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

Many people consider economic history, or the history of how our economies have evolved, especially pointless. Do we really need to know what happened two, three centuries ago in order to know that free trade promotes economic growth, that high taxes discourage wealth creation or that cutting red tape encourages business activities? Aren’t these and other economic wisdoms of our time all propositions derived from logically airtight theories and checked against a vast amount of contemporary statistical evidence?

The majority of economists agree. Economic history used to be a compulsory subject in graduate economics training in most American universities until the 1980s, but many of them don’t even offer courses in economic history any more. Among the more theoretically oriented economists, there is even a tendency to consider economic history at best as a harmless distraction, like trainspotting, and at worst as a refuge for the intellectually challenged who cannot handle ‘hard’ stuff like mathematics and statistics.

However, I present my readers with a brief (well, not so brief) history of capitalism because having some knowledge of that history is vital to fully understanding contemporary economic phenomena.

History affects the present – not simply because it is what came before the present but also because it (or, rather, what people think they know about it) informs people’s decisions. A lot of policy recommendations are backed up by historical examples because nothing is as effective as spectacular real-life cases – successful or otherwise – in persuading people. For example, those who promote free trade always point out that Britain and then the US became the world’s economic superpowers through free trade. If they realized that their version of history is incorrect (as I will show below), they might not have such conviction in their policy recommendations. They would also find it harder to persuade others.

History also forces us to question some assumptions that are taken for granted. Once you know that lots of things that cannot be bought and sold today – human beings (slaves), child labour, government offices – used to be perfectly marketable, you will stop thinking that the boundary of the ‘free market’ is drawn by some timeless law of science and begin to see that it can be redrawn. When you learn that the advanced capitalist economies grew the fastest in history between the 1950s and the 1970s, when there were a lot of regulations and high taxes, you will immediately become sceptical of the view that promoting growth requires cuts in taxes and red tape.

History is useful in highlighting the limits of economic theory. Life is often stranger than fiction, and history provides many successful economic experiences (at all levels – nations, companies, individuals) that cannot be tidily explained by any single economic theory. For example, if you only read things like The Economist or the Wall Street Journal , you would only hear about Singapore’s free trade policy and its welcoming attitudes towards foreign investment. This may make you conclude that Singapore’s economic success proves that free trade and the free market are the best for economic development – until you also learn that almost all the land in Singapore is owned by the government, 85 per cent of housing is supplied by the government-owned housing agency (the Housing Development Board) and 22 per cent of national output is produced by state-owned enterprises (the international average is around 10 per cent). There is no single type of economic theory – Neoclassical, Marxist, Keynesian, you name it – that can explain the success of this combination of free market and socialism. Examples like this should make you both more sceptical about the power of economic theory and more cautious in drawing policy conclusions from it.

Last but not least, we need to look at history because we have the moral duty to avoid ‘live experiments’ with people as much as possible. From the central planning in the former socialist bloc (and their ‘Big Bang’ transition back to capitalism), through to the disasters of ‘austerity’ policies in most European countries following the Great Depression, down to the failures of ‘trickle-down economics’ in the US and the UK during the 1980s and the 1990s, history is littered with radical policy experiments that have destroyed the lives of millions, or even tens of millions, of people. Studying history won’t allow us to completely avoid mistakes in the present, but we should do our best to extract lessons from history before we formulate a policy that will affect lives.

If you have been persuaded by any of the above points, please read through the rest of the chapter, in which a lot of the historical ‘facts’ that you thought you knew may be challenged and thus the way you understand capitalism hopefully transformed at least a little bit.

Tortoise vs. Snails: the World Economy before Capitalism

Western Europe grew really slowly . . .

Capitalism started in Western Europe, especially in Britain and the Low Countries (what are Belgium and the Netherlands today) around the sixteenth and the seventeenth centuries. Why it started there – rather than, say, China or India, which had been comparable to Western Europe in their levels of economic development until then – is a subject of intense and long-running debate. Everything from the Chinese elite’s disdain for practical pursuits (like commerce and industry) to the discovery of the Americas and the pattern of Britain’s coal deposits has been identified as the explanation. This debate need not detain us here. The fact is that capitalism developed first in Western Europe.

Before the rise of capitalism, the Western European societies, like all the other pre-capitalist societies, changed very slowly. The society was basically organized around farming, which used virtually the same technologies for centuries, with a limited degree of commerce and handicraft industries.

Between 1000 and 1500, the medieval era, income per capita, namely, income per person, in Western Europe grew at 0.12 per cent per year. [26] A. Maddison, Contours of the World Economy , 1–2030 AD (Oxford: Oxford University Press, 2007), p. 71, table 2.2. The long-term historical growth figures in the next few paragraphs are also from the same source. This means that income in 1500 was only 82 per cent higher than that in 1000. To put it into perspective, this is a growth that China, growing at 11 per cent a year, experienced in just six years between 2002 and 2008. This means that, in terms of material progress, one year in China today is equivalent to eighty-three years in medieval Western Europe (which were equivalent to three-and-a-half medieval lifetimes, as the average life expectancy at the time was only twenty-four years).

. . . but its growth was still faster than elsewhere in the world Having said all this, growth in Western Europe was still a sprint compared to those in Asia and Eastern Europe (including Russia), which are estimated to have grown at one-third the rate (0.04 per cent). This means that their incomes were only 22 per cent higher after half a millennium. Western Europe may have been moving like a tortoise, but other parts of the world were like snails.

In the sixteenth century, capitalism was born. But its birth was so slow that we cannot easily detect it from the numbers. During 1500–1820, the growth rate of per capita income in Western Europe was still only 0.14 per cent – basically the same to all intents and purposes as the one for 1000–1500 (0.12 per cent).