Economic history: Factors behind the Great Divergence

All too often during poor economic times many debunked economic fallacies of the past get reinvented. The reason is simple: a search for ideas and solutions alternative to the "mainstream" (however we define it) allows those who succumb to these fallacies to repeat the ancient errors classical economics was hoping to get rid of. The short-termism of politics plays a crucial role in the process of persistent perpetuation of such fallacies. This is why in times like these it is essential to go back in economic history and debunk some of the ideas that tend to surface repeatedly. In the following couple of posts, I attempt to do just that. 

My previous post on the benefits of the Industrial Revolution briefly touched upon the issue of the so-called Great Divergence. The Great Divergence isn't a fallacy, it is a fact, but understanding the reasons as to why it emerged is often subject to false interpretation.

As I've pointed out previously, after the Industrial Revolution and the rapid development of the West (both economic and political), many countries outside Europe resisted this change and as a consequence were left lagging behind shackled by the Malthusian trap.

Source: The Economist

These countries (the Ottoman Empire, Russian Empire, Austro-Hungarian Empire, China etc.) weren't any less developed than England or the Netherlands, in fact if anything they were equal in wealth and power before the 1800s (for example it was China where gunpowder and the compass, two crucial ingredients during the colonization era, were invented). But understanding why the Revolution started in Britain, not anywhere else in world, is key to understanding the Great Divergence itself.

Culture, geography, colonization and exploitation?  

The causes of the Great Divergence are one of the most hotly debated topics in the field of economic development. The layman may recognize these debates through the ultimate question: "why are some nations rich and other are poor?" Many of these debates start with culture. Weber's famous Protestant ethic argument is the centerpiece of the idea of cultural supremacy of Europe over the rest of the world. It stresses the European values of hard work, frugality and diligence that made the Europeans more prone to success and prosperity than the rest of the world.

A direct opposition to this argument is the so-called dependency theory, the notion that resources flow from the poor countries ("periphery") to the rich countries ("core") enriching the core at the expense of the periphery*. The pillaging and plundering of colonized areas in the 15th, 16th and 17th century have brought in enormous wealth to the European colonizers (not only in terms of raw material and gold, but also labour), who were enriching themselves at the expense of the rest of the world. Many dependency theorists like to point out that Britain's accumulated wealth during the colonization period led to their rampant success during the 19th century. But why hasn't the same thing happened to Spain? Or the Austro-Hungarian Empire, or the Ottoman Empire, all of which built their empires on theft and larceny of conquered areas, only to see their empires fall by the end of the 19th and beginning of the 20th century? 

The mercantilism phase (my next topic) did result in higher accumulation of wealth and resources for the Europeans, but it doesn't explain why the Revolution originated in Britain and not, say, Spain which at the time was even richer than England having controlled more fruitful lands of South America and having imported more gold than England and France. After all, the mercantilist system failed since it was based on entirely false assumptions of international trade. The dependency story looks at the patterns of development only from one angle, preventing it to see the deeper factors responsible for failure of the poor nations and the success of the richer ones. 

A very different take on the whole story, albeit in line with the colonization argument, is Diamond's emphasis on environmental factors and geography. He argued that Europeans, when they colonized the new world, brought with them the diseases they became immune to, but to which the indigenous populations of the new world weren't, causing the Europeans to conquer them more easily. Diamond's environmental endowment argument also explains why growth started in Europe:

"Europe was uniquely endowed with domesticable plants and animals. Its population was also more immune to diseases. These factors led to higher productivity and, crucially, higher population density. The upshot? The development of institutions such as cities, bureaucracies and literate classes, which contributed to economic growth." (The Economist, August 2013)

Why England?

But again, why England? England is hardly endowed with resources such as France, Spain, Russia, Turkey or the Austro-Hungarian Empire. Netherlands even less. And yet, it is precisely England where the Revolution started, and from which the Divergence emerged. The theory I subscribe to is the one presented last time, given by Acemoglu and Robinson (A&R):

"They explain in particularly detail why the Industrial Revolution started in England, not anywhere else in the world. It developed on the trails of the Glorious Revolution, where the demand for more property rights and a greater political voice set the stage for sustained growth and prosperity. The rising wealth of the merchants and manufacturers overcame the opposition from the elites and the sovereign, thus initiating the beginning of a new historical era. It was the broad coalition of the (albeit richer) people that succeeded in initiating progress. Acemoglu and Robinson call this irreversible political change that ensured constant institutional adaptation and the final switch towards greater political and economic inclusinvess."

Countries that failed to follow the same path of political inclusivness failed to achieve this dynamic progress. A&R cite the specific examples whose their ruling elites prevented development, fearing that they may lose power. All the aforementioned countries such as the Ottoman Empire, Austro-Hungary, Russia or Spain had rulers who strongly opposed and prevented any signs of innovation and progress. The same was actually true for Britain as well, where queen Elizabeth I also prevented progress by shutting down innovations such as the knitting machine. Both she and her successor feared the potential destabilization such an innovation would cause for jobs in the textile industry. But they and their further successors couldn't hold progress for long, and it was shortly after the Glorious Revolution and Cromwell's brief dictatorship (after which they executed the sovereign Charles I), that William III of Orange took over (after Charles II and James II) and gave more power to the Parliament. After that point there was no coming back. England was changed politically, and economic progress was under way. 

The point is that it first took political change to curb the power of the sovereign to foster innovation and technological progress. A society trapped by a dictator or a sovereign cannot be innovative and will always be condemned to stagnation.

Failure to adapt 

The Great Divergence was an event many see responsible for the huge inter-country inequality we have today. But this simply isn't true. Yes, after the Industrial Revolution many Western countries rose to prominence rather quickly, leaving most other countries behind. But they didn't grow on the expense of the poorer nations, the gap increased because the poorer nations failed to adapt. 

Looking at this from today's perspective, many nations fail today because they fail(ed) to adapt to the new economic environment being triggered by the Third Industrial Revolution. I've divided a great amount of attention to this topic on the blog; how technological changes or more precisely the failure to adapt to these changes led to a relative impoverishment of nations. All the once richer countries, particularly in the West, who got trapped in political dependency, got stuck in a welfare dependent society, and are now facing serious problems in reigniting their growth. In order to do so they need a complete revision of their growth model and they need to learn upon the lessons from history and adapt to the technological change. 

* A brief digression: The Eurozone sovereign debt crisis, according to some, follows on the trails of dependency theory, where the countries of the Euro periphery (Italy, Spain, Portugal, Greece, Ireland) blame the core countries (Germany, France, Netherlands, etc.) for benefiting at their expense. However, remember that capital was flowing from the core to the periphery, not vice versa. The large CA deficits experienced in the periphery after the introduction of the euro were misused by the periphery as the money ended up in consumption not investment. This is why their debt (both public and private) is a huge burden - you have troubles paying it off when you just used it for consumption.