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Big Business, Strong State: Collusion and Conflict in South Korea, 1960-1990

Author(s):Kim, Eum Mee
Reviewer(s):Ferrarini, Tawni Hunt

EH-NET BOOK REVIEW Published by H-Business@eh.net (December, 1997)

Eun Mee Kim. Big Business, Strong State: Collusion and Conflict in South Korea, 1960-1990. SUNY Series in Korean Studies. Albany: State University of New York Press, 1997. xvii + 280 pp. Tables, appendix, notes, references, and index. $59.50 (cloth), ISBN 0-7914-3209-2; $19.95 (paper), ISBN 0-7914-3210-6.

Reviewed for H-Business by Tawni Hunt Ferrarini , Northern Michigan University

South Korean Development and Institutional Change in State and Business: 1960-90

In Big Business, Strong State, Eun Mee Kim examines the roles the state and chaebol (large, family-owned enterprises) played independently in the development of the South Korean economy from 1960 to 1990. She also wittingly analyzes how these institutions acted upon and interacted with each other to produce development during the period of review. Using theoretical tools presented by Alexander Gerschenkron in his book Economic Backwardness in Historical Perspective (Cambridge: Harvard University Press, 1962), Kim begins by highlighting both the traditional and innovative aspects of these two institutions and identifies independent as well as co-dependent features of the development-oriented political and business environments created during Park rule. Taking into account the historical roots of Korean hierarchical and authoritarian government and economic environments, Kim argues that Park’s decision to create a “comprehensive” development-oriented political environment was both effective and efficient. It was effective in the sense that it allowed individuals targeted as development agents to rely on some well known habits, customs, and norms of behavior.

These traditionally-rooted behaviors had been acquired over five hundred years of Choson dynasty rule. During Park rule individuals relied on some of their “backward” habits, customs, and norms to act upon and interact in new development-oriented economic environments. This freed some resources, and agents could direct these resources toward learning and becoming gradually familiar with new environments. Park’s comprehensive development-oriented state was efficient because it successfully guided these agents to direct their freed as well as previously idle and inefficiently allocated resources to uses that encouraged industrialization, increased investment’s share of total output, increased export activity, and decreased the percentage of South Koreans living in poverty. Statistics to support empirically these claims are found throughout Kim’s book.

Through their policies, plans, and agencies, Park and his development technocrats solicited the help of the South Korean chaebol. The majority of these businesses were controlled by individuals with power and authority over members of their same kinship groups. In fashions similar to the state, hierarchical and authoritarian modes of action and interaction dominated the behaviors of individuals involved chaebol activities. Of course, these activities were initially guided by the state and were development-oriented in many respects.

As development proceeded in South Korea, individuals learned from their development-oriented experiences throughout the political and business hierarchies. Between 1960 and 1990, some traditional ways of engaging in economic activities were eventually replaced with modern practices. Individuals learned to manage some of their own global risks and no longer needed to rely totally on development technocrats. Laborers found jobs outside of family circles. Industrial activity increased in social acceptability. Overall, development technocrats under Park rule informed private individuals about attractive business opportunities, created new job opportunities, educated their labor force, and helped develop the entrepreneurial spirit of the private individual. Kim argues that these state efforts eventually produced a new breed of people in South Korea, and these people possessed skills, experiences, perceptions, needs, wants, and desires different from the majority of individuals living in South Korea in the early 1960s and before.

Noticeable competition for political and economic power began to emerge in the early 1970s as this new breed of people emerged. Many leaders of the chaebol as well as laborers in general decreased their dependence on government officials and development technocrats to create, identify, and modify prosperous economic opportunities. These business leaders and South Korean laborers now possessed the desire, intelligence, knowledge, and experiences to buy, sell, and derive income from their privately-owned resources in domestic and international markets. Hence, a private need for the state to take on the role of the protector of property rights emerged. Kim (1997: 5) calls this type of state a limited developmental state. It is a state that moves from being plan-oriented to market-oriented. In summary, the development institutions created under Park rule in the early 1960s played a role in changing the perceptions, skills, and experiences of business leaders and private individuals. These changes, in turn, led many individuals to call for political change in South Korea.

In conclusion, Kim succeeds in telling a non-neoclassical story of economic success in South Korea. She skillfully highlights the developmental importance of recognizing the long-term roles of the neo-classical features required in individual state and business institutions, but, also, she recognizes the importance of admitting that institutional change is gradual and not instantaneous. In addition, Kim claims institutions do not act in isolation but are a part of an intricate web of political, social, and economic institutions. By taking all of this into account, Kim provides a complete analysis of changing developmental roles played by the polity and chaebol of South Korea. She could expand her theoretical base by drawing on the institutional theories of Douglass C. North offered in his books Institutions, Institutional Change and Economic Performance (Cambridge, Mass: 1990) and Structure and Change in Economic History (New York: 1981). Additionally, Kim could include in her future research a detailed study of the role played by dominant social institutions present in South Korea during her period of review. Please refer to Tawni Hunt Ferrarini’s article The Economics Behind the Role of the Korean Family Institution in the Development of South Korea, presented in William R. Childs (ed), Essays in Economic and Business History, (Columbus, OH: the EBHS and the Department of History at Ohio State University: 1996), 27-43.

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Subject(s):Markets and Institutions
Geographic Area(s):Asia
Time Period(s):20th Century: WWII and post-WWII

Rulers, Religion, and Riches: Why the West Got Rich and the Middle East Did Not

Author(s):Rubin, Jared
Reviewer(s):Mokyr, Joel

Published by EH.Net (April 2017)

Jared Rubin, Rulers, Religion, and Riches: Why the West Got Rich and the Middle East Did Not. New York: Cambridge University Press, 2017. xxi + 273 pp. $30 (paperback), ISBN: 978-1-108-40005-3.

Reviewed for EH.Net by Joel Mokyr, Departments of Economics and History, Northwestern University.

The Middle East, it has been said, is not just a collection of failed states. It is a failed region. It generates a disproportional number of the world’s orphans and refugees, its GDP per capita is intolerably low despite oil riches, and there are few signs that there is light at the end of tunnel. Democracy seems to have been put on the back burner indefinitely, and human rights are a lost cause in most countries and in retreat elsewhere. Intellectually, too, things look rather dismal: In 2005 Harvard University alone produced more scientific papers than 17 Arabic-speaking countries combined. Muslim countries contribute just 2.5 percent of more than 11.5 million papers published worldwide each year (Muslims constituted 23 percent of the world’s population in 2010). A 1997 Scientometrics paper estimated that 46 Muslim countries (which of course contain much more than the Middle East) contributed 1.17 percent to world science literature as opposed to Spain (1.48 percent).

Is the Islamic religion to blame? Jared Rubin, in this stimulating and highly original study, would deny that emphatically. Although this is a book about religion and its implication for institutional and economic change, Rubin is little interested in the actual doctrinal content of religion. He points out, as many others have, that the essence of Islam could not possibly be as rigid and opposed to commerce and economic change as it may seem, because for the first centuries of its existence, the nations that adopted Islam flourished not just commercially but also in terms of technology, architecture, poetry, agriculture, medicine, and engineering, while western Europe was an ignorant, violent and poverty-stricken backwater. What we have witnessed since 1200 is more than a “divergence”: it is a Great Reversal, of momentous importance till the present day.

Rubin’s book presents us with an explanation for this great reversal, which will have to be taken into account from now on in all future discussions on the economic history of the Islamic world. He does not oversell his argument as the reason for the great reversal, he makes a plausible argument for it as a complementary argument to the ones other serious scholars have made. The book is divided into a few chapters that outline the theory and logic of the argument and then applies these insights to a number of historical case studies. It is a tale that combines economic history, political economy, and religion in a unique and novel way.

Here is the basic argument: any kind of ruler has power because his or her subjects accept their rule and their main concern is what Rubin calls “propagating their rule.”  How do you get people to accept you as their ruler and let you keep your job? Political power is supported by a combination of coercion (that is, violence) and legitimacy (people willingly accept a ruler because they believe that this person has the right to rule them). Through most of history, rulers depended on a combination of the two, though the weights of each differed greatly depending on their costs and benefits. Rubin is exclusively interested in the legitimacy part. Legitimacy is provided by what he calls “legitimizing agents” — groups or entities that have enough influence to make the subjects of the ruler follow instructions and pay taxes. An obvious legitimizing agent is the religious establishment — for example, European rulers once ruled ex dei gratia and called themselves the most Catholic King. Some modern royalty still include the line in their title, although in most places such relics are empty.

Rubin observes that in the early medieval period, both Christian and Muslim rulers used religious authorities as legitimizing agents, but that at some point in the later Middle Ages, Muslim and western European society diverged. Whereas in the Ottoman Empire the sultans continued to rely on religious authorities for their legitimacy, in many western societies the Church’s political leverage was diminished irreversibly. From the beginning, Rubin points out, Christian doctrine envisaged separate spheres for secular and religious power. The schisms and exiles to which the late medieval papacy was subject weakened it greatly in the face of ambitious rulers, and the reformation administered to religious legitimization the coup de grace. Apart from a few corners of Europe such as Spain, religion lost the power it had exercised since even before the prophet Samuel anointed Kings Saul and David.

Why and how did this matter to economic history? Rubin argues that religious authorities were in general conservative, and that the institutions they established are less aligned with commerce and finance than when an economically important elite such as rich urban merchants and artisans are more powerful. As a result of their political influence, religious authorities in the Middle East were successful in blocking critical breakthroughs, most notably the printing press and more sophisticated financial institutions. The printing press facilitated the success of the Reformation, and the Reformation had further favorable economic effects, as has recently been shown by a pair of important papers (Cantoni, Dittmar and Yuchtman, 2016; Dittmar and Meisenzahl, 2016). One might add that even in France, in which the reformation was suppressed, the power of religious authorities to legitimize the king disappeared. Napoleon famously took the crown out of the hands of Pope Pius VII during his 1804 coronation and crowned himself, symbolizing that his legitimization came from military power, not God.

In summary, Rubin argues that the leaders of organized religion tended to be conservative across the board. Their influence, he thinks, depended on their monopoly of eternal truths, and updating those truths threatened to erode their credibility.  The Islamic world was unable to curtail the influence of Islamic scholars until the Islamic world had fallen hopelessly behind Europe. Even within Christian Europe, the power of religious authorities, he feels, helped determine the difference between successful regions such as the Netherlands and Britain and economic laggards such as Spain. When discussing the past three centuries, the influence of religious authorities is somewhat diminished, but what counts in Rubin’s view is that in all poor and backward states, the institutional structure and the capability of key players to “sit at the bargaining table” as he calls it was little affected by the urban-commercial classes whose demands for free and open markets, constraints on the executive, and a rule of law led to rapid economic progress in the north-west corners of Europe.

By combining an institutional argument with religion through the effect that religion had on institutions and politics (rather than on cultural beliefs), Rubin’s argument is reminiscent of an important recent book by Karel Davids, which has not thus far received sufficient attention (Davids, 2013). Both books, in a different way, stress how religious institutions mattered regardless of the precise content of religion. Davids, however, emphasizes another aspect, namely the role of religion in the generation and dissemination of technology. Rubin is primarily interested in institutions that support markets. Yet an explanation of modern economic growth cannot possibly avoid the primum movens of economic growth, which was the rapid expansion and dissemination of useful knowledge. In early medieval Islam, engineers, doctors, and chemists were at the forefront of pushing the envelope. By 1600 the Islamic world had become a follower, by 1800 they were a laggard. A natural extension of Rubin’s idea is that a government dominated by religious authorities will also be less than accommodating to out-of-the-box ideas from natural philosophers, astronomers, mathematicians, and medical doctors. The tradeoff between religiosity and scientific and technological progress has become a serious topic of investigation in recent years (Benabou, Ticchi, and Vindigni, 2014; Squicciarini, 2016). Their findings support the notion that devoutness affects innovativeness negatively and that political institutions could be used by powerful religious leaders to suppress what they considered heretical views.

Rubin is correct in pointing out that in the most progressive countries in western Europe the ability of religious leaders to halt progress was limited.  A striking example of this phenomenon is provided by Amir Alexander (2014), who documents the fierce resistance to infinitesimal mathematics by the Jesuits in the seventeenth century, which seriously slowed down the development of mathematics in Italy. The reason the reactionary powers such as the Jesuits were not able to slow down the development of radical new ideas in Europe materially is primarily the high level of political fragmentation in Europe. If a particular ruler tried to crack down on his most creative subjects because they wrote things he felt to be subversive or heretical, they could always move across the border. Such outside options may have been much more limited in the Ottoman Empire and in China. Interstate competition is another factor that rulers worried about, beside Rubin’s legitimization story. After all, every ruler faced both internal and external threats. Without interstate competition, or “emulation” as eighteenth-century writers called it, Europe might never have had the Enlightenment, which opened the doors to so many of the institutional and technological changes that have helped create economic modernity.

Here and there one could nitpick some of Rubin’s historical interpretations. His account of Spain’s political economy would have greatly benefitted from a closer attention to Regina Grafe’s path-breaking work (Grafe, 2012). Rubin’s agnosticism as to the actual content of religion may be somewhat misplaced: the Sunni revival of the eleventh century did in time move the ruling orthodoxy into a more conservative direction, as Eric Chaney (2015) has shown. More generally, an argument that focuses on “the ruler” and the significance of the propagation of political power may exaggerate the ability of the state to control what the citizens did in pre-twentieth-century societies.

All the same, Rubin has written an important and timely book. His methodology is very much that of the historically informed economist: certain choices are made at some point because they make sense, that is, the benefits to those that make the decision exceed the costs. But once made, these initial conditions can have cascading unintended and unanticipated consequences, and those historically contingent causal chains may well be what drove much of the great and little divergences that our profession is so interested in. Equally important, this well-argued and sensible book about Islam provides a much-needed antidote to the toxic rubbish masquerading as scholarship produced by some of the Islamophobes in the current American administration (e.g., Gorka, 2016). The Middle East’s problem is not Islam; it is History.

References:

Alexander, Amir. 2014. Infinitesimal: How a Dangerous Mathematical Theory Shaped the Modern World. New York: Farrar, Straus and Giroux.

Benabou, Roland, Davide Ticchi, and Andrea Vindigni. 2014. “Forbidden Fruits: The Political Economy of Science, Religion and Growth.” Unpublished working paper, Princeton University.

Cantoni, Davide, Jeremiah Dittmar and Noam Yuchtman. 2016.  “Reformation and Reallocation: Religious and Secular Economic Activity in Early Modern Germany.” Unpublished.

Chaney, Eric. 2015. “Religion and the Rise and Fall of Islamic Science.” Unpublished working paper, Harvard University.

Davids, Karel. 2013. Religion, Technology and the Great and Little Divergences. Leiden: Brill.

Dittmar, Jeremiah E. and Ralf Meisenzahl. 2016. “Origins of Growth: Health Shocks, Institutions, and Human Capital in the Protestant Reformation.” Unpublished.

Gorka, Sebastian. 2016. Defeating Jihad: The Winnable War. Washington, DC: Regnery Publishing.

Grafe, Regina. 2012. Distant Tyranny: Markets, Power, and Backwardness in Spain, 1650–1800. Princeton, NJ: Princeton University Press.

Squicciarini, Mara. 2017. “Devotion and Development: Religiosity, Education, and Economic Progress in 19th-century France.” Unpublished working paper, Northwestern University.

Joel Mokyr is the author of Culture of Growth: The Origins of the Modern Economy (Princeton University Press, 2016).

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 (April 2017). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Economic Development, Growth, and Aggregate Productivity
Economywide Country Studies and Comparative History
Geographic Area(s):Europe
Middle East
Time Period(s):General or Comparative

The First Knowledge Economy: Human Capital and the European Economy, 1750-1850

Author(s):Jacob, Margaret C.
Reviewer(s):Hornung, Erik

Published by EH.Net (September 2015)

Margaret C. Jacob, The First Knowledge Economy: Human Capital and the European Economy, 1750-1850. Cambridge: Cambridge University Press, 2014. ix + 257 pp. $30 (paperback), ISBN: 978-1-107-61983-8.

Reviewed for EH.Net by Erik Hornung, Max Planck Institute for Tax Law and Public Finance.

Many factors have been identified as causes of the transition to sustained economic growth during the eighteenth and nineteenth centuries. Human capital may be one of the most controversial additions to the long list of causes, not least because the English are not known to have been well educated at the eve of the Industrial Revolution. In The First Knowledge Economy, Margaret C Jacob argues that English knowledge elites were at the heart of the transition. She especially focusses on the marriage between theoretical sciences and applied mechanical knowledge which helped creating many technological innovations during the Industrial Revolution. She, thus, aims at rectifying the prevalent hypothesis that technological progress resulted from tinkering of skilled but science-ignorant engineers. An impressive set of new archival sources supports her argument that English engineers were, indeed, well aware of and heavily influenced by recent advances in natural sciences.

Each of the first four chapter focuses on outstanding entrepreneurs and engineers whose records and transcripts have survived. Available information on technical and scientific knowledge is extracted from correspondence with fellow engineers and businessmen, calculations, lecture notes, thoughts about scientific readings, and involvement in scientific societies. In this manner, the reader learns how scientific content affected mindsets and decisions of famous entrepreneurs and eventually entered the production process. Understanding that their decisions were based on the latest advances in science helps to sort out the misconception that entrepreneurs were uninformed tinkerers who accidentally became successful. When tinkering, they did so with mechanical precision and regard for the known natural laws.

After a rather unstructured introduction, Chapter 1 depicts James Watt and Matthew Boulton, the inventor/entrepreneur duo famed for developing the steam engine. Analyzing a wealth of notebook entries and correspondence, Jacob depicts the views and attitudes towards religion, politics, education and science of the two businessmen and their family members. Although never formal scholars of science at any institute of higher learning, science infused the life and work of both Watt and Boulton.

The second chapter is mainly concerned with the argument that England was first because labor was expensive and coal was cheap, which made the invention of steam engines necessary. Jacob argues that technical knowledge was crucial for technological progress in mining. This claim is substantiated by transcripts which exemplify the technical knowledge of engineers, colliers, and so-called viewers working with steam engines. Clearly the majority of the technical staff in English mining must have been highly literate and capable of doing sophisticated calculations. They needed to estimate the size of engine cylinders, water-pumping potential, and the size and costs of a steam engine to advise mine owners on which steam engines to buy. Their knowledge eventually translated to a wide knowledge base which diffused through publications and public lectures.

Chapters 3 and 4 expand the established concepts to the Manchester cotton spinning industry and the Leeds textile industry. Using the correspondence of cotton barons John Kennedy and James M’Connel, Jacob describes how science and technical knowledge increased in importance during the mechanization of cotton spinning. Cloth manufacturing was arguably less prone to mechanization than spinning. Yet, the notebooks of textile manufacturers John Marshall and Benjamin Gott confirm the established pattern of adoption of scientific knowledge. The chapters conclude that a common language was needed to allow for the interaction between manufacturers and engineers. Once established entrepreneurs were able to mechanize, their businesses and machines became more sophisticated and complex.

Chapters 5 and 6 constitute a geographical change and a methodological break in the book. The center of attention is shifted to France and the “puzzle” why the French lagged behind in industrial development. Although highly interested in the practical uses of the new science, the Ancien Régime failed to create an optimal environment for industrial purposes. Jacob argues that scientific education was almost completely directed toward the aristocracy who entered into military positions. Consequently, technical knowledge was primarily used in military engineering and not for commercial activity. The French Revolution democratized education and increased the scientific content of the curricula, but, this was only a brief episode before the Restoration re-reformed education to replace scientific with religious content subject to harsh supervision by the clergy and police authorities.

Chapter 7 shifts the focus to the Low Countries, comparing Belgium and the Netherlands regarding how French occupying forces managed to instill scientific knowledge in the curricula of secondary schools and universities. Jacob argues that Belgium with its centralized system of education embraced and retained the French reforms towards industrial educational after 1795, which helped them industrialize quickly. Unlike Belgium, the Netherlands with its localized system of education did not embrace French educational reforms and industrialization evolved more slowly.

Jacob argues that we do not know enough about the curriculum in England, since schooling was organized locally. Thus, to understand whether industry benefited from sciences, we have to rely on the scientific knowledge of entrepreneurs and engineers without knowing where it was acquired. Due to the fact that France was more centralized, it can be convincingly established that the French institutional setting did not leave enough room for scientific content in public education. However, it remains unclear whether this argument suffices in contributing to solve the puzzle of continental backwardness. Instead of applying the established concept of relying on biographical information and the personal scientific knowledge of successful entrepreneurs to France (and the Low Countries), Jacob decides to provide a summary of the political economy of schooling and the curriculum during the pre- and post-Revolution. For a suitable comparison we would need to learn more about the adoption of scientific knowledge by continental entrepreneurs and engineers. We might end up finding similar patterns here.  A recent article by Squicciarini and Voigtlaender (2015) focusses on French knowledge elites (subscribers to Diderot’s Encyclopédie), who seem to have been relevant for industrial development during the period from 1750 to 1850.

This book makes an important contribution by showing that English technological development did not occur detached from scientific advances. Jacob carefully avoids drawing strong conclusions and generalizations. She asserts a central role to human capital without making causal claims. A little more structure and clearer statements might have been helpful. If cheap energy and expensive labor made inventing labor-saving technologies profitable, acquisition of scientific knowledge might be considered a proximate factor rather than the ultimate cause.

Reference:

Mara P. Squicciarini and Nico Voigtländer (2015). “Human Capital and Industrialization: Evidence from the Age of Enlightenment.” Quarterly Journal of Economics (forthcoming)

Erik Hornung (erik.hornung@tax.mpg.de) is Senior Research Fellow at the Max Planck Institute for Tax Law and Public Finance. He is author of the paper “Immigration and the Diffusion of Technology: The Huguenot Diaspora in Prussia,” American Economic Review 104-1 (2014): 84-122.

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 (September 2015). All EH.Net reviews are archived at http://eh.net/book-reviews/

Subject(s):Economic Development, Growth, and Aggregate Productivity
Education and Human Resource Development
History of Technology, including Technological Change
Geographic Area(s):Europe
Time Period(s):18th Century
19th Century

Lending to the Borrower from Hell: Debt, Taxes and Default in the Age of Philip II

Author(s):Drelichman, Mauricio
Voth, Hans-Joachim
Reviewer(s):Grafe, Regina

Published by EH.Net (July 2014)

Mauricio Drelichman and Hans-Joachim Voth, Lending to the Borrower from Hell: Debt, Taxes and Default in the Age of Philip II.  Princeton, NJ: Princeton University Press, 2014. xii + 310 pp. $35 (hardcover), ISBN: 978-0-691-15149-6.

Reviewed for EH.Net by Regina Grafe, Department of History of Civilization, European University Institute.

Why do investors lend to sovereigns? This is the central question that Lending to the Borrower from Hell addresses. A sovereign usually cannot be forced to make good on her commitments to foreign bankers. The historical regularity of sovereign default suggests that neither GDP-lowering sanctions nor the reputational damage to the borrower on their own are enough to avoid opportunistic behavior.

But avoiding defaults at all costs is also problematic. If the state’s fiscal woes are largely the result of an adverse shock to the economy, saving the state from default will drive the real economy further into recession. As the authors point out “state-dependent” debt contracts would be a solution. If the sovereign was not to blame for fiscal shortfalls, a default should be excusable. But how can lenders ever know for certain that the ruler is not faking it?

In this highly readable book Drelichman and Voth look at late sixteenth century Spain to investigate this puzzle. Their first step is to complement existing data on long-term borrowing and fiscal accounts with an in-depth study of every clause in short-term borrowing contracts. These so-called asientos were the means by which King Philip II dealt with the challenges that extremely volatile war spending posited to all European rulers.

Armed with an impressive amount of new data the authors pose four questions. 1) Were generations of historians and economists right in claiming that Spain’s debt was unsustainable? 2) Did Philip II only pay his debt because he had he suffered sanctions? Foremost was a brutal episode in the 1570s, when his lack of funding allegedly caused an infamous mutiny in Antwerp. 3) Did successive generations of lenders lose their shirts, as the historiography has claimed? 4) What actually happened during Philip’s four defaults?

The authors’ answers are surprising. Spain’s sixteenth century debt levels were sustainable. Philip II paid because the lenders imposed effective moratoria forcing him to negotiate, but they did not use other sanctions. The mutiny known as the Spanish Fury was not caused by lack of funds. Lenders made money throughout. Finally, “defaults” were effectively re-negotiations often anticipated in conditional clauses contained in the initial contract. In essence sixteenth century Genoese bankers succeeded at creating state-dependent debt.

Such financial success required a few specific ingredients. The first one was the transfer of banking acumen from first Southern Germany and then Genoa to Spain. The Fuggers were good at banking. Their European networks allowed them to borrow against their name in the service of the Spanish Crown. But the Genoese were better. On the back of almost three centuries of experience with sovereign finance in the form of Genoa’s Banco di San Giorgio they introduced two important novelties: overlapping lending networks and securitization.

Second, lender reputation was more important than that of the borrower. Because of cross-investments between Genoese houses Philip failed systematically in his attempts to entice individual lenders to cut a side deal when he suffered a liquidity problem. They were too worried that their business partners in turn would cheat on them. Philip reacted by expanding ordinary taxes, resulting in a consistently high primary surplus that kept the debt-revenue ratio virtually unchanged as debt levels expanded. Lenders in turn limited individual exposure by selling off participations in the loans insuring that liquidity crises could be managed. Short-term losses were offset by long-term profits.

Scholars from North and Thomas to Acemoglu, Johnson, Robinson have blamed Spain’s relative decline in the seventeenth and eighteenth centuries on poor fiscal governance. Drelichman and Voth prove them wrong. But if government finance was sound what was the problem? The authors support the recent literature that has zoomed in on political fragmentation limiting state capacity. But they add bad luck in military matters and silver inflows to the vector of causes of Spain’s decline. The reminder about the importance of military success is timely. What mattered was not war expenditure but winning.

What about the resource curse? Drelichman and Voth offer much needed perspective but their data may also question the importance of silver. Taxes on silver remittances accounted on average for 18 to 20 percent of annual revenue in the second half of the sixteenth century (Drelichman and Voth 2007). That was not to be sneezed at. Yet, when expenditures were subject to year-on-year changes that could reach multiples of two or three, no treasure fleet could sail to the rescue.

Philip’s Genoese bankers were rightly cautious. Only eight percent of asientos that mention contingent clauses refer to the fleet. Those that did carried a four percent risk premium. Given the sophisticated financial engineering, volatility was probably a lesser issue. But revenue from the 20 percent silver tax could not be leveraged up by using it as a guarantee for long-term bonds. And the state could not extend the fiscal base as it could and did with all manner of consumption taxes.

In its best years the share of mineral revenue in total revenue even exceeded oil revenues in today’s Norway. Yet, Norway’s state quota is 55 percent, Castile’s was well inside 10 percent. To put it another way: silver taxes amounted to 1 to 3 percent of Castile’s GDP at most. The Genoese for one seem to have preferred loans guaranteed by boring consumption taxes rather than dreams of Eldorado. Maybe silver is another part of Spanish history that is ripe for revision?

Lending to the Borrower from Hell is a wonderful example of what becomes possible when one takes economic theory on a trip to the archive and actually reads the small print of each contract. It provides for the first time an economically sound explanation for Spain’s ability to borrow in the sixteenth century that actually fits the facts. That is an outstanding achievement.

While lender irrationality is a favorite currently in the literature on sovereign lending, the authors show that continued lending and default could both be perfectly rational. Spanish monarchs were no systematic threat to private property rights. When they defaulted, they had a reason that was out of their control, and they duly compensated lenders. So the lenders kept lending.

Regina Grafe is the author of Distant Tyranny: Markets, Power and Backwardness in Spain, 1650-1800, Princeton University Press, 2012.

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 (July 2014). All EH.Net reviews are archived at http://www.eh.net/BookReview

Subject(s):Government, Law and Regulation, Public Finance
Geographic Area(s):Europe
Time Period(s):16th Century

Path Dependence

Douglas Puffert, University of Warwick

Path dependence is the dependence of economic outcomes on the path of previous outcomes, rather than simply on current conditions. In a path dependent process, “history matters” — it has an enduring influence. Choices made on the basis of transitory conditions can persist long after those conditions change. Thus, explanations of the outcomes of path-dependent processes require looking at history, rather than simply at current conditions of technology, preferences, and other factors that determine outcomes.

Path-dependent features of the economy range from small-scale technical standards to large-scale institutions and patterns of economic development. Several of the most prominent path-dependent features of the economy are technical standards, such as the “QWERTY” standard typewriter (and computer) keyboard and the “standard gauge” of railway track — i.e., the width between the rails. The case of QWERTY has been particularly controversial, and it is discussed at some length below. The case of track gauge is useful for introducing several typical features of path-dependent processes and their outcomes.

Standard Railway Gauges and the Questions They Suggest

Four feet 8-1/2 inches (1.435 meters) is the standard gauge for railways throughout North America, in much of Europe, and altogether on over half of the world’s railway routes. Indeed, it has been the most common gauge throughout the history of modern railways, since the late 1820s. Should we conclude, as economists often do for popular products or practices, that this standard gauge has proven itself technically and economically optimal? Has it been chosen because of its superior performance or lower costs? If so, has it proven superior for every new generation of railway technology and for all changes in traffic conditions? What of the other gauges, broader or narrower, that are used as local standards in some parts of the world — are these gauges generally used because different technology or different traffic conditions in those regions favor these gauges?

The answer to all these questions is no. The consensus of engineering opinion has usually favored gauges broader than 4’8.5″, and in the late nineteenth century an important minority of engineers favored narrower gauges. Nevertheless, the gauge of 4’8.5″ has always had greater use in practice because of the history of its use. Indeed, even the earliest modern railways adopted the gauge as a result of history. The “father of railways,” British engineer George Stephenson, had experience using the gauge on an older system of primitive coal tramways serving a small group of mines near Newcastle, England. Rather than determining optimal gauge anew for a new generation of railways, he simply continued his prior practice. Thus the gauge first adopted more than two hundred years ago for horse-drawn coal carts is the gauge now used for powerful locomotives, massive tonnages of freight shipments, and passenger trains traveling at speeds as great as 300 kilometers per hour (186 mph).

We will examine the case of railway track gauge in more detail below, along with other instances of path dependence. We first take an analytical look at what conditions may give rise to path dependence — or prevent it from arising, as some critics of the importance of path dependence have argued.

What Conditions Give Rise to Path Dependence?

Durability of Capital Equipment

The most trivial — and uninteresting — form of path dependence is based simply on the durability of capital equipment. Obsolete, inferior equipment may remain in use because its fixed cost is already “sunk” or paid for, while its variable costs are lower than the total costs of replacing it with a new generation of equipment. The duration of this sort of path dependence is limited by the service life of the obsolete equipment.

Technical Interrelatedness

In railways, none of the original gauge-specific capital equipment from the early nineteenth century remains in use today. Why, then, has Stephenson’s standard gauge persisted? Part of the reason is the technical interrelatedness of railway track and the wheel sets of rolling stock. When either track or rolling stock wears out, it must be replaced with equipment of the same gauge, so that the wheels will still fit the track and the track will still fit the wheels. Railways almost never replace all their track and rolling stock at the same time. Thus a gauge readily persists beyond the life of any piece of equipment that uses it.

Increasing Returns

A further reason for the persistence, and indeed spread, of the Stephenson gauge is increasing returns to the extent of use. Different railway companies or administrations benefit from using a common gauge, because this saves costs and improves both service quality and profits on through-shipments or passenger trips that pass over each other’s track. New railways have therefore nearly always adopted the gauge of established connecting lines, even when engineers have favored different gauges. Once built, railway lines are reluctant to change their gauge unless neighboring lines do so as well. This adds coordination costs to the physical costs of any conversion.

In early articles on path dependence, Paul David (1985, 1987) listed these same three conditions for path dependence: first, the technical interrelatedness of system components; second, increasing returns to scale in the use of a common technique; and, third, “quasi-irreversibility of investment,” for example in the durability of capital equipment (or of human capital). The third condition gives rise to switching costs, while the first two conditions make gradual change impractical and rapid change costly, due to the transactions costs required to coordinate the actions of different agents. Thus together, these three conditions may lend persistence or stability to a particular path of outcomes, “locking in” a particular feature of the economy, such as a standard railway track gauge.

David’s early work on path dependence represents, in part, the culmination of an earlier economic literature on technical interrelatedness (Veblen 1915; Frankel 1955; Kindleberger 1964; David 1975). By contrast, the other co-developer of the concept of path dependence, W. Brian Arthur, based his ideas on an analogy between increasing returns in the economy, particularly when expressed in the form of positive externalities, and conditions that give rise to positive feedbacks in the natural sciences.

Dynamic Increasing Returns to Adoption

In a series of theoretical papers starting in the early 1980s, Arthur (1989, 1990, 1994) emphasized the role of “increasing returns to adoption,” especially dynamic increasing returns that develop over time. These increasing returns might arise on the supply side of a market, as a result of learning effects that lower the cost or improve the quality of a product as its cumulative production increases. Alternatively, increasing returns might arise on the demand side of a market, as a result of positive “network” externalities, which raise the value of a product or technique for each user as the total number of users increases (Katz and Shapiro 1985, 1994). In the context of railways, for example, a railway finds a particular track gauge more valuable if a greater number of connecting railways use that gauge. (Note that a track gauge is not a “product” but rather a “technology,” as Arthur puts it, or a “technique,” as I prefer to call it.)

In Arthur’s (1989) basic analytical framework, “small events,” which he treated as random, lead to early fluctuations in the market shares of competing techniques. These fluctuations are magnified by positive feedbacks, because techniques with larger market shares tend to be more valuable to new adopters. As a result, one technique grows in market share until it is “locked in” as a de facto standard. In a simple version of Arthur’s model (Table 1), different consumers or firms initially favor different products or techniques. At first, market share for each technique fluctuates randomly, depending on how many early adopters happen to prefer each technique. Eventually, however, one of the techniques will gain enough of a lead in market share that it will offer higher payoffs to everyone — including to the consumers or firms that have a preference for the minority technique. For example, if the total number of adoptions for technique A reaches 80, while the number of adoptions of B is less than 60, then technique A offers higher payoffs for everyone, and it is locked in as the de facto standard.

Table 1. Adoption Payoffs in Arthur’s Basic Model

Number of previous adoptions 0 10 20 30 40 50 60 70 80 90
“R-type agents” (who prefer technique A):
Technique A 10 11 12 13 14 15 16 17 18 19
Technique B 8 9 10 11 12 13 14 15 16 17
“S-type agents” (who prefer technique B):
Technique A 8 9 10 11 12 13 14 15 16 17
Technique B 10 11 12 13 14 15 16 17 18 19

Source: Adapted from Arthur (1989).

Which of the competing techniques becomes the de facto standard is unpredictable on the basis of systematic conditions. Rather, later outcomes depend on the specific early history of the process. If early “small” events and choices are governed in part by non-systematic factors — even “historical accidents” — then these factors may have large effects on later outcomes. This is in contrast to the predictions of standard economic models, where decreasing returns and negative feedbacks diminish the impact of non-systematic factors. To cite another illustration from the history of railways, George Stephenson’s personal background was a non-systematic or “accidental” factor that, due to positive feedbacks, had a large influence on the entire subsequent history of track gauge.

Efficiency, Foresight, Remedies, and the Controversy over Path Dependence

Arthur’s (1989) basic model of a path-dependent process considered a case in which the selection of one outcome (or one path of outcomes) rather than another has no consequences for general economic efficiency — different economic agents favor different techniques, but no technique is best for all. Arthur also, however, used a variation of his modeling approach to argue that an inefficient outcome is possible. He considered a case where one technique offers higher payoffs than another for larger numbers of cumulative adoptions (technique B in Table 2), while for smaller numbers the other technique offers higher payoffs (technique A). Arthur argued that, given his model’s assumptions, each new adopter, arriving in turn, will prefer technique A and adopt only it, resulting later in lower total payoffs than would have resulted if each adopter had chosen technique B. Arthur’s assumptions were, first, that each agent’s payoff depends only on the number of previous adoptions and, second, that the competing techniques are “unsponsored,” that is, not owned and promoted by suppliers.

Table 2. Adoption Payoffs in Arthur’s Alternative Model

Number of previous adoptions 0 10 20 30 40 50 60 70 80 90
All agents:
Technique A 10 11 12 13 14 15 16 17 18 19
Technique B 4 7 10 13 16 19 22 25 28 31

Source: Arthur (1989), table 2.

Liebowitz and Margolis’s Critique of Arthur’s Model

Arthur’s discussion of efficiency provided the starting point for a theoretical critique of path dependence offered by Stan Liebowitz and Stephen E. Margolis (1995). Liebowitz and Margolis argued that two conditions, when present, prevent path-dependent processes from resulting in inefficient outcomes: first, foresight into the effects of choices and, second, opportunities to coordinate people’s choices, using direct communication, market interactions, and active product promotion. Using Arthur’s payoff table (Table 2), Liebowitz and Margolis argued that the purposeful, rational behavior of forward-looking, profit-seeking economic agents can override the effects of events in the past. In particular, if agents can foresee that some potential outcomes will be more efficient than others, then they have incentives to avoid the suboptimal ones. Agents who already own — or else find ways to appropriate — products or techniques that offer superior outcomes can often earn substantial profits by steering the process to favor those products or techniques. For the situation in Table 2, for example, the supplier of product or technique B could draw early adopters to that technique by temporarily setting a price below cost, making a profit by raising price above cost later.

Thus, in Liebowitz and Margolis’s analysis, the sort of inefficient or inferior outcomes that can arise in Arthur’s model are often not true equilibrium outcomes that market processes would lead to in the real world. Rather, they argued, purposeful behavior is likely to remedy any inferior outcome — except where the costs of a remedy, including transactions costs, are greater than the potential benefits. In that case, they argued, an apparently “inferior” outcome is actually the most efficient one available, once all costs are taken into account. “Remediable” inefficiency, they argued in contrast, is highly unlikely to persist.

Liebowitz and Margolis’s analysis gave rise to a substantial controversy over the meaning and implications of path dependence. In the view of Liebowitz and Margolis, the major claims of the economists who promote the concept of path dependence have amounted to assertions of remediable inefficiency. Liebowitz and Margolis coined the term “third-degree” path dependence to refer to such cases. They contrasted this category both to “first-degree” path dependence, which has no implications for efficiency, and to “second-degree” path dependence, where transactions costs and/or the impossibility of foresight lead to outcomes that offer lower payoffs than some hypothetical — but unattainable — alternative. In Liebowitz and Margolis’s view, only “third-degree” path dependence offers scope for optimizing behavior, and thus only this type stands in conflict with what they call “the neoclassical model of relentlessly rational behavior leading to efficient, and therefore predictable, outcomes” (1995). Only this category of path dependence, they argue, would constitute market failure. They cast strong doubt on the likelihood of its occurrence, and they asserted that no empirical examples have been demonstrated.

Responses to Liebowitz and Margolis’s Critique

Proponents of the importance of path dependence have responded, in large part, by asserting that the interesting features of path dependence have little to do with the question of remediability. David (1997, 2000) argued that the concept of third-degree path dependence proves incoherent upon close examination and that Liebowitz and Margolis had misconstrued the issues at stake. The present author asserted that one can usefully incorporate several of Liebowitz and Margolis’s ideas on foresight and forward-looking behavior into the theory of path dependence while still affirming the claims made by proponents (Puffert 2000, 2002, 2003).

Imperfect Foresight and Inefficiency

One point that I have emphasized is that the cases of path dependence cited by proponents typically involve imperfect foresight, and sometimes other features, that make remediation impossible. Indeed, proponents of the importance of path dependence partly recognized this point prior to the work of Liebowitz and Margolis. Nobel Prize-winner Kenneth Arrow argued in his foreword to Arthur’s collected articles that Arthur’s modeling approach applies specifically to cases where foresight is imperfect, or “expectations are based on limited information” (Arthur 1994). Thus, economic agents cannot foresee future payoffs, and they cannot know how best to direct the process to the outcomes they would prefer. In terms of the payoffs in Table 2, technique A might become locked-in because adopters as well as suppliers initially think, mistakenly, that technique A will continue to offer the higher payoffs. Similarly, David (1987) had argued still earlier that path dependence is sometimes of interest precisely because lock-in might happen too quickly, before the payoffs of different paths are known. Lock-in, as David and Arthur use the term, applies to a stable equilibrium — i.e., to an outcome that, if inefficient, is not remediable. (Liebowitz and Margolis introduce a different definition of lock-in.)

Imperfect foresight is, of course, a common condition — and especially common for new, unproven products (or techniques) in untested markets. Part of the difference between path-dependent and “path-independent” processes is that foresight doesn’t matter for path-independent processes. No matter what the path of events, path-independent processes still end up at unique outcomes that are predictable on the basis of fundamental conditions. Generally, these predictable outcomes are those that are most efficient and that offer the highest payoffs. By contrast, path-dependent processes have multiple potential outcomes, and the outcome selected is not necessarily the one offering the highest payoffs. This contrast to the results of standard economic analysis is part of what makes path dependence interesting.

Winners, Losers and Path Dependence

Path dependence is also interesting, however, when the issue at stake is not the overall efficiency (i.e., Pareto efficiency) of the outcome, but rather the distribution of rewards between “winners” and “losers” — for example, between firms competing to establish their products or techniques as a de facto standard, resulting in profits or economic rents to the winner only. This is something that finds no place in Liebowitz and Margolis’s taxonomy of “degrees.” In keeping with Liebowitz and Margolis’s analysis, competing firms certainly exercise forward-looking behavior in efforts to determine the outcome, but imperfect information and imperfect control over circumstances still make the outcome path dependent, as some of the case studies below illustrate.

Lack of Agreement on What the Debate Is About

Finally, market failure per se has never been the primary concern of proponents of the importance of path dependence. Even when proponents have highlighted inefficiency as one possible consequence of path dependence, this inefficiency is often the result of imperfect foresight rather than of market failure. Market failure is, however, the primary concern of Liebowitz and Margolis. This difference in perspective is one reason that the arguments of proponents and opponents have often failed to meet head on, as we shall consider in several case studies.

These contrasting analytical arguments can best be assessed through empirical cases. The case of the QWERTY keyboard is considered first, because it has generated the most controversy and it illustrates opposing arguments. Three further cases are particularly useful for the lessons they offer. Britain’s “coal wagon problem” offers a strong example of inefficiency. The worldwide history of railway track gauge, now considered at greater length, illustrates the roles of foresight (or lack thereof) and transitory circumstances, as well as the role of purposeful behavior to remedy outcomes. The case of competition in videocassette recorders illustrates how path dependence is compatible with purposeful behavior, and it shows how proponents and critics of the importance of path dependence can offer different interpretations of the same events.

The Debate over QWERTY

The most influential empirical case has been that of the “QWERTY” standard typewriter and computer keyboard, named for the first letters appearing on the top row of keys. The concept of path dependence first gained widespread attention through David’s (1985, 1986) interpretation of the emergence and persistence of the QWERTY standard. The critique of path dependence began with the alternative interpretation offered by Liebowitz and Margolis (1990).

David (1986) noted that the QWERTY keyboard was designed, in part, to reduce mechanical jamming on an early typewriter design that quickly went out of use, while other early keyboards were designed more with the intention of facilitating fast, efficient typing. In David’s account, QWERTY’s triumph over its initial revivals resulted largely from the happenstance that typing schools and manuals offered instruction in eight-finger “touch” typing first for QWERTY. The availability of trained typists encouraged office managers to buy QWERTY machines, which in turn gave further encouragement to budding typists to learn QWERTY. These positive feedbacks increased QWERTY’s market share until it was established as the de facto standard keyboard.

Furthermore, according to David, similar positive feedbacks have kept typewriter users “locked in” to QWERTY, so that new, superior keyboards could gain no more than a small foothold in the market. In particular the Dvorak Simplified Keyboard, introduced during the 1930s, has been locked out of the market despite experiments showing its superior ergonomic efficiency. David concluded that our choice of a keyboard even today is governed by history, not by what would be ergonomically and economically optimal apart from history.

Liebowitz and Margolis (1990) directed much of their counterargument to the alleged superiority of the Dvorak keyboard. They showed, indeed, that claims David cited for the dramatic superiority of the Dvorak keyboard were based on dubious experiments. The experiments that Liebowitz and Margolis prefer support the conclusion that it could never be profitable to retrain typists from QWERTY to the Dvorak keyboard. Moreover, Liebowitz and Margolis cited ergonomic studies that conclude that the Dvorak keyboard offers at most only a two to six percent efficiency advantage over QWERTY.

Liebowitz and Margolis did not address David’s proposed mechanism for the original triumph of QWERTY. Instead, they argued against the claims of some popular accounts that QWERTY owes its success largely to the demonstration effect of winning a single early typing contest. Liebowitz and Margolis showed that other, well-known typing contests were won by non-QWERTY typists, and so they cast doubt on the impact of a single historical accident. This, however, did not address the argument that David made about that one typing contest. David’s argument was that the contest’s modest impact consisted largely in vindicating the effectiveness of eight-finger touch-typing, which was being taught at the time only for QWERTY.

Although Liebowitz and Margolis never addressed David’s claims about the role of third-party typing instruction, they did argue that suppliers had opportunities to offer training in conjunction with selling typewriters to new offices, so that non-QWERTY keyboards would not have been disadvantaged. They did not, however, present evidence that suppliers actually offered such training during the early years of touch-typing, the time when QWERTY became dominant. Whether the early history of QWERTY was path dependent thus seems to depend largely on the unaddressed question of how much typing instruction was offered directly by suppliers, as Liebowitz and Margolis suggest could have happened, and how much was offered by third parties using QWERTY, as David showed did happen.

Liebowitz and Margolis showed that early typewriter manufacturers competed vigorously in the features of their machines. They inferred, therefore, that the reason that typewriter suppliers increasingly supported and promoted QWERTY must have been that it offered a competitive advantage as the most effective system available. This reasoning is plausible, but it was not supported by direct evidence. The alternative, path-dependent explanation would be that QWERTY’s competitive advantage in winning new customers consisted largely in its lead in trained typists and market share. That is, positive feedbacks would have affected the decisions of customers and, thus, also suppliers. David presented some evidence for this, although, in light of the issues raised by Liebowitz and Margolis, this evidence might now appear less than conclusive.

Liebowitz and Margolis highlighted the following lines from David’s article: “… competition in the absence of perfect futures markets drove the industry prematurely into de facto standardization on the wrong system — and that is where decentralized decision-making subsequently has sufficed to hold it” (emphasis original in David’s article). In Liebowitz and Margolis’s view, the focus here on decentralized decision-making constitutes a claim for market failure and third-degree path dependence, and they treat this as the central claim of David’s article. In the view of the present author, this interpretation is mistaken. David’s claim here plays only a minor role in his argument — indeed it is less than one sentence. Moreover, it is not clear that David’s comment about decentralized decision-making amounts to anything more than a reference to the high transactions costs that would be entailed in organizing a coordinated movement to an alternative outcome — a point that Liebowitz and Margolis themselves have argued in other (non-QWERTY) contexts. (A coordinated change would be necessary because few typists would wish to learn a non-QWERTY system unless they could be sure of conveniently finding a compatible keyboard wherever they go.) David may have wished to suggest that centralized decision-making (by government?) would have greatly reduced these transactions costs, but David made no explicit claim that such a remedy would be feasible. If David had wished to make market failure or remediable inefficiency the central focus of his claims for path dependence, then he surely could and would have done so in a more explicit and forceful manner.

Part of what remains of the case of QWERTY is modest support for David’s central claim that history has mattered, leaving us with a standard keyboard that is less efficient than alternatives available today — not as inefficient as the claims David cited, but still somewhat so. Donald Norman, one of the world’s leading authorities on ergonomics, estimates on the basis of several recent studies that QWERTY is about 10 percent less efficient than the Dvorak keyboard and other alternatives (Norman, 1990, and recent personal correspondence).

For Liebowitz and Margolis, it was most important to show that the costs of switching to an alternative keyboard would outweigh any benefits, so that there is no market failure in remaining with the QWERTY standard. This claim appears to stand. David had made no explicit claim for market failure, but Liebowitz and Margolis — as well, indeed, as some supporters of David’s account — took that as the main issue at stake in David’s argument.

Britain’s “Silly Little Bobtailed” Coal Wagons

A strong example of inefficiency in path dependence is offered by the small coal wagons that persisted in British railway traffic until the mid-twentieth century. Already in 1915, economist Thorstein Veblen cited these “silly little bobtailed carriages” as an example of how industrial modernization may be inhibited by “the restraining dead hand of … past achievement,” that is, the historical legacy of interrelated physical infrastructure: “the terminal facilities, tracks, shunting facilities, and all the ways and means of handling freight on this oldest and most complete of railway systems” (Veblen, 1915, pp. 125-8). Veblen’s analysis was the starting point for the literature on technical and institutional interrelatedness that formed the background to David’s early views on path dependence.

In recent years Van Vleck (1997, 1999) has defended the efficiency of Britain’s small coal wagons, arguing that they offered “a crude just-in-time approach to inventory” for coal users while economizing on the substantial costs of road haulage that would have been necessary for small deliveries if railway coal wagons were larger. More recently, however, Scott (1999, 2001) presented evidence that few coal users benefited from small deliveries. Rather, he showed, the wagons’ small size, widely dispersed ownership and control, antiquated braking and lubrication systems, and generally poor physical condition made them quite inefficient indeed. Replacing these cars and associated infrastructure with modern, larger wagons owned and controlled by the railways would have offered savings in railway operating costs of about 56 percent and a social rate of return of about 24 percent. Nevertheless, the small wagons were not replaced until both railways and collieries were nationalized after World War II. The reason, according to Scott, lay partly in the regulatory system that allocated certain rights to collieries and other car owners at the expense of the railways, and partly in the massive coordination problem that arose because railways would not have realized much savings in costs until a large proportion of antiquated cars were replaced. Together, these factors lowered the railways’ realizable private rate of return below profitable levels. (Van Vleck’s smaller estimates for potential efficiency gains from scrapping the small wagons were largely the result of assuming that there would be no change in the regulatory system or in the ownership and control of wagons. Scott argued that such changes added greatly to the potential cost savings.)

Scott noted that the persistence of small wagons was path dependent, because both the technology embodied in the small wagons and the institutions that supported fragmented ownership long outlasted the earlier, transitory conditions to which they were a rational response. Ownership of wagons by the collieries had been advantageous to railways as well as collieries in the mid-nineteenth century, and government regulation had assigned rights in a way designed to protect the interests of wagon owners from opportunistic behavior by the railways. By the early twentieth century, these regulatory institutions imposed a heavy burden on the railways, because they required either conveyance even of antiquated wagons for set rates or else payment of high levels of compensation to the wagon owners. The requirement for compensation helped to raise the railways’ private costs of scrapping the small wagons above the social costs of doing so.

The case shows the relevance of Paul David’s approach to path dependence, with its discussion of technical (and institutional) interrelatedness and quasi-irreversible investment, above and beyond Brian Arthur’s more narrow focus on increasing returns.

The case also supports Liebowitz and Margolis’s insight that an inferior path-dependent outcome can only persist where transactions costs (and other costs) prevent remediation, but it undercuts those authors’ skepticism toward the possibility of market failure. The high transactions costs that would have been entailed in scrapping Britain’s small wagons indeed outweighed the potential gains, but these costs were high only due to the institutions of property rights that supported fragmented ownership. When these institutions were later changed, a remedy to Britain’s coal-wagon problem followed quickly. Thus, the failure to scrap the small wagons earlier can be ascribed to institutional and market failure.

The case thus appears to satisfy Liebowitz and Margolis’s criterion for “third-degree” path dependence. This is not completely clear, however. Whether Britain’s coal-wagon problem qualifies for that status depends on whether the benefits of solving the problem would have been worth the cost of implementing the necessary institutional changes, a question that Scott did not address. Liebowitz and Margolis argue that an inferior outcome cannot be considered a result of market failure, or even meaningfully inefficient, unless this criterion of remediability is satisfied.

In this present author’s view, Liebowitz and Margolis’s criterion has some usefulness in the context of considering government policy toward inferior outcomes, which is Liebowitz and Margolis’s chief concern, but the criterion is much less useful for a more general analysis of these outcomes. If Britain’s coal-wagon problem does not qualify for “third-degree” status, then it suggests that Liebowitz and Margolis’s dismissive approach toward cases that they relegate to “second-degree” status is misplaced. The case seems to show that path dependence can have substantial effects on the economy, that the outcomes of path-dependent processes can vary substantially from the predictions of standard economic models, that these outcomes can exhibit substantial inefficiency of a sort discussed by proponents of path dependence, and that all this can happen despite the exercise of foresight and forward-looking behavior.

Railway Track Gauges

The case of railway track gauge illustrates how “accidental” or “contingent” events and transitory circumstances can affect choice of technique and economic efficiency over a period now approaching two centuries (Puffert 2000, 2002). The gauge now used on over half the world’s railways, 4 feet 8.5 inches (4’8.5″, 1435 mm), comes from the primitive mining tramway where George Stephenson gained his early experience. Stephenson transferred this gauge to the Liverpool and Manchester Railway, opened in 1830, which served as the model of best practice for many of the earliest modern railways in Britain, continental Europe, and North America. Many railway engineers today view this gauge as narrower than optimal. Yet, although they would choose a broader gauge today if the choice were open, they do not view potential gains in operating efficiency as worth the costs of conversion.

A much greater source of inefficiency has been the emergence of diversity in gauge. Six gauges came into widespread use in North America by the 1870s, and Britain’s extensive Great Western Railway system maintained a variant gauge for over half a century until 1892. Even today, Australia and Argentina each have three different regional-standard gauges, while India, Chile, and several other countries each make extensive use of two gauges. Breaks of gauge also persist at the border of France and Spain and most external borders of the former Russian and Soviet empires. This diversity adds costs and impairs service in interregional and international traffic. Where diversity has been resolved, conversion costs have sometimes been substantial.

This diversity arose as a result of several contributing factors: limited foresight, the search for an improved railway technology, transitory circumstances, and contingent events or “historical accidents.” Many early railway builders sought simply to serve local or regional transportation needs, and they did not foresee the later importance of railways in interregional traffic. Beginning in the late 1830s, locomotive builders found their ability to construct more powerful, easily maintained engines constrained by the Stephenson gauge, while some civil engineers thought that a broader gauge would offer improved capacity, speed, and passenger comfort. This led to a wave of adoption of broad gauges for new regions in Europe, the Americas, South Asia, and Australia. Changes in locomotive design soon eliminated much of the advantage of broad gauges, and by the 1860s it became possible to take advantage of the ability of narrow gauges to make sharper curves, following the contours of rugged landscape and reducing the need for costly bridges, embankments, cuttings, and tunnels. This, together with the beliefs of some engineers and promoters that narrow gauges would offer savings in operating costs, led to a wave of introductions of narrow gauges to new regions.

At every point of time there was some variation in engineering opinion and practice, so that which gauge was introduced to each new region often depended on the contingent circumstances of who decided the gauge. To cite only the most fateful example, Stephenson’s rivals for the contract to build the Liverpool and Manchester Railway proposed to adopt the gauge of 5’6″ (1676 mm). If that team had been employed, or if Stephenson had gained his earlier experience on almost any other mining tramway, then the ensuing worldwide history of railway gauge would have been different — perhaps far different.

After the introduction of particular gauges to new regions, later railways nearly always adopted the gauge of established connecting lines, reinforcing early contingent choices with positive feedbacks. As different local common-gauge regions expanded, regions that happened to have the same gauge merged into one another, but breaks of gauge emerged between regions of differing gauge. The extent of diversity that emerged at the national and continental levels, and thus the relative efficiency of the outcome, thus depended on earlier contingent events.

Once these patterns of diversity had been established by a path-dependent process, they were partly rationalized by the sort of forward-looking, profit-seeking behavior proposed by Liebowitz and Margolis. In North America, for example, a continental standard emerged quickly after demand for interregional transport grew, and standardization was facilitated both by the formation of interregional railway systems and by cooperation among independent railways. Elsewhere as well, much of the most inefficient diversity was resolved relatively quickly. Nonetheless, a costly diversity has persisted in places where variant-gauge regions had grown large and costly to convert before the value of conversion became apparent. Spain’s variant gauge has become more costly in recent years as the country’s economy has been integrated into that of the European Union, but estimated costs of (U.S.) $5 billion have precluded conversion. India and Australia have only recently made substantial progress toward the resolution of their century-old diversity.

Wherever gauge diversity has been resolved, it is one of the earliest gauges that has emerged as the standard. In no significant part of the world has current practice in gauge broken free of its early history. The inefficiency that has resulted, relative to what other sequences of events might have produced, was not the result of market failure. Rather, it resulted primarily from the natural inability of railway builders to foresee how railway networks and traffic patterns would develop and how technology would evolve.

The case also illustrates the usefulness of Arthur’s (1989) modeling approach for cases of unsponsored techniques and limited foresight (Puffert 2000, 2002). These were essentially the conditions Arthur assumed in proposing his model.

Videocassette Recording Systems

Markets for technical systems exhibiting network externalities (where users benefit from using the same system as other users) often tend to give rise to de facto standards — one system used by all. Foreseeing this, suppliers sometimes join to offer a common system standard from the outset, precluding any possibility for path-dependent competition. Examples include first-generation compact discs (CDs and CD-ROMs) and second-generation DVDs.

In the case of consumer videocassette recorders (VCRs), however, Sony with its Betamax system and JVC with its VHS system were unable to agree on a common set of technical specifications. This gave rise to a celebrated battle between the systems lasting from the mid-1970s to the mid-1980s. Arthur (1990) used this competition as the basis for a thought experiment to illustrate path dependence. He explained the triumph of VHS as the result of positive feedbacks in the video film rental market, as video rental stores stocked more film titles for the system with the larger user base, while new adopters chose the system for which they could rent more videos. He also suggested tentatively that, if the common perception that Betamax offered a superior picture quality is true, then the “the market’s choice” was not the best possible outcome.

In a closer look at the case, Cusumano et al. (1992) showed that Arthur’s suggested positive-feedback mechanism was real, and that this mechanism explains why Sony eventually withdrew Betamax from the market rather than continuing to offer it as an alternative system. However, they also showed that the video rental market emerged only at a late stage in the competition, after VHS already had a strong lead in market share. Thus, Arthur’s mechanism does not explain how the initial symmetry in competitors’ positions was broken.

Cusumano et al. argued, nonetheless, that the earlier competition already had a path-dependent market-share dynamic. They presented evidence that suppliers and distributors of VCRs increasingly chose to support VHS rather than Betamax because they saw other market participants doing so, leading them to believe that VHS would win the competition and emerge as a de facto standard. The authors did not make clear, however, why market participants believed that a single system would become so dominant. (In a private communication, coauthor Richard Rosenbloom said that this was largely because they foresaw the later emergence of a market for prerecorded videos.)

The authors argue that three early differences in promoters’ strategies gave VHS its initial lead. First, Sony proceeded without major co-sponsors for its Betamax system, while JVC shared VHS with several major competitors. Second, the VHS consortium quickly installed a large manufacturing capacity. Third, Sony opted for a more compact videocassette, while JVC chose instead a longer playing time for VHS. In the event, a longer playing time proved more important to many consumers and distributors, at least during early years of the competition when Sony cassettes could not accommodate a full (U.S.) football game.

This interpretation shows how purposeful, forward-looking behavior interacted with positive feedbacks in producing the final outcome. The different strategies, made under conditions of limited foresight, were contingent decisions that set competition among the firms on one path rather than another (Puffert 2003). Furthermore, the early inability of Sony cassettes to accommodate a football game was a transitory circumstance that may have affected outcomes long afterward.

Liebowitz and Margolis’s (1995) initial interpretation of the case responded only to Arthur’s brief discussion. They argued that the playing-time advantage for VHS was the crucial factor in the competition, so that VHS won because its features most closely matched consumer demand — and not due to path dependence. Although their discussion covers part of the same ground as that of Cusumano et al., Liebowitz and Margolis did not respond to the earlier article’s argument that the purposeful behavior of suppliers interacted with positive feedbacks. Rather, they treated this purposeful behavior as the antithesis of the mechanistic, non-purposeful evolution of market share that they see as the ultimate basis of path dependence.

Liebowitz and Margolis also presented substantial evidence that Betamax was not, in fact, a superior system for the consumer market. The primary concern of their argument was to refute a suggested case of path-dependent lock-in to an inferior technique, and in this they succeeded. It is arguable that they overstated their case, however, in asserting that what they refuted amounted to a claim for “third-degree” path dependence. Arthur had not argued that the selection of VHS, if inferior to Betamax, would have been remediable.

Recently, Liebowitz (2002) did respond to Cusumano et al. He argued, in part, that the larger VHS tape size offered a permanent rather than transitory advantage, as this size facilitated higher tape speeds and thus better picture quality for any given total playing time.

A Brief Discussion of Further Cases

Pest Control

Cowan and Gunby (1996) showed that there is path dependence in farmers’ choices between systems of chemical pest control and integrated pest management (IPM). IPM relies in part on predatory insects to devour harmful ones, and the drift of chemical pesticides from neighboring fields often makes the use of IPM impossible. Predatory insects also drift among fields, further raising farmers’ incentives to use the same techniques as neighbors. To be practical, IPM must be used on the whole set of farms that are in proximity to each other. Where this set is large, the transactions costs of persuading all farmers to forego chemical methods often prevent adoption. In addition to these localized positive feedbacks, local learning effects also make the choice between systems path dependent. The path-dependent local lock-in of each technique has sometimes been upset by such developments as invasions by new pests and the emergence of resistance to pesticides.

Nuclear Power Reactors

Cowan (1990) argued that transitory circumstances led to the establishment of the dominant “light-water” design for civilian nuclear power reactors. This design, adapted from power plants for nuclear submarines, was rushed into use during the Cold War because the political value of demonstrating peaceful uses for nuclear technology overrode the value of finding the most efficient technique. Thereafter, according to Cowan, learning effects arising from engineering experience for the light-water design continued to make it the rational choice for new reactors. He argued that there are fundamental scientific and engineering reasons for believing, however, that an equivalent degree of development of alternative designs may have made them superior.

Information Technology

Although Shapiro and Varian (1998) did not emphasize the term path dependence, they pointed to a broad range of research documenting positive feedbacks that affect competition in contemporary information technology. Like Morris and Ferguson (1993), they showed how competing firms recognize and seek to take advantage of these positive feedbacks. Strictly speaking, not all of these cases are path dependent, because in some cases firms have been able to control the direction and outcome of the allocation processes. In other cases, however, the allocation process has had its own path-dependent dynamic, affected both by the attempts of rival firms to promote their products and by factors that are unforeseen or out of their control.

Among the cases that Shapiro and Varian discuss are some involving Microsoft. In addition, some proponents of the importance of path dependence have argued that positive feedbacks favor Microsoft’s competitive position in ways that hinder competitors from developing and introducing innovative products (see, for example, Reback et al., 1995). Liebowitz and Margolis (2000), by contrast, offered evidence of cases where superior computer software products have had no trouble winning markets. Liebowitz and Margolis also argued that the lack of demonstrated empirical examples of “third-degree” path dependence creates a strong presumption against the existence of an inferior outcome that government antitrust measures could remedy.

Path Dependence at Larger Levels

Geography and Trade

The examples thus far all treat path dependence in the selection of alternative products or techniques. Krugman (1991, 1994) and Arthur (1994) have also pointed to a role for contingent events and positive feedbacks in economic geography, including in the establishment of Silicon Valley and other concentrations of economic activity. Some of these locations, they showed, are the result not of systematic advantages but rather of accidental origins reinforced by “agglomeration” economies that lead new firms to locate in the vicinity of similar established firms. Krugman (1994) also discussed how these same effects produce path dependence in patterns of international trade. Geographic patterns of economic activity, some of which arise as a result of contingent historical events, determine the patterns of comparative advantage that in turn determine patterns of trade.

Institutional Development

Path dependence also arises in the development of institutions — a term that economists use to refer to the “rules of the game” for an economy. Eichengreen (1996) showed, for example, that the emergence of international monetary systems, such as the classical gold standard of the late nineteenth century, was path dependent. This path dependence has been based on the benefits to different countries of adopting a common monetary system. Eichengreen noted that these benefits take the form of network externalities. Puffert (2003) has argued that path dependence in institutions is likely to be similar to path dependence in technology, as both are based on the value of adopting a common practice — some technique or rule — that becomes costly to change.

Thus path dependence can affect not only individual features of the economy but also larger patterns of economic activity and development. Indeed, some teachers of economic history interpret major regional and national patterns of industrialization and growth as partly the result of contingent events reinforced by positive feedbacks — that is, as path dependent. Some suggest, as well, that the institutions responsible for economic development in some parts of the world and those responsible for backwardness in others are, at least in part, path dependent. In the coming years we may expect these ideas to be included in a growing literature on path dependence.

Conclusion

Path dependence arises, ultimately, because there are increasing returns to the adoption of some technique or other practice and because there are costs in changing from an established practice to a different one. As a result, many current features of the economy are based on what appeared optimal or profit-maximizing at some point in the past, rather than on what might be preferred on the basis of current general conditions.

The theory of path dependence is not an alternative to neoclassical economics but rather a supplement to it. The theory of path dependence assumes, generally, that people optimize on the basis of their own interests and the information at their disposal, but it highlights ways that earlier choices put constraints on later ones, channeling the sequence of economic outcomes along one possible path rather than another. This theory offers reason to believe that some — or perhaps many — economic processes have multiple possible paths of outcomes, rather than a unique equilibrium (or unique path of equilibria). Thus the selection among outcomes may depend on nonsystematic or “contingent” choices or events. Empirical case studies offer examples of how such choices or events have led to the establishment, and “lock in,” of particular techniques, institutions, and other features of the economy that we observe today — although other outcomes would have been possible. Thus, the analysis of path dependence adds to what economists know on the basis of more established forms of neoclassical analysis.

It is not possible at this time to assess the overall importance of path dependence, either in determining individual features of the economy or in determining larger patterns of economic activity. Research has only partly sorted out the concrete conditions of technology, interactions among agents, foresight, and markets and other institutions that make allocation path dependent in some cases but not in others (Puffert 2003; see also David 1997, 1999, 2000 for recent refinements on theoretical conditions for path dependence).

Addendum: Technical Notes on Definitions

Path dependence, as economists use the term, corresponds closely to what mathematicians call non-ergodicity (David 2000). A non-ergodic stochastic process is one that, as it develops, undergoes a change in the limiting distribution of future states, that is, in the probabilities of different outcomes in the distant future. This is somewhat different from what mathematicians call path dependence. In mathematics, a stochastic process is called path dependent, as opposed to state dependent, if the probabilities of transition to alternative states depend not simply on the current state of the system but, additionally, on previous states.

Furthermore, the term path dependence is applied to economic processes in which small variations in early events can lead to large or discrete variations in later outcomes, but generally not to processes in which small variations in events lead only to small and continuous variations in outcomes. That is, the term is used for cases where positive feedbacks magnify the impact of early events, not for cases where negative feedbacks diminish this impact over time.

The term path dependence can also be used for cases in which the impact of early events persists without appreciably increasing or decreasing over time. The most important examples would be instances where transitory conditions have large, persistent impacts.

References

Arthur, W. Brian. 1989. “Competing Technologies, Increasing Returns, and Lock-in by Historical Events.” Economic Journal 99: 116‑31.

Arthur, W. Brian. 1990. “Positive Feedbacks in the Economy.” Scientific American 262 (February): 92-99.

Arthur, W. Brian. 1994. Increasing Returns and Path Dependence in the Economy. Ann Arbor: University of Michigan Press.

Cowan, Robin. 1990. “Nuclear Power Reactors: A Study in Technological Lock-in.” Journal of Economic History 50: 541-67.

Cowan, Robin, and Philip Gunby. 1996. “Sprayed to Death: Path Dependence, Lock-in and Pest Control Strategies.” Economic Journal 106: 521-42.

Cusumano, Michael A., Yiorgos Mylonadis, and Richard S. Rosenbloom. 1992. “Strategic Maneuvering and Mass-Market Dynamics: The Triumph of VHS over Beta.” Business History Review 66: 51-94.

David, Paul A. 1975. Technical Choice, Innovation and Economic Growth: Essays on American and British Experience in the Nineteenth Century. Cambridge: Cambridge University Press.

David, Paul A. 1985. “Clio and the Economics of QWERTY.” American Economic Review (Papers and Proceedings) 75: 332-37.

David, Paul A. 1986. “Understanding the Economics of QWERTY: The Necessity of History.” In W.N. Parker, ed., Economic History and the Modern Economist. Oxford: Oxford University Press.

David, Paul A. 1987. “Some New Standards for the Economics of Standardization in the Information Age.” In P. Dasgupta and P. Stoneman, eds., Economic Policy and Technological Performance. Cambridge, England: Cambridge University Press.

David, Paul A. 1997. “Path Dependence and the Quest for Historical Economics: One More Chorus of the Ballad of QWERTY.” University of Oxford Discussion Papers in Economic and Social History, Number 20. http://www.nuff.ox.ac.uk/economics/history/paper20/david3.pdf

David, Paul A. 1999. ” At Last, a Remedy for Chronic QWERTY-Skepticism!” Working paper, All Souls College, Oxford University. http://www.eh.net/Clio/Publications/remedy.shtml

David, Paul A. 2000. “Path Dependence, Its Critics and the Quest for ‘Historical Economics’.” Working paper, All Souls College, Oxford University.
http://www-econ.stanford.edu/faculty/workp/swp00011.html

Eichengreen, Barry. 1996 Globalizing Capital: A History of the International Monetary System. Princeton: Princeton University Press.

Frankel, M. 1955. “Obsolescence and Technological Change in a Maturing Economy.” American Economic Review 45: 296-319.

Katz, Michael L., and Carl Shapiro. 1985. “Network Externalities, Competition, and Compatibility.” American Economic Review 75: 424-40.

Katz, Michael L., and Carl Shapiro. 1994. “Systems Competition and Network Effects.” Journal of Economic Perspectives 8: 93-115.

Kindleberger, Charles P. 1964. Economic Growth in France and Britain, 1851-1950. Cambridge, MA: Harvard University Press.

Krugman, Paul. 1991. “Increasing Returns and Economic Geography.” Journal of Political Economy 99: 483-99.

Krugman, Paul. 1994. Peddling Prosperity. New York: W.W. Norton.

Liebowitz, S.J. 2002. Rethinking the Network Economy. New York: AMACOM

Liebowitz, S.J., and Stephen E. Margolis. 1990. “The Fable of the Keys.” Journal of Law and Economics 33: 1-25.

Liebowitz, S.J., and Stephen E. Margolis. 1995. “Path Dependence, Lock-In, and History.” Journal of Law, Economics, and Organization 11: 204-26. http://wwwpub.utdallas.edu/~liebowit/paths.html

Liebowitz, S.J., and Stephen E. Margolis. 2000. Winners, Losers, and Microsoft. Oakland: The Independent Institute.

Morris, Charles R., and Charles H. Ferguson. 1993. “How Architecture Wins Technology Wars.” Harvard Business Review (March-April): 86-96.

Norman, Donald A. 1990. The Design of Everyday Things. New York: Doubleday. (Originally published in 1988 as The Psychology of Everyday Things.)

Puffert, Douglas J. 2000. “The Standardization of Track Gauge on North American Railways, 1830-1890.” Journal of Economic History 60: 933-60.

Puffert, Douglas J. 2002. “Path Dependence in Spatial Networks: The Standardization of Railway Track Gauge.” Explorations in Economic History 39: 282-314.

Puffert, Douglas J. 2003 forthcoming. “Path Dependence, Network Form, and Technological Change.” In W. Sundstrom, T. Guinnane, and W. Whatley, eds., History Matters: Essays on Economic Growth, Technology, and Demographic Change. Stanford: Stanford University Press. http://www.vwl.uni-muenchen.de/ls_komlos/nettech1.pdf

Reback, Gary, Susan Creighton, David Killam, and Neil Nathanson. 1995. “Technological, Economic and Legal Perspectives Regarding Microsoft’s Business Strategy in Light of the Proposed Acquisition of Intuit, Inc.” (“Microsoft White Paper”). White paper, law firm of Wilson, Sonsini, Goodrich & Rosati. http://www.antitrust.org/cases/microsoft/whitep.html

Scott, Peter. 1999. “The Efficiency of Britain’s ‘Silly Little Bobtailed’ Coal Wagons: A Comment on Van Vleck.” Journal of Economic History 59: 1072-80.

Scott, Peter. 2001. “Path Dependence and Britain’s ‘Coal Wagon Problem’.” Explorations in Economic History 38: 366-85.

Shapiro, Carl and Hal R. Varian. 1998. Information Rules. Cambridge, MA: Harvard Business School Press.

Van Vleck, Va Nee L. 1997. “Delivering Coal by Road and Rail in Britain: The Efficiency of the ‘Silly Little Bobtailed’ Coal Wagons.” Journal of Economic History 57: 139-160.

Van Vleck, Va Nee L. 1999. “In Defense (Again) of ‘Silly Little Bobtailed’ Coal Wagons: Reply to Peter Scott.” Journal of Economic History 59: 1081-84.

Veblen, Thorstein. 1915. Imperial Germany and the Industrial Revolution. London: Macmillan.

Citation: Puffert, Douglas. “Path Dependence”. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL http://eh.net/encyclopedia/path-dependence/

Peaceful Surrender: The Depopulation of Rural Spain in the Twentieth Century

Author(s):Collantes, Fernando
Pinilla, Vicente
Reviewer(s):Rosés, Joan R.

Published by EH.Net (June 2012)

Fernando Collantes and Vicente Pinilla, Peaceful Surrender: The Depopulation of Rural Spain in the Twentieth Century. Newcastle-upon-Tyne: Cambridge Scholars Publishing, 2011.? viii + 202 pp. $60 (hardcover), ISBN: 978-1-4438-2838-3.

Reviewed for EH.Net by Joan R. Ros?s, Department of Economic History and Institutions, Universidad Carlos III.

Not only military history is written by the victors, but also economic and business history. Academic books and articles are mainly devoted to the histories of successful firms, industries, regions and countries. The losers receive much less attention than winners and sometimes are condemned for their reluctance toward economic development and resistance to the adoption of innovations. In sharp contrast, the authors of this book, Fernando Collantes and Vicente Pinilla from the University of Zaragoza, have published many contributions about one of the main losers of modern development: rural areas. It is an empirical regularity that, as a country develops, the countryside loses ground in comparison to cities, in terms of both population and relative income.

This well-written book examines the dramatic process of rural depopulation that took place in Spain during the twentieth century, particularly after the 1950. The aim of the authors is not censoring rural inhabitants for their inaction or indolence but explaining how they have been able to cope with the enormous economic and social changes that accompanied the process of rural depopulation. The book is divided into three main parts. The first provides theoretical, historical and comparative context for rural depopulation. Part two examines the causes for this process. Part three analyzes what happened with rural areas after the depopulation.

As Collantes and Pinilla persuasively argue, there were several forces behind rural depopulation, which often resulted in disparate experiences and outcomes. Urbanization and industrialization were the underlining prime movers of the process of rural change. This is easy to observe since urbanization and industrialization had an obvious parallel in the release of labor from the countryside. Demographic developments also had, nonetheless, their role in rural depopulation. In countries with low demographic dynamism, like the majority of European economies during the twentieth century, massive migrations from the countryside led to an absolute decrease in the amount of rural inhabitants. On the other hand, in countries with substantial natural rates of growth, such as many of today?s developing countries, the movements of labor from rural to urban locations were counterbalanced by birth rates, which implied that rural locations did not depopulate despite their release of labor. To complicate the picture, agrarian economic progress had no clear-cut consequences for rural population. When Smithian economic change takes place (that is, economic growth was based on increasing trade and specialization) rural population doesn?t necessarily decrease as an economy develops (this could be the case of Western Europe?s countryside during the Industrious Revolution).? However, when Schumpeterian innovations are implemented in agriculture (particularly the massive adoption of labor-saving innovations like tractors and threshers), the outcome is a decrease of the agrarian workforce and the subsequent release of labor. Finally, access to new consumption bundles (education, cultural amenities, health services and so on) also had a role in the allocation of population between urban and rural locations. So, rural locations with easy access to these amenities could maintain their inhabitants or attract former urbanites looking for a new lifestyle.??

In the rest of the book, the authors analyze the Spanish experience with rural depopulation in the light of this general framework. Rural depopulation arrived later in Spain than in other Western European countries due to the lack of ?pull? from Spanish industrial centers and the relative productivity improvements of Spanish agriculture prior to 1950. In other words, the income gap between rural and urban locations was not large enough to provoke a rural exodus. The situation was dramatically altered after 1950. Spanish agriculture began to adopt labor-saving technologies which dramatically reduced the workforce required to maintain production. Furthermore, a simultaneous expansion of many non-farm activities in rural areas was unable to cope with the increasing amount of underemployed agrarian workers. As a consequence, a massive rural exodus took place. Despite these economic transformations, and the subsequent substantial improvements in living conditions of rural inhabitants, a large ?rural penalty? persisted. Rural inhabitants had less income, infrastructure and services than urbanites. Therefore, many rural locations were unable to attract former urbanites and became (and will remain) practically uninhabited.??

There are many reasons to praise this volume. First, the book considers a topic practically untouched in economic history. Needless to say that urbanization and industrialization have received more attention by economic historians specializing in the twentieth century than rural communities and their (mis)fortunes. Second, Collantes and Pinilla do not identify rural population with agrarian activities but consider other non-agricultural activities in the countryside. Reluctance of the countryside to complete depopulation is more related to the development of these new activities than the subsistence of farming, which rapidly declined during the twentieth century. For example, in 1991, only one fourth of the rural employed population in Spain was still engaged in agriculture (p. 124). The failure to understand the diversified nature of rural economies hampers the relevance of many analyses of the European countryside which mechanically associate rural areas with farming. Third, the authors consider several facets of the process including what they label the ?rural penalty?; that is, the opportunity cost of living in the countryside instead of cities. As they forcefully argue, the ?rural penalty? is not only composed of income differences but also of the differences in labor opportunities and amenities among cities and the countryside. Interestingly, as the economy urbanized, the ?rural penalty? grew since services and jobs left the countryside and tended to cluster in the most densely populated locations. And, finally, the book has an underlining comparative narrative. The Spanish experience is not seen in isolation but is considered within a more ample framework. This makes their conclusions relevant not only for Spain?s economic historians but also for all researchers interested in studying the long-run development of rural societies.
?

Joan R. Ros?s (jroses@clio.uc3m.es) is Associate Professor and Director in the Department of Economic History and Institutions of Universidad Carlos III in Madrid, Spain.? He has recently published several papers related to Spanish regional development and the performance of factor markets. His most recent article on the topic (with Juan Carmona) appeared in the European Review of Economic History (?Land Markets and Agrarian Backwardness (Spain, 1904-1934),? February, 2012).

Copyright (c) 2012 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 (June 2012). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Economywide Country Studies and Comparative History
Urban and Regional History
Geographic Area(s):Europe
Time Period(s):20th Century: Pre WWII
20th Century: WWII and post-WWII

Secular Missionaries: Americans and African Development in the 1960s

Author(s):Grubbs, Larry
Reviewer(s):Levendis, John

Published by EH.NET (July 2011)

Larry Grubbs, Secular Missionaries: Americans and African Development in the 1960s.? Amherst, MA: University of Massachusetts Press, 2010.? 256 pp. $35 (cloth), ISBN: 978-1-55849-734-4.

Reviewed for EH.Net by John Levendis, Department of Economics, Loyola University ? New Orleans.

Secular Missionaries, by Larry Grubbs, explores the origins and course of developmental political economy in Africa during the 1960s, its first decade of post-colonial independence.? Drawing a connection to the missionary zeal of the nineteenth-century civilizing mission, Grubbs asserts that development economists and practitioners based in the United States approached the task of ?developing Africa? with similar assumptions regarding the backwardness of Africans first articulated a century earlier during the early days of colonization.?

Cultural histories, such as this, reveal that the types of development questions that economists ask are culturally determined. The possible answers also depend upon, for example, Americans? views of Africa and Africans.? Are they children needing an adult?s nurturing? Unruly teenagers needing an adult?s discipline? Is Africa a tabula rasa or a briar patch?

By the early 1960s, the U.S. was fascinated with sub-Saharan Africa, which it viewed as a
blank slate unencrusted by the historical baggage of vested interests. Development was considered likely, but would it develop along politically democratic lines (the U.S. model) or along communist lines (the U.S.S.R. model)?

In the beginning of the 1960s American leaders believed that African leaders would selflessly promote growth. They seemed blind-sided by the selfishness and corruption that became apparent by the end of the 1960s. This mirrors developments years later in economics. The traditional neoclassical model of economics, the Paretian welfare model, assumes that the problems of incomplete markets can be solved by a government whose motives are unquestioned. It was a (cultural) given among economists: governments can maximize the social welfare function. That they might be maximizing their own welfare was not even considered until the establishment of the Public Choice School of economics.

The leading development theory of the time was ?Modernization Theory.? Based upon the general classifications of Walt Rostow?s ?Five Stages of Growth? theory, modernization theory was gleaned primarily from anecdotal historical evidence. Countries were believed to transition through stages. The task of development practitioners was to determine which countries had the right kinds of preconditions which would, with a nudge, allow their economy to ?take off? (an appropriate label for a theory born in the Space Age). Those countries which seemed to have the ability to absorb capital fruitfully were candidates for bilateral U.S. development aid. Aid-givers of the early 1960s had determined, wrongly, that Africa was peaceful, homogeneous, and had a strong political foundation which they had inherited from their colonizers, all of which would enable ?takeoff.? Cultural modernization would accompany and reinforce economic development.

The Rostvian development model allowed economists and policy makers to abstract away from country-specific idiosyncrasies, rendering development and U.S. foreign relations deceptively simple. In Rostow?s model, ?all nations are merely at different points on the same development path? (p. 58 Grubbs, quoting Haefle). Years later, development economists would continue to make the same mistakes when arguing for Solow-type ?absolute convergence.? Fortunately, this would be replaced decades (decades!) later by the more nuanced theory known as ?conditional convergence.?

The preconditions existed:? American capital and expertise were forthcoming. It was believed that markets in Africa were not developed enough to be able to coordinate all the various mechanisms necessary for growth. The obvious solution was centralized national-scale economic planning ? obvious in blackboard Paretian economics: ?Thus, even African leaders committed to a free market orientation acknowledged the need for significant government involvement in the national economy. Taking their cue from Soviet, Chinese, and Indian progress through Five-Year Plans, African rulers regardless of ideological orientation supported the drafting and promulgating … of national development plans that established targets and some criteria for allocating resources (including foreign assistance) to propel the nation forward through the ?stages of economic growth?? (p. 76). It was believed that by treating the economy as an engineering problem, planning would remove ideology and even history from the development equation: it was thus the ?moral equivalent of anti-colonialism? (p. 74).

Perhaps it is no surprise that planning was promoted too enthusiastically. Americans had had (supposed) success with planning with the Tennessee Valley Authority. Moreover, ?planning fit in neatly with an authoritarian impulse among Africa?s new ruling elite? (p. 80). Planning enthusiast Arnold Rivkin even believed that ?a development plan ? even one conceived in a period of troubles and confusion ? is always an element of stabilization and order? (p. 96).

Although late in the book, Grubbs admits that there was no universally accepted blueprint for ?good? economic plans, he does not provide the economic argument for why this will always be the case. Rather, he focused on the practical, political problems. One of the practical drawbacks to plan-based aid funding was that once the U.S. endorsed a plan, it created the impression that the U.S. would fund the entire plan. The U.S. might also find it difficult to withdraw funding whenever the plan was not being followed verbatim. Thus, the U.S. wound up funding boondoggle projects and bandit politicians.

Wolfgang Stolper ? of the Stolper-Samuleson theorem in international economics ? was charged with writing Nigeria?s first national development plan, though he was grossly unfamiliar with Nigeria. ?When the British conquered it [Nigeria] around 1900,? said Stolper, ?it was completely degenerate, with bloodthirsty tyrants, cannibalism, human sacrifices on an enormous scale? (p. 103). Unfazed, he wrote in his diary, ?I am the best economist in West Africa? (p. 103). He believed Nigeria would develop more quickly than other African countries, as he considered it fairly homogenous: its residents had ?a common language, similar university education, similar concepts and practices of modern jurisprudence, a common system of administration … one could go on and on? (p. 111). Nigeria homogenous?!
?
All the development plans failed in short order. Development practitioners tended not to blame themselves or their plans, but blamed Africans. By the end of the decade, frustrated, Americans rediscovered their old caricature of Africans as ?irrational.? One may substitute ?lazy,? ?stubborn,? ?tribal,? ?backward,? ?incompetent,? ?corrupt,? or any number of pejoratives here.? The recipients of aid, on the other hand, were frustrated with the bureaucratic nature ? the red tape, inscrutable and obstructive ? of planning.

?Why and how corruption came to exist and flourish in Arica, how multinational corporations and Western governments are implicated, need not be asked, let alone answered? (p. 188). (Grubbs does not mention P. T. Bauer?s criticism that aid itself creates the incentives for corruption since aid distribution is a zero-sum game.)

When Stolper wrote Planning without Facts, he complained that developing ?optimal? plans was made difficult by the lack of good economic statistics. Another passage that illustrates the epistemological naivet? with which development planning occurred, as well as Grubbs? uncritical acceptance of planning in general: ?Rostow wished to know if MIT had anything on hand with which to quickly estimate the kind of five-year plan Nigeria could or should produce? (p. 105).

The response to the failures of Modernization Theory was ?Dependency Theory.? Grubbs seems to accept this now-discredited theory as the explanation for Africa?s stunted growth. He accepts, for example, the argument that Africa?s poverty can be blamed on its poor terms of trade. He also accepts the critique of the dependency theorists that the national plans did not work because they were created by aid agencies and foreign governments and therefore did not reflect adequately African interests. This is true, but it is only part of the criticism. It seems that this criticism should apply to all such development plans. That is, all plans have to originate in a central bureau, so they can only incompletely capture every citizen?s interests.? ?Like their colonial predecessors, American scholars, experts, commentators, and officials succumbed to the hubris that promised complete knowledge and freedom of action.? Despite Wolfgang Stolper?s admission to the contrary in Planning without Facts, before the Nigerian civil war the American consensus held that enough information, analysis, and calculations could be arrayed to study and solve many African barriers to development. … Epistemology, therefore, furnishes part of the explanation for the failure of the U.S.?African endeavor of the sixties? (p. 185). Amen.

What I find remarkable is that neither the U.S. development practitioners, nor the African leaders found the very idea of national economic planning to be a nonstarter. Nor does Grubbs, except in the final pages of his conclusion. There had always been dissenters ? voices in the wilderness such as Ludwig von Mises, F. A. Hayek, and later, P. T. Bauer ? but then, and now in Secular Missionaries, those voices remained unheard or unheeded.

There is no mention made by Stolper or Grubbs of the Misesian or Hayekian critique that planning without market-prices is impossible, as the planner cannot know the relative costs and benefits ? the supplies and demands among competing uses ? of resources. Perhaps he can be excused for this oversight, as most of the economics profession at the time had been swayed by the Keynesian revolution to ignore the epistemological critiques. To criticize Stolper for not knowing better would be anachronistic. Grubbs does not have the same excuse: he should have explained to his readers ? political and cultural historians less familiar with economics ? the deeper critique.

A second critique is dynamic: long-term central planning cannot account for change.? What was once ?optimal? may not be optimal when the world changes ? something it seems to do on a continual basis. Moreover, long-term planning stifles entrepreneurship, and the creative dynamism of a market economy.

After many setbacks, ?American policymakers began to distance themselves from the burden they had assumed in Africa? (p. 124). By the end of the 1960s they shifted from targeted bilateral aid to a more withdrawn position, hiding behind multilateral aid agencies such as the World Bank and other regional institutions.

Grubbs is clear that the subject of his study is middlebrow liberal American opinion only. He explicitly excludes conservative opinion as ?racist? and outside the mainstream of actual development work. Unfortunately, these blinders make it inescapable that the book contradicts its own purpose. Opinions and policies are not hermetically separated from each other. The book purports to illustrate this, but ignores too much of the cultural and political environment of the U.S. in the 1960s to accomplish this fully.

It has become commonplace among economists to proclaim that culture matters in determining economic outcomes. The possibility is largely ignored that culture also determines which questions to ask in the first place. That is, economists seem largely unaware that culture matters in determining theory! A little over a decade earlier America had emerged victorious from the war with significant economic planning of industry. The Soviet Union and India seemed to thrive under their own plans. This was part of the culture that American policymakers were operating within.

Grubbs seems intimately acquainted with the political economy of U.S. aid policy of the 1960s, but only marginally familiar with the development economics of the 1960s (no mention of Harrod-Domar or Solow, and vague descriptions of Dependency Theory and Rostovian Growth), and completely unfamiliar with development economics since the end of the 1960s. The book is also short on the details of African history.

Whatever was the cause of African poverty, Grubbs claims that the Americans are not blameless: ?American experts and officials helped write African plan, funded African projects that produced mixed results and substantial debt, and … blamed African culture for the failings that ensued? (p. 189-90).

Why is Africa poor? Grubbs does not say. This book is not about economics. This is not to say, however, that development economists have little to learn from the book. In fact, the very fact that it is not a traditional text on development economics is the source of its usefulness to development economists: it provides a different perspective.? Secular Missionaries reminds the development economist to reflect more deeply upon the cultural foundations of his own assumptions. It reminds development economists that even the most mathematical theories are products of their time, and as such, are ?cultural artifacts.? It provides a reminder that we, too, probably have a na?ve, overly simplistic, view of Africa, its economy, and the mechanisms behind its lack of development.

John Levendis is an assistant professor of economics at Loyola University ? New Orleans. His research is primarily econometrics applied toward issues of economic growth and development.

Copyright (c) 2011 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 2011). All EH.Net reviews are archived at http://www.eh.net/BookReview.

Subject(s):Economic Planning and Policy
History of Economic Thought; Methodology
Geographic Area(s):Africa
North America
Time Period(s):20th Century: WWII and post-WWII

Liberal Reform in an Illiberal Regime: The Creation of Private Property in Russia, 1906-1915

Author(s):Williams, Stephen F.
Reviewer(s):Nafziger, Steven

Published by EH.NET (July 2007)

Stephen F. Williams, Liberal Reform in an Illiberal Regime: The Creation of Private Property in Russia, 1906-1915. Stanford, CA: Hoover Institution Press, 2006. xiv + 320 pp. $15 (paperback), ISBN: 0-8179-4722-1.

Reviewed for EH.NET by Steven Nafziger, Department of Economics, Williams College.

Liberal Reform in an Illiberal Regime, by Stephen F. Williams, is an interesting, interdisciplinary study of one of the largest property rights reforms in European history ? the famed Stolypin reforms of late-Tsarist Russia. Initiated in the wake of the first Russian revolution of 1905-6, the Stolypin reforms (named for their guiding personality and then presiding Prime Minister, Petr Stolypin) aimed to help alleviate the backwardness and inefficiency of peasant agriculture through land titling and the consolidation of scattered plots into unified farms. Williams, a retired Federal Appeals court judge (DC Circuit) and former law professor at the University of Colorado, offers an interpretation of the reforms that draws heavily on political science, law and economics, and the economics of institutions.

Liberal Reform argues that the measures taken under Stolypin failed to truly modernize Russia’s economy because they were undertaken by a fundamentally illiberal regime that did not guarantee the enforcement of property rights or allow markets (especially in land) to freely function. Broadly comparative, especially to property rights issues in the modern developing world, the book implicitly and explicitly compares the Stolypin reforms under Tsar Nicholas II to recent reform efforts (or the lack thereof) in Russia under Vladimir Putin. As such, Williams’s analysis will appeal to scholars interested in property rights, land reforms, and the political implications of both, especially in authoritarian states. However, economic historians with an interest in Russian development are unlikely to be persuaded by the structure of the argument or the evidence brought to bear.

After 1905, Stolypin and his allies in the administration and the Duma passed a series of decrees and statutes aimed at transforming the prevailing regime of peasant property rights, thereby improving production incentives and the allocation of resources. This effort was motivated by the perceived inefficiencies of open-field agriculture and the communal organization of rural society. Since the reforms of the 1860s, which emancipated the peasants and endowed them with collective property rights (typically at the village level), Russian peasant agriculture appeared increasingly backward in comparison to the best practices in Western Europe and North America. The reforms were meant to spark technological modernization by enabling peasant households to shift from communal property rights and practices towards individualized farming and land tenure. This meant the establishment of individual title to land that was previously under collective community control and consolidations of scattered, open-field holdings into unified farms. The reforms set forth administrative and financial support for the millions of farmers and thousands of entire villages that undertook one of a menu of possible changes: from full enclosures of villages under individualized titles, to exchanges of intermingled fields among neighboring villages, to the resettlement of interested households in Siberia.[1] Alongside these changes in land-holdings and property rights, the reforms ended collective responsibility for tax and land obligations, forgave arrears on existing obligations, and officially did away with many other juridical limitations on peasant civil rights.

Given the epic scale of the reforms, historians have long argued over whether Stolypin’s efforts mattered (or would have, if not for World War I and the Bolsheviks) for Russian economic development. To Alexander Gerschenkron (1965), establishing private property rights and ending the commune’s hold on peasant initiative enabled Tsarist Russia’s belated turn towards modern economic growth.[2] In contrast, Williams argues that any productivity benefits, as well as peasant “freedoms” (Chapter 1) more generally, were undermined and ultimately failed to take root because they were enacted by a non-democratic, non-liberal state. He builds his study around a thematic question: is it possible for fundamental grass-roots reforms (enabling “freedom” and “liberal democracy” in his view) to take place under a centralized and “illiberal” regime such as Tsarist Russia. Williams eventually answers this potentially interesting query, recently investigated by economists such as Acemoglu and Robinson (2006), in the negative, but he bases his conclusions on theoretical musings and secondary sources, rather than any detailed analysis of available documents or official statistics.

After introducing the reforms and instrumental concepts such as “liberalism” in Chapter 1, Williams describes the agricultural and social context of pre-1905 Russia in Chapters 2 and 3. Overall, his review of a vast literature is well-done, but problems do emerge here that spill over the rest of the study. In several places, the book exhibits small but significant lapses when either describing historical developments or applying economic theory to explain them. For example, in Chapter 3 (pp. 104-06), a puzzling discussion of the positive correlation between grain and land prices puts much of the blame for high land prices on the Peasant Land Bank ? a fairly limited institution that definitely did not have market power when it came to credit or land. Moreover, although Williams acknowledges that practices of collective fiscal responsibility and land management were fairly flexible, he eventually accepts Gerschenkron’s association of the commune with agricultural backwardness and labor immobility. In contrast, recent studies (see Nafziger, 2006) have drawn on archival and statistical evidence to question these interpretations by econometrically testing for linkages between communal practices and economic inefficiencies. Finally, Williams refrains from discussing or analyzing his sources ? both secondary and primary ? in much depth. This allows him to either brush aside contradictory evidence or to qualify his conclusions to such a degree that the argument of the book becomes difficult to maintain and, eventually, to prove.

In Chapter 4, Williams describes the political context of the efforts by Stolypin and his supporters to enact property rights reforms. This chapter usefully outlines the views of the main political groups at the time (the nobility, the various parties of the left, the liberal Kadets, etc.) regarding land reforms, but these synopses exist in something of a vacuum, without much historical context to help the reader. Moreover, this chapter, along with Chapter 1, focuses almost exclusively on politics at the highest levels, often through the allusions to the personality and decisions of Stolypin, himself. The resulting depiction of events is rife with many quasi-counterfactual statements regarding what the reformers might have done differently, but little documentary evidence is analyzed beyond public speeches and memoirs to explain exactly how and why various choices were made.

This birds-eye focus on the mechanics of reform continues in Chapter 5, where Williams describes the particulars of the statutes and decrees and the take-up of different options by peasants and villages. The account is complemented by data at the provincial level, but the micro-level process of the reform process is left as a black box. In Chapter 6, which returns to the issues of reform design, the exclusive focus on legislation and decrees contrasts sharply with Pallot’s (1999) impressive study of the enactment of the Stolypin reforms. In her work, Pallot puts the emphasis squarely on how peasants encountered the reform through their interaction with surveyors, administrators, and each other. Unlike Williams, she views the failures of the Stolypin reforms to revolutionize rural society and economy as the outcome of peasants rationally choosing to retain communal practices and to resist certain aspects of the reforms. At the end of the day, this reviewer is much more convinced by Pallot’s careful study of the reform process based on archival and primary evidence, than by Williams’s analysis.

In Chapter 7, Williams concludes by studying the effects of the reforms, both immediate and long-term. Likening the Stolypin reforms to the English enclosure movement (although misinterpreting the state of the literature regarding productivity benefits of enclosure), Williams jumps from noting the lack of evidence on positive productivity gains to asserting that the reforms must have not gone far enough in liberalizing land markets or privatizing land holdings.[3] Besides this logical leap, Williams puzzlingly points to state support of the cooperative movement in the 1900s and 1910s as additional evidence that the regime was not really committed to becoming a liberal capitalist democracy (really now?). This leads him to conclude that although the intent of the reforms was very much “liberal” (p. 250), the “illiberalism” of the Tsarist state undermined Stolypin’s laudatory goals. The book ends with a consideration of property rights and liberal reforms in Putin’s Russia that is overly brief and highly conjectural. As a result, the book ends rather abruptly, without adequately summarizing what the reader should take away.

Overall, Liberal Reform in an Illiberal Regime is a significant contribution to our understanding of a critical moment in Russian economic and social history. Stephen Williams offers an impressive distillation of a large amount of secondary literature on the Stolypin reforms. He sheds deserved attention on the political context of what ended up being the last chance for the Tsarist regime to effect modernization in rural Russia before the October Revolution. Unfortunately, the limited use of original sources, several conceptual difficulties arising from not delving deep enough into the reforms’ context or process, and the polemical undertones of the study (published by Hoover Press) detract from this book’s usefulness as either an introduction to the Stolypin reforms or as a specialized study of the political implications of enclosing and privatizing communal land-holdings.

Notes:

1. The “take-up” of the reforms did involve millions of households and a large number of villages. However, these totals still only included a minority of the vast Russian peasant population. Pallot (1999, pp. 190-192) and Williams (2006, Chapter 5) review the relevant numbers. 2. This “Gerscheknronian” view has recently been questioned by Gregory (1994) and Nafziger (2006), based on aggregate and micro-evidence, respectively. 3. Surprisingly, Williams does not mention the only work this reviewer is aware of which “tests” for positive agricultural productivity effects of the Stolpyin reforms. The empirical work in Toumanoff (1984) is limited by significant identification problems, but it could have usefully served as a starting point for Williams’s research.

References:

Daron Acemoglu and James A. Robinson. Economic Origins of Dictatorship and Democracy. Cambridge: Cambridge University Press, 2006.

Alexander Gerschenkron. “Agrarian Policies and Industrialization, Russia 1861-1917.” The Cambridge Economic History of Europe. Vol. VI, Part II. Ed. H. J. Habakkuk and M. Postan. Cambridge: Cambridge University Press, 1965. 706-800.

Paul R. Gregory. Before Command: An Economic History of Russia from Emancipation to the First Five-Year Plan. Princeton, NJ: Princeton University Press, 1994.

Steven Nafziger. “Communal Institutions, Resource Allocation, and Russian Economic Development: 1861-1905.” Ph.D. dissertation, Yale University. 2006.

Judith Pallot. Land Reform in Russia 1906-1917: Peasant Responses to Stolypin’s Project of Rural Transformation. Oxford: Clarendon Press, 1999.

Peter Toumanoff. “Some Effects of Land Tenure Reforms on Russian Agricultural Productivity, 1901-1913.” Economic Development and Cultural Change 32, 4 (1984): 861-72.

Steven Nafziger is an Assistant Professor of Economics at Williams College. His research focuses on institutions and economic development in Imperial Russia before 1917.

Subject(s):Markets and Institutions
Geographic Area(s):Europe
Time Period(s):20th Century: Pre WWII

History Derailed: Central and Eastern Europe in the Long Nineteenth Century

Author(s):Berend, Ivan T.
Reviewer(s):Schulze, Max-Stephan

Published by EH.NET (August 2005)

Ivan T. Berend, History Derailed: Central and Eastern Europe in the Long Nineteenth Century. Berkeley, CA: University of California Press, 2003. xx + 330 pp. $39.95 (cloth), ISBN: 0-520-23299-2.

Reviewed for EH.NET by Max-Stephan Schulze, Department of Economic History, London School of Economics and Political Science.

Following his earlier Detour from the Periphery (1996) on the post-World War II period and Decades of Crisis (1998) on the inter-war years, the publication of History Derailed completes Ivan Berend’s impressive trilogy of Central and Eastern Europe’s history from the nineteenth to the end of the twentieth century. This book aims for a broad historical synthesis that traces the interrelations between economic, social, political and cultural factors, which, in turn, shaped the region’s societies before the First World War. The author’s key concerns are the origins of ‘backwardness,’ its pervasiveness and only partial diminution in the lands between Germany and Russia. Berend loses no time in setting out the standard of comparison: the successfully transforming societies of Western Europe. They serve both as the ideal pursued by contemporary reforming elites in East-Central Europe from the late eighteenth century and his choice of a model of modernization in action. Berend sees the region’s comparative backwardness defined by the lack of the nation-state, a lack of industrialization, the absence of modern, urbanized society and the preservation of traditional agricultural economies and rural-peasant societies. It is, then, the East’s non-conformance with the development patterns characteristic of the West that calls for explanation. Conceptually, such western perspective may seem old-fashioned to some, yet it makes for coherent reflection on the historical evidence within a clearly formulated analytical framework. Likewise, individual country-specialists may find Berend’s ambitious coverage of Central and Eastern Europe as, more or less, one whole difficult to take. However, cognizant of national differences he makes a broadly convincing case for regional comparisons and generalizations on the grounds of similarities in societal structures and challenges faced, as well as shared historical experiences across the region (even if the locus of this region lacks precise definition). Ultimately, the argument runs, it was Central and Eastern Europe’s deviation from the path of the West that made for its history becoming ‘derailed’ — incomplete socio-economic modernization and unfinished nation-building had dramatic consequences in the longer term, such as, in particular, the failure of parliamentary democracy to take firm root. History Derailed explores these core themes and develops the argument in a sequence of six chapters organized around topics rather than countries. These chapters assess the challenge of the ‘rising’ West to the ‘sleeping’ East, ponder the role of romanticism and nationalism in the region, trace the struggles for independence, map patterns of economic modernization in the later nineteenth century, identify the problem of ‘dual’ and ‘incomplete societies,’ and, finally, examine the evolution of the political system.

Berend starts off with a comparative sketch of historical development from the early sixteenth century when the Continent’s central and eastern regions began to diverge from Western Europe and shifted progressively to the periphery. The Central and East European countries lost their independent statehood and became ‘absorbed by huge, mostly despotic empires’ (p. 20), i.e. Tsarist Russia, the Habsburg Monarchy and the Ottoman Empire, during the early modern period just when the West experienced the emergence of strong absolutist states, foreshadowing the modern nation state, and the beginnings of capitalist transformation. Berend argues, though, that however damaging the regimes imposed on the region from outside were (and he offers a particularly damning assessment of the long term impact of Ottoman rule in the Balkans), the East’s failure to take on the challenge of the ‘rising (North) West’ also had a lot to do with internal social and institutional weaknesses that predate foreign rule. Demographic decline, peasant labor scarcity and the opening up of international trade triggered an altogether different response than in the West — a ‘second serfdom’ as the re-institution of (or regression to) earlier feudal structures. This was a world were the spirit of the Enlightenment and the dynamic of capitalism would not flourish for a long time. Thus the ‘dual revolution’ — the French political and the British industrial — met with no immediate and broad echo in the East. The stimulus to modernization and the spread of Western values in East-Central Europe, Berend maintains, came through nineteenth century romanticism that, in the region, combined romanticist ideals with the ideas of the Enlightenment. Strongly influenced by German concepts of ‘national individuality’ that expanded the notions of freedom and individuality beyond the realm of the person, romanticism became a vehicle of nation-building and fostered the creation of national myths and the formation of national identities (p. 43-45). The educated elite in East-Central Europe associated the nation state with socio-economic and political progress. Yet the nation had to be (re-) created first for the nation state as agent of modernization to follow. Nationalism, then, arrived in the region before the nation was actually born and it became ‘the paramount driving force of modern history’ (p. 88) in the region. Berend points to the fundamental problem of belated nationalism in Central and Eastern Europe: it became exclusionary, increasingly xenophobic and ‘genuinely antidemocratic’ (p. 119). In a region where historical state borders did not broadly coincide with cultural and linguistic boundaries, claims to national self-determination became de facto mutually exclusive. In parts, nationalism assumed such potency in the region since social and political conflicts between nobility and peasantry, rural landowners and urban industrialists, the emerging proletariat and the bourgeoisie were construed in terms of ethnic and religious differences. Yet romantic nationalism and ideas of national self-determination played a key role in triggering a series of uprisings, revolutions, wars, and reforms that not only signalled ‘national awakening’ but also helped pave the way for at least partial modernization during the nineteenth century. Even if the struggles for independence failed in most cases, political compromises created space for reform: the abolition of serfdom and the introduction of modern property rights, legal systems, parliamentary institutions and elections. Many of the institutional changes remained controversial, contested and severely restricted in scope. But they nevertheless marked an important step towards realizing the ‘requirements of the dual economic and political revolution of modernity’ (p. 133).

Structural change in society and economy from the mid-nineteenth century was limited in extent overall and extremely uneven across the region. Berend distinguishes the ‘dual’ societies and economies of East-Central Europe from their ‘incomplete’ counterparts in the Balkans. Here the reader finds the familiar theme of a development gradient (declining from the West and North-West of the region to the East and South-East) examined in terms of technology and skills transfers, international and inter-regional trade, the onset of industrialization in the west of the Habsburg Empire, foreign capital and the build-up of infrastructure, and a ‘belated agricultural revolution’ in most parts of the region. On the eve of the First World War, the region’s western rim, i.e. the territories of modern Austria and the Czech Lands, came fairly close to Western European levels in terms of per capita income, employment structure and industrialization (and probably did so already in the early nineteenth century, one might add). Likewise, it was in these areas where a modern middle class emerged first. Hungary and Poland, while remaining essentially agricultural economies, started out on the road to industrialization, though ‘their success was painfully limited’ (p. 179). Here some qualification and comparative standard are required: for instance, over 1870-1913 Hungary (or Transleithania) did measurably better than Cisleithania in terms of growth in per capita income, aggregate productivity and industrial output. However, the Balkans and the Habsburg Empire’s easternmost and southernmost provinces remained virtually unindustrialized — they did not even reach the degree of duality characteristic of East-Central Europe where a predominant and largely traditional agricultural sector coexisted alongside significant urban industrial centers. The differences in economic structure, wealth and income between the major parts of the region are mirrored in regional differences in social structure and the distribution of political power. Berend argues that social transformation (just like economic modernization) remained partial and unfinished in Central and Eastern Europe. Even after 1860, by which time the serfs had been liberated, noble privileges had been abolished and most feudal institutions dissolved, the old nobility remained the dominant social class even in the most advanced western provinces of Austria-Hungary. The reforms were extremely cautious — they neither threatened the socio-economic position of the noble elite as owners of large estates and latifundia nor seriously undermined its hold on political power — because ‘they were introduced from above either by the old elite itself or by the absolutist governments of the Habsburg and tsarist empires’ (p. 184). In Hungary, the economic and political position of the aristocracy remained even stronger than in Cisleithania. The survival of the old elites extended to the gentry and petty nobility. However, unlike the aristocracy, the gentry was hit hard by the emancipation of the serfs (which deprived them of free labor and tax exemptions) and saw its position as landowners progressively weakened by competition of the large modernized estates and the impact of the agricultural depression. Here status preservation came through absorption into the expanding state bureaucracy and army. The survival of the ‘old regime’ provided the basis for the continuing predominance of gentry values and attitudes. In most parts of Central and Eastern Europe, the process of embourgeoisement of society remained severely curtailed. With both upward and downward social mobility rigidly contained, Berend observes that a gap characterized the middle layers of the former noble societies. This gap was filled by ‘non-indigenous’ Germans, Greeks and, especially in the second half of the nineteenth century, Jews who formed the new business and middle class elite. Towards the end of the century political anti-Semitism, though, became an increasingly powerful and vocal force. Ethnic-religious divisions, Berend argues, deepened the conflict between the surviving ‘old’ establishment and the emerging ‘modern’ society. ‘The influence of the rising modern elite was profoundly weakened by its strong nonindigenous contingent’ (p. 204). The Balkan countries, which gained political independence before the lands under Habsburg and Russian rule, emerged as ‘incomplete societies’ without a traditional elite, which had been driven out or physically eliminated under the Ottomans. They began establishing their own new ‘bureaucratic-military-merchant elites.’ The political consequences of the nineteenth century failures of industrialization and social modernization were serious indeed: the continued role of the landed nobility, the rise of a bureaucratic-military elite, the political and social weakness of the bourgeoisie and the survival of large uneducated peasant societies created formidable obstacles on the road to parliamentary democracy, augmented by hostile, fundamental nationalism.

The originality of this volume springs not from its exploitation of sources unused so far or historical ‘facts’ not discussed before. What is genuinely novel is the thought-provoking, skillful analysis of the relationships between nationalism, social structure, political power and economic change over more than a century and across a large part of Europe. This is a fine book that speaks both to the general reader and the specialist historian.

Max-Stephan Schulze teaches at the London School of Economics. His recent publications include “Austria-Hungary’s Economy in World War I,” in S. Broadberry and M. Harrison, editors, The Economics of World War I (2005, forthcoming) and “Patterns of Growth and Stagnation in the late Nineteenth Century Habsburg Economy,” European Review of Economic History 4 (2000).

Subject(s):Economywide Country Studies and Comparative History
Geographic Area(s):Europe
Time Period(s):19th Century

The Origins of National Financial Systems: Alexander Gerschenkron Reconsidered

Author(s):Forsyth, Douglas J.
Verdier, Daniel
Reviewer(s):Sylla, Richard

Published by EH.NET (March 2005)

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Douglas J. Forsyth and Daniel Verdier, editors, The Origins of National Financial Systems: Alexander Gerschenkron Reconsidered. London and New York: Routledge, 2003. xv + 237 pp. $129.95 (cloth), ISBN: 0-415-30168-8.

Reviewed for EH.NET by Richard Sylla, Stern School of Business, New York University.

In what has been called “the battle of the systems,” so-called bank-based financial systems typified by German-style universal banking compete with so-called market-based financial systems of the Anglo-American variety. Bank-based systems, of course, always had securities markets, just as market-based systems always had large banking components. Indeed, a recent scholarly trend has been to emphasize the similarities of the two types of systems rather than their differences, and to see in contemporary developments — an increased role for securities markets in Germany, and leading U.K. and U.S. banks looking more and more like universal banks — a convergence of financial systems.

Be that as it may, the conference volume reviewed here focuses on why financial-system differences emerged in the first place, meaning in the period 1850-1914 when universal banking emerged in Germany. It spread from Germany to other countries in Europe, while the British and the Americans continued to develop in tandem the banking systems and securities markets they had established earlier in history. As the subtitle of the volume suggests, one of its major purposes is to reconsider Alexander Gerschenkron’s influential contention that universal banking, defined broadly in the introduction to the volume as “banks that accept deposits, and engage in both short- and long-term lending” (p. 7), was a substitute in moderately backward countries such as Germany for missing “prerequisites” of economic modernization. Such missing prerequisites for Gerschenkron included a long history of commercial development and an “original accumulation of capital” available to finance modern industrial technologies at the appropriate moment. Today we might say, as Joost Jonker more or less does in his contribution to the volume, that a financial revolution is also among the missing prerequisites. Countries that had financial revolutions — the Dutch Republic, the U.K., and the U.S. — tended to have commercial banking specializing in short-term lending, as well as securities markets specializing in financing longer-term capital needs of companies.

In his introduction to the volume, co-editor Forsyth (a historian at Bowling Green State University in Ohio) characterizes Gerschenkron’s approach as one that focuses on bank assets and loan demand. In relatively backward countries, capital scarcity creates a demand by firms for long-term loans from banks to take advantage of new, large-scale production technologies. Universal banks emerge is such countries to satisfy the demand for long-term financing that otherwise would not be met. In more advanced economies, by contrast, established firms can rely on retained earnings and securities markets for long-term capital, leaving banks to specialize on short-term commercial lending.

An alternative explanation to Gerschenkron’s, an exploration of which motivates the volume, is that of the other co-editor, Verdier, a political scientist at Ohio State University. Instead of emphasizing loan demand and bank assets, Verdier in earlier writings and the first chapter here focuses on the supply of deposits, liabilities of banks that are one source of funds to finance loans to companies. More than Gerschenkron, Verdier bases his explanation on politics. In decentralized polities such as nineteenth-century Germany, the political power of farmers and small business led the state to sponsor non-profit financial institutions such as savings banks and cooperative institutions. That meant that bigger banks serving large-scale industry found it difficult to capture a large share of bank deposits. So the big banks had to rely more on their own capital and retained earnings to fund loans, and that in turn meant that they were less prone to runs on deposits and could thus make more long-term loans. But such banks could still suffer runs, and were particularly vulnerable to them because of their long-term lending. So successful universal banking required the presence of a central bank that would actively provide liquidity by acting as a lender of last resort in financial crises. In a nutshell, Verdier’s alternative to Gerschenkron holds that universal banking arises when the deposit market is segmented between non-profit and profit-oriented institutions (which is more likely in decentralized polities), and when the central bank is active as a supplier of liquidity and lender of last resort. Deposit-market segmentation and a lender of last resort are thus said to be the necessary and (together) sufficient conditions for the emergence of universal banking. Gerschenkron’s relative backwardness has nothing to do with it.

Conversely in Verdier’s model, centralized polities such as the U.K. and France were less likely to allow non-profit financial institutions to capture large shares of bank deposits. Hence, commercial banks obtained most of the economies’ bank deposits. Relying less on their own capital and retained earnings, and more on deposits that might be withdrawn on short notice, such banks abandoned long-term lending in favor of short-term commercial loans.

The remaining nine chapters of the book subject the Gerschenkron and Verdier models to intense scrutiny, and in general find that both models are lacking. Ranald Michie (Chapter 2) and Joost Jonker (Chapter 3) in effect criticize both models for being too narrow in their focus on banking, slighting the important role of securities markets, which are both competitive with and complementary to banks, in modern financial systems. Michie notes that the value of securities in 1913 was three to four times greater than worldwide bank deposits, which has to make one wonder why banks and banking have received such disproportionate attention from financial historians. He also produces an interesting table showing that the U.S., with its peculiar banking system made up of tens of thousands of unit banks, somehow managed by 1913 to have 30 percent of total world deposits and 36 percent of world commercial bank deposits, both totals being far ahead of those of any other country. Knowledge of that might cause historians of American banking to temper their critiques of it. Jonker compares the financial systems of the Netherlands, Britain, France, and Germany. He sees the first three as relatively sophisticated financial systems with securities markets playing central roles in them, while Germany, which he cleverly describes as “building a boat while sailing it,” was hampered by late state formation and retarded securities-market development. These are provocative chapters.

The rest of the chapters are country case studies. Richard Deeg’s study of Germany and Alessandro Polsi’s of Italy are perhaps most favorable to Verdier’s emphasis on the primacy of political factors in shaping financial systems. Germany and Italy were two pillars of Gerschenkron’s banking edifice, and both Deeg and Polsi think Gerschenkron exaggerated the role of universal banks in these countries. Both countries had segmented deposit markets, central banks, and universal banking as Verdier’s model would predict. The results, however, were far better in Germany than in Italy.

Michel Lescure’s interesting essay places France squarely between Britain and Germany. Like Britain, France as a centralized state had national deposit banks concentrating on short-term commercial lending, and investment banks serving large-scale industry. But like Germany, it had local universal banks serving local, small- and medium-sized firms. The Bank of France aided the latter in the manner Verdier contends was necessary.

Sweden and Norway were semi-centralized Scandinavian states that do not fit well either the Gerschenkron or Verdier models. In their essay on Sweden, H?kan Lindgen and Hans Sj?gren show that the country had an early development of non-profit savings banks and a central bank, which would lead Verdier to predict the emergence of universal banking. And that may have happened at the turn of the twentieth century, later than Verdier’s model would imply. The explanation may be that Sweden’s savings banks were linked with its commercial banks, so there was not so much deposit-market segmentation. When universal banking did finally come late to Sweden, it may have been for Gerschenkronian reasons, or it may simply have been in imitation of nearby and admired Germany. Sverre Knutsen’s description of Norway make it sound ripe for universal banking under either Gerschenkron’s or Verdier’s model. It didn’t happen. Foreign capital appears to have substituted for Gerschenkronian universal banks, and the Bank of Norway was too timid a supplier of liquidity and lender of last resort to fulfill Verdier’s second precondition for universal banking.

Imperial Russia, according to Don Rowney’s chapter, had British-type commercial banking in Moscow and German-style universal banking in St. Petersburg. Neither Gerschenkron’s nor Verdier’s model seems very helpful in explaining that mixed outcome. Instead the Russian state seems to have sponsored both types of banking, in imitation of Britain in the 1880s (Moscow) and of Germany (St. Petersburg) in the early 1900s.

Jaime Reis’s essay on Portugal ends the volume. Portugal was a centralized state with a weak non-profit banking sector, so Verdier’s model would predict commercial banking, as in Britain. Instead, Portugal had universal banks. But these banks did not make Portugal grow as Germany did. Portugal’s problems seemed to be that it was a poor, underdeveloped country without many bank deposits of any kind, and that the Portuguese national debt, three times larger than the total of bank deposits, crowded out both banks and industrial investment.

The main lesson of this volume is that it is not easy to come up with simple, or even moderately complex, explanations for differences among national financial systems. That said, Daniel Verdier is surely correct in his emphasis on the importance of political factors in producing history’s diverse financial-system outcomes. I also think Gerschenkron, with whom I discussed these matters many times, would have agreed with him on that.

Richard Sylla is Henry Kaufman Professor of the History of Financial Institutions and Markets at New York University’s Stern School of Business. His latest article, with Peter L. Rousseau, is “Emerging Financial Markets and Early U.S. Growth,” Explorations in Economic History 42 (2005).

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