Ha-Joon Chang - Economics - The User's Guide

The development of capitalism began to accelerate around 1870. Clusters of new technological innovations emerged between the 1860s and the 1910s, resulting in the rise of the so-called heavy and chemical industries: electrical machinery, internal combustion engines, synthetic dyes, artificial fertilizers, and so on. Unlike the technologies of the Industrial Revolution, which had been invented by practical men with good intuition, these new technologies were developed through the systematic application of scientific and engineering principles. This meant that, once something was invented, it could be replicated and improved upon very quickly.

In addition, organization of the production process was revolutionized in many industries by the invention of the mass production system. The use of a moving assembly line (conveyor belt) and interchangeable parts dramatically lowered production costs. This system of production is the backbone (if not the entirety) of our production system today, despite frequent talks of its demise since the 1980s.

During its ‘high noon’, capitalism acquired the basic institutional shape that it has today – the limited liability company, bankruptcy law, the central bank, the welfare state, labour laws and so on. These institutional shifts came about basically because of the changes in underlying technologies and politics.

Recognizing the growing need for large-scale investments, limited liability, hitherto reserved only for privileged firms, was ‘generalized’ – that is, granted to any firm that met some minimum conditions. Enabling unprecedented scales of investment, the limited liability company became the most powerful vehicle for capitalist development – Karl Marx, spotting its enormous potential before any self-appointed cheerleader of capitalism, called it ‘capitalist production in its highest development’.

Before the 1849 British reform, the bankruptcy law focused on punishing the bankrupt businessman, with a debtors’ prison in the worst case. New bankruptcy laws, introduced in the second half of the nineteenth century, gave failed businessmen a second chance by allowing them not to pay interest to creditors while they were reorganizing their business (as in Chapter 11 of the US Federal Bankruptcy Act, introduced in 1898) and by forcing the creditors to write off parts of their debts. Being a businessman became far less risky.

With larger companies came larger banks. The risk was then heightened that the failure of one bank could destabilisze the whole financial system, so central banks were set up to deal with such problems by acting as the lender of last resort, starting with the Bank of England in 1844.

With increasing socialist agitation and reformist pressures in relation to the condition of the working class, a raft of welfare and labour legislations were implemented from the 1870s: industrial accident insurance, health insurance, old age pensions and unemployment insurance. Many countries also banned the employment of younger children (typically, those under ten to twelve) and restricted the working hours of older children (initially only to twelve hours!). They also regulated the working conditions and hours of women. Unfortunately, this was done not out of chivalry but out of contempt for women. Unlike men, it was believed, women lacked full mental faculties and therefore could sign a labour contract that was disadvantageous to them – they needed to be protected from themselves. This welfare and labour legislation took the roughest edges off capitalism and made a lot of poor people’s lives better – if only slightly at the beginning.

These institutional changes promoted economic growth. Limited liability and debtor-friendly bankruptcy laws reduced risk involved in business activities, thereby encouraging wealth creation. Central banking, on the one hand, and labour and welfare legislations, on the other, also helped growth by enhancing, respectively, economic and political stability, which increased investment and thus growth. The growth rate of per capita income in Western Europe accelerated during this ‘high noon’ from 1 per cent during 1820–70 to 1.3 per cent during 1870–1913.

The ‘high noon’ of capitalism is often described as the first age of globalization, that is, the first time in which the whole world economy was integrated into one system of production and exchange. Many commentators attribute this outcome to the liberaleconomic policies adopted during this period, when there were few policy restrictions on cross-border movements of goods, capital and people. This liberalism on the international front was matched by the laissez-faireapproach to domestic economic policy (see the box below for definitions of these terms). Allowance of maximum freedom for business, pursuit of a balanced budget(that is, the government spending exactly as much as it collects in taxes) and the adoption of the Gold Standard were the key ingredients, they say. Things were, however, far more complicated.

‘LIBERAL’: THE MOST CONFUSING TERM IN THE WORLD?

Few words have generated more confusion than the word ‘liberal’. Although the term was not explicitly used until the nineteenth century, the ideas behind liberalismcan be traced back to at least the seventeenth century, starting with thinkers like Thomas Hobbes and John Locke. The classical meaning of the term describes a position that gives priority to freedom of the individual. In economic terms, this means protecting the right of the individual to use his property as he pleases, especially to make money. In this view, the ideal government is the one that provides only the minimum conditions that are conducive to the exercise of such a right, such as law and order. Such a government (state) is known as the minimal state. The famous slogan among the liberals of the time was ‘laissez faire’ (let things be), so liberalism is also known as the laissez-faire doctrine.

Today, liberalism is usually equated with the advocacy of democracy, given its emphasis on individual political rights, including the freedom of speech. However, until the mid-twentieth century, most liberals were not democrats. They did reject the conservative view that tradition and social hierarchy should have priority over individual rights. But they also believed that not everyone was worthy of such rights. They thought women lacked full mental faculties and thus did not deserve the right to vote. They also insisted that poor people should not be given the right to vote, since they believed the poor would vote in politicians who would confiscate private properties. Adam Smith openly admitted that the government ‘is in reality instituted for the defence of the rich against the poor, or of those who have some property against those who have none at all’. [38] A. Smith, An Inquiry into the Nature and Causes of the Wealth of Nations (Oxford: Clarendon Press, 1976), p. 181.

What makes it even more confusing is that, in the US, the term ‘liberal’ is used to describe a view that is the left-of-centre. American ‘liberals’, such as Ted Kennedy or Paul Krugman, would be called social democrats in Europe. In Europe, the term is reserved for people like the supporters of the German Free Democratic Party (FDP), who would be called libertariansin the US.