deteriorating external conditions. Mexico had, as yet, not discovered the oil reserves (1978) that were to provide a temporary respite from economic adjustment after the shock of the peso devaluation of 1976—the first change in its value in over 20 years. At the same time, external demand fell, principally transmitted from the United States, Mexico’s largest trading partner, where the economy had fallen into recession in late 1973. Yet it seems reasonable to conclude that the difficult international environment, while important in bring Mexico’s “miracle” period to a close, was not helped by Echeverría’s propensity for demagoguery, of the loss of fiscal discipline that had long characterized government policy, at least since the 1950s. The only question to be resolved was to what sort of conclusion the period would come. The answer, unfortunately, was disastrous.[57]

 

Meltdown: The Debt Crisis, the Lost Decade and After

In contemporary parlance, Mexico had passed from “stabilizing” to “shared” development under Echeverría. But the devaluation of 1976 from 12.5 to 20.5 pesos to the dollar suggested that something had gone awry. One might suppose that some adjustment in course, especially in public spending and borrowing, would have occurred. But precisely the opposite occurred. Between 1976 and 1979, nominal federal spending doubled. The budget deficit increased by a factor of 15. The reason for this odd performance was the discovery of crude oil in the Gulf of Mexico, perhaps unsurprising in light of the spiking prices of the 1970s (the oil shocks of 1973-74, 1978-79), but nevertheless of considerable magnitude. In 1975, Mexico’s proven reserves were 6 billion barrels of oil. By 1978, they had increased to 40 billion. President López Portillo set himself to the task of “administering abundance” and Mexican analysts confidently predicted crude oil at $100 a barrel (when it stood at $37 in current prices in 1980). The scope of the miscalculation was catastrophic. At the same time, encouraged by bank loan pushing and effectively negative real rates of interest, Mexico borrowed abroad. Consumption subsidies, while vital in the face of slowing import substitution, were also costly, and when supported by foreign borrowing, unsustainable, but foreign indebtedness doubled between 1976 and 1979, and even further thereafter.

Matters came to a head in 1982. By then, Mexico’s foreign indebtedness was estimated at over $80 billion dollars, an increase from less than $20 billion in 1975. Real interest rates had begun to rise in the United States in mid-1981, and with Mexican borrowing tied to international rates, debt service rapidly increased. Oil revenue, which had come to constitute the great bulk of foreign exchange, followed international crude prices downward, driven in large part by a recession that had begun in the United States in mid-1981. Within six months, Mexico, too, had fallen into recession. Real per capital output was to decline by 8 percent in 1982.  Forced to sharply devalue, the real exchange rate fell by 50 percent in 1982 and inflation approached 100 percent. By the late summer, Finance Minister Jesus Silva Herzog admitted that the country could not meet an upcoming payment obligation, and was forced to turn to the US Federal Reserve, to the IMF, and to a committee of bank creditors for assistance. In late August, in a remarkable display of intemperance, President López Portillo nationalized the banking system. By December 20, 1982, Mexico’s incoming President, Miguel de la Madrid (1982-88) appeared, beleaguered, on the cover of Time Magazine framed by the caption, “We are in an Emergency.”  It was, as the saying goes, a perfect storm, and with it, the Debt Crisis and the “Lost Decade” in Mexico had begun. It would be years before anything resembling stability, let alone prosperity, was restored. Even then, what growth there was a pale imitation of what had occurred during the decades of the “Miracle.”

 

The 1980s

The 1980s were a difficult decade.[58]  After 1981, annual real per capita growth would not reach 4 percent again until 1989, and in 1986, it fell by 6 percent. In 1987, inflation reached 159 percent. The nominal exchange rate fell by 139 percent in 1986-1987. By the standards of the years of stabilizing development, the record of the 1980s was disastrous. To complete the devastation, on September 19, 1985, the worst earthquake in Mexican history, 7.8 on the Richter Scale, devastated large parts of central Mexico City and killed 5 thousand (some estimates run as high as 25 thousand), many of whom were simply buried in mass graves. It was as if a plague of biblical proportions had struck the country.

Massive indebtedness produced a dramatic decline in the standard of living as structural adjustment occurred. Servicing the debt required the production of an export surplus in non-oil exports, which in turn, required a reduction in domestic consumption. In an effort to surmount the crisis, the government implemented an agreement between organized labor, the private sector, and agricultural producers called the Economic Solidarity Pact (PSE). The PSE combined an incomes policy with fiscal austerity, trade and financial liberalization, generally tight monetary policy, and debt renegotiation and reduction. The centerpiece of the “remaking” of the previously inward orientation of the domestic economy was the North American Free Trade Agreement (NAFTA, 1993) linking Mexico, the United States, and Canada. While average tariff rates in Mexico had fallen from 34 percent in 1985 to 4 percent in 1992—even before NAFTA was signed—the agreement was generally seen as creating the institutional and legal framework whereby the reforms of Miguel de la Madrid and Carlos Salinas (1988-1994) would be preserved. Most economists thought its effects would be relatively larger in Mexico than in the United States, which generally appears to have been the case. Nevertheless, NAFTA has been predictably controversial, as trade agreements are wont to be. The political furor (and, in some places, euphoria) surrounding the agreement have faded, but never entirely disappeared. In the United States in particular, NAFTA is blamed for deindustrialization, although pressure on manufacturing, like trade liberalization itself, was underway long before NAFTA was negotiated. In Mexico, there has been much hand wringing over the fate of agriculture and small maize producers in particular. While none of this is likely to cease, it is nevertheless the case that there has been a large increase in the volume of trade between the NAFTA partners. To dismiss this is, quite plainly, misguided, even where sensitive and well organized political constituencies are concerned. But the legacy of NAFTA, like most everything in Mexican economic history, remains unsettled.

 

Post Crisis: No Miracles

Still, while some prosperity was restored to Mexico by the reforms of the 1980s and 1990s, the general macroeconomic results have been disappointing, not to say mediocre. The average real compensation per person in manufacturing in 2008 was virtually unchanged from 1993 according to the Instituto Nacional De Estadística  Geografía e Informática, and there is little reason to think the compensation has improved at all since then. It is generally conceded that per capita GDP growth has probably averaged not much more than 1 percent a year. Real GDP growth since NAFTA according to the OECD has rarely reached 5 percent and since 2010, it has been well below that.

 

 

Source: http://www.worldbank.org/en/country/mexico (Accessed July 21, 2016). The vertical scale cuts the horizontal axis at 1982

 

For virtually everyone in Mexico, the question is why, and the answers proposed include virtually any plausible factor: the breakdown of the political system after the PRI’s historic loss of presidential power in 2000; the rise of China as a competitor to Mexico in international markets; the explosive spread of narcoviolence in recent years, albeit concentrated in the states of Sonora, Sinaloa, Tamaulipas, Nuevo León and Veracruz; the results of NAFTA itself; the failure of the political system to undertake further structural economic reforms and privatizations after the initial changes of the 1980s, especially regarding the national oil monopoly, Petroleos Mexicanos (PEMEX); the failure of the border industrialization program (maquiladoras) to develop substantive backward linkages to the rest of the economy. This is by no means an exhaustive list of the candidates for poor economic performance. The choice of a cause tends to reflect the ideology of the critic.[59]

Yet it seems that, at the end of the day, the reason why post-NAFTA Mexico has failed to grow comes down to something much more fundamental: a fear of growing, embedded in the belief that the collapse of the 1980s and early 1990s (including the devastating “Tequila Crisis” of 1994-1995, which resulted in a another enormous devaluation of the peso after an initial attempt to contain the crisis was bungled)  was so traumatic and costly as to render event modest efforts to promote growth, let alone the dirigisme of times past, as essentially unwarranted. The central bank, the Banco de México (Banxico) rules out the promotion of economic growth as part of its remit—even as a theoretical proposition, let alone as a goal of macroeconomic policy– and concerns itself only with price stability. The language of its formulation is striking. “During the 1970s, there was a debate as to whether it was possible to stimulate economic growth via monetary policy.  As a result, some governments and central banks tried to reduce unemployment through expansive monetary policy.  Both economic theory and the experience of economies that tried this prescription demonstrated that it lacked validity. Thus, it became clear that monetary policy could not actively and directly stimulate economic activity and employment. For that reason, modern central banks have as their primary goal the promotion of price stability” (translation mine). Banxico is not the Fed: there is no dual mandate in Mexico.[60]

The Mexican banking system has scarcely made things easier. Private credit stands at only about a third of GDP. In recent years, the increase in private sector savings has been largely channeled to government bonds, but until quite recently, public sector deficits were very small, which is to say, fiscal policy has not been expansionary. If monetary and fiscal policy are both relatively tight, if private credit is not easy to come by, and if growth is typically presumed to be an inevitable concomitant to economic stability for which no actor (other than the private sector) is deemed responsible, it should come as no surprise that economic growth over the past two decades has been lackluster.  In the long run, aggregate supply determines real GDP, but in the short run, nominal demand matters: there is no point in creating productive capacity to satisfy demand that does not exist. And, unlike during the period of the Miracle and Stabilizing Development, attention to demand since 1982 has been limited, not to say off the table completely. It may be understandable, but Mexico’s fiscal and monetary authorities seem to suffer from what could be termed, “Fear of Growth.” For better or worse, the results are now on display. After its current (2016) return to a relatively austere budget, it remains to be seen how the economic and political system in contemporary Mexico handles slow economic growth. For that would now seem to be, in a basic sense, its largest challenge for the future.

[1] I am grateful to Ivan Escamilla and Robert Whaples for their careful readings and thoughtful criticisms.

[2] The standard reference work is Sandra Kuntz Ficker, (ed), Historia económica general de México. De la Colonia a nuestros días (México, DF: El Colegio de Mexico, 2010).

[3] Oscar Martinez, Troublesome Border (rev. ed., University of Arizona Press: Tucson, AZ, 2006) is the most helpful general account in English.

[4] There are literally dozens of general accounts of the pre-conquest world. A good starting point is Richard E.W. Adams, Prehistoric Mesoamerica (3d ed., University of Oklahoma Press: Norman, OK, 2005). More advanced is Richard E.W. Adams and Murdo J. Macleod, The Cambridge History of the Mesoamerican Peoples: Mesoamerica. (2 parts, New York: Cambridge University Press, 2000).

[5] Nora C. England and Roberto Zavala Maldonado, “Mesoamerican Languages” Oxford Bibliographies http://www.oxfordbibliographies.com/view/document/obo-9780199772810/obo-9780199772810-0080.xml

(Accessed July 10, 2016)

[6] For an introduction to the nearly endless controversy over the pre- and post-contact population of the Americas, see William M. Denevan (ed.), The Native Population of the Americas in 1492 (2d rev ed., Madison: University of Wisconsin Press, 1992).

[7] Sherburne F Cook and Woodrow Borah, Essays in Population History: Mexico and California (Berkeley, CA: University of California Press, 1979), p. 159.

[8]Gene C. Wilken, Good Farmers Traditional Agricultural Resource Management in Mexico and Central America (Berkeley: University of California Press, 1987), p. 24.

[9] Bernard Ortiz de Montellano, Aztec Medicine Health and Nutrition (New Brunswick, NJ: Rutgers University Press, 1990).

[10] Bernardo García Martínez, “Encomenderos españoles y British residents: El sistema de dominio indirecto desde la perspectiva novohispana”, in Historia Mexicana, LX: 4 [140] (abr-jun 2011), pp. 1915-1978.

[11] These epidemics are extensively and exceedingly well documented. One of the most recent examinations is Rodofo Acuna-Soto, David W. Stahle, Matthew D. Therrell , Richard D. Griffin,  and Malcolm K. Cleaveland, “When Half of the Population Died: The Epidemic of Hemorrhagic Fevers of 1576 in Mexico,” FEMS Microbiology Letters 240 (2004) 1–5. (http:// femsle.oxfordjournals.org/content/femsle/240/1/1.full.pdf, accessed July 10, 2016.) See in particular the exceptional map and table on pp. 2-3.

[12] See in particular, Bernardo García Martínez. Los pueblos de la Sierrael poder y el espacio entre los indios del norte de Puebla hasta 1700 (Mexico, DF: El Colegio de México, 1987) and Elinor G.K. Melville, A Plague of Sheep: Environmental Consequences of the Conquest of Mexico (New York: Cambridge University Press, 1997).

[13] J. H. Elliott, “A Europe of Composite Monarchies,” Past & Present 137 (The Cultural and Political Construction of Europe): 48–71; Guadalupe Jiménez Codinach, “De Alta Lealtad: Ignacio Allende y los sucesos de 1808-1811,” in Marta Terán and José Antonio Serrano Ortega, eds., Las guerras de independencia en la América Española (La Piedad, Michoacán, MX: El Colegio de Michoacán, 2002), p. 68.

[14] Richard Salvucci, “Capitalism and Dependency in Latin America,” in Larry Neal and Jeffrey G. Williamson, eds., The Cambridge History of Capitalism (2 vols.), New York: Cambridge University Press, 2014), 1: pp. 403-408.

[15] Source: TePaske Page, http://www.insidemydesk.com/hdd.html (Accessed July 19, 2016)

[16]  Edith Boorstein Couturier, The Silver King: The Remarkable Life of the Count of Regla in Colonial Mexico (Albuquerque, NM: University of New Mexico Press, 2003).  Dana Velasco Murillo, Urban Indians in a Silver City: Zacatecas, Mexico, 1546-1810 (Stanford, CA: Stanford University Press, 2015), p. 43. The standard work on the subject is David Brading, Miners and Merchants in Bourbon Mexico, 1763-1810 (New York: Cambridge University Press, 1971) But also see Robert Haskett, “Our Suffering with the Taxco Tribute: Involuntary Mine Labor and Indigenous Society in Central New Spain,” Hispanic American Historical Review, 71:3 (1991), pp. 447-475. For silver in China see http://afe.easia.columbia.edu/chinawh/web/s5/s5_4.html (accessed July 13, 2016). For the rents of empire question, see Michael Costeloe, Response to Revolution: Imperial Spain and the Spanish American Revolutions, 1810-1840 (New York: Cambridge University Press, 1986).

[17] This is an estimate. David Ringrose concluded that in the 1780s, the colonies accounted for 45 percent of Crown income, and one would suppose that Mexico would account for at least about half of that. See David R. Ringrose, Spain, Europe and the ‘Spanish Miracle’, 1700-1900 (New York: Cambridge University Press, 1996), p. 93; Mauricio Drelichman, “The Curse of Moctezuma: American Silver and the Dutch Disease,” Explorations in Economic History 42:3 (2005), pp. 349-380.

[18] José Antonio Escudero, El supuesto memorial del Conde de Aranda sobre la Independencia de América) México, DF: Universidad Nacional Autónoma de México, 2014) (http://bibliohistorico.juridicas.unam.mx/libros/libro.htm?l=3637, accessed July 13, 2016)

[19] Allan J. Kuethe and Kenneth J. Andrien, The Spanish Atlantic World in the Eighteenth Century. War and the Bourbon Reforms, 1713-1796 (New York: Cambridge University Press, 2014) is the most recent account of this period.

[20] Richard J. Salvucci, “Economic Growth and Change in Bourbon Mexico: A Review Essay,” The Americas, 51:2 (1994), pp. 219-231; William B Taylor, Magistrates of the Sacred: Priests and Parishioners in Eighteenth Century Mexico (Palo Alto: Stanford University Press, 1996), p. 24; Luis Jáuregui, La Real Hacienda de Nueva España. Su Administración en la Época de los Intendentes, 1786-1821 (México, DF: UNAM, 1999), p. 157.

[21] Jeremy Baskes, Staying AfloatRisk and Uncertainty in Spanish Atlantic World Trade, 1760-1820 (Stanford, CA: Stanford University Press, 2013); Xabier Lamikiz, Trade and Trust in the Eighteenth-century Atlantic World: Spanish Merchants and their Overseas Networks (Suffolk, UK: The Boydell Press., 2013). The starting point of all these studies is Clarence Haring, Trade and Navigation between Spain and the Indies in the Time of the Hapsburgs (Cambridge, MA: Harvard University Press, 1918).

[22] The best, and indeed, virtually unique starting point for considering these changes in their broadest dimensions   are the joint works of Stanley and Barbara Stein: Silver, Trade, and War (2003); Apogee of Empire (2004), and Edge of Crisis (2010), All were published by Johns Hopkins University Press and do for the Spanish Empire what Laurence Henry Gipson did for the First British Empire.

[23] The key work is María Eugenia Romero Sotelo, Minería y Guerra. La economía de Nueva España, 1810-1821 (México, DF: UNAM, 1997)

[24] Calculated from José María Luis Mora, Crédito Público ([1837] México, DF: Miguel Angel Porrúa, 1986), pp. 413-460. Also see Richard J. Salvucci, Politics, Markets, and Mexico’s “London Debt,” 1823-1887 (NY: Cambridge University Press, 2009).

[25] Jesús Hernández Jaimes, La Formación de la Hacienda Pública Mexicana y las Tensiones Centro -Periferia, 1821-1835  (México, DF: El Colegio de México, 2013). Javier Torres Medina, Centralismo y Reorganización. La Hacienda Pública Durante la Primera República Central de México, 1835-1842 (México, DF: Instituto Mora, 2013). The only treatment in English is Michael P. Costeloe, The Central Republic in Mexico, 1835-1846 (New York: Cambridge University Press, 1993).

[26] An agricultural worker who worked full time, 6 days a week, for the entire year (a strong assumption), in Central Mexico could have expected cash income of perhaps 24 pesos. If food, such as beans and tortilla were added, the whole pay might reach 30. The figure of 40 pesos comes from considerably richer agricultural lands around the city of Querétaro, and includes as an average income from nonagricultural employment as well, which was higher.  Measuring Worth would put the relative historic standard of living value in 2010 prices at $1.040, with the caveat that this is relative to a bundle of goods purchased in the United States. (https://www.measuringworth.com/uscompare/relativevalue.php).

[27]The phrase comes from Guido di Tella and Manuel Zymelman. See Colin Lewis, “Explaining Economic Decline: A review of recent debates in the economic and social history literature on the Argentine,” European Review of Latin American and Caribbean Studies, 64 (1998), pp. 49-68.

[28] Francisco Téllez Guerrero, De reales y granos. Las finanzas y el abasto de la Puebla de los Angeles, 1820-1840 (Puebla, MX: CIHS, 1986). Pp. 47-79.

[29]This is based on an analysis of government lending contracts. See Rosa María Meyer and Richard Salvucci, “The Panic of 1837 in Mexico: Evidence from Government Contracts” (in progress).

[30] There is an interesting summary of this data in U.S Govt., 57th Cong., 1 st sess., House, Monthly Summary of Commerce and Finance of the United States (September 1901) (Washington, DC: GPO, 1901), pp. 984-986.

[31] Salvucci, Politics and Markets, pp. 201-221.

[32] Miguel Galindo y Galindo, La Gran Década Nacional o Relación Histórica de la Guerra de Reforma, Intervención Extranjera, y gobierno del archiduque Maximiliano, 1857-1867 ([1902], 3 vols., México, DF: Fondo de Cultura Económica, 1987).

[33] Carmen Vázquez Mantecón, Santa Anna y la encrucijada del Estado. La dictadura, 1853-1855 (México, DF: Fondo de Cultura Económica, 1986).

[34] Moramay López-Alonso, Measuring Up: A History of Living Standards in Mexico, 1850-1950 (Stanford, CA: Stanford University Press, 2012);  Amilcar Challú and Auroro Gómez Galvarriato, “Mexico’s Real Wages in the Age of the Great Divergence, 1730-1930,” Revista de Historia Económica 33:1 (2015), pp. 123-152; Amílcar E. Challú, “The Great Decline: Biological Well-Being and Living Standards in Mexico, 1730-1840,” in Ricardo Salvatore, John H. Coatsworth, and Amilcar E. Challú, Living Standards in Latin American History: Height, Welfare, and Development, 1750-2000 (Cambridge, MA: Harvard University Press, 2010), pp. 23-67.

[35]See Challú and Gómez Galvarriato, “Real Wages,” Figure 5, p. 101.

[36] Luis González et al, La economía mexicana durante la época de Juárez (México, DF: 1976).

[37] Teresa Rojas Rabiela and Ignacio Gutiérrez Ruvalcaba, Cien ventanas a los países de antaño: fotografías del campo mexicano de hace un siglo) (México, DF: CONACYT, 2013), pp. 18-65.

[38] Alma Parra, “La Plata en la Estructura Económica Mexicana al Inicio del Siglo XX,” El Mercado de Valores 49:11 (1999), p. 14.

[39] Sandra Kuntz Ficker, Empresa Extranjera y Mercado Interno: El Ferrocarril Central Mexicano (1880-1907) (México, DF: El Colegio de México, 1995).

[40] Priscilla Connolly, El Contratista de Don Porfirio. Obras públicas, deuda y desarrollo desigual (México, DF: Fondo de Cultura Económica, 1997).

[41] Most notably John Tutino, From Insurrection to Revolution in Mexico: Social Bases of Agrarian Violence, 1750-1940 (Princeton, NJ: Princeton University Press, 1986). p. 229. My growth figures are based on the INEGI, Estadísticas Historicas de México, 2014) (http://dgcnesyp.inegi.org.mx/cgi-win/ehm2014.exe/CI080010, Accessed July 15, 2016).

[42] Stephen H. Haber, Industry and Underdevelopment: The Industrialization of Mexico, 1890-1940 (Stanford, CA: Stanford University Press, 1989); Aurora Gómez-Galvarriato, Industry and Revolution: Social and Economic Change in the Orizaba Valley (Cambridge, MA: Harvard University Press, 2013).

[43] There are literally dozens of accounts of the Revolution. The usual starting point, in English, is Alan Knight, The Mexican Revolution (reprint ed., 2 vols., Lincoln, NE: 1990).

[44] This argument has been made most insistently in Armando Razo and Stephen Haber, “The Rate of Growth of Productivity in Mexico, 1850-1933: Evidence from the Cotton Textile Industry,” Journal of Latin American Studies 30:3 (1998), pp. 481-517.

[45]Robert McCaa, “Missing Millions: The Demographic Cost of the Mexican revolution,” Mexican Studies/Estudios Mexicanos 19:2 (Summer 2003): 367-400; Virgilio Partida-Bush, “Demographic Transition, Demographic Bonus, and Ageing in Mexico, “ Proceedings of the United Nations Expert Group Meeting on Social and Economic Implications of Changing Population Age Structures. (http://www.un.org/esa/population/meetings/Proceedings_EGM_Mex_2005/partida.pdf) (Accessed July 15, 2016), pp. 287-290.

[46] An implication of the studies of Alan Knight, and of Clark Reynolds, The Mexican Economy: Twentieth Century Structure and Growth (New Haven, CT: Yale University Press, 1971).

[47] An interesting summary of revisionist thinking on the nature and history of the ejido appears in Emilio Kuri, “La invención del ejido, Nexos, January 2015.

[48]Alan Knight, “Cardenismo: Juggernaut or Jalopy?” Journal of Latin American Studies, 26:1 (1994), pp. 73-107.

[49] Stephen Haber, “The Political Economy of Industrialization,” in Victor Bulmer-Thomas, John Coatsworth, and Roberto Cortes-Conde, eds., The Cambridge Economic History of Latin America (2 vols., New York: Cambridge University Press, 2006), 2:  537-584.

[50]Again, there are dozens of studies of the Mexican economy in this period. Ros’ figures come from “Mexico’s Trade and Industrialization Experience Since 1960: A Reconsideration of Past Policies and Assessment of Current Reforms,” Kellogg Institute (Working Paper 186, January 1993). For a more general study, see Juan Carlos Moreno-Brid and Jaime Ros, Development and Growth in the Me3xican Economy. A Historical Perspective (New York: Oxford University Press, 2009). A recent Spanish language treatment is Enrique Cárdenas Sánchez, El largo curso de la economía mexicana. De 1780 a nuestros días (México, DF: Fondo de Cultura Económica, 2015). A view from a different perspective is Carlos Tello, Estado y desarrollo económico. México 1920-2006 (México, DF, UNAM, 2007).

[51]André A. Hoffman, Long Run Economic Development in Latin America in a Comparative Perspective: Proximate and Ultimate Causes (Santiago, Chile: CEPAL, 2001), p. 19.

[52]Tello, Estado y desarrollo, pp. 501-505.

[53] Mario Vargas Llosa, “Mexico: The Perfect Dictatorship,” New Perspectives Quarterly 8 (1991), pp. 23-24.

[54] Rafael Izquierdo, Política Hacendario del Desarrollo Estabilizador, 1958-1970 (México, DF: Fondo de Cultura Económica, 1995. The term stabilizing development was itself termed by Izquierdo as a government minister.

[55]See Foreign Relations of the United States, 1964-1968. Mexico and Central America http://2001-2009.state.gov/r/pa/ho/frus/johnsonlb/xxxi/36313.htm (Accessed July 15, 2016).

[56] José Aguilar Retureta, “The GDP Per Capita of the Mexican Regions (1895:1930): New Estimates, Revista de Historia Económica, 33: 3 (2015), pp. 387-423.

[57] For a contemporary account with a sense of the immediacy of the end of the Echeverría regime, see “Así se devaluó el peso,” Proceso, November 13, 1976.

[58] The standard account is Stephen Haber, Herbert Klein, Noel Maurer, and Kevin Middlebrook, Mexico since 1980 (New York: Cambridge University Press, 2008). A particularly astute economic account is Nora Lustig, Mexico: The Remaking of an Economy (2d ed., Washington, DC: The Brookings Institution, 1998).  But also Louise E. Walker, Waking from the Dream. Mexico’s Middle Classes After 1968 (Stanford, CA: Stanford University Press, 2013).

[59] See, for example, Jaime Ros Bosch, Algunas tesis equivocadas sobre el estancamiento económico de México (México, DF: El Colegio de México, 2013).

[60] La Banca Central y la Importancia de la Estabilidad Económica  June 16, 2008.  (http://www.banxico.org.mx/politica-monetaria-e-inflacion/material-de-referencia/intermedio/politica-monetaria/%7B3C1A08B1-FD93-0931-44F8-96F5950FC926%7D.pdf, Accessed July 15, 2016.). Also see Brian Winter, “This Man is Brilliant: So Why Doesn’t Mexico’s Economy Grow Faster?” Americas Quarterly (http://americasquarterly.org/content/man-brilliant-so-why-doesnt-mexicos-economy-grow-faster) (Accessed July 21, 2016)

 

 

Hall of Mirrors: The Great Depression, the Great Recession, and the Uses — and Misuses — of History

Author(s):Eichengreen, Barry
Reviewer(s):Rockoff, Hugh

Published by EH.Net (February 2016)

Barry Eichengreen, Hall of Mirrors: The Great Depression, the Great Recession, and the Uses — and Misuses — of History. New York: Oxford University Press, 2015. vi + 512 pp. $30 (hardcover), ISBN: 978-0-19-939200-1.

Reviewed for EH.Net by Hugh Rockoff, Department of Economics, Rutgers University.
Barry Eichengreen knows as much or more about the financial history of the Great Depression as any living economic historian, and it shows in this splendid new book which compares the Great Recession with the Great Depression. The U.S. story, on which I will focus here, is the centerpiece, but as might be expected from Eichengreen, what happened in the rest of the world is also explored in detail. Eichengreen’s thesis is straightforward. In 2008 the United States, and with it the rest of the world, was headed for another Great Depression. Thanks to strong doses of monetary and fiscal stimulus, and lender-of-last-resort operations, especially in the United States, a second Great Depression was averted. Ideas were important: Much of the success can be attributed to John Maynard Keynes, Milton Friedman, and Anna Schwartz, and the lessons they drew from the Great Depression. But there was a downside to success. Because of the severity of the crisis in the 1930s the financial system underwent a massive reform that put it in a tough but effective straightjacket. The Great Recession was milder; politicians and lobbyists who opposed strict regulation regrouped, and the reforms were moderate at best. The Great Depression and the Great Recession were separated by eighty years, a long period of financial stability produced, according to Eichengreen, by New Deal financial reforms. But, he concludes, because the damage done by deregulation was only partly undone, “we are likely to see another such crisis in less than eighty years (p. 387).”

The analysis in the book is rigorous. Nevertheless, Eichengreen has written a book that can be read by policy makers, journalists, and the famous, and hopefully numerous, intelligent layperson. There are no charts, tables, or equations. Indeed, it would make a good textbook for an undergraduate course on the financial crisis. Eichengreen writes clearly. And he has sprinkled the text with biographical snippets that both inform and entertain. We meet William Jennings Bryan in the 1920s when he is using his oratorical skills to sell real estate in Florida; and we meet Charles Dawes, prominent banker, Vice President, Nobel Peace Prize winner (for his work on German Reparations), and composer of the melody for “It’s All in the Game.”

To make his case that the two crises were similar except for actions taken by governments, Eichengreen recounts both crises and identifies one parallel after another. The 1920s had Charles Ponzi; we had Bernie Madoff. In the 1920s the head of the Bank of England, Montagu Norman, was given, perhaps unconsciously, to “constructive ambiguity” (p. 23); we had Alan Greenspan. The 1920s witnessed the Florida land boom; we had subprime mortgages. Charles Dawes’s bank got needed assistance from the Reconstruction Finance Corporation, but the Guardian Group in Detroit was allowed to fail; we had Bear Stearns and Lehman Brothers. And this is just a taste. Eichengreen adds many, many more. Indeed, the parallels come so thick and fast that one is reminded of the phrase Albert Einstein used to describe two distant particles that were thought to be entangled: “spooky action at a distance.”

The book is divided into four parts. Part I, “The Best of Times,” consists of six chapters that cover the 1920s and the first decade of our century.  Here we learn (without attempting to be exhaustive) about real estate booms in the twenties, the attempt after World War I to reconstruct the gold standard, the repeated attempts to solve the German reparations problem, the Smoot-Hawley tariff, and the U.S. Stock market bubble. Then Eichengreen turns to our era and describes financial deregulation, the subprime mortgage boom, the expansion of the shadow banking sector, and the spread of this type of banking to Europe. Eichengreen doesn’t present new, controversial interpretations of events. Rather he presents conclusions based on careful readings of the available literature including the latest work by economic historians. What is new is the web of parallels he draws between the two crises. Others, of course, have noted the similarities, not the least Ben Bernanke as he wrestled with the crisis; but no one has created such a large catalog of parallels.

In Part II, “The Worst of Times,” nine chapters in all, we learn first about the stock market crash in 1929, the banking crises of 1930-33, and the spread of the Great Depression to Europe. Then he turns to the Great Recession: Bear Stearns, Lehman Brothers, AIG and all that, and the spread of the crisis to Europe.

In the seven chapters of Part III, “Toward Better Times,” we learn about Roosevelt’s attempts to revive the economy: the National Industrial Recovery Act, the Reconstruction Finance Corporation, Federal Reserve Policy in the 1930s, and Roosevelt’s conflicted ideas about budget deficits. European responses to the crisis are also discussed at length, and Japan’s Korekiyo Takahashi is celebrated as the finance minister who got it right. Takahashi, aided it must be said by costly Japanese military adventures, authorized a heavy dose of money-financed deficit spending and the result was the best economic performance among the industrial nations. Eichengreen then turns to our crisis: zero interest rates, quantitative easing, bailouts, and the fiscal stimulus. The argument is usually that what the government did helped, but more should have been done.

In Part IV, “Avoiding the Next Time,” Eichengreen focusses particularly on Dodd-Frank and the Euro. His main efforts are directed at explaining why so little was done to prevent another crisis. A number of potential reforms get favorable mentions: consolidation of regulatory agencies, higher capital requirements for financial institutions, and regulations that limit risk taking. But Eichengreen doesn’t rank possible reforms or explain in detail how they would work. Here I wanted Eichengreen to go on a bit, and tell us more about his ideas on what should have and presumably still can be done to prevent another crisis. His approach to Glass-Steagall is an example of his above the fray stance toward regulation. Eichengreen mentions Glass-Steagall, and the separation of commercial from investment banking many times — one chapter is titled “Shattered Glass.” He rejects the argument made mostly forcefully by Andrew Ross Sorkin (2012) — although it is one that must have occurred to many observers — that ending the separation of commercial and investment banking didn’t have much to do with causing the crisis. After all, Merrill Lynch, Bear Stearns, and Lehman brothers were not branches of commercial banks when they went off the rails. And AIG was an insurance company. Eichengreen tells us that ending Glass Steagall was “indicative of a trend” (p. 424), which it surely was, but he seems to feel that it was more than that. Here I would have liked to learn more about Eichengreen’s ideas about how ending Glass-Steagall undermined the system. Did it create moral hazard, because firms knew they could merge with a bank if they got in trouble? Or was it some other mechanism? And more urgently, I would have liked to have read more about Eichengreen’s views on how high a priority restoring Glass-Steagall should be, and where the lines should be drawn.

Comment and Conclusion

Eichengreen’s book is a synthesis. It pulls together an enormous body of studies by economic historians, policy makers, and journalists. Specialists in financial history will be familiar with many parts of the story. But I doubt there are any who will not learn a great deal from reading Eichengreen’s account. While I was persuaded by most of Eichengreen’s arguments I did have a recurring concern about how far we can go as social scientists, as opposed to policy advocates, in making assertions about what would have happened if alternative policies had been followed on the basis of two observations. It is one thing to claim that without aggressive monetary and fiscal actions and bailouts we might have ended up in another Great Depression.  And for me, as I suspect for most of us, that possibility justifies much of what was done. Even, say, a one-third chance of another Great Depression makes pulling out the stops worthwhile. But that claim is very different from the claim that we would have ended up in a Great Depression if less had been done. The truth is that we can’t be sure what path the economy would have followed if less had been done, or where we would be today.

Consider the following table which shows unemployment after four financial panics. When you compare 2008 only with 1930, it seems clear that we did a lot a better after the panic of 2008, and the things we did in 2008 “worked” at least up to a point: We avoided a Great Depression. On the other hand, we did, arguably, worse after 2008 than after the panic of 1907 when help for the economy was provided mainly through the circumscribed lender-of last-resort actions undertaken by J.P. Morgan.  And we did almost exactly the same as after the crisis of 1893, when only some limited stimulus came well after the crisis in the form of gold inflows and spending on the Spanish-American War. In fact, the 2008 and 1893 unemployment rates are so similar that it looks like another case of “spooky action at a distance.”

2008 1930 1907 1893
-1 4.6 2.9 2.5 4.3
0 5.8 8.9 3.1 6.8
1 9.3 15.7 7.5 9.3
2 9.6 22.9 5.7 8.5
3 8.9 20.9 5.9 9.3
4 8.1 16.2 7.0 8.5
5 7.4 14.4 5.9 7.8
6 6.2 10.0 5.7 5.9
7 5.3 9.2 8.5 5.0

Source: Historical Statistics of the United States, Millennial Edition: Volume 2, Work and Welfare, series Ba475 for 1893, 1907, and 1930 (pp. 2-82 and 2-83), and the standard Bureau of Labor Statistics series for 2008.

My point is not that 1893 is necessarily a better analog than 1930. One could argue the point, but I don’t think we know. Constructing a counterfactual macroeconomic history of a financial crisis and recession is essentially an exercise in forecasting, and we economists are just not very good at macroeconomic forecasting. We are in the position, I believe, of physicians in days gone by: we have some drugs that experience tells us sometimes relieve pain and suffering. But how they work and why they work in some cases and not in others, and what the long-run side effects are – we have some ideas we can discuss, or more likely debate, but the bottom line is that we don’t know.

(If we were entangled with the Depression of 1890s, we would want to know what happened in 1901 the year that corresponds to 2016. Among other things, 1901 began with a slide on the stock market of about 9%. Sound familiar?! Despite a spring rally the market finished the year off by about the same percentage. By the way, this is just an observation; I am not giving investment advice.)

Many excellent books and articles have been written about the financial crisis of 2008 and there will undoubtedly be many more. Gary Gorton’s papers and books and Ben Bernanke’s memoir immediately spring to mind, but the list of good books and articles is already a long one. There is nothing like a financial crisis to concentrate the minds of economists. However, if financial history is not your thing, and you want to read just one book about the financial crisis, you couldn’t do better than Hall of Mirrors.

Reference:

Andrew Ross Sorkin, “Reinstating an Old Rule Is Not a Cure for Crisis” New York Times, May 21, 2012. http://dealbook.nytimes.com/2012/05/21/reinstating-an-old-rule-is-not-a-cure-for-crisis/?_r=0.

Hugh Rockoff is Distinguished Professor of Economics at Rutgers University and a Research Associate with the National Bureau of Economic Research.

Copyright (c) 2016 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (February 2016). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Macroeconomics and Fluctuations
Geographic Area(s):General, International, or Comparative
Europe
North America
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Strained Relations: U.S. Foreign-Exchange Operations and Monetary Policy in the Twentieth Century

Author(s):Bordo, Michael D.
Humpage, Owen F.
Schwartz, Anna J.
Reviewer(s):Edison, Hali J.

Published by EH.Net (August 2015)

Michael D. Bordo, Owen F. Humpage and Anna J. Schwartz, Strained Relations: U.S. Foreign-Exchange Operations and Monetary Policy in the Twentieth Century.  Chicago: University of Chicago Press, 2015. x + 442 pp. $97.50 (cloth), ISBN: 978-0-226-05148-2.

Reviewed for EH.Net by Hali J. Edison, International Monetary Fund.

This book is clearly destined to become a classic, leaving a mark on future research on foreign-exchange operations. In 1990, Michael Bordo (Rutgers University and NBER) and Anna Schwartz (NBER) began their collaboration to document the evolution of U.S. intervention. Ten years later, Owen Humpage of the Federal Reserve Bank of Cleveland joined the team. Regrettably, in 2012, before the book was finalized Anna Schwartz passed away.

The book explores the evolution of foreign-exchange intervention in the United States in the twentieth century. During this period, the United States transitioned from participating in the international gold standard regime to fixed exchange rates (“dollar standard”) and finally to a regime of floating exchange rates. Policymakers around the world during this period grappled with the choice of exchange rate regime, the role of monetary policy, and international capital mobility — often referred to as the trilemma. The book traces the changes in U.S. institutional arrangements and policymakers’ thinking to the economic and political events drawing extensively from Federal Reserve documents.

Chapter 1 lays out the plan of the book. It starts by describing how attitudes about foreign-exchange intervention and monetary policy evolved over the decades and how this was eventually reflected in theories of intervention and institutional arrangements.

Chapter 2 explains that the model for modern foreign-exchange-market operations can be linked to the operations under the gold standard. The authors argue that the historical evolution of exchange-market operations before 1934 yields important insights into understanding modern-day practices. For instance, the chapter illustrates early uses of secrecy, sterilization, and forward transactions, all of which became important methods of modern intervention.

The creation of the Exchange Stabilization Fund (ESF) in the United States is described in Chapter 3. This chapter was written by Anna Schwartz and maintains the same rich details as contained in her 1963 seminal book with Milton Friedman, A Monetary History of the United States, 1867-1960. It clarifies the role of the ESF and elaborates on the institutional arrangements. Two key features of the ESF are that it is under exclusive control of the U.S. Secretary of the Treasury and is self-financing, such that ESF funding is outside of the congressional appropriation process.

After outlining the background of the institutional arrangements, chapters 4 through 6 discuss the evolution of U.S. foreign-exchange operations since the end of World War II. Each of the chapters captures a distinct episode, describing the economic and political developments and the evolution of institutional arrangements. Chapters 5 and 6 also evaluate the effectiveness of U.S. intervention, drawing heavily from the methodology laid out in research conducted by the authors.

Chapter 4 focuses on the Bretton Woods era from 1944 to 1973. During this period countries attempted to maintain par values for their currencies, promote free cross-border financial flows, and achieve domestic macroeconomic objectives such as full employment. Intervention was one of the policy instruments used to achieve these objectives. According to the authors, intervention may have been successful in the sense that it delayed the disintegration of the Bretton Woods system but it did not fix the problem: Current account surplus countries did not want to undermine their domestic macroeconomic objectives to maintain fixed exchange rates.

Chapter 5 covers the foreign-exchange-market operations during the early float period (1973 to 1981). On March 12, 1973, the Bretton Woods era fixed-exchange-rate system ended. During much of the period, policymakers viewed that foreign-exchange markets were subject to bouts of disorder, requiring intervention to direct the exchange rate along a path they viewed consistent with their domestic policy objectives. The chapter describes the evolution of the institutional arrangement, including the Federal Reserve’s swap line with the U.S. Treasury, known as the warehousing facility.

Chapter 6 considers the currency operations and the ongoing debates during the Volcker and Greenspan era (1981 to 1997). Early in the period, between 1981 and 1985, the U.S. adopted a minimalist approach that was spearheaded by the U.S. Treasury. As the dollar strengthened in 1985, the United States assumed an activist approach, intervening frequently. The chapter includes details of the 1983 Jurgensen Report, commissioned by G7 officials to study intervention. In addition, it provides a rich discussion of the 1989-1990 conversation within the Federal Reserve of its involvement in U.S. intervention operations, partly reflecting the report from a staff Task Force on System Foreign Exchange Operations. The United States essentially stopped intervening in the mid-1990s, but has never officially ruled out intervention.

Overall, this book describes the evolution of U.S. policy regarding currency-market interventions, the institutional arrangements, and the interaction of currency-market policy with monetary policy. It documents how U.S. intervention and exchange rate policy changed over time, reflecting a learning process. The work leaves open many interesting doors for more analysis that could and should engage future scholars.

Hali J. Edison (Hedison@imf.org), International Monetary Fund, is author of The Effectiveness of Central-Bank Intervention: A Survey of the Literature after 1982 (Special Papers in International Economics, Princeton University Press).

Copyright (c) 2015 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (August 2015). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: WWII and post-WWII

Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as Decisive Leader

Author(s):Toma, Mark
Reviewer(s):Smith, Daniel J.

Published by EH.Net (May 2015)

Mark Toma, Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as Decisive Leader. New York: Palgrave Macmillan, 2013. xix + 214 pp. $115 (hardcover), ISBN: 978-1-137-37254-3.

Reviewed for EH.Net by Daniel J. Smith, Department of Economics, Troy University.

Mark Toma’s short, but dense Monetary Policy and the Onset of the Great Depression: The Myth of Benjamin Strong as a Decisive Leader provides a revisionist history of the Benjamin Strong leadership years at the Fed leading up the Great Depression. Despite the title, the book focuses entirely on this period and doesn’t delve into the actual causes of the Great Depression. Rather than provide a casual explanation of the Great Depression per se, Toma’s project is to convince monetarist and Austrian economists that both of their accepted histories of the Great Depression are empirically unfounded. Thus, Toma argues that mismanaged monetary policy — tightening per the monetarist narrative or loosening per the Austrian narrative — can be ruled out as a causal factor of the Great Depression.

In questioning the Strong decisive leader theory — the theory that Benjamin Strong played a decisive role in the monetary policies of the 1920’s as the President of the influential New York Federal Reserve Bank and that his untimely death ultimately led to the wrong-headed policies that brought on the Great Depression — Toma does not stand alone. Temin (1989, 35), Wheelock (1992), and Brunner and Meltzer (1968) all question the strong leader hypothesis. However, Toma discredits each of their theories and forges a completely new explanation for why Strong’s leadership was not a decisive factor. Toma makes the case that the Fed operated as a self-regulating, decentralized system. According to Toma, this system operated effectively as intended, so the credit for Friedman and Schwartz’s (1963, Ch. 6) description of the 1921-1929 Fed era as the “high tide” of the Fed system should go to the founders of the Fed, not Benjamin Strong.

Overall, the book would have benefitted from a more thorough engagement with the modern literature. Instead of addressing modern developments and more nuanced and refined arguments in the monetarist and Austrian tradition, Toma sets up the book against the narratives of Rothbard (1975) and Friedman and Schwartz (1963).

Modern accounts have certainly built upon and improved upon Rothbard’s America’s Great Depression (e.g., Garrison 1999; White 2012; Eichengreen and Mitchener 2003; Laidler 2003). In addition, modern Austrians have also made sure to note that the monetarist and Austrian narrative aren’t mutually exclusive or contradictory (Horwitz 2012; Selgin 2013). As Eichengreen and Mitchener (2003, 53) put it, “a horse-race is not the appropriate context in which to assess theories of the Great Depression. The Depression was a complex and multifaceted event.” While Toma addresses the distinctive Austrian and monetarist explanation, he does not address this modern synthetic narrative.
On a similar note, monetarists and new Keynesians have also built upon and improved the monetarist account beyond Friedman and Schwartz (1963) (e.g., Romer 1993; Bordo, Erceg, and Evans 2000; Hall and Ferguson 1998). A third explanation, real factor productivity, is left unexamined by Toma (Kehoe and Prescott 2007; Cole and Ohanian 2001; Temin 1976; Gordon and Wilcox 1981). Finally, Toma also leaves out important new developments in the literature on the Great Depression from a comparative institutions framework examining the experiences of other countries during the Great Depression (Bernanke 1995). Toma certainly levies some convincing challenges to the above literature, but by not specifically addressing it in this book he leaves a lot of territory uncovered.

While the book provides a thorough theoretical and empirical case for Toma’s contention, it lacks convincing anecdotal evidence, especially in regard to the Fed’s independence, which does not seem to support Toma’s narrative of Fed self-regulation. Given the difficulties of empirically measuring these types of influences on monetary policy, supplemental anecdotal evidence is necessary (Smith and Boettke, forthcoming).

For instance, the independence of the Fed was undermined immediately during World War I (Hanna 1936; Mehrling 2011, Ch. 2; Eichengreen 1992; Meltzer 2003, Ch. 3). As Friedman and Schwartz (1963, 216) argue, “The Federal Reserve became to all intents and purposes the bond-selling window of the Treasury, using its monetary powers almost exclusively to that end.”  Many early Fed Board members actually held the opinion that the Fed was just “an adjunct of the Treasury Department rather than an independent body” after this encroachment of their independence (Kettl 1986, 25). In fact, the Board meetings were actually held in the Treasury Department and the Secretary of Treasury was the Chairperson of the Board ex officio until the Banking Act of 1935 (Havrilesky 1995, 44; Kettl 1986, 24). According Benjamin Strong, if the Fed did not deliver the desired Treasury support, it would have been “an invitation to Congress to have their power modified — a perfectly unthinkable and most dangerous possibility” (as quoted in Kettl 1986, 26-7).

Pressures from the executive branch, legislative branch, and the Treasury were all exerted on the Fed to provide easy monetary policy even following World War I. The Treasury used its positions on the Fed Board to ensure that the price of government bonds didn’t fall (Eichengreen 1992, 114; Friedman and Schwartz 1963, 223-4, 228; Havrilesky 1995, 44).  For instance, the Secretary of the Treasury, Carter Glass, threatened to have Benjamin Strong removed from office by the President when Strong threatened to raise rates without the approval of the Board (Clifford 1965, 114-6). From the legislative branch, strong pressure from agricultural interests to keep interest rates low resulted in the introduction of an agricultural member on the Board and the inclusion of nine month’s agriculture paper in the rediscounting facilities of the Reserve Banks (Hanna 1936, 623; Meltzer 2003, 114). As Meltzer (2003, 132) summarizes, “Congressmen from agricultural areas, particularly in the South and West, were highly critical of the higher discount rates in those regions. Bills were introduced limiting the System’s [Fed’s] ability to increase rates. The Federal Reserve yielded to this political pressure by lowering discount rates.”
The same pressures that were exerted following World War I remained in place leading into the Great Depression (Meltzer 2003, Ch. 4). The Fed caved into these pressures, expanding the money supply by 34 percent in between June 1922 and June 1927, and another 10 percent in between June 1927 and December 1928 (White 2012, 69).

Toma’s book levies a serious challenge against two strong economic traditions and their interpretations of arguably one of the most important economic events in American economic history. It offers yet another theoretical and empirical factor that scholars of the Great Depression will have to wrestle with in order to advance our understanding of this “Holy Grail of macroeconomics” (Bernanke 1995, 1).

References:
Bernanke, Benjamin (1995). “The Macroeconomics of the Great Depression: A Comparative Approach,” Journal of Money, Credit and Banking 27(1): 1-28.

Bordo, Michael, Christopher Erceg, and Charles Evans (2000). “Money, Sticky Wages and the Great Depression.” American Economics Review 90, 1447-1463.

Brunner, Karl and Allan H. Meltzer (1968). “What Did We Learn from the Monetary Experience of the United States in the Great Depression?” Canadian Journal of Economics 1(2): 334-348.

Clifford, A. Jerome (1965). The Independence of the Federal Reserve System. Philadelphia: University of Pennsylvania Press.

Cole, Hal, and Lee Ohanian (2001). “Reexamining the Contribution of Money and Banking Shocks to the Great Depression.” In Benjamin Bernanke and Kenneth Rogoff (Eds.), NBER Macroeconomics Annual 2000, pp. 183-227. Cambridge, MA: MIT Press.

Eichengreen Barry (1992). Golden Fetters: The Gold Standard and the Great Depression, 1919-1939. New York: Oxford University Press.

Eichengreen, Barry and Kris Mitchener (2003). “The Great Depression as a Credit Boom Gone Wrong,” BIS Working Paper No. 137. Available online: http://www.bis.org/publ/work137.pdf.

Friedman, Milton and Anna J. Schwartz (1963). A Monetary History of the United States, 1867-1960. Princeton, NJ: Princeton University Press.

Garrison, Roger (1999). “The Great Depression Revisited,” The Independent Review 3(4): 595-603.

Gordon, Robert J., and James Wilcox (1981). “Monetarist Interpretations of the Great Depression: Evaluation and Critique.” In Karl Brunner (Ed.), The Great Depression Revisited, pp. 49-107. Boston: Martinus Nijhoff, 49-107.

Hall, Thomas E. and J. David Ferguson (1998). The Great Depression: An International Disaster of Perverse Economic Policies. Ann Arbor: University of Michigan Press.

Hanna, John (1936). “The Banking Act of 1935,” Virginia Law Review 22(6): 617-641.

Havrilesky, Thomas (1995). The Pressures on American Monetary Policy (second edition). Norwell, MA:  Kluwer Academic Publishers

Horwitz, Steven (2012). “What the Austrian Business Cycle Theory Can and Cannot Explain,” Coordination Problem. Available online: http://www.coordinationproblem.org/2012/02/what-the-austrian-business-cycle-theory-can-and-cannot-explain.html

Kehoe, Timothy J., and Edward C. Prescott (2007). “Great Depressions of the Twentieth Century,” In Timothy J. Kehoe and Edward C. Prescott (Eds.), Great Depressions of the Twentieth Century. Minneapolis: Federal Reserve Bank of Minneapolis.

Kettl, Donald F. (1986). Leadership at the Fed. New Haven, CT: Yale University Press.

Laidler, David (2003). “The Price Level, Relative Prices and Economic Stability: Aspects of the Interwar Debate,” BIS Working Papers, No. 136. Available online: http://www.bis.org/publ/work136.pdf.

Mehrling, Perry (2011). The New Lombard Street: How the Fed Became the Dealer of Last Resort. Princeton, NJ: Princeton University Press.

Meltzer, Allan H. (2003). A History of the Federal Reserve, Volume 1: 1913-1951. Chicago, IL: University of Chicago Press.

Romer, Christina D. (1993). “The Nation in Depression,” Journal of Economic Perspectives 7(2): 19-39.

Rothbard, Murray (1975). America’s Great Depression. Kansas City: Sheed and Ward, Inc.

Selgin, George (2013). “Booms, Bubbles, Busts, and Bogus Dichotomies,” Alt-M, August 30. Available online: http://www.alt-m.org/2013/08/30/booms-bubbles-busts-and-bogus-dichotomies/.

Smith, Daniel J. and Peter J. Boettke (forthcoming). “An Episodic History of Federal Reserve Independence,” The Independent Review.

Temin, Peter (1976). Did Monetary Forces Cause the Great Depression? New York: W. W. Norton.

Temin, Peter (1989). Lessons from the Great Depression. Cambridge, MA: MIT Press.

Wheelock, David C. (1992). “Monetary Policy in the Great Depression: What the Fed Did, and Why,” Federal Reserve Bank of St. Louis Review 74(2): 3-28.

White, Lawrence H. (2012). The Clash of Economic Ideas: The Great Policy Debates and Experiments of the Last Hundred Years. New York: Cambridge University Press.

Daniel J. Smith is an Associate Professor of Economics in the Jonson Center at Troy University.

Copyright (c) 2015 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (May 2015). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):North America
Time Period(s):20th Century: Pre WWII

The Taylor Rule and the Transformation of Monetary Policy

Editor(s):Koenig, Evan F.
Leeson, Robert
Kahn, George A.
Reviewer(s):Gentle, Paul F.

Published by EH.Net (April 2014)

Evan F. Koenig, Robert Leeson, and George A. Kahn, editors, The Taylor Rule and the Transformation of Monetary Policy. Stanford, CA: Hoover Institution Press, 2012. xix + 347 pp. $35 (hardcover), ISBN: 978-0-8179-1404-2.

Reviewed for EH.Net by Paul F. Gentle, NCC British Higher Education (Guangzhou, China).

This book explains the creation and application of the Taylor Rule, one of the most important and well-known rules of monetary policy. The volume includes chapters by Pier Francesco Asso, Ben Benanke, Richard Fisher, Otmar Issing, George Kahn, Evan Koenig, Donald Kohn, Robert Leeson, John Lipsky, Robert Lucas, Edward Nelson, Guillermo Ortiz, Lars Svensson, John Taylor, Michael Woodford and Janet Yellen. These chapters make it very clear that the Taylor Rule is one of the most important monetary policy devices to come along in the last three decades.

The volume provides a detailed history of economic thought, leading up to the Taylor Rule equation, then reviews applications of the Taylor Rule in the United States, the United Kingdom, Australia, Japan and other countries.  As the preface explains, “back in the late 1970s and early 1980s, John Taylor and a few others embraced the notion that households and firms are forward-looking in their decision-making and intelligent in forming their expectations, but rejected the view that wages and prices adjust instantaneously to their market-clearing levels” (p. vii).  In Taylor’s view of New Keynesian economics, consumers try to develop rational expectations about the future. Yet due to nominal frictions (sticky prices and sticky wages), market-clearing levels of wages and prices are not reached instantaneously.  “Taylor helped bridge the gap between monetary theory and applied monetary policy when he showed that the set of activist feedback rules consistent with a well-behaved equilibrium includes certain interest-rate rules” (p. xi). Due to the need to see how well different performance rules worked, Taylor “developed the Taylor Curve, which shows efficient combinations of output and inflation variability” (p. x). Keeping unemployment low and inflation low are goals that are especially important given both the Great Depression of the 1930s and the Great Inflation of the 1970s. Many rules or guidelines have been created to deal with these twin concerns.  The Taylor Rule attempts to do this and its results have often been very good, although many economists believe that the Taylor Rule should be used in conjunction with other policy rules.

Here is John Taylor’s expression of his rule:[1]

r = p + .5y + .5(p – 2) + 2

where r = the federal funds rate; p = the rate of inflation over the previous four quarters; and y = the percent deviation of real GDP from a target.

Convertibility of money to a commodity, such as gold, was one of the first rules for monetary policy.  However, now we have fiat money, which needs a rule or rules to govern its growth.  “The Taylor rule synthesized (and provided a compromise between) competing schools of thought in a language devoid of rhetorical passion” (p. 5). The Taylor Rule with its equal weights has the advantage of offering a compromise solution between y-hawks (output hawks) and p-hawks (price hawks).  The rule is intended as a formative guide to policy and actually describes the conduct of U.S. monetary policy during a period of macroeconomic stability.  This fact helped influence the embrace of the Taylor Rule by policy makers.  Federal Reserve Governor Kohn gives a historical perspective of past episodes, suggesting that the Fed acted gradually in a certain period of time, though not at the slower pace as in estimated Taylor rules.  “These rules do not account for changes in the Fed’s inflation target from 1987 to the second half of the 1990s while the Fed was pursuing opportunistic disinflation” (p. 82). And the Fed’s monetary policy deviated from the Taylor Rule, from 2003 to 2006, when the funds rate was kept below Taylor Rule prescription for a long time (p. 83).  Of course that deviation of the Federal Reserve has been criticized by many economists. The deviation resulted in too much credit, which led up to the U.S. housing bubble and its aftermath.

As mentioned previously, there is also the idea of the Taylor Curve (pp. 148-151). The diagram has a vertical axis that denotes the variance of output.  The variance of inflation is shown on the horizontal axis.  The Taylor equation has proven to be more useful for policy than the Taylor Curve.  The Taylor Rule equation provides prescriptions for monetary policy.  Then there’s the “Great Moderation” – the reduced volatility of inflation and output in the decades before the 2008 recession. Some economists argue that such a moderation can by more readily achieved by central bankers, if they try to follow the Taylor equation.  But Taylor also refers to the “Great Deviation” (p.163) – the period when the Taylor Rule was not followed, to the point of a boom, followed by a bust.  Several economists discuss the ideas of inflation forecasts and the Taylor Rule contending that “forecast targeting and instrumental rules (such as the Taylor Rule) are complementary, rather than alternatives” (p. 236).

Lars Svensson argues that the “institutional framework for monetary policy rests on three pillars:  1. There is a mandate for monetary policy from the government or parliamentary, normally to maintain price stability. 2. There is independence for the central bank to conduct monetary policy and fulfill the mandate. 3. There is accountability of the central bank for its policy and decisions (pp. 245 -246).  Taylor has done in his work with these ideas in mind.  According to former Fed chair Ben Bernanke, the influence of Taylor upon “monetary theory and policy has been profound indeed” (p. 277), while the current Fed chair, Janet Yellen, states that Taylor’s work and “his research has affected the way policy makers and economists analyze the economy and approach to monetary policy” (p. 281).

Ultimately, this book is well worth the read.  A large array, of distinguished contributors give the reader a spectrum of viewpoints about the Taylor Rule.  The views of the Fed and many other central banks are given.  The academic side of monetary theory as it relates to the Taylor rule is covered in detail.  Taylor has done his research work in academic settings, government settings and within the commercial areas of financial markets — and from all those perspectives economists in this book have provided valuable analysis and commentary.

Reference:
1. John B. Taylor, “Cross-Checking ‘Checking in on the Taylor Rule.’” Economics One blog, July 16, 2013,  http://economicsone.com/2013/07/16/cross-checking-checking-in-on-the-taylor-rule/

Paul F. Gentle is the author of articles in Applied Economics, Applied Economics Letters, Economia Internazionale, Banks and Bank Systems and China and World Economy. He has taught at Samford University, Peking University, University of International Business and Economics, and City University of Hong Kong.

Copyright (c) 2014 by EH.Net. All rights reserved. This work may be copied for non-profit educational uses if proper credit is given to the author and the list. For other permission, please contact the EH.Net Administrator (administrator@eh.net). Published by EH.Net (April 2014). All EH.Net reviews are archived at http://www.eh.net/BookReview

Subject(s):Financial Markets, Financial Institutions, and Monetary History
Geographic Area(s):General, International, or Comparative
North America
Time Period(s):20th Century: WWII and post-WWII