Lesson 2- Preindustrial ages (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 16/10/2016
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Lesson 2: Rural firms, trade, finances and manufacturing in the preindustrial age (apuntes del 6 y 7 de octubre)

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a.villagrasa IBE, 2nd Year - 1st Term Business history Lesson 2: The preindustrial age Outline AGRICULTURE ................................................................................................................... 2 The agrarian family ....................................................................................................... 2 Characteristics .......................................................................................................... 2 Agrarian revolution (17th and 18th century) ................................................................. 2 TRADE AND FINANCES ...................................................................................................... 3 Functioning of markets ................................................................................................. 3 Ingredients of exchange ........................................................................................... 3 Preindustrial institutions of trade ............................................................................ 3 Transaction cost........................................................................................................ 3 International exchange ............................................................................................. 4 New financial instruments............................................................................................ 4 Money supply ........................................................................................................... 4 MANUFACTURING ACTIVITIES .......................................................................................... 6 Commercial firm types ................................................................................................. 6 Guilds ............................................................................................................................ 6 The system ................................................................................................................ 6 Wages ....................................................................................................................... 6 Problems ................................................................................................................... 7 Putting out system........................................................................................................ 7 The idea .................................................................................................................... 7 The system ................................................................................................................ 8 Wages ....................................................................................................................... 8 Advantages ............................................................................................................... 9 End of the putting out system .................................................................................. 9 Centralized production ............................................................................................... 10 TECHNOLOGY AND ORGANIZATION OF INDUSTRIAL ACTIVITY ..................................... 11 1 a.villagrasa IBE, 2nd Year - 1st Term Business history AGRICULTURE The agrarian family In the preindustrial ages, due the limitations of the technology they had, agriculture was self-sufficient. In other words, the unit of production was the family and the unit of consumption was also the family, as they were producing by and for themselves.
Production was very low so they didn’t produce enough to sell it in the market. One of the reasons was feudalism. As explained in the lesson 1, producers had to pay the feudal income, which reduced the available income, preventing saving.
Characteristics  Diversity of activities: the family had to do everything. They had to plant, take care of the animals...
 Low division (specialization): nobody had a “fixed” task. They had to do what was necessary in that moment.
 Self consumption: they didn’t produce enough to sell in the market.
Agrarian revolution (17th and 18th century) We usually talk about the British agrarian revolution, but the first countries to implement those changes and increase their productivities were the northern Europe countries.
The technological development thanks to the increase in investment made productivity increase. This started the agrarian revolution, which preceded the industrial revolution.
Investment  Technological transformation  Increase in productivity With the agrarian revolution there were technological transformations such as breeding, selection of the best seeds and crops rotation and some structural changes consisting in the privatization of lands (enclosure). Thanks to them productivity increased, allowing families to have surpluses and sell them in the market. This lead to a process of specialization in the most profitable sectors. The explanation is that selfsufficient agriculture needs the farmers to grow different kinds of plants and animals, as they need different food. When there’s market economy the farmers can specialize in producing only one product because with the money they will get for selling the surplus they can buy other foods.
Despite the specialization farms can’t be considered firms in that period.
2 a.villagrasa IBE, 2nd Year - 1st Term Business history TRADE AND FINANCES The first models of business (as we understand them now) appeared in sectors such as trade and industry.
Functioning of markets Ingredients of exchange Markets don’t appear, they are not abstract. They are institutions that have to be created. The creation of the trade was a progressive process in which the “ingredients” of the market were set. To have a functioning market in which there can be trade it is needed to have: 1. Available information: In those times getting information was very difficult. In micro we assume that information is perfect, but in reality no one knows the prices of everything.
2. Coordination: There’s a need to guarantee that the parties will be able to meet and negotiate, so a mechanism to coordinate transitions had to be created.
3. Enforcement: There wasn’t any legal system nor mechanism to force the other party to accomplish the agreement, so it was needed something to ensure that the payment would be done. Agreements must be fulfilled and fraud must be punished.
Preindustrial institutions of trade To fulfil these conditions there some institutions were created: a. Fairs: they were an annual meeting between producers and consumers in which capital and expensive goods were sold, as they were protected by an enforcing authority. They reduced the information cost and the coordination problems.
b. Markets: they were meetings taking place once or twice a week. People bought everyday goods. The authority helped the enforcement of rules and applied limits and regulations.
c. Shops: they sold artisan goods and had a frequent demand The most important trades took place in fairs and markets, which had the aim of reducing information and coordination problems.
Transaction cost The transaction cost is what you pay when you buy a good apart from the price, for example the cost of transport. Transaction costs were very high in the preindustrial ages, and this discouraged trade. The institutions created (see above) couldn’t solve this problem.
3 IBE, 2nd Year - 1st Term a.villagrasa Business history Because of this, exchange was only carried out between geographically near countries.
Maybe one country (China) could produce at a cheaper price, but the transportation costs were so high that, at the end, it was more expensive than buying from a country with a higher production cost.
International exchange As we have seen, transportation costs were too high to have international trade. Only when transaction cost is such that it is cheaper to purchase from another country (which has lower production costs) there can be international trade.
Trade expanded with the improvement in transportations, as they lowered the cost of transaction. For example, trade increased when in the 10 th century maritime transport was made easier. Thanks to this, oceanic trade grew and become one of the originators of the European economic dynamism. International exchange became easier because of: 1. Techniques of transport: Improvements in navigation which increased oceanic transport.
2. Liquidity: Increase in the monetary base, creation of institutions of credit, accounting systems and legal institutions.
3. Commercial companies: Types of companies.
Thanks to the increase in trade and the creation of a market labour division appeared among countries. Europe specialized in capital, Asia in silk and species...
New financial instruments One of the main challenges when engaging in trade is obtaining the money to finance these activities. As trade increased, the demand of credit increased and new forms of credit were created to satisfy it.
Money supply Economists often ask how much money is needed in an economy. In the preindustrial ages money had a real value, in the sense that it was made out of gold or silver. This leads to the problem of increasing the monetary base because, at least in the short run, the amount of gold and silver can’t be increased.
As we have seen, trade was increasing, and therefore, income was increasing too.
According to equation of exchange, there’s a relation between the level of income and the level of prices (P*Y=Ms*V1). This formula can also be used with transactions (T) instead of income (Y), as Fisher did.
Production = Income ≠ Money 1 Velocity of circulation: how many times a unit of currency is used in an economy.
4 a.villagrasa IBE, 2nd Year - 1st Term Business history In preindustrial ages income was not an equivalent of money, and trade needs money.
This explains the need of expanding the monetary base.
Thanks to the new facilities of trade and capital, trade increased faster than income (not proportionally). This was because, before, a large part of income was still used for self-consumption instead of exchanged, but increasingly, a bigger part of the income was going to the market.
The discovery of America helped to increase the monetary base (Ms) due all the precious metals coming from the “new” continent. Before the discovery of America and other places rich in metals they increased liquidity using two mechanisms: a. Process of devaluation: it consisted in the adulteration of the monetary base.
They made the currency cheaper by mixing gold and silver with other metals.
b. Letters of exchange: they were the first means of credit. They could be discounted in a bank: exchange it for money, paying some interest.
Before the 19 th century the central bank didn’t have the monopoly of money supply.
The highest demand of money was in the 19th century, as there was a very fast increase in the level of income and production. However, preindustrial economies also needed liquidity. Another change related to money was starting keeping track of all transactions, which lead to the creation of accounting.
5 a.villagrasa IBE, 2nd Year - 1st Term Business history MANUFACTURING ACTIVITIES Commercial firm types a. Free trade: they were the simplest type. They only made one product. They were individual traders and mercantile associations.
b. Privileged trade: they worked under privileged conditions. They acted as a monopolist, for example exploiting a certain route. They diversified (produced more than one product) to reduce risk. The idea of limited liability appeared here and it makes sense because they needed larger initial investments and assumed a higher risk.
Guilds The preindustrial workshops2 were characterized by the following features:  It was artisan production with the help of an apprentice  They did high added value activities  Those activities were carried out in urban regions  They satisfied a luxury demand  They were members of a guild3 The system For many years production was organized under the guild system. However, this changed after the industrial revolution.
Before the industrial revolution, there were workshops, who were members of a guild.
Guilds acted as a monopoly because they set prices, quality and quantity, defined the process of production and imposed barriers of entry. As they were a monopoly, they could set higher prices, which made wages be high.
The function of the guild was to organize labour and capital, which meant that they organized the whole process of production: they said what kind of tools, raw materials and technology had to be used in the production.
Wages A wage is the compensation for doing a job, the remuneration of the labour factors. In the workshops there were a master (the artisan) and an apprentice (who wasn’t paid).
The artisan provided labour and capital and got all the income, so he got a wage (remuneration of the labour factor) and the profit (remuneration of the capital factor).
As the artisan provided more labour than capital, the main part of the income received was wage.
2 3 Taller Gremio 6 a.villagrasa IBE, 2nd Year - 1st Term Business history Remember that we say that a marke t is in equilibrium in the long run when profits are 0. This makes sense because they still get the wages.
There wasn’t division of labour or specialization. The artisan was doing everything, and the appendices only did the easiest steps. As a result, productivity was difficult to increase. Moreover, technology didn’t improve because the guilt constrained it by setting a way of doing the process. In summary, wages were high, so they had the opportunity to invest and improve technology, but the guild impeded it.
As we see it was a quite inefficient system. In theory there has to be a correlation between wages and income, but this is not true in real life. Wages depend on the labour market conditions. If not, according to the theory, people with lowest wages would be the less productive ones. For example, nowadays, young workers receive the lowest wages, not because they aren’t productive, but because they don’t have an alternative (there’s high rate of young unemployment) so they are willing to work for lower wages.
Problems Under this system production was very low because workshops were constrained by the guild itself. Although all the producers were in the guild, the production unit was very small as artisans worked alone. As a result, the degree of specialization and the division of labour was very low, which meant a very low productivity. Moreover, any innovation in the production process had to be agreed by everyone in the guild and, as they were “protected” (all had the same information, so there wasn’t competition) there were low incentives to increase productivity. In addition two threads to the guild system appeared: 1. Consolidation of the absolutist state: After the loss of power of the feudal lords, kings and other powerful authorities wanted to control the cities and the guilds.
2. Putting out system: It was an alternative system that put manufacturing out of the city. Because of being in the countryside it was out of the control of the guild and could have lower wages.
Putting out system The idea The putting out system was made by the first entrepreneurs, who looked for an alternative to guilds and to satisfy the increase in demand from the countryside. They established out of the city, so they were out of the guild’s power and could give lower wages.
7 a.villagrasa IBE, 2nd Year - 1st Term Business history Entrepreneur: Somebody investing money and adopting risks. They have to invest (risking losing money) to start a new project and their task is to define and organize production.
The entrepreneurs in the putting out system were the first in the manufacturing sector, the idea of investment didn’t exist with the guilds. They saw the opportunity to manufacture out of the guilds, which were producing with low productivity and high prices and started organizing the process of production.
The system The entrepreneurs, using their own savings, purchased raw materials and paid wages with the hope of getting some profits afterwards. In the putting out system there was a disperse industry because workers worked from home with the raw material (mainly cotton) and tools that the entrepreneur had given them. They did a part of the process (depending on the difficulty of the task) and received a wage per unit produced.
Advantages with respect guilds    Lower wages: Because the opportunity cost was low.
Higher productivity: Productivity was higher thanks to the division of labour and the increase in the degree of specialization. Since workers did only one stage of the process, at the end they could do it very fast.
Employ non qualified workers: They had in charge the easiest parts and received a lower wage. There was no need of training.
Wages Opportunity cost is crucial to understand wages as they have to be, at least, as much as in the next best alternative.
The workers of the putting out system were peasants that employed some hours to manufacture, instead of working 10h in the crops, they worked 8h and then 2h in manufacturing, or one of the members of the family (in large families) instead of working in agriculture worked in the manufacturing process.
The opportunity cost was the marginal productivity in agriculture and, as we know, productivity in agriculture was very low. Moreover, the marginal productivity is always decreasing (due diminishing returns to scale). This means that you get more production in the first hours. As they were willing to work for a very low wage, the entrepreneur had to pay very little.
In micro theory, if the productivity of labour increases, wages should increase too but, overall, wages are linked to the situation of the labour force.
8 a.villagrasa IBE, 2nd Year - 1st Term Business history Advantages The advantages with respect to the guild system were the following:      Low labour cost: Labour cost was the biggest part of the total costs, but as wages were lower than in the city, they were able to set lower prices.
Low investment: As in any other project it was necessary to invest some capital, but it was a little investment. The entrepreneur only had to purchase raw materials and tools that came from the UK colonies at a low price (due the consolidation of the British colonialism).
Low risk: The level of risk is determined by uncertainty, but the UK protected its market, so there was less uncertainty than in an international market.
Moreover, employees were paid by units produced, not for time, so they were always able to sell all the production.
Flexibility: It was very flexible because if there was a reduction in demand the entrepreneur would hire less people or make them work less. This made this system very fast to adapt to changes.
Low maturity: Profits came quite fast after the initial investment because fixed costs were little and they only produced what they knew that they were going to sell.
The boom in manufacturing before the industrial revolution is known as the proto-industrial period.
End of the putting out system The putting out system made the UK the leader in manufacturing activities (also other European countries). This model of manufacturing had a huge success and it coexisted for a long time with the factory system. It lasted from 18th to 19th century, but at the end it collapsed because it was so successful that it couldn’t handle the increase in demand.
Diseconomies of scale The system had some limits, linked to the existence of diseconomies to scale.
Diseconomies to scale are the opposite to economies of scale. With economies of scale, the higher the production, the lower the unitary costs because each unit bears less fixed cost and many firms in the heavy industry benefit of it. However, in the putting out system the costs were mainly wages (paid per unit produced), raw materials and transportation costs.
This manufacturing system had diseconomies of scale because as demand increased it was needed to increase production, which could be done in two ways: 1. Hire more workers: To find new people the entrepreneur had to travel further and having more workers, coordination become more difficult.
9 a.villagrasa IBE, 2nd Year - 1st Term Business history 2. Work more hours: Asking your current workers to work more hours implied having to pay a higher wage because opportunity cost was higher. This is because the marginal productivity is decreasing, so the marginal production is lower in the last 2 hours in the last 4 hours.
The putting out system appeared as a competitor with the guild system, and finally replaced it. At the end the putting out system was replaced by the factory system.
Centralized production Centralized system appears when all workers start working together, in the same place (factory). This kind of production was an exception before the industrial revolution and it only appeared only in some sectors, so it wasn’t a competition for the putting out system. It emerged because: a. Product: to produce some kinds of product (ship, building...) workers needed to be together.
b. Source of raw material: if the work consisted in obtaining material which came from the same place it was needed to have all the workers in the same place (mining).
c. Valuable materials: when the raw materials were valuable (metals and minerals) someone had to control the workers.
Despite working together, each worked had one role, making productivity higher.
These kinds of organization were often protected by royal patents, so they could act as a monopoly.
10 a.villagrasa IBE, 2nd Year - 1st Term Business history TECHNOLOGY AND ORGANIZATION OF INDUSTRIAL ACTIVITY We must take into account that at this point industry was organic and labour centred.
This means that industry was also constrained by the limits of growth of organic economies (human energy, transport by animals, raw materials) so the amount of capital and labour was limited. The UK could overcome these organic difficulties producing cotton with slave workface in its colonies.
In this period technology didn’t develop much and the most important change was going to the countryside to take advantage of the lower wages.
During the proto-industrial revolution (before the industrial revolution) there was a process of labour intensification. Wages started to decrease relative to prices: products were becoming more expensive. However, manufacturing products became cheaper and people started working more hours. There’s a debate about the reasons: a. Reduction of wages: In the period before the industrialization there was a demographic boom, so there was a decrease in productivity (diminishing returns) so wages decreased too. In theory when wages are lower, less people are willing to work, but they had to work more to earn and produce the same as before.
b. Change in relative prices: This other theory says that people wanted to work in the putting out system because they could earn more and food was becoming more expensive.
It is more interesting to look at relative prices rather than nominal prices.
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