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An Economic History of Finland

Riitta Hjerppe, University of Helsinki

Finland in the early 2000s is a small industrialized country with a standard of living ranked among the top twenty in the world. At the beginning of the twentieth century it was a poor agrarian country with a gross domestic product per capita less than half of that of the United Kingdom and the United States, world leaders at the time in this respect. Finland was part of Sweden until 1809, and a Grand Duchy of Russia from 1809 to 1917, with relatively broad autonomy in its economic and many internal affairs. It became an independent republic in 1917. While not directly involved in the fighting in World War I, the country went through a civil war during the years of early independence in 1918, and fought against the Soviet Union during World War II. Participation in Western trade liberalization and bilateral trade with the Soviet Union required careful balancing of foreign policy, but also enhanced the welfare of the population. Finland has been a member of the European Union since 1995, and has belonged to the European Economic and Monetary Union since 1999, when it adopted the euro as its currency.

Gross Domestic Product per capita in Finland and in EU 15, 1860-2004, index 2004 = 100

Sources: Eurostat (2001–2005)

Finland has large forest areas of coniferous trees, and forests have been and still are an important natural resource in its economic development. Other natural resources are scarce: there is no coal or oil, and relatively few minerals. Outokumpu, the biggest copper mine in Europe in its time, was depleted in the 1980s. Even water power is scarce, despite the large number of lakes, because of the small height differences. The country is among the larger ones in Europe in area, but it is sparsely populated with 44 people per square mile, 5.3 million people altogether. The population is very homogeneous. There are a small number of people of foreign origin, about two percent, and for historical reasons there are two official language groups, the Finnish-speaking majority and a Swedish-speaking minority. In recent years population has grown at about 0.3 percent per year.

The Beginnings of Industrialization and Accelerating Growth

Finland was an agrarian country in the 1800s, despite poor climatic conditions for efficient grain growing. Seventy percent of the population was engaged in agriculture and forestry, and half of the value of production came from these primary industries in 1900. Slash and burn cultivation finally gave way to field cultivation during the nineteenth century, even in the eastern parts of the country.

Some iron works were founded in the southwestern part of the country in order to process Swedish iron ore as early as in the seventeenth century. Significant tar burning, sawmilling and fur trading brought cash with which to buy a few imported items such as salt, and some luxuries – coffee, sugar, wines and fine cloths. The small towns in the coastal areas flourished through the shipping of these items, even if restrictive legislation in the eighteenth century required transport via Stockholm. The income from tar and timber shipping accumulated capital for the first industrial plants.

The nineteenth century saw the modest beginnings of industrialization, clearly later than in Western Europe. The first modern cotton factories started up in the 1830s and 1840s, as did the first machine shops. The first steam machines were introduced in the cotton factories and the first rag paper machine in the 1840s. The first steam sawmills were allowed to start only in 1860. The first railroad shortened the traveling time from the inland towns to the coast in 1862, and the first telegraphs came at around the same time. Some new inventions, such as electrical power and the telephone, came into use early in the 1880s, but generally the diffusion of new technology to everyday use took a long time.

The export of various industrial and artisan products to Russia from the 1840s on, as well as the opening up of British markets to Finnish sawmill products in the 1860s were important triggers of industrial development. From the 1870s on pulp and paper based on wood fiber became major export items to the Russian market, and before World War I one-third of the demand of the vast Russian empire was satisfied with Finnish paper. Finland became a very open economy after the 1860s and 1870s, with an export share equaling one-fifth of GDP and an import share of one-fourth. A happy coincidence was the considerable improvement in the terms of trade (export prices/import prices) from the late 1860s to 1900, when timber and other export prices improved in relation to the international prices of grain and industrial products.

Openness of the economies (exports+imports of goods/GDP, percent) in Finland and EU 15, 1960-2005

Sources: Heikkinen and van Zanden 2004; Hjerppe 1989.

Finland participated fully in the global economy of the first gold-standard era, importing much of its grain tariff-free and a lot of other foodstuffs. Half of the imports consisted of food, beverages and tobacco. Agriculture turned to dairy farming, as in Denmark, but with poorer results. The Finnish currency, the markka from 1865, was tied to gold in 1878 and the Finnish Senate borrowed money from Western banking houses in order to build railways and schools.

GDP grew at a slightly accelerating average rate of 2.6 percent per annum, and GDP per capita rose 1.5 percent per year on average between 1860 and 1913. The population was also growing rapidly, and from two million in the 1860s it reached three million on the eve of World War I. Only about ten percent of the population lived in towns. The investment rate was a little over 10 percent of GDP between the 1860s and 1913 and labor productivity was low compared to the leading nations. Accordingly, economic growth depended mostly on added labor inputs, as well as a growing cultivated area.

Catching up in the Interwar Years

The revolution of 1917 in Russia and Finland’s independence cut off Russian trade, which was devastating for Finland’s economy. The food situation was particularly difficult as 60 percent of grain required had been imported.

Postwar reconstruction in Europe and the consequent demand for timber soon put the economy on a swift growth path. The gap between the Finnish economy and Western economies narrowed dramatically in the interwar period, although it remained the same among the Scandinavian countries, which also experienced fast growth: GDP grew by 4.7 percent per annum and GDP per capita by 3.8 percent in 1920–1938. The investment rate rose to new heights, which also improved labor productivity. The 1930s depression was milder than in many other European countries because of the continued demand for pulp and paper. On the other hand, Finnish industries went into depression at different times, which made the downturn milder than it would have been if all the industries had experienced their troughs simultaneously. The Depression, however, had serious and long-drawn-out consequences for poor people.

The land reform of 1918 secured land for tenant farmers and farm workers. A large number of new, small farms were established, which could only support families if they had extra income from forest work. The country remained largely agrarian. On the eve of World War II, almost half of the labor force and one-third of the production were still in the primary industries. Small-scale agriculture used horses and horse-drawn machines, lumberjacks went into the forest with axes and saws, and logs were transported from the forest by horses or by floating. Tariff protection and other policy measures helped to raise the domestic grain production to 80–90 percent of consumption by 1939.

Soon after the end of World War I, Finnish sawmill products, pulp and paper found old and new markets in the Western world. The structure of exports became more one-sided, however. Textiles and metal products found no markets in the West and had to compete hard with imports on the domestic market. More than four-fifths of exports were based on wood, and one-third of industrial production was in sawmilling, other wood products, pulp and paper. Other growing industries included mining, basic metal industries and machine production, but they operated on the domestic market, protected by the customs barriers that were typical of Europe at that time.

The Postwar Boom until the 1970s

Finland came out of World War II crippled by the loss of a full tenth of its territory, and with 400.000 evacuees from Karelia. Productive units were dilapidated and the raw material situation was poor. The huge war reparations to the Soviet Union were the priority problem of the decision makers. The favorable development of the domestic machinery and shipbuilding industries, which was based on domestic demand during the interwar period and arms deliveries to the army during the War made war-reparations deliveries possible. They were paid on time and according to the agreements. At the same time, timber exports to the West started again. Gradually the productive capacity was modernized and the whole industry was reformed. Evacuees and soldiers were given land on which to settle, and this contributed to the decrease in farm size.

Finland became part of the Western European trade-liberalization movement by joining the World Bank, the International Monetary Fund (IMF) and the Bretton Woods agreement in 1948, becoming a member of the General Agreement on Tariffs and Trade (GATT) two years later, and joining Finnefta (an agreement between the European Free Trade Area (EFTA) and Finland) in 1961. The government chose not to receive Marshall Aid because of the world political situation. Bilateral trade agreements with the Soviet Union started in 1947 and continued until 1991. Tariffs were eased and imports from market economies liberated from 1957. Exports and imports, which had stayed at internationally high levels during the interwar years, only slowly returned to the earlier relative levels.

The investment rate climbed to new levels soon after War World II under a government policy favoring investments and it remained on this very high level until the end of the 1980s. The labor-force growth stopped in the early 1960s, and economic growth has since depended on increases in productivity rather than increased labor inputs. GDP growth was 4.9 percent and GDP per capita 4.3 percent in 1950–1973 – matching the rapid pace of many other European countries.

Exports and, accordingly, the structure of the manufacturing industry were diversified by Soviet and, later, on Western orders for machinery products including paper machines, cranes, elevators, and special ships such as icebreakers. The vast Soviet Union provided good markets for clothing and footwear, while Finnish wool and cotton factories slowly disappeared because of competition from low-wage countries. The modern chemical industry started to develop in the early twentieth century, often led by foreign entrepreneurs, and the first small oil refinery was built by the government in the 1950s. The government became actively involved in industrial activities in the early twentieth century, with investments in mining, basic industries, energy production and transmission, and the construction of infrastructure, and this continued in the postwar period.

The new agricultural policy, the aim of which was to secure reasonable incomes and favorable loans to the farmers and the availability of domestic agricultural products for the population, soon led to overproduction in several product groups, and further to government-subsidized dumping on the international markets. The first limitations on agricultural production were introduced at the end of the 1960s.

The population reached four million in 1950, and the postwar baby boom put extra pressure on the educational system. The educational level of the Finnish population was low in Western European terms in the 1950s, even if everybody could read and write. The underdeveloped educational system was expanded and renewed as new universities and vocational schools were founded, and the number of years of basic, compulsory education increased. Education has been government run since the 1960s and 1970s, and is free at all levels. Finland started to follow the so-called Nordic welfare model, and similar improvements in health and social care have been introduced, normally somewhat later than in the other Nordic countries. Public child-health centers, cash allowances for children, and maternity leave were established in the 1940s, and pension plans have covered the whole population since the 1950s. National unemployment programs had their beginnings in the 1930s and were gradually expanded. A public health-care system was introduced in 1970, and national health insurance also covers some of the cost of private health care. During the 1980s the income distribution became one of the most even in the world.

Slower Growth from the 1970s

The oil crises of the 1970s put the Finnish economy under pressure. Although the oil reserves of the main supplier, the Soviet Union, showed no signs of running out, the price increased in line with world market prices. This was a source of devastating inflation in Finland. On the other hand, it was possible to increase exports under the terms of the bilateral trade agreement with the Soviet Union. This boosted export demand and helped Finland to avoid the high and sustained unemployment that plagued Western Europe.

Economic growth in the 1980s was somewhat better than in most Western economies, and at the end of the 1980s Finland caught up with the sluggishly-growing Swedish GDP per capita for the first time. In the early 1990s the collapse of the Soviet trade, Western European recession and problems in adjusting to the new liberal order of international capital movement led the Finnish economy into a depression that was worse than that of the 1930s. GDP fell by over 10 percent in three years, and unemployment rose to 18 percent. The banking crisis triggered a profound structural change in the Finnish financial sector. The economy revived again to a brisk growth rate of 3.6 percent in 1994-2005: GDP growth was 2.5 percent and GDP per capita 2.1 percent between 1973 and 2005.

Electronics started its spectacular rise in the 1980s and it is now the largest single manufacturing industry with a 25 percent share of all manufacturing. Nokia is the world’s largest producer of mobile phones and a major transmission-station constructor. Connected to this development was the increase in the research-and- development outlay to three percent of GDP, one of the highest in the world. The Finnish paper companies UPM-Kymmene and M-real and the Finnish-Swedish Stora-Enso are among the largest paper producers in the world, although paper production now accounts for only 10 percent of manufacturing output. The recent discussion on the future of the industry is alarming, however. The position of the Nordic paper industry, which is based on expensive, slowly-growing timber, is threatened by new paper factories founded near the expanding consumption areas in Asia and South America, which use local, fast-growing tropical timber. The formerly significant sawmilling operations now constitute a very small percentage of the activities, although the production volumes have been growing. The textile and clothing industries have shrunk into insignificance.

What has typified the last couple of decades is the globalization that has spread to all areas. Exports and imports have increased as a result of export-favoring policies. Some 80 percent of the stocks of Finnish public companies are now in foreign hands: foreign ownership was limited and controlled until the early 1990s. A quarter of the companies operating in Finland are foreign-owned, and Finnish companies have even bigger investments abroad. Most big companies are truly international nowadays. Migration to Finland has increased, and since the collapse of the eastern bloc Russian immigrants have become the largest single foreign group. The number of foreigners is still lower than in many other countries – there are about 120.000 people with foreign background out of a population of 5.3 million.

The directions of foreign trade have been changing because trade with the rising Asian economies has been gaining in importance and Russian trade has fluctuated. Otherwise, almost the same country distribution prevails as has been common for over a century. Western Europe has a share of three-fifths, which has been typical. The United Kingdom was for long Finland’s biggest trading partner, with a share of one-third, but this started to diminish in the 1960s. Russia accounted for one-third of Finnish foreign trade in the early 1900s, but the Soviet Union had minimal trade with the West at first, and its share of the Finnish foreign trade was just a few percentage points. After World War II Soviet-Finnish trade increased gradually until it reached 25 percent of Finnish foreign trade in the 1970s and early 1980s. Trade with Russia is now gradually gaining ground again from the low point of the early 1990s, and had risen to about ten percent in 2006. This makes Russia one of Finland’s three biggest trading partners, Sweden and Germany being the other two with a ten percent share each.

The balance of payments was a continuing problem in the Finnish economy until the 1990s. Particularly in the post-World War II period inflation repeatedly eroded the competitive capacity of the economy and led to numerous devaluations of the currency. An economic policy favoring exports helped the country out of the depression of the 1990s and improved the balance of payments.

Agriculture continued its problematic development of overproduction and high subsidies, which finally became very unpopular. The number of farms has shrunk since the 1960s and the average size has recently risen to average European levels. The share of agricultural production and labor are also on the Western European levels nowadays. Finnish agriculture is incorporated into the Common Agricultural Policy of the European Union and shares its problems, even if Finnish overproduction has been virtually eliminated.

The share of forestry is equally low, even if it supplies four-fifths of the wood used in Finnish sawmills and paper factories: the remaining fifth is imported mainly from the northwestern parts of Russia. The share of manufacturing is somewhat above Western European levels and, accordingly, that of services is high but slightly lower than in the old industrialized countries.

Recent discussion on the state of the economy mainly focuses on two issues. The very open economy of Finland is very much influenced by the rather sluggish economic development of the European Union. Accordingly, not very high growth rates are to be expected in Finland either. Since the 1990s depression, the investment rate has remained at a lower level than was common in the postwar period, and this is cause for concern.

The other issue concerns the prominent role of the public sector in the economy. The Nordic welfare model is basically approved of, but the costs create tensions. High taxation is one consequence of this and political parties discuss whether or not the high public-sector share slows down economic growth.

The aging population, high unemployment and the decreasing numbers of taxpayers in the rural areas of eastern and central Finland place a burden on the local governments. There is also continuing discussion about tax competition inside the European Union: how does the high taxation in some member countries affect the location decisions of companies?

Development of Finland’s exports by commodity group 1900-2005, percent

Source: Finnish National Board of Customs, Statistics Unit

Note on classification: Metal industry products SITC 28, 67, 68, 7, 87; Chemical products SITC 27, 32, 33, 34, 5, 66; Textiles SITC 26, 61, 65, 84, 85; Wood, paper and printed products SITC 24, 25, 63, 64, 82; Food, beverages, tobacco SITC 0, 1, 4.

Development of Finland’s imports by commodity group 1900-2005, percent

Source: Finnish National Board of Customs, Statistics Unit

Note on classification: Metal industry products SITC 28, 67, 68, 7, 87; Chemical products SITC 27, 32, 33, 34, 5, 66; Textiles SITC 26, 61, 65, 84, 85; Wood, paper and printed products SITC 24, 25, 63, 64, 82; Food, beverages, tobacco SITC 0, 1, 4.


Heikkinen, S. and J.L van Zanden, eds. Explorations in Economic Growth. Amsterdam: Aksant, 2004.

Heikkinen, S. Labour and the Market: Workers, Wages and Living Standards in Finland, 1850–1913. Commentationes Scientiarum Socialium 51 (1997).

Hjerppe, R. The Finnish Economy 1860–1985: Growth and Structural Change. Studies on Finland’s Economic Growth XIII. Helsinki: Bank of Finland Publications, 1989.

Jalava, J., S. Heikkinen and R. Hjerppe. “Technology and Structural Change: Productivity in the Finnish Manufacturing Industries, 1925-2000.” Transformation, Integration and Globalization Economic Research (TIGER), Working Paper No. 34, December 2002.

Kaukiainen, Yrjö. A History of Finnish Shipping. London: Routledge, 1993.

Myllyntaus, Timo. Electrification of Finland: The Transfer of a New Technology into a Late Industrializing Economy. Worcester, MA: Macmillan, Worcester, 1991.

Ojala, J., J. Eloranta and J. Jalava, editors. The Road to Prosperity: An Economic History of Finland. Helsinki: Suomalaisen Kirjallisuuden Seura, 2006.

Pekkarinen, J. and J. Vartiainen. Finlands ekonomiska politik: den långa linjen 1918–2000, Stockholm: Stiftelsen Fackföreningsrörelsens institut för ekonomisk forskning FIEF, 2001.

Citation: Hjerppe, Riitta. “An Economic History of Finland”. EH.Net Encyclopedia, edited by Robert Whaples. February 10, 2008. URL

Education and Economic Growth in Historical Perspective

David Mitch, University of Maryland Baltimore County

In his introduction to the Wealth of Nations, Adam Smith (1776, p. 1) states that the proportion between the annual produce of a nation and the number of people who are to consume that produce depends on “the skill, dexterity, and judgment with which its labour is generally applied.” In recent decades, analysts of economic productivity in the United States during the twentieth century have made allowance for Smith’s “skill, dexterity, and judgment” of the labor force under the rubric of labor force quality (Ho and Jorgenson 1999; Aaronson and Sullivan 2001; DeLong, Goldin, and Katz 2003). These studies have found that a variety of factors have influenced labor force quality in the U.S., including age structure and workforce experience, female labor force participation, and immigration. One of the most important determinants of labor force quality has been years of schooling completed by the labor force.

Data limitations complicate generalizing these findings to periods before the twentieth century and to geographical areas beyond the United States. However, the rise of modern economic growth over the last few centuries seems to roughly coincide with the rise of mass schooling throughout the world. The sustained growth in income per capita evidenced in much of the world over the past two to two and a half centuries is a marked divergence from previous tendencies. Kuznets (1966) used the phrase “modern economic growth” to describe this divergence and he placed its onset in the mid-eighteenth century. More recently, Maddison (2001) has placed the start of sustained economic growth in the early nineteenth century. Maddison (1995) estimates that per capita income between 1520 and 1992 increased some eight times for the world as a whole and up to seventeen times for certain regions. Popular schooling was not widespread anywhere in the world before 1600. By 1800, most of North America, Scandinavia, and Germany had achieved literacy rates well in excess of fifty percent. In France and England literacy rates were closer to fifty percent and school attendance before the age of ten was certainly widespread, if not yet the rule. It was not until later in the nineteenth century and the early twentieth century that Southern and Eastern Europe were to catch up with Western Europe and it was only the first half of the twentieth century that saw schooling become widespread through much of Asia and Latin America. Only later in the twentieth century did schooling begin to spread throughout Africa. The twentieth century has seen the spread of secondary and university education to much of the adult population in the United States and to a lesser extent in other developed countries.[2] However, correlation is not causation; rising income per capita may have contributed to rising levels of schooling, as well as schooling to income levels. Thus, the contribution of rising schooling to economic growth should be examined more directly.

Estimating the Contribution of the Rise of Mass Schooling to Economic Growth: A Growth Accounting Perspective

Growth accounting can be used to estimate the general bounds of the contribution the rise of schooling has made to economic growth over the past few centuries.[3] A key assumption of growth accounting is that factors of production are paid their social marginal products. Growth accounting starts with estimates of the growth of individual factors of production, as well as the shares of these factors in total output and estimates of the growth of total product. It then apportions the growth in output into that attributable to growth in each factor of production specified in the analysis and into that due to a residual that cannot otherwise be explained. Estimates of how much schooling has increased the productivity of individual workers, combined with estimates of the increase in schooling completed by the labor force, yield estimates of how much the increase in schooling has contributed to increasing output. A growth accounting approach offers the advantage that with basic estimates (or at least possible ranges) for trends in output, labor force, schooling attainment, and preferably capital stock and factor shares, it yields estimates of schooling’s contribution to economic growth. An important disadvantage is that it relies on indirect estimates at the micro level for how schooling influences productivity at the aggregate level, rather than on direct empirical evidence.[4]

Back-of-the-envelope estimates of increases in income per capita attributable to rising levels of education over a period of a few centuries can be obtained by considering possible ranges of levels of schooling increases as measured in average years of schooling along with possible ranges of rates of return per year of schooling, in terms of the percentage by which a year of schooling raises earnings and common ranges for labor’s share in national income. By using a Cobb-Douglas specification of the aggregate production function with two factors of production, labor and physical capital, one can arrive at the following equation for the ratio between final and initial national income per worker due to increases in average school years completed between the two time periods:

1) (Y/L)1/ (Y/L)0 = ( (1 + r )S1 – S0 )α

Where Y = output, L = the labor force, r = the percent by which a year of schooling increases labor productivity, S is the average years of schooling completed by the labor force in each time period, α is labor’s share in national income, and the subscripts 0 and 1 denote the initial and final time period over which the schooling changes occur.[5] This formulation is a partial equilibrium one, holding constant the level of physical capital. However, the level of physical capital should be expected to increase in response to improved labor force quality due to more schooling. A common specification of a growth model that allows for such responses of physical capital implies the following ratio between final and initial national income per worker (see Lord 2001, 99-100):

2) (Y/L)1/ (Y/L)0 = ( (1 + r )S1 – S0 )

The bounds on increases in years of schooling can be placed at between zero and 16, that is, between a completely unschooled and presumably illiterate population to one in which a college education is universal. As bounds on returns to increasing earnings per year of schooling, one can employ Krueger and Lindahl’s (2001) survey of results from recent estimates of earnings functions, which finds that returns range from 5 percent to 15 percent. The implications of varying these two parameters are reported in Tables 1A and 1B. Table 1A reports estimates based on the partial equilibrium specification holding constant the level of physical capital in equation 1). Table 1B reports estimates allowing for a changing level of physical capital as in equation 2). Labor’s share of income has been set at a commonly used value of 0.7 (see DeLong, Goldin and Katz 2003, 29; Maddison 1995, 255).

Table 1A
Increase in per Capita Income over a Base Level of 1 Attributable to Hypothetical Increases in Average Schooling Levels — Holding the Physical Capital Stock Constant

Percent Increase in Earnings per Extra Year of Schooling
Increase in Average
Years of Schooling
5% 10% 15%
1 1.035 1.07 1.10
3 1.11 1.22 1.34
6 – illiteracy to
universal grammar school
.23 1.49 1.80
12 – illiteracy to
universal high school
1.51 2.23 3.23
16 – illiteracy to
universal college
1.73 2.91 4.78

Table 1B
Increase in per Capita Income over a Base Level of 1 Attributable to Hypothetical Increases in Average Schooling Levels — Allowing for Steady-state Changes in the Physical Capital Stock

Percent Increase in Earnings per Extra Year of Schooling
Increase in Average
Years of Schooling
5% 10% 15%
1 1.05 1.10 1.15
3 1.16 1.33 1.52
6 – illiteracy to
universal grammar school
1.34 1.77 2.31
12 – illiteracy to
universal high school
1.79 3.14 5.35
16 – illiteracy to
universal college
2.18 4.59 9.36

The back-of-the-envelope calculations in Tables 1A and 1B make two simple points. First, schooling increases have the potential to explain a good deal of estimated long-term increases in per capita income. With the average member of an economy’s labor force embodying investments of twelve years of schooling and a moderate ten-percent rate of return per year of schooling and no increase in the capital stock, at least 17 percent of Maddison’s eight-fold increase in per capita income can be accounted for (i.e. 1.23/7) by rising schooling. Indeed, a 16 year schooling increase allowing for steady-state capital stock increases and at 15 percent per year return overexplains Maddison’s eight-fold increase (8.36/7). After all, if schooling has had substantial effects on the productivity of individual workers, if a sizable share of the labor force has experienced improvements in schooling completed and with labor’s share of output greater than half, then the contribution of rising schooling to increasing output should be large.

Second, the contribution of schooling increases that have actually occurred historically to per capita income increases is more modest accounting for at best about one fifth of Maddison’s one-fold increase. Thus an increase in average years of schooling completed by the labor force of 6 years, roughly that entailed by the spread of universal grammar schooling, would account for 19 percent (1.31/7) of an eight-fold per capita output increase at a high 15 percent rate of return allowing for steady state changes in the physical capital stock (Table 1B). And at a low 5 percent return per year of schooling, the contribution would be only 5 percent of the increase (0.34/7). Making lower-level elementary education universal would entail increasing average years of schooling completed by the labor force by 1 to 3 years; in most circumstances this is not a trivial accomplishment as measured by the societal resources required. However, even at a high 15 percent per year return and allowing for steady state changes in the capital stock (Table 1B), the contribution of a 3 year increase in average years of schooling would only account for 7 percent (0.52/7) of Maddison’s eight-fold increase.

How do the above proposed bounds on schooling increases compare with possible increases in the physical capital stock? Kendrick (1993, 143) finds a somewhat larger growth rate in his estimated human capital stock than in the stock of non-human capital for the U.S. between 1929 and 1969, though for the sub-period 1929-48, he estimates a slightly higher growth rate for the non-human capital stock. In contrast, Maddison (1995, 35-37) estimates larger increases in the value of non-residential structures per worker and in the value of machinery and equipment per worker than in years of schooling per adult for the U.S. and the U.K. between 1820 and 1992. For the U.S., he estimates that the value of non-residential structures per worker rose by 21 times and the value of machinery and equipment per worker rose by 141 times in comparison with a ten-fold increase in the years of schooling per adult between 1820 and 1992. For the U.K., his estimates indicate a 15 fold increase in the value of structures per worker and a 97 fold increase in value of machinery and equipment per worker in contrast with a seven-fold increase in average years of schooling between 1820 and 1992. It should be noted that these estimates are based on cumulated investments in schooling to estimate human capital; that is, they are based on the costs incurred to produce human capital. Davies and Whalley (1991, 188-189) argue that estimates based on the alternative approach of calculating the present value of future earnings premiums attributable to schooling and other forms of human capital yield substantially higher estimates of human capital due to capturing inframarginal returns above costs accruing to human capital investments. For the growth accounting approach employed here, the cumulated investment or cost approach would seem the appropriate one. Are there more inherent bounds on the accumulation of human capital over time than non-human capital? One limit on the accumulation of human capital is set by how much of one’s potential working life a worker is willing to sacrifice for purposes of improving education and future productivity. This can be compared with the corresponding limit on the willingness to sacrifice current consumption for wealth accumulation.

However, this discussion makes no explicit allowance for changes over time in the quality of schooling. Improvements in teacher training and teacher recruitment along with ongoing curriculum developments among other factors could lead to ongoing improvements over time in how much a year of school attendance would improve the underlying future productivity of the student. Woessmann (2002) and Hanushek and Kimcoe (2000) have recently argued for the importance of allowing for variation in school quality in estimating the impact of cross national variation in human capital levels on economic growth. Woessmann (2002) makes the suggestion that allowing for improvements in the quality of schooling can remove the upper bounds on schooling investment that would be present if this was simply a matter of increasing the percentage of the population enrolled in school at given levels of quality. While there would seem to be inherent bounds on the proportion of one’s life that one is willing to spend in school, such bounds would not apply to increases in expenditures and other means of improving school quality.

Expenditures per pupil appear to have risen markedly over long periods of time. Thus, in the United States, expenditure per pupil in public elementary and secondary schools in constant 1989-90 dollars rose by over 6 times between 1923-24 and 1973-74 (National Center for Educational Statistics, 60). And in Victorian England, nominal expenditures per pupil in state subsidized schools more than doubled between 1870 and 1900, despite falling prices (Mitch 1982, 204). These figures do not control for the rising percentage of students enrolled in higher grade levels (presumably at higher expenditure per student), general rises in living standards affecting teachers’ salaries and other factors influencing the abilities of those recruited into teaching. Nevertheless, they suggest the possibility of sizable improvements over time in school quality.

It can be argued that implicitly allowance is made for improvements in school quality in the rate of return imputed per year of schooling completed on average by the labor force. Insofar as schools became more effective over time in transmitting knowledge and skills, the economic return per year of schooling should have increased correspondingly. Thus any attempt to allow for school quality in a growth accounting analysis should be careful to avoid double counting school quality in both school inputs and in returns per year of schooling.

The benchmark for the impact of increases in average levels of schooling completed in Table 1 are Maddison’s estimates of changes in output per capita over the last two centuries. In fact, major increases in schooling levels have most commonly been compressed into intervals of several decades or less, rather than periods of a century or more. This would imply that the contribution to output growth of improvements in labor force quality due to increases in schooling levels would have been concentrated primarily in periods of marked improvement in schooling levels and would have been far more modest during periods of more sluggish increase in educational attainment. In order to gauge the impact of the time interval over which changes in schooling occur on growth rates of output, Table 2 provides the change in average years of schooling implied by some of the hypothetical changes in average levels of schooling attainment reported in Table 1 for various time periods.

Table 2

Annual Change in Average Years of Schooling per Adult per Year Implied by Hypothetical Figures in Table 1

Time period over which increase occurred
Total Increase in
Average Years of
Schooling per Adult
5 years 10 years 30 years 50 years 100 years
1 0.2 0.1 0.033 0.02 0.01
3 0.6 0.3 0.1 0.06 0.03
6 1.2 0.6 0.2 0.12 0.06
9 1.8 0.9 0.3 0.18 0.09

Table 3 translates these rates of schooling growth into output growth rates using the partial equilibrium framework of equation 1) using a value for the share of labor of 0.7 as above. The contribution of schooling to growth rates of output and output per capita can be calculated as labor’s share times the percentage return per year of schooling on earnings times the annual increase in average years of schooling.

Table 3A
Contribution of Schooling for Large Increases in Schooling to Annual Growth Rates of Output

Length of time for schooling increase 6 year rise in average years of schooling 6 year rise in average years of schooling 9 year rise in average years of schooling 9 year rise in average years of schooling
5% return 10 % return 5 % return 10% return
30 years 0.7% 1.4% 1.05% 2.1%
50 years 0.42% 0.84% 0.63% 1.26%

Table 3B
Contribution of Schooling for Small to Modest Increases in Schooling to Annual Growth Rates of Output

Length of time for schooling increase 1 year rise in average years of schooling 1 year rise in average years of schooling 3 year rise in average years of schooling 3 year rise in average years of schooling
5 % return 10 % return 5% return 10% return
5 years 0.7% 1.4% 2.1% 4.2%
10 years 0.35% 0.7% 1.05% 2.1%
20 years 0.175% 0.35% 0.525% 1.05%
30 years 0.12% 0.23% 0.35% 0.7%
50 years 0.07% 0.14% 0.21% 0.42%
100 years 0.035% 0.07% 0.105% 0.21%

The case of the U.S. in the twentieth century as analyzed in DeLong, Goldin and Katz (2003) offers an example of how apparent limits or at least resistance to ongoing expansion of schooling have lowered the contribution of schooling to growth. They find that between World War I and the end of the century, improvements in labor quality attributable to schooling can account for about a quarter of the growth of output per capita in the U.S. during this period; this is similar in magnitude to Denison’s (1962) estimates for the first part of this period. This era saw the mean years of schooling completed by age 35 increased from 7.4 years for an American born in 1875 to 14.1 years for an American born in 1975 (DeLong, Goldin and Katz 2003, 22). However, in the last two decades of the twentieth century the rate of increase of mean years of schooling completed leveled off and correspondingly the contribution of schooling to labor quality improvements fell almost in half.

Maddison (1995) has compiled estimates of the average years of schooling completed for a number of countries going back to 1820. It is indicative of the sparseness of schooling completed by adult population estimates that Maddison reports estimates for only 3 countries, the U.S., the U.K., and Japan, all the way back to 1820. Maddison’s figures come from other studies and their reliability warrants further critical scrutiny than can be accorded them here. Since systematic census evidence on adult educational attainment did not begin until the mid-twentieth century, estimates of labor force educational attainment prior to 1900 should be treated with some skepticism. Nevertheless, Maddison’s estimates can be used to give a sense of plausible changes in levels of schooling completed over the last century and a half. The average increases in years of schooling per year for various time periods implied by Maddison’s figures are reported in Table 4. Maddison constructed his figures by giving primary education a weight of 1, secondary education a weight of 1.4, and tertiary, a weight of 2 based on evidence on relative earnings for each level of education.

Table 4
Estimates of the Annual Change in Average Years of Schooling per Person aged 15-64 for Selected Countries and Time Periods

Country 1913-1973 1870-1973 1870-1913
U.S. 0 .112 0.107 0.092
France 0.0783
Germany 0.053
Netherlands 0.064
U.K. 0.0473 0.0722 0.102
Japan 0.112 0.106 0.090

Source: Maddison (1995), 37, Table 2-3

Table 5
Annual Growth Rates in GDP per Capita

Region 1820-70 1870-1913 1913-50 1950-73 1973-92
12 West European Countries 0.9 1.3 1.2 3.8 1.8
4 Western Offshoots 1.4 1.5 1.3 2.4 1.2
5 South European Countries n.a. 0.9 0.7 4.8 2.2
7 East European Countries n.a. 1.2 1.0 4.0 -0.8
7 Latin American Countries n.a. 1.5 1.9 2.4 0.4
11 Asian Countries 0.1 0.7 -0.2 3.1 3.5
10 African countries n.a. n.a. 1.0 1.8 -0.4

Source: Maddison (1995), 62-63, Table 3-2.

In comparing Tables 2 and 4 it can be observed that the estimated actual changes in years of schooling compiled by Maddison (as well as the average over 55 countries reported by Lichtenberg (1994) for the third quarter of the twentieth century) fall within a lower bound set in the hypothetical ranges of a 3 year increase in average schooling spread over a century and an upper bound set by a 6 year increase in average schooling spread over 50 years.

Equations 1) and 2) above assume that each year of schooling of a worker has the same impact on productivity. In fact it has been common to find that the impact of schooling on productivity varies according to level of education. While the rate of return as a percentage of costs tends to be higher for primary than secondary schooling, which is in turn higher than tertiary education, this reflects the far lower costs, especially lower foregone earnings, of primary schooling (Psacharopolous and Patrinos 2004). The earnings premium per year of schooling tends to be higher for higher levels of education and this earnings premium, rather than the rate of return as a percentage costs, is the appropriate measure for assessing the contribution of rising schooling to growth (OECD 2001). Accordingly growth accounting analyses commonly construct schooling indexes weighting years of schooling according to estimates of each year’s impact on earnings (see for example Maddison 1995; Denison 1962). DeLong, Goldin and Katz (2003) use chain weighted indexes of returns according to each level of schooling. A rough approximation of the effect of allowing for variation in economic impact by level of schooling in the analysis in Table 1 is simply to focus on the mid-range 10 percent rate of return as an approximate average of high, low, and medium level returns.[6]

The U.S. is notable for rapid expansion in schooling attainment over the twentieth century at both the secondary and tertiary level, while in Europe widespread expansion has tended to focus on the primary and lower secondary level. These differences are evident in Denison’s estimates of the actual differences in educational distribution between the United States and a number of Western European countries in the mid-twentieth century (see Table 6).

Table 6

Percentage Distributions of the Male Labor Force by Years of Schooling Completed

Years of School Completed United States 1957 France 1954 United Kingdom 1951 Italy 1961
0 1.4 0.3 0.2 13.7
1-4 5.7 2.4 0.2 26.1
5-6 6.3 19.2 0.8 38.0
7 5.8 21.1 4.0 4.2
8 17.2 27.8 27.2 8.1
9 6.3 4.6 45.1 0.7
10 7.3 4.1 8.4 0.7
11 6.0 6.5 7.3 0.6
12 26.2 5.4 2.5 1.8
13-15 8.3 5.4 2.2 3.0
16 or more 9.5 3.2 2.1 3.1

Source: Denison (1967), 80, Table 8-1.

Some segments of the population are likely to have much greater enhancements of productivity from additional years of schooling than others. Insofar as the more able benefit from schooling compared to the rest of the ability distribution, putting substantially greater relative emphasis on expansion of higher levels of schooling could considerably augment growth rates over a more egalitarian strategy. This result would follow from a substantially greater premium assigned to higher levels of education. However, some studies of education in developing countries have found that they allocate a disproportionate share of resources to tertiary schooling at the expense of primary schooling, reflecting efforts of elites to benefit their offspring. How this has impeded economic growth would depend on the disparity in rates of return among levels of education, a point of some controversy in the economics of education literature (Birdsall 1996; Psacharopoulos 1996).

While allocating schooling disproportionately towards the more able in a society may have promoted growth, there would have been corresponding losses stemming from groups that have been systematically excluded or at least restricted in their access to education due to discrimination by factors such as race, gender and religion (Margo 1990). These losses could be attributed in part to the presence of individuals of high ability in groups experiencing discrimination due to failure to provide them with sufficient education to properly utilize their talents. However, historians such as Ashton (1948, 15) have argued that the exclusion of non-Anglicans from English universities prior to the mid-nineteenth century resulted in the channeling of their talents into manufacturing and commerce.

Even if returns have been higher at some levels of education than others, a sustained and substantial increase in labor force quality would seem to entail an egalitarian strategy of widespread increase in access to schooling. The contrast between the rapid increase in access to secondary and tertiary schooling in the U.S. and the much more limited increase in access in Europe during the twentieth century with the correspondingly much greater role for schooling in accounting for economic growth in the U.S. than in Europe (see Denison 1967) points to the importance of an egalitarian strategy in sustaining ongoing increases in aggregate labor force quality.

One would expect on increase in the relative supply of more schooled labor to lead to a decline in the premium to schooling, other things equal. Some recent analyses of the contribution of schooling to growth have allowed for this by specifying a parametric relationship between the distribution of schooling in an economy’s labor force and its impact on output or on a hypothesized intermediary human capital factor (Bils and Klenow 2000).[7]

Direct empirical evidence on trends in the premium to schooling is helpful both to obviate reliance on a theoretical specification and to allow for factors such as technical change that may have offset the impact of the increasing supply of schooling. Goldin and Katz (2001) have developed evidence on trends in the premium to schooling over the twentieth century that have allowed them to adjust for these trends in estimating the contribution of schooling to economic growth (DeLong, Goldin and Katz 2003). They find a marked fall in the premium to schooling, roughly falling in half between 1910 and 1950. However, they also find that this decline in the schooling premium was more than offset by their estimated increase over this same period in years of schooling completed by the average worker of 2.9 years and hence that on net schooling increases contributed to improved productivity of the U.S. workforce. They estimate increases of 0.5 percent per year in labor productivity due to increased educational attainment between 1910 and 1950 relative to the average total annual increase in labor productivity of 1.62 percent over the entire period 1915 to 2000. For the period since 1960, DeLong, Goldin and Katz find that the premium to education has increased while the increase in educational attainment at first increased and then declined. During this latter period, the increase in labor force quality has declined, as noted above, despite a widening premium to education, due to the slowing down in the increase in educational attainment.

Classifying the Range of Possible Relationships between Schooling and Economic Growth

In generalizing beyond the twentieth-century U.S. experience, allowance should be made both for the role of influences other than education on economic growth and for the possibility that the impact of education on growth can vary considerably according to the historical situation. In fact to understand why and how education might contribute to economic growth over the range of historical experience, it is important to investigate the variation in the impact of education on growth that has occurred historically. In relating education to economic growth, one can distinguish four basic possibilities.

The first is one of stagnation in both educational attainment and in output per head. Arguably, this was the most common situation throughout the world until 1750 and even after that date characterized Southern and Eastern Europe through the late nineteenth century, as well as most of Africa, Asia, and Latin American through the mid-twentieth century. The qualifier “arguably” is inserted here, because this view of the matter almost surely makes inadequate allowance for the improvements in informal acquisition of skills through family transmission and direct experience as well as through more formal non-schooling channels such as guild-sponsored apprenticeships, an aspect to be taken up further below. It also makes no allowance for the possible long-term improvements in per capita income that took place prior to 1750 but have been inadequately documented. Still focusing on formal schooling as the source of improvement in labor force, there is reason to think that this may have been a pervasive situation throughout much of human history.

The second situation is one in which income per capita rose despite stagnating education levels; factors other than improvements in educational attainment were generating economic growth. England during its industrial revolution, 1750 to 1840 is a notable instance in which some historians have argued that this situation prevailed. During this period, English schooling and literacy rates rose only slightly if at all, while income per capita appears to have risen. Literacy and schooling appears to have been of little use in newly created manufacturing occupations such as in cotton spinning. Indeed, literacy rates and schooling actually appears to have declined in some of the most rapidly industrializing areas of England such as Lancashire (Sanderson 1972; Nicholas and Nicholas 1992). Not all have concurred with this interpretation of the role of education in the English industrial revolution and the result depends on how educational trends are measured and how education is specified as affecting output (see Laqueur; Crafts 1995; Mitch 1999). Moreover this makes no allowance for the role of informal acquisition of skills. Boot (1995) argues that in the case of cotton spinners, informal skill acquisition with experience was substantial.

The simplest interpretation of this situation is that other factors contributed to economic growth other than schooling or human capital more generally. The clearest non-human capital explanatory factor would perhaps be physical capital accumulation; another might be foreign trade. However, if one turns to technological advance as a driving force, then this gives rise to the possibility that human capital — at least broadly defined — was if not the underlying force at least a central contributing factor to the industrial revolution. The argument for this possibility is that the improvements in knowledge and skills associated with technological advance are embodied in human agents and hence are forms of human capital. Recent work by Mokyr (2002) would suggest this interpretation. Nevertheless, the British industrial revolution does remain as a prominent instance in which human capital conventionally defined as schooling stagnated in the presence of a notable upsurge in economic growth. A less extreme case is provided by the post-World War II European catch-up with the United States, as Denison’s (1967) growth accounting analysis indicates that this occurred despite slower European increases in educational attainment due to other factors offsetting this. Historical instances such as that of the British industrial revolution call into question the common assumption that education is a necessary prerequisite for economic growth (see Mitch 1990).

The third situation is one in which rising educational attainment corresponds with rising rates of economic growth. This is the situation one would expect to prevail if education contributes to economic productivity and if any negative factors are not sufficient to offset this influence. One sub-set of instances would be those in which very large and reasonably compressed increases in the educational attainment of the labor force occurred. One important example of this is the twentieth century U.S., with the high school movement followed by increases in college attendance, as noted above. Another would be those of certain East Asian economies since World War II, as documented in the growth accounting analysis by Young (1995) of the substantial contributions of their rising educational attainment to their rapid growth rates. Another sub-set of cases corresponding to more modest increases in schooling can be interpreted as applying either to countries experiencing schooling increases focussed at the elementary level, as in much of Western Europe over the nineteenth century. The so-called literacy campaigns, as in the Soviet Union and Cuba (see Arnove and Graff eds. 1987) in the early and mid-twentieth century with modest improvements in educational attainment over compressed time periods of just a few decades could also be viewed as fitting into this sub-category. However, whether there were increases in output per capita corresponding to these more modest increases in educational attainment remains to be established.

The fourth situation is one in which economic growth has stagnated despite the presence of marked improvements in educational attainment. Possible examples of this situation would include the early rise of literacy in some Northern European areas, such as Scotland and Scandinavia, in the seventeenth and eighteenth centuries (see Houston 1988; Sandberg 1979) and some regions of Africa and Asia in the later twentieth century (see Pritchett 2001). One explanation of this situation is that it reflects instances in which any positive impact of educational attainment is small relative to other influences having an adverse impact. But one can also interpret it as reflecting situations in which incentive structures direct educated people into destructive and transfer activities inimical to economic growth (see North 1990; Baumol 1990; Murphy, Shleifer, and Vishny 1991).

Cross-country studies of the relationship between changes in schooling and growth since 1960 have yielded conflicting results which in itself could be interpreted as supporting the presence of some mix of the four situations just surveyed. A number of studies have found at best a weak relationship between changes in schooling and growth (Pritchett 2001; Bils and Klenow 2000); others have found a stronger relationship (Topel 1999). Much seems to depend on issues of measurement and on how the relationship between schooling and output is specified (Temple 2001b; Woessmann 2002, 2003).

The Determinants of Schooling

Whether education contributes to economic growth can be seen as depending on two factors, the extent to which educational levels improve over time and the impact of education on economic productivity. The first factor is a topic for extended discussion in its own right and no attempt will be made to consider it in depth here. Factors commonly considered include rising income per capita, distribution of political power, and cultural influences (Goldin 2001, Lindert 2004, Mariscal and Sokoloff 2000, Easterlin 1981; Mitch 2004). The issue of endogeneity of determination has often been raised with respect to the determinants of schooling. Thus, it is plausible that rising income contributes to rising levels of schooling and that the spread of mass education can influence the distribution of political power as well as the reverse. While these are important considerations, they are sufficiently complex to warrant extended attention in their own right.[8]

Influences on the Economic Impact of Schooling

Insofar as schooling improves general human intellectual capacities, it could be seen as having a universal impact irrespective of context. However, Rosenzweig (1995; 1999) has noted that the even the general influence of education on individual productivity or adaptability depend on the complexity of the situation. He notes that for agricultural tasks primarily involving physical exertion, no difference in productivity is evident between workers according to education levels; however, in more complex allocative decisions, education does enhance performance. This could account for findings that literacy rates were low among cotton spinners in the British industrial revolution despite findings of substantial premiums to experience (Sanderson 1972; Boot 1995). However, other studies have found literacy to have a substantial positive impact on labor productivity in cotton textile manufacture in the U.S., Italy, and Japan (Bessen 2003; A’Hearn 1998, Saxonhouse 1977) and have suggested a connection between literacy and labor discipline.

A more macro influence is the changing sectoral composition of the economy. It is common to suggest that the service and manufacturing sector have more functional uses for educated labor than the agricultural sector and hence that the shift from agriculture to industry in particular will lead to greater use of educated labor and in turn to require more educated labor forces. However, there are no clear theoretical or empirical grounds for the claim that agriculture makes less use of educated labor than other sectors of the economy. In fact, farmers have often had relatively high literacy rates and there are more obvious functional uses for education in agriculture in keeping accounts and keeping up with technological developments than in manufacturing. Nilsson et al (1999) argue that the process of enclosure in nineteenth-century Sweden, with the increased demands for reading and writing land transfer documents that this entailed, increased the value of literacy in the Swedish agrarian economy. The findings noted above that those in cotton textile occupations associated with early industrialization in Britain had relatively low literacy rates is one indication of the lack of any clear cut ranking across broad economic sectors in the use of educated labor.

Changes in the organization of decision making within major sectors as well as changes in the composition of production within sectors are more likely to have had an impact on demands for educated labor. Thus, within agriculture the extent of centralization or decentralization of decision making, that is the extent to which farm work forces consisted of farmers and large numbers of hired workers or of large numbers of peasants each with scope for making allocative decisions, is likely to have affected the uses made of educated labor in agriculture. Within manufacturing, a given country’s endowment of skilled relative to unskilled labor has been seen as influencing the extent to which openness to trade increases skill premiums, though this entails endogenous determination (Wood 1995).

Technological advance would have tended to boost the demand for more skilled and educated labor if technological advance and skills are complementary, as is often asserted.

However, there is no theoretical reason why technology and skills need be complementary and indeed concepts of directed technological change or induced innovation would suggest that in the presence of relatively high skill premiums, technological advance would be skill saving rather than skill using. Goldin and Katz (1998) have argued that the shift from the factory to continuous processing and batch production associated with the shift of power sources from steam to electricity in the early twentieth century lead to rising technology skill complementarity in U.S. manufacturing. It remains to be established how general this trend has been. It could be related to the distinction made between the dominance in the United States of extensive growth in the nineteenth century due to the growth of factors of production such as labor and capital and the increasing importance of intensive growth in the twentieth century. Intensive growth is often associated with technological advance and a presumed enhanced value for education (Abramovitz and David 2000). Some analysts have emphasized the importance of capital-skill complementarity. For example, Galor and Moav (2003) point to the level of the physical capital stock as a key influence on the return to human capital investment; they suggest that once physical capital stock accumulation surpassed a certain level, the positive impact of human capital accumulation on the return to physical capital became large enough that owners of physical capital came to support the rise of mass schooling. They cite the case of schooling reform in early twentieth century Britain as an example.

Even sharp declines in the premiums to schooling do not preclude a significant impact of education on economic growth. DeLong, Goldin and Katz’s (2003) growth accounting analysis for the twentieth century U.S. makes the point that even at modest positive returns to schooling on the order of 5 percent per year of schooling, with large enough increases in educational attainment, the contribution to growth can be substantial.

Human Capital

Economists have generalized the impact of schooling on labor force quality into the concept of human capital. Human capital refers to the investments that human beings make in themselves to enhance their economic productivity. These investments can take on many forms and include not only schooling but also apprenticeship, a healthy diet, and exercise, among other possibilities. Some economists have even suggested that more amorphous societal factors such as trust, institutional tradition, technological know how and innovation can all be viewed as forms of human capital (Temple 2001a; Topel 1999; Mokyr 2002). Thus broadly defined, human capital would appear as a prime candidate for explaining much of the difference across nations and over time in output and economic growth. However, gaining much insight into the actual magnitudes and the channels of influence by which human capital might influence economic growth requires specification of both the nature and determinants of human capital and how human capital affects aggregate production of an economy.

Much of the literature on human capital and growth makes the implicit assumption that some sort of numerical scale exists for human capital, even if multidimensional and even if unobservable. This in turn implies that it is meaningful to relate levels and changes of human capital to levels of income per capita and rates of economic growth. Given the multiplicity of factors that influence human knowledge and skill and in turn how these influence labor productivity, difficulties would seem likely to arise with attempts to measure aggregate human capital similar to those that have arisen with attempts to specify and measure the nature of human intelligence. Woessmann (2002, 2003) provides useful surveys of some of the issues involved in attempting to specify human capital at the aggregate level appropriate for relating it to economic growth.

One can distinguish between approaches to the measurement of human capital that focus on schooling, as in the discussion above, and those that take a broader view. Broad view approaches try to capture all investments that may have improved human productivity from whatever source, including not just schooling but other productivity enhancing investments, such as on-the-job training. The basic premise of broad view approaches is that for an aggregate economy, the income going to labor over and above what that labor would earn if it were paid the income of an unskilled worker can be viewed as human capital. This measure can be constructed in various ways including as a ratio using unskilled labor earnings as the denominator as in Mulligan and Sala-I-Martin (1997) or using the share of labor income not going as compensation for unskilled labor as in Crafts (1995) and Mitch (2004). Mulligan and Sala-I-Martin (2000) point to some of the major index number problems that can arise in using this approach to aggregate heterogeneous workers.

Crafts and Mitch find that for Britain during its late eighteenth and early nineteenth century industrial revolution between one-sixth and one-fourth of income per capita can be attributed to human capital measured as the share of labor income not going as compensation for unskilled labor.

One approach that has been taken recently to estimate the role of human capital differences in explaining international differences in income per capita is to consider changes in immigrant earnings between origin and destination countries along with differences between immigrant and native workers in the destination country. Olson (1996) suggested that the large increase in earnings of immigrants commonly observed in moving from a low income to a high income country points to a small role for human capital in explaining the wide variation in per capita income across countries. Hendricks (2002) has used differences between immigrant and native earnings in the U.S. to estimate the contribution of otherwise unobserved skill differences to explaining differences in income per capita across countries and finds that they account for only a small part of the latter differences. Hendricks’ approach raises the issue of whether there could be long-term increases in otherwise unobserved skills that could have contributed to economic growth.

The Informal Acquisition of Human Capital

One possible source of such skills is through the informal acquisition of human capital through on-the-job experience. Insofar as work has been common from early adolescence onwards, the issue arises of why the aggregate stock of skills acquired through experience would vary over time and thus influence rates of economic growth. Some types of on-the-job experience which contribute to economic productivity, such as apprenticeship, may entail an opportunity cost and aggregate trends in skill accumulation will be influenced by societal willingness to incur such opportunity costs.

Insofar as schooling continues through adolescence, this can interfere with the accumulation of workforce experience. DeLong, Goldin and Katz (2003) note the tradeoff between rising average years of schooling completed and decreasing years of labor force experience in influencing labor force quality of the U.S. labor force in the last half of the twentieth century. Connolly (2004) has found that informal experience played a relatively greater role in Southern economic growth than for other regions of the United States.

Hansen (1997) has also distinguished the academically-oriented secondary schooling the United States developed in the late nineteenth and early twentieth century from the vocationally-oriented schooling and apprenticeship system that Germany developed over the same time period. Goldin (2001) argues that in the United States the educational system developed general abilities suitable for the greater opportunities for geographical and occupational mobility that prevailed there, while specific vocational training was more suitable for the more restricted mobility opportunities in Germany.

Little evidence exists on whether long-term trends in informal opportunities for skill acquisition have influenced growth rates. However, Smith’s (1776) view of the importance of the division of labor in influencing productivity would suggest that the impact of trends in these opportunities may well have been quite sizable.

Externalities from Education

Economists commonly claim that education yields benefits to society over and above the impact on labor market productivity perceived by the person receiving the education. These benefits can include impacts on economic productivity, such as impacts on technological advance. They can also include non-labor market benefits. Thus McMahon (2002, 11) in his assessment of the social benefits of education includes not only direct effects on economic productivity but also impacts on a) population growth rates and health b) democratization, political stability, and human rights, c) the environment, d) reduction of poverty and inequality, e) crime and drug use, and f) labor force participation. While these effects may appear to involve primarily non-market activity and thus would not be reflected in national output measures and growth rates, factors such as political stability, democratization, population growth, and health have obvious consequences for prospects for long-term growth. However, allowance should be made for the simultaneous influence of the distribution of political power and life expectancy on societal investments in schooling.

For the period since 1960, numerous studies have employed cross country variation in various estimates of human capital and income per capita to directly estimate the impact of human capital on levels of income per capita and growth. A central goal of many such estimates is to see if there are externalities to education on output over and above the private returns estimated from micro data. The results have been conflicting and this has been attributed not only to problems of measurement error but also to differences in specification of human capital and its impact on growth. There does not appear to be strong evidence of large positive externalities to human capital (Temple 2001a). Furthermore, McMahon (2004) reports some empirical specifications which yield substantial indirect long-run effects.

For the period before 1960, limits on the availability of data on schooling and income have limited the use of this empirical regression approach. Thus, any discussion of the impact of externalities of education on production is considerably more conjectural. The central role of government, religious, and philanthropic agencies in the provision of schooling suggests the presence of externalities. Politicians and educators more frequently justified government and philanthropic provision of schooling by its impacts on religious and moral behavior than by any market failure resulting in sub-optimal provision of schooling from the standpoint of maximizing labor productivity. Thus, Adam Smith in his discussion of mass schooling in The Wealth of Nations, places more emphasis on its value to the state in enhancing orderliness and decency while reducing the propensity to popular superstition than on its immediate value in enhancing the economic productivity of the individual worker.

The Impact of the Level of Human Capital on Rates of Economic Growth

The approaches considered thus far relate changes in educational attainment of the labor force to changes in output per worker. An alternative, though not mutually exclusive, approach is to relate the level of educational attainment of an economy’s labor force to its rate of economic growth. The argument for doing so is that a high but unchanging level of educational attainment should contribute to growth by facilitating creativity, innovation and adaptation to change as well as facilitating the ongoing maintenance and improvement of skill in the workforce. Topel (1999) has argued that there may not be any fundamental difference between the two types of approach insofar as ongoing sources of productivity advance and adaptation to change could be viewed as reflecting ongoing improvements in human capital. Nevertheless, some empirical studies based on international data for the late twentieth century have found that a country’s level of educational attainment has a much stronger impact on its rate of economic growth than its rate of improvement in educational attainment (Benhabib and Spiegel 1994).

The paucity of data on schooling attainment has limited the empirical examination of the relationship between levels of human capital and economic growth for periods before the late twentieth century. However, Sandberg (1982) has argued, based on a descriptive comparison of economies in various categories, that those with high levels of schooling in 1850 subsequently experienced faster rates of economic growth. Some studies, such as O’Rourke and Williamson (1997) and Foreman-Peck and Lains (1999), have found that high levels of schooling and literacy have contributed to more rapid rates of convergence for European countries in the late nineteenth century and at the state level for the U.S. over the twentieth century (Connolly 2004).

Bowman and Anderson (1963), a much earlier study based on international evidence for the mid-twentieth century, can be interpreted in the spirit of relating levels of education to subsequent levels of income growth. Their reading of the cross-country relationship between literacy rates and per capita income at mid-twentieth-century was that a threshold of 40 percent adult literacy was required for a country to have a per capita income above 300 1955 dollars. Some have ahistorically projected back this literacy threshold to earlier centuries although the Bowman and Anderson proposal was intended to apply to mid-twentieth century development patterns.

The mechanisms by which the level of schooling would influence the rate of economic growth are problematic to establish. One can distinguish two general possibilities. One would be that higher levels of educational attainment facilitate adaptation and responsiveness to change throughout the workforce. This would be especially important where a large percentage of workers are in decision making positions such as an economy composed largely of small farmers and other small enterprises. The finding of Foster and Rosenzweig (1996) for late twentieth century India that the rate of return to schooling is higher during periods of more rapid technological advance in agriculture would be consistent with this. Likewise, Nilsson et al (1999) find that literacy was important for nineteenth-century Swedish farmers in dealing with enclosure, an institutional change. The other possibility is that higher levels of educational attainment increase the potential pool from which an elite group responsible for innovation can be recruited. This could be viewed as applying specifically to scientific and technical innovation as in Mokyr (2002) and Jones (2002) — but also to technological and industrial leadership more generally (Nelson and Wright 1992) and to facilitating advancement in society by ability irrespective of social origins (Galor and Tsiddon 1997). Recently, Labuske and Baten (2004) have found that international rates of patenting are related to secondary enrollment rates.

Two issues have arisen in the recent theoretical literature regarding specifying relationships between the level of human capital and rates of economic growth. First, Lucas (1988) in an influential model of the impact of human capital on growth, specifies that the rate of growth of human capital formation depends on initial levels of human capital, in other words that parents’ and teachers’ human capital has a direct positive influence on the rate of growth of learners’ human capital. This specification of the impact of the initial level of human capital allows for ongoing and unbounded growth of human capital and through this its ongoing contribution to economic growth. Such ongoing growth of human capital could occur through improvements in the quality of schooling or through enhanced improvements in learning from parents and other informal settings. While it might be plausible to suppose that improved education of teachers will enhance their effectiveness with learners, it seems less plausible to suppose that this enhanced effectiveness will increase unbounded in proportion to initial levels of education (Lord 2001, 82).

A second issue is that insofar as higher levels of human capital contribute to economic growth through increases in research and development activity and innovative activity more generally, one would expect the presence of scale effects. Economies with larger populations holding constant their level of human capital per person should benefit from more overall innovative activity simply because they have more people engaged in innovative activity. Jones (1995) has pointed out that such scale effects seem implausible if one looks at the time series relationship between rates of economic growth and those engaged in innovative activity. In recent decades the growth of the number of scientists, engineers, and others engaged in innovative activity has far outstripped the actual growth of productivity and other indicators of direct impact on innovation. Thus, one should allow for diminishing returns in the relationship between levels of education and technological advance.

Thus, as with schooling externalities, considering the impact of levels of education on growth offers numerous channels of influence leaving the challenge for the historian of ascertaining their quantitative importance in the past.


This survey has considered some of the basic ways in which the rise of mass education has contributed to economic growth in recent centuries. Given their potential influence on labor productivity, levels and changes in schooling and of human capital more generally have the potential for explaining a large share of increases in per capita output over time. However, increases in mass schooling seem to explain a major share of economic growth only over relatively short periods of time, with a more modest impact over longer time horizons. In some situations, such as the United States in the twentieth century, it appears that improvements in the schooling of the labor force have made substantial contributions to economic growth. Yet schooling should not be seen as either a necessary or sufficient condition for generating economic growth. Factors other than education can contribute to economic growth and in their absence, it is not clear that schooling in itself can contribute to economic growth. Moreover, there are likely limits on the extent to which average years of schooling of the labor force can expand, although improvement in the quality of schooling is not so obviously bounded. Perhaps the most obvious avenue through which education has contributed to economic growth is by expanding the rate of technological change. But as has been noted, there are numerous other possible channels of influence ranging from political stability and property rights to life expectancy and fertility. The diversity of these channels point to both the challenges and the opportunities in examining the historical connections between education and economic growth.


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[1] I have received helpful comments on this essay from Mac Boot, Claudia Goldin, Bill Lord, Lant Pritchett, Robert Whaples, and an anonymous referee. At an earlier stage in working through some of this material, I benefited from a quite useful conversation with Nick Crafts. However, I bear sole responsibility for remaining errors and shortcomings.

[2] For a detailed survey of trends in schooling in the early modern and modern period see Graff (1987).

[3] See Barro (1998) for a brief intellectual history of growth accounting.

[4] Blaug (1970) provides an accessible, detailed critique of the assumptions behind Denison’s growth accounting approach and Topel (1999) provides a further discussion of the problems of using a growth accounting approach to measure the contribution of education, especially those due to omitting social externalities.

[5] By using a Cobb-Douglas specification of the aggregate production function, one can arrive at the following equation for the ratio between final and initial national income per worker due to increases in average school years completed between the two time periods, t = 0 and t =1:

Start with the aggregate production function specification:

Y = A K(1-α) [(1+r)S L]α

Y/L = A (K/L)(1-α) [(1+r)S L/L]α

Y/L = A (K/L)(1-α) [(1+r)S]α

Assume that the average years of schooling of the labor force is the only change between t = 0 and t =1; that is, assume no change in the ratio of capital to labor between time periods. Then the ratio of the income per worker in the later time period to the earlier time period will be:

(Y/L)1/ (Y/L)0 = ( (1 + r )S1– S0 )α

Where Y = output, A = a measure of the current state of technology, K = the physical capital stock, L = the labor force, r = the percent by which a year of schooling increases labor productivity, S is the average years of schooling completed by the labor force in each time period, α is labor’s share in national income, and the subscripts 0 and 1 denote initial and final time periods.

As noted above, the derivation above is for a partial equilibrium change in years of schooling of the labor force holding constant the physical capital stock. Allowing for physical capital stock accumulation in response to schooling increases in a Solow-type model implies that the ratio of final to initial output per worker will be

(Y/L)1/ (Y/L)0 = ( (1 + r )S1 – S0 ) .

For a derivation of this see Lord (2001, 99-100). Lord’s derivation differs from that here by specifying the technology parameter A as labor augmenting. Allowing for increases in A over time due to technical change would further increase the contribution to output per worker of additional years of schooling.

[6]To take a specific example, suppose that in the steady-state case of Table 1B, a 5 percent earnings premium per year of schooling is assigned to the first 6 years of schooling, i.e. primary schooling, a 10 percent earnings premium per year is assigned to the next 6 years of schooling, i.e. secondary schooling, and a 15 percent earnings premium per year is assigned to the final 4 years of schooling, that is college. In that case, the impact on steady state income per capita compared with no schooling at all would be (1.05)6x(1.10)6x(1.15)4 = 4.15, compared with the 4.59 in going from no schooling to universal college at a 10 percent rate of return for every year of school completed.

[7] Denison’s standard growth accounting approach assumes that education is labor augmenting and, in particular, that there is an infinite elasticity of substitution between skilled and unskilled labor. This specification is conventional in growth accounting analysis. But another common specification in entering education into aggregate production functions is to specify human capital as a third factor of production along with unskilled labor and physical capital. Insofar as this is done with a Cobb-Douglas production function specification, as is conventional, the implied elasticity of substitution between human capital and either unskilled labor or physical capital is unity. The complementarity between human capital and other inputs this implies will tend to increase the contribution of human capital increases to economic growth by decreasing the tendency for diminishing returns to set in. (For a fuller treatment of the considerations involved see Griliches 1970, Conlisk 1970, Broadberry 2003). For an application of this approach in a historical growth accounting exercise, see Crafts (1995), who finds a fairly substantial contribution of human capital during the English industrial revolution. For a critique of Crafts’ estimates see Mitch (1999).

[8] For an examination of long-run growth dynamics with schooling investments endogenously determined by transfer-constrained family decisions see Lord 2001, 209-213 and Rangazas 2000. Lord and Rangazas find that allowing for the fact that families are credit constrained in making schooling investment decisions is consistent with the time path of interest rates in the U.S. between 1870 and 1970.

Citation: Mitch, David. “Education and Economic Growth in Historical Perspective”. EH.Net Encyclopedia, edited by Robert Whaples. July 26, 2005. URL

Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity

Author(s):Baumol, William J.
Litan, Robert E.
Schramm, Carl J.
Reviewer(s):Keech, William R.

Published by EH.NET (May 2009)

William J. Baumol, Robert E. Litan and Carl J. Schramm, Good Capitalism, Bad Capitalism and the Economics of Growth and Prosperity. New Haven: Yale University Press, 2007. x + 321 pp. $30 (hardcover), ISBN: 978-0-300-10941-2.

Reviewed for EH.NET by William R. Keech, Department of Political Science, Duke University.

This is a good book that celebrates capitalism as practiced in the United States just as features of that capitalism were bringing the world into the deepest financial crisis since the Great Depression. But it would be a great mistake to ignore this book because it did not anticipate events that have for some observers called into question whether capitalism is a reliable and desirable system. The book is a unique addition to the expanding literature on economic growth, and its main contribution is highlighted by the title of the first chapter: ?Entrepreneurship and Growth: The Missing Piece of the Puzzle.? While highlighting the role of innovation in economic growth, the book delineates four different types of capitalism according to the role of entrepreneurship in them. These ?archetypes? are oriented largely to how production is organized. They are to be contrasted with other treatments of the varieties of capitalism, such as the contrast between ?liberal market capitalism? and ?coordinated market capitalism,? which is oriented more toward different degrees of dependence on markets or non-market institutions to coordinate financial and industrial relations systems. (See Hall and Soskice, eds. 2001, especially chapter 1).

?Why Economic Growth Matters? is the topic of chapter 2, which defends growth against several familiar criticisms, such as resource constraints and the relationship between growth and happiness. Chapter 3 is a readable introduction to modern growth theory. It stresses the importance of innovation, and reviews empirical evidence. Baumol, Litan and Schramm show how the Washington Consensus has broken down as a consensual explanation of a path to growth, and suggest that the four faces of capitalism is a new and more constructive way to understand growth.

The core of the book is in chapter 4, which differentiates four types of capitalism and their impacts on economic growth. In doing so, the authors make an important contribution to the literature on economic growth. In state-guided capitalism, the government decides which sectors shall grow. This type of capitalism is found in many countries, but has been most common in Asia and Latin America. Initially motivated by a desire to foster growth, this type of capitalism has several pitfalls: excessive investment, picking the wrong winners, susceptibility to corruption and difficulties of ending support when it is no longer appropriate.

Oligarchic capitalism differs from the state-led variety largely in the motivations of its leaders. The oligarchic variety is oriented towards protecting and enriching a very narrow fraction of the population, and perhaps even the ruler. Economic growth is not a central objective, and countries with this variety have a great deal of inequality and corruption.

Big-firm capitalism is a variety that takes advantage of economies of scale and network effects. This type is important for mass production of products, but although its firms have research and development capabilities, these are not central, and big firms often lose their competitive edge and engage in rent-seeking.

Entrepreneurial capitalism is the kind that produces new breakthroughs like the automobile, the telephone and the computer. These innovations are, according to the authors, usually the product of individuals and new firms. However, it takes big firms to mass produce and market them, so the optimal combination of capitalism is a mix of big-firm and entrepreneurial varieties. This is the kind that characterizes the United States more than any other country. But that is the same capitalism in which the current financial crisis began, and this crisis is undermining the faith that some have in capitalism itself.

?Growth on the Cutting Edge? (chapter 5) elaborates four basic elements of a well-oiled growth machine, the successful entrepreneurial economy. It must be easy to form a business. There must be rewards for productive entrepreneurial activity, based in the rule of law, and especially property and contract rights, including ?proper regulation (or deregulation)? (p. 106). Government must discourage activity that aims to divide up the economic pie rather than increase its size. And government must assure continued incentives to innovate with trade policy and antitrust enforcement. The roles of macroeconomic stability and democracy are discussed in this chapter.

Chapter 6 applies the perspective to less developed economies, by giving suggestions for moving away from state guidance and from oligarchic varieties of capitalism, and encouraging entrepreneurship. Chapter 7 gives suggestions for preventing retreat and stagnation in wealthy economies, and for mobilizing the growth that will be necessary to meet coming demographic challenges.

A long concluding chapter reviews the advice of chapter 5 and reflects rather inconclusively on the political economy of growth. The authors suggest that it may take a crisis for politicians to act, and ?in the absence of a crisis that impels them to act, policy makers cannot be expected to take apparently radical actions to raise long-term growth by creating the right mix of ?capitalisms?? (p. 273). Well there is a crisis now, and little evidence that the radical actions of the U.S. government reflect the good ideas of this book.

I have two main misgivings about this fine book. One is that the archetypes of capitalism are not clearly operationalized, and are described with a broad brush. Specific industries might be described in terms of the four types at any given time, and countries might be similarly characterized by aggregating industry descriptions. The authors are aware of this weakness and devote an appendix to measurement issues. The other is that the occasional references to regulation, such as the Glass-Steagall and Sarbanes-Oxley Acts do not address the kinds of conditions that might have avoided the current crisis.

The book is a unique and original contribution to the literature on economic growth, which for the most part does not consider varieties of capitalism and does not emphasize the kinds of institutions that are discussed here. Baumol, Litan and Schramm highlight the importance of innovation in economic growth, the role of the entrepreneur in creating innovation, and the institutional setting in which new ideas are put into production and create economic growth.


Peter A. Hall and David Soskice, editors, 2001. Varieties of Capitalism: The Institutional Foundations of Comparative Advantage. New York: Oxford University Press.

William R. Keech is Research Professor of Political Economy in the Department of Political Science at Duke University. He was previously on the faculties of the University of North Carolina at Chapel Hill, and of Carnegie Mellon University. He is working on a book entitled Economic Politics in Latin America: Rethinking Democracy and Authoritarianism. His email address is

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

The Agrarian Origins of Modern Japan

Author(s):Smith, Thomas C.
Reviewer(s):Saito, Osamu

Classic Reviews in Economic History

Thomas C. Smith, The Agrarian Origins of Modern Japan. Stanford: Stanford University Press, 1959. xi + 250 pp.

Review Essay by Osamu Saito, Institute of Economic Research, Hitotsubashi University.

A Peasant Economy and the Growth of the Market

In the 1950s, when the late Professor Thomas Smith wrote this book, peasant farming was portrayed as a mode of production and livelihood incompatible with the market economy. Japan before Meiji was regarded as a typical example of such peasant economies. As Smith notes in the opening sentence of the book, this was to some extent true because “In the course of its long history, Japanese agriculture has in some respects changed remarkably little”: farming was a family enterprise, holdings tiny and fragmented, and cultivation methods simple — all features of a typical peasant society. Of course, there were some changes but they were never as dramatic as the agrarian changes the West experienced, so that for many scholars “it is tempting to dismiss as unimportant such changes as in fact have taken place.” Against this historiographical background, Smith argues in the book that the changes that actually took place in Japanese history, especially in the Tokugawa period (1603-1868), were in fact of great importance. His argument is that “their central feature was a shift from cooperative to individual farming” and that “if one of its causes may be singled out as especially important, it must be the growth of the market” (pp. ix-x; emphasis added).

The book is about these changes and, based largely on a body of evidence uncovered by Japanese historians, traces their social and economic consequences. It begins with a model of the traditional village society in the seventeenth century, which is set out in Part I. At the core of village society, according to that model, was a large landholder’s domestic group. It was composed of three concentric circles with the inner one being the family of the holder, the main household. The second circle consisted of a group of relatives outside the direct line of descent, and the third circle of hereditary servants and similar subordinate persons who were related to the holder by neither blood nor marriage but were nonetheless registered as part of his family group. In every village such large holder households were not many; only a few took this form of “extended family.” Other villagers were all small holders whose family form was, according to Smith, in most cases “nuclear”; and they were in all likelihood households created by partitioning. Since the partition of family land, even when practiced, was never made on an equal footing, those “new” groups of branch-family households were bound to be small holders who had to rely on resources provided by the main household as well as the village itself. Thus the structure of the traditional village was both cooperative and hierarchical, with “clusters of interdependent interests that clung together with great force and were broken up only when competitive inducements of trade began, much later, to dissolve the internal ties” (p. 54).

Such “competitive inducements” came from market growth in the countryside, which, it is suggested, was concomitant with urban growth. Thus, Smith begins Part II with a survey of the extent of commercial farming (cultivation of cotton, indigo, mulberries, oilseeds, tobacco, and other cash crops) and farm family by-employment (spinning, reeling, weaving, straw plaiting, etc.), both of which are supposed to have spread in the rural provinces during the eighteenth and nineteenth centuries. Then in the subsequent chapters Smith traces the consequent changes: how agricultural technology changed, how labor was transformed, how wealthy landlords emerged within the village society, and how the traditional ties between households dissolved. The underlying tendency in the eighteenth and nineteenth centuries was for some branch families and hereditary servants to become separate from the main household. They formed their own households. Their landholding was sometimes too small to feed themselves on the farm, but thanks to the expanding market economy, they were in all likelihood able to find either by-employment opportunities or wage jobs, or both, as former labor service was increasingly replaced by live-in servants on yearly contract, who were eventually substituted by workers employed by the day. Sometimes, especially in crisis years, they had to borrow money from large holders in the village with a parcel of land placed in pawn, which in many cases ended up with the loss of its holding right: they became tenants of the large holders. The latter half of the Tokugawa period saw their numbers increasing, but at the same time it is not unlikely that increased tenancy in turn allowed them to stay on the land. With these significant, if not revolutionary, tendencies established, Smith devotes the final chapter to relating them to the making of modern Japan, placing particular emphasis on what commercial farming and expanding labor markets taught peasants in relation to the forthcoming age of the factory.

The book’s major points, such as the supposition that the weight of non-agricultural income in the rural economy had become substantial by the early nineteenth century, have subsequently been confirmed by his own and other historians’ works (Smith 1969/88, Nishikawa 1987, Shimbo and Saito 2004). From an early twenty-first century vantage point, however, it is not surprising that the progress of research since then has made some of the other propositions no longer tenable. One such example is his description of a shift from “extended” to “nuclear” family. Each of the cooperative groups in seventeenth-century documents that he regarded as one large and complex family household was probably nothing but an estate organization accommodating several separate domestic groups together, most of which were family households in a much simpler form and possessed their own hearth and living space. As a unit of production, however, the structure of the seventeenth-century estate organization may have been not much different from what he described in the book: it was hierarchical and there were extra-economic ties between those households. On the other hand, the family form that he considered “nuclear” should now be taken to mean “stem family,” since by the term “nuclear” Smith meant a small family that had no lateral extension but tended to extend vertically. As far as the family system is concerned, therefore, there seems to have been little change throughout the Tokugawa period. What actually changed was the way in which farming was organized and its tasks carried out, which was not associated with a transformation in the system of family formation. Another point I have to make concerns the extent of urbanization and the role given to it as an engine of market growth. In the chapter on “The Growth of the Market,” Smith noted that “in the two centuries after 1600, urban population grew with astonishing speed” (p. 67). Probably it did as far as the seventeenth century is concerned, but we now know, from Smith’s own research work published later, that urban population did not grow in the one and a half centuries after 1700: Edo, Osaka and some of the castle towns even recorded a population decline. Market-led output growth — “Smithian growth” in recent terminology (named after Adam Smith) — that took place in the latter half of the Tokugawa period should now be considered “rural-centered” (Smith 1973/88; see also Shimbo and Saito 2004).

Such necessary revisions notwithstanding, The Agrarian Origins of Modern Japan remains a landmark achievement in Tokugawa economic history. It is not just because the book is still very informative and makes lucid reading, but chiefly because what Smith delineated with respect to “what changed” and “what remained unchanged” is largely accurate. Given the intellectual milieu of the 1950s and the 60s, however, this publication may have been considered a book about “what changed” only — a work fitting very nicely in the framework of modernization theses such as the rise of individualism and the transition from status to contract, since the “growth of the market,” the guiding concept of the book, has long been regarded as an important component of the modernization process.

However, Smith makes several important points that do not necessarily fit with the modernization scenarios. First, he makes it clear that Tokugawa Japan’s path of agricultural progress was distinctly different from the Western one, suggesting that they would never converge on a single model. As he describes in the chapter on “Agricultural Technology,” farm output rose with the expansion of commercial farming, which was closely associated with the more intensive use of fertilizers, widening plant varieties, proliferation of farming tools, and the extension of irrigation. The irrigation work, i.e. construction of dikes, ponds, ditches, devices for lifting water into paddy fields and for other purposes, required a substantial amount of capital, much of which was provided by overlords and wealthy merchants. At the same time, however, the construction work itself required a substantial input of labor. And all the other improvements in farming methods were also labor intensive. Some individual innovations may have reduced labor requirements per unit of cultivated land, but the overall effect was to intensify the use of labor. All this made farming even more labor intensive and the unit of farming even smaller, the characteristics that remained unchanged throughout the period from Tokugawa to Meiji. To put it differently, “the character of agrarian change [in Tokugawa and Meiji Japan] … was determined as much by what did not change about farming as by what did” (p. 208; see also Ishikawa 1978, Francks 1983).

Secondly, while Smith examines in detail the rise of landlord-tenant relations and its accompanying phenomenon of increasing differentiation of landholdings within the agrarian society, and also the processes of hereditary subordinates evolving into servants for yearly wages and of service agreements becoming from long-term to short-term contracts, thus describing a long-run transition to wage labor, he never speaks of the emergence of a wage earning class of landless agricultural labors. This may be interpreted as suggesting that those tendencies, together with the above-mentioned move towards the intensification in farming and the spread of non-agricultural by-employments in the rural districts, resulted in keeping the peasantry from disintegrating itself (Saito 1986).

Thirdly, therefore, all this “kept the agricultural population a relatively homogeneous class of small peasant farmers despite the presence of landlords and obvious differences in wealth; [and] it preserved the organic unity of the village community despite the growth of a nonfarming population within it” (p. 107). In other words, the coming of commercial farming and the associated growth of labor markets in the Tokugawa period did not signal the end of a peasant economy. Rather, in the Japanese past peasant farming evolved towards more uniformity as the market grew.

Thus, this 1959 book suggested that the Tokugawa peasant household, as an integral unit of production and reproduction, had a modus operandi distinctly different from those found for other early modern agricultural populations, and also that it emerged in the process of interactions with the growth of the market. Smith addressed this research question later when he worked on demography and on the history of time discipline (Smith 1977, 1986/88). In the first, he demonstrated how the Tokugawa peasant families tried, with a dim idea of family planning, to adjust their size and composition to alternating life-cycle stages and also changing economic circumstances, and in the second, how they developed a stringent sense of time discipline within the household in order to cope with the increased intensity of labor in farming and by-employment activities and, hence, an increased need for planning over the whole farming year. This latter point implies that Meiji Japanese workers did not need to be taught time discipline in the factory, which strongly suggests that there was continuity from Tokugawa to Meiji. In the former demographic study, Smith made a strong argument that Tokugawa peasants adjusted their family size and composition by means of sex selective infanticide. This provoked a debate, but as I have commented elsewhere (Saito 1989), the gist of his entire argument was that the Tokugawa peasant family household tried hard to balance its numbers with farm size and to secure the right composition in the family workforce, for which purpose infanticide was only one of the options accessible to the family. There were some other means of demographic adjustments such as abortion and the timing of marriage-out of non-inheriting children, as well as economic ones such as sending children, both male and female, into service in the village and in cities and towns, or getting them to take up an industrial by-employment at home. Those economic opportunities increased with the growth of the market, and with changes that accelerated after the Meiji reforms. This consideration, therefore, points to another element of continuity from the early modern to the modern period, the theme already explicit in the writing of The Agrarian Origins of Modern Japan.

Smith noted, retrospectively in the preface to a collection of essays he had published since the 1950s, that while writing on “how Japan became a modern society … with a generalized notion drawn from Western history of how much transformations occur,” he had “paid particular attention to factors that contributed to making modern Japanese society similar to but profoundly different from Western counterparts” (Smith 1988, p. 1; emphasis added). As such, therefore, his work collectively made a pioneering contribution to the on-going debates in global economic history.


Francks, P. (1983), Technology and Agricultural Development in Pre-war Japan, New Haven: Yale University Press.

Ishikawa, S. (1978), Labour Absorption in Asian Agriculture: An Issues Paper, Bangkok: Asian Regional Programme for Employment Promotion of the International Labour Office; reprinted in S. Ishikawa (1981), Essays on Technology, Employment and Institutions in Economic Development, Tokyo: Kinokuniya, 1-149.

Nishikawa, S. (1987), “The Economy of Choshu on the Eve of Industrialization,” Economics Studies Quarterly 38 (December), 323-37.

Saito, O. (1986), “The Rural Economy: Commercial Agriculture, By-employment and Wage Work,” in M.B. Jansen and G. Rozman, eds., Japan in Transition: From Tokugawa to Meiji, Princeton: Princeton University Press, 400-420.

Saito, O. (1989), “Bringing the Covert Structure of the Past to Light: Review Article of T.C. Smith, Native Sources of Japanese Industrialization, 1750-1920,” Journal of Economic History 49 (December), 992-999.

Shimbo, H. and O. Saito (2004), “The Economy on the Eve of Industrialization,” in A. Hayami, O. Saito and R.P. Toby, eds., The Economic History of Japan, 1600-1990. I: Emergence of Economic Society in Japan, 1600-1859, Oxford: Oxford University Press, 337-68.

Smith, T.C. (1969), “Farm Family By-employments in Preindustrial Japan,” Journal of Economic History 29 (December), 687-715; reprinted in Smith (1988), 71-102.

Smith, T.C. (1973), “Pre-modern Economic Growth: Japan and the West,” Past and Present 60 (August), 127-160; reprinted in Smith (1988), 15-49.

Smith, T.C. (1977), Nakahara: Family Farming and Population in a Japanese Village, 1717-1830, Stanford: Stanford University Press.

Smith, T.C. (1986), “Peasant Time and Factory Time in Japan,” Past and Present 111 (May), 165-197; reprinted in Smith (1988), 199-235.

Smith, T.C. (1988), Native Sources of Japanese Industrialization, 1750-1920, Berkeley: University of California Press.

Subject(s):Markets and Institutions
Geographic Area(s):Asia
Time Period(s):19th Century

Classical Macroeconomics: Some Modern Variations and Distortions

Author(s):Ahiakpor, James C. W.
Reviewer(s):Muzhani, Marin

Published by EH.NET (December 2005)

James C. W. Ahiakpor, Classical Macroeconomics: Some Modern Variations and Distortions. New York: Routledge, 2003. xvii + 256 pp. $120 (cloth), ISBN: 0-415-15332-8.

Reviewed for EH.NET by Marin Muzhani, Department of Economics, University of Florence, Italy.

James Ahiakpor has written a fascinating book which readers will find difficult to put down. Students of macroeconomics should not deprive themselves of the opportunity to study this rich volume on classical macroeconomics.

The broad range of the book presents difficulties to the reviewer since it is difficult to cover it adequately in a few pages. Ahiakpor may have had this difficulty, too, since his treatment is sometimes (but not often) cursory, wordy and not very helpful. I have chosen a few topics to show both the range of the book and the shortcomings of the treatment.

About half the chapters were published in journals from the mid-1980s and to the late 1990s. The preface describes the difficulties encountered from referees when Ahiakpor submitted papers on Keynes’s misinterpretation of “capital” in the classical theory of interest. Indeed, his goal is to explain the confusions and misinterpretations of classical macroeconomics – especially the theory of capital and interest –contained in textbooks covering the works of B?hm-Bawerk, Fisher, Wicksell and Hayek.

The second chapter looks directly at the theory of value, which is one of the foundations of macroeconomic analysis. This chapter restates the theory of value in Smith, Ricardo, Malthus and Mill and interprets it in a straightforward way without variations and distortions. The main point is that the classical theory of exchange value is not about the utilities of commodities but the ratio in which different units of goods are exchanged for one another. Ahiakpor emphasizes that the misinterpretation of the classical theory of value by Austrians, Marxists and other economists influenced several writers including Alfred Marshall. Later this theory was distorted by Paul Douglas (1928) and Emil Kauder (1953) who influenced other modern writers, and attempts to restate it have not been wholly successful. The correct interpretation of the classical theory of value is based on the cost of production measured in terms of the quantity of labor. The concept of utility is essential but should not be considered as a measure of exchangeable value. Valuable quotations from classical works are given to support this argument.

A rich but pithy chapter three tackles the difficult task of establishing the definition of money. The classical economists defined money as a particular commodity (such as gold and silver) used to measure the value of other commodities and which, most important, serves as a medium of exchange. They held a clear distinction between money credit and capital. Ahiakpor emphasizes the idea that a correct understanding of classical theories requires a very careful distinction of money from credit, and credit from “capital” and capital goods. Capital is supposed to arise from savings or loans. According to the author, the classical distinction between money and savings or “capital” is more helpful than the modern definition of money. A high-powered currency in the classical definition is supposed to explain better the changes in the price level or the value of money from the supply and demand for money. The latter determines the rate of interest. This statement is completely different from Keynes’s argument that the quantity of money determines the supply of liquid resources and therefore the rate of interest. In fact, during the Great Depression it was the change in high-powered currency or in the quantity of money that caused the fall in savings as the public increased its demand for cash balances. Because of this, the increase in the reserve-deposit ratio of banks, the money supply multiplier was reduced and the currency stock declined rapidly. So the classical savings theory of growth confirms that the significant decline in GDP during the Great Depression came as a result of considerable contraction in savings.

In chapter four reexamines of the classical theory of interest, the price level, and inflation. In the classics the theory of the price level is almost a direct application of the theory of value. The price level is determined by the supply and demand for money. In the same way interest is established as by the supply and demand for capital. It is the borrowed “capital” that is offered and taken in loan on the basis of the borrower’s ability to pay back the credit. In this context interest is described as the cost of credit. Thus the classical theory of interest is more logical on the meaning of “capital.” Robertson and Friedman are the two modern economists that, remarkably, have included the classical credit theory or the loanable-funds theory in their works. In effect, “the classical version is superior because it avoids the confusion between money and credit which Friedman correctly notes as plaguing the Keynesian monetary or liquidity preference theory of interest” (p. 77). Hence the application of the classical theory of value to “capital” better explains the determination of interest rates than the traditional Keynesian money supply and demand theory of interest. Keynes misinterpreted the classical theory of interest. He incorrectly included hoarding in the classical definition of saving and his contemporaries were not able to persuade him of his erroneous criticism of the classical theory of capital.

Chapters six, seven and eight deal with the Austrian theory of capital and interest, Wicksell’s monetary theory and Fisher’s macroeconomic analysis. The Austrian school and predominantly Eugen B?hm-Bawerk interpreted capital-goods as “capital” only in the classical theory of interest and proceeded incorrectly to criticize it. B?hm-Bawerk introduced the theory of time-preference in place of the classical theory of capital. He observed that interest is a premium borrowers are willing to pay for their impatience for present consumption. The production process is affected by variations in the rate of interest and more roundabout methods are adopted when the rate of interest falls.

Wicksell reacted to the classical theory of interest. He believed that observed high interest rates with high rate of inflation and low interest rates with low rates of inflation contradict the classical theory of interest. He developed the “cumulative process” by which deviations between the market and “natural” rates of interest cause the price level to change continually. According to chapter seven, Wicksell repeated almost the same theory of price dynamics as in classics, except that in his model the process starts from banks lowering their rates of interest without any new injection of money.

Irving Fisher rejected the classical “capital” supply and demand theory of interest and adopted the Austrian time-preference theory. In conflict with his time-preference theory of interest, Fisher defined “capital” as an asset that yields a flow of income over time, which is quite different from the classical flow-of-funds concept. Fisher associated the “stock of goods” with a fixed quantity existing at an instant of time and “capital” as capital goods only. His principal differences with classical monetary analysis include the notion of circulating currency to include money and bank deposits. But the inclusion of bank deposits in his analysis is inconsistent with the process of inflation.

Chapter ten is all about Kyenes’s full-employment argument. Keynes attributed erroneously to the classics the forced-saving doctrine where increases in the money supply may boost real output and employment in the short run while lowering the rate of interest and raising the price level. Keynes’s misinterpretation of the classics was based on his presumption that Say’s Law of Markets must be founded on the assumption of full employment. He criticized the classics for not recognizing the existence of hoarding while arguing the Law of Markets. His contemporaries including Pigou and Robertson, despite their attempts to correct his assumptions, did not give a clear interpretation of Keynes’s inaccuracy. “Rather, they attempted to sketch their own versions of classical economics, much to their disadvantage” (p. 175). Although some may agree with this statement, I must disagree. Rather than sketching their versions of classical economics, they developed new assumptions in the classical tradition regarding full employment — about which the classics were not comprehensible at all.

Chapter eleven explains the success of the IS-LM model created by Hicks in spreading Keynesian macroeconomics and at the same time Keynes’s distortion of classical macroeconomics. The IS-LM model based on changes in the supply and demand for money to explain interest rates does not take into consideration the determination of the price level from supply and demand for money as in the classical quantity theory. This model implies that the price level rises from increases in the quantity of money only after an economy has reached its full productivity capacity or full employment reaching the position of equilibrium (for a static state). However a real monetary economy is much more complex than the IS-LM model represents. The IS-LM model is inconsistent with economies experiencing high rates of unemployment, high rates of inflation and continuous economic fluctuations and hardly can be applied in modern realities. Despite distortions and variations claimed by the author, the IS-LM model still remains the basis for every undergraduate textbook in macroeconomics. It is the first and the most simple, well-known macroeconomic model combining real and monetary factors, making it easy for anyone with some basic notions in economics to understand the dimensions and the complexity of a national economy. This model merely shows the daily macroeconomic problems but certainly does not resolve them.

The mythology of Keynesian multiplier is developed in chapter twelve. The concept of the multiplier is based on consumption spending and on incomes that derive from expenditure. People normally consume a portion of their income and such purchases for consumption are incomes for producers who in turn make investments. The consumption spending is a means by which aggregate demand is raised and the growth of output and employment is promoted. Saving in Keynes’s view, as opposed to the classics, has no special effect on supplying the funds for investment. Ahiakpor states that the Keynesian multiplier is nothing more than a misinterpretation of the classical definition of saving to include the hoarding cash. It is founded on a misconception of the role of consumption rather than production in the income determination process. The question raised in the Keynesian multiplier is: “From where do people find the means to make their consumption purchases?” Keynes rejected the classical concept that production is the source of income and, therefore, comes from savings supply. Increased output in one sector, by increasing the demand for the output in other sectors causes an increase in their production also. This process is described as a “multiplier effect” (quite different from the Keynesian multiplier) and is supposed to affect major sectors of an economy. Ahiakpor argues that: “Keynes’s argument that saving is not needed to finance investment spending because the multiplier process makes it possible for investments to pay themselves through additional savings out of newly created income may have given confidence to supporters of public works program, but it is simply fallacious” (p. 209).

The Keynesian revolution (or the Keynesian event) can be summarized in a few words. The Keynesian theoretical event can be expressed in terms of the combination of his multiplier theory with his liquidity preference theory. For many governments it is a primary duty to control the level of total effective demand for goods and services. If demand is insufficient to provide full employment, it is government’s duty to raise it by stimulating the injections (investment, and government expenditure) and by reducing the proportions of income saved (or paid in taxes). If demand is excessive, then it is the government’s duty to restrain the injections. This general task of controlling the level of total effective demand throughout the economy was not recognized to be a duty of government before the Second World War (and especially during the nineteenth century); it has at least been generally so recognized since the war.

This duty, unfortunately, was not a major concern for classics. Despite their efforts, the classics were not able to set up a consistent macroeconomic model in which the economic system adjusted itself to full employment. The legacy of Keynes can be recapitulated in Pigou’s remarks: ” Nobody before him, so far as I know, had brought all the relevant factors, real and monetary at once, together in a single formal scheme, through which their interplay could be coherently investigated” (p. 175).

As Ahiakpor suggests, it is true that by a very “careful reading” we may find more consistency in the classics than is generally believed, but it is also true that by using the same method of study we may find a lot of anomalies and contradictions which enable us to appreciate the classical explanation today.

The greatest value of the book is to professional economists, chiefly because of some of the penetrating suggestions, and its coverage of an immense range of subjects bearing on development. The inherent importance of the principal theme, the forceful reasoning with which it is developed, the excellent style and the wealth of topics covered will ensure that this book will be read by all seriously interested in the subject.

Marin Muzhani is Associate Researcher in Economics at the University of Florence, Italy. His book From the Path of “Warranted Growth” to Technological Progress and Endogenous Growth: The Evolution of the Theory of Growth in the Post-war Period, Six Decades of Controversies in the Theory of Economic Growth will be published soon in English. Other papers and publications are related to modern monetary theories such as optimum currency areas, endogenous money and monetary unions.

Subject(s):History of Economic Thought; Methodology
Geographic Area(s):General, International, or Comparative
Time Period(s):20th Century: WWII and post-WWII

The Hidden Cost of Economic Development: The Biological Standard of Living in Antebellum Pennsylvania

Author(s):Cuff, Timothy
Reviewer(s):Craig, Lee A.

Published by EH.NET (November 2005)

Timothy Cuff, The Hidden Cost of Economic Development: The Biological Standard of Living in Antebellum Pennsylvania. Aldershot, UK: Ashgate Publishing, 2005. xvii + 277 pp. $100 (hardcover), ISBN: 0-7546-4119-8.

Reviewed for EH.NET by Lee A. Craig, Department of Economics, North Carolina State University.

A long time ago, on college campuses far, far away, a great battle raged over the effects of industrialization. The “optimists” viewed modern economic growth and its boon companion, industrialization, as unambiguously good — led as they were by good things like the market. There might have been some collateral damage, but living standards, defined by economic indicators — e.g. wages and your favorite column in the national income and product accounts — increased steadily. And, hey, that’s the point, right? Not necessarily, answered the “pessimists,” who chanted: “Enclosure, the Workhouse, and Satanic Mills!”

While it’s a judgement a call, a good case can be made that, at least on the Cliometric side of things, the optimists got the best of the debate. But before they could secure final victory, there emerged a research agenda that yielded a new set of weapons — new to the cliometricians anyway. Rather than GDP per capita, the Hectors of this war hurled biological indicators like mortality rates, stature, and body-mass indices. Of these, stature became the standard weapon, and in several countries, including the antebellum United States, the trends in stature diverged from the trends in the standard economic indicators. This divergence characterized the so-called “antebellum puzzle,” and in turn breathed new life into the pessimists’ case.

Timothy Cuff’s The Hidden Cost of Economic Development can best be seen against this intellectual backdrop. The title gives away the punch line. Cuff, professor of Religion, History, Philosophy, and Classics at Westminster College, is a New Age pessimist. Though he focuses on the state of Pennsylvania from c.1800 through c.1860 — the antebellum era that produced the antebellum puzzle — he clearly wants to extrapolate the Keystone State’s experiences. In Cuff’s view, the problem in Pennsylvania, and more generally, was that while the nexus of industrialization, urbanization, and trade led to an obvious increase in productivity and economic output, there were less obvious biological costs, the primary manifestation of which was that people got shorter. There’s more to it than that, of course. As Cuff notes, “it is not the population’s ‘shortness’ that mattered. Rather what mattered was that they likely were less healthy adults and probably lived shorter lives as a consequence” (p. 215). Cuff’s findings are consistent with the so-called “insult accumulation model,” which suggests that illness and nutritional deficiencies weaken the individual and ultimately result in higher mortality.[1]

Cuff begins by making the argument that Pennsylvania is a good case study for industrialization’s impact on the biological standard of living. As one who is guilty of dismissing too quickly region-specific studies, on the grounds that “I don’t care about (say) antebellum Pennsylvania,” I hope potential readers take a look at this chapter. Cuff convinces the reader that one should care about Pennsylvania, because as a rapidly industrializing, yet economically and geographically diverse, region it is in fact a very good case study for the period in question.

In Chapter 2 Cuff offers the reader an outstanding summary of both the history and current state of anthropometrics, which, following Noel Cameron, Cuff defines formally as “the technique of expressing quantitatively the form of the body” (p. 10).[2] Using concise, yet descriptive, prose Cuff gives a lesson in the history of the science, and social science, of anthropometrics. The chapter contains an especially thoughtful and thorough summary of recent work and the current state of the field. If you don’t have time to read the complete works of John Komlos, and you want something more recent than Rick Steckel’s fine review in the Journal of Economic Literature [3] a decade ago, then this chapter might be the place to start. I have already recommended the chapter to a few economics graduate students and colleagues who asked for a primer on “the heights stuff.”

Having persuaded the reader of his mastery of the art of anthropometry, in Chapter 3 Cuff turns to the theory of economic exchange, which might seem a curious topic for an anthropometric historian, but here Cuff is laying the groundwork for his exploration of the divergence between stature and output per capita. The causal chain is laid out: Industrialization, urbanization, trade, disease, nutritional deficits, shorter statures and the aforementioned less-healthy, shorter lives. Cuff’s summary of market integration, trade theory, and trade’s role in economic growth is as good as his summary of the literature on anthropometrics. His ability to master vast literatures on topics as diverse as human biology and comparative advantage and make them accessible to the reader in a relatively small number of pages is truly remarkable. Economists have a hard time explaining gains from trade without equations and diagrams. Cuff does not. I have already recommended this chapter to several undergraduates and non-economists.

In Chapter 4, we learn about the economic history of antebellum Pennsylvania, perhaps a bit more than the casual reader might fully appreciate. As I approached the end of the chapter, I was hoping to run into a colleague or student who would stop me and ask if I knew of a good concise history of antebellum Pennsylvania. Alas, even with the passage of some time, I still have not.

Chapters 5 and 6 contain the empirical evidence and Cuff’s conclusions concerning economic factors and human stature. Employing data on the heights of Civil War veterans, Cuff pushes them about as hard as they can be pushed. In Pennsylvania, during at least some portion of the first half of the nineteenth century, Cuff finds that just about every identifiable group got shorter. Some groups did better than others. Rural dwellers did better than urban and town dwellers; farmers fared better than wage workers; and farmers in less developed regions fared better than those in regions experiencing industrialization. If you’re looking for variables that are strongly and positively correlated with human stature, then look for hogs, home manufactures, and nutritional surpluses. As for those that are negatively correlated, they include living on a navigable waterway and market garden activity. The key is net nutrition. Moving to town and selling one’s labor to a capitalist might have increased one’s income, but simultaneously some combination of work, disease, and diet tended to erode the biological standard of living.

Overall this volume must be considered a strong scholarly effort. Well-written, tightly reasoned, and carefully crafted, it represents a valuable contribution to both the anthropometric literature and the historiography of the antebellum United States. While supporting the case for a pessimistic “Malthusian squeeze” [4], Cuff does not destroy the optimists’ most basic arguments. After all, many of us have and will voluntarily endure some hardships for a job at the mill, some overtime, or a consulting check, and once cashed the monies will be spent eagerly on cheeseburgers and milk shakes or, perhaps, foie gras and H?agen Dazs. The optimists understand homo economicus all too well. A few high-fat utils beat an increase in bad cholesterol. Still, Cuff’s research suggests that in the future a bit of skepticism will aid the digestion of the optimists’ case.


1. James C. Riley, Sickness, Recovery, and Death: A History of Forecast of Ill Health. Iowa City: University of Iowa Press, 1989.

2. Noel Cameron, “The Methods of Auxological Anthropometry.” In Human Growth: A Comprehensive Treatise, second edition, Vol. 3, edited by F. Falkner and J.M. Tanner. New York: Plenum, 1986, pp. 263-81.

3. Richard Steckel, “Stature and the Standard of Living,” Journal of Economic Literature 33, no. 4 (1995), pp. 1903-40.

4. Michael Haines, Lee A. Craig and Thomas Weiss, “The Short and the Dead: Nutrition, Mortality, and the ‘Antebellum Puzzle’ in the United States,” Journal of Economic History 63, no. 2 (2003), pp. 385-416.

Lee A. Craig is Alumni Distinguished Professor of Economics at North Carolina State University. His most recent research is, with Matthew Holt, “Nonlinear Dynamics and Structural Change in the U.S. Hog-Corn Relationship,” American Journal of Agricultural Economics, forthcoming. His most recent book, with Robert Clark and Jack Wilson, is A History of Public Sector Pensions in the United States (Philadelphia: University of Pennsylvania Press, 2003). He is currently writing a biography of Josephus Daniels.

Subject(s):Living Standards, Anthropometric History, Economic Anthropology
Geographic Area(s):North America
Time Period(s):19th Century

Britain’s Economic Blockade of Germany, 1914-1919

Author(s):Osborne, Eric W.
Reviewer(s):Eloranta, Jari

Published by EH.NET (July 2005)

Eric W. Osborne, Britain’s Economic Blockade of Germany, 1914-1919. London and New York: Frank Cass, 2004. viii + 215 pp. $115.00 (hardback), ISBN: 0-7146-5474-4.

Reviewed for EH.NET by Jari Eloranta, Department of History, Appalachian State University.

Eric W. Osborne’s study explores a topic that has not been adequately researched in the past, namely Britain’s economic blockade of Germany in World War I. As he points out, it is “a glaring omission because of the enormous role that it played in the defeat of the Central Powers in the war” (p. 1). He also points out that previous forays into this topic have been too narrow in their focus, especially given their mutually exclusive emphasis either on the diplomatic, military, or political dimensions. Osborne thus has set out to correct these shortcomings in this volume. However, while on the one hand it is a perfectly adequate book of the politics of the blockade and how such decisions were made (by the British side), on the other hand it fails to convince the reader as a study of the effectiveness of the blockade, which the author raises again and again as the central aim of the book.

This book starts out with a review of the British naval buildup, foreign policy decisions, and early perceptions of blockades. Then the author discusses the failed international cooperation before the Great War (chapter 2) and blockade preparations (chapter 3). After this, he discusses in a thorough fashion the various stages of the blockade during the war in a chronological manner (chapters 4 through 7), concluding with an analysis of the final year of the blockade and its legacy. A two-page chapter finishes the book, along with a fairly extensive bibliography and index.

Before I start the criticism of this study, I would like to reiterate that this book is a perfectly capable study, based on extensive archival sources, of the British political and military processes behind the maintenance of the blockade. It avoids a purely British focus in its analysis, thereby also emphasizing the role of the smaller states (like Sweden) in this game. However, it fails to convince an educated reader on whether the blockade was effective or not. It simply lacks the evidence to back up its claims. Usually Osborne cites British official sources, for example governmental reports on the German economy (e.g., p. 102), as proof of the efficacy of the blockade. He also makes good use of British intelligence sources (e.g., pp. 127, 140) to this effect, but one has to be somewhat skeptical of these types of sources as well. At various points he mentions the “German war weariness” (p. 140) and the “decline in Germany’s condition” (p. 141) as outcomes of the blockade. The author finally attempts to provide conclusive proof of Germany’s decline in chapter 7. He cites the decline of trade etc. as hurting the German economy, yet the evidentiary base for the figures and assertions (e.g., pp. 168-169) consists solely of sources in English (one exception being Ludendorff’s biography, as an English translation). In fact, quite curiously, the secondary sources in the book do not include anything in languages other than English. I would argue that this presents a bias in the account of the effectiveness of the blockade, for example from the German perspective.

Moreover, the author does not attempt to prove his causal assertion that this form of economic warfare, in fact, was successful. This could be perhaps tested in a quantitative fashion, yet one would have to prove the direction of the causal flow (for example, from the number of ships sunk to trade flows to the development of the German economy). Even these types of exercises would, by necessity, be difficult to undertake. Fortunately one can find fairly detailed accounts of the impact of World War I on various economies, including Germany, in the forthcoming book on the economics of this war.[1] These accounts will enable us to evaluate the deterioration of the German economy in a more precise manner. This author could have made a more convincing case, as a matter of fact, if he had read a bit more of the relevant literature. Curiously enough, for example Niall Ferguson’s works [2] do not feature in the book’s bibliography. Also, Osborne makes use of Paul Kennedy’s The Rise and Fall of the Great Powers, but does not cite the more applicable The Rise and Fall of British Naval Mastery.[3]

Another aspect that is not explored in the book relates to the concept of economic warfare, namely when and how it can achieve its goals. Most cases in history point to a negative conclusion; that it simply does not work. This, however, pertains to peacetime measures of economic warfare, such as sanctions and embargoes. During a massive conflict, embracing all aspects of total war, economic warfare can be effective if pursued correctly. As Alan Milward has pointed out, economic warfare has become an intricate part of the strategy arsenal of modern states since the French Revolutionary Wars and Napoleonic era.[4] Moreover, economic warfare is intricately linked to the political, social, and economic processes that evolve during a conflict. There is an abundance of interdisciplinary literature dedicated to this concept, and it is a shame that the author decided on a more narrow focus. He certainly could have made an important contribution to this debate. For example, why and how exactly did the blockade succeed? What particularly made it effective? What was the importance of the restrictions on strategic materials during the war, instead of only focusing on foodstuffs, etc.? But, despite these criticisms, one must give the author credit for writing a thorough account of the British aims, execution, and evaluation of the blockade effort. It will certainly serve as a starting point for future efforts to evaluate the effectiveness of the blockade.


1. Stephen Broadberry and Mark Harrison, editors, The Economics of World War I. Cambridge: Cambridge University Press, 2005.

2. See e.g. Niall Ferguson, The Pity of War, New York, NY: Basic Books, 1999; Niall Ferguson, The Cash Nexus: Money and Power in the Modern World, 1700-2000, New York: Basic Books, 2001.

3. Paul Kennedy, The Rise and Fall of the Great Powers. Economic Change and Military Conflict from 1500 to 2000, London: Fontana, 1989; Paul Kennedy, The Rise and Fall of British Naval Mastery, third edition, London: Penguin, 1991.

4. Alan Milward, “Economic Warfare in Perspective.” East-West Trade and the Cold War, Jari Eloranta and Jari Ojala, editors. Jyvaskyla Studies in Humanities 36, University of Jyvaskyla: Jyvaskyla, 2005. Economic warfare, of course, has been around as long as human civilizations. Nonetheless, it has not been used as a specific military strategy tool, in conjunction with the execution of total war aims, until the last couple of centuries.

Jari Eloranta is assistant professor of economic and business history in the Department of History, Appalachian State University in Boone, North Carolina. His research interests include corporate political action in the long run, defense economics and the financing of wars, as well as the analysis of government spending in the nineteenth and twentieth centuries. His most recent publications include: Juha-Antti Lamberg, Mika Skippari, Jari Eloranta, and Saku M?kinen “The Evolution of Corporate Political Action: A Framework for Processual Analysis” (2004) 4, Business and Society; Jari Eloranta, “Filling the Void? Implications of Hegemonic Competition and the Lack of American Military Leadership on the Military Spending of European Democracies, 1920-1938”. History and Change, edited by Kirsi Vainio-Korhonen and Anu Laitinen. SKS: Turku, 2004; Jari Eloranta,”Warfare and Welfare? Understanding Nineteenth and Twentieth Century Central Government Spending”. Studying Economic Growth: New Tools and Perspectives, edited by Peter Vikstr?m. Occasional Papers in Economic History, Umea University No. 7. Ume?, 2004. He is also writing (with Svetlozar Andreev) a paper titled “The Importance of Democratization in Determining Central Government Spending, 1870-1938.”

Subject(s):International and Domestic Trade and Relations
Geographic Area(s):Europe
Time Period(s):20th Century: Pre WWII

The Mystery of Economic Growth

Author(s):Helpman, Elhanan
Reviewer(s):Davis, George K.

Published by EH.NET (March 2005)

Elhanan Helpman, The Mystery of Economic Growth. Cambridge, MA: Harvard University Press, 2004. ix + 223 pp. $25.95 (cloth), ISBN: 0-674-01572-X.

Reviewed for EH.NET by George K. Davis, Department of Economics, Miami University, Oxford, Ohio.

In The Mystery of Economic Growth Elhanan Helpman makes a sharp point. Economic growth is in large part driven by innovation and institutions that have evolved in rich countries that promote innovative activity and allow change to take place. It is therefore of primary importance that economists continue their investigation of the nature and functions of institutions. Helpman is himself a master of the art of economics and his master’s hand is evident on each page. In making his point, he takes the reader on a fast, yet detailed tour of some of the most important writing on economic growth in the last twenty years. He reviews the emergence of endogenous growth theory, the interaction of international trade and economic growth, the relationship between inequality and growth, and the role of the institutions that provide the fundamental groundwork for economic growth.

Helpman begins with a review of the facts. The salient facts are well documented. Incomes across countries differ by large margins. For example, per capita income in the United States is roughly three times higher than per capita income in Argentina, sixteen times higher than the per capita income in Pakistan, and thirty times higher than the per capita income in Mozambique. Growth rates of per capita income also vary widely, and, unfortunately, it is not always the lower income countries that grow rapidly. Some countries with relatively low incomes in 1960, such as the Asian Tigers, have grown rapidly, converging towards the income levels of rich countries. Other low income countries have grown slower than rich countries, widening the divide between rich and poor. What are the forces that drive convergence and what are the factors that stifle material progress? These are the questions that Helpman sets for himself.

Helpman adopts a historical approach to discuss the evolution of the explanations of the key growth facts. He begins with a very brief discussion of Solow’s model. He uses Solow’s model to examine the role of capital accumulation, both physical and human, in the growth process. The diminishing marginal product of capital implies that countries will converge to the given rate of technological growth and that countries with relatively low initial capital-to-labor ratios should grow relatively fast. The second implication predicts that the level of per capita income in poor countries will converge to the level of per capita incomes in rich countries.

The failure of such convergence to take place is one of the key facts to be explained. Helpman describes the efforts to rehabilitate Solow’s model. These efforts rest on the observation that savings rates, population growth rates, and the like differ across countries. These differences lead different countries to have different long-run capital-to-labor ratios. After controlling for these differences, many studies find what Barro and Sala-i-Martin (1992) called conditional convergence. A particularly important example of such a study is Mankiw, Weil, and Romer (1992) who conclude that Solow’s model explains the data well.

Helpman does not accept this conclusion. His objection rests on the interaction of technological progress and capital accumulation. Technology is exogenous and common across countries in Solow’s model, so variations in technology cannot explain differing growth experiences. Helpman’s review of the literature on growth accounting shows that growth in total factor productivity accounts for a large part of growth. However, even if these methods are reliable in measuring total factor productivity growth, Helpman emphasizes the inability of these methods to identify causality. For example, technological change may, and probably does, raise the productivity of capital, and so spurs capital accumulation. Technological progress is the ultimate cause of the subsequent output growth, but growth accounting will attribute at least part of this growth to capital accumulation. The failure to account for this correlation between investment and total factor productivity growth will lead researchers who assume that total factor productivity does not vary systematically across countries to attribute too large a role in the growth process to capital accumulation. Helpman argues that the analysis of Mankiw, Romer, and Weil is subject to such bias.

Once it is established that total factor productivity growth is an important, and perhaps the most important, factor in accounting for economic growth, models that focus on input accumulation will not do. In Helpman’s next chapter, he reviews the emergence of new growth theory that changed the focus of growth theory from accumulation to knowledge creation and innovation. The renaissance in growth theory was led by Paul Romer and Robert Lucas. Romer and Lucas argued that externalities in the accumulation of knowledge generated increasing returns that could offset the diminishing returns inherent in input accumulation. In Romer’s first generation model, knowledge accumulation took place passively in the accumulation of capital. Lucas focused on externalities in human capital accumulation. Rather rapidly, Romer produced a second generation of models that placed the purposeful accumulation of knowledge at the forefront. The knowledge created provides a source of profit for the innovators, but also produces a spillover that helps innovators who come later. If the spillovers are sufficiently large, growth can be self-sustained.

An interesting feature of these “idea driven” models is scale effects. An increase in the size of an economy generates higher growth rates. For example, an increase in population raises the number of people who may have good ideas, and this raises the growth rate of output. Michael Kremer’s well-known paper provides some empirical support for this idea. However, Kremer’s evidence is in the minority. Others, in particular Charles Jones, have argued persuasively that scale effects are absent from the data. Jones and others have been able to modify new growth models by introducing diminishing returns to idea creation or an ever increasing variety of goods that can offset scale effects while still generating persistent growth.

Countries are linked through their terms of trade, the diffusion of knowledge, and the interaction of the two. Helpman, along with his frequent coauthor Gene Grossman, pioneered the analysis of this interdependence and this chapter is particularly rich in detail and insight. A brief summary of his discussion of the relationship between trade and research and development will give the reader a flavor of the chapter and will highlight an important point that Helpman emphasizes throughout the chapter and the book. Opening international trade between countries may affect research and development and so total factor productivity growth through several different channels. The increase in the size of the market, the reduction in redundancy, the sharing of knowledge, and the increase in specialized inputs all spur the process of research and development, and so increases the rate of technical progress. On the other hand, increases in competition and changes in factor prices may act to slow technical progress. In general, international trade does not necessarily lead to convergence of incomes or growth rates, and it is plausible that for some countries trade will lead to a lower growth rate. Instead, trade unleashes a complex set of forces with many subtle avenues of causation.

This complexity suggests that the interpretation of empirical results should be done cautiously. For example, regressions that show a positive correlation between, say, openness and growth are at best averaging the various effects. We cannot be sure if it is spillovers from research and development or knowledge created by learning-by-doing that is behind the correlation. If it is increased research and development, we don?t know if the elimination of redundancy or the increase in the size of the market is driving the result. We also cannot be sure if this result will hold for all countries. In general, empirical results have been unable to disentangle the various channels through which a particular variable affects growth, and, as a result, interpretations of correlations, conclusions about welfare, and policy prescriptions should be made with a great deal of caution and humility.

We are fortunate that Helpman is willing share his own, necessarily tentative, conclusions about some of the more important issues. He concludes that the positive effects of increasing trade volume on growth appear to have dominated on average. Protection may well have promoted growth in the late nineteenth century, but in the post World War II era, protection has tended to slow growth. Finally, research and development in rich countries appears to benefit poor countries through spillover effects. However, the gains to rich countries exceed those of poor countries, so research and development leads to divergence in the incomes between the rich and poor.

Helpman next considers inequality. He reviews the work of Bourguignon and Morrisson (2002) that documents an increase in inequality in the world’s distribution of personal income from 1820 to 1992. There was a particularly sharp increase in the first ninety years of the sample. Since World War II, inequality has risen, but only modestly. How does inequality affect growth? Like trade, the potential avenues of causation are several and in differing directions. Helpman concludes, again tentatively, that the negative forces have dominated and inequality slows growth. Also like trade, the contribution of the various factors remains to be discovered. Although conclusions with respect to inequality must be tentative, the effect of growth on the poor is much clearer. Growth may raise or lower income inequality, but the majority of people and the poor in particular share in the gains.

In his last chapter, Helpman discusses the role of institutions and he gives them the lead role in the growth process. In earlier chapters, he argued that growth is driven in large part by innovation, but why have some countries been so successful at innovating and adapting to change, while others have not. Helpman looks to institutions for an answer. Work on institutions is associated with economic historians, such as North, Mokyr, and Rosenberg, with recent innovative empirical analysis exemplified by the work of Acemoglu, Johnson, and Robinson (2001), and with the theoretical work of Greif (1993), and Glaeser and Shleifer (2002). Institutions can be defined as a system of rules, beliefs, and organizations. These rules, beliefs, and organizations can protect property rights and allow change to take place, or they can be confiscatory and protective of the status quo, or they can be somewhere between these two extremes.

The evidence in support of a key role for institutions comes in large part from the work of Acemoglu, Johnson, and Robinson. They showed that regions with higher mortality rates during the colonial period had lower per capita incomes in 1995. The connection between the two is good institution. In areas with low mortality rates, settlers imported and maintained good institutions. In areas with high mortality rates, resources were extracted and institutions suited for exploitation were created. Institutions persist and incomes in areas with good institutions grew relatively rapidly, while those with poor institution grew slowly.

Helpman details this argument, criticisms of it, and rejoinders to the criticisms. A particularly important critique of these results by Sachs argues that geography has a direct impact on growth. Acemoglu, Johnson, and Robinson (2002) counter this argument by noting that countries that were relatively wealthy in 1500 fell in their relative fortunes by 1995. Since geography does not change much over such a short span of time, it cannot explain this “reversal of fortune.” It can be explained by Europeans colonizing poorer regions centuries ago and leaving institutions that were supportive of economic growth. Regions that were relatively wealthy were not ripe for colonization, and so did not inherit good institutions. Institutions emerge as the fundamental building block of economic growth. Indeed, Helpman closes his book by observing that we have just begun to study institutions and that we are now in a position to delve more deeply into how institutions evolve and how they matter for economic growth. A better understanding of this relationship will equip economists to better craft reforms and so be more successful than we have been in the past in helping the poor grow rich.

Helpman provides a very a high ratio of substance per page. In just 142 pages of text he tells an exciting story and develops his characters in remarkably rich detail. I have not even mentioned insightful discussions of the college wage premium, Greif’s analysis of the Maghribi traders, or the workings of the terms of trade. The Mystery of Economic Growth is best read by a reader already familiar with general literature. I would recommend Easterly’s Elusive Quest for Growth (2001) or Rosenberg and Birdzell’s How the West Grew Rich (1986) to a general reader interested in economic growth. The depth of Helpman’s insight is best appreciated by someone already familiar with the theoretical and empirical tools of economists.

Works cited:

Daron Acemoglu, Simon Johnson and James A. Robinson, 2001. “The Colonial Origins of Comparative Development: An Empirical Investigation,” American Economic Review 91, pp. 1369-1401.

Daron Acemoglu, Simon Johnson and James A. Robinson, 2002. “Reversal Of Fortune: Geography and Institutions in the Making of the Modern World Income Distribution,” Quarterly Journal of Economics 117, pp. 1231-1294.

Robert J. Barro and Xavier Sala-i-Martin, 1992. “Convergence,” Journal of Political Economy 100, pp. 223-258.

Francois Bourguignon and Christian Morrisson, 2002. “Inequality among World Citizens: 1820-1992,” American Economic Review 91, pp.1369-1401.

William Easterly, 2001. The Elusive Quest for Growth: Economists? Adventures and Misadventures in the Tropics, Boston: MIT Press.

Edward L. Glaeser and Andrei Shleifer, 2002. “Legal Origins,” Quarterly Journal of Economics 117, pp. 1193-1229.

Avner Greif, 1993. “Contract Enforceability and Economic Institutions in Early Trade: The Maghribi Traders’ Coalition,” American Economic Review 83, pp. 99-118.

N. Gregory Mankiw, David Romer and David N. Weil, 1992. “A Contribution to the Empirics of Economic Growth,” Quarterly Journal of Economics 107, pp. 407-438.

Nathan Rosenberg and L.E. Birdzell, 1986. How the West Grew Rich, New York: Basic Books.

Among George K. Davis’s recent publications are “The Emancipation Proclamation, Confederate Expectations, and the Price of Southern Bank Notes” (with Gary Pecquet and Bryce Kanago), Southern Economic Journal (2004).

Subject(s):Economic Development, Growth, and Aggregate Productivity
Geographic Area(s):General, International, or Comparative
Time Period(s):General or Comparative

The Spirit of Capitalism: Nationalism and Economic Growth

Author(s):Greenfeld, Liah
Reviewer(s):Lal, Deepak

Published by EH.NET (February 2003)

Liah Greenfeld, The Spirit of Capitalism: Nationalism and Economic

Growth. Cambridge, MA: Harvard University Press, 2001. xi + 541 pp. $45

(hardcover), ISBN: 0-674-00614-3.

Reviewed for EH.NET by Deepak Lal, Department of Economics, UCLA.

I found this prolix book by Liah Greenfeld, a Professor of Political Science

and Sociology at Boston University, both confused and confusing. She states

that her book attempts to answer two questions: “(1) What was the direct cause

of the emergence of modern economy; that is what explains the sustained

orientation of this economy, which distinguishes it from all others, to growth?

(2) What made the economic sphere so central in the modern, and in particular

American, consciousness that our civilization can in truth be called an

‘economic civilization’.” Her answer is “that the factor responsible for the

reorientation of economic activity toward growth is nationalism, and that the

unprecedented position of the economic sphere in the modern consciousness is a

product of the dynamics of American society, in turn shaped by the singular

characteristics of American nationalism” (p. 1).

She tries to establish these claims by extended excerpts from secondary sources

concerning economic thought and development in England, Holland, France,

Germany, Japan and the United States. In all these cases, she claims, except

for Holland, nationalism was the prime mover in creating capitalism, in

contradistinction to other sociologists and historians (Gellner and Hobsbawm)

who believed nationalism “to be caused by capitalism and

industrialization” (p. 4). As she explicitly eschews both the historian’s craft

as well as the economist’s, it makes it particularly difficult to review such a

book to an audience of economic historians. Even though many of the excerpts

she quotes are interesting in themselves — and I particularly enjoyed those

from Japan and the US — they do not in themselves provide a substantiation of

her thesis. In the circumstances the only recourse is to try and determine her

general argument and see how it matches up with the evidence from not only

economic history but also the economics of developing countries, which is

intimately linked to many of her preoccupations.

The trouble I had with the book starts with the first of the questions she has

set herself. She seeks the causes of the emergence of the modern economy, which

she sees as its sustained orientation to economic growth. But this definition

of modernity would only be applicable at best to the last 150 years. After all,

the nineteenth century classical economists were still preoccupied by the

stationary state! Moreover, this question is different from the one that Max

Weber asked and which is the title of her book, namely about the origins of

Western capitalism, which is linked to the question of the great divergence

between the ancient agrarian civilizations of Eurasia. This question in turn is

different from the subsidiary question: why within Western Europe, England

blazed the path to modern economic growth? Greenfeld’s book is largely about

this second question and not the first. This confusion is responsible for her

vacuous definition — for an economist — of modern economic growth.

Development economists and economic historians distinguish between

extensive growth — which has been ubiquitous through human history —

with output rising pari passu with population, and intensive growth,

which results in a sustained rise in per capita income. Moreover, two types of

intensive growth need to be distinguished which I like to call Smithian and

Promethean (see Lal 1998). The first can and has occurred even in agrarian

economies usually with the establishment or extension of empires, which by

bringing hitherto autarkic regions with differing resources into a common

economic space lead to the gains from trade and specialization emphasized by

Adam Smith. But as the primary factor of production in agrarian economies –

land — was ultimately fixed, diminishing returns would set in, which combined

with the Malthusian principle would end this spurt of Smithian intensive

growth. As E.A. Wrigley (1988) has rightly emphasized, it was the substitution

of mineral energy resources, which were in virtually perfectly elastic supply,

for the land-based sources of energy in the organic agrarian economy, which led

to unbounded intensive growth of the Promethean kind. It is the latter which is

the hallmark of modern economic growth.

The spirit of capitalism, which Hicks (1969) emphasized is embodied in the rise

of the merchant and a mercantile society, predates the emergence of Promethean

growth. The torch of this spirit passed from the Greek city states, the

mediaeval Italian city states, the Hanseatic league and Holland to the United

Kingdom. Greenfeld recognizes this. So clearly for her, the spirit of

capitalism, which she identifies as arising with nationalism in

sixteenth-century England, could not be merely the prevalence of this

mercantile economy. As regards Weber’s question about the date and origins of

the great divergence, I have argued (Lal 1998) that it is associated with two

Papal medieval revolutions, which generated a value unique to the West –

individualism — and all the legal infrastructure needed for a functioning

market economy (see Goody 1983 and Berman 1983). But, though perhaps

preconditions, these factors did not by themselves generate Promethean growth.

It was the spirit of capitalism allied to the switch from an organic to a

mineral energy based economy which did, in Holland and then in England — even

in their agrarian economies — from the fifteenth and sixteenth centuries and

then with the scientific revolution in England in the new industrial economy

from the eighteenth century that generated Promethean growth.

On this view, Greenfeld’s discussion of the rise and decline of the Dutch

mercantile economy will seem perverse. As she rightly notes, the Dutch grew

rich through adopting a truly mercantile capitalism (which generated Smithian

growth). What she does not emphasize (only noting it in passing) is that they

also saw Promethean growth based on using deposits of peat to convert their

organic into a mineral energy based economy (see Wrigley). Their relative

decline arose as, unlike the much more abundant mineral energy source in

England — coal — the stock of peat was soon exhausted and the Navigation Acts

impeded the importation of English coal. Greenfeld, however, attributes the

Dutch decline to a failure to foster nationalism. But here is what Angus

Maddison (2001) (whose 13 pages (pp. 75-88) provide a much more succinct and

accurate account of the rise and decline of Holland) has to say: After the

Dutch revolted against the Hapsburgs in 1580: “they created a modern nation

state, which protected property rights of merchants and entrepreneurs,

promoted secular education and practiced religious tolerance” (p. 20 emphasis

added). But this nation state did not practice economic nationalism — i.e.

mercantilism. And there’s the rub.

For Greenfeld asserts: “There was no national consciousness in the Dutch

republic, the identity of the Republican Dutch was not national, and the

republic was not a nation” (p. 96). By this she means they were not economic

nationalists, as becomes clear when she writes: “It is this difference in

perspective, in the nature of identity, that explains … why the Dutch rather

consistently … advocated free trade in the face of perfectly consistent

protectionist (or ‘mercantilist’), measures their neighbors directed against

them” (p. 101). That, in her view, the Dutch decline was due to their not being

economic nationalists (i.e. mercantilists) is made clear by the title of the

subheading that follows “The Costs of Economic Liberalism” (p. 101). This book

is thus ultimately a mercantilist tract.

Greenfeld rightly cites the great Eli Heckscher, who in his magisterial book

Mercantilism argued that mercantilism was used by the absolute

monarchies in Europe after the Renaissance to consolidate their power by

incorporating various feuding and seemingly disorderly groups, which

constituted the relatively weak states they inherited from the ruins of the

Roman empire into a nation. Its purpose, he argued, was to achieve “unification

and power,” making the “State’s purposes decisive in a uniform economic sphere

and to make all economic activity subservient to considerations corresponding

to the requirements of the State.” But, what Greenfeld fails to mention is that

Heckscher (1955) went on to show that, the unintended consequence of

mercantilism was that this attempt to use it to establish order bred disorder,

as the attendant dirigisme bred corruption, rent-seeking, tax evasion

and illegal activities in underground economies. The most serious consequence

for the State was an erosion of its fiscal base and the accompanying prospect

of the un-Marxian withering away of the state. Economic liberalization was then

undertaken to restore the fiscal base, and thence government control over what

had become ungovernable economies. In some cases — as in France — the change

only occurred with revolution (see Aftalion 1990). Paradoxically, as Heckscher

noted: “great power for the state, the perpetual and fruitless goal of

mercantilist endeavor, was translated into fact in the nineteenth century. In

many respects this was the work of laissez-faire. … The result was attained

primarily by limiting the functions of the State, which task laissez-faire

carried through radically. The maladjustment between ends and means was one of

the typical features of mercantilism, but it disappeared once the aims were

considerably limited. … Disobedience and arbitrariness, unpunished

infringements of the law, smuggling and embezzlement flourished particularly

under a very extensive state administration. … It was because the regime

de l’ordre bore this impress that disorder was one of its characteristic

features” (p. 325).

There is further evidence against the thrust of Greenfeld’s main argument that

mercantilism is needed for economic growth. We now have the experience of over

fifty years of neo-mercantilist policies in the Third World, motivated in large

part by the same desire for ‘nation-building’ — carried to even further

extremes in the former Communist countries. The outcomes have been much the

same as with the mercantilist countries of yore. The disorder bred by

dirigiste neo-mercantilist policies has led to the recent wave of

economic liberalization, which no doubt Greenfeld — judging from her epilogue

— would deplore. (See Lal and Myint 1996, and Lal 1985 and 2000.) Moreover,

nationalism was a common attribute of the ideology of most developing countries

after the Second World War. Hence, it in itself could not be an explanation for

the manifest differences in their growth outcomes. What differentiated their

performance was the extent to which they followed mercantilist policies. Though

none apart from Hong Kong followed the classical liberal policy of

laissez-faire and free trade (and its performance was perhaps the best (Lal and

Myint 1996), the closer they were to this prescription the better the outcome.

Thus neither the distant (as Greenfeld seems to claim) or more recent past (as

is implied in her epilogue) provides any justification for what it turns out is

really her main message: economic nationalism (a.k.a. ‘mercantilism’) fosters

modern growth. All the evidence is to the contrary. But, having eschewed both

history and economics, Greenfeld blithely ignores all this. Weber, the

sociologist who took account of both, would I am sure be appalled by this

travesty, which the publishers in their publicity leaflet advertise as “Moving

Beyond Max Weber”!


F. Aftalion (1990), The French Revolution: An Economic Interpretation.

Cambridge University Press, Cambridge.

H. J. Berman (1983), Law and Revolution: The Formation of the Western Legal

Tradition. Harvard University Press, Cambridge, MA.

J Goody (1983), The Development of the Family and Marriage in Europe.

Cambridge University Press, Cambridge.

E. Heckscher (1955), Mercantilism, 2 volumes, revised second edition.

Allen and Unwin, London.

J.R. Hicks (1969), A Theory of Economic History. Clarendon Press,


D. Lal (1985/2000), The Poverty of ‘Development Economics.’ Harvard

University Press, Cambridge Mass; revised second edition, MIT Press, Cambridge


D. Lal (1988), Unintended Consequences: The Impact of Factor Endowments,

Culture, and Politics on Long-Run Economic Performance. MIT Press,

Cambridge Mass.

D. Lal and H. Myint (1996), The Political Economy of Poverty, Equity, and

Growth: A Comparative Study. Clarendon Press, Oxford.

A. Maddison (2001), The World Economy: A Millennial Perspective. OECD.


E.A. Wrigley (1988), Continuity, Chance and Change: The Character of the

Industrial Revolution in England. Cambridge University Press, Cambridge.

Deepak Lal is the James S. Coleman Professor of International Development

Studies at the University of California — Los Angeles. His most recent book

was Unintended Consequences: The impact of Factor Endowments, Culture and

Politics on Long-Run Economic Performance (MIT, 1998). He is currently

working on a book on globalization and order.

Subject(s):Markets and Institutions
Geographic Area(s):General, International, or Comparative
Time Period(s):General or Comparative

Freedom and Growth: The Rise of States and Markets in Europe, 1300-1750

Author(s):Epstein, S. R.
Reviewer(s):Persson, Karl Gunnar

Published by EH.NET (February 2003)

S. R. Epstein, Freedom and Growth: The Rise of States and Markets in Europe,

1300-1750. London: Routledge, 2000. 223 pp. $100 (hardcover), ISBN:


Reviewed for EH.NET by Karl Gunnar Persson, Institute of Economics, University

of Copenhagen.

Freedom and Growth is a carefully and densely argued book which

delivers new and important insights on the political conditions for

pre-industrial economic growth and the nature and historical evolution of an

efficient and modern state. The author, S.R. (Larry) Epstein is professor of

economic history at the London School of Economics. As a medievalist and early

modern scholar he works within a comparative approach and is free from the

constraints of ‘foreign language illiteracy’ sometimes found at British and US

universities. The book relies both on original research based on primary

sources and on an impressive list of secondary sources. The forty-page

bibliography lists everything worth looking at in the English, French and

Italian literature and a fair share of the German discussion.

Epstein’s new book is a contribution to a relatively new approach in

pre-industrial studies taking an explicit anti-Ricardian view. Recognizing that

the large regional income differentials in late medieval Europe and onwards

cannot be ascribed to differences in resource endowments and land constraints,

this new literature singles out rent-seeking, market imperfections and

coordination failures as an explanation for backwardness. It is suggested that

many economies operated below their capacity for long stretches of time.

Freedom and Growth offers a more sophisticated view of the impact of

political constitutions on solving coordination problems and permitting

‘Smithian’ growth, that is growth dependent on efficiency gains from spatial

specialization and division of labor. The outline of the book is presented in

Chapter 1.

In Chapter 2 Epstein takes issue with the prevailing ‘Whig’ interpretation of

political constitutions, which suggests that economic freedom and limited

government are the keys to economic growth. Not so, says Epstein: Good

government is not necessarily small government. The essential element for

growth is undisputed jurisdictional sovereignty over the realm both of economic

and political spheres. Smithian growth requires extension of and free entry to

markets but many pre-modern states, with parliamentary checks and balances or

not, were instead characterized by jurisdictional fragmentation. Regions and

cities, feudal lords and corporations asked for and obtained privileges. That

made tax collection difficult and costly and made barriers to trade pervasive.

Chapter 3 develops the critique of the Ricardian and Malthusian interpretation

of the medieval crisis suggesting instead that it was an ‘integration crisis.’

The main problems were the high costs of trade due to institutional regulation

and tariffs and the absence of social order due to endemic conflicts and

warfare. Political centralization was the response and the late medieval period

witnessed attempts to standardize coinage and measures facilitating trade. One

aspect of the regeneration of trade is explored in Chapter 4, which deals with

regional fairs. Epstein believes that this innovation was an efficient response

undermining established and privileged trading networks. The argument fits into

his general idea that the main problem of pre-industrial constitutions was the

debilitating impact of particular interests, but it is framed in a simplistic

functional form. The author suggests that the stability of the institutional

innovation is a proof of its efficiency but that argument cannot be generalized

to all stable institutions in the pre-modern period.

In Chapters 5 through 7 the focus narrows to different aspects of Italian

city-state relationships. Here Epstein relies on his own research. The

diversity of the Italian political landscape after the Black Death makes a

comparative analysis useful and the development of Lombardy, Sicily and the

Florentine republic are closely monitored. The Italian city-republics often had

accountable governments, which contributed to low interest rates of public debt

and, in general, a sophisticated financial system kept interest rates low for

the general public as well. By and large there was a declining trend in price

volatility of grain in Europe from 1300 to 1600, which in Epstein’s view stems

from political centralization that stimulated market integration. However, the

thesis that political integration precedes market integration must be

qualified, says Epstein. The relationship between a dominant city, say

Florence, and the other cities in the republic mattered. The city of Florence

acquired a privileged position in the food supply network of Tuscany which

delayed market integration compared to other regions, such as Lombardy. I am

not fully convinced that Epstein’s empirical evidence suggests a significant

difference between these two Italian provinces, however.

Chapter 8 concludes: “Prisoner’s dilemmas caused by decentralised rent-seeking

and co-ordination failures caused by jurisdictional fragmentation, posed the

most significant constraint on pre-modern growth.” Furthermore Epstein argues

that modern individualism developed with the modern state — that is a state

with a clear separation between the legislative, executive and judicial

functions and with full sovereignty.

Freedom and Growth will, I believe, have a lasting impact on the

analysis of early modern economic growth because it convincingly shows that the

economics of growth must incorporate the political economy of growth.

Karl Gunnar Persson’s most recent paper is “Mind the Gap! Transport Costs and

Price Convergence in the Nineteenth-Century Atlantic Economy,” (Discussion

Paper from the Institute of Economics, University of Copenhagen, 02-2002). His

most recent book is Grain Markets in Europe, 1500-1900, Cambridge

University Press, 1999.

Subject(s):Markets and Institutions
Geographic Area(s):Europe
Time Period(s):Medieval