The decline and fall of the British economy

Words by Davis Kedrosky
21st July 2022
Issue 8

When America’s economy overtook Britain’s a century ago, it remade the world order. How it happened is still debated – but might help us understand whether China could do the same to America today.

Economics

Once upon a time, Western opinion leaders found themselves both impressed and frightened by the extraordinary growth rates achieved by an overseas economy. [1] Inspired by Paul Krugman’s 1994 essay ‘The Myth of East Asia’s Miracle’. Although this economy was still not fully developed, the speed with which it had transformed itself from an agrarian system into an industrial powerhouse, achieved growth rates several times higher than the advanced nations, and adopted and improved Western technologies seemed to augur the end of a century’s hegemony. This late-industrializer disdained globalization and free trade, proudly asserting big business and imperfect competition. As its cutting-edge low-cost exports outsold producers across the industrial core, commentators fell over themselves to praise the upstart’s superior economic system, and for the first time in 60 years, the press clamored for tariff protection.

When Paul Krugman wrote something similar to this in 1994, he was describing the rise of China and other Asian Tiger economies. But his tale also fits the 1890s, when the Western hegemon was Great Britain and the late-industrializer was the United States. At some point during that decade, America’s GDP per capita overtook and sped away from Britain’s, which had been the world’s highest for over a century. In fact, Britain’s industrial dominance was already under threat by 1870 and had been comfortably surpassed by the end of the century. Even the service sector, bolstered by long-cultivated prowess in shipping and finance, was lagging behind America’s by the First World War.

What had happened? In 1851, the year of the Crystal Palace Exhibition, Britain’s preeminence had seemed unassailable. Writing on British transportation machinery, for example, the American visitor Benjamin P Johnson noted that ‘in this department, as was to have been expected, the English display a far more extensive assortment than all the other nations. The exhibition shows what perfection has been attained, and the beauty of finish and arrangement, is certainly worthy of all praise.’ During the next 20 years, Britain experienced the fastest sustained annual growth in GDP per capita in its history – a then-staggering 2.06 percent – and its exports, two thirds of which were manufactured goods, tripled in volume. After stumbling along for a century, the Industrial Revolution – and Britain’s economic model – seemed to finally have reached maturity.

But, in relative terms, things were already falling apart. In 1870, American industry already enjoyed a 50 percent advantage in labor productivity over British industry; by the eve of the First World War, US manufacturing workers were twice as productive as their British counterparts. Worse, this decline was not only relative to the United States, but to Britain’s own recent past. After two decades of two percent growth, Britain’s annual GDP per capita growth slumped to scarcely more than one percent over 1873–99, and then crawled along at .84 percent per annum up to 1914. Total factor productivity – the efficiency with which Britain used economic inputs – growth fell by two thirds in the final decades of the 1871–1914 Belle Epoque.

Contemporary writers were aware that something was going wrong. The Great Exhibition had been staged, in part, to demonstrate that Britain was falling behind its international rivals and thus drum up support for industrial policy. Books like Frederick Arthur McKenzie’s The American Invaders and WT Stead’s The Americanization of the World (both 1901) were just two of an avalanche of publications advertising the rot of Britain and the inevitability of its supersession by its youthful, vigorous former colony. Economists cast about for something, or someone, to blame. Alfred Marshall wrote in 1903:

Sixty years ago England had leadership in most branches of industry. It was inevitable that she should cede much to the great land which attracts alert minds of all nations to sharpen their inventive and resourceful faculties by impact on one another. It was inevitable that she should yield a little of it to that land of great industrial traditions which yoked science in the service of man with unrivalled energy. It was not inevitable that she should lose so much of it as she has done.

Marshall, like many of his contemporaries, chalked it all up to ‘complacency’. While America and Germany were embroiled in wars of unification, British industrialists could turn profits with ease, shortening their working hours and neglecting investments in new technology. 

The ‘entrepreneurial failure’ hypothesis – that the ‘sons of manufacturers’ followed ‘mechanically’ in the steps of their forefathers rather than innovating themselves – was also popular with the postwar generation of economic historians. David Landes, for example, emphasized ‘the importance of this human factor – the success of entrepreneurial and technological creativity on one side, the failure on the other’ in explaining how America and Germany overhauled Britain. DH Aldcroft, in this vein, specifically blamed ‘irrational’ decisions not to adopt best-practice techniques. These included the late emergence in the cotton industry of ring spinning, a new continuous-process technique for producing yarn that was higher output and more consistent than the mule-driven spinning that preceded it, and the automatic loom, which multiplied the productivity of a single weaver. He also cited the sluggish arrival of the mechanical cutter – which would finally begin to replace hand-hewing – in coal mines, as well as underinvestment in laboratories and research personnel and insufficient aggression in foreign markets.

Semiautomatic Lancashire loom. Image by Richard Marsden.

The ring spinning machine worked as follows. Spindles are located on each side of the cast-iron frame, above each of which is located a stand containing rollers. The roving, or unspun thread, is passed from the bobbins mounted on the central creel to the drafting rollers. The back roller stabilizes the threads and passes them on to the faster-spinning forward rollers, stretching out the roving and attenuating it to a sufficient thinness for the threads to be spun. The roving then passes through a guide wire, situated above the spindle top, and then down to the ring, threaded through a D-shaped ring called the traveler and finally to the bobbin upon the spindle. Revolving at 7,000–8,000 rpm, the spindle then twists the roving as it moves from the front rollers and, when thus spun, it is wound upon the bobbins. The continuous-process operation of the ring spinning machine, which drew and twisted the rovings in a single action, contrasts with the mule, a cross between two key Industrial Revolution textile inventions, the spinning jenny and the water frame, whose intermittent process twisted the rovings and wrapped them onto the spindles in separate strokes.

Others cited capital market failures that led to excessive investment overseas, depriving domestic industry of the funds needed to compete at scale. A golden torrent of British capital flowed abroad from 1870 to 1914, annually averaging about a third of the nation’s investment. In 1913, 32 percent of Britain’s wealth (a total of £4 billion at the time) was vested in overseas assets, primarily the bonds of railroads and utilities in the United States, Argentina, and other settler regions. John Maynard Keynes suspected anti-home bias; in the 1931 Macmillan Report, he and his colleagues concluded that ‘our financial machinery is definitely weak in that it fails to give clear guidance to the investor when appeals are made to him on the behalf of home industry’. Sidney Pollard, writing in 1987, added that ‘there was virtually total ignorance among financial institutions and advisors about investment opportunities in home industry, and that banks and other institutional lenders operated with traditional and irrational prejudices as to which type of investments they should support and which they should not’.

Today, a more popular story tells of a British education system that was elitist, conformist, and defective. Unlike the United States, the tale goes, Britain did not provide universal primary schooling until late in the nineteenth century, and what they did offer was of poor quality and low social status. Secondary and higher education were weak and exclusive, geared toward inculcating a gentlemanly elite in the social graces rather than training an industrial workforce. In The Unbound Prometheus, David Landes contrasted ‘the late and stunted growth of technical and scientific education in Britain’ with ‘the vigorous, precociously developed German system . . . Until the middle of the century, Britain had nothing [in the way of scientific education] but the young University of London, the good, bad and indifferent mechanics’ institutes, occasional evening lectures or classes, and courses in the rudiments of science in a few enlightened grammar and secondary schools.’ Robert Allen puts the point succinctly in his Very Short Introduction entry on the Industrial Revolution: ‘The new technologies of the late 19th century required educated labour, and Britain fell behind Germany and the USA, both of which had larger State financed educational systems’.

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However, many economic historians have been critical of the standard story – the idea that American firms were more entrepreneurial than British ones and more willing to adopt new technologies like ring spinning in place of mule spinning. In 1970, the economic historian Deirdre McCloskey shot back at the declinists. Her paper ‘Did Victorian Britain Fail?’ contends that the country was ‘growing as rapidly as permitted by the growth of its resources and the effective exploitation of the available technology’. She rebutted the view that Britain had been biased toward foreign investment by demonstrating that, even assuming financiers were omniscient, they could not have invested much better. Even a perfectly efficient deployment of investment would have increased income over 1870–1913 by only 7.3 percent (.21 percent per annum) – barely nudging up the growth rate. She also showed that British firms did make efficient technical choices, with a viciously competitive market environment forcing out technological laggards.

Subsequent research has largely vindicated McCloskey. While many of the early industry studies seemed to qualitatively confirm the original view of entrepreneurial failure, microeconomic critiques like that of Tim Leunig have shown that even the central empirical case made for the theory, that the persistence of mule spinning after ring spinning had emerged in America demonstrates a broader malaise across British industry, was actually a rational response to the price of labor and other factors of production in Britain at the time. 

Though the modern ring spindle was ‘technically viable’ for spinning coarse yarns by 1880, Lancashire had access to cheap supplies of skilled spinners capable of operating the mule. This lowered the potential cost savings from adopting the new invention by comparison with New England. Why, after all, would a producer purchase expensive early-stage machinery when the task could be completed by relatively inexpensive workers? As a result, only 25 percent of British spindles (against 90 percent of American) had been upgraded to the ring variety in 1913. Leunig also found that factor costs explained variations in adoption within British industry – firms in regions where it was profitable to do so used ring spinning, while others did not. Moreover, Lancashire’s supposedly outmoded mule spinners were ten percent more productive than New England ring spinners. There was no crisis of entrepreneurial conservatism.

Britain was not overinvesting abroad either. Michael Edelstein calculated risk-adjusted rates of return abroad and found that they were higher than for domestic assets – 5.7 percent per annum versus 4.6 percent at home – suggesting that Britons may have underinvested in foreign assets. While the measure used (the variance of returns around their respective means) is undoubtedly crude, foreign bias would appear highly unlikely. The qualitative evidence, in any event, offers a plausible explanation for the gap. Developing countries such as Australia, India, and the United States needed money to build railroads, but lacked domestic savings and sophisticated capital markets, which drove up bond yields. Rates of return were falling in Britain across the Belle Epoque, driven by emigration of younger workers to America, leaving behind a relatively older population with money to invest in the sort of overseas projects that their children and grandchildren might be leaving to work on. This channel may explain fully two thirds of the capital flows. Both of these mechanisms for driving British investment overseas – lucrative shovel-ready projects abroad, and younger migrants eager to work on them –  would be symptoms of the disparity in growth rates between the New and Old Worlds, not causes of it.

Differences in education may be the worst red herring of all. The United States, it is true, was the first nation to institute universal primary schooling, and by 1870 was easily the world leader, with 390 out of every 1,000 children under 20 enrolled. Prussia was not far behind, with 365 of every 1,000 citizens under 20 enrolled in school, and the comparable British figure at the time was a miserable 120. But there are two important caveats to this story.

The first is that the gap was closing at the very time that the economic gulf was widening. In 1870, Forster’s Education Act was passed, providing for the creation of school boards in England and Wales, which could build and run schools in areas where voluntary (i.e., religious) schools were lacking. The 1880 Education Act made attendance compulsory for children between the ages of five and ten. Though enforcement and quality were inevitably imperfect, the results were clear. Male illiteracy tumbled from 30 percent in 1860 to just 1 percent in 1914, while primary education among under-20s surged to 373 per 1,000 – still behind the US, but ahead of Germany. And though secondary and higher education did remain exclusive, enrollment was equivalent to German levels and not significantly short of those in America. The high school movement was chiefly a twentieth-century phenomenon; in 1910, enrollment rates for 5-to-19-year-olds were similar among all advanced countries.

The second caveat is that formal education was not essential, contrary to what Landes claimed, to cultivating the kind of human capital required for a nineteenth-century industrial labor force. Steelworkers, shipbuilders, and garment makers barely needed literacy and numeracy, let alone accounting and chemistry. What they could use most was craft, engineering, and other technical training directly relevant to their specific tasks – and at this kind of education, Britain was the unquestioned world leader.

Though it had fewer formal higher-level institutions, late-nineteenth-century Britain imparted skills through a ‘flourishing’ system of five-to-seven-year apprenticeships which was well-adapted to existing forms of industry. These arrangements obliged (and incentivized) employers to provide specific on-the-job training. Apprentice-to-employment ratios in industry were over four times higher in Britain than the United States in 1900 (and about ten times higher across the whole economy), though they both lagged behind Germany. Many historians believe that the British system of technical education, focused on on-the-job training, was equally effective as more formal school-based education. Why shouldn’t it have been? When skills are acquired primarily through learning-by-doing, apprenticeship rather than outside instruction is a highly favorable route.

Despite the success of this approach, the British state did begin to intervene to support technical and scientific education. After 1859, the Department of Science and Art began to sponsor and fund instruction in machine drawing, mathematics, physics, chemistry, and related subjects. More complex training was offered by the City and Guilds of London Institute from 1879; by the early twentieth century, they taught courses across the country in 70 subjects, including salt and alkali manufacture, bread making, sugar processing, iron and steel manufacture, pottery and porcelain, and leather tanning. Both these departments made capital grants for buildings and equipment and paid teachers at schools run by local boards, and the Technical Instruction Act of 1889 made rate money available for this purpose. British technical schooling complemented apprenticeship and on-the-job training via evening classes (a fact admired by American observers), and was remarkably successful: total enrollment increased from 10,000 in 1867 to 227,000 in 1896. Far from steadfastly refusing to offer scientific education, the state elastically supplied training in both basic skills and foundational knowledge on top of workplace learning-by-doing.

So while Britain did lag Germany and the United States in some areas of formal education, in the places where it mattered its informal education and training processes did not. And even in terms of formal institutions, it took steps to catch up with the others that undercut any claim that a lack of education, whether formal or informal, could explain the UK’s relative decline.

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If Britain was deficient in neither technology adoption nor entrepreneurial vigor, in neither willingness to invest nor vocational skills, what was to blame for her demise? The answer is simple: Competing with America was impossible. The breakthrough technological and organizational advances of the early Second Industrial Revolution revolved around the Chandlerian firm: vertically and horizontally integrated high-throughput mass production. Mass production suited America’s unique factor endowments. She had abundant fuel and raw materials – the world leader in natural gas, petroleum, coal, iron ore, and copper output, as well as sheer space – but was labor-scarce relative to the Old World, especially in skilled workers. This scarcity is of course part of why wages there were so high, and why so many migrants went across.

American technological innovation resulted in methods uniquely suited to this environment, substituting fixed capital and machinery for costly labor, wasting fuel and raw material inputs, and churning out long production runs at high speed for mass urban markets. Britain, increasingly shut off from Continental markets by tariff barriers imposed by her rivals, could not hope to replicate (or profitably implement) these processes. Her input costs soared: By 1938–9, for example, Ford UK paid 50 percent more than Ford US for steel.

Mass production technologies were designed for an American economy with cheap fuel and raw materials and expensive labor. Economic historian Gavin Wright analyzed the composition of US exports prior to 1940 and found that their intensity in nonreproducible natural resources was increasing – that is, that the US had a comparative advantage in resource-heavy manufacturing. This shift coincided with the US attaining global leadership in the production of many of these resources, which made them relatively inexpensive for domestic firms to purchase; in 1913, for example, the US was the world’s biggest producer of natural gas, petroleum, copper, phosphate, coal, and iron ore. On this basis, Wright argues that ‘the distinctively American industrial innovations’ were developed for the specific circumstances of the late-nineteenth-century American economy – abundant natural resources and large markets.

These innovations were inappropriate for Britain, with its elastic supplies of skilled workers and scarcer inputs. The only possible solution was to specialize for as long as possible in the industries that suited her best: skill-intensive sectors reliant on flexible production of customized outputs, such as shipbuilding, which normally built vessels to order, and often with bespoke designs that required high levels of experience among the workers and engineers involved.

So Victorian Britain’s slowdown may have been a product of technological change that used a country’s resource base intensively – methods which were obviously unprofitable in Britain. It was inevitable that technological innovation would focus on the largest and most profitable market – the USA – as it grew. As the frontier in innovation shifted overseas, the best-practice techniques became increasingly unsuited for use in British industry. Learning possibilities from new technologies, through learning-by-doing and agglomeration, were precluded because the best firms were abroad. And this happened at the same time as the older learning possibilities were exhausted, as Britain’s major industries slid in importance. Overall, the consequences were disastrous.

If this story seems familiar, well, that’s because it is. The last four decades have seen an ‘invasion’ of low-cost mass production goods sweep across the Western world, churned out by a Chinese industrial behemoth whose access to human and natural resources appears boundless. China’s pursuit of economic development has, until recently, advanced heedless of environmental costs, scorning pollution and resource depletion in a relentless attempt to converge with the advanced economies. Is the closing gap an American failure? And is America doomed to suffer Britain’s fate, helplessly treading economic water as the foreign juggernaut advances?

Key differences with the British Belle Epoque suggest that the answers may be no and no. Unlike Victorian Britain, America still stands on the technological frontier, and her methods continue to lay out the path ahead for the rest of the world. Its well-educated, high-skill labor force – while deficient by comparison with some other advanced economies – is still the intended operator of new technologies. China, unlike Gilded Age America, is experiencing declining growth rates at relatively lower living standards, and is slowly coming to realize that unrestrained resource use and pollution are imposing intolerable economic and political costs – just as, decades later, America eventually did too. And while her advances in information technology and semiconductor production have been impressive, they remain some distance from transforming an economy that remains predominantly agricultural and poor away from coastal commercial centers.

This is not a call for complacency, but for realism about what makes and breaks the wealth of nations. There’s no secret formula, and if there are any universal principles that are binding across the long centuries, most remain hidden behind the bewildering idiosyncrasies of each national development story. What works and fails is contingent on the geographical, intellectual, and technical realities of the here and now. It’s why the mystery of economic growth is so difficult to solve – and why, as a great economist once remarked, it’s almost impossible to stop thinking about.

 

Davis Kedrosky is an economic historian at the University of California, Berkeley. You can follow him on Twitter here.