| Metamorphosis:
...A complete change of form, structure, or substance, as transformation
by magic or witchcraft.
- Random House Dictionary Industrial Revolution: A period of rapid industrial growth, characterized by mechanization in industry and agriculture, new uses of energy in industry, the factory system, division of labor both within factories and throughout particular industries, large-scale production, development of transportation and communications systems to effect large-scale distribution, and attendant economic growth and development.
- Ammer & Ammer, Dictionary of Business and
Economics |
Sometime by the mid-18th Century the economy of Western Europe entered a path of sustained growth. While comparisons of living standards over centuries cannot be particularly accurate, evidence suggests that Western Europe, between 1700 and 1750, had an average standard of living similar to that of the Philippines today. More important, however, than seeking a precise measurement of 18th century incomes, is to keep in mind that incomes and production methods were little changed from what had existed 500 or even 1,000 years before. Prior to the 18th century, Europeans experienced good times and bad times, fat harvests and plagues, but long-term sustained economic growth had been unknown.
Yet, in the two and one half centuries that followed, per capita incomes grew immensely - probably about ten-fold - even in the face of interruptions such as major wars and depressions. The economic revolution that began in Britain and Holland spread to the rest of Western Europe as well as to North America and Japan.
This chapter identifies the economic conditions that must be present for such a transformation to take place. It is necessarily abstract, but will help place the pieces together. The following chapter will compare the different forms taken by the actual industrial revolution as it spread from Great Britain to other parts of the world. The patterns of growth identified here will be applied to the present day problems of the underdeveloped countries later in this text. The concepts in this chapter apply primarily to the economic transformation of market economies. The socialist model of economic development will be examined in Chapter 20.
Political and cultural aspects of the transformation
are also critical. Cultural barriers to change can slow economic
development. A political system that leaves political power in
the hands of classes that have no interest in economic development
will also hinder the transformation process. These issues will
be treated in later chapters. For the present, we will examine
the economic side of the transformation from a pre-industrial
to an industrial economy in a hypothetical market economy with
no cultural or political barriers to economic development.
There are a number of pre-conditions which must be met before an economic transformation can occur. Keep in mind that the purpose of this chapter is to lay a conceptual foundation for understanding the industrial revolutions that started in the 18th and 19th centuries. These pre-conditions will not necessarily be applicable to countries that did not start their industrial revolutions until the 20th century, nor will they be applicable to countries that pursued industrialization via a socialist, rather than capitalist, economic system.
It will be easier to understand the process of industrial revolution by following the path twice. The first time through we will simply pick up the major points, identifying the critical linkages and stages. The second time we will go through each stage in more detail and offer more examples. Chart 1 will serve to illustrate the temporal relationships of the key phases of industrial revolution.
Start with a preindustrial economy that has achieved the preconditions for economic development. Output per worker and purchasing power per worker are both very low. Thus there are economic barriers to growth from both the supply side and the demand side. With low output per worker, most of it must be used to meet basic needs - with little potential for investment. With low incomes, slack demand can retard economic growth even if sufficient investment occurs.
Sustained growth in output per worker can begin only when investment levels are high relative to population growth. If it takes about $3 of investment to increase output (and income) by $1 per year, a society will have to be able to invest 3% of its GDP for each 1% of growth it hopes to attain. If population is growing 2% per year, then 6% of GDP will need to be invested just to keep per capita output from falling. Attaining per capita growth of 2% per year would require 12% of GDP to be invested. Think of this as a threshold point, similar to the initial sprouting of a plant. Investment needs to climb to levels high enough to provide perceptible growth.
There is no reason to expect that economic development will in any way be balanced. It will start in one - or at most a very few - key industries. Then it will expand and spread through four mechanisms:
While the industrial revolution is deepening and broadening, the economy will be characterized by a mixture of modernized sectors, in which the new production technologies dominate, and unmodernized sectors, in which productivity remains low. We call this phase a dual economy.
During the dual economy phase, the modern sectors can simply hire all of the unskilled labor that can profitably be absorbed from the low productivity sectors at the same low level of wages prevailing in those sectors. At some point, the modern sectors will be so large and growing so fast that this is no longer possible. Then wages will begin to rise. Reaching this threshold can be called ripening. When ripening is complete, we will have an economy in which high - and rising - productivity is matched by high - and rising - levels of purchasing power.
With the overall picture in mind of an industrial revolution starting with sufficient investment to achieve sprouting, going through a long period of a dual economy, and finally ripening, we can now go back and look at each phase in greater detail.
The potential rate of economic growth depends on both the proportion of total output than can be dedicated to new investment and the additional output that new investment generates. The ratio of additional output to new investment is called the Incremental Capital-Output Ratio [ICOR]. Statistical evidence suggests that this ratio was between 3 and 4 during the 19th century, although it will vary widely from industry to industry.
The potential growth rate can be calculated by dividing the investment rate by the ICOR. If a country can devote 12% of its total output to new investment, and it takes 3 dollars of investment to increase output by 1 dollar per year, then the growth rate will be 4% (12%/3). If the ICOR were higher - if it took 4 dollars of new investment to increase output by 1 dollar per year - then the growth rate would only be 3% (12%/4). Note that an economy rich enough to be able to 'live' on 80% of its output could devote 20% of its output to new investment and thus increase its growth rate. So one of the determinants of the rate of economic growth is the size and use of the social surplus.
There is one other hitch. If the economic growth rate is no higher than the population growth rate, output per person will not grow. If we want to calculate the per capita economic growth rate, we need to subtract the population growth rate from the economic growth rate. So while a 12% investment rate divided by a capital/output ratio of 3 gives us an economic growth rate of 4%, population growth of 2% per year will leave us with a per capita output growth of only 2%.
Keep in mind that economic growth works like compound interest. An economy in which per capita output is growing at 2% per year will be doubling output per person every 36 years. If the growth rate falls to 1.5%, it will take 48 years to double output. Increasing the growth rate to 2.5% per year will get us to double output in less than 29 years. Thus even small increases or decreases in the growth rate are significant when we look at their effects over three or four decades. [1]
So the process of economic development can begin once there is sufficient investment to lift the economic growth rate above the population growth rate and keep it there. W. W. Rostow, an economic historian who developed a "stage" theory of economic development, called this important threshold the "Take Off," and that is its usual name. But Rostow was trying to show that the rest of the economic development process was more or less inevitable once "take off" occurred, a proposition which does not fit particularly well with the facts of history. I prefer to call this threshold a "sprouting" - evidence of the first signs of growth, but of a growth that may very well wither away and never quite become a modern industrial economy.
We should also consider some of the less quantifiable aspects of growth. A long period of sustained growth makes growth seem normal. Politicians expect it to continue and alter policies when it does not. Philosophers try to explain it. Business leaders act on the expectation of economic growth. These political and psychological aspects of growth help growth become self-sustaining once it begins. If the social surplus, ICOR and population growth rate combined to give a society a growth rate of 1/2% per year in per capita terms, it is likely that no one would perceive it as growth. It would take, at that rate, 144 years to double per capita income! Perhaps there is a psychological threshold to economic growth: we begin to accept growth as normal when our generation is visibly better off than our parents' generation.
The section above examined the potential economic growth rate. It investigated the conditions under which supply can grow. But supply is only one part of the growth process. Capitalists will not invest and produce if they cannot realize a profit; they cannot realize a profit if there is insufficient demand. Thus economic development is a dual process. The ability to produce and the ability to purchase must develop in tandem.
The critical point is the relationship between productivity and wages. For the society as a whole rising productivity allows wages to rise. But as long as there are surplus workers available for hire, rising productivity alone cannot force wages to rise. Bosses will pay workers only what labor market conditions determine must be paid in order to get the quantity and quality or workers that they need. You may produce $10,000 worth of stuff per day, but as long as there are plenty of people like you willing to work for $50 a day, then $50 a day is all the boss will need to pay you.
The dual economy phase is really a long period of disparity between productivity and wages. As workers are shifted from the low productivity sectors to the high productivity sectors, their productivity rises drastically but their wages rise little or not at all. Thus output per worker rises faster than wages. Since much of this output is composed of basic goods (the very products most susceptible to early industrial progress), lack of demand can limit the expansion of the high productivity sectors.
Of course it helps to be rich in the first place. One of the determinants of demand is the initial income level in the low productivity sectors. A country with a relatively 'rich' peasantry - Britain in the 1700s - or with plenty of land available to its farmers - the northern United States in the 1800s - can support a more rapid industrialization than can a country with much of its population living close to the minimum necessary for subsistence - such as India today.
An economy in which most people can only afford basic subsistence goods and where the small number of rich usually consume their luxuries in the form of direct personal services hardly offers a favorable market for new consumer goods. Now we tend to think of entrepreneurs as the developers of new products. But entrepreneurs in the early stages of an industrial revolution could usually succeed only by producing the types of goods already subject to mass consumption; they were the developers of new production processes that could be applied to the production (or transportation) of basic goods.
The early stages (1750-1850) of Britain's industrial revolution were characterized by innovations in the production of goods which were already widely used:
Producing basic goods by more efficient means does have one drawback however. A large part of the labor force will already be employed in these traditional industries. So employment gains in the high productivity sectors will be partially offset by employment losses in the low productivity sectors. The spinning jenny displaces traditional spinners; the power loom displaces hand-loom weavers. For example: if the early spinning jennies produce nine times as much yarn per worker as spinning wheels, but the reduction in the price of yarn triples the amount of yarn purchased by the average household, then 2/3 of the spinners will lose their jobs. Moreover, the modern methods of production often required less skill than the craft methods. Hand-loom weavers were skilled adults who earned premium wages. Power-loom workers were often unskilled children earning less than a subsistence wage.
Fortunately, there were other tendencies at work which increased employment and demand. Factories could not displace craft workers until they were built and equipped: the investment needed to utilize these new production processes provided employment. Carpenters and blacksmiths had to build the new spinning jennies. Bricklayers were hired to build the new factories. A factory (along with its machines) that will employ 100 workers when finished might take 300 worker/years of labor to produce. And while the factory might employ mostly unskilled workers - even children - much of the labor needed to build the factory and tools will be highly skilled. Since the skilled workers were often in short supply, highly skilled also meant relatively well paid.
Another addition to demand comes from the opportunity to reach export markets. Britain could increase the output of manufactured goods much faster than the rate of growth of British incomes because of certain advantages in export markets. One advantage was being the first to exploit new technologies - British firms in the early 1800s could produce textiles much cheaper than firms in other countries.
Another British advantage was a vast network of colonies. Independent countries (e.g., France and the United States) could - and did - simply tax British manufactured goods in order to allow their own firms to catch up through a process of import substitution. India and other British colonies could not. The colonial system also assured the colonizing powers secure sources of the raw materials needed by their expanding industries - cotton is the obvious example. Many of the countries that are now among the most industrially advanced made effective use of colonies as markets and sources of raw materials during the early stages of their industrial revolutions - Britain, France, Holland, Germany and Japan in particular. And many of the now lesser developed countries served as their colonies. [2]
Sometimes the new production processes were applied to products which were being imported. After a period of importing manufactured textiles from Britain, the United States (and many other countries) began a process of import substitution - that is, of replacing imported British products with their own products. Of course this adds to employment growth in the country doing the substituting unless it is offset by a decline in exports.
An economy's development cannot be forever based on the key industries in which the process started. Development must branch out into other industries. Much of this branching out will involve the exploitation of linkages from the key industries.
Backward linkages occur when other industries develop or expand in order to produce goods or services used by the key industry. The expansion of railroads - certainly a key industry - increased the market for iron and steel. Once an expanding and modernizing steel industry reduced the price of steel significantly, steel could be used for many other purposes (bridges, ships, building construction). The iron and steel industries, in turn, needed vast amounts of coal. The textile industry purchased power looms, which needed metal bearings. As it modernized and reduced its costs, the bearing industry could also become an input into mass-produced sewing machines and bicycles.
Forward linkages are linkages with industries that use the key industry's product as an input. Cheap cloth plus sewing machines are the inputs into the 'ready to wear' clothing industry. New England's colonial-era lumber industry led to shipbuilding. Sweden in the mid-1800s exported lumber, then went on to expand production and exports of wood products such as matches and furniture.
Agriculture presents a particular challenge to the progress of an industrial revolution. Industrial workers need to eat, so if the proportion of farm workers in the total labor force is going to shrink, then farm workers' labor must become more productive. But landlords did not always have the same attitudes as industrial entrepreneurs. They could not be counted upon to continually reinvest their share of the social surplus. They were often more inclined to expand their country estates and staff them with uniformed servants.
Chart 2 depicts the flow of wages, landrents and profits in early 19th century Great Britain. For the purposes of analysis, three simplifying assumptions are used in this chart. First, workers earn only enough to get by and thus quickly spend their entire incomes. This assumption is not far from the truth for the period we are examining. Second, capitalists reinvest their profits. Again, this is not stretching the truth too far, although a small part of their profits were drained off into luxury expenditures. Third, landlords simply rented their lands to farmers (who we can look at as small-scale capitalists in the business of agriculture). This was a fairly common practice, although many landlords continued to manage their lands themselves.
This is the very form of capitalism that David Ricardo was analyzing; we can readily see why he was so concerned with the way the social surplus was divided into landrents and profits. Returning to Chart 2, note that the arrows depict the flow of money. Workers spend their entire incomes on manufactured goods and agricultural goods. Their spending provides profit for capitalists and rent for landlords in addition to covering the direct costs of production. Population growth increases the demand for agricultural commodities. But with a fixed amount of land, the extra wheat to make bread for an expanding population must come from bringing poorer quality land into cultivation. This will raise the rent of the better agricultural land. As the price of bread goes up, capitalists will have to raise the wage rate (counted in money, not in workers' spending power) so that workers will still be able to eat enough to do their work. But the 'extra' amount paid in higher wages will simply be captured by the landlords as landrents. The overall effect is to reduce profits. While the landlords will spend their growing rental income, they will not usually invest it. So investment spending falls along with profits, and the economy stagnates.
Fortunately, Ricardo's predictions eventually proved to be wrong on three counts. First, many farmers and even some landlords turned out to be less traditional than Ricardo had thought. Agriculture had an 'industrial revolution' of its own and the productivity of agricultural labor and land increased drastically. Second, the railroad and (later) the steamship brought vast expanses of rich agricultural land within the reach of the industrializing regions. Third, Ricardo's ideas influenced public policy leading to the elimination of barriers to the importation of grain. But there is still an important lesson in Ricardo's logic: if agriculture fails to modernize along with industry, an industrial revolution will choke on its own growth long before it reaches the ripening stage.
Now we can evaluate the combined effect of all the contradictory forces at work in the dual economy (see Chart 3). The high productivity sectors are growing in size while spawning new high productivity sectors through forward and backward linkages. The basic goods produced in the high productivity sectors are being sold throughout the economy and are rapidly destroying jobs in the low productivity sectors. But jobs are also being created as the new industry's output is substituted for imported goods and as export markets expand. Building and equipping the new factories absorbs a lot of labor, much of it skilled. And the skilled workers earn more and thus spend more, adding to the demand for the goods produced in the high productivity sectors. If employment gains outpace both population growth and employment losses, the high productivity sectors will employ an ever-growing proportion of the total labor force.
If such growth goes on long enough, at some point the low productivity sectors will become so small relative to the high productivity sectors that the labor flow will not be large enough to meet the high productivity sectors' demand for labor at prevailing wage rates. The only way firms in the high productivity sectors will be able to expand is by offering higher wages.
The point at which wages for average workers begins to increase represents a fundamental turning point - a deep transformation in the very nature of the economy. While there is no accepted term for this point, I like to call it "ripening," since this is the point at which the economic system begins to bear a little fruit for the majority of the population. [3]
However, we must note the large numbers of "ifs" involved. Population growth might swamp the growth in employment and keep wages close to subsistence. That is what Smith, Malthus and Ricardo all predicted. Productivity in consumer goods industries might increase faster than the demand for consumer goods, which would keep employment in those industries from growing. That is what Marx predicted. This should warn us that there is nothing automatic about the progress of an industrial revolution. Keep in mind that even today, less than one-fifth of the world's people live in economies that have reached the ripening point.
The immediately obvious effect of rising wages is increasing demand. In fact, demand for the products made in the high productivity sectors will increase even faster than wages. Since a significant part of most workers' wages will be spent on goods and services still produced in traditional ways in the low productivity sectors - much of their food, for example - any additional income will be spent disproportionately on goods produced in the high productivity sectors.
Consider the example of an industrial worker earning $100 per month. He spends 80% ($80) of his income on food and housing. Much of the food and the building materials for his house are still made in the low productivity sectors. The other 20% ($20) of the income is spent on clothing and beer that are made in the modern sectors. Lets give him a 10% raise, bringing his wages up to $110 a month. Now he can afford to buy even more of the 'better' products produced in the high productivity sectors. So he increases his spending on 'modern' goods by $5 to a total of $25, while spending the other $5 for additional goods made in the low productivity sectors. But the $5 increase in consumption of modern goods represents a 25% increase over his old spending level of $20 per month. With many workers spending their raises this way, the high productivity sectors will grow even faster, needing more workers and adding to the pressure for further wage increases.
Another effect of rising wages is the acceleration of the elimination of the low productivity sectors. Backward farm owners and manufacturers will be forced to increase wages as their workers leave for jobs in the high productivity sectors. Since they will not be able to pay their workers more than their workers produce, the only solution - other than going out of business - is to adopt modern production methods and the use of modern tools in order to increase productivity. Where it is impossible to drastically increase productivity, the good or service will increase in price and its market will narrow.
With no new sources of cheap labor, business expansion leads to continually rising wages. Since wage increases can be offset by increasing productivity, firms will now be much quicker to adopt the latest production technologies. Factories and equipment that are far from 'worn out' in a technical sense become outmoded in an economic sense. This increases the pace of investment and establishes the linkage from rising wages to increased productivity back to rising wages and so on that is a fundamental characteristic of a 'ripe' industrial economy. These post-ripening linkages will be analyzed in more depth in Chapter 16.
A successful industrial revolution drastically transforms our ability to produce goods and services. In a capitalist economy, this new productive capacity can only be utilized as long as the output can be sold. Purchasing power must increase along with productive power if an industrial revolution is to be complete. However, the initial stages of an industrial revolution are characterized by an abundance of labor available at subsistence - or traditional - wage levels. The newly applied industrial technology itself contributes to this abundance of labor, particularly as the laborious processes of spinning and weaving become mechanized.
Wages will only begin to break their links with subsistence when a shortage of labor forces businesses to share some of the increasing productivity with the work force. If the job-destroying aspects of the industrial revolution - such as the mechanization of agriculture - outweigh the job-creating aspects of the industrial revolution, there will be a permanent abundance of labor and wages will stay low. Only if job creation - from the expansion of export markets, and from the building of factories, machinery, roads, canals and railroads - outpaces job destruction will the dual economy end and wages begin to increase with productivity.
Once this "ripening" occurs, the growth can continue at an even faster pace. Wage increases quickly translate into increased demand for the products of the industrial revolution. Wage increases also force the backward industries to modernize or go out of business. Thus the stage is set for an even more rapid transformation of production processes. As there is no longer a huge pool of low-productivity workers to draw from, wages and productivity - and thus output and consumption - can remained linked in an upward spiral.
1. What role is played by demand in an industrial revolution?
2. New technologies that drastically increase productivity can also be very disruptive as they eliminate certain types of jobs. Can you find examples of such technologies in today's economy?
3. Under what conditions could a dual economy go on indefinitely?
4. What are the differences between the two thresholds of sprouting and ripening?
Backward Linkages
Dual Economy
Forward Linkages
Import Substitution
Incremental Capital-Output Ratio
Industrial Revolution
Ripening
Rule of 72
Sprouting
Economic History of the Western World - The Making
of Economic Society, Chapter 4, "The Industrial Revolution,"
Chapter 5, "The Impact of Industrial Technology" ; Economic
Development of the North Atlantic Community, Chapter 14.
Further Reading