Source: lecture of Brad DeLong

1. Source: lecture of Brad DeLong

2. Malthus Today Galor, Oded and David N. Weil. 1999. “From Malthusian Stagnation to Modern Growth”American Economic Review. (May): 150-154. The article focuses on three aspects of economic development: 1. Malthusian Regime 2. Post-Malthusian Regime 3. Modern Growth Regime Refer to Figure 1 in the article.

3. Summarizing Malthus Two aspects of the Malthusian Model First: Diminishing Returns • A factor of production (land) is in fixed supply. Hence diminishing returns applies to all other factors of production. • Law of Diminishing Returns (agina): Adding more workers – holding all else constant – will eventually result in the productivity of each additional worker to decline. • In other words, if you hire more an d more labor, but don’t change the amount of land or capital employed, each person you hire will be less and less productive. • Hence, output from land may increase, but at a diminishing rate.

4. Summarizing Malthus Second: Link between resources and population • There exists a positive relationship between standard of living and population growth. Increases in income will lead to increases in population. • Conclusion: Level of per-capita income will remain the same in the long-run. Increases in income will only lead to more people, which will lower per-capita income.

5. Evidence Supporting Malthus • Agnus Madison (1982) estimates that the growth rate of GDP per-capita in Europe between 500 and 1500 was zero. • Massimo Livi-Bacci estimates that the growth rate of world population between 1 A.D. and 1750 to be 0.064%. In other words, population was very stable. • The argument that population and wages are linked was borne out by the Black Death. The plague in Europe in the 14th century reduced population, which in turn raised wages. Higher wages, in turn, lead to increases in population. • Population could rise if technology improved. However, increases in technology would not change per-capita income, only the size of population. We do observe differences in technological levels across pre-capitalist societies, but little difference in standard of living.

6. What Happened? As per-capita income rose in Europe, initially population also rose. However, the increase in population could not keep pace with the increase in technology. Hence, Western civilization escaped the Malthusian trap. Evidence: Between 1740 and 1840, life expectancy in England increased from 33 to 40. In France, life expectancy rose from 25 to 40. In other words, standards of living were improving. Initially population also increased. Fertility rates, though, by the end of the19th century slowed. How is it that the link between income per capita and population growth was severed? How does one account for the sudden spurt in growth rates?

7. The Galor-Weil model • Technological progress raises the rate of return to human capital and hence induces parents to substitute quality for quantity of children. Evidence: Rates of schooling in Europe increases from 2.3 years to 9.1 years from the beginning of the 19th century to the onset of the 20th century. • As children become more educated, the speed of technological progress increases. • As population rises, the land to population ratio falls, and wages decline. Hence, population will fall. Rapid technological progress, though, overcomes the land constraint, allowing wages to rise.

8. Galor and Weil Regimes • Malthusian Regime • Increases in income lead to increases in population, which means per-capita income falls back to its original levels. • Therefore, income per-capita is roughly constant • Post-Malthusian Regime • Increases in income lead to increases in population • But income rises faster than population so per-capita income rises • Modern Growth Regime • Per-capita incomes continues to rise. • Parents choose quality of children over quantity and population starts to fall.

9. Technological Progress and Population Growth • Higher incomes allow families to have more children. • The return on human capital increases, encouraging families to substitute quality for quantity. • In the Post-Malthusian world, the first effect dominates. In the Modern Growth era,the second effect is more important.

10. Technophysio Evolution • Fogel, Robert W. 1999. “Catching Up with the Economy.” American Economic Review. March: 1-21. • “Technophysio evolution (the existence of a link between technological and physiological improvements) implies that human beings now have so great a degree of control over their environment that they are set apart not only from all other species, but also all previous generations of Home Sapiens. The new degree of control has enabled Homo Sapiens to increase its average body size by over 50 percent, to increase it average longevity by more than 100 percent, and to improve greatly the robustness and capacity of vital organs.”

11. What is the impact of technophysio evolution? • The human species is increasing in size. A male of average size (5 ft. 10 in, 172 pounds) requires 2300 calories per day. If the population of Europe averaged this size in 1700, the quantity of food would have proved insufficient to support work. Hence, we can conclude (and the evidence supports this conclusion) that the population had a smaller average size. • Fogel argues that technophysio evolution accounts for about 50% of British economic growth over the past two centuries.

12. U.S. Economic Growth Data • EH.net (or Economic History Net) • http://eh.net/ • How much is that? • http://eh.net/hmit/

13. US GDP History What Was the U.S. GDP Then? http://www.measuringworth.org/usgdp/

14. Economic Growth in the 19th century(from EH.net)

15. Economic Growth in the 20th century(from EH.net)

16. Growth Happens!! • Real GDP per-capita has increased in every decade in U.S. history. • Growth was faster in the 20th century (relative to the 19th century). • Average annual growth in the 20th century was about 2% per year. • For the past 100 years…. • Real Gross Domestic Product has increased (on average) 38.4% in each decade • Real GDP per capita has increased (on average) 22.5% in each decade

17. Here is the 21st Century (assuming growth continues – at 2.1% -- as it has for the past 100 years)AND YES, that is $122 trillion in 2111 with average income nearing $400,000!!

18. David Ricardo (1772-1823) http://eh.net/encyclopedia/article/stead.ricardo David Ricardo (1772-1823) was one of the greatest theoretical economists of all time. The third child (of 17) of Abigail and Abraham (a prosperous Jewish stockbroker who had emigrated to London from Holland), Ricardo attended school in London and Amsterdam and at the age of fourteen entered his father's business. In 1793 he married a Quaker, Priscilla Wilkinson, with whom he was to have eight children. The couple's different religious backgrounds meant that the marriage created a rift with both their families, and Ricardo was forced to set up independently as a broker on the London Stock Exchange. Ricardo, though, prospered in the financial business to a far greater extent than his father, amassing a fortune of about £700,000 (equivalent to approximately £40 million today).

19. David Ricardo’s Writings David Ricardo: http://www.econlib.org/library/Enc/bios/Ricardo.html The High Price of Bullion (1810) His first pamphlet. Essays on the Corn Laws (1815) Principles of Political Economy and Taxation

20. Early Corn Laws History • http://www.math.grin.edu/~simpsone/Teaching/Romantics/ellen.html • In 1436 and 1463, England issued the first Corn Laws granting grain growers a monopolistic advantage of the market. The laws mandated high grain prices and specified price levels necessary for exportation and importation. The Corn laws were constantly adapted to changing foreign and domestic market conditions during the 16th, 17th, and 18th centuries. Before 1660, consumer happiness was the chief concern. However, afterwards, wheat producers became equally influential and England grew to become a great consumer and producer of wheat. • With the Corn Laws, England established a well-defined system for regulating corn trade from 1660 through 1814. Importation and exportation duties or tariffs on a sliding scale, meaning that they are adjusted to changing economic conditions, enforced the laws' chief purpose to secure enough grain to supply domestic needs and to sustain profitable and reasonable grain price levels. Until 1750, the laws remained undisturbed. 

21. End of War with France • On June 8, 1815, Napoleon is finally defeated at the Battle of Waterloo. This ends a war between England and France that had essentially began in 1689. • The end of the war means that France can now export “corn” (this means grain) to England • The importation of grain will lower food prices. • But not everyone benefits from this trade.

22. Corn Law Economics • Three groups in society • Workers: Paid in Wages • Landowners (aristocracy): Paid in Rents • Manufacturers (capitalists): Paid in Profits

23. Iron Law of Wages • http://www.econlib.org/library/Ricardo/ricP2.html#Ch.5, Of Wages • http://www.fordham.edu/halsall/mod/ricardo-wages.asp • It is when the market price of labour exceeds its natural price, that the condition of the labourer is flourishing and happy, that he has it in his power to command a greater proportion of the necessaries and enjoyments of life, and therefore to rear a healthy and numerous family. When, however, by the encouragement which high wages give to the increase of population, the number of labourers is increased, wages again fall to their natural price, and indeed from a reaction sometimes fall below it. • Notwithstanding the tendency of wages to conform to their natural rate, their market rate may, in an improving society, for an indefinite period, be constantly above it; for no sooner may the impulse, which an increased capital gives to a new demand for labour, be obeyed, than another increase of capital may produce the same effect; and thus, if the increase of capital be gradual and constant, the demand for labour may give a continued stimulus to an increase of people.... • Thus, then, with every improvement of society, with every increase in its capital, the market wages of labour will rise; but the permanence of their rise will depend on the question, whether the natural price of labour has also risen; and this again will depend on the rise in the natural price of those necessaries on which the wages of labour are expended.... • As population increases, these necessaries will be constantly rising in price, because more labour will be necessary to produce them. If, then, the money wages of labour should fall, whilst every commodity on which the wages of labour were expended rose, the labourer would be doubly affected, and would be soon totally deprived of subsistence. Instead, therefore, of the money wages of labour falling, they would rise; but they would not rise sufficiently to enable the labourer to purchase as many comforts and necessaries as he did before the rise in the price of those commodities.... • These, then, are the laws by which wages are regulated, and by which the happiness of far the greatest part of every community is governed. Like all other contracts, wages should be left to the fair and free competition of the market, and should never be controlled by the interference of the legislature.

24. Landowners and Rent • Given the Iron Law of Wages, changing the price of corn will not alter the “natural price” of labor. So this does not directly impact workers in the long-run. • The higher price does benefit landowners. • The key is the concept of “rent” • The following slides are taken from: people.westminstercollege.edu/faculty/jwatkins/105/.../ricardo2.PPT

25. Rent • Return to an factor of production for which there are no substitutes or no “good” substitutes • Examples: land, a particular location, a living legend, etc.

26. Ricardian Rent • Ricardo defined rent as follows: • different between output on the most and least fertile land in cultivation • difference between costs of production on the most and least fertile lands in cultivation

37. Summarizing the impact of the Corn Laws • Workers are not impacted in the long-run (although food riots did happen in the short-run) • Landowners see their “rents” increase as more and more marginal land is put into production • Manufacturers see their “profits” decline as higher Corn Laws increase wages.

38. Why 1815 to 1846? • In 1815, the House of Commons is dominated by Landowners • http://www.parliament.uk/about/living-heritage/evolutionofparliament/houseofcommons/reformacts/overview/reformact1832/ • The Reform Act of 1832 • The Representation of the People Act 1832, known as the first Reform Act or Great Reform Act: • disenfranchised 56 boroughs in England and Wales and reduced another 31 to only one MP • created 67 new constituencies • broadened the franchise's property qualification in the counties, to include small landowners, tenant farmers, and shopkeepers • created a uniform franchise in the boroughs, giving the vote to all householders who paid a yearly rental of £10 or more and some lodgers • Limited change had been achieved but for many it did not go far enough. The property qualifications meant that the majority of working men still could not vote. But it had been proved that change was possible and over the next decades the call for further parliamentary reform continued • Why 1846? The Irish Potato Famine appears to be the key event that leads to the triumph of the Anti-Corn League

39. Triumph of Free Trade? • The movement to repeal the Corn Laws has been commonly treated in the literature as an example of the power of non-self-interested ideology to influence economic policy. Without denying that ideology played a role, there is ample evidence to question the dominance of ideology in motivating the repeal campaign. Specifically, we have presented considerable evidence to support two propositions: 1) the Anti-Corn Law League, despite its name, devoted substantial efforts towards preventing and impeding the passage of further Factory Acts in the cotton textile industry and towards the repeal of the raw cotton duty; and 2) the principal financial support for the League came from the cotton textile industry, which had a strong economic interest in these activities (if not repeal of the Corn Laws per se). A concentrated and localized industry group, sharing very specific common interests, invested heavily in promoting the League and its activities. • Gary M. Anderson and Robert D. Tollison (1985)

40. Says Law and the Short-Run • http://www.econlib.org/library/Enc/bios/Say.html • French economist J. B. Say is most commonly identified with Say’s Law, which states that supply creates its own demand. Over the years Say’s Law has been embroiled in two kinds of controversy—the first over its authorship, the second over what it means and, given each meaning, whether it is true. • On the first controversy, it is clear that Say did invent something like Say’s Law. But the first person actually to use the words “supply creates its own demand” appears to have been James Mill, the father of john stuart mill. • Say’s Law has various interpretations. The long-run version is that there cannot be overproduction of goods in general for a very long time because those who produce the goods, by their act of producing, produce the purchasing power to buy other goods. Say wrote:1Withthis statement Say had the long run in min “How could it be possible that there should now be bought and sold in France five or six times as many commodities as in the miserable reign of Charles VI?”d. Certainly the long-run version is correct. Given enough time, supply does create its own demand. There can be no long-run glut of goods. • But Say also said that even in the short run there could be no overproduction of goods relative to demand. It was this short-run version that thomasrobertmalthus attacked in the nineteenth century and john maynardkeynes attacked in the twentieth. They were right to attack it. Ricardo and Malthus disagreed on whether a “general glut” could exist in the short-run. History suggests Malthus was right on this point.

41. The Steady State (the Long-Run) • Given the law of diminishing returns, what will we see in the long-run? • Free trade and markets increases a nation’s output • As output increases, population increases • As population increases, more and more marginal land is put into production. • This will increase rents and the subsistence wage. But it will eventually reduce profits to zero (i.e. eliminate economic profits) • So in the long-run steady state... • Landowners see their rents maximized • Workers still get a subsistence wage • Economic profits vanish • There is no more growth!

42. Interdependence and the Gains from Trade Absolute advantage - the comparison among producers of a good according to their productivity. Comparative advantage - the comparison among producers of a good according to their opportunity cost.

43. “England may be so circumstanced, that to produce the cloth may require the labour of 100 men for one year; and if she attempted to make the wine, it might require the labour of 120 men for the same time. England would therefore find it her interest to import wine, and to purchase it by the exportation of cloth. To produce wine in Portugal, might require only the labour of 80 men for one year, and to produce the cloth in the same country, might require the labour of 90 men for the same time. It would therefore be advantageous for her to export wine in exchange for cloth.” [Ricardo (1817) as reprinted in McCulloch (1888, p. 76-77)]

44. “This exchange might even take place, notwithstanding that the commodity imported by Portugal could be produced with less labour than in England. Though she could make the cloth with the labour of 90 men, she would import it from a country where it required the labour of 100 men to produce it, because it would be advantageous to her rather to employ her capital in the production of wine, for which she would obtain more cloth from England, than she could produce by diverting a portion of her capital from the cultivation of vines to the manufacture of cloth.”(Ricardo (1817) as reprinted in McCulloch (1888, p. 76-77).

45. Ricardo, the numbers NationWineCloth England 120 100 Portugal 80 90 In Ricardo’s example, Portugal has an absolute advantage with respect to both goods. However, Portugal’s comparative advantage only lies in the production of wine.

46. Another Example • Venezuela can produce a unit of cloth with 15 units of labor while a unit of grain requires 30 units of labor. Spain can produce a unit of cloth with 6 units of labor while a unit of grain requires 3 units of labor. Let’s assume each nation has 3,000 units of labor. • Prior to trade: • For Venezuela one unit of cloth costs ½ a unit of grain. • one unit of grain costs 2 units of cloth • For Spain one unit of cloth costs 2 units of grain • one unit of grain costs ½ a unit of cloth

47. More on “another example” • With free trade Venezuela can specialize in cloth, Spain can specialize in grain. Without trade, a unit of cloth costs Spain two units of grain. What if the terms of exchange allowed Spain to acquire a unit of cloth for only one unit of grain? Spain would be better off. • Would Venezuela benefit from this trade? Grain costs Venezuela two units of cloth before trade. After trade, one unit of grain only costs one unit of cloth. Venezuela is also better off. • Trade allows a nation to expand its consumption possibilities beyond its production possibilities. And everyone ends up with more.

48. Ricardo’s conclusions • Comparative advantage, not absolute advantage, determines the pattern of trade. • Free trade benefits every nation by expanding each nation’s consumption possibilities beyond its production possibilities.

49. Additional Benefits from Trade • Increased Variety of Goods • Increase Competition • Enhanced flow of technology • The benefits of free trade highlight the benefits of capitalism. In capitalism each individual specializes and then trades with others for what they need (and want). Capitalism, though, is a rather recent phenomenon.

50. Why Protectionism? • If free trade is so wonderful, why isn’t it universal? • Free Trade Benefits Every Nation, but Not Everyone in Every Nation • Back to the Corn Laws... • Free trade in corn benefits industry and hurts landowners • Free trade in textiles might harm industry (and help landowners) • Even Great Britain was not practicing completely free trade in the latter 19th century. And neither was the U.S.