Tag Archives: Economic geography

Was Stalin’s Economic Policy the Root of Nazi Germany’s Defeat?

Was Stalin Necessary for Russia’s Economic Development?

By Anton Cheremukhin (Dallas Fed), Mikhail Golosov (Princeton), Sergei Guriev (SciencesPo), Aleh Tsyvinski (Yale)

Abstract: This paper studies structural transformation of Soviet Russia in 1928-1940 from an agrarian to an industrial economy through the lens of a two-sector neoclassical growth model. We construct a large dataset that covers Soviet Russia during 1928-1940 and Tsarist Russia during 1885-1913. We use a two-sector growth model to compute sectoral TFPs as well as distortions and wedges in the capital, labor and product markets. We find that most wedges substantially increased in 1928-1935 and then fell in 1936-1940 relative to their 1885-1913 levels, while TFP remained generally below pre-WWI trends. Under the neoclassical growth model, projections of these estimated wedges imply that Stalin’s economic policies led to welfare loss of -24 percent of consumption in 1928-1940, but a +16 percent welfare gain after 1941. A representative consumer born at the start of Stalin’s policies in 1928 experiences a reduction in welfare of -1 percent of consumption, a number that does not take into account additional costs of political repression during this time period. We provide three additional counterfactuals: comparison with Japan, comparison with the New Economic Policy (NEP), and assuming alternative post-1940 growth scenarios.

URL: http://EconPapers.repec.org/RePEc:nbr:nberwo:19425

Distributed by NEP-HIS on 2013-09-28

Review by Emanuele Felice

Until the late 1950s, the era of rapid Soviet growth and of Sputnik, the main question among Western scholars was: When would the Soviet Union catch up with and overtake the U.S.?*

As Cheremukhin et al. correctly emphasize, the subject of this paper – Soviet industrialization in the 1930s – is one of the most important in economic history, and in world history: Soviet Union was the country which played by far the biggest role in the defeat of Nazi Germany, standing almost alone against the land force of the Third Reich and its allies for most of the war and causing 87% of the total Axis’ military deaths (in sharp contrast with World War I, when the Tsarist empire was defeated by a German Reich fighting on two fronts). Emerging from World War II as a superpower, the victorious Soviet Union contributed to shape the next four decades of human history, boasting among its technological achievements the first voyage of a human being to the space. At the same time and during the Stalin regime (1922-1953), the scale of (politically caused) human suffering has had few parallels in world history. Furthermore, as early as the 1930s Stalin’s rule was one of the first totalitarian regimes capable of reaching levels of oppressiveness and manipulation over society unobserved before.

For these reasons Stalin’s Soviet Union should continue to be interrogated by systematic studies. At the core of that regime was industrialization, which aimed to be the material pillar of a new «civilization» (e.g. Kotkin, 1995). Regarding its impact over policy making in the twentieth century, Stalin’s forced industrialization was a source of inspiration for both economists and politicians throughout the world: its planned, top-down, implementation was widely considered to be a successful, though harsh, strategy by some contemporaries.

Joseph Stalin (b 1878 - 1953), Leader of the Soviet Union (1922-1953)

Joseph Stalin (b 1878 – 1953), Leader of the Soviet Union (1922-1953)

And yet, we still have relatively little macro-economic evidence about the Stalinist period. The article Cheremukhin et al. aims to partially fill this gap, by providing consistent figures, some new arguments and insightful counterfactuals. It builds upon a remarkable amount of original research. First, it provides a comprehensive and coherent reconstruction of data on output, consumption, investments, foreign trade and labour force. These figures are presented separately for the agricultural and non-agricultural sectors. Data begins in the last decades of Tsarist Russia (1885-1913) and for the the Soviet Union covers the launch of the first five-year plan until the Nazi’s invasion (1928-1940).

Secondly, Cheremukhin et al. propose and elaborate a growth model for the Russian economy in those two periods (i.e. Tsarist Russian and pre-Nazi invention Soviet Union). This is a multi-sector neoclassical model, which is modified to allow for the peculiarity of the economy under scrutiny; namely, due to the institutional frictions and policies that distorted household and firm decisions, three wedges are defined, corresponding to the intratemporal between-sector distortions in capital and labor allocations and to an intertemporal distortion, and price scissors in agricultural prices (between producers and consumers) − which may also be thought of as a fourth wedge − are also introduced for the Stalin’s period.

It may be worth adding that when connecting wedges to policies, the Cheremukhin et al. appear to be adequately aware of the historical context and of the differences between a planned economy and a free-market one: for instance, the response of the Stalinist economy to a drop in agricultural output is likely to be the opposite − because of the price scissors policy which kept producer’s agricultural prices artificially low − to the predictions of a frictionless neoclassical growth model: it will probably lead to a further reallocation of labour from agriculture to industry and services and, therefore, to an additional reduction of agricultural output; such a distortion is here acknowledged and reasonably calibrated.

 “Smoke of chimneys is the breath of Soviet Russia”, early Soviet poster promoting industrialization, 1917-1921

“Smoke of chimneys is the breath of Soviet Russia”, early Soviet poster promoting industrialization, 1917-1921

Thirdly, the paper by Cheremukhin et al. further elaborates on data and models, by providing a number of counterfactuals. Comparisons are made with the Tsarist economy by extrapolating Tsarist wedges for 1885-1913 to the 1928-1940 years. Also by comparing the performance of both economies (Tsarist and Stalinist), for the years following 1940 under the assumption that World War II never happened.

Another comparison takes place with Japan, a country similar to Russia before World War I in terms of GDP levels and growth rates. Early in the twentieth century Japan suffered similar distortions as Russia but during the interwar period Japan undertook an economic transformation which provided Cheremukhin et al. an alternative scenario to both the Tsarist and the Stalin policies (the Japanese projections are based upon previous reconstructions of the Japanese macro-economic figures, which happen to be available for the same period as for Russia, 1885-1940).

Japanese assault on the entrenched Russian forces, 1904

Japanese assault on the entrenched Russian forces, 1904

And what is probably the most intriguing counterfactual, at least in actual historical terms, is yet one more alternative scenario, constructed by assuming that Lenin’s New Economic Policy or NEP (launched in 1921 and outliving Lenin until 1927) would have continued even after 1927: such a counterfactual requires elaborating a model for the NEP economy as well, but unfortunately the lack of reliable data for the years 1921 to 1927 makes the discussion for this scenario «particularly tentative». Furthermore, it is worth mentioning that two more alternative scenarios are provided for the Stalin economy based on alternative growth rates for the years 1940 to 1960 and again under the assumption that World War II never happened; and that robustness exercises are also performed (with further details provided in the appendix).

Broadly speaking, the results are not favourable to Stalin. According to Cheremukhin et al., Stalin was not necessary for Russian industrialization − neither, it could be consequently argued, to the defeat of Nazism and to the Russia’s rise to a superpower status. Actually, by 1940 the Tsarist economy would probably have reached levels of production and a structure of the economy similar to the Stalinist one, but which far less short-term human costs. This result may not be irreconcilable to Gerschenkron’s (1962) theses about substitute factor − in Russia this was the State, already exerting such a role in late Tzarist times − and the advantages of backwardness: these latter would have permitted to backward Russia, once its industrialization had been set in motion at the end of the nineteenth century, to see its distance to the industrialized West reduced by the time of World War II more than in World War I, in any case – that is, also under the Tzarist regime. It does contrast, however, with other findings from pioneering cliometric articles on the issue, such as the one by Robert Allen published almost twenty years ago, according to which Stalin’s planned system brought about rapid industrialization and even a significant increase of the standard of living (Allen, 1998). Similarly, but from a different perspective, long-run reconstructions of Soviet labour productivity tend to emphasize as a problem the slow-down in the period following post World War II, rather than the performance the 1930s (Harrison, 1998) – both Allen and Harrison are cited in this paper, but not these specific articles.

The Dnieper Hydroelectric Station under construction, South-Eastern Ukraine (the work was begun in 1927 and inaugurated in 1932)

The Dnieper Hydroelectric Station under construction, South-Eastern Ukraine (the work was begun in 1927 and inaugurated in 1932)

Now, at the core of the results by Cheremukhin et al. is the finding that, according to their estimates, total factor productivity of the USSR in the non-agricultural sector did not grow from 1928 to 1940. Maybe it is worth discussing this point in a little more detail. Is such a finding plausible? At a first sight it seems puzzling, given the technological advance of that period especially in the heavy sectors. And yet, at a closer inspection it may turn out to be entirely logical: the growth of output was a consequence of massive inflows of inputs, both machinery (capital) and labour. But all considered these were not used in a more efficient way.

In the model by Cheremukhin et al., capital and labour are computed through a Cobb-Douglas production function, with constant elasticity coefficients for labour and capital (0.7 and 0.3 respectively in the non-agricultural sector; 0.55 and 0.14 in the agricultural one, thus assuming a land’s elasticity of 0.31). The authors make a point that the new labour force entering the non-agricultural sector was largely unskilled and, often, was not even usefully employed. Actually exceeding the real needs of that sector: this politically induced distortion could hardly have increased TFP (although, under different assumptions, it could be alternatively modeled through a decreasing elasticity of labour: but the results in terms of total output would not change). This may also explain the good performance of Soviet Union during World War II, when due to manpower shortage the exceeding labour force finally could be profitably employed. The capital stock is calculated by the authors at 1937 prices, for the years 1928-1940.

Anti-Nazi propaganda poster, 1945

Anti-Nazi propaganda poster, 1945

We do not have enough information in order to judge whether a bias can be caused by the use of constant prices based on a late-year of the series. But this possible bias should lead to an underestimation of capital growth in that period  − given that quantities are probably weighted with relative prices lower in 1937 for the heavy sectors, than in 1928 − which would then produce an overestimation in the TFP growth proposed by the authors: in actual terms, therefore, the growth of TFP may be even lower than what estimated; in more general terms – and although caution is warranted for the lack of detailed figures – their results look realistic in this respect.

The most interesting finding, however, is the one relative to the NEP counterfactual. It is the most interesting because, in genuine historical terms, the Tzarist model was no longer a viable option to Stalin, while NEP’s strategy was. But of course, data for the NEP years are much more precarious and thus this counterfactual can only be a particularly tentative one. Nonetheless, the authors build two scenarios for the NEP policy: a lower-bound one, where a growth rate of TFP in manufacturing after 1928 similar to the average Tsarist 0.5% is tested; and an upper-bound one, with a growth rate of 2% similar to the one experienced by Japan in the same interwar period. In the first scenario the results for the Soviet economy would have been slightly worse, but in the second one much better. Given that the two scenarios correspond to the boundaries of the possibility frontier, we may conclude that probably, under the NEP, the performance of the Soviet economy would have been better than both the one observed under the Stalin and that predictable under the Tzar. This may confirm the view that the 1920s were somehow the “golden age” of Soviet communism, as well as the favourable assessment of Lenin’s and later of the collective Soviet leadership in that decade (although, admittedly, Lenin intended the NEP only as a temporary policy). After all, a more inclusive leadership – as opposed to the harshness of Stalinist autocracy in the 1930s, as well as to Hitler despotic conduct of war since the winter of 1941 – was also the one which helped the Red Army to win World War II.

“The victory of socialism in the USSR is guaranteed”, 1932

“The victory of socialism in the USSR is guaranteed”, 1932

References

Allen,  Robert C., Capital accumulation, the soft budget constraint and Soviet industrialization, in «European Review of Economic History», 1998, 2(1), pp. 1-24.

Gerschenkron, Alexander, Economic backwardness in historical perspective, Cambridge, Mass., The Belknap Press of Harvard University Press, 1962.

Harrison, Mark, Trends in Soviet Labour Productivity, 1928−85: War, postwar recovery, and slowdown, in «European Review of Economic History», 1998, 2(2), pp. 171-200.

Kotkin, Stephen, Magnetic Mountain: Stalinism as a Civilization, University of California Press, Berkeley, Los Angeles, and London, 1995.

Source of quote:
Gur Ofer (1987) “Soviet Economic Growth: 1928-1985,” Journal of Economic Literature, Vol. 25, No. 4, pp. 1767-1833 (cited in this paper, p. 2).

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The postman always rings twice: measuring market access and endowment in the German Empire through postal data

It’s all in the Mail: The Economic Geography of the German Empire

by

Florian PLOECKL (florian.ploeckl@adelaide.edu.au) University of Adelaide

ABSTRACT

Information exchange is a necessary prerequisite for economic exchange over space. This relationship implies that information exchange data corresponds to the location of economic activity and therefore also of population. Building on this relationship we use postal data to analyse the spatial structure of the population distribution in the German Empire of 1871. In particular we utilize local volume data of a number of postal information transmission services and a New Economic Geography model to create two index measures, Information Intensity and Amenity. These variables respectively influence the two mechanisms behind the urban population distribution, namely agglomeration forces and location endowments. By testing the influence of actual location characteristics on these indices we identify which location factors mattered for the population distribution and show that a number of characteristics worked through both mechanisms. The model is then used to determine counterfactual population distributions, which demonstrate the relative importance of particular factors, most notably the railroad whose removal shows a 34% lower urban population. A data set of large locations for the years 1877 to 1895 shows that market access increases drove the magnitude of the increase in urban population, while endowment changes shaped their relative pattern.

URL: http://econpapers.repec.org/scripts/search.pf?aus=Florian%20Ploeckl

Review by Anna Missiaia

This paper was distributed by NEP-HIS on 2015-04-11. The work by Florian Ploeckl lays in the expanding branch of historical economic geography, which looks at, broadly speaking, the role of geographical factors in regional development. In particular, the author looks at the effect of actual location characteristics on the information exchange and endowment (calculated through two indices) in the German Empire between 1877 and 1895. The empirical model used in the paper uses the indices that describe market access and endowments effects as dependent variables and test which geographic, institutional and cultural characteristics shaped them.

220px-Bundesarchiv_Bild_146-1990-023-06A,_Otto_von_Bismarck

Otto Von Bismarck (1815-1898), First Chancellor of Germany

The paper relies on detailed data on the postal system to measure the diffusion of information across 41 districts in the Empire. The creation, after the German unification, of a common and homogeneous postal system with the same rates across locations allows the author to use postal flows as proxy for “information intensity”.   This measure tells us the level of information exchange for each location considered. The author meticulously identifies business related correspondence for each location by selecting specific types of mail for the analysis and relating it to the general mail. The empirical exercise appears very well engineered and executed.

220px-Kaiserlich

 Kaiserliches Postamt sign, about 1900

The next step is to relate this indirect measure of economic activity to the access to markets for any given location. Following a well-established practice in the discipline, Ploeckl relies on the concept of market potential. Market potential is a measure of the centrality of a given location and can be constructed in two main ways. The first option, when trade volumes among locations are available, is a gravity model. This is the method used nowadays by economic geographers but also economic historians lucky enough to have access to internal trade flows (see Redding and Venables, 2004 for the former and Wolf, 2007 for the latter). This method basically looks at actual levels of trade and derives from these the potential for a location. The second option, used when trade flows are unknown, relies on the methodology proposed by Harris (1954) which uses GDP of the locations weighted by the inverse of distance to calculate the potential levels of trade across the locations given the size of their economies. Examples of this estimation procedure are Crafts (2005), Schulze (2007) and more recently Crafts and Klein (2012). This paper approaches the issue in a very innovative way, escaping the dichotomy that normally characterizes the calculation of market potential. As we understand, neither trade volumes nor regional GDP are available for Germany in this period. Therefore the author relies on the assumptions that “market potential translates in commercial transactions” and that “each transaction causes the same amount of mail” to claim that the measure from step 1 is able to capture the access to markets of the locations. The first assumption is shared with the broader group of scholars that use gravity models for market access and is perfectly reasonable when dealing with trade volumes. The use of quantitative evidence on correspondence to proxy for economic activity is not new in the literature: Crafts (1983) provided GDP estimates based, among the others, on letters per capita. The method proved to be quite misleading applied for instance to the Italian case (Esposto, 1997). Because of the indirect measure used in the paper, the relationship between information flows, market potential and actual exchange is of course much more questionable. However, it must be pointed out that the empirical effort in this paper makes its use of postal data more convincing compared to other more dated attempts.

The paper is also very interesting in that it finds a way to split market access into firm market access and consumer market access. This is a crucial point in the analysis of market forces as the two measures could well be following very different trajectories.

The last step is to calculate an endowment index based on real wages and the trade cost matrix across locations (the details on the methodology are explained in Ploeckl, 2012).

The bottom line results of the paper are that important factors like railroads and coal were important in the location of population (and therefore economic activity) both through the market channel and the endowment channel. The impact of these channels is quantified through counterfactual analysis, leading for instance to a 30% impact of the removal of the railroads on the population level.

Summing up, this paper contributes to a very hot debate on the determinants of the location of economic activity. It does so by finding an innovative empirical method to overcome the chronic lack of data in historical research. The limitations of these indirect methods should not, as usual, be neglected. However, the exercise appears more than reasonable and some features of these papers could find fruitful applications in a variety of other lines of research in historical economic geography.

REFERENCES

Crafts, N., 1983, Gross National Product in Europe 1970-1910: Some New Estimates, Explorations in Economic History, Vol. 20, No. 4, 387-401.

Crafts, N., 2005, Market Potential in British regions, 1871-1931, Regional Studies, Vol. 39, pp. 1159-1166.

Esposto, A., 1997, Estimate Regional Per Capita Income: Italy, 1861-1914, Journal of European Economic History, Vol. 26, No. 3, p.585-604.

Ploeckl, F., 2012, Endowments and Market Access; the Size of Towns in Historical Perspective: Saxony 1550-1834, Vol. 42, p. 607-618.

Redding, S. and A. Venables, 2004, Economic Geography and International Inequality, Journal of International Economics, Vol. 62, No. 1, pp. 53-82.

Schulze, M. S., 2007, Regional Income Dispersion and Market Potential in the Late Nineteenth Century Hapsburg Empire, LSE Working Papers no. 106/07.

Wolf, N., 2007, Endowments vs. Market Potential: What Explains the Relocation of Industry after the Polish Reunification in 1918?, Explorations in Economic History, Vol. 44, (2007), 22-42.

 

 

Technology and Financial Inclusion in North America

Did Railroads Make Antebellum U.S. Banks More Sound?

By Jeremy Atack (Vanderbilt), Matthew Steven Jaremski (Colgate), and Peter Rousseau (Vanderbilt).

Abstract: We investigate the relationships of bank failures and balance sheet conditions with measures of proximity to different forms of transportation in the United States over the period from 1830-1860. A series of hazard models and bank-level regressions indicate a systematic relationship between proximity to railroads (but not to other means of transportation) and “good” banking outcomes. Although railroads improved economic conditions along their routes, we offer evidence of another channel. Specifically, railroads facilitated better information flows about banks that led to modifications in bank asset composition consistent with reductions in the incidence of moral hazard.

URL: http://econpapers.repec.org/paper/nbrnberwo/20032.htm

Review by Bernardo Bátiz-Lazo

Executive briefing

This paper was distributed by NEP-HIS on 2014-04-18. Atack, Jaremski and Rousseau (henceforward AJR) deal with the otherwise thorny issue of causation in the relationship between financial intermediation and economic growth. They focus on bank issued notes rather deposits; and argue for and provide empirical evidence of bi-directional causation based on empirical estimates that combine geography (ie GIS) and financial data. The nature of their reported causation emerges from their approach to railroads as a transport technology that shapes markets while also shaped by its users.

Summary

In this paper AJR study the effect of improved means of communication on market integration and particularly whether banks in previously remote areas of pre-Civil War USA had an incentive to over extend their liabilities. AJR’s paper is an important contribution: first, because they focus on bank issued notes and bills rather than deposits to understand how banks financed themselves. Second, because of the dearth of systematic empirical testing whether the improvements in the means of communication affected the operation of banks.

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In 19th century north America and in the absence of a central bank, notes from local banks were substitutes among themselves and between them and payment in species. Those in the most remote communities (ie with little or no oversight) had an opportunity to misbehave “in ways that compromised the positions of their liability holders” (behaviour which AJR label “quasi-wildcatting”). Railroads, canals and boats connected communities and enabled better trading opportunities. But ease of communication also meant greater potential for oversight.

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ACJ test bank failure rates (banks that didn’t redeem notes at full value), closed banks (ceased operation but redeem at full value), new banks and balance sheet management for 1,818 banks in existence in the US in 5 year increments between 1830 and 1862. Measures of distance between forms of communication (i.e. railroads, canals, steam navegable river, navegable lake and maritime trade) and bank location emerged from overlapping contemporary maps with GIS data. Financial data was collected from annual editions of the “Merchants and Bankers’ Almanac”. They distinguish between states that passed “free banking laws” (from 1837 to the early 1850s) and those that did not. They also considered changes in failure rates and balance sheet variance (applying the so called CAMEL model – to the best of data availability) for locations that had issuing banks before new transport infrastructure and those where banks appear only after new means of communication were deployed:

Improvements in finance over the period also provided a means of payment that promoted increasingly impersonal trade. To the extent that the railroads drew new banks closer to the centers of economic activity and allowed existing banks to participate in the growth opportunities afforded by efficient connections.(p. 2)

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Railroads were the only transport technology that returned statistically significant effects. It suggested that the advent of railroads did indeed pushed bankers to reduce the risk in their portfolios. But regardless of transport variables, “[l]arger banks with more reserves, loans, and deposits and fewer bank notes were less likely to fail.” (p.20). It is thus likely that railroads impact banks’ operation as they brought about greater economic diversity, urbanisation and other measures of economic development which translated in larger volume of deposits but also greater scrutiny and oversight. In this sense railroads (as exogenous variable) made banks less likely to fail.

But ACJ note that means of transportation were not necessarily exogenous to banks. Reasons for the endogeneity of transport infrastructure included bankers promoting and investing in railroads to bring them to their communities. Also railways could find advantages to expand into vigorously active locations (where new banks could establish to capture a growing volume of deposits and serve a growing demand for loans).

Other empirical results include banks decreased the amount of excess reserves, notes in circulation and bond holdings while also increased the volume of loans after the arrival of a railroad. In short, considering railroads an endogenous variable also results in transport technologies lowering bank failure rates by encouraging banks to operate more safely.

Comment

The work of AJR is part of a growing and increasingly fruitful trend which combines GPS data with other more “traditional” sources. But for me the paper could also inform contemporary debates on payments. Specifically their focus is on banks of issue, in itself a novelty in the history of payment systems. For AJR technological change improves means of payment when it reduces transaction costs by increasing trust on the issuer. But as noted above, there are a number of alternative technologies which have, in principle, equal opportunity to succeed. In this regard AJR state:

Here, we describe a mechanism by which railroads not only affected finance on the extensive margin, but also led to efficiency changes that enhanced the intensity of financial intermediation. And, of course, it is the interaction of the intensity of intermediation along with its quantity that seems most important for long-run growth (Rousseau and Wachtel 1998, 2011). This relationship proves to be one that does not generalize to all types of transportation; rather, railroads seem to have been the only transportation methods that affected banks in this way.(p4)

In other words, financial inclusion and improvements in the payment system interact and enhance economic growth when the former take place through specific forms of technological change. It is the interaction with users that which helps railroads to dominate and effectively change the payments system. Moreover, this process involves changes in the portfolio (and overall level of risk) of individual banks.

The idea that users shape technology is not new to those well versed in the social studies of technology. However, AJR’s argument is novel not only for the study of the economic history of Antibellum America but also when considering that in today’s complex payments ecosystem there are a number or alternatives for digital payments, many of which are based on mobile phones. Yet it would seem that there is greater competition between mobile phone apps than between mobile and other payment solutions (cash and coins, Visa/Mastercard issued credit cards, PayPal, Bitcoin and digital currencies, etc.). AJR results would then suggest that, ceteris paribus, the technology with greater chance to succeed is that which has great bi-directional causality (i.e. significant exogenous and endogenous features). So people’s love for smart phones would suggest mobile payments might have greater chance to change the payment ecosystem than digital currencies (such as Bitcoin), but is early days to decide which of the different mobile apps has greater chance to actually do so.

Wall Street (1867)

Wall Street (1867)

Another aspect in which AJR’s has a contemporary slant refers to security and trust. These are key issues in today’s digital payments debate, yet the possibility of fraud is absence from AJR’s narrative. For this I mean not “wildcatting” but ascertaining whether notes of a trust worthy bank could have been forged. I am not clear how to capture this phenomenon empirically. It is also unlikely that the volume of forged notes of any one trusted issuer was significant. But the point is, as Patrice Baubeau (IDHES-Nanterre) has noted, that in the 19th century the technological effort for fraud was rather simple: a small furnace or a printing press. Yet today that effort is n-times more complex.

AJR also make the point that changes in the payments ecosystem are linked to bank stability and the fragility of the financial system. This is an argument that often escapes those discussing the digital payments debate.

Overall it is a short but well put together paper. It does what it says on the can, and thus highly recommended reading.

Immigration and the Economy: An Interdisciplinary Subject

Immigrant Diversity and Economic Development in Cities: A Critical Review

By Thomas Kemeny (London School of Economics)

Abstract: This paper reviews a growing literature investigating how ‘immigrant’ diversity relates to urban economic performance. As distinct from the labor-supply focus of much of the economics of immigration, this paper reviews work that examines how growing heterogeneity in the composition of the workforce may beneficially or harmfully affect the production of goods, services and ideas, especially in regional economies. Taking stock of the existing literature, the paper argues that the low-hanging fruit in this field has now been picked, and lays out a set of open issues that need to be taken up in future research in order to fulfil the promise of this work.

URL: http://econpapers.repec.org/paper/cepsercdp/0149.htm

Revised by: Anthony C. Evans (final year graduate Business Studies & Marketing, Bangor University – Wales)

Summary

Kemeny’s paper was circulated by NEP-HIS on 2013-12-06 and it seeks to understand the relationship between immigrant diversity and economic performance, primarily by considering the effects of “interactions among a diverse populace” (p.1).

The review is motivated by the theory that “immigrant-diverse individuals could simultaneously improve economic outcomes by bringing together different perspectives and heuristics, and reduce performance by making co-operation more costly.” (p.2) This additional cost of co-operation is associated with Tajfel’s (1974) Social Identity theory, and is supported by the quoted findings of Richard et al. (2002), Bandiera et al. (2005) and O’Reilly et al. (1989); that teams who share few commonalities find it hard to integrate and suffer from reduced co-operation and higher staff turnover. Empirical studies by Hoffman and Maier (1961) and Joshi and Roh (2009) are cited, and display a modest positive economic impact of workplace diversity.

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Kemeny quotes Ottaviano and Peri’s (2006) findings that a 0.1 increase in the Fractionalization index increased native wages by 13% and rents more so within the US. Kemeny (2012) and Spaber (2010) find similar results, as does Bellini et al.’s (2013) European work. Alesina et al.’s (2013) global study finds birthplace diversity is positively related to GDP per capita and total factor productivity, with the strongest association in rich countries for high-skill workers.

However, Kemeny notes that many studies, including Suedekum et al.’s (2009) study of Germany and Nathan’s (2011) study of the UK, have demonstrated a negative economic effect of immigrant diversity, especially upon those in lower skilled jobs.

Citing empirical studies by Stephan and Levin (2001), Bosetti et al. (2012) and Hunt and Gauthier-Loiselle (2010), immigrant diversity is found to be positively linked to the number of research papers published and to the number of patent applications for highly skilled industries.

Kemeny finds that there is inconsistent evidence as to the link between immigration and entrepreneurship in Mariano et al. (2012), Audretsch et al. (2010) and Cheng and Li’s (2011) extant work.

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Through his review Kemeny identifies a number of stylised facts across the relevant literature. Some of these follow.

The paper refers to a growing body of work supporting Bakens et al.’s (2013) findings that the individual’s characteristics emerge as the primary determinants of variation in wages and rents. Kemeny proposes individual heterogeneity may overstate diversity’s positive impact upon productivity, as immigrants may self-select areas based upon higher wages, personal interests and their skill level. The validity of the shift share instruments used to address reverse causality rely upon initial waves of immigrants having chosen locations based upon extra-economic concerns, which likely may not be the case.

Kemeny’s (2012) previous work finds that wages in areas with high levels of social capital, often promoted by regional institutions, are typically 7% higher than those living in equally diverse areas with lower levels of social capital, a consideration not accounted for by other authors.

Overall the paper finds little consensus as to the impact of team diversity within the organizational literature.

Several issues with the measurements currently used are highlighted. Productivity gains for lower-skilled labour may not necessarily result in wage increases, and process innovation within this segment may not be patented. Kemeny cites Alesina et al.’s (2013) findings that skin colour or language spoken at home are less likely to result in production complementarities than social values are. Their research finds ethnic fractionalization and birthplace diversity are largely unrelated, whilst birthplace also fails to capture the importance of second-generation immigrants. Under Roback’s (1982) Spatial Equilibrium, higher wages may either reflect greater productivity brought about by diversity, or compensate workers for the disutility of living in a diverse area. Because of this paradox one cannot determine from wages alone how productivity and diversity may be linked.

Kemeny condemns an inherent assumption of urban studies; that “bio-diversity reflects intellectual diversity” (p.35) and contends “the idea that national culture shapes heuristics and perspectives ought to be subject to empirical validation.” (p.37)

Kemeny argues, that based upon the literature reviewed, diversity is generally positively related to wages, and either rents, productivity or cultural amenities, with least square analysis’ demonstrating the direction of causality is from diversity to economic gain. It is reasoned that this indicates the productivity augmenting effects of immigrant diversity outweigh the cost of transacting across cultures.

Kemeny proposes that further work into the role of institutions, the relative importance of city specific manifestations of diversity and the differing impact of diversity between skill levels and industries would advance this modern field.

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Critique

Value and Implications of the Research

Kemeny provides a useful viewpoint by combining the findings of both economic geography and organizational theory. In identifying limitations in the methodologies of both fields, future work can seek to address these issues and generate a better understanding of the relationship between immigrant diversity and economic development. This understanding may help inform frequently inaccurate (Economist, 2013) popular debates on immigration, which argue that immigration results in fewer jobs for natives (Kemeny, 2013) and a drain on state welfare (Economist, 2013). Furthermore greater understanding of how immigration affects the economy should result in better-informed immigration policy. The finding that institutions can augment economic gains may be beneficial to both immigrants and natives, and represent a pragmatic way to enhance the quality of life for both parties.

Limitations and Future Research

By omitting the level at which quoted results were found to be statistically significant, the paper makes it difficult to interpret the frequently contradicting results of the various research cited.

One issue Kemeny fails to address is whether mild racial or cultural preferences can produce extreme segregation in urban areas, as is illustrated by Schelling’s (1978) famous checkerboard model. Becker (1971) observed that the economic penalty to employers who display taste-based discrimination increased as the size of the group being discriminated against increased, therefore larger populations of immigrants should experience less discrimination and thus higher wages than smaller populations. Further discussion of the link between immigration and discrimination, and the economic impact of the latter may provide valuable insight to public policy debate and formulation.

Whilst Kemeny addresses the fact that many studies fail to acknowledge that individual competencies play a significant role, an issue the research does not expand upon is difference between immigrants of different cultural backgrounds. Immigrants from nations with similar language and cultural values will experience lower transactional costs (Rokeach, 1979), which correspond with Hofstede’s (2001) organizational research findings. Goodhart (2013) finds significant differences in economic prosperity between immigrants of different national origin in Britain during the 20th Century.

Whilst a controversial topic it must be noted that the recent consensus in psychology research is that there is a strong heritability of “intelligence” (Bouchard, 2004). As measures of “intelligence” have been shown to be linked to wage differentials (Benjamin et al. 2012), then it should be considered that the economic prosperity brought by immigrants may be related to their genetic makeup and enhancing genetic diversity (Ashraf and Galor, 2013; Ager and Bruckner, 2013). There is a growing body of work in this field of genoeconomics, broadly covered in Benjamin et al. (2012) and Navarro’s (2009) reviews of the existing literature, which could further enhance Kemeny’s spatial economics paper.

An additional source of heterogeneity is the individuals’ decision to emigrate. Ruiz and Vargas-Silva’s (2013) work finds that forced migration produces different economic effects to that of voluntary migration. An improved understanding of the reason for immigration may help explain the differences between skilled and unskilled labour, as one could hypothesise that those in skilled segments may be moving due to prearranged employment. The effect of capital stock brought by immigrants is also not considered, which would increase the steady state under the Solow (1956) model.

With the growing economic importance of Asia and Latin America (Mpoyi, 2012) future research considering immigration from the West to these nations would be of value to this field.

References

Ager, P.; Bruckner, M.; (2013) Immigrants’ Genes: Genetic Diversity and Economic Development in the US. Munich Personal RePEc Archive. Paper No. 51906

Ashraf, Q. and Galor, O. (2013) The ‘Out of Africa’ Hypothesis, Human Genetic Diversity, and Comparative Economic Development. American Economic Review. Vol. 103(1) pp.1-46

Becker, G. (1971) The Economics of Discrimination. 2nd Edition. University Of Chicago Press. Chicago.

Benjamin, D.; Cesarini, D.; Chabris, C.; Glaeser, E.; Laibson, D.; Guðnason, V.; Harris, T. et al. (2012) The promises and pitfalls of genoeconomics. Annual Review of Economics. Vol. 4 pp.627-662.

Bouchard, T. (2004) Genetic Influence on Human Psychological Traits: A Survey. Current Directions in Psychological Science. Vol. 13(4) pp.148-151

Goodhart, D. (2013) The British Dream: Successes and Failures of Post-war Immigration. Atlantic Books. London.

Hofstede, G. (2001) Culture’s Consequences: Comparing Values, Behaviors, Institutions and Organizations Across Nations. 2nd Edition. Sage Publications. Thousand Oaks, CA.

Kemeny, T. (2013) Immigrant Diversity and Economic Development in Cities: A Critical Review. Spatial Economics Research Centre. London School of Economics. Discussion Paper 149

Mpoyi, R. (2012) The Impact of the “BRIC Thesis” and the Rise of Emerging Economies on Global Competitive Advantage: Will There Be a Shift from West to East? Journal of Applied Business & Economics. Vol. 13(3) pp.36-47

Navarro, A. (2009) Genoeconomics: Promises and Caveats for a New Field. Annals of the New York Academy of Sciences. Vol. 1167 pp. 57–65

Rokeach, M. (1979) Understanding Human Values. The Free Press. New York. NY.

Schelling, T. (1978) Micromotives and Macrobehavior. Norton. New York, NY.

Solow, R. (1956) A Contribution to the Theory of Economic Growth. The Quarterly Journal of Economics. Vol. 70(1) pp. 65-94

The Economist (Dec 21st 2013) British immigration. You’re Welcome.

The Economist (Nov 9th 2013) Little England or Great Britain.

Zhang, J. (2009) Tipping and residential segregation: a unified Schelling model. IZA Discussion Papers. No. 4413

Industrial Location and Path Dependency during the British Industrial Revolution

The Location of the UK Cotton Textiles Industry in 1838: a Quantitative Analysis

by

Nicholas CRAFTS (n.crafts@warwick.ac.uk)  University of Warwick

Nikolaus WOLF (nikolaus.wolf@wiwi.hu-berlin.de) Humboldt University

ABSTRACT

We examine the geography of cotton textiles in Britain in 1838 to test claims about why the industry came to be so heavily concentrated in Lancashire. Our analysis considers both first and second nature aspects of geography including the availability of water power, humidity, coal prices, market access and sunk costs. We show that some of these characteristics have substantial explanatory power. Moreover, we exploit the change from water to steam power to show that the persistent effect of first nature characteristics on industry location can be explained by a combination of sunk costs and agglomeration effects.

URL:  http://econpapers.repec.org/paper/heswpaper/0045.htm

Review by Anna Missiaia

This paper was distributed by NEP-HIS on 2013-09-13. Nick Crafts and Nikolaus Wolf, who have both provided significant contributions to the literature on industrial location, engage here in the analysis of the UK cotton textile industry. In particular cotton production during the Industrial Revolution was heavily concentrated in Lancashire, the region just north of Manchester. Moreover, this concentration persisted over the 19th century. The two authors are therefore interested in explaining both the original concentration and its persistence throughout time.

The paper presents a solid statistical work. The dataset comprises 1823 cotton mills and covers 148 locations in all of the UK. To explain the employment in textiles across these locations, the authors use information on coal prices, geography, climate and access to markets. All these measures are specific to each location and region fixed effects are included to avoid the omitted variable bias. Firms are assumed to be profit maximizers in their location decisions. The factors that influence the location decisions are considered into two broad groups: the “first nature” characteristics, which are considered exogenous to earlier location choices (i.e. climate) and the “second nature” characteristics which are endogenous (i.e. access to markets). Crafts and Wolf separate these two elements because they are interested in identifying the case of location choices that eventually modify the characteristic of the location itself (in particular market access).

They reckon that access to market can be so important that the cotton industry remained in a location in spite of higher variable costs because these were outweighed by better access to markets. Another way in which past choices can affect current choices is through sunk costs: once an investment in energy production was made in one location, it could hardly be moved to another location. However, it could often be adapted to new technology. The example provided is the switch from water to steam power, during which waterwheels were adapted to steam. This allowed some location that at that point did not have a fist nature advantage, to maintain their industries through path dependence.

hibbert-cotton-machines

Hibert, Platt & Son’s cotton machines.  Illustrated London News, 23 August 1851. 

On the empirical side, the paper uses a Poisson model to estimate the expected number of cotton mills and employed persons for each location as a function of the characteristics of the locations. The main findings are that water power production and number of patents registered increase the likelihood of location; coal prices had a surprisingly weak effect; agglomeration forces had a positive effect on the number of persons employed but a negative effect of the average size of the mills, suggesting that cotton industry was organized in a network of small specialized mills. This is confirmed by anecdotal evidence on Lancashire’s cotton industry. The authors also provide several robustness checks on their data to support their claims.

The paper then moves on to discussing why Lancashire achieved such a high concentration of cotton industries. The two authors explain that the high concentration was the result of a combination of first and second nature geography. To prove this statistically, Crafts and Wolf perform a counterfactual analysis in which they replace each characteristic with the average value of the UK and then impose a 10% change in the variables to compare their effect individually. Doing so, they come up with a “conversion table” that tells us what variation of the x variable is needed to offset a 10% variation of the y variable. The main results are that the location choices were driven both by first nature characteristics such as water power and second nature characteristics such as market access. The persistence of the location is liked to sunk costs and agglomeration economies, which allow some regions to maintain their industries in spite of the original advantage being vanished.

textile

An image of the Lewis Textile Museum in Blackburn, Lancashire.

To conclude, the contributions of this paper are several. First, it makes for the first time use of statistical techniques to explain the location of cotton industries, which were crucial during the British Industrial revolution. Doing so, it contributes to the wider debate about the determinants of the location of industries in general, proposing a methodology based on counterfactuals which allows to compare the relative strenghts of the different factors. Finally, the paper adresses the always ‘hot issue’ of path dependency in location choices, which is faced by any researcher in this particular field. The next step in the research, to which we look forward,  will be to estimate the model as a panel in order to cast more light on the persistence of location through time.

Italy and the World Economy: celebrating Italy’s 150th birthday with some data crunching

The Well-Being of Italians: A Comparative Historical Approach

by Andrea Brandolini (andrea.brandolini@bancaditalia.it) and Giovanni Vecchi (giovanni.vecchi@uniroma2.it)

URL: http://d.repec.org/n?u=RePEc:bdi:workqs:qse_19&r=his

Abstract

The paper describes the evolution of the well-being of the Italians during the 150 years since the country’s unification. The progress in material standard of living was substantial, with GDP per capita growing 13 times between 1861 and 2010 and hours of work (and hence effort) falling considerably, but was roughly in line with that experienced by most other European countries. By relying on a novel database on household budgets, the paper shows that economic growth was accompanied by a long-run reduction of inequality that appears however to have been reversed in the last two decades. Progress was not limited to the economic domain: educational attainment improved considerably, although less than in other countries; on the other hand, the increase in life expectancy was spectacular and brought Italians to lead the international ranking.”

“Comparative Advantages in Italy: A Long-run Perspective”

by Giovanni Federico (giovanni.federico@eui.eu) and Nikolaus Wolf  (nikolaus.wolf@wiwi.hu-berlin.de)

URL: http://d.repec.org/n?u=RePEc:bdi:workqs:qse_9&r=his

Abstract

The history of Italy since her unification in 1861 reflects the two-way relationship between foreign trade and economic development. Its growth was accompanied by a dramatic increase in the country’s integration with European and global commodity markets: foreign trade in the long run grew on average faster than the overall economy. Behind the dynamics of aggregate trade, Italy’s comparative advantage changed fundamentally over the last 150 years. The composition of trade, in terms of both commodities imported and exported and in terms of trading partners, developed from a high concentration of a few trading partners and a handful of rather simple commodities into a wide diversification of trading partners and more sophisticated commodities. In this chapter we use a new long-term database on Italian foreign trade at a high level of disaggregation to document and analyze these changes. We will conclude with an assessment of Italy’s prospects from a historical perspective.”

Review by: Anna Missiaia

In 2011 the Bank of Italy promoted an extensive research project to celebrate the 150th anniversary of the Unification of the country. The project focused on the various aspects of the economic history of Italy since 1861. The goal was to cast light on the economic and social development of unified Italy and on Italy’s position in the world today. The project involved an impressive number of prominent scholars (mostly historians, economic historians and economists) both Italian and international.  The results of the research project were presented at the international conference held at the Bank of Italy in Rome from 12 to 15 October 2011. The project included twenty studies, most of these coauthored by Italian and non-Italian scholars (all of which were distributed by nep-his on 2011 12 19). The topics analyzed included: productivity and wealth, technology, production specialization, business internationalization, human capital, social capital, trade, migration, legal system, regional divergence, financial system and public finance, political economy. All the works presented adopt a long run perspective, embracing all the 150 years of unitary history of Italy. One of the most interesting results of this project was the revision of Italian historical statistics and the release of new historical series of the main national accounts aggregates. All the working papers presented at the conference are available from the website of the Bank of Italy.

Here we propose to comment on two contributions that were presented at the conference. The first one is “ The Well-Being of Italians: A Comparative Historical Approach” by Andrea Brandolini and Giovanni Vecchi which is concerned with measures of standard of living of the Italian population over 150 years. The second paper is “Comparative Advantages in Italy: A Long-run Perspective” by Giovanni Federico and Nikolaus Wolf which is concerned with the relationship between foreign trade and economic development in Italy.

Brandolini and Vecchi propose an overview of measures of standard of living that go beyond GDP per capita, including new estimates made available within the project. First of all, they show new estimates of income per capita recently released by Banca d’Italia, ISTAT and University of Rome Tor Vergata. They then compare these with the updated international series by Maddison. The result is that Italy lagged behind until WWII, after which the big catch up took place resulting in an overall increase by a factor of 13. The two scholars then propose a measure that takes account of the economies of scales in consumption: GDP per equivalent person. This measure takes into account of the household size, allowing to consider pooling benefits. The difference between the two series are large at the beginning of the period and shirk over time because of the reduction of household size. On worked time, third measure of well-being proposed here, they find that the number of hours worked decreased dramatically. The most interesting result is that child work decreased as well during industrialization, which is a result that makes Italy different from other industrializing countries like Belgium, the US and the UK. The next step is to look at inequality over the 150 years. For this purpose, they use the data available from the Italian Household Budget Database. As for inequality, the experience of Italy seems to be different from other countries such as the US and the UK: inequality, measured through the Gini and the Atkinson indices, decreased until the 1980s, with a resumption in the last 30 years. The last measures proposed are life expectancy, anthropometric measures and the Human Development Index (HDI). Life expectancy rose dramatically over the 150 years at a higher pace compared to that of other industrializing countries. This was due to a great improvement of health conditions. Heights appear to be negatively affected by industrialization, showing once again the difference between Italy and the others. The performance of the HDI is quite poor, mostly because of the slow increase in school enrollment rates. Concluding, the main features of the development of well-being of Italians between 1861 and today is an increase in GDP in line with that of other Western countries and a decreasing inequality and longevity/health in spite of industrialization.

The second paper reviewed here deals with assessment of the evolution of the comparative advantage of Italy in international trade. The common wisdom at the time of unification was that Italy should have focused on exporting primary rather than manufacturing goods. Federico and Wolf use a new dataset on Italian trade to show how comparative advantage of Italy changed over the 150 years. The dataset as been constructed within a project funded by Banca d’Italia and provides systematic information on Italian trade from 1862 onwards. The authors calculate comparative advantages through the index of Revealed Comparative Advantage for each type of product. Intuitively, for each of these they measure the difference between the product’s normalized net balance and the total normalized net balance. If the index is positive, there is a comparative advantage in that type of export. The result is a shift in the comparative advantage of Italy from primary goods to manufacturing around the 1920s. This result is interesting as it shows that Italy achieved this shift earlier than previously thought and it managed to reverse the expectations at the time of Unification. Federico and Wolf also comment on the change of trading partners that Italy experienced over the period, starting with a 90% of exports towards Europe and ending with a much higher degree of openness towards the rest of the world.

In conclusion, the research project promoted by the Bank of Italy for the 150th anniversary of Unification was a very fruitful opportunity for economic historians. Existing series have been revised and expanded, giving great opportunities for new research in a number of related fields. The two working papers reviewed here are only two examples of the use of these data.