Lesson 1 - European preindustrial economies (2016)

Apunte Inglés
Universidad Universidad Pompeu Fabra (UPF)
Grado International Business Economics - 2º curso
Asignatura International Economic and Business History I
Año del apunte 2016
Páginas 11
Fecha de subida 13/10/2016 (Actualizado: 16/10/2016)
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a.villagrasa IBE, 2nd Year - 1st Term Business history Lesson 1: European preindustrial economies Outline ORGANIC ECONOMIES ...................................................................................................... 2 LIMITS OF GROWTH .......................................................................................................... 3 1. Quantity of soil ......................................................................................................... 3 2. Diminishing returns .................................................................................................. 3 3. Classical economists ................................................................................................. 4 David Ricardo (1772 - 1823) ..................................................................................... 4 Thomas Malthus (1766 - 1834)................................................................................. 4 Modern thoughts...................................................................................................... 5 ANCIENT DEMOGRAPHIC MODEL..................................................................................... 6 FEUDAL SYSTEMS .............................................................................................................. 7 Characteristics of the feudal system ............................................................................ 7 Absence of growth........................................................................................................ 7 The first crisis of the feudal system .............................................................................. 8 TRADE ............................................................................................................................... 9 Specialization ................................................................................................................ 9 Comparative advantage.............................................................................................. 10 MANUFACTURING TRANSFORMATIONS ........................................................................ 11 Northern Europe supremacy ...................................................................................... 11 British revolution ........................................................................................................ 11 1 a.villagrasa IBE, 2nd Year - 1st Term Business history ORGANIC ECONOMIES Preindustrial economies were characterized by the lack of growth, being organic and agrarian (the most important sector was agriculture). They existed until the Industrial Revolution (19th century).
When we say that they were organic economies it is because they only used organic raw materials and energies (solar radiation, bio-mass, etc). They were using labour, land and capital (animals) as production factors.
Capital: something we invest in to obtain profits.
Investment: is the part of income that you don’t consume and you use to get capital and profits.
Nowadays organic economy doesn’t exist, as we use coal and oil as the main source of energy.
2 a.villagrasa IBE, 2nd Year - 1st Term Business history LIMITS OF GROWTH Until the economy wasn’t based in inorganic sources it was limited by, mainly, three things.
1. Quantity of soil When everything depends on organic sources, everything comes from the nature, so everything comes from land. There is a limited amount of land that it is profitable (of high quality), so there was competition for the soil. This competition was in two senses: a. Trade off of the use of the land: People had to decide what they did with their land. If they only grew vegetables they wouldn’t be able to feed their animals, so they had to give up part of the land to grow food for the animals.
b. Quality of the land: Not all soil has the same quality, and the highest quality ones were scarce. This generated competition to have the best lands. As population grew there was more competition because there was the same amount of good land but there were much more people.
2. Diminishing returns The diminishing returns law says that, if you only increase one of the factors, at the beginning your production is going to increase a lot. However, as you keep increasing this factor (keeping the other fixed) production grows less and less until stopping or even decrease. So, at the end, you are increasing the production less than by the amount you are increasing the factor. In other words, the increase in the amount of production is not proportional to the increase of the factors of production.
Before the Industrial Revolution there wasn’t a labour market, so when population increases we assume that there was more labour. When this happened, there were more workers per land. However, if the workers are doubled the production won’t be doubled because only one factor is being increased (labour) while the other has not 3 a.villagrasa IBE, 2nd Year - 1st Term Business history changed (amount of land and capital). Moreover, due the increase of population new lands were used, but they were marginal lands, meaning that they were the lands nobody wanted due their low quality because they produced less. Another reason is that if you exploit a land it will produce less, you need to let it rest.
3. Classical economists Famous classical economists were Adam Smith, John Stuart Mill, Malthus, David Ricardo... They were very concerned by the fact that the economy could stop growing, as they thought that the law of diminishing returns would lead to the stationary state 1.
Classical theories were based in the ancient demographic model and tend to be quite pessimistic. The main criticism of classical economists is that they didn’t take technological progress into account. These pessimistic theories didn’t accomplished because in the 19th century there was a demographic transition, so birth rates maintained high but mortality rates reduced.
David Ricardo (1772 - 1823) In his book On the Principles of Political Economy and Taxation he discusses about the need of the rent of the land and the specialization due comparative and total advantage. He defends the rent of land because in a world without diminishing returns or without so many people only the best lands would be used. In that case nobody would be willing to pay, as they could work in a land as good as that one. However in the real world land is limited and there are diminishing returns. Because of this, as there’s more people rent has to be higher and this justifies that wages are lower. In his view the land owner was the only one with the right of getting a wage higher than the subsistence level.
He also developed the Iron of wages theory, which says that salaries tend to decrease until a subsistence level because as there’s more people, lands are worst, so at the end they can only give subsistence production. This implies that salaries are also going to be of subsistence. Moreover, due the great competence among workers, at the end all of them have the same salary, even those with the best lands. However he also said that wages could be kept above the subsistence level if there was technological growth.
Thomas Malthus (1766 - 1834) According to him, population increases in a geometric progression (exponentially), but food only growths in an arithmetic progression (diminishing returns). Therefore, population’s capacity of growth is way higher than human’s capacity to produce food.
Malthus had the theory that, due decreasing returns, people will die of starving, as 1 Point in where there isn’t more growth.
4 a.villagrasa IBE, 2nd Year - 1st Term Business history there will be a lack of food. He said that the only way of avoiding it was reducing population, which could be done in two ways: 1. Preventive checks: with the aim of reducing birth rates. This could be done by making people stay single, abortions, celibacy, prostitution and birth control.
2. Positive checks: with the aim of increasing mortality rates. They included diseases, hunger and wars.
Modern thoughts Neo-Malthusians Neo-Malthusianism is a modern school referring to people concerned by the high grow of people compared with the factor’s growth. However, they are mostly concerned about environment. They think it is necessary to reduce the level of population (or at least the level of consumption) because it is not sustainable for the earth.
They assume that the level of population is correlated with the amount of production.
This means that population grows as production grows: Population = f(Production) Ester Boserup (1910 - 1999) She was a critic of Malthusianism and a supporter of women education. Her thoery said that the amount of population determined the level of production, as “necessity is the mother of invention”. She believed that people had (and will) always find a way of increasing production. She assumed that economic growth is due growing population facing and solving challenges. In this sense she was more optimistic.
Production = f(Population) 5 a.villagrasa IBE, 2nd Year - 1st Term Business history ANCIENT DEMOGRAPHIC MODEL Demography changes over time. At the beginning (ancient demographic model) birth and mortality rates were very high, with periods with more mortality than births. As we observe in the graph below it was the model corresponding to European preindustrial societies (it started transitioning in the mid 18th century).
The ancient model was characterized by:  High birth rates  High mortality rates (high infant mortality)  Low population growth rate: because there were a lot of births but also a lot of deaths, so one thing “compensated” the other.
 Low life expectancy 6 a.villagrasa IBE, 2nd Year - 1st Term Business history FEUDAL SYSTEMS Feudalism organized European societies from the 11th century and the beginning of the industrial revolution. It was based in the legal inequality of people, meaning that they had different rights and duties. The state as a central institution didn’t exist. There was a personal relation between the feudal lords and the peasants, as the land lords weren’t the owners of the lands, property didn’t exist. Therefore there wasn’t a free market for land and neither a labour market. The peasants had to pay the land lord due their personal relation (not as the rent of the land, but because he was the lord, as we pay the king just for being the king).
Characteristics of the feudal system    Decentralization: feudal lords appropriated the public power and incomes, so the state was not longer the highest political organization.
Legal inequality: men weren’t equal, as lords and subject had different rights and duties.
Lords’ power Absence of growth Lords received a payment from their subjects just for being lords (personal relation), which was a hereditary power. Income distribution restricted the possibility of increasing productivity and prevented technological development.
Rent is the remuneration for the land, wages are the remunerations for the labour and profit is the remuneration for the capital.
Peasants had to work and then pay a feudal income. This money was used for war and for lords’ consumption. The lords weren’t concerned about production, so they didn’t save. Peasants were the ones putting all the production factors and were very poor.
So, in general the saving rate was very low.
Feudalism was constraining technology because the ones with enough income to invest (lords) didn’t have interest on it. On the other hand, peasants had incentives to invest and improve the production but didn’t have enough income to save and invest.
Income is generally correlated with the saving rate, as the poorer the peo ple, the lower the saving rate.
Saving: In economics, saving is not keeping some money for the future. It refers to, instead of consuming the money, using the money to buy something that will have profits in the future.
7 a.villagrasa IBE, 2nd Year - 1st Term Business history The first crisis of the feudal system In the mid 14th century there was a huge crisis of the feudal system due the Black Death, which ended with 1/3 of the European population. With diminishing returns, the reduction of people (labour), increases productivity. After the Black Death population grew again and they arrived, again, to a not-growth state.
The pandemic reduced a lot the population, so feudal income reduced a lot too, as land lords received it from all the people living on their lands. Then monarchy took advantage of lord’s weakness, trying to retain their economic and political power and it appeared a new centralized system. So we can summarize that the crisis lead to: a. Change of the organization model b. Lords lose power The agrarian revolution started when the feudalism syste m disappeared.
8 a.villagrasa IBE, 2nd Year - 1st Term Business history TRADE Trade experienced a revolution in the 11th and 12th centuries and became the second most important activity (mainly in cities), although it was far from agriculture, as it was very constrained by the cost of transport. Trade revolution was motivated by:  Military and naval superiority: they gave commercial privileges.
 Increase in manufacturing urban activity.
 Improvements in transport.
 Improvements in commercial organization and in commercial techniques and instruments: fairs, credit, banking.
Trade of luxury products (silk, species...), mainly with Asia, was important because the cost was compensated by the high price.
Specialization When America was discovered (1492) and European citizens colonized it, starting a military and commercial expansion that made Europe the leader of the world. With it countries start specializing, creating an international labour division. Specialization was something new and it put the bases for the Industrial Revolution.
Division of labour: each worker does a step of the production. It also refers to countries specializing in certain industries.
The most important raw materials for textile production (the most important during the Industrial Revolution) came from American colonies, so America specialized in producing cotton and Africa specialized in “producing” slaves to work in plantations.
Specialization was motivated by the fact that it leads to an increase in productivity.
However, it requires a process of specialization that is not always possible to do.
Division of labour is much related to trade (because you need somebody to teach you).
From a theoretical point of view there are gains for everybody, so international trade is always good. The problem with this model is that it doesn’t take into account what happens with prices in the long run. It is also important to note that there are sectors where specializing is more profitable than in others. For example, if you specialize in agrarian products the terms of trade have deteriorated.
Terms of trade: The terms of trade are the ratio of the prices of the exports and the prices of the incomes. In other words, sell products cheap and buy at higher prices.
It is not the same specialising in agriculture or in textile, as prices will evolve in a different way.
9 IBE, 2nd Year - 1st Term a.villagrasa Business history Adam Smith (1723 - 1790) The Wealth of the nations by Adam Smith tries to explain what created the wealth of the economies. His conclusion is that the division of labour (specialisation) is what makes a nation wealthy. Because of this he defended trade as opposed to protectionism. Smith is known by his theory of the “invisible hand” and for being the father of the liberalism.
Comparative advantage This concept was developed by David Ricardo. We have to differentiate between the comparative and absolute total advantage.
Example: UK and Portugal produce wine and clothes, and each unit requires x hours of work.
TOTAL COST Wine Clothes UK 2h 1h Portugal 4h 3h OPPORTUNITY COST Wine Clothes UK 2 clothes ½ wine Portugal 4/3 clothes ¾ wine As we see in the 1st table, UK has absolute advantage, as it needs less time to make wine and cloths than Portugal. However, if we look at the 2nd table, we see that UK needs to stop producing 2 units of clothes to produce 1 unit of wine, and that it needs to give up ½ of wine to produce one unit of cloth. On the other hand, Portugal has to give up 1,33 clothes to produce one unit of wine. So, we see that UK has comparative advantage producing clothes and Portugal producing wine (it is cheaper for them to produce this products), so it is better for both of them that UK makes clothes and Portugal produces wine and sells it to UK.
10 a.villagrasa IBE, 2nd Year - 1st Term Business history MANUFACTURING TRANSFORMATIONS During the 17th and the 18th centuries industry didn’t change much. There wasn’t a big technology change, only some improvements, and although production increased thanks o trade it was still unimportant in global economy. However, after the revolution new machinery and processes appeared and there were transformations in energy use and industrial location. We can distinguish two types of changes: a. Technology changes: specialization, investment and acclimatization of American plants. Growing potatoes helped a lot the development of agriculture because they increased production a lot. They also started using the best seeds and animals to get the best ones.
b. Structural changes: these changes were related to property and land. There was an increase in land rent and property rights appeared with the privatization of lands. They made people have incentives to increase their land’s productivity. In Spain this process of privatization was called desamortización and it consisted in expropriating the land from the church or lords and selling it, creating a land market the property of the land.
These changes took countries to a revolution that preceded the Industrial Revolution.
Northern Europe supremacy The UK, France and Netherlands exploited their colonies by giving monopolies to some companies, which became public limited companies and having plantations with slave workforce. This helped these countries to be the first ones to have the Industrial Revolution.
British revolution The UK industrialized the first and become the most powerful textile industry because it took advantage of its colonies (colonies, cotton plantations and slaves).
UK was the first country in which people stopped producing for subsistence and started producing to sell in the market. There was an increase in income but also saving. Structural changes in the UK consisted in a process of enclosure (privatization of the land), as before it everyone could use the land. The main transformations were:  Concern for agrarian progress.
 Seed and animal selection.
 Crop rotation (pulses and fodders)  Reduction or elimination of fallow.
 Investment in land improvements.
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