Tag Archives: inequality

(Superstar) Firms and Inequality

The Fall of the Labor Share and the Rise of Superstar Firms

By: David Autor (MIT, NBER and IZA), David Dorn (University of Zurich and IZA), Lawrence F. Katz (Harvard University, NBER and IZA), Christina Patterson (MIT) and John Van Reenen (MIT, NBER and IZA)

Abstract: The fall of labor’s share of GDP in the United States and many other countries in recent decades is well documented but its causes remain uncertain. Existing empirical assessments of trends in labor’s share typically have relied on industry or macro data, obscuring heterogeneity among firms. In this paper, we analyze micro panel data from the U.S. Economic Census since 1982 and international sources and document empirical patterns to assess a new interpretation of the fall in the labor share based on the rise of “superstar firms.” If globalization or technological changes advantage the most productive firms in each industry, product market concentration will rise as industries become increasingly dominated by superstar firms with high profits and a low share of labor in firm value-added and sales. As the importance of superstar firms increases, the aggregate labor share will tend to fall. Our hypothesis offers several testable predictions: industry sales will increasingly concentrate in a small number of firms; industries where concentration rises most will have the largest declines in the labor share; the fall in the labor share will be driven largely by between-firm reallocation rather than (primarily) a fall in the unweighted mean labor share within firms; the between-firm reallocation component of the fall in the labor share will be greatest in the sectors with the largest increases in market concentration; and finally, such patterns will be observed not only in U.S. firms, but also internationally. We find support for all of these predictions.

URL: http://EconPapers.repec.org/RePEc:iza:izadps:dp10756

Distributed by NEP-HIS on: 2017‒05‒28

Review by: Sebastian Fleitas (University of Arizona)

In the last few years, inequality has been at the center of many political and academic debates. It turns out that, although less mentioned in these debates, the rapid growth of some developing countries in the last decades has actually decreased global inequality. But then, why is there a big debate about inequality? The issue is that, on the other hand, inequality in developed countries has been increasing over time. From the perspective of the functional distribution of income between labor and capital, one of the indicators of this increase in inequality is that the labor’s share of GDP has been falling in the United States and other countries in recent decades. These forces have generated winners and losers. As economist Branko Milanovic points out with his famous “elephant chart,” the middle class of the world and the very rich of the world are the two groups whose incomes have increased more rapidly. In contrast, it can be easily seen that there are large groups of people uncomfortable with increased inequality. Moreover, the factors assumed to be causing inequality have taken a vital role in political debates and recent elections.

ElephantChart

“Elephant Chart”: Lakner & Milanovic (2016)

In this context, it is extremely important to understand what is driving these changes in inequality. There are different approaches to understand the increase in inequality in developed countries. The two main perspectives point to the importance of top incomes and changes in the tax system (e.g. Piketty and Saez, 2014), on one hand, and to changes in the labor market, mainly related to the incorporation of technological change that is more favorable to skilled workers (e.g. Autor, 2014), on the other. More recent approaches have begun to more directly incorporate the role of firms. For example, a growing literature estimates models to separate the firm’s and employee’s contributions to wage differences via double fixed-effects models, with many studies finding that firm wage effects account for approximately 20% of the overall variance of wages and have had an increasingly important role over time (e.g. Card et al., 2016). However, while we can all see that “superstar firms” like Apple, Microsoft, Google or many others in different sectors of the economy are growing very quickly, we still do not know what their effect of inequality is.

Do these “superstar firms” increase inequality because they are responsible for the decrease in labor’s share? The paper by Autor, Dorn, Katz, Patterson and Van Reenen addresses exactly this issue. If we are interested in understanding the role of firms in the increase in inequality, it is particularly important to answer the question of whether the decrease in labor’s share of income can be explained by technological changes occurring within firms, or if it is better explained by a rise of “superstar” firms, which tend to use new technologies and are more capital-intensive. The main argument of the authors is that markets have changed in such a way that firms with superior quality, lower costs, or greater innovation get disproportionately high rewards relative to previous periods. Since these “superstar firms” have higher profit levels, they also tend to have a lower share of labor in sales and value-added. Therefore, as these firms gain market share across a wide range of sectors, the aggregate share of labor falls. In this way, “superstar firms” are one of the drivers of the decrease in labor’s share (in favor of capital’s share) of value added.

Before they start developing the evidence for this argument, the authors clearly document the fall in labor’s share of GDP in the United States and other developed countries. After that, they formalize their main argument in a model of “superstar firms,” in order to derive the set of predictions that will be taken to the data. With this model in hand, the authors use several sources of information (U.S. Economic Census, KLEMS, UN Comtrade Database, and others) to run a series of regressions and decompositions to analyze the testable predictions of the model. First, the authors find that sales concentration levels have risen in most sectors. Second, they show that the larger decreases in labor’s share are observed in industries where concentration has increased the most. Third, by comparing the weighted and unweighted mean of labor’s share, the authors conclude that the fall in labor’s share has an important component of reallocation between (and not within) firms. Furthermore, they find that the between-firm reallocation of labor’s share is greatest in the sectors that are concentrating the most. Finally, these patterns are not only present in the US but also in many European countries.

Overall, all of these findings are consistent with the idea of a rise of “superstar firms” that have lower labor’s share, and which have gained more importance by concentrating large shares of sales in different sectors of the economy. It should be noted, however, that the authors do not provide a clean causal identification of the superstar firm model. The empirical exercises are done carefully and controlling for the factors that can more clearly affect the tested relationships. The use of fixed effects and trends by industry allow the authors to obtain identification exclusively from the acceleration or deceleration of labor’s shares and concentration conditional on these controlled trends. Thus, any potential threat to this identification strategy would have to come from other factors not captured by these trends or fixed effects and which are correlated with industry concentration and inequality.

This paper makes a major contribution by pointing out the role of “superstar firms” in explaining increasing inequality and opens some avenues for future research in a direction that had not been typically considered in the literature. In this sense, a particularly interesting direction would be to use the matched employer-employee databases with census data on sales to test if industry concentration has impacts on the firm component of wages and the within and between firm decomposition in each sector.

Sweated LabourFinally, the paper addresses the question of what is the driver of the growth of these “superstar firms.” The main debate here is whether the rise of these “superstar firms” and industry concentration are associated with competitive forces, or if they are a signal of an economy with competition problems. Increased concentration can be a result of technological changes: some sectors could be introducing technologies that have a “winner takes all” aspect. An alternative, more worrisome story is that leading firms are less exposed to competition because they can create barriers to entry or have more lobbying power. The authors provide evidence that is somewhat comforting about this point. They show that concentration is greater in industries experiencing faster technical change, approximated either by patent activity or by total factor productivity growth. However, this evidence is still subject to debate. It could be the case that these originally innovative firms are now using their market power to generate barriers to entry. This can be even more important in some technology sectors where network effects generate an important advantage to the innovators. I think this discussion is actually one of the main directions where this stream of research can be expanded and complemented in the future. In this sense, for example, sector-specific partial equilibrium models could allow formalizing the product and labor markets under innovation dynamics, and such models could be estimated using data for specific industries and structural econometrics estimation techniques.

To sum up, I think that this paper makes a major contribution by pointing out the effect of “superstar firms” on the decrease of labor’s share of GDP, and therefore increased inequality in developed countries. Additionally, this paper opens several avenues for future work in order to generate more evidence consistent with the “superstar firms” model and, critically, to understand its causes and consequences at the individual micro level, especially using matched individual and firm level databases and sector-specific analysis. To understand the relationship between firms and inequality is a key task in a world of “superstar firms,” and these are key inputs for the discussion of, for example, the roles of tax policies, labor market institutions and their relationship with the increasing heterogeneity of firms.

REFERENCES

Autor, D. (2014). Skills, Education, and the Rise of Earnings Inequality Among the “Other 99 Percent.” Science 344 (6186), 843-851.

Card, D., Cardoso, A. R., Heining, J., & Kline, P. (2016). Firms and Labor Market Inequality: Evidence and Some Theory. National Bureau of Economic Research Working Paper 22850

Lakner, C., & Milanovic, B. (2016). Global Income Distribution: From the Fall of the Berlin Wall to the Great Recession. World Bank Economic Review 30(2), 203-232.

Piketty, T., & Saez, E. (2014). Inequality in the Long Run. Science 344(6186), 838-843.

 

 

Is the Glass Half Full?: Positivist Views on American Consumption

Fifty Years of Growth in American Consumption, Income, and Wages

By Bruce Sacerdote (Darmouth)

Abstract: Despite the large increase in U.S. income inequality, consumption for families at the 25th and 50th percentiles of income has grown steadily over the time period 1960-2015. The number of cars per household with below median income has doubled since 1980 and the number of bedrooms per household has grown 10 percent despite decreases in household size. The finding of zero growth in American real wages since the 1970s is driven in part by the choice of the CPI-U as the price deflator; small biases in any price deflator compound over long periods of time. Using a different deflator such as the Personal Consumption Expenditures index (PCE) yields modest growth in real wages and in median household incomes throughout the time period. Accounting for the Hamilton (1998) and Costa (2001) estimates of CPI bias yields estimated wage growth of 1 percent per year during 1975-2015. Meaningful growth in consumption for below median income families has occurred even in a prolonged period of increasing income inequality, increasing consumption inequality and a decreasing share of national income accruing to labor.

URL: http://EconPapers.repec.org/RePEc:nbr:nberwo:23292
(Click here for a free download version)

Distributed by NEP-HIS on:2017-04-23

Revised by: Stefano Tijerina (Maine)

Contrary to the popular outcry that the gap between rich and poor in the United States has steadily increased since the 1960s and that the quality of life has steadily deteriorated, Bruce Sacerdote argues that the picture is not as grim and that the steady rise of household consumption for households “with below median income” is evidence that the national economy has continued to thrive for all U.S. citizens and not just those on the top.[1] In “Fifty Years of Growth in American Consumption, Income, and Wages” Sacerdote reveals that the focus on wage growth favored by economists and policy makers impedes us from focusing on other aspects of growth, such as consumption and the quality of consumed goods.[2] From his perspective focusing on real wage growth and the inflated rates of the Consumer Price Index (CPI) only tells half of the story and that it is therefore necessary to center on consumption data in order to construct a more holistic picture of the economic realities of the below median income household.[3] From his perspective, “low income families have seen important gains in at least some areas of consumption” thanks in part to a steady growth in consumption of 1.7 percent per year since 1960.[4]

Bruce Sacerdote adjusted the CPI to the bias corrections developed by Dora Costa and Bruce Hamilton who previously worked on similar questions, looking at “the true costs of living” and new ways of estimating “real incomes” in the United States.[5] His findings for the period between 1960 to 2015 concluded that there was an increase of 164 percent in consumption for those below the median household income.[6] A previous consumption measure for the same period of time, excluding the bias measures from Costa and Hamilton, showed a 62 percent increase in consumption.[7] A third measurement that calculated real wages using the Federal Reserve’s Personal Consumption Expenditures (PCE) for the same period of time reversed the claims of wage stagnation furthered by some economists, policy makers, citizens, and labor union advocacy groups. This last measurement showed that when using the PCE to deflate nominal wages, the growth of real wages was 0.54 percent per year.[8] This contradicts the arguments of data sets such as the “2016 Distressed Community Index” that focus specifically on the increasing gap between rich and poor in the United States.[9]

Beside the bias corrections and other measurements, Sacerdote argues that the quality, technology, and durability of current consumption goods is superior to that of previous decades, therefore expanding the relative capacity of consumption of those below the median income. For example he claims that “the number of cars per household has risen from 1 to 1.6 during 1970-2015,” while the median home square footage for this income segment has risen about 8 percent during this same period of time.[10]

His objective of focusing “on growth rates in consumption instead of changes in poverty rates” is achieved by using data and methodologies for analyzing data that shows that “the glass half full” but as it is evident from the working paper, quantitative data can be tailored to fit the researcher’s agenda. Numerous questions surface regarding consumption trends in the United States that lead to further conclusions that indicate that the 164 percent increase of the past fifty-plus years is the result of greater household debt and cheaper consumer goods prices that are tied to the impacts of globalization. Consumer households that fall below the median income continue to steadily consume more, there is not doubt about that, but their wages continue to depreciate while their debt continues to rise. Moreover, globalization has allowed companies to transfer their production overseas, leading to a loss of jobs in the manufacturing sector that potentially offered higher than minimum wage salaries to those households that ranked below the median income. The transfer of production has at the same time guaranteed cheaper products to these consumers that then are able to consume more with their lower wages and their greater access to loans that artificially maintain their consumption capacity while increasing their debt to income ratio.

According to the U.S. Census Bureau, the median household income for the year 2014 was $53,719.[11] This means that half of Americans earned less than that amount. This population, that represents the central focus of Sacerdote’s research, currently has an average household debt of $130,000 (assuming that those earning below the median income are forced to go into debt to maintain their standard of living).[12] The breakdown of this debt shows that mortgages, credit cards, auto loans, and student loans make up most of the American debt.[13] This could indicate that the steady consumption increase demonstrated by Sacerdote could actually be artificially maintained by the financial system that keeps the American consumer afloat.

Sacerdote’s work could also benefit from qualitative research that would provide more in-depth analysis and at the same time counter-balance his claims on consumer choice and the reliability of products being consumed. Qualitative research could provide a different explanation as to why low-income consumers have opted to hold on to their vehicles for longer periods of time, how they are able to purchase expensive technology such as cell phones and access services such as internet and cable television, if indoor plumbing is a sign of a higher quality of life or simply a response to policy and the standardization of construction norms, and if the increase in housing square footage per household really represents a higher quality of life.  

Selectivity of data and research approach in this case clearly benefits the researcher’s argument but this could quickly be turned around with other sets of data and a different research approach. A focus on credit rates and debt rates over the same period of time shifts the argument around and leads to completely different conclusions, and so would a qualitative analysis of the quality of life of Americans. Although controversial, Sacerdote’s work forces the reader to think more critically about the changes that have taken place in American society in the past fifty-plus years and brings up the question of whether or not this consumption approach is more reflective of the nation’s economic dependence on consumer consumption as a percentage of the GDP.

References

[1] See for example Thomas Piketty’s argument on the increasing gap between rich and poor and the possible threat to capitalism and democratic stability in “Capital in the 21st Century.” Cambridge: Harvard University (2014).

[2] Bruce Sacerdote. “Fifty Years of Growth in American Consumption, Income, and Wages.” National Bureau of Economic Research, working paper series, working paper 23292, March 2017. Accessed April 25, 2017. http://nber.org/papers/w23292, 2.

[3] Ibid.

[4] Ibid., 1-7.

[5] See Dora L. Costa. “Estimating Real Income in the United States from 1888 to 1994: Correcting CPI Bias Using Engel Curves.” Journal of Political Economy 109, no. 6 (2001): 1288-1310, and Bruce W. Hamilton. “The True Cost of Living: 1974-1991.” Working paper in Economics, The John Hopkins University Department of Economics, January 1998.

[6] Sacerdote. “Fifty Years of Growth in American Consumption, Income, and Wages,” 2.

[7] Ibid., 1.

[8] Ibid., 3.

[9] “2016 Distressed Community Index: A Analysis of Community Well-Being Across the United State.” Accessed April 25, 2017. http://eig.org/dci/report. See also for example Gillian B. White. “Inequality Between America’s Rich and Poor is at a 30-Year High.” Washington Post, December 18, 2014. Accessed May 1, 2017. https://www.theatlantic.com/business/archive/2014/12/inequality-between-americas-rich-and-americas-poor-at-30-year-high/383866/.

[10] Sacerdote. “Fifty Years of Growth in American Consumption, Income, and Wages,” 2.

[11] Matthew Frankel. “Here’s the Average American Household Income: How do you Compare?” USA Today November 24, 2016. Accessed May 2, 2017. https://www.usatoday.com/story/money/personalfinance/2016/11/24/average-american-household-income/93002252/

[12] Matthew Frankel. “The Average American Household Owes 90,336 – How do you Compare?” The Motley Fool May 8, 2016. Accessed May 10, 2017. https://www.fool.com/retirement/general/2016/05/08/the-average-american-household-owes-90336-how-do-y.aspx

[13] Ibid.

How do we eliminate wealth inequality and financial fragility?

The market turn: From social democracy to market liberalism

By Avner Offer, All Souls College, University of Oxford (avner.offer@all-souls.ox.ac.uk)

Abstract: Social democracy and market liberalism offered different solutions to the same problem: how to provide for life-cycle dependency. Social democracy makes lateral transfers from producers to dependents by means of progressive taxation. Market liberalism uses financial markets to transfer financial entitlement over time. Social democracy came up against the limits of public expenditure in the 1970s. The ‘market turn’ from social democracy to market liberalism was enabled by easy credit in the 1980s. Much of this was absorbed into homeownership, which attracted majorities of households (and voters) in the developed world. Early movers did well, but easy credit eventually drove house prices beyond the reach of younger cohorts. Debt service diminished effective demand, which instigated financial instability. Both social democracy and market liberalism are in crisis.

URL: http://EconPapers.repec.org/RePEc:nuf:esohwp:_149

Distributed by NEP-HIS on: 2017-01-29

Review by: Sergio Castellanos-Gamboa, Bangor University

Summary

This paper emerged from Avner Offer’s Tawney Lecture at the Economic History Society’s annual conference, Cambridge, 3 April 2016 (the video of which can be found here).

In this paper Offer discussed two macroeconomic innovations of the 20th century, which he calls “the market turn”. These are the changes in fiscal policy and financialisation that encompassed the shift  from social democracy to market liberalism from the 1970s onwards. Social democracy is understood as a fiscal innovation which resulted in the doubling of public expenditure (from aprox. 25 to 50 per cent of GDP between 1920 and 1980). Its aim was reducing wealth inequality. Market liberalism encompassed a monetary innovation, namely the deregulation of credit which allowed households to increase their indebtedness from around 50 to 150 per cent of personal disposable income, mainly for the purpose of home ownership. According to Offer the end result of market liberalism was increasing wealth inequality. See Offer’s depiction of this process in the graph below.

Two macroeconomic financial innovations in the 20th century, UK calibration. (Note: Diffusion curves are schematic, not descriptive.)

Two macroeconomic financial innovations in the 20th century, UK calibration.
(Note: Diffusion curves are schematic, not descriptive.)

Offer considers that both social democracy and market liberalism are norms captured by the single concept of a “Just World Theory” (Offer & Söderberg, 2016).The ideals behind social democracy are said to be supported by ideas found in classical economics, while the ideals behind market liberalism are said to have emerged from a redefinition of the origins and nature of economic value found in neoclassical economics. Contrasting the ideas behind social democracy and market liberalism brings about  questions such as:

  • Where does value come from?,
  • Is it from production or is it from personal preferences and demand for the good/service?,
  • What is just and fair?,
  • What do we as individuals deserve as reward?, and
  • Is there really a trade-off between equality and efficiency?

Answering any of these question is not simple and heated debates abound around them. Offer, however, rescues the idea of life-cycle dependency, where the situation of the most vulnerable individuals is alleviated through collective risk pooling rather than financial markets. According to Offer,  life-cycle dependency was the dominant approach to reducing poverty in most developed countries until the oil crisis of the early 1970s. Then collapse of the Bretton Woods accord that followed, led to the liberalization of credit by removing previous constraints. This in turn resulted in the “market turn”.

Avner Offer

Professor Avner Offer (1944). MA, DPhil, FBA. Emeritus Fellow of All Souls College, Oxford since 2011.

Offer then turns to analyse the events after the collapse of Bretton Woods that led to the increase of household indebtedness while focusing on the UK. The 1970s was a very volatile decade for Britain.  For instance, oil price increases and the secondary banking crises of 1973 resulted in the highest annual increase of the inflation rate on record. Offer argues, while citing John Fforde (Executive Director of the Bank of England at that time), that the Competition and Credit Control Act 1971 was as a leap of faith in the pursuit of greater efficiency in financial markets. This Act was accompanied by a new monetary policy where changes in interest rates (the price of money) by the central bank was to bring about the control of the quantity of money. Perhaps unexpectedly and probably due to a lack of a better understanding of the origins of money, that was not the case. Previously lifted credit restrictions had to be reinstated.

Credit controls were again lifted in the 1980s. This time policy innovations went further by allowing clearing (ie commercial) banks to re-enter the personal mortgage market. The Building Societies Act 1986  allowed building societies to offer personal loans and current accounts as well as opened a pathway for them to become commercial banks (which many did after 1989 and all those societies that converted  either collapsed or were taken over by clearing banks or both). Initially and up to the crash of house prices in September, 1992, personal mortgage credit grew continuously and to levels never seen before in the UK. According to Offer, during this period both political parties supported the idea of homeownership and incentivised it through programs like “Help to Buy”. However, the rise in the demand for housing combined with the stagnation in the supply of dwellings pushed up house prices, making it more difficult for first-time buyers to become homeowners. Additionally, according to Offer, the wave of easy credit of the 1980s brought with it an increase in wealth inequality and an increase in the fragility of the financial system. As debt repayments grew as proportion of income, consumption was driven down, with subsequent effects on production and services. On this Offer opined:

“In the quest for economic security, the best personal strategy is to be rich.” (p. 17)

The paper ends with possible and desirable futures for public policy initiatives to deal with today’s challenges around wealth inequality and mounting personal credit. He argues that personal debt should be reduced through rising inflation,  a policy driven write-off or a combination of both. He also argues to reinstate a regime where credit is rationed. He states that financial institutions should not have the ability to create money and therefore the housing market funding should return to the old model of building societies. He has a clear preference for social democracy over market liberalism and as such argues that austerity should end, since it is having the exact opposite effects to what was intended.

Brief Comment

Offer’s thought provoking ideas comes at a time when several political and economic events are taking place (e.g. Brexit, Trump’s attack on Dodd-Frank, etc.) which, together, could be of the magnitude as “the market turn”. Once again economic historians could help better inform the debate. Citing R. H. Tawney, Offer opened the lecture (rather than the paper) by stating that:

“to be an effective advocate in the present, you need a correct and impartial understanding of the past.”

Offer clearly fulfils the latter, even though some orthodox economists might disagree with his inflationary and credit control proposals. As per usual his idea are a great contribution to the debate around market efficiency in a time when the world seems to be in constant distress. Perhaps we ought to generate more and better research to understand the mechanisms through which market liberalism generated the current levels of wealth inequality and financial instability that Offer describes. More importantly though, is analysing if social democracy can bring inequality down as it did in the past. In my view, however, in a world where productivity seems to be stagnated, real wages are decreasing, and debt keeps growing, it is highly unlikely that the public sector can produce the recipe that will set us in the path of economic prosperity for all.

Additional References

Offer, A., & Söderberg, G. (2016). The Nobel Factor: The Prize in Economics, Social Democracy, and the Market Turn. Princeton University Press.
(Read an excellent review of this book here)

On Social Tables, Inequality and Pre-Industrial Societies

“Towards an explanation of inequality in pre-modern societies: the role of colonies and high population density”

by Branko Milanovic (City University of New York)

Abstract: Using the newly expanded set of 40 social tables from pre-modern societies, the paper tries to find out the factors associated with the level of inequality and the inequality extraction ratio (how close to the maximum inequality have the elites pushed the actual inequality). We find strong evidence that elites in colonies were more extractive, and that more densely populated countries exhibited lower extraction ratios. We propose several possibilities linking high population density to low inequality and to low elite extraction.

URL: http://econpapers.repec.org/paper/pramprapa/74877.htm

Distributed by NEP-HIS on: 2016-11-13

Guido Alfani (Bocconi University, Milan)

Given the recent increase in the availability of good-quality data on pre-industrial (or pre-modern) societies, there is much need for works of synthesis aimed at discovering the factors shaping long-term inequality trends. Branko Milanovic has been particularly active in this field, with the publication of a recent book on Global Inequality: A New Approach for the Age of Globalization (2016, Harvard University Press) [see the reviews here – Ed]. In this new working paper, Milanovic tries to move forward, using a large database of social tables to single out the potential causes of differences in historical inequality levels and in inequality extraction. He focuses in particular on institutional factors (inequality in colonies vs other areas) and on demographic factors (population density). The results are very interesting and represent a useful step forward in our understanding of inequality change in preindustrial societies.

Summary
This paper was distributed by NEP-HIS on 2016-11-13. It makes use of a relatively large collection of social tables for preindustrial societies, including overall 40 social tables for about 30 distinct countries/world areas over a very long time: from Athens in 330 BCE to British India in 1938. As is well known, social tables allow us to roughly estimate income inequality. They are particularly useful in situations of relative scarcity of data and although they have been in use for centuries – the first example is Gregory King’s social table dating 1688 – many new ones have recently been produced for a variety of preindustrial societies across the world (see Lindert and Williamson 2016 for the U.S., Saito 2015 for Japan, Broadberry et al. 2015 for England, and Alfani and Tadei 2017 for Ivory Coast, Senegal and the Central African Republic). Although estimating complete distributions is the better option (see for example the accurate reconstruction of income distribution in Old Castile around 1750 by Nicolini and Ramos 2016, the impressive work by Reis 2017 on Portugal from 1565 to 1770, and finally, the estimates of wealth inequality in the period 1300-1800 produced by the EINITE project for a variety of Italian pre-unification states and other European areas: Alfani (2015, 2017); Alfani and Ryckbosch (2016); Alfani and Ammannati (2017), this is not always possible or feasible and social tables must be considered a good alternative especially when there is a relative scarcity of data.

101524445-153289425-530x298

As rightly argued by Milanovic, the recent accumulation of new evidence has not been accompanied by equal advances in the work on causal factors driving inequality change in preindustrial times. The seminal article by Van Zanden (1995), in which long-term inequality growth in the Dutch Republic was explained by long-term economic growth, has later been nuanced by works demonstrating that during the early modern period, in many parts of Europe inequality grew also in phases of economic stagnation, or even decline (Alfani 2015; Alfani and Ryckbosch 2016). The role played by large-scale mortality crises, particularly plague epidemics, has been underlined and the Black Death of 1347-51 has been shown to be the only event able to produce large-scale and enduring inequality decline in the period from ca. 1300 to 1800 (Alfani 2015; Alfani and Ammannati 2017). In a very recent book, Scheidel (2017) has taken this line of reasoning further, arguing that all substantial declines in inequality recorded in human history are due to catastrophic events (epidemics, wars, revolutions…).

Milanovic’s aim is to find further regularities, looking for possible economic, institutional or demographic drivers of inequality change in preindustrial times. He adopts the theoretical framework of the Inequality Possibility Frontier (introduced in Milanovic, Lindert and Williamson 2011), arguing that we should focus not only on how unequal a society is, but also on how much inequality it manages to “extract” compared to the maximum inequality it could achieve given that everybody needs to reach at least the subsistence level. Hence, as an economy manages to increase the per-capita surplus produced, it also acquires a potential for becoming more unequal. A first relevant empirical finding is that colonies tend to be exceptionally extractive, especially at low levels of per-capita GDP. As Milanovic points out, this is not surprising and can be explained by colonies being more exploitative, i.e. being pushed closer to the inequality possibility frontier by rapacious elites. This is apparent when looking at inequality extraction (being a colony raises the “inequality extraction ratio” by almost 13 percent points), but not necessarily when looking at overall inequality as measured by a Gini index.

Branko Milanovic

Branko Milanovic

A more novel finding is the negative correlation between population density and both inequality and inequality extraction. In fact, a “high number of people per square kilometer seems to be a strong predictor of relatively egalitarian economic outcomes” (p. 16). Explaining this empirical finding is not easy and Milanovic resorts to two conjunctures: 1) in a less extractive economy, the poor enjoy relatively good living conditions and this might lead to greater population growth; or 2) a particularly dense population might be better able to make the position of the elite/of the ruler relatively precarious, enjoying de facto some sort of control over the actions of the elite and forcing it to adopt less extractive policies. As is clear, the direction of causality is the opposite in the two explanations – which are probably to be considered not mutually exclusive. Other correlates of inequality and inequality extraction include per-capita GDP and urbanization rates, which turn out being borderline significant (per-capita GDP) or positively but non-significantly correlated (urbanization rate), coherently with what was found by other recent comparative studies (Alfani and Ryckbosch 2016; Alfani and Ammannati 2017).

Comment

Undoubtedly, Milanovic’s new article helps to fill in a real need for more comparative research on preindustrial societies. The findings, albeit provisional, are very interesting and either they provide useful confirmation of what has already been argued by others – for example about the inability of per-capita GDP to explain preindustrial inequality growth in a satisfying way– or they lead us to think along new lines, especially regarding the impact on inequality of demographic variables. In fact, as urbanization rates proved to be a far poorer explanatory variable for inequality change than we expected (see in particular Ryckbosch 2016; Alfani and Ryckbosch 2016; Alfani and Ammannati 2017), demographic factors came to be perceived as probably relevant, but also somewhat puzzling (exception made for mass-mortality events like the Black Death, whose inequality-reducing effects now stand out very clearly). Population density offers us a novel perspective and in time, might prove to be the right path to follow.

However, there is also some space for constructive criticism. A first point to underline is that, differently from what Milanovic argues, the time might not yet be ripe for the kind of definitive and encompassing comparison that he seems to have in mind. The data available is still relatively scarce, including for Europe, which is the world area that has attracted the greatest amount of recent research. Additionally, social tables, albeit easily comparable, are not perfectly comparable – for example because they can include a greatly varying number of classes/groups. In some instances, classes are very few and we have no hint at within-class inequality. These are two reasons why, as argued above, complete distributions are strictly preferable to social tables. Finally, in the current version of Milanovic’s database, for the vast majority of countries only one social table is available, whereas multiple social tables for the same country at different time points would make for sounder statistical analyses. There are ongoing projects, especially EINITE and related projects, whose aim is to provide comparable state-level information on wealth and income inequality for large areas of the world at different points in time in the long run of history, but these projects are heavily dependent on new archival research and require time to be completed.

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Secondly there are other possible common factors shaping long-term inequality change which Milanovic cannot consider in the context of the current article. Some of these have been underlined by a recent comparative paper by Alfani and Ryckbosch (2016) which, although focusing on “only” four European states during 1500-1800, nevertheless had the advantage of having recourse to inequality measures produced with a common methodology and covering all states continuously in time. This study underlined two factors common to all the areas covered: 1) “proletarianization”, i.e. the progressive disappearance of small peasant ownership, which occurred throughout Europe during the early modern period, and 2) the inequality-increasing consequences of the rise of the fiscal-military states from ca. 1500. These factors might have played a role also in other world areas, from the broader Mediterranean to East Asia and maybe elsewhere – but at present that is no more than speculation.

Obviously, such criticism in no way negates the considerable usefulness of Milanovic’s new paper – which is also a further demonstration of how his relatively new concept of the inequality possibility frontier allows for a deeper understanding of the actual conditions and consequences of distribution. It does, however, indicate that we are still a long way from being able to identify without ambiguity the main causes of inequality change in preindustrial societies that so many international economic historians are now attempting to discover.

Selected bibliography

Alfani, G. (2015), “Economic inequality in northwestern Italy: A long-term view (fourteenth to eighteenth centuries)”, Journal of Economic History, 75(4), 2015, pp. 1058-1096.

Alfani, G. (2017), “The rich in historical perspective. Evidence for preindustrial Europe (ca. 1300-1800)”, Cliometrica 11(3), forthcoming (early view: http://link.springer.com/article/10.1007/s11698-016-0151-8 ).

Alfani, G., Ryckbosch, W. (2016), “Growing apart in early modern Europe? A comparison of inequality trends in Italy and the Low Countries, 1500–1800”, Explorations in Economic History, 62, pp. 143-153.

Alfani, G., Ammannati, F. (2017), “Long-term trends in economic inequality: the case of the Florentine State, ca. 1300-1800”, Economic History Review, forthcoming.

Alfani, G., Tadei, F. (2017), Income Inequality in Colonial Africa: Building Social Tables for Pre-Independence Central African Republic, Ivory Coast, and Senegal, IGIER Working Paper, forthcoming.

Broadberry, S., Campbell, B., Klein, A., Overton, M, Van Leeuwen, B. (2015), British Economic Growth 1270-1870, Cambridge University Press.

Lindert, P.H. and Williamson, J.G., Unequal gains. American growth and inequality since 1700, Princeton University Press, Princeton 2016.

Milanovic, B. (2016), Global Inequality: A New Approach for the Age of Globalization, Harvard University Press.

Milanovic, B., Lindert, P.H., Williamson, J.G. (2011). “Pre-Industrial Inequality”, The Economic Journal, 121, pp. 255-272.

Nicolini, E.A., Ramos Palencia, F. (2016), “Decomposing income inequality in a backward pre-industrial economy: Old Castile (Spain) in the middle of the eighteenth century”, Economic History Review, 69(3), pp. 747–772.

Reis, J. (2017), “Deviant behaviour? Inequality in Portugal 1565–1770”, Cliometrica, 11(3), forthcoming (early view: http://link.springer.com/article/10.1007/s11698-016-0152-7).

Ryckbosch, W. (2016), “Economic inequality and growth before the industrial revolution: the case of the Low Countries (fourteenth to nineteenth centuries)”. European Review of Economic History, 20(1), pp. 1-22.

Saito, O. (2015), “Growth and inequality in the great and little divergence debate: a Japanese perspective”, Economic History Review, 68(2), pp. 399–419.

Scheidel, W. (2017), The Great Leveller: Violence and the Global History of Inequality from the Stone Age to the Present, Oxford University Press.

Van Zanden, J.L. (1995), “Tracing the Beginning of the Kuznets Curve: Western Europe during the Early Modern Period”, Economic History Review 48(4): 643-664.

Wealth and Income Inequality in the Early Modern Period

Comparing Income and Wealth Inequality in Pre-Industrial Economies: Lessons from 18th-Century Spain

By Esteban A. Nicolini (Universidad Carlos III de Madrid) and Fernando Ramos Palencia (Universidad Pablo de Olavide)

Abstract: In this new working paper on preindustrial inequality, Nicolini and Ramos Palencia build upon their earlier work on income inequality in eighteenth-century Old Castile (Nicolini and Ramos Palencia 2015) by looking into one particularly important, and difficult to assess, aspect: how to reconstruct, for a given preindustrial society, estimates of both income and wealth inequality – considering that the sources, according to the place and the period, have the tendency to inform us only about one of the two. Given the amount of new information about long-term trends in preindustrial inequality, of either income or wealth, which has been made available by recent research, the authors point at what clearly constitutes one of the next steps we should take and in doing so, they also provide a useful contribution to the methodological debates which are taking place among scholars working on preindustrial inequality.

URL: http://econpapers.repec.org/paper/heswpaper/0095.htm

Distributed by NEP-HIS on 2016-03-29

Review by Guido Alfani

Summary

In this paper Nicolini and Ramos explore the connection between income and wealth for a large sample of communities from different Spanish provinces: Palencia, Madrid, Guadalajara and Granada. They combine information from two different sources:

1. the Catastro de Ensenada (ca. 1750), which provides information about household income, and

2. probate inventories (covering the period 1753-68), a source which has often been used to estimate wealth inequality.

These two sources are combined using nominative linkage techniques in order to take advantages of one to solve the weaknesses of the other. In particular, the almost-universal scope of the survey within the Cadastre enables Nicolini and Ramos to assess with certain precision the actual coverage of the probate inventories (which tend to be biased towards the upper part of the distribution). This allows them the resampling or weighthing of the information to improve the study of wealth inequality. It should be underlined that the Catastro de Ensenada is a truly exceptional source. It was an early attempt at introducing a universal tax on income. As the new tax was proportional and should have replaced a number of indirect provincial taxes with regressive effects, this fiscal innovation clearly moved in the direction of a more equitable system of taxation. Unfortunately, the new tax was never implemented – but at the very least, the attempt to introduce it generated a vast amount of useful information.

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Nicolini and Ramos were able to reconstruct both income and wealth for 194 observations, out of the much larger sample of 6,214 households for which they only have information about income. Nicolini and Ramos then explore the connection between income and wealth, finding (as was expected) a very strong correlation. However, they go much deeper, thanks to an econometric approach in which the distortions in the sample (determined in particular by over-representation of rich households) are corrected by weighting. They obtain many interesting and potentially useful results, in particular:

  1. they estimate the average rate of return to wealth to be 2.9% p.a. – which is, generally speaking, much smaller that usually implied in the literature. For instance, the rate of return to wealth implied by Lindert in his work on the Florentine Cadastre of 1427 was 7% p.a. (see below). However, if the association between income and wealth is analyzed by considering their logarithm (which is the econometric specification preferred by Nicolini and Ramos), then the elasticity of income to wealth varies between 0.4 and 0.9 depending on the region. This means that a 10% increase in household wealth is associated to an income increase comprised in the 4-9% range. This range is consistent with empirical findings in many studies of past and present societies, all of which suggest that income inequality is lower than wealth inequality;
  2. the distribution of household income increases less steeply than the distribution of household wealth. This might be due to the fact that labour income is relatively larger in the bottom part of the distribution, or that the wealth of the bottom part of the distribution consists for a larger part of income-producing assets, while the wealth of the richest people would consist also of other assets, including (unproductive) status goods and luxuries as well as cash;
  3. the relationship between wealth and income differs depending on the sector of activity of the household head (primary vs secondary/tertiary) and on the place of residence – although somewhat surprisingly, and differently from what reported for other European regions (for example Tuscany by Alfani and Ammannati 2014), Nicolini and Ramos do not find that urban households had greater wealth than rural ones. In the study by Nicolini and Ramos urban and rural wealth were usually on par, but in the extreme case of Guadalajara urban dwellers were less wealthy than rural dwellers.

 

Sample of Catastro de Ensenada (Archivo Simancas)

Sample of Catastro de Ensenada (Archivo Simancas)

 

Comment

This paper makes many interesting and potentially important contributions to the study of inequality in the early modern period, a field which has been particularly fertile in recent years. First, it provides new information about inequality in the Iberian peninsula, integrating other recent studies (e.g. Santiago-Caballero 2011; Reis and Martins 2012). Secondly, it contributes considerably to the development of a methodology to translate in a non-arbitrary way income distributions into wealth distributions, and vice versa. This is a crucial point, which deserves some attention.

The Ensenada Cadastre is an exceptional source as it provides data on income. As a matter of fact, most other sources of the “cadastrial” kind are essentially property tax records, which always list real estate and sometimes other components of wealth – but not income. However, it has also been argued that for the preindustrial period, in most instances wealth distributions are the best proxy we have for income distributions (Lindert 2014; Alfani 2015). This being said, moving from the good-quality distributions of wealth that have recently been made available for different parts of late medieval and early modern Europe (in particular, Alfani 2015; Alfani and Ryckbosch 2015) to acceptable distributions of income is clearly a worthy pursuit.

I would differ with Nicolini and Ramos Palencia in their statement that theirs is the first attempt at studying together income and wealth distributions in the pre-industrial period. For example, Soltow and Van Zanden (1998) did so in their study of the Netherlands. However, Nicolini and Ramos do provide useful and interesting insights into how to convert wealth distributions into income distributions. Many such attempts are currently underway and there are earlier examples, like Lindert’s method to convert the distribution of wealth in the 1427 Florentine catasto into an income distribution (results used in Milanovic, Lindert and Williamson 2011).

Moreover, Nicolini and Ramos Palencia stress many potential pitfalls in procedures of this kind. This being said, there are aspects of their current reconstructions which are a bit surprising and might be the result of sampling issues, as 59% of the 194 observations relate to the province of Palencia. Is Guadalajara, where rural dwellers were wealthier than urban dwellers, an exceptional case or does this depend on the very small sample (just 12 observations) the authors have for that region? To dispel any doubts, more probate inventories should be collected, in order to improve the territorial balance within the sample and to better account, both in the estimation process and in the econometric analysis, for possible regional variations. However, this does not alter the general conclusion. The paper by Nicolini and Ramos is a very useful piece of innovative research, grounded in new archival data and packed with useful insights about how to improve our knowledge of inequality in the pre-industrial period.

 

Ferdinand VI (1713 – 1759), called the Learned, was King of Spain from 9 July 1746 until his death.

Ferdinand VI (1713 – 1759), called the Learned, was King of Spain from 9 July 1746 until his death.

 

Selected Bibliography

Alfani, G. (2015), “Economic inequality in northwestern Italy: A long-term view (fourteenth to eighteenth centuries)”, Journal of Economic History, 75 (4), 2015, pp. 1058-1096.

Alfani, G. and Ammannati, F. (2014), Economic inequality and poverty in the very long run: The case of the Florentine State (late thirteenth-early nineteenth centuries), Dondena Working Paper No. 70.

Alfani, G., Ryckbosch, W. (2015), Was there a ‘Little Convergence’ in inequality? Italy and the Low Countries compared, ca. 1500-1800, IGIER Working Paper No. 557.

Lindert, P.H. (2014), Making the most of Capital in the 21st Century, NBER Working Paper No. 20232.

Milanovic, B., Lindert, P.H. and Williamson, J.G. (2011). “Pre-Industrial Inequality”, The Economic Journal 121: 255-272.

Nicolini, E.A. and F. Ramos Palencia (2015), “Decomposing income inequality in a backward pre-industrial economy: Old Castile (Spain) in the middle of the eighteenth century”, The Economic History Review, online-first version, DOI: 10.1111/ehr.12122.

Reis, J., Martins, A. (2012), “Inequality in Early Modern Europe: The “Strange” Case of Portugal, 1550-1770”. Paper given at the conference Wellbeing and Inequality in the Long Run (Madrid, 1 June 2012).

Santiago-Caballero, C. (2011), “Income inequality in central Spain, 1690-1800”, Explorations in Economic History 48(1): 83-96.

Soltow, L. and Van Zanden, J.L. (1998), Income and Wealth Inequality in the Netherlands, 16th-20th Century. Amsterdam, Het Spinhuis.

Society? Economics? Politics? Personality? What causes inequality?

What Drives Inequality?

by Jon D. Wisman (American)

Abstract Over the past 40 years, inequality has exploded in the U.S. and significantly increased in virtually all nations. Why? The current debate typically identifies the causes as economic, due to some combination of technological change, globalization, inadequate education, demographics, and most recently, Piketty’s claim that it is the rate of return on capital exceeding the growth rate. But to the extent true, these are proximate causes. They all take place within a political framework in which they could in principle be neutralized. Indeed, this mistake is itself political. It masks the true cause of inequality and presents it as if natural, due to the forces of progress, just as in pre-modern times it was the will of gods. By examining three broad distributional changes in modern times, this article demonstrates the dynamics by which inequality is a political phenomenon through and through. It places special emphasis on the role played by ideology – politics’ most powerful instrument – in making inequality appear as necessary.

Source: http://EconPapers.repec.org/RePEc:amu:wpaper:2015-09

Distributed by NEP-HIS on 2015-10-04

Reviewed by Mark J Crowley

This paper was circulated by NEP-HIS on 2015-05-05.  It explores a topical issue in political discourse at present, in which the debate has largely been categorised into two major camps.  First, the Conservative argument, stretching back to Margaret Thatcher in Britain (and simultaneously championed by Ronald Reagan and Charles Murray in the USA) was that inequality was good and accepted by the populace as a way of categorising and organising the nation.  Their argument, it so followed, ensured that those who were at the lower part of society would be inspired to work harder as a means to lessen their inequality.  The second argument that has now experienced resurgence in the UK following the election of the left wing veteran Jeremy Corbyn to the leadership of the opposition Labour Party is that inequality is an evil in society that punishes the poor for their poverty.  The counter argument is that the richer, which have the broadest shoulders, should bear the heaviest burden in times of hardship, and that austerity should not hit the poorest of society in the hardest way.  Thus a political solution should be sought to ensure a fairer distribution of wealth in favour of the poorest in society.  Similar arguments have been made in the US by proponents of increased state welfare.  It is in this context that the debates highlighted in this paper should be seen.

Thatcher and Reagan were the major architects of a change in economic policy away from state welfare.

Thatcher and Reagan were the major architects of a change in economic policy away from state welfare.

This meticulously researched article demonstrates that inequality as a phenomenon has long roots.  Citing that inequality has virtually been omnipresent in the world since the dawn of civilisation, Wisman couches the argument concerning inequality within the wider organisation and economic hierarchy of society.  Building on the argument of Simon Kuznets that inequality, at the beginning of economic development shows vast differences between rich and poor but subsequently stabilises, he looks at other factors beyond economics that contribute to the growing inequality in society.  The heavy focus on political literature examining the impact of politics on rising inequality is especially interesting, and takes this paper beyond the traditional Marxist arguments that have often been proposed about the failures and flaws of capitalism.  Other arguments, such as the impact of the industrial revolution, are explored in detail and are shown to be significant factors in defining inequality.  This runs as a counter-exploration to the work of Nick Crafts who has explored the extent to which the industrial revolution, especially in Britain, was ‘successful’.

Despite the arguments and debates about why inequality exists, there still appears to be no conclusive answer about its cause.

Despite the arguments and debates about why inequality exists, there still appears to be no conclusive answer about its cause.

Ideology is also a factor that is explored in detail.  The explanations for inequality have often been provided with ideological labels, with some offering proposals for eradicating inequality, while others propose that individuals, and not society, should change in order to reverse the trend.  The latter was forcefully proposed by Margaret Thatcher and Milton Friedman, whereas the former was commonly the battle-cry of post-war socialist-leaning parties (most notably the largely out-of power Labour Party of Britain in the post-war period, with the exception of 1945-51 and brief periods in the 1970s).

The religious argument about helping people who are less fortunate than yourself has now become more tenuous in favour of using religion as a form of legitimizing inequality.

The religious argument about helping people who are less fortunate than yourself has now become more tenuous in favour of using religion as a form of legitimizing inequality.

The exploration of religion as a factor is also particularly interesting here.  Wisman argues that providing state institutions with religious foundations thus legitimises their status, and hereby ensures that inequality has a stronger place in society.  This point, while contentious, has been alluded to in previous literature, but has not been explored in great depth.  The section in this paper on religion is also small, although such is its significance, I am sure the author would seek to expand on this in a later draft.

Critique

This paper is wide-ranging, and shows a large number of factors that have contributed to inequality in the western world, especially the USA.  It highlights the fact that the arguments concerning inequality are more complex than has possibly been previously assumed.  Arguing that politics and economics are intertwined, it effectively argues that a synthesis of these two disciplines are required in order to address the issue of inequality and reduce the gap between rich and poor in society.

I found this article absolutely fascinating.  I can offer very little in terms of suggestions for improvement.  However, one aspect did come to mind, and that was the impact of inequality on individual/collective advancement?  Perhaps this would take the research off into a tangent too far away from the author’s original focus, but the issue that sprung to mind for me was the impact of the inequality mentioned by the author on aspects such as educational attainment and future employment opportunities?  For example, in the UK, the major debate for decades has been the apparent disparity between the numbers of state school and privately-educated students attending the nation’s elite universities, namely Oxbridge.  Arguments have often centred on the assumption that private, fee-paying schools are perceived to be better in terms of educational quality, and thus admissions officers disproportionately favour these students when applying to university.  While official figures show that Oxbridge is made up of a higher proportion of state school student than their privately-educated counterparts, this ignores the fact that over 90% of British students are still educated in the state system.  Furthermore, so the argument goes, those with an elite education then attain the highest-paying jobs and occupy the highest positions in society, thus generating the argument that positions in the judiciary and politics are not representative of the composition of society.  These are complex arguments.  This paper alludes to many of these points concerning the origins of inequality.  Perhaps a future direction of this research would be to apply the models highlighted and apply them to certain examples in society to test their validity?

References

Dorey, Peter, British Conservatism: the Politics and Philosophy of Inequality (London, I. B. Tauris, 2011)

Thane, Pat (ed.) The Origins of British Social Policy (London: Croom Helm ; Totowa, N.J.: Rowman & Littlefield, 1978).

Thane, Pat, The Foundations of the Welfare State, (Harlow: Longman, 1982).

Does Technological Progress Lead to more Human Capital Formation? Evidence from the French Industrial Revolution

The Complementarity between Technology and Human Capital in the Early Phase of Industrialization

By Raphael Franck (Bar-Ilan University and Brown University, raphael.franck@biu.ac.il) and Oded Galor (Brown University, Oded_Galor@brown.edu)

URL: http://d.repec.org/n?u=RePEc:bro:econwp:2015-3&r=his

Abstract

The research explores the effect of industrialization on human capital formation. Exploiting exogenous regional variations in the adoption of steam engines across France, the study establishes that in contrast to conventional wisdom that views early industrialization as a predominantly deskilling process, the industrial revolution was conducive for human capital formation, generating broad increases in literacy rates and education attainment.

Review by Natacha Postel-Vinay (University of Warwick)

While human capital is often thought to be at the root of any development process, early industrialization itself is often thought to be de-skilling. Images of children working long hours executing repetitive tasks usually come up when one thinks of the Industrial Revolution (Humphries, 2010). Yet there is also the idea that industrial and technical development might lead to a greater need for skilled labour to maintain, fix and adapt new machinery. In this case industrial development might lead to a greater supply of schooling and might result in significant human capital improvements. Focusing on early French industrialization in a recent working paper (distributed by NEP-HIS on 2015-05-02), Franck and Galor attempt to demonstrate just this.

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Steam engine from Lille (Nord departement)

Making use of data from the 1840s, the authors find a positive correlation across French departements between the number of steam engines and human capital indicators such as the share of literate conscripts, the share of pupils in the population, and the number of teachers (which would be more suggestive if also set relative to population). This correlation is best illustrated in a series of shaded maps (Figure 3), although the strikingly high levels schooling and literacy in the north-eastern part of France remain to be explained. Of course, correlation does not necessarily imply causation: it may be that other factors caused both the number of steam engines and the number of teachers to increase in certain areas, which could render any relationship between the two fortuitous.

Figure 3 in Franck and Oded Galor (2015).

Figure 3 in Franck and Oded Galor (2015).

To tackle this endogeneity problem, the authors make clever use of the fact that the first steam engine was introduced in 1735 in Fresnes-sur-Escaut in the Nord departement, near the northern tip of France. Since technology diffusion can be reasonably assumed to occur first around the region where the new technology was first introduced (which was indeed the case), it seems possible to use each departement’s distance from Fresnes-sur-Escaut as an instrument in the regression. In the first stage of the regression, they successfully show that the shorter a departement’s distance from the first steam engine location, the larger the number of steam engines in the departement, which seems quite reasonable.

To prove the exogeneity of the instrument, the authors have to show that human capital formation was not higher closer to the first steam engine location. This is trickier. To support their case, Franck and Galor investigate the relationship between distance from Nord and economic development indicators from around 1700, such as urban population, literacy rates and university location. They find that there is no correlation (although this may be surprising in light of Figure 1). More importantly, human capital may be quite imperfectly captured by these indicators in the pre-industrial era, when human capital may have developed in ways that are quite difficult to measure: through the transmission of skills from masters to apprentices, or learning-by-doing. It has often been shown that there was no clear relationship between technological progress and literacy rates in the early modern era (Mitch, 1999). Accordingly perhaps more detail should be provided in the paper as to why the steam engine was first introduced in this region and not elsewhere.

Figure 1 in Franck and Galor (2015)

Figure 1 in Franck and Galor (2015)

Which brings me to a broader point about the paper. Although its stated aim is to investigate the causal relationship running from technological progress to human capital formation, causality could run the other way around. Although endogeneity issues are explicitly addressed in the paper from (and confounding factors such as land suitability, rainfall, access to waterways, distance from Paris, and market integration duly controlled for), the specific problem of reverse causality is not explicitly dealt with in the text. Reassuringly the IV model should theoretically take care of reverse causality, but the authors could still discuss this possibility in more detail.

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Boys at school in Nord departement in the 19th c.

Overall though, Franck and Galor rather successfully tackle a very important and highly complex aspect of industrialization processes. By showing that technological improvement led to advances in human capital accumulation, these results in turn trigger a number of questions. Through which mechanism did industrialization lead to better schooling and literacy rates? Was the process demand-driven? Or did parents’ higher wages mean that children no longer had to work to help the family? Finally, could child labour abuse in factories have led to local initiatives to promote schooling? This latter hypothesis is discussed by Weissbach (1989), who emphasizes a particularly strong will to change the status quo in Alsatian and nearby regions — which could partly explain the greater spread of schooling in this part of France. Such inquiries could be the subject of fascinating future research.

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Children in a textile factory in 19th c. Provence

References

Humphries, Jane. 2010. Childhood and Child Labour in the British Industrial Revolution. Cambridge: Cambridge University Press.

Mitch, David. 1999. “The Role of Education and Skill in the British Industrial Revolution.” In Joel Mokyr, ed., The British Industrial Revolution: An Economic Perspective, 2 ed. Boulder, nd CO: Westview Press, pp. 241–79.

Weissbach, L. S. 1989. Child Labor Reform in Nineteenth Century France: Assuring the Future Harvest. Louisiana State University Press.