Research Korner: Industrial Revolution Examples

THESIS CHAPTER 2 ON DEVELOPING COUNTRY MULTINATIONAL CORPORATIONS: A SURVEY OF THE LITERATURE REVIEW

CHAPTER 2   DEVELOPING COUNTRY MULTINATIONAL CORPORATIONS: A SURVEY OF THE LITERATURE REVIEW                                      2.0 Introduction   2.1 Emergence of Developing Country Multinational Corporations: The Theoretical Explanation of MNC 2.1.1     General Theories of Multinational Corporation   i.              The Pioneering Work of Stephen Hymer: The Industrial Organization Theory ii.            The Transaction Cost Theory to the Internalisation Theory iii.           The Product Life Cycle Theory iv.           Dunning Eclectic Paradigm v.            A Selected View of MNCs Theories: FDI and Country Development   IDP and Stage Theory: Side by Side   2.2 the Emergence and Evolution of Multinational Corporations: from developed Country: the Theoretical Explanation       The origins of trade and industry are innate to the history of mankind who, as soon as he learned to walk on his two feet, discovered the value of moving in teams and packs similar to the animals they hunted for food back in the prehistoric times. As humans became more civilized, they developed the social order which only humans can do as rational beings. Within the social order, man developed the underpinnings of society through roles, protocol, work assignments, rights, duties and responsibilities thereby creating the human society. As the societies’ functions were initially internal and for survival, roles and functions revolved around these. Later, and with sporadic contact with other like small societies, human beings blended into a more homogenous community with slightly altered roles until the land and its resources which they occupied could not be cultivated to support the lifestyle of the community – thus communities tended to be nomadic until they found a place that could sustain their livelihood while maintaining contact with the outside world: the river systems.   The roadmap that history presents to humankind was born on the riverside: these were considered the highways to the rest of the world and this is why such waterways as the Ganges, Mississippi, Rio Grande, Panama Canal, the Chinese Yellow River, the Amazon, Hudson and Nile, among others, have never lost their places in history. These water highways paved the way for indigenous goods per tribe or civilization to be traded with other cultures, other tribes – other nationalities. The galleon ships of Spain and Portugal, the Chinese merchant junks as well as the dreaded sea pirates were proof that there was riches to be found in the water-based commerce. However, a system had to be in place to facilitate the trade such as the discovery of the barter concept, and later the concept of currency which was usually salt, gold or common precious minerals. These later evolved into more complex economic principles – such as overseas trading.   As early as 2500 BC, Sumerian merchants found in their foreign commerce that they needed men stationed abroad to receive, to store and to sell their goods. The famed conquistadors of the Indian people – the British – had their East India Company chartered in London during the 1600 and established branch overseas. The mid-seventeenth century saw the English, French and Dutch mercantile families sending relatives to America and the West Indies to represent their firms. It was only in due time that the American colonists discovered in their own foreign trade that it was desirable to have agents and, on occasion, branch houses in important trading centers to warehouse and to sell American exports.   History also describes the Virginia Company which was chartered in 1606 by King James I to establish the first permanent English settlement at Jamestown as “the first foreign direct investment in America” which went bankrupt by 1624. The period of 1875-1914 is identified by historian Mira Wilkins as “the rise of truly large-scale foreign investments in the private sector” including “more foreign direct investments than most subsequent commentaries have recognized”. Wilkins identified two types of these investments as one being a carrier of potentials for control but having a fragile if not negligible home office with little capacity beyond that of raising capital while the other one would be more akin to today’s multinational companies which provide extension of a company and its operating organizational and competitive advantages.   The domains where multinationals were normally involved in where in railways, mining, tramways, water, gas, electricity, banking, insurance, finance, land plantations and even manufacturing – most of them being infrastructure projects that one can see as key operational and competitive advantages of the developed nations during the industrial revolution. These infrastructure projects have been conceived with the ancient concept of trade in mind. The key transport systems of railways and tramways were mere conduits of transferring the produced goods from the farm to the international marketplace via land, sea and later, by air in the different ports. The infrastructure and distribution projects of water and electricity made sure the production of the goods were done efficiently and with proper irrigation, power and electricity. The financial intermediaries made sure the working capital for the farm and manufacturing sectors during the industrial revolution were kept in place while the continuous mining of precious elements ensured the valuation of the loans as well as financial instruments were viable when presented to the market. By adopting this complex interplay of strategies of the developing countries during the industrial revolution, the world as we know it today is composed of countries that have been able to implement properly said strategies and become developed countries. Of course, the strategies would not have had their share of losses particularly during a time when there was a need for strong political will, a dedicated and committed leadership as well as conducive cultures and natural resources able to support such strategy. It can be seen in other countries that tried the same strategy but lacked a strong leadership or a favorable culture – even a country that can accommodate laying the back-breaking groundwork for railways and telecommunication lines especially within intense warring factions or geographic and archipelagic constraints: that the strategy had to integrate with the nation’s strengths and abilities to be led toward development.   The American and European economies were at the forefront of the industrial revolution – with capital intensive projects focusing on enhancing the competitive advantage of their nations and a rich source of natural resources, they were able to perfect their craft within their backyard using their own indigenous resources. They each propelled their economies through public flotations, bonds, money market placements, financial derivatives including options and securities although records other than these such as the Latin American and Asian economies, particularly those of China and Japan, have not been considered in the literature of US economic history. The American and European development model was grounded on very strong antitrust policy, market competition and private ownership. However, the industrial giants of the time also realized that with their exploding economies and advances in sciences and the arts, their intrinsic local natural resources could be imperiled which led them to exploit and look outward: their immediate neighbors and more importantly: their colonies. The American and European colonies at that time were very rich in key ingredients for the expansion of the industrial revolution not only within their boundaries but to outside territories as well. The arrogance and pride of the white race coupled with their more advanced weaponry and gadgets made a formidable stance versus the colored race of the rest of the world.  The stance which also set the US and European counterparts from the rest of the world was their perceived supremacy and management of this perception vis-à-vis other trading partners, even those it did not trade with always had a fair share of market perception of the Caucasian traders from its other contemporaries who may have traded with the whites.   The era of puritanism especially in the conquest of the whites over the Indian inhabitants of the virgin Americas as well as the issue of black slavery during the two world wars was very pronounced and provided a strong backdrop to the statement that British, American and European supremacy, although hinged on a gentleman’s agreement amongst themselves, was pervasive and affected the growth of their respective economies although history proves that as each party adopts its own strategy i.e. America becomes unifies its domain to become the United States of America (hereafter referred to as USA in this chapter) while the British adopts a monarchy controlled by Parliament and Europe adopts the more laissez faire style amongst its member countries and each country strategy has its own resultant socio-political economy.   The American and European economies are largely developed economies and as such have much to protect which is how the propensity to create a strong military competence arose. The Depression in the 1930’s was a result of the absence of any real threat to the ballooning economy of America and Europe that overindulgence and overspending contributed to an overheated economy thereby reducing the value of such revered assets as mining inventories, precious metals – most of which undermined the commercial value of the marketplace.   Given that the developing nations were expanding their territories across the globe, seeking more indigenous cultures to conquer and annex, the developing entities created two power blocks: the Central Powers of Germany, Austria and Hungary versus the Allied composed of Britain, France and Russia. Their respective alliance structures, imperial rivalries and mutual distrust escalated a minor conflict into the Great War struck at Sarajevo during the assassination of Austrian’s crown prince sometime in 1914. It was only when the Central Powers downed three US merchantmen three years into the war that the USA sided with the Allies. The sheer number as well as firepower of the US contingent contributed to a compromise for peace resulting in the oppressive Treaty of Versailles in 1919, imposing stringent sanctions on Germany and the rest of the Central Powers.   After the momentary peace offered by the respite from the previous world war – despite being localized in Northern American and European territories, the industrial revolution continued to bear much industry to the extent of easy credit leading to widespread stock speculation in local and offshore activities, having not fully recovered from the war. Further, economic policies under the English and European economies created domestic overproduction and less foreign trade resulting in the implosion of the Great Depression for the respective countries as well as for the whole North America and European states. It was during this time that the Allied forces were perceived by the embittered Germans regarding the sanctions of the Versailles Treaty that launched the second World War – and that helped the English economies, particularly the Americans, to recover using military and defense spending.   Slightly prior to these events in history, a small archipelago in the Southeast Asia was slowly studying and imbibing the developmental models of its bigger contemporaries in the Northern hemisphere of the globe. Japan was rising from a largely feudalistic society with shoguns and warlords keeping the governance of its empire and evolving into a Meiji empire or “enlightened rule” where intellect and learning was sought throughout the world in order to establish the foundation of the empire. Japanese rule was a combined effort of government and businesslike commitment to adopted strategy by all sectors of society. With surprising perspicacity, Japan saw that military strength, which was one of their objectives, depended on industrial power, technical knowledge, and administrative efficiency and that it would not be enough to merely acquire Western armaments. Thus, they embarked upon a broad and intensive program of economic, political and even social reform with impetus mainly driven by the government. The Japanese borrowed several models from the developed countries: the French prefectural system of local governance, the German national railway system model versus the local-based railway system of Western countries, the German national and excellence training for technology and engineering, the US banking model of having several national banks issuing business notes and currency versus the British central bank model where only the central bank issues said notes and currencies to control the inflation and lastly – the penchant for total quality excellence in production of US Industrial Engineer William E. Deming in the early 1950’s. Of the four borrowed models, it was the US banking model that failed for Japan after the Bank Act of 1872 which spurred several expensive rebellions for Japan and resulted in a restructured banking system. What followed was a depletion of natural resources particularly gold, silk and tea which enamored the British colonizers in the first place amidst farmers and working class who took to more luxurious lifestyles given their previous victories in economic policy improvements. This was when the capital-rich Westerns loaned finances to simple Asiafolk such as Japan in order to indebt the country and become a de facto annex to its burgeoning empire.   When the Germans launched their offensive on the weakened economies and spirits of the western world, they used superior weaponry, blind-loyalty to the supremacy of the Aryan race and a promise of rich spoils for its allies – among which was debt-ridden Japan. Further that the Great Depression intensely affected Japan due to its borrowed banking and financial model that was interpreted by the anti-American Japanese as a devious and underhanded manner of acquiring an ally thru indebtedness unlike the Germans and the French who allowed relative freedom in letting Japan adopt its accordant operational model of railways and governance respectively. The effects of World War 2 left deep scars in the German and Japanese economies in 1945 – one of which was used by Japan to heal itself quickly and surpass the growth of the world developed leaders to become one of them.    A key component of the war’s aftermath was the agreements made between Japan and the victorious countries. Concern with US reactions did not prevent some Japanese from desiring to amend their new constitution – particularly the contentious provisions that made not the emperor but the people – sovereign, and that denied Japan the right to wage war. A resultant budgetary savings from military resources was immediately realized compared to other recovering economies. The war also enabled the spectrum of political parties within Japan to be one of two: the Liberal Democratic Party (LDP) and the small but growing Communist party. The previous efforts to broaden the educational system in Japan proved instrumental in rebuilding Japan and fueling its miracle growth during the postwar era. The previous cooperation between government and business was strengthened by lessons learned in the war and the Ministry of International Trade and Industry (MITI) evolved to be the cementing factor between government and the large family-owned businesses called zaibatsus which were similar to the Korean chaebols. Government was given a very deliberate role in focusing on which economic policies to pursue, which industries to develop, and which ones to cease supporting – all of which were followed and supported by the zaibatsus. Government and zaibatsus determined the basic industries and goods that had to be protected which included rice and staple food items attributable to its culture. Strong protectionist policies were set up as well as complex tax and distribution schemes which were applied even to later Japan-exported value-added products such as VCRs, tape recorders, and the like.   One of the industries severely affected by the war was the steel industry which was maximized by the Japanese in making weapons and armaments. These were now highly unutilized but presented a key component in Japan’s economy resurrection. Japan saw the opportunity for building not only its foundations and infrastructure but also those of others affected by the war. With the penchant for discipline and excellent workmanship which was augmented by the Total Quality Management principle from an American who was rejected by his own countrymen, W.E. Deming taught the Japanese the tools of zero wastage, effectiveness and efficiency in production, manufacturing as well as in basic service industries, Japan’s leaders saw the opportunity to use its steel industry components as building blocks to economic supremacy. From being a swollen military production facility, the steel industry produced high quality metal for shipbuilding, skyscrapers, houses, automobiles and airplanes. The grade and quality of the steel outstripped those coming from the US and German counterparts, being more bulky and heavy. The technological training of Japanese students abroad applied their skills in Japan’s steel mills churning slabs and sheets of metal – importing their raw materials from around the world and adding value by using already existing and continuously improving production facilities and practices. Parallel to this, the Western counterparts were experiencing postwar boom in terms of sale of preventive firearms – those which would be used only for last resort purposes based on agreements made after the war. World economies also progressed under the cloak of peace and the start of the cold war simply made the viability of weapons manufacture a continually viable economic activity.   In this context, the multinationals of the West and those of the East had key characteristics: the West had the more sophisticated technology and mass-produced commodities being marketed to the whole world where most were still annexes of its previous conquests but made legal under the operation of law while the East had more direct-materials and indigenous products that were marketed usually through western intermediaries. However, Japan, among the Asian countries, was exceptional since it went beyond its core competitive advantage of high-quality grade steel making, distribution, procurement and pricing by moving into higher value-add manufacturing such as technology and automobiles. Of course, the accompanying shortages in food, energy, raw materials and foreign exchange and the rampant postwar inflation led forced laborers from Korea and China crippling the nation’s coal industry which in turn threatened the manufacturing and transportation industries and increased the country’s dependence on imports. Since Japan’s chief sources of raw materials: China, Manchuria and Korea, were closed to Japanese trade postwar, Japan had to turn to western suppliers who were more expensive and usually required letters of credit from western-accredited Japanese financial intermediaries. This was the situation of Japan as it deliberately focused on its steel industry.   By 1975, Japan produced 113 million tons of crude steel, approximately 16% of world steel output or 20% of all world steel exports done by its zaibatsus - an amount approximately equal to US steel production that year which indicated Japanese steel industry’s phenomenal postwar growth and development. The US could then feel the emerging dominance of a country which was able to pay its international debt, pull ahead of Britain, France and West Germany in terms of GNP, develop a world-respected work-ethic and limited imports to only the most essential products. By 1983, Japan had the unique problem of an unprecedented large world trade surplus which was fueled by the growth of three key industries in Japan: steel, electronics and autos. By 1987, Japan registered a nearly one hundred billion trade surplus, the largest surplus for any country in history which was offset only by and equivalent amount in long term capital outflows per annum.   Fast forward to the present time, the emergence of American and Western multinationals may have been explosive during times when strong military spending was important – even as recent as the September 11 attack on the Twin Towers where smaller nations have expressed inadequacy of their superior’s ability (US) to protect itself, how much more can it provide for other less developed countries? Although the technology aspect has always been the compelling advantage of the western world, its application for the defense and monitoring tasks of governance are largely attributable to military applications, despite the erstwhile commercial functions its has been touted to perform. As for the Japanese emergence of its indigenous multinationals, they have focused on the commercial and higher value-add commodities such as electronics and automobiles, veering away from the basic industries which could be copied by similar emerging economies as had been done by Korea which focused more on shipbuilding than automobiles given its accessibility to nearby ports and given an inherited competence from the postwar era. Given that the Japanese were highly disciplined and trained in quality management, they countered the American atomic bomb in Nagasaki and Hiroshima by unleashing the economic bomb in the US by virtue of their adaptable constituency and economic prowess – to become the economic superpower of the 1980’s.   2.3 The Emergence and International Expansion of Developing Countries Multinationals: Theoretical Review (i)            The Emergence of Developing Country MNCs: The ‘First Wave’ of Literature (ii)          The Expansion of Developing Country MNCs: The ‘Second Wave’ of Literature   2.4       Summary of the Literature on Developing Country Multinationals   2.5 the Comparison of Multinationals from Developed and Developing Countries (i)            Behavior and Characteristics – Multinationals in Developed and Developing Countries exhibit the basic behavioral components and characteristics in their commercial objective: to engage in commerce beyond their sovereign borders where such economic activity shall net a favorable return of expenditures on the said overseas investment.   The timeline of history has shown that trade and commerce have always had the resultant beneficial outcome in mind for the owner of such proposed transactions. The proactive party has historically occupied the position of power in negotiations of transactions thereby resulting in a net gain compared to the more passive recipient of the transaction who, although may gain from the deal, such gain may not be comparable to that of the initiator. To illustrate, developed countries are assumed to have more mature infrastructure systems: physical as well as intellectual and legal infrastructure. Their characteristic penchant for banding together and leading cooperative efforts stem from the basic learnings of history that more heads are better than one especially in a collaborative effort where it is clear that the positions of power will benefit the most and ably determine the outcome to their advantage. Thus, the GATT, WTO and United Nations, among other collaborations, develop from painful losses in the world wars and use the operation of common law – despite and in spite of sovereign laws governing each nation in the world. The developing nations are thus at a perceived disadvantage in that by operation of law and of peer pressure to be admitted into the communities of countries participating in world trade, they have to be accredited, accepted and vouched for as if in an old boy’s exclusive club or even the pre-pubescent treehouse of western boyhood years.    Multinationals in developed countries are perceived to be remnants of the time when the human race was starting to master its world – thereby gaining first to market strategies which also carried the priority rights over discovered channels or complementary systems or products to their already expanding empire. The general characteristic and behavior of western multinationals were therefore expansive in their focus rather than complementary given that their innate culture was one of annexing, expanding and colonizing – gaining for itself for the pure purpose of ownership, expansion and exploitation. It is only recently with the resurgence of globalization, wide media coverage and more benevolent multinationals that aspects such as corporate responsibility and commitment to community development are being imbibed. These shall be discussed further in the succeeding section.   (ii)          Business Strategies and Performance – It should be considered that Developed Countries were Developing countries at one time and while applying similar strategies, the variable factors such as timing, leadership, resources and environmental conditions at the very least could spell the difference from a successful implementation of business strategies or a failure.   The previous section mentioned about the expansive focus on the strategies of multinationals from the previous developed nations – which have been stymied by the globalization and digitization of technology that enables an idea to be spread at the speed of thought throughout the world in an instant. Multinationals at this point have blurred – either deliberately or not – since the world has sensitized itself to the sins of the past which dealt with racism, prejudice and divisive behavior. Multinationals have been defined by ownership in the past although by virtue of globalization, the boundaries have blurred except for a few who remain to be very strong at certain localities particularly when location is a prime competitive advantage for the multinational company. In the past, western multinationals were very aggressive in adopting international strategies mainly for expanding their market and searching for low-cost production facilities outside their expensive factories. This still takes place particularly for labor and basic capital outlay projects that do not require much technology or infrastructure dependence such as the migration of factories into the sweat-factories of China, Tibet and Latin America. However, for multinational operations that require more coverage in terms of market, a sophisticated but lesser costing area of operations, business process outsourcing of non-core competencies, coupled with strong infrastructure but relatively accommodating legal systems – plenty of potential multinational sites fall into this category. This is the current strategy being adopted by a more sensitized developed country with multinational expansion plans – or even transplanting plans similar to when many multinationals transferred their regional headquarters from Hong Kong to Singapore before the turnover to China in 1997.   The current strategy of multinationals, both from developed and developing countries, is to be more sensitive to a globally politically correct way of setting up and dealing with its multinational efforts. Whereas the less competitive times during the early 1900’s to the 1980’s offered countries and companies to adopt industry specific strategies without regard for the others, or core-competency of business dictating economic development, versus technology driven or even human-capital competency strategy, the 2000’s offer similar but more niche areas to develop since the developed countries have led in the development of the more basic areas and that more value-added industries and activities are needed to spur the next leapfrog in world economic development.   As presented in the beginning of this section, the same business strategies may be in play but the how, in what context, who is playing the cards and other variable factors should be considered but with a similar viewpoint that Japan did after the war: it gave itself an honest appraisal of its strengths, weaknesses, opportunities and threats, plus a key factor of its strong government-business cooperation that withstood the restructuring challenges in order to attain Japan’s collective vision. In essence, the success of Mitsubishi, Sony, Toshiba, Toyota, Nissan and the other initially Japanese-born zaibatsus who are in their own right multinationals with co-owners in the United States, England, and Britain – is the success of Japan.   (iii)         Structure – Business sense dictates that the structural bias of a multinational depends largely on the purpose for which it was set up. The developing countries’ multinationals were set up vis-à-vis the legal parameters available during that time which were: agencies, sole proprietorships, partnerships and corporations. Any multinational office or branch would fall within the confines of these legal structures, differing only in the description of the main purpose in the area of operations. The usual office structure of owner and worker was embellished as time went by given the different mandates of the overseas offices. Most of them also took off from the military hierarchy where a chain of command and accountability was established for reportorial, monitoring and management purposes of satellite offices. In fact, the first multinationals were military outposts that had to be outfitted with defensive measures in case of hostilities. The evolution of this structure came to pass as the industrial revolution necessitated more productive hands, feet, and parts of a persons body that could be employed to produce a good for commerce. These were later replaced by machines and automation until the term systems became all encompassing as descriptive of monitoring and management tools.   Present day multinationals have blurred in ownerships since the strategies employed were not for mere operational efficiencies but also, as offshoot of being business entities, for tax efficiency purposes. In this sense, a multinational can be set up to be in the tax-haven areas of the Bahamas or Cayman Islands but actual operations in a low-cost Asian locale with marketing and sales in the Western hemisphere and human resource a combination of tax-haven/flexible taxation locale in South or Latin America. Regardless, the multinational is still dictated where the seat of power resides: and that is a philosophical debate this paper does not intend to discuss.   2.6         Conclusion and Research Propositions In view of the above criticisms, this thesis adopts a non-comparative approach in analyzing and examining the expansion and development of indigenous Malaysian multinational corporations. It seeks to understand the mechanism that allows the selected firms to strengthen their strategies and core competencies in order to become a respected global player. In essence, this thesis proposed (as discussed in the proposal in chapter 1) that the developing country multinational’s strategy in competing with their competitors is not solely dependent on the technology accumulation process, as has been suggested by the conventional literature on developing country multinationals, but it is also dependent on the variety of resources and other advantages enabling their growth at home and on the international level. This portion of the discussion has also shown that strategies which may have worked before for other countries and multinational corporations may not work for the emerging Malaysian multinational since other factors which are yet to be discussed in the remainder of this paper have to be seriously considered in drafting the combined strategic plan of Malaysian Multinational Incorporated.   References: 1.    Multinationals and the Developing Countries, Louis T. Wells Jr. Journal of International Business Studies, Vol, 29 Issue 1, 1998 2.    Report from Japan 1972 – Part II. Herbert P. Bix. Bulletin of Concerned Asian Scholars. Vol 4, Issue 4, 1972 3.    How MNCs choose entry modes and form alliances: the China Experience. David K. Tse, Yigang pan & Kevin Y. Au. The Journal of International Studies. Vol 28, Issue 4, 1997 4.    Uncertainty, imitation, and plant location: Japanese multinational corporations, 1990 – 1996. Witold J. Henisz & Andrew Delios. Administrative Science Quarterly. Vol 46, Issue 3, 2002 5.    Multinational Corporations. John Stopford. The Foreign Policy. Issue 113, Winter 1998 6.    Multinationals, Intracorporate Competition, and Regional Development, N.A. Phelps & C. Fuler. Economic Geography, Vol 76, Issue 3, 2000 7.    Statistics on Foreign Direct Investment and Multinational Corporations: A Survey. Anna M. Falzoni. University of Bergamo, Centro Studi Luca d’Agliano and CESPRI, May 15, 2000 8.    Foreign Direct Investment and the operations of multinational firms: concepts, history and data. Robert E. Lipsey. National Bureau of Economic Research, 2001 9.    Expansion Strategies of US multinational firms. Gordon H. Hanson. National Bureau of Economic Research, 2001 10. Foreign Direct Investment in the Restructuring of the Japanese Economy. Magnus Blomstrom, Denise Konan & Ronal E. Lipsey, National Bureau of Economic Research, 2000 11. The Development of the Japanese Steel Industry. Patricia A. O’Brien, Harvard Business School, Harvard College. 1987 12. Japan: The Meiji Restoration. Audrey T. Sproat, Harvard Business School, Harvard College, 1974 13. Japan: Confronting Economic Maturity? Patricia A. O’Brien, Harvard Business School, Harvard College, 1988 14. University of Berkeley Online Library (www.lib.berkeley.edu/)

THESIS CHAPTER 2 ON DEVELOPING COUNTRY MULTINATIONAL CORPORATIONS: A SURVEY OF THE LITERATURE REVIEW

CHAPTER 2 DEVELOPING COUNTRY MULTINATIONAL CORPORATIONS: A SURVEY OF THE LITERATURE REVIEW ...

AN ECONOMIC HISTORY OF MODERN EUROPE: SECTORAL DEVELOPMENTS, 1870-1914

AN ECONOMIC HISTORY OF MODERN EUROPE: SECTORAL DEVELOPMENTS, 1870-1914   I. INTRODUCTION Gross domestic product consists of a wide array of activities, and the structure of those activities has changed over time as the European economy has developed. Economists have long classified activities on the basis of a distinction between agriculture, industry and services, although there has been less than complete agreement on which occupations to include in each sector ( 1951). In this chapter we will follow the modern European convention of including forestry and fishing together with farming as “agriculture” and include mineral extraction together with manufacturing, construction and gas, electricity and water in “industry”. Services then covers all other activities, including transport and communications, distribution, finance, personal and professional services, and government. In 1870, most of Europe still had a majority of the labour force engaged in agriculture, although this was no longer the case in the most industrialised economies of northwest Europe. In particular, agriculture accounted for less than a quarter of the labour force in Britain. The share of the labour force in agriculture was considerably higher in southern Europe and in eastern and central Europe. Between 1870 and 1914, agriculture’s share of economic activity continued to shrink throughout Europe, but at varying rates. Of some importance in western Europe was the contrast between countries which protected their agriculture in the face of cheap imports from the New World, and countries where the agricultural interest lost out to the free trade lobby ( 1997). In many east European countries, however, it was the threat of grain invasion from Russia that was of more significance. Falling food prices and declining employment opportunities in farming led to worries about economic depression at the time, particularly in societies dominated by agriculture. However, it makes more sense to see the declining share of agriculture in employment as arising from the combination of a relatively low income elasticity of demand for food and a healthy pace of labour productivity growth due to technological progress and growing market integration. The flip side of the declining share of employment in agriculture was the rising share of industry and services. Much of the existing literature on national economies focuses on industry, with industrialisation seen as the key to economic development during this period ( 1969; 1985; 1981). A key theme here is the Second Industrial Revolution, with the development of modern industries based on scientific research, such as chemicals and electrical engineering, and involving the final steps towards genuine mass production (1990). The new technologies sometimes provided an opportunity for newly industrialising countries such as Germany or the Netherlands to leapfrog more established industrial countries such as Britain or Belgium (1997;  1994). A balanced account of European industry must also cover the less glamorous sectors such as textiles and food, drink and tobacco, as well as the countries that failed to make much headway in the process of industrialisation. Equally important, however, is the need to recognise that for many countries, services accounted for a larger share of economic activity than industry. Furthermore, a process of “industrialisation” of services was already underway, leading to high volumes of activity and high levels of productivity (2005b). In many ways, this process was linked to the Second Industrial Revolution, with high volume production in manufacturing only possible given the productivity improvements in transport and communications, distribution and finance ( 1977). However, it is important not to treat services as merely subservient to manufacturing. Many services are provided directly to consumers as well as to producers, and services matter for aggregate productivity not just because of their impact on industrial productivity, but because of their own productivity performance ( 1998). For an economy to have high living standards, it is necessary to have high productivity in all sectors. However, it is also clear that the structure of the economy matters, because value added per worker is higher in some sectors than in others. Since agriculture has historically tended to be the lowest value-added sector, the share of the labour force in agriculture turns out to be a very good predictor of per capita income. In general, European countries that remained heavily committed to agriculture remained poor, while those that reallocated labour to industry and services became better off ( 2005a). II. STRUCTURE OF THE ECONOMY Table 1 provides data on the sectoral distribution of the labour force between agriculture, industry and services for up to 20 countries in the three major regions of northwest Europe, southern Europe and central and eastern Europe. In the countries for which we have data in 1910, agriculture still accounted for around half of all employment. Our sample of countries for 1870 is smaller, but clearly indicates a larger share of employment in agriculture than in 1910. For the sample of 14 countries available in both years, the share of employment in agriculture declined from 51.7 per cent in 1870 to 41.4 per cent in 1913. Although on average, agriculture accounted for a larger share of the labour force in southern Europe than in northwest Europe in 1910, there was considerable variation across countries, with some south European countries such as France being less agricultural than some northwest European countries such as Finland. On the other hand, the share of the labour force accounted for by agriculture in the United Kingdom was as low as 22.2 percent in 1870, falling to just 11.8 per cent by 1910.On average, agriculture accounted for a still larger share of the labour force in central and eastern Europe than in southern Europe in 1910, but again there was considerable variation across countries, with Germany and Switzerland, for example, having agricultural shares more in line with many northwest European countries. As the share of the labour force in agriculture declined, the shares in industry and services increased, and this trend can also be seen in Table 1. For the fourteen country sample, industry expanded its share of employment from 26.9 to 32.3 per cent, while services increased their share from 21.4 to 26.3 per cent. Looking at the cross sectional variation in 1910, the share of industry was highest in northwest Europe and lowest in central and eastern Europe, with southern Europe occupying an intermediate position. However, as with agriculture, there was considerable crosscountry variation within each region. In the United Kingdom and Belgium, over 40 per cent of the labour force was engaged in industry in 1910, while in Bulgaria the figure was just 8.1 per cent. The share of the labour force in services in 1910 was highest in northwest Europe, lower in southern Europe and lower still in central and eastern Europe, but again with substantial variation across countries within each region. It is helpful at this point to note the relationship between these differences in the sectoral allocation of labour across sectors, and the prosperity of nations and regions. The point is perhaps most forcefully made with the help of Figure 1, showing the strong relationship between the level of per capita income and the share of the labour force in agriculture in 1913. It was already clear by this time that escaping from poverty required the reallocation of labour away from agriculture, so that modernising governments across Europe adopted industrialisation as a policy goal. However, the relationship between GDP per capita and the share of the labour force in industry was actually much less clear, as can be seen in Table 2. This table formalises the relationship between GDP per capita and the sectoral allocation of labour using regression analysis, and pooling cross sectional observations for a number of years between 1870 and 1992. The first column confirms the statistically significant negative relationship between living standards and the share of the labour force in agriculture, and also finds a significant positive relationship between GDP per capita and the share of the labour force in industry. However, notice that the fit of the equation, as measured by R2, is much weaker for industry than for agriculture. Note also that the fit becomes stronger once again in the regression of GDP per capita on the share of the labour force in services. III. AGRICULTURE 1. Opportunities and challenges Population growth and growing incomes increased the demand for agricultural products. Total consumption of calories per capita increased in some quite poor countries, such as Italy and, above all, demand shifted away from cereals towards more income-elastic goods such as livestock products in Southern Europe and fruit and vegetables in Northern Europe ( 2003a,  2005). The reduction in transport costs fostered trade in agricultural products, with a significant impact on relative prices, especially within agriculture. The real price of agricultural products remained constant, while the inter-sectoral terms of trade (the price of agricultural products relative to manufactures) improved in most countries or, at worst, remained constant ( 2002). Prices of crops (mainly cereals) declined relative to livestock in all European countries. Figures 2 and 3 show these trends in the inter-sectoral terms of trade and the relative price of crops to livestock for France, the United Kingdom and the United States. Industrialisation and modern economic growth offered opportunities of employment to farmers (or more precisely to their sons and daughters) and to agricultural capital, while scientific and technological progress provided new techniques, such as fertilisers. 2. The performance Conventional wisdom does not rate the performance of European agriculture during the period 1870-1913 very highly. However, as Table 3 shows, this view needs to be revised in the light of the quantitative evidence. The growth rate of gross output – i.e. the total production available for consumption within or outside agriculture - was quite high for the continent as a whole and also for the main regions. Although medium-term output trends were remarkably stable, production did nevertheless fluctuate quite a lot from one year to another, following the vagaries of the weather (1999). In particular, there is some statistical evidence of a slowdown in growth between 1873 and 1896 during the so-called Great Depression, although the severity of this has been somewhat exaggerated in the literature, leading one writer to coin the phrase “the myth of the Great Depression” (1969).   The country rankings of agricultural growth performance in Table 3 are also somewhat at odds with the conventional wisdom. In fact, the best growth performance by far was recorded by Russia, where production increased by a factor of 2.5 over 43 years, and the next highest increase was in the Habsburg empire. Clearly, these figures have to be considered with caution, but there is no doubt that Russia was a success story, as confirmed by the great increase in its agricultural exports (1960). Most countries increased agricultural production at a rate of around 1.0 to 1.5 per cent per annum, exceeding or keeping up with the increase in their population. In only four cases (Portugal, Greece, the Netherlands and the United Kingdom) did agricultural production per capita decline. Between 1870 and 1913, trade in primary products, which went almost entirely to Western Europe, increased by a factor of 3.5. This increase fed Britons and allowed other Western Europeans to improve their nutritional standards. 3. The proximate causes of growth: factor inputs and TFP The growth of factor inputs contributed very little to the growth of agricultural output, as can be seen in Table 4. Unfortunately, it is not possible to measure the total stock of land in use, because the data on pasture are scarce and hardly comparable across countries. However, the data on cropland and tree-crops are good enough, and they do not show any Europe-wide growth. They remained constant or even declined in Western Europe (with the possible exception of Spain) and rose by a few percentage points in the East. The same pattern holds true for labour. The number of agricultural workers increased by almost a half in Russia, increased slightly in Germany and Italy and declined, by about 10 per cent, only in the most developed countries of Western Europe. With the exception of Russia, all these movements remain well within the margins of statistical error. For one thing, the number of permanent workers may not be a good proxy for the input of agricultural labour in nineteenth century Europe. A lot of non-agricultural workers helped at peak time (e.g. during harvests), the quality of work differed according to the age, sex and skill of the worker, and the number of hours worked or the intensity of work differed by country. Furthermore, all these features may have changed over time. The evidence on these issues is scarce, but the least bad guess suggests that these biases, although important if taken separately, might cancel each other out. For instance, it seems likely that the contribution of nonagricultural workers declined, while the number of hours worked increased in France, Ireland and Belgium ( 2005). Capital is the most difficult factor of production to measure accurately. As a first approximation, an increase in total agricultural capital would be expected, as a result of the growing use of modern, capital-intensive techniques. However, fixed agricultural capital consists largely of land improvements and buildings, which are bound to grow slowly, if at all, in long-settled areas like Europe. Indeed, the few available series rule out rapid growth, with the exception of Russia (2005) Capital stock declined in the United Kingdom and rose at about 1 per cent per annum in other West European countries. The effect of the diffusion of modern techniques can be detected in the growth of purchases outside agriculture. A simple measure of these purchases is the ratio between value added (which excludes them) and gross output (which includes them). As  demonstrates, the ratio in 1913 shows quite substantial differences among countries, which tally well with the conventional wisdom about the level of technical development in each country. The combination of substantial production growth and relatively slow increase in inputs implies a healthy growth of total factor productivity (TFP). Indeed, without an increase in TFP somewhere in the world, the agricultural terms of trade, or price of agricultural products relative to industrial products, would have risen, and this was not the case. In a well-known paper, (1991) has estimated rates of TFP growth for many countries, ranging from 0.19 per cent per annum in the United Kingdom to 1.53 per cent in Germany. Several authors have produced alternative estimates, including  (2005). Although the results do not always coincide with van Zanden’s, the story is broadly the same. The average rate of TFP growth for ten countries was 0.7 per cent per annum, which corresponds to a cumulated 30 to 40 per cent increase over the 1870-1913 period (2005). The European performance compares quite favourably with that of the countries of Western Settlement over the same years, with TFP in agriculture growing at a rate of 0.2 to 0.5 per cent per annum in the United States. 4. The underlying causes of growth: technical progress or market integration? Most authors attribute growth in TFP to technical progress, and there were some important technological innovations in nineteenth century European agriculture. Fallow practically disappeared from Western Europe, with the conspicuous exception of Spain, although it remained important in the East (2000)  In Russia the cropping ratio was still as low as 0.70 (i.e. about a third of land was under fallow) on the eve of World War I ( 1930). Tools improved. In the more backward countries, such as Russia, iron ploughs substituted for traditional wooden ploughs, while in more advanced areas, better design improved performance and reduced the need for draft power. Mechanisation proceeded more slowly, making a significant breakthrough only with the introduction of tractors after World War II. Machines such as the reaper were still pulled by animals, and the only “modern” machine widely used in the European countryside in the early twentieth century was the steam thresher ( 2003b). All these innovations continued the trends of the pre-1870 period. However, there was a major breakthrough with the massive adoption of chemical fertilisers. European farmers had used imported guano and nitrates since the 1830s, and the commercial production of phosphates had started in the 1840s. However, from the 1860s, the chemical industry made available new products such as ammonium sulphate and calcium-cyanamide, at lower and lower prices. In the Netherlands, for instance, the price of fertiliser relative to rye fell by 40 per cent from the 1870s to World War I ( 1994). Fertiliser consumption per hectare increased by a factor of 13 in Germany, from 3.1 kg of nutrients per hectare in 1880 to 42 in 1913 ( 2005). Not surprisingly, consumption was much higher in the Netherlands (163 kg per hectare). Perhaps more surprisingly, Italy (13.3 kg) and even Russia (6.9 kg) consumed more fertilisers per hectare than the United States (5.8 kg). Indeed fertilisers, as a land-saving innovation, were particularly suitable for a land-scarce area such as Europe. Although surely important, technical progress does not necessarily account for the whole of the growth in TFP. Productivity growth may also have been due to the more efficient allocation of resources, as a result of the growing development of markets. This process included commercialisation and market integration (price convergence). Although we know very little about the former, there is a substantial literature on market integration, at least for wheat (1986;  2005). However, the effects of this increasing market integration on agriculture are not well explored, with the exception of  (1989) for France, who focuses largely on the pre-railway age. To what extent did integration cause relative prices to change and to what extent did production adjust via local specialisation? To be sure, there is evidence of the growth of specialised production around the cities or in some wellendowed areas, such as the South Italian and Spanish vineyards. Also, there was a modest increase in the share of livestock in total gross output, from 41 to 46 per cent, consistent with the increase in its relative price (2004). However, much more detailed data would be needed to provide a comprehensive assessment of the real impact of commercialisation and globalisation. 5. The role of institutions By and large, farmers were left to themselves. Support for technical progress, although useful, was very limited and although land reform was much debated, very little action followed, except in Ireland. Even intervention in product markets was relatively modest. This statement may seem surprising, given the conventional wisdom about the protectionist backlash to the grain invasion from the United States (1997). However, three points need to be considered. First, Russia rather than the United States was the main invader in most European markets, at least for wheat. Second, the protectionist backlash developed in only a few Continental countries and the barriers to wheat imports were not that high, especially compared with the effects of market regulations since the 1930s. Third, wheat accounted for only a small part of total output – no more than 15 to 20 per cent. The rest of agriculture was affected much less by global competition, if at all, and did not trigger any comparable reaction. Indeed the aggregate Producer Subsidy Equivalent (PSE) was in the region of 5 per cent, compared with figures around 40 per cent in the heyday of the later Common Agricultural Policy of the European Economic Community (2005). Institutions loom large in the historical literature on agriculture, more often than not in the role of the villain. Most historians blame institutions for what they perceive as the disappointing performance of European agriculture. It is argued that common property of land and traditional contracts, most notably sharecropping, hindered innovation. The process of enclosing common land in Great Britain had long finished by 1870, but a similar process was going on in Continental Europe, possibly until the early twentieth century (1980). In Russia, serfdom had been abolished only in 1861, and land ownership had typically been vested in peasant communes, the obschina or mir (1983).  (1966) famously argued that the periodic redistribution of common land prevented investment and innovation, and retarded the migration of labour from the countryside to the cities. However, this interpretation has been severely criticised by (1994), who argues that communal institutions were in practice much more flexible than appears to be the case on paper. Sharecropping is often blamed for the poor performance of Mediterranean agriculture ( 1968). Landlords are said to have been more interested in accumulating land than in making productivity-increasing investments, while tenants were too poor to risk anything. The empirical evidence for this statement is, however, very thin. The failed adoption of innovations such as British “new husbandry” can be explained by environmental factors, while admittedly crude econometric tests fail to find any effect of contracts on productivity (1994) 1986) Note that in seeking to assess the importance of institutions, it is not appropriate simply to contrast the different growth rates of agricultural output in Russia and Britain, which are usually seen as the most backward and the most modern countries, respectively. First, the catching-up perspective suggests that we should expect a negative relationship between the growth rate and the starting level of productivity. Since Britain had the highest level of agricultural labour productivity in Europe in 1870, slow productivity growth was only to be expected. Similarly, the low initial level of productivity in Russia opened up the opportunity of rapid catching-up growth. Second, institutions are only one possible reason for the failure of a country to catch-up, with other factors such as land quality and economic policy also playing their part. IV. INDUSTRY 1. Europe’s industrial production, 1870-1913 Industrial production generally grew faster than GDP in Europe between 1870 and 1913, as Europe developed, and agriculture declined in relative importance. Table 5 presents data on the average annual growth rate of industrial production by countries grouped together in the main regions. The scope for rapid catching-up growth was greater in the less developed parts of Europe, which in 1870 had still not embarked upon the development of modern industry. In eastern and central Europe, Germany, Austria-Hungary and Russia all recorded rapid growth rates of industrial output as they began the process of catching-up on Britain, the most highly developed country in Europe. In northwestern Europe, the Netherlands and Sweden also began a sustained period of industrial development from around 1870. However, being backward is not sufficient for the achievement of rapid industrial growth, and many relatively poor countries, particularly in southern Europe, recorded relatively unimpressive rates of industrial output growth. It is therefore important to consider both levels and growth rates when assessing economic performance. Russia, for example, shows rapid industrial growth after 1870, but starting from an extremely low level of industrialisation. In Table 6, we thus see that despite this very rapid industrial growth after 1870, Russia had still reached only 15 per cent of the UK level of industrialisation on a per capita basis by 1900. By 1913, this had crept up only to 17.4 per cent, because the level of industrialisation was growing in Britain as well as in Russia, and part of the more rapid output growth in Russia reflected population expansion. Table 6 provides a good summary of the industrial development gradient within Europe, with the UK the most heavily industrialised country and with Belgium, France and Switzerland also substantially more heavily industrialised than Europe as a whole throughout the whole period 1860-1913. Sweden and Germany started the period with below average levels of per capita industrialisation, but ended it with significantly above average levels. Although per capita industrialisation increased in all countries, the level remained relatively low in much of Europe. European industrialisation can thus be thought of as geographically concentrated in a series of Marshallian districts. Marshall [1920] explained the spatial concentration of industrial production through external economies of scale, which he attributed to learning (knowledge spillovers between firms), matching (thick markets making it easier to match employers and employees) and sharing (giving firms better access to customers and suppliers in the presence of significant transport costs) (1994) One potential explanation for these patterns is simply geographical, with an important role for natural resource endowments. In particular, it would be difficult to understand patterns of industrial location at this time without taking into account mineral deposits. Put simply, much industrial development in the age of iron and steam took place around coal and ore fields, although this is not always particularly well captured by the boundaries of nation states (1981). However, the period after 1870 also saw the development of a new scientific approach to industry, which began a process of freeing industry from the constraints of location around natural resource deposits. This was most obvious in the development of wholly new industries such as synthetic dyestuffs, based on new chemical processes, or electrical goods, based around a new source of energy ( 1990;  1969). However, it also affected many old industries, such as brewing, where research could improve both processes and products, and iron, where research led to the utilisation of new ores and the production of better products, such as varieties of steel. Also, the development of “mass production” in engineering industries on the basis of the assembly of interchangeable parts, allowed the possibility of substituting machinery for skilled craft labour, threatening the position of established producers and creating opportunities for newly industrialising nations without a large stock of experienced workers. The “Second Industrial Revolution” thus offered countries with little previous industrial experience the opportunity to replace established producers through the more rapid development and adoption of new technology. 2. Performance of countries and regions The United Kingdom was Europe’s most industrialised country in 1860, in terms of the absolute level of production as well as on a per capita basis. However, Britain’s position was actually more vulnerable than is often appreciated. For, as (1985) notes, Britain’s achievement during the Industrial Revolution was not so much the achievement of high productivity in industry as the redeployment of labour away from agriculture in a large but still quite labour-intensive industrial sector. Britain had a very dominant position in world export markets in a small number of products, such as cotton textiles, iron and coal. Britain’s position was most obviously challenged during the period 1870-1913 by Germany and the United States. The challenge was most successful in heavy industry, where the scientific methods of the Second Industrial Revolution were developed. However, as  (1997) notes, there has been a tendency to overstate any failings in British industry at this time, and to ignore success stories. First, comparative labour productivity in manufacturing as a whole changed little between the three major industrialised countries of Britain, the United States and Germany during the period 1870-1913. So the proximate cause of the faster industrial output growth in Germany compared with Britain was simply the faster growth of the labour input, with labour productivity in Britain and Germany remaining broadly equal. Labour productivity in manufacturing in both countries remained substantially lower than in the United States, where higher labour productivity has usually been attributed to labour scarcity and natural resource abundance, leading already by the mid-nineteenth century to the development of a machine intensive technology that was not well suited to European conditions ( 1962; 1997). Second, although Germany did very well in a number of heavy industries, such as chemicals and iron and steel, where labour productivity was higher than in Britain, and where Germany took an impressive share of world export markets by 1913, there were also lighter industries such as textiles and food, drink and tobacco, where Britain retained a substantial productivity advantage and remained strong in world export markets (2005). In the case of shipbuilding, Britain even displaced the United States to become the world’s major producer as the industry moved from wood and sail to iron and steam ( 1979). The traditional view of French industry during the late nineteenth century was that it was relatively backward and, in contrast with Germany, failed to catch up with Britain (1964; 1969;  1977). Nevertheless, this generally negative assessment of French industrial performance was tempered by the fact that the pace of industrial output growth picked up after 1895, particularly in sectors based on the new technologies of the Second Industrial Revolution, such as electrical engineering, electro-metallurgy, electro-chemicals and motor vehicles (1977, 1979;1989)  However, the revisionist views of  (1978), who claimed that levels of industrial labour productivity were higher in France than in Great Britain for most of the nineteenth century, surely went too far in rehabilitating French industrial performance. Taking both output and employment from census sources,  (2004) finds that in 1906, output per worker in French industry was just 74.1 per cent of the British level. The French may have found an alternative path to the twentieth century, based on small family firms catering to niche markets, but it was not without its costs in terms of living standards ( 1978 ;1979) Most studies of Austria-Hungary emphasise the wide variation in the levels of economic development within the imperial territories. Austria (Cisleithania) was generally more industrialised than Hungary (Transleithania), but industry was far from evenly spread even within Austria ( 1977; 1981;  1983; 1984). Thus the Alpine lands and the Czech lands were much more developed than Galicia in the north and the Italian and Slavonic provinces in the south ( 1981). Viewed as a whole, Austria-Hungary had a relatively low level of industrialisation per capita, as can be seen in Table 6, but the Empire nevertheless produced a significant share of Europe’s industrial output on account of its size. Although early quantitative research indicated a very rapid growth rate of industrial output in the Austrian part of the Empire, subsequent research has modified this picture. Whereas  (1976) suggested an industrial growth rate of 3.8 per cent per annum for the period 1870-1913, the addition of a wider range of industries and the use of improved value added weights has reduced this to 2.5 per cent ( 1983;  2000). Allowing for a faster rate of growth in Hungary, however, produces a rate of industrial growth for the Empire as a whole of 2.8 per cent per annum, reported here in  ( 2000). The downward revision of the industrial growth rate by the later researchers was concentrated particularly in the period before 1896, leading to an unfortunate resurrection of the use of the term “Great Depression” for a period when output did not fall but continued to grow (1978; 1978). The catching-up perspective leads to the expectation that Austria-Hungary should have been experiencing rapid industrial growth to catch up with the leading European industrial nations at this time. From this perspective, Austria-Hungary clearly under-performed during the period 1870-1913. We have already noted in our discussion of Table 6 that Russia was a very backward economy in the mid-nineteenth century, so the rapid rate of industrial growth exhibited by Russia during the period 1870-1913 in Table 5 conforms to the predictions of the catching-up framework. Indeed, no other European country experienced such rapid industrial growth, which was generally of the order of 5 per cent per annum, with a particularly strong spurt during the 1890s. The experience of Tsarist Russia led  (1962) to formulate a number of propositions concerning the link between backwardness and economic development. These included a greater role for the state, substituting for the lack of private entrepreneurship, a greater focus on capital goods industries to get around the lack of consumer demand, a greater role for banks in directing scarce capital into industrial projects, and a greater role for imported technology. Gerschenkron placed little weight on the role of agriculture, which he saw as almost immune to change in backward societies. Although some of Gerschenkron’s generalisations do seem to fit the Russian case well, others have not stood up so well to quantitative scrutiny. The state did play a role in fostering industrialisation, fearing that Russia would lose its great power status without reform, and up-to-date technology was imported from abroad ( 1972). However, consumer goods such as textiles and foodstuffs accounted for a large share of industrial production, and banks did not play a decisive directing role in these industries (1986). Furthermore,  (1982) data suggest that agriculture made a significant contribution to Russian development through productivity growth (1986) Even more than Austria-Hungary, Russia remained an important European producer of industrial goods despite its relatively low level of per capita industrial production, because of its large size in population and territory. The catching-up perspective suggests that we should expect a similar performance from the countries of the northern and southern peripheries of Europe. In we see that per capita levels of industrialisation in Italy and Iberia were similar to levels in Scandinavia in 1860. Industrial growth rates in Table 5, however, were much higher in the Scandinavian countries than the Mediterranean countries. In particular, Sweden stands out as having experienced a very rapid phase of industrial growth, achieving a level of industrialisation by 1913 that was on a par with the European core. This represents a notable case of leap-frogging on the basis of the technologies of the Second Industrial Revolution, drawing particularly on Sweden’s abundant supply of hydro-electric power ( 1981). All the Scandinavian economies became significant exporters of timber and wood products, and benefited from the replacement of rags by wood pulp as the major raw material in paper manufacturing (1997). The relatively slow overall rate of industrial growth in Italy and Iberia masks some regional sparks of industrial development. The most important Mediterranean growth spurt was in northern Italy from the 1890s, in a triangle between Genoa, Milan and Turin, and based again on hydro-electric power ( 1981). There were also some stirrings of industrial growth in Spain, but based largely on traditional industrial products such as cotton textiles in Catalonia and iron and steel in the Basque region (1977:) The Balkan countries remained the least industrialised throughout the period (1997) 3. Developments in particular branches Industry covers a wide range of activities, and we now dig down below the aggregates of industrial production to survey briefly a number of important sectors, highlighting the contributions of the major European producers. We begin with coal, the major source of energy in the age of steam, but which was being increasingly challenged by the rise of electricity. As noted earlier, industry was heavily concentrated around coalfields during the nineteenth century, so it is not surprising to see in Table 7 that Britain was Europe’s major coal producer throughout the period. Germany was Europe’s second most important producer of coal at this time, with production growing more rapidly than in Britain. Belgium, a very small country but an early industrialiser, was overtaken by Germany, France and Russia as these much larger countries industrialised. Although coal production also grew rapidly in Austria- Hungary, it remained behind Belgium throughout the period, despite its much greater size. Although Britain remained Europe’s largest coal producer, and increased output significantly, labour productivity stagnated, with technological and organisational changes such as the replacement of bord and pillar working by longwall working methods, the mechanisation of cutting, loading, conveying and winding, merely offsetting diminishing returns, as pits were sunk ever deeper and coal was mined further from the pithead (1990). German growth was more rapid, and driven by bank finance, but allegations of entrepreneurial failure for the British industry as a whole, rather than for individual pit-owners, are probably wide of the mark in an industry described by (1984) as being as close as it is possible to get in practice to perfect competition (1971;  1971). Although European production was still increasing, coal from the New World was already being mined in more favourable geological conditions and taking an increasing share of world production ( 1954: 107). In iron and steel, major technological developments drew on science, with wrought iron increasingly replaced by varieties of mass-produced steel, following the introduction of the Bessemer process in 1856, the Siemens-Martin (open hearth) process in 1869, and the Thomas (basic) process in 1879 (1954). The general picture of Germany leap-frogging Britain is illustrated in Table 7, which shows output of pig iron among Europe’s main producers. Allegations of entrepreneurial failure in Britain have again been overdrawn, since account must be taken of iron ore endowments and demand side factors such as protective barriers raised in the rapidly growing markets of Germany and the United States, combined with Britain’s continued free trade policy (1971;1991). The Russian growth spurt of the 1890s is also evident, with Russia overtaking France before the French forged ahead again after 1900. During the period 1895-99, around 60 per cent of Russian iron and steel production was supplied to the railways, while the French boom was more oriented towards higher grade steels (1986 ;1979)  Austria-Hungary was also a major iron and steel producer despite a low per capita level of industrialisation. Like Russia, Austria-Hungary was dependent on the large home market, with a railway construction boom providing a substantial boost to demand ( 1977). During the period 1870-1914, the chemical industry was transformed on the basis of scientific research. The production of inorganic products such as soda ash, sulphuric acid and sodium sulphate, that had been produced on an industrial scale since the early nineteenth century, was revolutionised by new processes such as the replacement of the Leblanc process by the Solvay process in soda ash, and the introduction of electricity as an important agent in chemical processes (1954)  However, of even more significance for the long run development of the industry was the synthesis of organic (carbon-based) products, such as dyestuffs, pharmaceuticals, perfumes and photographic chemicals ( 1954). Since the synthesis of organic products needed large quantities of inorganic chemicals, the production of sulphuric acid in Table 7 can be taken as an indicator of the general state of Europe’s national chemical industries ( 1954)  As in other heavy industries, Germany overtook Britain, although the scale of the German advantage towards the end of the period is understated, since Germany was much more dominant in organic products, where Switzerland was the only serious competitor. In synthetic dyestuffs, for example, Germany produced 85.1 per cent of world output in 1913 (1954:). The finding by  (1971) that Britain hung on to the Leblanc process after it was profitable to switch to the Solvay process is consistent with (1971) contention that competition generally ensured the adoption of the profit-maximising technology in pre-1914 Britain, since the soda ash industry was subject to a cartel. The chemical industry remained relatively underdeveloped in eastern Europe, with neither Russia nor Austria-Hungary featuring among the major producers. Small, relatively rich countries such as Belgium and the Netherlands were also significant producers, alongside France, while Italy showed strong growth from the 1890s. The Industrial Revolution began in cotton textiles, which continued to be an important branch of European industry until 1914. Britain remained the largest producer in the world despite some inevitable loss of market share as other countries industrialised ( 1974). The switch from mules to rings in spinning and from the powerloom to the automatic loom in weaving removed some of the skill from the production process, and enabled countries with a less skilled but cheaper labour force to compete with Britain, in line with V (1966) product cycle model. Seen from this perspective,  (1986) forceful allegations of British failure in cotton textiles are surprising, and it would seem more appropriate to ask how the British managed to hang on to such a large market share for so long ( 1987).  (2002) emphasise the importance of external economies of scale in this industry that was highly localised in Lancashire, but consisted of around 2,000 spinning and weaving firms and another 1,000 merchant companies involved in marketing. The product cycle perspective also helps to understand the high output figures achieved towards the end of the period in low-wage countries such as Russia and Austria-Hungary, with Russia almost catching-up on Germany, and with Austria- Hungary ahead of Italy and not too far behind France (1986;1977) The home market was more important for the food, drink and tobacco sector, although even here tradability was increasing with urbanisation and the emergence of a substantial urban working class demanding more processed foodstuffs. Data on beer production are available on a consistent basis in Table 7, and suggest a strong link to home market size and per capita income, with the highest levels of production and consumption in Germany and Britain, and with substantial production also in Austria- Hungary, France and Russia. Although possibilities of transporting such a heavy and perishable product were limited, a small country such as Belgium was able to export to a number of neighbouring countries. Of course, it must be borne in mind that France produced large quantities of wine for export as well as for home consumption, so that more general data on production of alcoholic drinks would show a much bigger contribution from the Mediterranean countries, including Italy, Spain and Portugal (2002). V. SERVICES 1. Europe’s service sector output, 1870-1914 Most economic histories of the period 1870-1914 pay little attention to services, apart from railways and banks, which are seen as supporting industry. The national accounting approach allows us to place the contributions of the railways and banks in the wider context of the service sector as a whole, and to bring out the contributions to consumers as well as to industrial producers. Railways moved people and agricultural produce as well as industrial goods, and it was not the sole purpose of banks to provide cheap loans to heavy industry. Furthermore, in addition to transport and communications and finance, services also comprised the important sectors of distribution, professional and personal services and government. 2. Regional developments The most highly developed service sectors were in northwest Europe, particularly in Britain and the Netherlands, where high productivity was achieved in the specialised and standardised supply of services in a highly urbanised environment. In sectors where international trade was possible, this played an important role in increasing the size of the market and allowing economies to benefit from the division of labour. High productivity required the “industrialisation” of services, involving a transition from customised, low-volume, high-margin business organised on the basis of networks, to standardised, high-volume, low-margin business with hierarchical management (2005b). In some sectors, such as shipping, and insurance, this involved the emergence of large firms in classic Chandlerian fashion, but in others, such as investment banking, it involved Marshallian external economies of scale for the financial districts of London and Amsterdam, on the basis of large numbers of small firms ( 2002; 2004) Large firms also grew in importance in a number of sectors where international trade was impractical, such as retail distribution, retail banking and the railways. Germany was a land of contrasts. Although it contained some modernised service sectors such as the railways and the universal banks, which have been highlighted in the literature, the continued importance of agriculture and the associated low levels of urban agglomeration limited the extent of the market for specialised services. Distribution remained dominated by small wholesalers and retailers, and although  (1962) focused on the role of the universal banks in directing funds into heavy industry, a balanced overview of the banking sector as a whole has to take account of the public savings banks (Sparkassen), credit co-operatives, mortgage banks and other small institutions that made up the banking sector, and which pulled down the average productivity performance of the German banking sector, with municipal control often leading to the sacrifice of profits for social objectives and the ambitions of local politicians (2002;2004) The service sector in Italy during the late nineteenth century bears a certain resemblance to its German counterpart, with the railways playing an important role in the unification of a new state that was keen to foster modernisation, and with universal banks channelling resources into heavy industry ( 1977)  However, recent research has tended to play down the contribution of these two sectors to economic growth, with (2001) pointing out that Italy’s per capita railway mileage was still only one-half that of France in 1913, and with  (1998) claiming that Italy’s universal banks tended to support large, established companies rather than provide venture capital to small, promising firms. The existing literature on services in the Habsburg Empire is also heavily oriented towards the railways and the banks. The Austro-Hungarian railway system was one of the largest in Europe, although this owed more to geography than high levels of economic development. Indeed, the railways were mostly single tracks with fewer sidings, used fewer locomotives and had a lower ratio of carried freight to the length of railways than in the rest of Europe (1977). In  (1962) work, the banks are seen as playing an important role in mobilising capital for industry and the railways. However, although there were a number of large joint-stock banks, particularly in Cisleithania, banks became less involved in financing investment in industry and the railways after the crash of 1873 ( 1976). After this date, the state and foreign capital played a greater role (1977). 3. Developments in particular sectors Table 8 provides some indicators of activity in Europe’s transport and communications sector on the eve of World War I. Railways are often seen as playing an important role in integrating national economies in the nineteenth century, and were in many cases actively promoted by governments seeking to speed up the process of industrialisation (1962). The largest railway systems were inevitably in the countries covering the largest geographical area, with central and eastern Europe claiming the three largest systems within the empires of Russia, Germany and Austria-Hungary. Western Europe was more fragmented politically, with the next largest systems being in France, the United Kingdom and Italy. To assess the economic significance of the American railways, (1964) proposed the concept of social savings. For freight traffic, this is calculated as the extra cost of transporting the quantity of freight shipped on the railways by the next best alternative. Where a good alternative existed, such as canals in the US case, the social saving was shown by Fogel to be relatively modest when expressed as a share of GNP. Fogel saw this as breaking the “axiom of indispensability” of the railways for US economic growth.  (1983) provides a survey of social savings estimates for a number of European countries, reproduced here in Table 9. A number of conclusions can be drawn from these estimates. First, the estimates conform broadly to Fogel’s pattern of relatively small social savings where a good system of inland waterways existed, such as in Belgium, England and Wales, France, Germany and Russia. However, social savings were much larger where there was no good system of inland waterways, such as in Spain, although even Spanish social savings were dwarfed by the case of Mexico, where railways do seem to have been indispensable. Second, the social savings of the railways increased over time, due to technological progress, which led to freight rates on the railways falling relative to freight rates on inland waterways. There was no scope for international competition in railways, so that relatively under-developed countries in Eastern Europe had the largest systems on account of their geographical size. In shipping, however, international competition was possible, allowing the most efficient providers to gain market share. Data on the net tonnage of the main European merchant fleets are shown in . By far the most successful nation in shipping was the United Kingdom, which operated around 35 per cent of the world merchant net tonnage throughout the period 1870-1913 ( [1914]). The next largest shipping nation was Germany, with less than 10per cent of world net tonnage, while the third largest owner of merchant tonnage was Norway. Indeed, the Scandinavian countries, despite their relatively small populations, revealed a strong comparative advantage in shipping at this time. Although Britain was being challenged by Germany and the United States in the scheduled liner business, the most industrialised part of the shipping sector, Britain’s position remained very strong in the more entrepreneurial tramping business ( 2005;  1995). Turning to telecommunications, international competition was not possible at this time, so that population and income per capita were the main determinants of the level of activity, as with the railways. The highest levels of activity, visible in were in the rich, large countries of Britain, France and Germany, but the poorer large countries such as Russia, Austria-Hungary and Italy also show large volumes of business. By 1913, telephones were becoming more common, and there is some evidence to suggest that public sector telecommunications monopolies delayed the development of the telephone system to protect their investments in the older telegraph technology. Britain’s position in telecommunications therefore looks less impressive if telephone calls are included with telegrams (1994;2005)  provides some indicators of activity in finance and distribution in 1913. Financial activity is represented by banknotes in circulation and commercial bank deposits. Since estimates for individual countries are in national currencies, it is necessary to convert them to a common currency to make international comparisons, in this case in terms of 1913 US dollars. Again population size and per capita income are important determinants of activity. However, per capita income has a negative effect on the circulation of banknotes but a positive effect on the scale of bank deposits. This means that the degree of financial intermediation increases with the level of economic development ( 1987). Hence large, backward economies such as Russia and Austria-Hungary have high levels of banknote circulation, whilst even small but highly developed economies such as Belgium have quite high commercial bank deposits. Note that the United Kingdom, with the most highly developed financial sector, had very high levels of commercial bank deposits but very low levels of banknote circulation. The City of London established a dominant position at the centre of world finance in the second half of the nineteenth century, which it retained until after World War I, despite challenges from Berlin and Paris as well as New York ( 1969; 1995). To capture levels of activity in distribution, it is necessary to turn to indirect indicators such as the level of exports and domestic consumption of agricultural and manufactured products. Table 10 provides comparative data on merchandise exports. The most successful European exporters were the United Kingdom, Germany and France, whose exports dwarfed those of the large eastern economies, Russia and Austria-Hungary. Even the small nation of Belgium had exports that were larger than Austria-Hungary’s and close to the Russian level. Furthermore, if re-exports were to be added in, the Netherlands would also feature as a major international wholesale distributor, on account of its links with Indonesia. While wholesale distribution tended to remain in the hands of entrepreneurial merchant houses, the process of industrialising services went further in retailing, which saw the emergence of large scale organisations, including co-operative societies as well as department stores and multiple (or chain) stores ( 2005; 1992; 1954). This shift towards large-scale distribution was dependent on the process of urbanisation, and therefore proceeded more rapidly in industrialised areas than in more rural societies. There is less that can be said quantitatively about personal and professional services and government, and these parts of the economy will not be discussed in detail here. However, the provision of education is discussed in the chapter on population, in the context of human capital formation, while the role of government is considered more fully in the chapter on aggregate growth. VI. CONCLUSION This chapter reminds us that GDP consists of a wide variety of activities, and that prosperity depends both on achieving high productivity in each sector and on allocating resources efficiently across sectors. In general, we find that within Europe between 1870 and 1914, achieving high productivity overall required shifting labour out of agriculture and into industry and services. Although the literature has tended to focus on industrialisation as the main way out of economic backwardness, the growth and modernisation of the service sector was of at least equal importance. Indeed, much of the process of achieving high productivity in services required a kind of “service sector industrialisation”, with provision on a high volume basis, in a standardised form, using modern technology, overseen by hierarchical management. The discussion of individual sectors is organised around the catching-up framework, with low-productivity countries at the start of the period facing opportunities to grow rapidly by borrowing technology and organisational forms from high-productivity countries. However, the mere existence of an opportunity does not guarantee that catching-up will occur, and Europe’s economic history reminds us that backwardness can persist. This can be related to institutions, and in particular to the failure of institutional reforms to enable a country to take advantage of the potential for catching-up. However, we must be careful not to use institutions simply as a device to plug gaps in our knowledge. Breaking down economic activity by sector is one way of doing this, because it also suggests other factors, such as resource endowments for differences in performance between countries. Thus, for example, there can be no doubt that not having coalfields was a serious impediment to high productivity in the coal mining industry. And since coal was a major source of power, its availability was bound to affect the performance of countries in energy intensive sectors such as steel. Hence we do not need to appeal to institutional problems to explain why, for example, Portugal was not a major force in heavy industry.

AN ECONOMIC HISTORY OF MODERN EUROPE: SECTORAL DEVELOPMENTS, 1870-1914

AN ECONOMIC HISTORY OF MODERN EUROPE: SECTORAL DEVELOPMENTS, 1870-1914 I. INTRODUCTION Gross domestic product consists of a wide...