LECTURE 1The Making of Europe and What Economic History can Tell You About It

Topics discussed today

Why war and territorial conflicts were endemic in Europe.

An inquiry into what made Europe into a regional unit despite the wars and conflicts.

An analysis of the patterns of trade in Europe supporting the ‘gravity theory of trade’.

What economic history is about. The last topic is dealt with in the Introduction

and the other topics in Chapter 1.

Resources and efficiency

Economic history explores how well mankind transforms resources into income and wealth in history.

History confirms that mankind, over time, has increased the degree of efficiency (= productivity) in her use of renewable resources, as well as those in fixed supply.

The constraints of resource endowments for producing a given output have eased over time and use of resources per unit of output has fallen dramatically.

What is efficiency?

Efficiency (= productivity) means that you produce more output, income, from given inputs or a constant output from less input. Even better more from less.

Technology and institutions determine efficiency.

Institutional reform, say, changes in property rights or taxation can improve the efficiency of resource allocation.

Technological change is resource saving, for example land-use per ton of wheat has fallen systematically in history.

An example.

Total factor productivity was about 0.1 per cent per year between year 800 and 1800 and averaged 0.75 per cent per year between 1800 and year 2000.

Assume that at year 800 income per head was at a subsistence level.

Implication: in year 2000 a subsistence income could be produced by 8 per cent of the resources needed in year 800.

So why worry about resource constraints? Because at the same time population

has increased by a factor of 10 and income per head by a factor of 40.

A ‘resource –neutral’ condition would be to have TFP growth equal to population growth plus income per head growth.

Pre-industrial economies were not far above that rule, but industrial economies are.

Rival vs. non-rival goods

Resources are rival goods and impose constraints on growth.

Efficiency (productivity) enhancing technologies and institutions are non-rival, your consumption does not reduce the availability of them. Some non-rival goods are (or become) public goods, that is they are non-excludable and non-rival.

The impact of non-rival and public goods on growth has increased in history, particularly since 1800.

More about institutions

Some institutions emerge spontaneously, such as exchange and markets, but will need a legal framework, contract enforcement, to be well functioning.

Some institutions, say, law and order, have public goods (non-exclusive) characteristics and need co-ordinated public action to develop.

Privileged interests can delay the introduction of beneficial institutions.

Sources of technological progress Until the 19th century technological

knowledge was based on learning by doing and trial and error.

By the middle of the 19th century scientific knowledge became the basis for the development of new products and technologies.

Deliberate Research and Development (R&D) spending speeded up the rate of technological progress significantly.

Note that knowledge is a non-rival good in the short run and also non-exclusive, public, in the long run.

Lessons from history:13 propositions 1.Economies which are richly endowed with

natural resources are not necessarily rich, but nations which use resources efficiently are almost always rich irrespective of resource endowment.

2. Europe trades therefore it is. 3. Gains from occupational and regional

division of labour is the basis for pre-industrial (pre 19th century) growth.

4. Malthusian fears of land as a binding resource constraint tend to ignore technological progress in land use.

A few more propositions

5. Population growth stimulates aggregate demand and technological progress. (Pepys’ rule)

6. Efficient institutions are often stable, but stable institutions are not necessarily efficient.

7.Banks are efficiency enhancing institutions (hard to believe these days but we take a very long run view) by increasing savings and efficiency in the use of savings.

8. Transfer of non-rival technologies is the secret of 19th and 20th century convergence in Europe.

Three more

9. Net gains but winners and losers from free trade repeatedly foster protectionist backlashes in history.

10. Fixed exchange rates did not survive democracy and the demand for domestic policy objectives.

11. The Great Depression killed the idea that the economy was self-equilibrating. Enter the political economy.

Final propositions

12. World inequality has peaked. More equality ahead!

13. The present globalization hype underlines the importance of knowledge of economic history. The world economy was as (if not more) globalized 100 years ago.

The making of Europe.

The Carolingian empire c.800 emerged from the ashes of the Roman empire. But soon broke up in smaller units.

There is a remarkable similarity between the geography of the Roman empire and the present EU, including candidate nations.

There is a remarkable similarity between the geographical lay-out of the Carolingian empire and the original members of the EU, or EEC as it was called then.

The destiny of Europe

Forces of integration and dis-integration have shaped Europe

Dis-integration: wars and territorial conflicts.

Integration: trade and transfer of ideas, culture, law.

The three maps (Maps 1.1-1.3 in the textbook) illustrate the remarkable geo-political continuity of Europe.

The Carolingian Empire

European Union in year 2010

Why has war been a permanent characteristic of European history?

Elites maximize state income by capturing land rent from land of constant quality. (MR=AR)

Next slide depicts a situation when the elites of two nations, A and B, both strive to extend their borders until marginal land rent equals marginal cost of extending/defending the nation.

Marginal costs increase with distance from centre of nation (to the right from A, to the left from B).

War erupts because there is a contested area over which both states (elites) can increase income.

A core

B core

Distance from centre A and B

Marginal cost of extending/defending empire

Land rent, marginal =average

Contested area

€ €

An ’arms race’ peace might develop. Peace can be established in a classical ’arms

race’ scenario even if there is, initially, a disputed area.

The condition is that each nation (elite) increases armament spending as a response to the expected increase of the other until each nation (elite) is equalizing marginal land revenue with marginal armament cost.

The implication is that the marginal defence cost curve shifts upwards for both until an equilibrium border is established which leaves no disputed area.

A BDistance from centre of A and B respectively

Marginal cost of extending/defending empire

Land rent, marginal =average

Contested area

Arms-race peace border

€€

Integrating forces

Despite endemic political conflicts Europe did not dis-integrate.

Integration is helped by a lingua franca, a common language, spoken at least by the elite.

Religion has been both a dis-integrating and integrating force.

Mobility of people. There was a remarkable interaction including inter-marrige of the land-owning elites and intellectuals.

Trade was the most important economic force in the making of Europe.

Trade relied on a network of transport routes, by land and water.

The determinants of trade.

Trade is stimulated by proximity and similarity of trading partners.

Proximity means that a nation trades more with neighbouring nations because of low transport costs

Similarity relates to equal income levels, preferences, language and culture, commercial law and institutions.

Lack of similarity generates border effects. Large core economies exert a force of gravity on smaller neighbouring economies.

What border effects do to trade. Border effects represent an additional

trading cost on top of the costs imposed by distance, that is transport costs, and tariffs.

Border effects impede trade also between hetrogeneous (non-similar) neighbouring nations thereby reinforcing initial differences (lack of similarity) in preferences and income.

Border effects determine the extent of a regional unit like Europe.

The impact of distance and border effects on trade.

Germany

Border effects

Trade

Trading Costs

Trade Outlier (Large Economy)

Trading Costs,Trade

Distance from Ith Economy

Trade and geography

Trade between nations of equal size falls with distance.

Trade with a relatively larger economy will be relatively larger than with an economy of equal size at equal distance. (The German outlier case in the Figure).

Border effects create a negative shock to trade.

The Pirenne thesis.

Henri Pirenne did not use the terminology but was the first to discuss the essence of border effects.

Thesis: ‘The Arab conquest of territories formerly in the Roman Empire (Spain, Northern Africa, Middle East) introduced a religious and cultural heterogeneity (lack of similarity) which impeded previously flourishing trade between the Mediterranean and Western and Northern Europe’.

Additional factor reducing trade: Income levels in Europe had fallen below levels in the Arab world which made Europe less attractive as a trading partner.

The extent of integration of the Mediterranean world existing in the Roman period has still not been restored!

Exploring the pottery-map!

The diffusion of archaeological find spots indicate a clear border effect along the limits, roughly the Rhine and Donau rivers, of the Roman empire.

Northeast of the Rhine and Donau, income levels were presumably lower, preferences and language different, and political conflicts frequent, which impeded the penetration of Roman type pottery.

The geographical diffusion of French pottery in the Roman era.

Europe trades, therefore it is

The present trading pattern of European nations confirms the impact of proximity and similarity.

Denmark trades more with Sweden than with Italy, Spain and France combined.

Since proximity is positively associated with similarity, the combined effect is to impede trade with distant partners which generates regional integration, for example the European Union.

European trade pattern. Table 1.1. Intra – European trade and trade with ROW (Rest of the World), in

year 2005. Percent of total trade.Importing Country

Exporting country

EU25Norway

SwitzerlandDenmark France Germany Italy Netherlands Spain Sweden

United Kingdom

ROW

Denmark 76% 5% 18% 3% 5% 3% 13% 9% 24%

France 67% 1% 15% 9% 4% 10% 1% 8% 33%

Germany 72% 2% 11% 7% 4% 5% 2% 8% 28%

Italy 65% 1% 13% 14% 2% 8% 1% 7% 35%

Netherlands 82% 2% 9% 25% 6% 4% 2% 9% 18%

Spain 76% 1% 20% 12% 9% 3% 1% 9% 24%

Sweden 72% 7% 5% 11% 4% 5% 3% 8% 28%

United Kingdom

67% 1% 10% 12% 5% 7% 6% 2% 33%

Summary

Regions such as Europe were shaped by: the force of gravity of large core economies. the proximity and initial similarity which

stimulated trade. Trade that reinforced similarity in

preferences and income levels. initial border effects which tended to be self-

perpetuating by limiting trade with border regions and setting a territorial limit.