SARA$TACCONE$

ECONOMIC'HISTORY'
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TOPIC'4:'THE'INDUSTRIAL'REVOLUTION'
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ALLEN,' R.' C.' [2009];' The' industrial' Revolution' in' Miniature:' The'
Spinning' Jenny' in' Britain,' France,' and' India,' Journal' of' Economic'
History,'Vol.69'No.4,pp.901W927'
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The$spinning$jenny$helps$explain$why$the$Industrial$Revolution$occurred$in$Britain$
rather$ than$ in$ other$ countries;$ in$ fact$ wages$ were$ exceptionally$ high$ relative$ to$
capital$ prices$ in$ Britain$ and$ Britain$ was$ the$ only$ country$ where$ it$ as$ worth$
incurring$the$costs$of$developing$the$spinning$jenny.$$
Ashton$ used$ the$ words$ of$ a$ schoolboy$ to$ define$ the$ Industrial$ Revolution.$ This$
schoolboy$ said:$ About$ 1760$ a$ wave$ of$ gadgets$ swept$ over$ Engalnd$ but$ why$ in$
England?$The$answer$to$this$question$found$by$Allen$in$this$article$is$based$on$the$
case$study$of$the$spinning$jenny.$$
The$ spinning$ jenny$ was$ invented$ by$ James$ Hargreaves$ in$ Lancashire$ in$ the$ midQ
1760s$but$it$was$used$in$a$profitable$way$only$in$England.$$
The$reasons$found$to$explain$the$Industrial$Revolution$are$the$following:$$
Political$ structure$ (that$ created$ a$ favorable$ climate$ for$ investment$ that$
made$the$Industrial$Revolution$possible)$
Inventiveness$ back$ to$ culture$ ($ Max$ Webers$ theory:$ Calvinism$ made$
protestants$ particularly$ rational$ and$ oriented$ towards$ economic$
achievement$ $ French$ were$ poor$ enterpreneurs$ who$ failed$ to$ adopt$
British$technology).$
We$ can$ sum$ up$ that$ good$ law$ and$ good$ culture$ may$ have$ been$ necessary$
conditions$for$the$Industrial$revolution$but$they$were$not$sufficient.$$
This$ article$ argues$ that$ Britain$ had$ a$ highQwage$ economy$ that$ increased$ the$
demand$ for$ technology$ that$ substituted$ capital$ for$ labor$ in$ fact$ the$ famous$
inventions$ of$ the$ Industrial$ Revolution$ were$ invented$ in$ Britain$ because$ they$
generated$ enough$ profit$ to$ make$ the$ cost$ of$ developing$ and$ perfecting$ them$
worthwhile.$(In$France$and$India,$the$rate$of$return$to$inventing$British$technology$
was$too$low$to$justify$the$necessary$R&D).$$
Allen$ investigated$ a$ sequeences$ of$ problems$ related$ to$ the$ invention$ of$ the$
spinning$ jenny$ in$ order$ to$ find$ an$ answer$ to$ the$ initial$ question$ (why$ Industrial$
revolution$in$England?);$$
1. Inventions$ like$ the$ spinning$ jenny$ are$ examples$ of$ Edisons$ dictum$ that$
invention$ is$ 1%$ inspiration$ and$ 99%$ perspiration..$ Only$ in$ this$ way$ we$
can$understand$why$they$were$made$by$focusing$on$the$incentives$to$do$the$
hard$ work$ of$ development$ rather$ than$ concentrating$ on$ the$ sources$ of$
inspiration.$$
2. How$ did$ the$ inventions$ affect$ the$ input$ requirements$ of$ production?$
Techniques$ like$ the$ spinning$ jenny$ were$ biased$ and$ increased$ capital$
requirements$ while$ reducing$ labour$ requirementshence$ the$ incentive$ to$
adopt$the$new$techniques$was$greater$where$wages$were$highest$relative$to$
capital$costs.$$
3. Englad$stood$apart$from$the$rest$of$the$world$in$having$relative$wages$and$
that$ is$ why$ british$ technology$ was$ adopted$ initially$ in$ Britain$ and$ not$
elsewhere.$$

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4. Since$ invention$ was$ basically$ R&D,$ it$ generates$ expenses$ and$ Britain$ was$
the$ only$ place$ in$ which$ new$ technologies$ generated$ profits$
(profitsinvestment$ in$ R&Dnew$ technologies,$ it$ was$ a$ perpetual$
circle)$$
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HOW'THE'SPINNING'JENNY'WAS'INVENTED''
To$ understand$ what$ was$ involved$ in$ inventing$ the$ jenny,$ first$ we$ consider$ the$
spinning$wheel$which$was$repleaced$by$the$spinning$jenny.$$
The$two$fundamental$operations$in$spinning$wheel$were$drawing$and$twisting.$$
The$spinning$jenny$was$an$example$of$local$learning$(=studying$existing$practice$
in$an$effort$to$modify$it$in$order$to$reduce$costs).$Hargreaves,$the$inventor$of$the$
spinning$jenny,$in$1764$was$inspired$by$seeing$how$a$spinning$wheel,$which$had$
toppled$over$on$its$side,$continued$to$rotate$and$spin$automatically;$he$had$tried$to$
operate$ several$ wheels$ simultaneously$ by$ holding$ all$ of$ the$ threads$ from$ each$ in$
his$left$hand$but$that$proved$impossible$with$horizontal$spindles.$$
The$ spinning$ jenny$ had$ a$ row$ of$ spindles$ on$ one$ side$ and,$ on$ the$ other$ side,$ a$
parallel$ row$ of$ pins.$ The$ rowings$ were$ wound$ on$ these$ pins$ and$ each$ roving$
extended$across$the$jenny$to$the$opposite$spindle.$The$spindles$were$spun$by$belts$
from$ a$ single$ wheel.$ Between$ the$ spindles$ and$ the$ pins$ was$ a$ sliding$ bar$ with$
clamps$that$could$grasp$the$rovings$and$draw$them$out.$Twist$was$then$imparted$
by$turning$the$spindles,$and$finally,$the$yarn$was$wound$onto$the$spindles$as$the$
sliding$bar$was$pushed$towards$them.$At$the$same$time,$the$sliding$bar$pulled$out$
more$roving,$and$the$sequence$was$repeated.$$
Hargreaves$ needed$ several$ years$ to$ perfect$ the$ jenny$ in$ fact$ it$ said$ that$ it$ was$
invented$ in$ 1767.$ At$ first,$ Hargreaves$ was$ supplied$ with$ accomodation$ in$
Ramsclough,$a$remote$village$in$Lancashire,$and$he$was$economically$supported$by$
Robert$Peel.$$
Not$few$were$the$troubles$for$the$two$men,$in$fact$their$machines$ware$destroyed$
several$times.$$
When$Hargreaves$moved$to$Nottigham,$he$found$a$new$joiner$that$became$his$new$
financier;$ Thomas$ James.$ In$ 1770$ Hargreaves$ patented$ the$ jenny$ but$ he$ didnt$
succeed$ in$ enforcing$ his$ rights$ because$ his$ attorney$ had$ earlier$ sold$ jennies$ in$
Lancashire.$$
Improvements$in$the$jenny$were$rapid$in$the$1770s.$The$wheel$was$changed$from$
an$horizontal$to$a$vertical$orientation,$and$the$treadle$that$turned$it$was$repleaced$
by$ a$ simpler$ handQoperate$ device.$ A$ roller$ was$ introduced$ that$ allowed$ the$
number$ of$ spindles$ to$ be$ increased$ to$ as$ many$ as$ operator$ could$ turn.$ A$ 24$
spindles$ became$ the$ standard$ design$ for$ the$ jennies$ (1775).$ By$ 1780,$ a$ 120$
spindles$ jenny$ was$ built,$ although$ 80$ spindles$ became$ a$ standard.$ This$ mode$ of$
production$ was$ cheaper$ but$ these$ improvements$ were$ accomplished$ without$
patenting$and$were$affected$by$collctive$invention.$$
The$ simplicity$ in$ bulding$ the$ spinning$ jenny$ was$ an$ important$ image$ of$ the$
Industrial$ Enlightenment$ (Mokyr);$ this$ movement$ involved$ the$ collection$ and$
dissemination$ of$ descriptions$ of$ technical$ processes$ through$ publications$ as$ well$
as$ professional$ meetings$ and$ informal$ discussions$ involving$ leading$
manufacturers$and$scientists$in$provincial$associations,$universities$and$the$Royal$
Society.$Mokyr$believes$this$vanguard$of$industrial$progress$was$limited$to$a$few$

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thousand$people$that$were$mainly$from$the$upper$classes.$Even$if$Hargaves$doesnt$
fit$this$model,$he$doesnt$invalidate$the$Industrial$Enlightenment$model.$$
Hargreavers$ experience$ is$ much$ more$ consistent$ with$ the$ democratic$ view$ of$
invention$ propouned$ by$ Zorina$ Khan$ and$ Khan$ and$ Ken$ Sokoloff,$ in$ fact$ they$
believed$ that$ inventors$ were$ drawn$ from$ across$ the$ social$ spectrum,$ with$ many$
coming$from$humble$backgrounds.$$
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THE'BIAS'OF'TECHNOLOGY'AND'THE'INCENTIVES'TO'INVENT'
It$ had$ been$ noticed$ that$ the$ spinning$ jenny$ cuts$ costs$ only$ for$ the$ highQwage$
country.$$
If$ we$ recongnize$ that$ invention$ involves$ costs,$ we$ can$ also$ see$ that$ invention$
depends$ on$ factor$ prices.$ Clearly,$ if$ it$ was$ not$ worthwhile$ to$ use$ the$ invention$
when$ there$ were$ no$ R&D$ costs(as$ in$ the$ low$ wage$ economy),$ theres$ even$ less$
incentive$ when$ R&D$ costs$ would$ be$ incurred.$ Conversely,$ there$ are$ two$
possibilities$in$the$highQwage$economy:$
1. The$R&D$project$is$worth$undertaking$$its$profitable$to$invent$the$jenny.$
2. Market$size$affects$the$propensity$to$invent.$
Explicitly$ recognizing$ that$ inventions$ can$ be$ biased$ and$ that$ they$ require$ R&D$
expenditures$ to$ realize$ them$ is$ one$ way$ to$ show$ that$ factor$ prices$ mattered$ for$
invention.$ By$ influencing$ the$ profitability$ of$ R&D$ projects,$ they$ could$ affect$ both$
the$bias$and$the$pace$of$technical$change.$$
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FACTOR'PRICES'IN'EUROPE'AND'INDIA''
To$apply$the$aboveQmentioned$approach$to$the$spinning$jenny,$we$must$compare$
the$prices$of$capital$and$labor$in$England,$France$and$India;$$
England$stands$out$as$the$country$with$expensive$labor$and$cheap$capital,$
and$ that$ explains$ why$ Enlish$ producers$ took$ up$ their$ jenny$ so$
enthusiastically.$
Wages$ in$ France$ were$ lower$ than$ wages$ in$ England$ but$ the$ low$ wage$
earned$ by$ workers$ in$ France$ was$ not$ matched$ by$ low$ consumer$ goods$
prices$hence$French$purchasing$power$was$lower.$$
The$data$respecting$wages$and$prices$in$India$are$much$less$complete$than$
those$ for$ Europe;$ indian$ wages$ were$ too$ low$ to$ purchase$ the$ standard$ of$
living$enjoyed$by$english$workers.$$
English$ wages$ were$ high$ relative$ to$ both$ consumer$ and$ producers$ goods$ prices$
because$England$had$a$more$advanced$economy$than$France$or$India$in$the$midQ
eighteenth$century.$Five$factors$increased$the$demand$for$labour:$$
1. Larger$ firms$ realized$ internal$ economies$ of$ scale$ through$ the$ division$ of$
labour$(as$emphasized$by$Adam$Smith)$$
2. England$ was$ more$ urbanized$ than$ the$ other$ countries$ and$ cities$ raised$
productivity$through$external$economies.$
3. The$growth$of$London$also$lead$to$the$expansion$of$the$coal$industry$$
4. Agriculture$was$more$productive$than$on$the$continent$$
5. The$spinning$jenny$was$not$alone$in$fact$seventeenth$and$earlyQeighteenthQ
century$ increases$ in$ the$ wage$ led$ to$ inventions$ that$ increased$ the$ capitalQ
labour$ratio.$(as$was$noticed$by$Bentley)$
Early$ modern$ England$ experienced$ an$ ascending$ spiral$ of$ progress$ in$ which$ the$
rise$ in$ the$ wage$ induced$ the$ invention$ and$ use$ of$ machines$ that$ raised$ labor$
productivity.$The$rise$in$productivity$raised$the$wage$even$more$and$the$process$

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continued.$ The$ inventions$ of$ the$ industrial$ revolution$ were$ the$ culmination$ of$ a$
century$and$a$half$of$economic$growth.$$
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WHY' THE' ENGLISH' ADOPTED' THE' SPINNING' JENNY' AND' THE' FRENCH' AND'
INDIANS'DID'NOT'
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The$jenny$was$taken$up$very$rapidly$in$England$but,$as$we$can$image,$the$situation$
was$ very$ differet$ in$ India$ and$ France.$ (theres$ no$ record$ that$ the$ jenny$ was$ ever$
considered$in$India).$$
The$historical$question$is$whether$it$was$equally$profitable$for$French$and$English$
spinners$to$buy$jennies.$$
It$was$used$in$Enlgand$because$it$was$profitable$and$that$profit$was$a$measure$of$
its$ social$ utility.$ The$ social$ utility$ (total$ profit)$ is$ the$ product$ of$ the$ number$ of$
pounds$spun$and$the$profit$per$pound,$so$total$profit$depended$on$the$size$of$the$
market$as$well$as$the$reduction$in$unit$costs.$$
The$profit$generated$by$the$jenny$i$salso$a$measure$of$the$income$that$Hargreaves$
could$hope$to$realize$by$patenting$it.$Hargreaves$did$get$a$patent$but$he$was$not$
able$to$defend$his$rights.$$
There$was$no$point$in$inventing$the$jenny$in$either$France$or$India$because$it$was$
not$used$in$those$countries$even$when$it$was$avaible,$so$the$social$rate$of$return$to$
inventing$it$would$have$been$negative.$$
So$the$difference$among$the$three$countries$has$to$be$found$in$the$differences$in$
the$national$economic$ocnditions.$
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CONCLUSION'
Focusing$on$the$artisans$is$more$promising$than$focusing$on$the$upper$classes$in$
understanding$ Englands$ ascendancy,$ since$ many$ of$ the$ inventions$ of$ the$
Industrial$Revolution$originated$from$below.$$
The$question$is$whether$Englands$distinctiveness$should$be$attributed$to$a$unique$
trajectory$ of$ cultural$ development$ uninfluenced$ by$ economic$ incentives$ or$
whether$ it$ should$ be$ seen$ as$ an$ endogenous$ response$ to$ the$ opportunities$
presented$by$the$economy$(as$was$deeply$underlined$in$the$article).$$
Englands$ price$ structure$ created$ unique$ incentives$ to$ develop$ machines$ that$
substituted$ capital$ for$ labor:$ they$ were$ profitable$ to$ be$ used$ in$ Britain$ and$
unprofitable$ elsewhere.$ The$ costs$ of$ the$ inventions$ were$ balanced$ by$ economic$
benefits$(high$incomes).$$
The$ story$ of$ the$ jenny$ illustrates$ another$ feature$ of$ technology$ and$ economic$
development;$in$the$modern$world,$much$technology$is$developed$in$rich$countries$
and$proves$highly$profitable$there.$This$technology$is$much$less$profitable$in$poor$
countries$ and$ is$ consequently$ much$ less$ used.$ The$ reason$ is$ that$ technology$
developed$in$rich$countries$reflects$their$factor$prices$and$embodies$that$influence$
in$a$high$capitalQlabor$ratio.$This$factor$proportion$makes$their$use$uneconomic$in$
lowQwage$economies$like$France$and$India.$
The$unexpected$conclusion$is$that$the$Industrial$Revolution$was$the$consequence$
of$the$highQwage$economy,$not$its$cause.$
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TOPIC'5:'THE'FIRST'WAVE'OF'GLOBALIZATION'
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Daudin,' G.,' M.' Morys' and' K.H.' ORourke' [2010];' Globalization,' 1870W
1914,' in' Broadberry,' S.' and' K.' ORourke,' K.' (eds.);' The' Cambridge'
Economic' History' of' Modern' Europe,' Vol' II' (Cambridge' University'
Press)'
The$period$from$1870$to$1914$is$the$central$period$for$globalization.$$
NineteenthQcentury$ globalization$ involved$ increasing$ transfers$ of$ commodities,$
people,$ capital,$ and$ ideas$ between$ and$ within$ continents.$ The$ most$
straightforward$ measure$ of$ integration$ is$ simply$ the$ growing$ volume$ of$ these$
international$ flows$ ,$ pheraps$ scaled$ by$ measures$ of$ economic$ activity$ $ (ex.$ The$
ratio$ of$ commodity$ trade$ to$ GDP,$ or$ the$ number$ of$ migrants$ per$ head$ of$
population).$Another$measure$is$the$cost$of$moving$goods$or$factors$of$production$
across$borders$and$this$cos$twill$show$up$in$international$price$gaps.$Because$it$is$
less$ easy$ to$ measure$ integration$ in$ the$ international$ markets$ for$ ideas$ and$
technology,$ these$ flows$ are$ often$ not$ discussed$ in$ economists$ accounts$ of$
globalization,$but$they$are$sufficiently$important$to$be$briefly$considered$here.$$
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TRADE,'1870W1914'
European$international$trade$in$current$values$grew$at$4.1$percent$a$year$between$
1870$and$1913,$as$against$16.1$percent$percent$a$year$between$1830$and$1870.$In$
1990$prices,$European$international$trade$grew$at$6.8$percent$a$year$with$growth$
being$particularly$high$in$Belgium,$Germany,$Switzerland$and$Finland.$$
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Price$evidence$also$shows$impressive$international$integration$during$this$period.$$
International$trade$grew$for$many$reasons:$$

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International$freight$rates$declined$steadily$as$a$result$of$constant$technical$
improvments$and$the$growth$in$the$use$of$faster$and$more$regular$
steamships,$especially$after$the$opening$in$1869$of$the$Suez$Canal$(which$
could$only$be$used$by$steamships);$$
The$reduction$of$internal$transport$costs$through$the$development$of$
railroads$was$crucial$(and$it$let$the$cost$of$shipping$decrease);$railroads$
were$particularly$important$in$large$countries$such$as$Russia;$
Pace$between$the$main$powers$between$1871$and$1914$promoted$trade$in$
fact$the$development$of$European$formal$and$informal$empires$increased$
extraQEuropean$trade$through$the$reduction$of$trade$barriers,$the$inclusion$
of$colonies$in$currency$unions$and$the$better$protection$of$(European)$
property$rigths.$Meanwhile$the$gradual$spread$of$the$gold$standard$
dampened$exchange$rate$fluctuations$and$reduced$uncertainty$in$trade.$$

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Falling$transport$costs$implied$increasing$potential$market$integration,$but$
politicians$always$had$the$option$of$muting$or$even$reversing$this$via$protectionist$
polices.$$
As$regards$the$pattern$of$trade,$Europe$as$a$whole$was$a$net$exporter$of$
manufactures$and$a$net$importer$of$primary$products,$although$this$masks$
important$differences$among$regions.$At$one$extreme$lay$the$UK,$massively$
dependent$on$imported$food$and$raw$materials$paid$for$with$exports$of$
manufactures$and$services.$The$rest$of$northwest$Europe$had$a$similar$but$less$
extreme$specialization.$$Estern$and$southern$Europe,$however$despite$growing$
industrialization,$still$exported$primary$products$and$imported$manufactures.$The$
overall$European$deficit$in$commodity$trade$was$partly$balanced$by$net$exports$of$
services.$$
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CAPITAL'FLOWS,'1870W1914'
International$capital$market$integration$was$extremely$impressive$during$this$
period.$Europe$was$the$worlds$banker$and$those$regions$with$good$access$to$
European$capital$and$abundant$resources$such$as$the$USA,$Canada,$Argentina,$and$
Australia$prospered$most$between$1870$and$1913.$There$was$also$a$smaller$but$
still$important$transfer$of$capital$from$the$western$European$core$to$the$more$
peripheral$economies$of$south,$central$and$eastern$Europe.$Europe$as$a$whole$
dominated$foreign$investment.$$
Therere$different$measures$of$integration:$$

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Obstfeld$and$Taylor:$capital$market$integration$has$traced$out$a$UQshape$
over$the$past$150$years$with$late$nineteenthQcentury$integration$being$
followed$by$interwar$disintegration$and$a$slow$move$towards$reintegration$
in$the$late$twentieth$century.$
Feldstein$and$Horioka:$international$capital$mobility$breaks$the$link$
between$domestic$savings$and$domestic$investment,$as$domestic$savings$
can$be$invested$abroad$and$domestic$investment$can$be$financed$externally.$
Consequently,$the$weaker$the$relationship$between$domestic$savings$and$
domestic$investment,$the$higher$is$international$capital$mobility.$The$UQ
shaped$pattern$emerges$yet$again$from$the$data.$$
Flandreau$and$Zumer:$they$look$at$bond$spreads$between$peripheral$
economies,$whether$in$Europe$or$elsewhere,$from$some$5$percent$in$1870$
to$only$1$percent$in$1914.$

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Capital$market$integration$was$not$a$continuous$process;$a$first$wave$of$financial$
integration$came$to$an$end$with$the$Baring$crisis$of$1891.$Capital$receded$
dramatically$for$roughly$a$decade$before$massive$foreign$lending$resumed$again$
around$the$turn$of$the$century.$$
What$explain$late$nineteenthQcentury$capital$market$integration?$$
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The$absence$of$military$conflict$among$the$main$lending$countries$between$
the$FrancoQPrussian$War$and$the$First$World$War$certainly$helped$create$
and$stabilize$an$atmosphere$conducive$to$foreign$lending.$$
Marxists$have$long$argued$that$late$nineteenth$century$capital$exports$and$
imperialism$are$only$two$sides$of$the$same$coin:$excessive$saving$at$home,$
generated$by$a$highly$unequal$distribution$of$income,$required$outlets$in$
underdeveloped$countries,$as$domestic$investment$would$have$been$
subject$to$Marxs$law$of$the$falling$rate$of$profit.$(this$idea$prompted$Lenin$
to$delcare$imperialism$to$be$the$highest$stage$of$capitalism).$$
The$contention$of$a$connection$between$empire$and$capital$exports$was$
subsequently$discredited;$Ferguson$and$Schularick$argued$that$countries$in$
the$British$Empire$benefited$from$their$colonial$status$through$
substantially$reduced$interest$rates.$There$are$doubts$about$the$fact$that$
colonial$affiliation$mattered$for$the$size$and$the$direction$of$capital$flows.$$
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Bordo$and$Rockoff:$gold$standard$$goldi$s$seen$as$having$promoted$global$
financial$integration$in$two$ways:$1)it$eliminated$exchange$rate$risk;$2)it$
signaled$that$the$government$would$pursue$conservative$fiscal$and$
monetary$policies,$which$assured$potential$investors$that$returns$were$
reasonably$safe.$$
Economic$fundamentals$have$to$be$considered$as$the$main$determinant$in$
explaining$the$size$and$direction$of$flows.$$over$50%$of$British$capital$
exports$went$to$areas$of$recent$settlment$where$natural$resources$could$be$
exploited$and$not$to$where$labour$was$cheap.$$
Flandreau$and$Zumer:$sound$fiscal$policies$
Clemens$and$Williamson:$railroads$had$to$make$the$food$produced$in$the$
New$World$land$accessible$to$European$consumers.$They$argued$that$
British$capital$exports$went$to$countries$with$abundant$supplies$of$natural$
resources,$immigrants,$and$young,$educated$urban$populations.$They$also$
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find$that$the$gold$standard$and$empire$promoted$foreign$investment,$
supply$and$demand.$$

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MIGRATION,'1870W1914'
Its$in$the$area$of$migration$that$the$late$nineteenth$century$was$most$impressively$
globalized,$even$compared$with$today.$At$the$beginning$of$the$century,$
intercontinental$migration$was$dominated$by$slavery$and$it$was$followed$by$free$
immigration$which$inflow,$twenty$yearsa$later,$was$more$than$four$times$as$high$
as$the$slave$flow.$$
In$addition$to$these$transoceanic$migrations,$there$were$significant$migrations$
within$Europe.$The$casuses$of$this$mass$migration$are$by$now$well$understood:$
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1. The$New$Wold$was$endowed$with$a$higher$landQlabor$ratio$than$Europe.$$
Hence$the$gains$from$migration$were$potentially$enormous$and$once$the$
new$steam$technologies$had$lowered$the$cost$of$travel$sufficiently,$mass$
emigration$became$inevitable.$$
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2. What$determined$the$timing$of$emigration$streams$from$different$European$
countries?$Hatton$and$Williamson$argued$that$EM$(European$Migration)$is$
a$downwardQsloping$function$relating$emigration$rates$from$a$given$
European$economy$to$home$wage$rates;$as$home$wage$rise,$emigration$
rates$should$fall,$ceteris$paribus.$$
3. Rising$fertility,$structural$transformation$and$falling$transport$costs$thus$
increased$emigration$rates,$initially$in$the$richer$economie$sas$living$
strandards$rose$across$the$continent.$This$emigration$was$initially$
selfrenforcing,$as$a$result$of$the$friends$and$relatives$effect:$all$these$factors$
led$to$EM$shifting$rightwards.$But$eventually,$the$emigration$function$
stabilized,$and$when$this$happened,$emigration$became$selfQlimiting:$by$
lowering$labor$supply$at$home,$it$pushed$up$real$wages$and$economies$thus$
moved$up$their$EM$schedules,$experiencing$lower$migration$rates$can$be$
explained$on$economic$grounds$alone$without$appealing$to$cultural$
behaviour$in$either$country.$$
'
TRADE'IN'KNOWLEDGE,'1870W1914'
Economic$globalization$includes$technological$transfers$and$the$deepending$of$
other$intellectual$exchanges.$In$Europe$and$in$the$Atlantic$world,$technologies$had$
been$circulating$for$a$long$time;$textile$mills$around$the$world$used$similar$
machines$often$imported$from$Britain.$$
Europe$was$internally$exchanging$new$technologies,$diffusing$them$and$receiving$
new$technologies,$mainly$from$the$United$States.$$
Several$new$factors$increased$the$speed$and$the$reach$of$technological$transfers:$
Migration$was$easy$
Imperialism$allowed$European$enterpreneurs$to$invest$overseas,$taking$
advantage$of$low$wages,$with$no$fear$of$expropriation$by$hostile$
governments$
The$decline$in$transport$and$communication$costs$helped$the$diffusion$of$
ideas,$new$goods,$and$machines.$$more$and$more$technoogy$was$
embedded$in$machines$rather$than$individual$knowQhow,$even$if$training$
8

SARA$TACCONE$
$

was$still$necessary.$$
Due$to$many$political$restrictions,$several$firms$set$up$production$in$foreing$
countries$and$transformed$themselves$into$multinationals$during$this$
period.$$
Creation$of$scientific$and$technical$organizations$(such$as$the$Institution$of$
Naval$Architects)$

$
We$dont$have$to$forget$that$science$was$seen$as$one$of$the$weapons$in$the$struggle$
between$European$nations.$Although$governments$increased$formal$technical$
cooperation$by$creating$global$institutions(International$Telegraph$Union,$
Universal$Post$Union,$Red$Cross)$$joined$by$European$and$nonQEuropean$nations.$$
$
Another$form$of$rising$globalization$was$the$growing$number$of$international$
exchanges$and$competitions$(first$World$Fair,$1876$in$Philadelphia;$first$Venice$
Biennale,$1895;$modern$Olympics,$1896;$first$five$Nobel$prizes,$1091).$
$
Labor$movements$were$increasingly$globalized$as$well.$$
$
GLOBALIZATION'AND'FACTOR'PRICE'CONVERGENCE''
Weve$to$understand$how$the$booming$commodity$trade$and$mass$migration$from$
the$Old$World$to$the$New$influenced$the$income$distribution$within$and$between$
countries.$$
$
According$to$HeckscherQOhlin$logic,$the$landQabundant$and$laborQscarse$New$
World$should$have$exchanged$food$and$raw$materials$for$European$manufactured$
goods$and$trade$should$have$led$to$the$wageQrental$ratio,$w/r,$converging$
internationally$hence$9n$the$New$World$economies,$where$w/r$was$high,$w/r$
should$have$declined$as$farmers$exported$more$and$manufacturing$suffered$from$
foreign$competition.$While$in$landQscarce$European$economies,$where$w/r$was$
low,$it$should$have$increased$as$workers$were$hired$by$expanding$manufacturing$
industries$and$land$rents$were$undermined$by$cheap$food$imports.$These$predicts$
hold$good$for$the$late$nineteenth$century.$The$increase$was$less$pronunced$in$
protectionist$economies$and$this$suggests$a$link$between$trade$and$factor$price$
trends,$which$is$confirmed$by$both$econometric$evidence$and$CGE$simulations.$
Another$thing$that$has$to$be$taken$into$consideration$is$that$these$wageQrental$
ratio$trends$implied$that$European$income$distribution$was$becoming$more$equal$
since$landowners$were$typically$better$off$than$unskilled$workers.$$
Declining$transport$costs$were$good$for$European$workers$because$cheaper$
transport$meant$cheaper$food$and$higher$real$wages.$$
$
Migration$was$the$dimension$of$globalization$that$had$the$greatest$impact$on$
European$workers$living$standards$during$this$period.$$
Emigration$lowered$the$baor$force$(1870Q1910)$by$45%$in$Ireland,$39%$in$Italy$
and$24%$in$Norway$and$researches$showed$that$living$standards$in$these$
economies$rose$more$rapidly$than$in$Britain.$$
Both$econometric$and$simulation$studies$show$that$emigration$was$an$important$
source$of$living$stardand$convergence$for$countries$such$as$Ireland.$Taylor$and$
Williamson$find$that$emigration$(1870Q1910)$raised$Irish$wages$by$32%,$Italian$by$
28%$and$Norwegian$by$10%.$$

SARA$TACCONE$
$

International$real$wage$dispersion$fell$by$28%$between$1870$and$1910,$reflecting$
a$convergence$of$poorer$countries$on$the$rich$but$in$the$absence$of$the$mass$
migrations$international$real$wage$dispersion$would$have$increased$by$7%;$the$
results$suggest$that$more$than$all$(125%)$of$the$real$wage$convergence$between$
1870$and$1910$was$attributable$to$migration.$Mass$migration$accounted$for$all$of$
the$Irelands$and$Italys$convergence$on$the$United$States,$and$for$the$65Q87%$of$
their$convergence$on$Britain.$$
$
CAPITAL'FLOWS,'PERIPHERAL'DEVELOPMENT,'AND'CORE'WELFARE'
Assuming$identical$production$functions$with$capital$and$labor$as$the$only$inputs,$
lower$wages$in$the$European$periphery$should$have$been$due$to$lower$capitalQtoQ
labor$ratios,$which$should$have$implied$higher$returns$to$capital.$$
Sweden$is$one$of$the$few$cases$for$which$we$have$relatively$reliable$data;$capital$
imports$after$1870$served$to$make$the$Swedish$capital$stock$50%$bigger$than$it$
would$have$been$in$their$absence,$increasing$Swedish$real$wages$by$25%.$
These$results$cannot$be$easily$replicated$for$other$countries$in$the$European$
periphery;$AustriaQHungary,$the$largest$periperal$economy$in$preQ1914$Europe,$
seems$to$have$enjoyed$substantial$capital$imports$but$a$recent$recontruction$of$the$
AustoQHungarian$balance$of$payments,$by$contrast,$concluded$that,$over$the$period$
1880Q1913,$AustriaQHungary$exported$rather$than$imported$capital.$Similar$
uncertainty$are$valid$also$for$Italy,$Spain$and$Portugal.$$
$
The$question$to$which$weve$to$find$an$answer$is:$why$was$the$European$periphery$
not$able$to$attract$more$capital$from$the$European$core?$
Capital$usually$flows$to$rich$rather$tha$to$poor$countries,$despite$the$fact$that$
wages$are$lower$in$poor$countries$(Lucas$paradox).$$Three$explanations$have$been$
offered$for$this$phenomenon:$$
1. Lower$labor$productivity$in$the$European$periphery$can$potentially$explain$
why$capital$did$not$flow$there;$
2. NonQadherence$to$gold$may$have$dissuaded$foreign$investors$
3. It$may$simply$be$that$these$contries$were$not$attractive$to$investors$as$the$
landQabundant$New$World.$$
$
Another$question$to$which$weve$to$find$an$answer$is:$what$were$the$effects$of$
capital$flows$on$welfare$levels$in$the$capitalQexporting$countries?$$
As$investors$preferred$foreign$investment$opportunities$to$domestic$ones$based$on$
their$relative$profitability,$capital$exports$should$have$been$beneficial$to$the$core$
countries$lowering$GDP$(output)$but$raising$GNP$(income).$But$there$were$some$
problems$$because$the$1931$Macmillan$Report$claimed$that$the$City$of$London$
systematically$discriminated$against$domestic$borrowers,$preferring$instead$to$
invest$overseas.$This$situation$let$another$problem$rise;$could$Britain$have$done$
better$by$retaining$more$savings$in$the$domestic$economy?$Research$has$shown$
that$entrepreneurs$had$strong$internal$sources$of$funding$and$easy$access$to$local,$
provincial$financing.$Rather,$what$was$missing$was$the$highly$skilled$workQforce$
required$to$take$full$advantage$of$the$opportunities$offered$by$the$Second$
Industrial$Revolution.$
$
IMPERIALISM'AND'EUROPEAN'WELFARE'

10

SARA$TACCONE$
$

One$of$the$driving$forces$behind$imperialism$was$the$influence$of$European$
traders,$who$saw$in$political$control$a$way$to$facilitate$their$economic$exchanges$
with$African$and$Asian$producers$and$consumers.$Some$industrialists$also$believed$
that$the$creation$of$a$reserved$market$would$be$a$suitable$answer$to$international$
competition,$and$they$managed$to$convince$certain$politicians.$$
Its$not$certain$whther$empires$represented$a$net$benefit$for$the$European$powers;$
weve$to$focus$on$the$British$Empire$because$it$was$the$largest$and$the$only$that$
controlled$economically$advanced$settler$colonies.$According$to$Davis$and$
Huttenback,$private$British$investment$in$the$empire$after$1880$yielded$higher$
returns$than$investment$in$the$domestic$economy,$but$smaller$returns$than$
investment$in$foreign$countries.$$
To$determine$the$effect$of$empire$on$European$economic$welfare,$its$crucial$to$
decide$on$the$appropriate$conterfactual;$analyzing$the$data$Edelstein$showed$that$
the$benefits$of$empire$for$UK$may$have$been$somewhere$between$0.4%$and$6.8%$
of$its$GDP$in$1913.$Edelstain$assumed$that$there$would$have$been$no$redirection$of$
trade$to$compensate$for$lower$imperial$demand$but$they$do$not$take$into$account$
any$impact$of$empire$in$facilitating$emigration$from$the$UK.$$
Even$if$global$economic$effect$of$empires$was$small,$they$may$have$had$an$
important$redistributive$role;$certainly$the$military$and$state$apparatus$benefited$
everywhere,$while$there$was$an$obvious$cost$to$taxpayers.$On$the$whole,$the$
European$benefits$from$imperialism$were$small$and$uncertain.$$
$
$
PERSSON,'K.'G.'[2010];'An'Economic'History'of'Europe,'ch.'9''
'
INTERNATIONAL'MONETARY'REGIMES'IN'HISTORY'
'
WHY'IS'AN'INTERNATIONAL'MONETARY'SYSTEM'NECESSARY?'
Countries$must$be$able$to$convert$their$currencies$if$trade$is$not$to$be$restricted$to$
barter;$hence$the$need$for$an$international$monetary$system.$$
There$are$several$advantages$in$an$international$monetary$system$and$these$
advantages$can$be$understood$by$considering$the$wellQknown$national$income$
accounting$identity:$
$
national$production$=$C+$I+$government$consumption$+$net$X$
$
Hence$production,$or$aggregate$supply,$in$an$economy$must$be$equal$to$aggregate$
demand,$because$national$saving$is$defined$by$the$difference$between$income$
(production)$and$consumption.$$
$
savings=production$$consumption$$government$consumption$
Net$exports$=$savings$$investment$$
This$identity$must$hold$for$every$economy.$$
A$current$account$deficit$(=negative$net$exports)$implies$that$the$country$is$
borrowing$from$the$rest$of$the$world$to$finance$investment,$whereas$a$current$
account$surplus$implies$that$it$is$investigating$aborad.$The$desirability$of$this$
depends$on$whether$investments$are$more$profitable$at$home$or$abroad.$Clearly,$if$
there$isnt$an$international$monetary$system$and$trade$is$balanced,$then$the$net$
exports$are$equal$to$zero$and$domestic$investment$is$constrained$by$domestic$

11

SARA$TACCONE$
$

saving.$Without$a$functional$international$monetary$system,$trade$is$restricted$and$
foreing$investment$is$impossible.$$
$
HOW'DO'POLICYMAKERS'CHOOSE'THE'INTERNATIONAL'MONETARY'
REGIME?'
Historically,$it$was$believed$that$commodity$currencies$and$fixed$exchange$rates$
were$essential$to$a$functional$international$monetary$regime.$Commodity'money$is$
fixed$in$value$relative$to$some$particular$commodity$and$this$implies$that$
currencies$based$on$the$same$commodity$were$fixed$in$value$in$relation$to$each$
other.$$
However$floating$exchange$rates$dominate$and$all$different$currencies$are$all$
floating$against$each$other.$In$the$late$twentieth$century$there$was$a$move$to$fiat$
currencies$$where$the$value$depends$solely$on$the$order,$fiat,$of$the$government$$
and$the$automatic$link$between$currencies$broke$down.$The$reason$for$the$
dominance$of$floating$exchange$rates$in$todays$world$is$the$changing$in$priorities$
of$policymakers.$$
Fixed$exchange$rates$provide$some$advantages$because$international$traders$are$
not$subjected$to$unexpected$changes$in$exchange$rates$and$do$not$need$to$factor$
this$uncertainty$into$the$price$they$demand$for$their$goods.$Lowering$the$interest$
rate$increases$the$range$of$profitable$investments$in$the$economy$and$will$
stimulate$investment$and$thus$increase$aggregate$demand$and$hence$production.$
Under$a$fixed$exchange$rate$regime,$monetary$policy$is$geared$towards$ensuring$
that$the$currency$maintains$some$fixed$value$against$other$currencies$or$a$certain$
commodity.$If$the$CB$lowers$i,$investors$will$sell$the$domestic$currency$and$buy$
higherQyielding$foreign$assets.$If$the$demand$for$domestic$currency$is$lowered,$$its$
value$will$tend$to$depreciate$against$other$currencies,$and$this$is$not$allowed$in$a$
fixed$exchange$rate$system.$$
But$to$be$sure$about$the$fact$that$this$phenomenon$is$always$true,$weve$to$take$
into$consideration$the$role$of$arbitrage;$speculators$respond$to$the$lower$return$
return$to$domestic$capital$by$moving$assets$out$of$the$country$an$thus$impacting$
on$the$exchange$rate.$However$if$capital$controls$are$in$place,$this$will$be$
impossible.$By$limiting$the$movement$of$capital$between$countries,$also$trade$will$
be$penalized$and$thus$capital$controls$may$be$unattractive$in$the$sense$that$they$
limit$trade.$From$this$we$can$deduce$that$fixed$exchange$rates$can$only$be$
combined$with$monetary$autonomy$at$the$expense$of$unrestricted$capital$mobility$
as$well$as$unrestricted$capital$mobility$can$only$be$combined$with$monetary$
autonomy$at$the$expense$of$a$fixed$exchange$rate$regime.$This$is$the$open$
economy$trilemma$described$by$Obstfeld$and$Taylor).$$
$
A$monetary$union$is$the$extreme$form$of$a$fixed$exchange$rate,$where$exchange$
rates$are$abolished$altogether.$$
$
The$trilemma$is$a$convenient$way$to$understand$the$history$of$international$
monetary$regimes.$$
$
Dont$forget$that$worldwide$fixed$exchange$rate$systems$are$a$thing$of$the$past.$$
INTERNATIONAL'MONETARY'REGIMES'IN'HISTORY'
THE'INTERNATIONAL'GOLD'STANDARD'

12

SARA$TACCONE$
$

The$history$of$international$monetary$system$can$be$seen$as$a$gradual$realization$
that$fixed$exchange$rates$are$not$necessary,$although$a$political$attachment$to$
them$remains$in$and$between$certain$countries.$$
Gold$had$been$used$as$money$since$ancient$times$but$when$countries$started$to$fix$
their$currencies$ahgainst$gold$in$a$more$institutionalized$way$(in$the$nineteenth$
century)$their$currencies$automatically$became$fixed$against$each$other.$$
$
The$gold$standard,$as$an$institution,$emerged$in$Britain$in$1819$with$the$
Resumption$Act$which$both$resumed$and$institutionalized$the$practice$of$
exchanging$currency$notes$for$gold$on$demand$at$a$fixed$rate.$The$history$of$the$
emergence$of$the$gold$standard$shows$that$it$is$politics$as$well$as$economics$that$
determines$monetary$policy.$Emerging$states,$such$as$the$United$States$and$
Germany,$were$quick$to$form$their$own$monetary$unions.$We$can$talk$about$a$
more$general$spirit$of$internationalism$in$the$globalized$world$of$the$late$
nineteenth$century$led$to$attempts$at$international$monetary$union$with$the$
Scandinavian$Monetary$Union$from$1875$and$the$Latin$Monetary$Union$(LMU)$
from$1865.$$
$
France$saw$the$LMU$as$the$nucleus$of$an$international$system$based$on$the$franc$
and$Paris$and$one$consequence$was$that$the$LMU$was$based$on$a$bimetallic$
standard$ratger$than$the$british$gold$standard.$$
$
Despite$their$political$significance,$monetary$unions$are$not$particularly$
economically$important$in$a$world$of$fixed$exchange$rates$and$by$1870s$all$the$
countries$were$basing$their$currencies$on$gold$and$this$implied$fixed$exchange$
rates.$$
The$rules$of$the$game$of$the$gold$standard$depended$on$the$law$and$practice$of$
individual$countries$but$the$more$important$and$the$most$common$were:$$
$
1. The$currency$should$be$freely$convertible$to$gold$at$a$set$price$or$mint$
parity,$
2. There$should$be$no$barriers$to$the$flow$of$capital,$
3. Money$should$be$convertible$on$request$to$gold,$and$thus$backed$by$gold$
reserves.$$
$
However$small$deviations$in$the$exchange$rate$were$possible$due$to$the$transport$
and$transaction$costs$involved$in$shipping$gold$hence$arbitrage$will$only$take$place$
as$long$as$the$gains$from$it$outwigh$the$costs.$$
$
Governments$under$the$gold$standard$took$on$the$whole$a$laissez$faire$attitude$
towards$economic$policy.$Hume$described$the$priceQspecieQflow$
mechanismwhereby$the$glod$standard$should$automatically$ensure$balance$of$
payments$equilibrium.$He$imagened$a$situation$whereby$gold$was$flowing$into$
Britain$from$abroad,$thus$causing$British$prices$to$rise$in$relation$to$those$abroad$
hence,$as$the$British$demand$for$foreign$goods$increased$and$demand$for$british$
goods$decreased,$gold$would$start$flowing$abroad$again$and$equilibrium$would$be$
restored.$However,$if$Britain$was$enjoying$a$trade$surplus,$traders$would$
accumulate$an$excess$of$foreign$currency;$they$would$present$this$to$foreign$banks$
for$gold,$which$would$then$flow$into$Britain$and$be$exchanged$for$British$currency$

13

SARA$TACCONE$
$

by$British$banks.$The$money$supply$and$the$price$level$in$Britain$would$increase$
and$this$will$restore$the$equilibrium$in$the$same$way$as$before.$$
$
CBs$were$$more$worried$about$gold$losses$thn$gold$gains.$CBs$often$practised$
sterilization$of$gold$inflows,$thus$preventing$them$from$entering$the$money$supply.$$
This$enable$them$to$build$up$excess$of$gold$reserves,$without$affecting$the$money$
supply.$$
$
Nevertheless,$despite$the$above$mentioned$deviations$from$the$rules$of$the$game,$
the$gold$standard$lasted$many$decades$because$of:$
Commitment$deviations$from$the$gold$standard$would$be$followed$by$a$
return$to$the$original$parity$
$confidence$$people$believed$that$exchange$rates$would$remain$fixed,$so$
all$the$speculation$went$in$the$direction$of$maintaining$the$fixed$exchange$
rates$
symmetry$no$one$country$have$an$overwhelming$influence$on$price$
levels.$$
$
Although$$the$gold$standard$ensured$price$stability$over$longer$periods,$for$shorter$
periods$there$were$uniform$rates$of$inflation$or$defleation$across$countries.$$
$
THE'INTERWAR'PERIOD'
The$interwar$years$were$to$see$the$end$of$the$gold$standard$both$for$political$and$
economics$reasons.$$
During$the$First$World$War,$the$gold$standard$was$suspended$but$after$the$war,$
some$governments$financed$reconstruction$by$printing$even$more$money$and$this$
led$to$inflation,$often$on$massive$scale.$When$governments$were$in$this$situation,$
they$prioritized$a$return$to$gold.$$
$
Deflation$can$be$painful$for$economies,$because$wages$do$not$normally$fall$so$
labour$becomes$relatively$expensive$and$output$declines.$$
$
By$1929$the$US$was$trying$to$slow$its$overheated$economy$through$monetary$
contraction$and$France$was$ending$an$inflationary$period$with$a$return$to$gold.$
Both$France$and$US$were$sterilizing$gold$inflows$and$absorbing$the$worlds$gold,$to$
the$extent$that$they$ended$holding$70%$of$global$supply.$As$a$consequence,$the$
other$countries$were$forced$to$restrict$their$money$supply;$this$contraction$and$
the$Wall$Street$Crash$of$1929$led$to$the$Great$Depression$of$1930s.$$
Eichengreen$has$demonstrated$that$the$gold$standard$played$a$large$part$in$
prolonging$and$worsening$the$Depression$in$fact$countries$refused$to$provide$
liquidity$because$they$needed$to$protect$their$gold$reserves.$In$addition,$many$
countries$that$had$previously$been$forced$to$rely$on$American$loans$were$forced$to$
introduce$currency$controls$$currency$controls$+$very$low$capital$mobility$=$
decline$in$world$trade.$$
$
In$1931$UK$left$the$gold$standard$and$it$was$soon$followed$by$other$countries.$
These$nations$early$devalued$to$about$60%$of$their$1929$exchange$rate$and$
recovered$faster$from$the$Great$Depression.$$

14

SARA$TACCONE$
$

Devaluation$implied$an$increase$in$inflation,$which$reduced$product$wages$(that$is$
the$wage$cost$relative$to$the$price$of$the$product),$and$real$interest$rates$(because$
nominal$wages$were$constant$while$devaluation$permitted$producers$to$increase$
prices).$$
$
Countries$that$left$the$gold$standard$early$enjoyed$a$faster$recovery.$$
$
The$international$gold$standard$relied$on$fixed$exchange$rates$and$free$capital$
mobility$and$thus$could$not$survive$in$a$world$where$monetary$policy$became$
crucially$important.$$
$
THE'BRETTON'WOODS'SYSTEM'
The$reaction$to$Great$Depression$was$disastrous.$Protectionism$increased$hence$
restrictions$were$imposed$on$capital$flows$and$countries$general$became$more$
autarkic.$$
$
In$July$1944,$44$countries$signed$the$Article$of$Agreement$of$the$International$
Monetary$Found$(IMF)$at$Bretton$Woods.$$
The$British$representative,$Keynes,$hoped$to$design$a$system$whereby$exchange$
rates$could$be$fixed$and$monetary$policy$applied$without$trade$restrinctions$being$
necessary.$They$designed$the$Bretton$Woods$System$as$a$dollar$exchange$
standard:$$
the$dollar$was$fixed$against$the$price$of$gold:$$35$an$ounce$
member$countries$held$reserves$in$gold$or$dollar$assets,$with$the$right$to$
sell$dollars$to$the$US$Federal$Reserve$for$gold$at$the$official$price.$These$
reserves$were$to$guard$against$shortQterm$swings$in$exchange$rates,$
without$a$link$to$the$monetary$supply$as$they$had$had$under$the$gold$
standard$
all$currencies$were$fixed$in$value$against$the$dollar,$giving$NQ1$exchange$
rates.$$
$
This$system$was$very$similar$to$the$gold$standard$but$the$important$difference$led$
to$the$freedom$of$countries$to$use$monetary$policy.$Hence,$according$to$the$
trilemma,$capital$movements$must$be$restricted$by$requiring$convertibility$of$
currencies$only$on$the$current$account$(for$goods$and$services)$and$not$on$the$
financial$account$(for$financial$assets).$$
$
The$Bretton$Woods$System$aimed$to$ensure$flexibility$for$countries$that$were$
experiencing$current$account$deficits$and$this$implies$two$things:$$
1. the$IMF$would$control$a$pool$of$gold$and$currencies$from$member$countries$
which$it$could$lend$to$memebers$that$were$experiencing$current$account$
deficits,$but$where$contractionary$policy$would$cause$unemployment.$
(memebers$taht$borrowed$from$the$IMF$would$be$supervised$by$the$IMF)$
2. parities$were$adjustable$hence$if$the$balance$of$payments$was$in$
fundamental$disequilibrium,$countries$could$devalue$against$the$dollari$f$
they$suffered$permanent$adverse$international$shifta$in$the$demand$for$
their$products.$$

15

SARA$TACCONE$
$

The$flexibility$of$the$system$was$one$of$the$causes$of$its$instability;$speculators$
found$ways$by$borrowing$from$abroad,$by$delaying$payment$for$goods$or$lending$
by$forewarding$money$in$advance.$$
$
The$downfall$of$the$Bretton$Woods$System$was$its$assymetry$in$fact$only$the$USA$
had$the$freedom$to$set$its$interest$rate$and$use$monetary$policy;$the$other$nations$
had$to$use$monetary$policy$to$tie$their$currencies$to$the$dollar.$$
However$in$1960s$Democratic$administrations$expanded$welfare$spending$and$got$
involved$in$the$Vietnam$War$with$the$result$that$budget$deficits,$expansionary$
monetary$policies$and$inflation$doubled.$Inflation$continued$over$time$and$gold$
convertibility$eas$abandoned$in$1973$destroying$the$Bretton$Woods$System.$The$
possibility$of$combining$monetary$freedom$with$fixed$exchange$rates$depend$
crucially$on$the$ability$to$avoid$destabilizing$speculation.$$
$
THE'WORLD'OF'FLOATING'EXCHANGE'RATES'
Floating$exchange$rates$were$initially$seen$as$a$temporary$measure$but$after$the$
collapse$of$Bretton$Woods$System,$countries$soon$lost$interest$in$an$international$
fixed$exchange$rate$system,$since$floating$exchange$rates$turned$out$to$be$
compatible$with$free$capital$flows$and$trade.$$
$
The$new$exchange$rate$orders$were$regional$rather$than$truly$international$
however,$even$at$a$regional$level,$the$stability$of$European$system$was$difficult$to$
maintain$without$defections$and$frequent$exchange$rate$adjustments.$$
$
In$the$EMS$(European$Monetary$System)$Germany$was$the$conductor$of$monetary$
policy;$many$countries$pegged$their$currencies$to$the$German$mark$because$
Germany$had$a$reputation$for$low$infaltion$but$they$had$to$obey$to$the$German$
monetary$policy.$$
$
$A$monetary$union,$such$the$european$one$in$2002,$deprives$domestic$
governments$of$monetary$autonomy$and$the$independent$European$Central$Bank$
has$adopted$an$explicit$inflation$target.$The$coordination$of$fiscal$policies$when$
needed$is$the$crucial$difference$with$the$Bretton$Woods$System.$This$coQordination$
has$mainly$aimed$at$setting$ceilings$on$public$debt$and$borrowing,$and$even$that$
has$not$been$easy$to$accomplish.$$
$
$
TOPIC'6:'THE'WORLD'BETWEEN'WARS'
'
FEINSTEIN,'C.H.,'P.'TEMIN,'and'G.'TONIOLO'[2008],'The'World'Economy'between'the'World'
Wars'(Oxford'University'Press),'ch.1W2'$
'
1.1 MODERN'ECONOMIC'GROWTH'IN'A'TWENTIETHWCENTURY'PERPESCTIVE'
The$years$between$the$two$world$wars$were$politically$and$economically$turbolent.$$
To$analyse$these$years,$weve$to$start$by$placing$interwar$years$in$the$context$of$modern$economic$growth.$$
During$the$first$part$of$the$nineteenth$century,$and$in$some$regions$for$long$after$that,$the$standard$of$
living$of$the$average$peasant$family$in$the$most$advanced$areas$of$western$Europe$and$North$America$had$
far$more$in$common$with$the$standard$of$living$of$their$medieval$ancestors$serving$on$feudal$manors$than$
with$their$postQSecond$World$War$greatQgrandchildren.$$
$
The$large$majority$of$people$living$outside$of$western$Europe$and$the$so$called$European$overseas$
offshoots$survived$on$an$amount$of$resources$possibly$30$to$50%$lower$than$those$avaible$to$the$masses$

16

SARA$TACCONE$
$

in$the$areas$of$the$world$where$an$industrial$revolution$of$some$kind$had$sparked$the$transformation$of$
the$daily$life$of$ordinary$people$for$which$Simon$Kuznets$coined$the$term$modern$economic$growth.$$
$
Kuznets$showed$that$those$countries$in$which$modern$economic$growth$occurs$experience$a$number$of$
similar$quantitative$developments$related$to$the$longQrun$rates$of$growth$of$aggregate$and$sectoral$
production,$consumption$and$saving$patterns,$and$structural$chages$in$the$economy.$$
$
The$main$features$of$the$modern$economic$growth$are$the$following:$$
Acceleration$in$the$growth$of$population$and$consumption;$
A$rise$in$savings$and$investments$ratios;$
A$shift$in$the$composition$of$GDP$away$from$agriculture;$$
Tremendous$increase$in$the$international$movement$of$goods,$services,$and$factors$of$production.$$
$
In$the$early$part$of$the$nineteenth$century,$modern$economic$growth$had$spread$all$over$Europe$and$in$the$
US$but$it$was$only$after$the$Second$World$War$that$industrialization$and$GDPQgrowth$acceleration$became$
an$increasingly$common$feature$of$the$other$countries,$particularly$in$Asia.$$
$
The$years$between$the$two$World$Wars$are$years$of$longQterm$economic$growth.$However$divergence,$
rather$than$convergence$towards$the$productivity$leaders,$has$tended$to$characterize$the$longQrun$growth$
process$of$the$world$economy,$at$least$until$the$1980s$(except$for$Japan).$$
Rates$of$growth$also$differed$over$time,$beyond$the$normal$cyclical$fluctuations,$suggesting$that$in$each$
given$period,$factors$such$as$technology,$institutions,$and$economic$polices$affected$the$world$economy$in$
different$ways.$$
$
1.2 SOME'QUANTITATIVE'FEATURES'OF'THE'INTERWAR'YEARS'
'
The$slowdown$in$the$worlds$real$per$capita$growth$between$1913$and$1950$provides$the$background$to$
the$present$history.$$
To$analyze$the$various$aspects$of$the$international$economy$during$the$interwar$years,$its$useful$to$
discuss$a$few$stylized$facts$that$are$prominent$features$of$the$aggregate$quantitative$changes$between$
1913$and$1950;$$
1. The$slowdown$in$economic$activity$affected$individual$areas$in$quite$different$ways,$$
2. The$overall$slowdown$was$the$result$of$quite$satisfactory$rates$in$the$1920s$and$of$dismal$
economic$performance$in$the$1930s,$
3. Far$from$keeping$pace$with$output$trends,$international$trade$declined$in$real$terms$
4. High$and$structural$unemployment$was$the$shocking$new$phenomenon$of$those$years$$
5. Labor$productivity$increased$more$rapidly$than$in$1890Q1913.$
$
Slower'Growth'
The$reduction$in$the$growth$of$real$per$capita$GDP$between$1870$and$1913$and$between$1913$and$1950$
characterized$Western$Europe,$United$States,$Latin$America,$Japan,$China$and$India.$$
$
The$Soviet$Union$in$the$1930s$provided$a$striking$contrast$to$the$dismal$performance$of$most$of$the$
market$economies.$$$
$

$
$

17

SARA$TACCONE$
$

THE'GLOBALIZATION'BACKLASH'
$
The$distribution$of$international$trade$and$the$sharp$reduction$in$the$crossQborder$movements$of$factors$
of$production$are$known$as$"globalization$backlash".$$
$
International$movements$of$goods,$services,$capital,$and$labor$typically$depend$on$two$sets$of$factors:$$
$
1)$technology$Q$which$reduces$transport$and$communication$costs$and$hence$created$increasingly$
favorable$conditions$for$crossQborder$economic$integration$
2)$institutions$(domestic$and$international)$Q$that$may$favor$or$hinder$international$economic$integration$$
$
For$what$concerns$institutions,$we've$to$divide$between$international$and$domestic$ones;$continuous$
tension,$misunderstandings$and$lack$of$cooperation$characterized$international$relations$resulting$in$the$
creation$of$an$institutional$environment$inimical$to$trade$add$to$the$cross$border$movement$of$people.$On$
the$domestic$front,$countries$were$busy$erecting$tariff$and$nontariff$walls,$limiting$immigration$and$
minutely$regulating$international$financial$transactions.$$
$
Europe$was$largely$responsible$for$the$dramatic$fall$in$international$trade$growth$during$the$Great$War$
and$the$interwar$years;$in$the$1930s$the$volume$of$the$Western$European$exports$actually$declined.$$
$
(TABELLA)$$
$
An$important$factor$that$has$to$be$mentioned$while$taking$into$consideration$this$period,$is$that$forced$
migration$increased.$$
$
CrossQborder$capital$flows$reached$an$all$time$peak$in$1913.$They$became$a$casualty$of$the$Great$War$and$
remained$depressed$in$the$following$two$decades,$characterized$as$they$were$by$administrative$controls$
on$crossQborder$monetary$transactions$(=exchange$controls)$and$by$uncertainty$future$exchange$rates.$
$
THE'RISE'IN'UNEMPLOYMENT'
$
High$unemployment$rates,$stand$out$in$collective$memories$as$the$most$deeply$felt$economic$feature$of$the$
interwar$period.$$
$
Comparing$unemployment$over$time$and$across$countries$is$a$daunting$task$however$there$senses$to$be$
some$consensus$among$scholars$that$unemployment$before$the$First$World$War$was$shorter$average$
duration$than$that$experienced$after$1918.$$
What$can$be$noticed$is$that$exceptionally$high$unemployment$rates$stand$out$as$a$feature$of$1930s$while$
unemployment$in$the$1960s$was$exceptionally$low.$$
$
PRODUCTIVITY$CONTINUES$TO$IMPROVE$$
While$the$number$of$unemployed$rose,$availed$evidence$shows$that$product$per$hour$worked$by$those$
who$retained$their$jobs$continued$to$increase.$$
$
There$are$three$plausible$reasons$for$this$phenomenon:$$
1)$1920s$and$1930s$were$rich$in$technological$innovations$(such$as$the$combustion$engine,$the$assembly$
line$and$the$electrical$network$and$motor)$
2)$continuation$of$the$prewar$trend$of$extending$elementary$and$secondary$education$to$an$evenQlarger$
number$of$people$and$of$investing$in$higher$education$$
3)$it$may$be$a$consequence$of$unemployment$itself.$$
$
Whatever$caused$this$constant$improvement,$it's$important$for$two$reasons:$$
1)it$reinforces$the$by$that$slow$growth$and$depression$were$manQmade$rather$than$natural$phenomena;$
2)it$(partly)$explain$the$extraordinary$growth$rates$of$the$years$after$the$Second$World$War.$$
$
OUTPUT'GROWTH:'BELLIGERANTS'AND'NEUTRALS'
$
Given$the$lenght$and$the$complexity$of$the$period$taken$into$consideration$(1913Q1950),$growth$rates$
were$the$result$of$participation$or$neutrality$in$one$or$both$world$wars,$the$speed$of$respective$recoveries,$

18

SARA$TACCONE$
$

monetary$and$exchangeQrate$polices,$semiQplanned$fascist$economies,$and$other$factors.$Two$of$the$fastestQ
growing$countires,$Sweden$and$Switzerland,$remained$neutral$during$both$the$First$and$the$Second$World$
Wars.$$
$
While$in$the$period$from$1913$to$1929$are$taken$into$consideration$countries$that$partecipated$in$the$
Great$War;$the$results$show$that$neutral$outperform$all$winners$while$the$winners$(except$for$UK)$do$
better$than$the$cores$of$the$two$preQ1918$cenral$empires$that$were$defeated$in$the$war$and$lost$significant$
parts$of$their$territories.$$
$
The$third$element$taken$into$consideration$is$the$adherence$to$the$gold$standard$until$1935Q1936;$the$
countries$that$left$gold$definitely$outperform$the$memebers$of$the$gold$bloc$and$Switzerland.$$
$
To$understand$the$slowdown$in$modern$economic$growth$experienced$in$the$period$of$our$study,$its$
appropriate$to$explore$first$and$foremost$the$effects$of$the$war$and$of$illQadvised$economic$polices.$
$
1.3 TWO'PROPOSITIONS'ABOUT'INTERNATIONAL'ECONOMIC'ORGANIZATION'
'
STRUCTURAL'IMBALANCES'AND'THE'END'OF'THE'EMPIRE'
'
The$traditional$explanation$for$the$depth$and$persistence$of$widespread$postwar$difficulties$is$the$problem$
of$structural$imbalance$within$and$between$countries.$The$origins$of$this$dislocation$are$found$in$the$
changes$in$the$composition$of$production$and$demand$resulting$from$the$wartime$disruption$of$
international$trade,$from$the$geopolitical$effects$of$the$Treaty$of$Versailles,$and$from$the$postwar$changes$
in$technology$and$patterns$of$demand.$$
$
Although$the$effects$of$these$changes$are$not$always$clearly$spelled$out,$they$may$be$taken$to$relate$
particularly$to$a$misallocation$of$resources$that$was$responsible$for$the$high$rate$of$unemployment$in$
Europe$in$1920s$and$that$also$made$the$adjustment$process$longer$and$more$costly.$$
$
Conflict$in$Asia$both$within$China$and$between$China$and$Japan$impeded$economic$growth$and$prosperty$
there.$The$collapse$of$the$Chinese$Empire$was$not$as$closely$tied$to$the$war$as$was$the$collapse$of$the$
empires$nearer$to$the$actual$conflict.$China$was$doubly$disadvantaged$by$having$inexperienced$leaders$at$
home$and$an$aggressive$Japan$on$its$doorstep.$$
$
POLITICS'AND'ECONOMICS''
'
A$lack$of$leadership$by$governments,$CBs,$and$international$institutions$in$the$operation$of$restoring$the$
gold$standard$and$in$international$economic$policy$making$has$been$noted$by$Brown$and$Kindleberger.$$
$
The$diminished$political,$military$and$financial$status$of$the$UK$meant$that$London$was$unable$to$acta$s$
sole$conductor$of$the$international$orchestra$while$the$US$was$not$yet$willing$to$take$over$this$role,$despite$
the$enormous$improvement$in$its$international$standing.$$
$
The$specific$financial$manifestation$of$the$lack$of$leadership$was$that$there$was$no$country$able$and$
willing$to$stabilize$the$global$monetary$environment$and$this$lack$was$compounded$by$the$absence$of$
international$cooperation$between$the$US,$Britain,$France$and$Germany$and$the$major$nations$to$
coordinate$their$domestic$economic$polices.$$
Eichengreen$suggested$lack$of$cooperation$as$a$central$feature$of$the$entire$period,$manifested$particularly$
in$the$attempt$of$each$of$the$main$powers$to$secure$for$itself$a$disproportionate$share$of$the$worlds$
limited$stocks$of$monetary$gold.$Prior$to$the$colapse$of$the$gold$standard$in$1931,$their$uncoperative$
behaviour$involved$the$imposition$of$tight$monetary$polices$by$both$countires$in$deficit$and$in$surplus;$
this$added$to$the$deflationary$pressures$on$the$world$economy$and$increased$the$vulnerability$of$the$weak$
currencies.$$
$
The$shortcomings$of$the$interwar$adjustment$mechanism$are$explained$by$the$unwillingness$of$central$
banks$to$operate$the$gold$standard$according$to$the$rules$of$the$game$under$which$all$movements$in$gold$
should$have$been$fully$reflected$in$compensating$chaanges$in$domestic$money$supplies.$The$main$reason$
for$this$tendency$to$neutralize$changes$in$gold$and$foreignQexchange$reserves,$rather$than$allowing$them$
to$influence$internal$monetary$conditions,$was$that$postwar$governemnts$were$no$longer$willing$to$give$

19

SARA$TACCONE$
$

unconditional$support$to$external$equilinrium$and$the$defense$of$the$reserves,$due$to$increased$political$
cost$of$the$necessary$measures.$$
$
Democratic$electorates$increasingly$required$that$governments$should$attach$greater$weight$to$internal$
stability$of$prices$and$incomes.$$
$
The$inability$of$the$powers$to$cooperate$was$dramatically$symbolized$at$the$World$Monetary$Conference$
in$the$summer$of$1933,$where$the$governments$decided$to$abandon$the$gold$standard$and$allowed$the$
dollar$to$depreciate.$$
$
Since$also$global$political$relations$were$rapidly$deteriorating,$the$decade$witnessed$an$epidemic$of$
competitive$currency$depreciation;$extended$resort$to$exchange$controls;$the$rise$of$protectionism,$
bilateralism,$import$quotas$and$other$barriers$to$trade;$and$the$development$of$hostile,$noncooperating$
trade$and$currency$blocs.$$
$
Even$whene$leaders$acted$responsabily$and$cooperation$was$tried,$problems$arose$from$the$hold$that$oldQ
fashioned$political$and$financial$idiologies$exerted$on$policyQmakers.$$
$
THE'LEGACY'OF'THE'FIRST'WORLD'WAR''
'
2.1 THE'ECONOMICS'OF'TOTAL'WAR'
'
The$First$World$War$marked$the$true$watershed$between$the$nineteenth$and$twentieth$centuries.$The$late$
nineteenth$century$was$characterized$by$a$relatively$weelQfunctionating$international$payment$system$
based$on$the$gold$standard.$London$played$a$pivotal$and$stabilizing$role$and$the$leading$central$banks$
cooperated$as$necessary$and$there$was$almost$perfect$mobility$of$factors$of$production,$reflected$in$largeQ
scale$movements$of$labour$and$capital$from$Europe$to$the$New$World.$Commercial$treaties$mitigated$the$
impact$of$tarifss$on$international$commodity$trade,$stimulated$by$rapidly$falling$transportation$costs.$$
$
The$war$itself$was$a$major$economic$revolution.$When$the$governemnts$realized$that$the$concept$at$the$
basis$of$the$shortQwar$theorem$$(any$modern$war$was$bound$to$be$brief$given$the$limited$resources$
avaible$and$the$disruption$in$economic$and$social$life$that$a$war$would$create)$started$to$be$unreliable,$$
they$rapidly$started$to$organize$the$total$war.$$$
Germanys$central$planning$of$the$supply$of$raw$materials$and$their$distribution$to$companies$working$for$
the$government$turned$out$to$be$particularly$effective$and$it$was$accompained$by$an$industrial$
reorganization$that$more$often$than$not$entailed$compulsory$cartelization.$This$situation$implied$the$fact$
that$small$industry$was$sacrificed$to$the$needs$of$industrial$giants.$$
In$Britain$we$assisted$to$the$creation$of$the$Ministry$of$Munitions$in$1915$and$it$supervised$private$
business$and$supplemented$their$efforts$with$direct$investments$when$needed.$$
In$many$areas$this$colossal$productive$effort$was$coupled$with$an$acceleration$of$technical$progress$bith$in$
products$and$production$processes$even$because$the$workforce,$subject$to$military$discipline,$was$
scientifically$organized.$$
$
With$rthe$total$war$society,$particulary$in$the$countryside,$was$deeply$changed$by$the$departure$of$
almost$all$acceptable$men$and$their$replacement$by$women,$children$and$older$workers.$Meanwhile$in$the$
trenches$men$learned$ways$of$organizing$large$numbers$of$people$for$political$purposes.$$
$
From$a$political$point$of$view,$the$political$change$came$when$the$mass$movements$overwhelmed$the$
government$leading$to$fundamental$political$changes;$in$Germany$the$Kaiser$abdicated$and$was$replaced$
by$a$republic,$the$AustroQHungarian$Empire$collapsed$into$a$set$of$small$countries,$the$Russian$Empire$was$
taken$over$by$the$Bolsheviks,$the$Ottoman$Empire$collapsed$but$only$Turkey$and$Egypt$emerged$as$
independent$countries.$However$the$Japanese$Empire$emerged$stronger$from$the$war;$Tokyos$almost$
costless$alliance$with$the$Entente$allowed$it$to$make$some$territorial$gains$and$to$consolidate$its$colonial$
holdings$and$its$commmercial$influence$in$Asia.$$
$
One$of$the$reason$of$the$demise$of$the$various$empires$had$to$do$with$the$fact$that$farmers$felt$hardQ
pressed$and$reluctant$to$sell$food$and$this$led$to$acute$food$scarcity$in$the$cities$and$abundant$food$in$the$
countryside$with$no$market.$Lack$of$food$is$a$classic$source$of$civil$unrest$and$the$inevitable$result$was$
revolution.$$

20

SARA$TACCONE$
$

$
In$the$international$economy,$the$war$brought$about$two$major$developments:$$
1. The$displacement$of$the$agricultural$sector$in$the$belligerent$countries$led$to$lifting$of$import$
duties$in$order$to$gain$access$to$the$cheapest$overseas$supplies;$
2. Financial$cooperation$was$undertaken$by$the$Entente$powers$in$the$form$of$interQAllied$loans$$
(Britain$lent$to$its$financially$weaker$allies,$France,$Italy$and$Belgium.$Later$USA$provided$war$
loans$to$all$the$European$countries$fighting$against$the$central$empires).$
$
As$a$result,$the$allies$exhange$rates$could$be$pegged$at$politically$acceptable$levels$and$hard$
$
currency$was$made$avaible$to$buy$overseas$supplies,$mostly$in$the$home$markets$of$creditor$
$
countries$themselves.$$
$
2.2 THE'ECONOMIC'CONSEQUENCES'OF'THE'WAR'
'
In$the$international$arena,$the$period$between$the$Armistice$of$November$11,$1918,$and$the$crisis$of$1923Q
1924$that$led$to$some$kind$of$stabilization$was$one$of$the$great$upheaval.$The$war$left$a$permanent$scar$
on$international$relations$that$made$cooperation$much$more$difficult$for$many$years$to$come.$$
$
Unsettled$domestic$and$international$conditions$played$a$major$role$in$generating$an$unstable$
international$economic$environment.$$
'
THE'TWO'EXOGENOUS'SHOCKS'
'
The$war$caused$a$major$disruption$of$the$real$economy,$both$on$the$demand$side$and$on$the$supply$side;$
heroic$efforts$were$made$to$increase$productive$capacity$in$warQrelated$industries$such$as$engineering,$
iron$and$steel,$and$shipbuilding.$
$
The$second$exogeous$shock$occurred$when$much$of$the$productive$capacity$in$warQrelated$industries$
became$superflous$once$the$war$ended$and$the$relocation$of$$physical$assets$and$labor$to$pacetime$
production$was$not$easy$to$be$managed.$$
Another$difficulty$was$related$to$the$fact$that$not$few$changes$occurred$in$the$world$markets$during$the$
war;$in$fact$countries$like$USA$and$Japan$invaded$the$European$markets$to$support$the$inability$of$
European$manufacturers$during$the$war$hence$imports$from$Europe$were$substituted$by$domestic$
production$(particularly$in$nonQEuropean$countries).$$
Also$the$end$of$Empires$has$to$be$taken$into$cosideration;$large$markets$were$replaced$by$tariff$barriers$
that$restricted$the$flow$of$goods.$$
$
A'MORE'RIGID'ECONOMIC'ENVIRONMENT'
'
In$the$postwar$labor$market,$wage$flexibility$was$diminished$as$many$more$decisions$were$centrally$
negotiated$in$a$greatly$extended$process$of$collective$bargaining.$$
$
In$the$good$markets$there$was$a$similar$tendency$toward$reduced$flexibility$of$property$incomes$and$
prices.$The$war$contributed$to$this$tendency$by$causing$an$increase$in$government$intervention$in$
economic$life,$the$formation$or$strengthening$of$trade$associations$and$cartles,$and$the$imposition$of$
numerous$controls.$$
$
The$war$accellerated$the$trend$toward$larger$business$units.$In$the$extremely$difficult$cirumstances$of$
1920s,$many$firms$looked$to$collusion,$cartels,$and$the$exercise$of$monopoly$powers$to$excape$the$
consequences$of$increasing$competition$for$shrinking$markets.$$
$
A'WEAKER'FINANCIAL'STRUCTURE''
'
The$war$and$its$aftermath$gave$rise$to$unprecedent$needs$for$revenue;$in$all$countries,$note$issues$and$
bank$credits$were$expanded$by$immense$amounts,$with$little$or$no$attempt$either$to$raise$taxes$or$to$
borrow$from$public$on$the$scale$needed$to$offset$the$additional$demand$on$resources$generated$by$the$
enormous$military$expenditures.$$
After$the$war,$finance$ministers$faced$the$need$to$service$the$internal$public$debts$as$well$as$external$
demands$for$payments$of$war$debts$and$reparations.$$
'

21

SARA$TACCONE$
$

A'FRAGILE'INTERNATIONAL'MONETARY'SYSTEM'
'
The$classic$gold$standard$was$an$early$casualty$of$the$conflict;$within$a$few$months$of$the$declaration$of$
war,$almost$all$European$CBs$suspended$gold$payments.$During$the$war,$the$powers$of$the$Entente$
developed$their$own$payment$system$but$once$the$war$was$over,$cooperation$ceased.$$
$
2.3 THE'ECONOMIC'CONSEQUENCES'OF'THE'POSTWAR'SETTLEMENTS''
'
THE'SHOCK'OF'ECONOMIC'RESTRUCTURING'AND'SOCIAL'UNREST'
'
During$the$war,$as$much$as$30Q40%$of$the$belligerentss$GDP$was$directly$or$indirectly$controlled$by$the$
state.$While$supplies$to$the$army$came$to$be$direct$responsability$of$the$governments,$the$rest$of$the$
economy$was$to$a$great$extent$subject$to$various$forms$of$state$supervision.$Forms$of$administrative$
controls$on$prices,$wages,$capital$and$foreignQexchange$markets$were$introduced$more$often$than$not.$$
The$return$to$pacetime$economic$organization$and$production$entailed$a$huge$process$of$resource$
reallocation$that,$not$only$required$a$long$period$of$time$but$also$met$with$the$resistance$of$the$vested$
interests$that$had$been$created$by$the$war.$$
$
Businessmen$and$industrialists$were$devided$between$those$who$favored$an$immediate$return$to$a$laissez$
faire$economy$and$those$who$asked$for$a$slow$return$to$normality$with$strong$state$help$in$the$process.$$
$
Whatever$the$pace$was$to$be,$industrial$restructuring$implied$the$closing$of$a$number$of$plants;$capital$for$
the$creation$of$factories$that$would$meet$consumers$demand$was$scarce$at$home$and$unlikely$to$come$
from$foreign$sources.$The$result$was$unemployment.$At$the$same$time,$householders$were$frustated$by$the$
fall$in$the$real$value$of$the$wartime$savings.$$The$combinations$of$these$two$conditions$produced$a$short$
but$deep$recession$between$1920$and$1921.$$
$
Social$unrest$was$the$main$postwar$problem.$The$almost$universal$explosion$of$workingQclass$struggles$
and$protests$after$the$war$can$be$primarly$attributed$to$two$factors:$$
1. Powerful$growth$of$the$organization,$strenght$and$solidarity$of$the$working$class;$
2. The$Russian$revolution$exercised$considerable$influence$on$workingQclass$movements.$'
$
The$economic$impact$of$social$developments$differed$according$to$the$realtive$weakness$of$the$economies$
and$of$the$governments$that$emerged$from$the$war.$$
'
THE'ECONOMIC'CONSEQUENCES'OF'THE'PEACE'TREATIES'
'
Peace$treaties$were$signed$in$1919$,$various$aspects$of$these$treaties$were$to$be$a$cause$of$severe$
disturbance$to$postwar$trade$and$production;$$
1. The$way$in$which$the$political$map$of$central$and$eastern$Europe$was$redrawn$disrupted$longQ
standing$economic$relations$and$created$new$barriers$to$trade$
2. The$attempt$to$hold$Germany$responsible$for$the$war$by$imporing$huge$demand$for$reparations$
for$the$losses$suffered$by$the$victorious$powers$became$a$major$cause$of$political$antagonism$and$
economic$discord.$$
$
In$deciding$on$the$changes$to$the$map$of$central$and$eastern$Europe,$the$victorious$powers$were$primarly$
guided$by$the$principle$of$national$selfQdetermination,$not$by$economic$considerations.$Foreign$trade$was$
affected$by$the$new$frontiers,$with$significant$consequences$both$for$the$development$of$the$region$and$for$
the$overall$performance$of$the$international$economy.$This$process$of$border$adjustments$and$state$
formation$failed$to$reconcile$and$satisfy$all$the$conflicting$interests$and$aspirations$involved,$leaving$
behind$a$permanent$residue$of$social$and$national$resentments.$$
$
The$dismemberement$of$the$Dual$Monarchy,$the$splitting$off$of$partes$of$the$German$and$Russian$empires$
and$the$latters$autarkic$evolution$all$represented$a$major$shock$to$the$international$economy.$$These$
developments$caused$widespread$resource$misallocation,$resulting$in$lower$output$and$higher$prices.$$
$
THE'END'OF'FINANCIAL'SOLIDARITY'AMONG'THE'ALLIES''
$

22

SARA$TACCONE$
$

The$war$had$been$tremendously$demanding$of$Europes$resources,$both$human$and$economic.$In$various$
part$of$the$continent,$particularly$in$the$defeated$countries,$food$emergencies$developed$that$could$be$
addressed$only$with$considerable$difficulty,$given$the$lack$of$foreign$exchange$to$pay$for$agricultural$
imports.$In$other$areas,$reconstruction$required$considerable$amounts$of$capita$$
$
Finance$was$needed$all$over$Europe$to$carry$on$the$reallocation$of$resources$from$warQrelated$production$
to$peacetime$production.$In$these$circumstances,$the$European$countries,$most$notably$Britain$and$France,$
argued$in$favour$of$a$soft$landing.$This$would$have$meant$a$continuation$of$financial$assistance$from$the$
USA$and$a$slow$relaxation$of$wartime$controls$on$exchange$reates$and$on$the$international$economy$more$
generally.$$
$
France$demanded$the$imposition$of$very$harsh$conditions$on$Germany;$France$also$insisted$that$the$
reimbursment$of$their$debts$to$USA$and$Great$Britain$must$be$linked$to$the$actual$receipt$of$reparations$
from$Germany.$The$two$sets$of$requests$were$not$mutually$consistent;$if$the$aim$was$international$
solidarity$to$rebuild$the$European$economy,$then$everyone$should$have$been$required$to$pay$a$price$for$
the$success$of$the$cooperative$effort$buti$f,$on$the$other$hand,$the$aim$was$equitable$justice,$then$there$was$
no$reason$to$establish$a$link$between$debts$and$reparations.$$
$
The$USA$did$not$respond$adequately$to$its$newly$acquired$responsability$as$world$leader;$the$leaders$of$
the$USA$lacked$the$necessity$insight$to$understand$where$the$long$term$interests$of$the$country$actually$
lay.$The$Victory$Loan$Act$(March$1919)$authorized$the$government$to$open$credit$to$foreign$countries$only$
for$the$purchase$of$goods$directly$or$indirectly$belonging$to$the$government,$and$of$grains$the$price$of$
which$was$guaranteed$by$the$United$States.$$
$
One$of$the$features$of$the$postwar$shock$was$the$immense$turmoil$in$the$world$markets$for$forign$
exchange.$$
$
REPARATIONS'
'
Keynes$was$the$first$to$condemn$reparations$as$economically$irrational$and$politically$unwise;$he$argued$
that$it$was$not$sensible$to$cripple$Germany$economically$because$much$of$Europes$preQ1914$welfare$had$
depended$on$German$economic$growth.$From$Keynes$point$of$view,$reparations$were$vincictive,$
insane,$and$unworkable.$$
$
In$March$1921,$the$German$failure$to$fulfill$part$of$those$preliminary$requests$prompted$Allied$troops$to$
occupy$the$towns$of$Dussendorf,$Duisberg,$and$Ruhrhort$on$the$east$side$of$the$river$Rhine.$One$month$
later,$the$London$Schedule$of$Payments$for$the$first$time$formally$established$Germanys$reparation$
obligations.$$
It$was$not$until$1924$that$an$greement$was$reached$that$created$the$preconditions$for$a$reasonably$stable$
system$of$international$payments,$allowing$private$capital$to$flow$into$Germany.$' '
'
'
'
TOPIC'7:'POST'WAR'GROWTH''
'
EICHENGREEN,'B.'[2008];'The'European'Economy'since'1945'(Princeton'University'Press),'
ch.2,''
'
MAINSPRINGS'OF'GROWTH'
'
From$the$analysis$of$Europes$economic$growth$from$1820$to$2000,$we$noticed$that$Western$Europe$grew$
more$than$twice$as$fast$from$1950$through$1973$as$it$did$over$the$whole$of$the$nineteteenth$and$twentieth$
centuries$(data$coming$from$the$analysis$of$the$GDPs).$The$exceptional$nature$of$the$golden$age$is$clear.$$
The$same$broad$patterns$are$evident$in$Peripheral$Europe$(Greece,$Ireland,$Portugal,$Spain$and$Turkey,$so$
classified$because$they$were$relatively$poor$countries$at$the$start$of$the$golden$age)$and$this$is$also$a$clear$
evidence$of$the$fact$that$these$peripheral$countries$had$the$tendency$to$catch$up$with$Western$Europe$
leaders.$$
$
In$contrast,$the$tendency$in$Eastern$Europe$was$different;$in$fact$by$the$middle$of$the$twentieth$century,$
this$region$had$fallen$behind$both$the$Western$European$core$and$the$Western$European$periphery.$$

23

SARA$TACCONE$
$

There$was$an$accelleration$after$1950$but$there$wasnt$the$tendency$to$catch$up$with$western$European$
leaders$and$the$growth$of$per$capita$GDP$remained$slower$than$in$the$West.$$
$
Its$important$to$take$into$consideration$also$the$comparison$with$the$USA;$data$tell$us$that$Western$
European$output$and$living$standards$fell$significantly$below$those$of$the$USA$in$the$first$half$of$the$
twentieth$century.$On$the$eve$of$the$Great$Depression,$output$per$capita$was$less$than$twoQthird$of$USA$
levels$and$after$the$Worl$War$II,$the$gap$among$the$two$parts$became$bigger.$Although$the$golden$age$was$
global,$the$accelleration$between$1950$and$1973$was$even$faster$in$Western$Europe$than$in$the$USA$but$in$
this$period$Europe$succeded$in$eliminating$40%$of$the$initial$postQWorl$War$II$gap.$$
$
To$define$the$situation$for$the$period$since$1973,$weve$to$make$some$important$differences$because$if$
output$and$productivity$are$measured$by$GDP$per$capita,$then$the$final$quarter$of$the$twentieth$century$
appears$as$a$period$of$relative$stagnation.$European$GDP$per$capita$in$2003$was$still$only$72$per$cent$of$
USA$levels$buti$f$we$consider$GDP$per$hour$worked,$reflecting$the$shortening$of$the$work$year$in$Europe$in$
the$final$quarter$of$the$twentieth$century,$$European$and$USA$productivity$continued$to$converge$through$
the$easrly$1990s,$when$European$GDP$per$workerQhour$stabilized$in$the$range$of$90$to$95%$of$USA$levels.$$
$
Another$important$comparison$with$the$usa$has$to$be$made$by$taking$into$account$the$growth$of$output$
with$the$growth$of$physical$capital,$the$growth$of$human$capital$and$technical$change.$$USA$was$the$
technological$leader$in$1950$and$all$fifeteen$European$countries$converged$to$a$greater$or$lesser$extent$in$
the$second$half$of$the$century.$Obviously,$the$sources$were$different$in$fact$throughout$Europe,$the$
physical$capital$stock$per$worker$grew$faster$than$in$USA;$average$levels$of$human$capital,$derived$from$
average$years$of$schooling,$also$grew$more$quickly$in$about$twoQthirds$of$European$countries.$$
$
PROBING'DEEPER''
$
Which$are$the$economic$factors$that$can$explain$in$a$clearer$way$the$situation?$
$
CatchQup$and$convergence:$$
$
Catch&'up$refers$to$the$rapid$growth$achieved$by$reversing$the$loss$of$output$and$destruction$of$
capacity$caused$by$World$War$II$(hence$by$rebulding$the$capital$stock$and$expanding$
employment).$$by$1948$industrial$production$matched$the$levels$of$ten$years$earlier$$to$some$
extent,$the$rapid$growth$of$the$golden$age$represented$a$simple$return$to$normalcy$(but$
remember$that$normalcy,$whether$construed$narrowly$in$terms$of$the$steadyQstate$capitalQlabor$
ratio$or$more$broadly$as$the$resumption$of$stability$and$growth,$could$not$be$taken$for$granted.)$
However$catchQup$required$higher$than$customary$levels$of$investment$in$fact$a$striking$feature$of$
the$1950s$and$1960s$is$the$rise$in$investment$rates$continentQwide.$$gross$fixed$investment$as$a$
share$of$GDP$rose,$on$average,$by$5%$$but$what$delivered$high$levels$of$investment$in$the$postwar$
period?$And$why$Europe$was$not$equally$successful$in$translating$capital$accumulation$into$rapid$
growth$after$1973?$
$
Convergence$refers$to$the$additional$growth$achieved$by$closing$the$efficiency$gap$that$had$opened$
up$visQQvis$the$USA.$By$the$end$of$the$nineteenth$century,$the$USA$had$assumed$a$significant$lead$
in$GDP$per$capita$by$harnessing$its$endoements$of$land$and$resources$and$pioneering$massQ
production$methods.$It$had$created$a$unified$internal$market$on$a$scale$unmatched$anywhere$in$
the$world$and$for$this$reason$it$was$able$to$develop$the$multidivisional$corporation,$an$
organization$from$capable$of$exploiting$economies$of$scale$by$ensuring$that$integrated$producers$
had$reliable$suppliers$of$raw$materials$and$economic$access$to$dispersed$local$markets.$(In$fact$
American$corporations$cut$production$costs,$leading$to$their$emergence$as$worldQclass$exporters$
and$giving$a$further$fillip$to$the$development$of$the$American$system$of$mass$production.)$$
evidence$of$the$situation:$the$gap$in$GDP$per$person$between$Europe$and$the$USA$rose$from$25%$
(in$1870)$to$more$than$40%$(in$1913).$This$was$due$to$the$fact$that$three$decades$of$low$
investment$had$not$been$conducive$to$Europes$assimilation$of$massQproduction$methods.'
'
$
The$growth$of$intraQ$and$extraQEuropean$trade$was$one$of$the$features$of$the$1950s$and$1960s$
$
that$stands$in$sharp$contrast$with$the$preceding$decades;$in$fact$trade$integration$removed$
$
market$size$as$a$constraint$on$the$adoption$of$new$technologies.$The$Code$of$Liberalization$of$the$
$
Organization$for$European$Economic$Cooperation$(OEEC),$the$General$Agreement$on$Tariffs$and$

24

SARA$TACCONE$
$

$
$
'
$
$
$
$
$
'
$
$
$
$
$
$
$
$
$
$
$
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$
$
$
$
$
$
$

Trade$(GATT),$and$the$Common$Market$were$powerful$motors$for$the$expansion$of$Europes$
trade.$'
Technological$transfer$proceeded$apace;$a$growing$share$of$technological$progress$was$science$
based,$facilitating$the$spread$of$new$knowledge;$new$communications$technologies$eased$the$
dissemination$of$information.$The$internationalization$of$business$deepened$commercial$
contracts,$multinational$corporations$operated$production$facilities$in$multiple$European$
countries.$'
On$the$other$hand,$technology$transfer$requires$that$the$acquiring$economy$have$the$capacity$to$
assimilate$foreign$knowledge$and$postQWorld$War$II$Europe$was$singularly$well$positioned$from$
this$point$of$view$nut$the$problem$was$education.$$In$the$countries$of$continental$Europe,$
education$and$training$were$heavily$vocational.$Europes$educational$system$was$tailored$to$a$
situation$where$the$task$was$to$assimilate$existing$techniques$rather$than$to$create$new$ones.$The$
principal$exception$was$the$UK,$where$higher$education$tended$to$be$of$a$general$nature$and$there$
the$convergence$of$productivity$to$USA$levels$proceeded$more$slowly.$$
Another$growth$that$has$to$be$emphasized$is$the$growth$of$labor$force;$from$1947$thrugh$1950,$
nearly$one$million$of$persons$moved$from$Eastern$to$Western$Europe.$$The$modern$industrial$
sector,$which$was$the$locus$of$learning$effects$and$productivity$spillovers,$could$grow$rapidly$by$
tapping$these$elastic$labor$supplies.$With$the$consolidation$of$small$farms$and$the$adoption$of$new$
agricultural$technologies,$workers$could$move$from$Southern$to$Northen$Europe$and$from$farm$to$
city$without$depressing$food$supplies.$This$permitted$the$industrial$and$service$sectors$to$grow$
more$rapidly$than$the$economy$as$a$whole.$$
Symbolic$of$labors$newfound$militancy$were$the$stikes$and$political$demonstrations$of$the$hot$
summer$of$1968;$with$the$breakdown$of$wage$discipline,$the$share$of$profits$in$gross$national$
product$(GNP)$began$to$fall$and$with$declining$profits$came$declining$investment,$reflecting$the$
reduction$in$the$rate$of$return$on$new$capital.$$

Cyclical$stability'
$
Steady$growth$meant$steady$sales,$heightening$the$porfitability$and$actrativness$of$investment.$$
$
The$early$1970s$saw$the$breakdown$of$the$Bretton$Woods$System$of$pegged$but$adjustable$
$
exchange$rates;$this$was$a$shock$to$confidence$and$a$threat$to$the$growth$of$trade.$European$
$
countries$sought$to$replace$Bretton$Woods$whit$a$series$of$locally$formed$substitutes$but$not$until$
$
the$1980s$did$these$efforts$succeed$in$restorign$a$modicum$of$currency$stability.$In$addition,$1973$
$
saw$the$first$oil$shock$resulting$from$price$increases$by$the$OPEC.$This$supply$shock$was$a$
$
challenge$for$a$set$of$policy$instruments$designed$to$manage$aggregate$demand.$Statistical$studies$
$
point$to$an$increase$in$the$magnitude$and$dispersion$of$aggregate$demand$disturbances$after$the$
$
early$1970s,$Europe$may$have$simply$been$lucky$in$the$1950s$and$1960s.$$
$
INSTITUTIONAL'FOUNDATIONS'OF'THE'GOLDEN'AGE'
'
One$explanation$for$the$high$investment,$rapid$export$growth$and$wage$moderation$that$sustained$the$
golden$age$is$a$set$of$institutions$singularly$well$suited$to$the$growth$imperatives$of$the$day.$European$
societies$now$developed$neocorporatist$structures$(tripartite$governing$institutions$involving$
government,$management,$and$labor)$to$restrain$wage$growth$and$plow$profits$into$investment.$Those$
arrangements$were$intended$to$prevent$a$repetition$of$earlier$events$and$in$this$they$succeeded;$this$time$
wage$increases$did$not$suqeeze$profitability.$$
$
Postwar$governments$supported$the$neocorporatist$bargain;$they$asked$unions$to$limit$wage$demands$in$
order$to$make$profits$avaible$for$modernization$and$capacity$expansion$and$provided$assurances$that$
labor$would$share$fully$in$the$eventual$increase$in$incomes.$The$challenge$was$to$reassure$workers$that$
management$would$in$fact$invest$the$profits$that$accrued$as$a$result$of$their$restraint.$$
$
The$postwar$period$turned$out$differently$because$cooperation$between$capital$and$labor$was$cemented$
by$a$series$of$institutional$bargains.$A$first$set$of$institutions$allowed$the$parties$to$monitor$one$anothers$
compliance$with$the$terms$of$their$agreement.$(Germanys$coQdetermination$law,$which$placed$worker$
representatives$on$the$supervisory$boards$of$large$firms$similar$systems$were$developed$also$in$other$
countries).$$

25

SARA$TACCONE$
$

$
A$second$set$of$institutions$created$rewards$and$penalities$to$encourage$cooperation$and$a$parallel$set$of$
public$programs$bonded$labor.$$
$
Many$elements$of$the$postwar$social$market$economy$originated$in$this$perioda$s$part$of$the$effort$to$more$
firmly$bind$capital$and$labor$to$cooperate.$But$if$wage$restraint$by$one$union$resulted$mainly$in$higher$
investment$and$employment$growth$elsewhere,$since$profits$originating$in$any$one$sector$could$finance$
investment$economyQwide,$the$incentive$to$defect$from$the$agreement$could$prove$irresistible.$The$
solution$was$to$coordinate$wage$bargains$across$firms$and$sectors.$$
In$Germany,$the$unions$adopted$a$followQtheQleader$approach;$bargaining$was$centralized$in$the$hands$of$
trade$union$federations$and$employers$associations,$and$governments$used$their$influence$to$harmonize$
the$terms$of$the$bargains$reached$by$unions$and$employers$at$the$branch$level.$$
Swedish$arrangements$were$prototypical;$the$SAF,$the$federation$of$emloyers$associations$and$the$LO,$the$
umbrella$organization$of$blueQcollar$workers,$meta$t$the$outset$of$the$annual$wage$round.$After$they$
reached$a$framework$agreement,$negotiations$between$branch$unions$and$employers$commenced;$the$
terms$of$the$LOS/SAF$negotiation$were$designed$to$reconcile$the$workers$desire$for$wage$increases$with$
the$restraint$necessary$to$sustain$profitability$and$employment.$They$provided$a$recognized$norm$for$
wage$settlements.$Through$the$first$half$of$the$1960s,$the$LO/SAF$norm$guided$even$private$whiteQcollar$
and$publicQemployee$negotiations;$in$fact$the$SAF$encouraged$compliance$bby$its$memeber$associations$
and$individual$employers$by$issuing$warnings,$chastising$those$who$hesitated$to$comply,$and$threatening$
to$fine$employers$who$offered$wage$increases$in$excess$of$the$authorized$norm$while$the$LO$enjoyed$
considerable$but$not$complete$control$over$its$member$unions.$$
$
Internationally,$the$institutions$of$regional$integration$worked$to$solve$a$second$set$of$coordination$
problems$that$hampered$the$recontruction$of$Europes$trade;$in$1947,$UK$restored$currentQaccount$
convertibility,$reserves$immediately$hemorrhaged$out$of$the$country$and$controls$on$merchandise$
transactions$were$reimposed$after$barely$a$month.$European$countries$understood$that$they$needed$to$
work$together$in$opening$their$economies$and$to$find$a$more$gradual$approach$to$restoring$currentQ
account$convertibility$since$given$the$difficulty$of$competing$in$US$markets,$the$only$way$to$gain$access$to$
markets$in$neighboring$European$countries$was$by$opening$the$current$account.$European$countries$had$
to$move$together$down$the$road$to$currentQaccount$convertibility$if$they$were$to$move$that$way$at$all.$The$
European$Payments$Union$(EPU),$established$in$1950,$helped$to$coordinate$their$response;$the$members$
accepted$the$OECCs$Code$of$LIberalization,$which$committed$them$to$remove$import$controls$at$a$
predetermined$pace.$Membership$entitled$a$participating$country$to$credits$from$its$EPU$parterns$with$
which$to$finance$temporary$trade$deficits.$The$US$provided$both$political$and$financial$support$for$this$
copoperative$undertaking.$$
$
The$European$Coal$and$Steel$Community$(ECSC)$established$in$1951,$addressed$the$special$problems$of$
heavy$industry.$Leadership$came$from$France$in$the$persons$of$the$foreign$minister$Robert$Schuman$and$
his$adviser$Jean$Monnet$but$also$in$this$case,$America$lent$critical$support.$The$role$of$the$community$was$
the$one$of$monitoring$production$and$investment$decisions$in$the$six$founding$member$states$but$it$also$
was$an$anticipation$of$the$European$Commission,$the$European$Parliament,$the$Europeam$Council$and$the$
European$Court$of$Law$(through$the$creation$of$the$Common$Assembly,$the$High$Authority,$a$Council$of$
Minister$and$an$High$Court).$$
$
The$most$enduring$transnational$institution$was$the$European$Union$and$it$was$essential$to$sustain$the$
growth$of$Europes$trade,$in$fact$over$the$second$half$of$the$twentieth$century,$intraQEuropean$rade$grew$
even$faster$than$Europes$trade$wit$the$rest$of$the$world.$We$can$say$that$this$represented$a$reconstitution$
of$the$continents$natural$trade$pattern$$the$tendency$for$European$countries$to$trade$
disproportionately$with$their$neighbors$owing$to$low$transport$and$communication$costs.$The$growth$of$
trade$allowed$countries$to$restructure$along$exportQoriented$lines$and$another$important$thing$is$that$the$
increase$of$the$market$facilitated$the$adoption$of$USQstyle$massQprodiuction$methods.$$
$
However$conditions$that$limited$the$growth$of$real$wages$limited$the$appreciation$of$real$exchange$rates;$
we$had$an$undervaluation$phenomenon,$except$for$Belgium$and$France$which$stabilized$at$levels$rgar$
produced$no$improvment$in$competitivness$relative$to$1938.$$
Undervaluation$and$export$growth$were$especially$dramatic$in$Germany,$reflecting$the$favorable$rate$at$
which$the$mark$was$stabilized$in$1948$and$further$devaluation$in$1949$and$because$wage$and$price$

26

SARA$TACCONE$
$

inflation$did$not$exceed$the$growth$of$labor$productivity$in$the$1950s,$the$favorable$competitive$position$
tended$to$persist.$$
$
Competitive$labor$costs$allowed$Europe$to$shift$resources$into$manufacturing,$where$learning$effects$and$
productivity$spillovers$were$strong;$they$allowed$producers$to$lengthen$production$runs$and$exploit$
economies$of$scale$and$scope.$With$European$interest$rates$linked$to$those$in$the$United$States,$rapid$
growth$did$little$to$drive$America$up.$Thus,$the$interpretation$of$Europes$growth$as$investmentQled$and$
exportQled$are$two$sides$of$the$same$coin$but$its$necessary$to$keeo$in$mind$the$important$role$of$
institutions$that$facilitated$the$removal$of$barriers$to$trade.$$
$
Domestically,$the$postwar$period$saw$a$political$settlment$that$strengthened$the$hand$of$centerQleft$and$
centerQright$parties.$The$neocorporatist$bargain$in$which$labor$and$capital$accepted$lower$current$
incomes$in$return$for$higher$future$living$standards$was$easier$to$sustain$when$there$was$little$risk$that$
come$future$government$would$renege$on$the$agreement.$$
Internationally,$the$GATT$system$of$trade$liberalization$and$the$Bretton$Woods$System$of$pegged$but$
adjustable$exchange$rates$encouraged$the$expansion$of$Europes$trade.$The$Interantional$Monetary$Fund$
was$established$to$lend$support$and$money$if$discolations$arose$along$the$way.$$
$
INSTITUTIONS'AND'HISTORY'
'
Growth$required$institutions$capable$of$addressing$coordination$problems$that$cannot$be$solved$at$arms$
lenght$and$this$meant$coordinatin$bargaining$across$sectors$and$coordinating$trade$liberalization$across$
countries.$$
$
The$new$postwar$european$generation$was$predisposed$to$an$european$integration$as$a$solution$to$the$
continents$economic$and$political$problems$but$one$critical$factor$in$this$situation$was$the$attitude$of$the$
US$since$their$troops$were$still$stationed$in$Europe$and$because$of$the$Marshall$Plan.$The$Truman$Doctrine$
encouraged$European$integration$in$order$to$create$a$bulwark$against$the$Soviet$threat$and$to$foster$the$
European$market$for$US$exports.$In$response$to$the$disastrous$consequences$of$its$pressure$on$the$UK$to$
restore$currentQaccount$convertibility$in$1947,$the$US$provided$350$million$dollars$of$Marshall$Plan$money$
fot$the$EPU$and$encouraged$the$development$of$the$ECSC,$putting$aside$worries$that$regional$initiatives$
could$lead$to$a$Fortress$Europe.$$
$
On$the$European$continent,$where$industrialization$had$begun$later$than$in$Britain,$governments$had$
always$played$an$active$role$in$helping$to$surmount$the$obstacles$to$modern$economic$growth$and$
preventing$countries$from$falling$behind$their$industrial$rivals$with$potentially$dangerous$security$
consequences.$Between$1914$and$1918,$governments$had$brought$together$unions$and$management$to$
negotiate$economyQwide$wage$agreements$and$avert$work$stoppages$that$might$have$disrupted$the$war$
effort.$$
The$Russian$Revolution$futher$encouraged$Western$European$Governments$to$incorporate$labor$
movements$into$processes$for$overseeing$the$operation$of$the$economy,$partly$in$order$to$head$off$more$
extreme$solutions$suggested$by$the$more$radical$returning$servicemen.$$
$
Mancur$Olson$stated$that$periods$of$rapid$growth$typically$follow$major$distruptions,$such$as$war,$that$
clear$away$the$inheritance$of$vested$interests$and$restricitve$institutional$arrangements$clogging$the$
operation$of$economic$system.$In$Olsons$model,$its$the$absence$of$a$historical$legacy$rather$tham$its$
existence$that$is$the$precondition$for$a$rapid$growth.$However$compelling$this$general$theory$of$economic$
success,$its$hard$to$see$how$it$applies$to$postwar$Europe$in$fact$the$war$removed$from$European$scene$
neither$Frances$influential$farm$lobby$nor$Germanys$powerful$unions$hence$in$the$case$of$postwar$
Europe,$institutional$continutiy$more$than$institutional$distruotion$provides$the$backdrop$to$economic$
recovery$and$growth.$The$institutional$arrangements$of$the$postwar$period,$from$government$involvment$
in$labor/management$negotiations$to$bankQdominated$financial$systems,$can$be$seen$as$legacies$of$the$
process$of$institutional$substitution$emphasized$by$scholars.$$
$
THE'END'OF'THE'GOLDEN'AGE'
'
Toward$the$end$of$the$1960s,$output$and$productivity$growth$began$to$slow$hence$its$necessary$to$
understand$why$a$set$of$arrangements$that$had$been$so$conducive$to$growth$and$stability$for$a$quarter$
century$now$produced$less$satisactory$results.$$

27

SARA$TACCONE$
$

Possible$solutions:$$
$
Rise$of$capitalQlabor$ratio$toward$the$steady$state$levels$ownig$to$Europes$success$in$building$up$
its$capital$stock$after$a$long$period$of$subpar$investment$and$to$the$exhaustion$of$elastic$supplies$
of$labor$and$hence$to$the$disappearance$of$supernormal$returns.$$
Changes$in$the$conditions$making$for$a$comfortable$fit$between$the$continents$institutions$and$its$
technological$circumstances;$the$more$efficiently$the$technological$backlog$was$exploited,$the$less$
scope$remained$for$fast$growth$through$the$old$system$of$technology$transfer.$(insitutions$became$
obstacles$to$growth$since$sustaining$a$growth$now$involved$investing$in$new$products$and$
unproven$technologies.$Hence$it$became$more$difficult$for$governments$holding$companies,$
planning$commissions$and$bureaucrats$to$identify$highQreturn$uses$for$fund.$Growth$required$
innovation$and$an$education$system$that$imparted$vocational$rather$than$general$training$made$it$
hard$for$workers$to$accustom$themselves$to$unfamiliar$tasks$and$new$forms$of$work$
organization.)$$
The$wage$restraint$that$had$upported$profitability$and$investment$for$nearly$two$decades$began$
to$weaken;$attitudes$changed$with$fading$memories$of$unemplyment$in$the$1930s$and$with$the$
entry$of$a$new$generation$of$workers$into$the$labor$force.$$
With$the$rise$of$capital$mobility,$unions$began$to$worry$that$inflation$would$persist;$keynesian$
demand$stimulus$increased$wage$demands$and$inflation$instead$of$emplyment$and$growth.$In$
addition$to$this$there$was$a$declining$scope$for$catchQup$and$convergence$that$led$to$a$slowdown$
in$growth.$$
$
$
European$coutnries$responded$with$the$now$traditional$tratment,$depending$the$involvment$of$
government$in$the$economy,$$extending$the$welfare$state,$and$accellerating$European$integration$and$
everything$was$done$in$order$to$reinforce$wage$moderation,$subdue$inflation,$and$stimulate$exports$and$
growth.$Governements$sought$to$extend$the$system$of$bonds,$sanctions,$and$rewards$wth$which$they$had$
supported$the$postwar$social$compact$and$helped$to$sustain$wage$and$price$stability$for$more$than$two$
decades.$Unions$were$promised$increased$health$and$unemplyment$payments$and$were$offered$larger$
social$security$stipends.$This$strategy$encountered$diminishing$returns$because$the$costs$came$in$the$form$
of$growing$puglic$spending$and$a$bloated$state$sector.$$
$
In$Europe,$risinf$unemplyment$and$slowing$growth$led$first$to$experimentation$with$heterodox$remedies.$
The$failure$of$these$experiments$then$led$to$policy$consolidation,$with$Tachers$disinflation$in$Britain,$
Mitterrands$turn$away$from$stateQled$expansion$in$France$and$fiscal$retrenchment$in$Denmark$and$
Ireland.$The$European$Community$responded$in$1986$with$the$Single$Market$Program$to$intensify$product$
market$competition$and$in$1989$with$plans$for$monetary$unification.$$
$
$
EICHENGREEN,'B.'[2008];'The'European'Economy'since'1945'(Princeton'University'Press),'
ch.9'pp.252W282'
$
DECLING'GROWTH,'RISIGN'RIGIDITIES'
$
By$the$1970s,$the$opportunities$for$rapid$growth$through$repair$of$wartime$damage$had$long$since$
vanished.$Extensive$growth$had$run$its$course$and,$as$we$saw$in$chapter$2,$this$situation$had$important$
consequences.$Further$complicating$the$transition$was$the$collpase$of$the$Smithsonian$Agreement$and$the$
demise$of$the$Bretton$Woods$System.$Exchange$rates$began$to$fluctuate,$disturbing$competitiveness$and$
fueling$a$backlash$against$international$trade.$Then$there$was$the$OPEC$oilQprice$rise$following$the$
outbreak$of$the$1973$Yom$Kippur$war$and$its$echo$in$1979.$These$were$the$major$disturbances$to$a$
European$economy$dependent$on$imports$for$the$bulk$of$its$energy$supplies.$$
Above$all$there$was$the$slowdown$in$productivity$growth$affecting$the$entire$industrial$world.$$
$
THE'PRODUCTIVITY'SLOWDOWN'
'
A$flood$of$studies$soon$appeared$analyzing$the$slowdown$in$growth$of$output$per$emplyed$person.$$
$
Helliwell,$Sturm$and$Salou$laid$out$what$came$to$be$regarded$as$the$canonical$model$of$the$deteminants$of$
productivity$growth,$one$that$incorporated$roles$for$both$supply$and$demand.$They$model$the$longQterm$

28

SARA$TACCONE$
$

productive$potential$of$the$national$economy$as$depending$on$a$bundle$of$capital$and$energy$inputs$
combined$with$efficicncy$units$of$labor.$This$is$the$point$at$which$the$longQrun$rate$of$technical$progress$
enters$the$story$by$determining$the$efficiency$of$labor$and$actual$productivity$fluctuates$around$normal$
levels$as$a$function$og$unexpected$changes$in$final$demand,$abnormal$movements$in$porfitability$and$
undesired$inventory$changes.$$
$
On$the$demand$side,$falling$profitability,$rising$invetories$and$unexpectedly$low$final$sales$led$to$declines$
in$factor$utilization.$Thus,$the$return$of$the$business$cycle,$which$led$to$unexpected$declines$in$sales$and$
rises$in$inventories,$precupitating$a$fall$in$capacity$utilization,$helps$to$explain$why$productivity$grew$
more$slowly$in$a$period$that$included$the$relatively$severe$postQ1973$and$postQ1979$recessions.$$
They$concluded$that$80%$of$the$slowdown$between$1962Q1973$and$1973Q1982$was$due$to$these$demandQ
side$factors.$$
$
Its$also$important$the$role$played$by$the$oil$shocks,$in$fact$the$higher$oil$prices$caused$producers$to$
economize$on$their$use$ogf$petroleum,$reducing$the$amount$of$energy$in$the$composite$capitalQenergy$
bundle.$But$studies$showed$that$the$quantitative$impact$of$the$effect$was$slight.$
$
Following$studies$showed$that$high$energy$prices$were$now$a$fact$of$economic$life$in$fact$the$real$price$of$
energy$and$related$commodities$was$not$significantly$higher$after$1985$than$before$1973,$reflecting$the$
difficulty$of$holding$together$the$cartel$of$oilQproducing$countries$but$even$this$theory$turned$out$to$be$
incorrect$in$fact,$if$changes$in$the$energy/labor$mix$really$explained$the$supplyQside$deterioration$of$the$
1970s,$then$ot$was$not$clear$why$producers$did$not$now$simply$move$back$to$the$more$efficent$factor$mix$
of$the$1960s.$$
The$slowdown$in$the$rate$of$technical$progress$was$gratest$in$countries$that$had$started$put$behind$and$
were$still$attempting$the$gap$visQaQvis$the$technological$leaders$and$from$this$we$can$understand$that$the$
slowdown$was$a$function$not$just$of$the$OPEC$shock$and$the$collapse$of$the$Brettib$Woods$but$also$of$the$
adjustment$to$a$more$intensive,$innovationQbased$model$of$growth$following$the$end$of$the$catchQup$
process.$$
$
INNOVATION''
'
Continuting$to$raise$technical$efficiency$at$the$customary$pace$now$became$more$difficult.$$
$
The$Fordist$model$of$using$assemblyQline$methods$to$divide,$conquer,$and$scale$up$the$labor$process$gave$
way$to$flexible$production$and$decentralized$work$organization.$The$challenge$now$was$to$develop$new$
products$and$processes$and$reorganize$production$accordingly.$$
$
There$was$no$way$that$Europe$could$match$the$United$States$in$the$development$of$scienceQbased$
technologies.$The$United$States$invested$moe$in$general$education,$especially$at$the$postgraduate$level.$Its$
universitites$had$closer$links$to$industry$and$its$securities$markets$allowed$investors$to$take$bets$on$
competing$technologies.$All$this$made$the$UNited$States$a$motor$for$radical$innovation.$$
$
Europes$advantage,$lay$in$incremental$innovation;$European$R&D$focused$more$on$microinventions$and$
incremental$improvements$in$chemicals,$textiles,$and$electrical$and$mechanical$machinery.$This$
technological$orientation$was$compatible$with$the$fact$that$small$and$mediumQsized$firms$lacked$the$
research$departments,$R&D$budgets,$and$all$the$scale$needed$to$pursue$a$portfolio$of$ambitious$research$
projects,$one$of$which$might$pay$off$handsomely$but$whose$prospects$were$uncertain$and$required$a$
lengthy$gestation$period.$$
European$R&D$was$not$inferior,$it$simply$was$organized$differently.$Firms$developing$and$applying$these$
incremental$innovations$tended$to$form$communities$if$loosely$coQoperating$competitors$and$suppliers$
and$for$this$reason$we$talk$about$industrial$districts.$This$allowed$suppliers$to$specialize$without$
becoming$vulnerable$to$holdQup$porblems$and$the$existence$of$these$industrial$districts$encouraged$the$
development$of$support$services$such$as$marketing$syndacates,$specialized$finance$and$joint$research$
projects.$$
Europes$regional$banks$were$ideally$suited$to$assembling$infomration$about$the$credit$needs$of$this$
network$of$local$producers,$and$their$patient$finance$contributed$to$the$low$turnover$of$firms.$The$
continents$system$of$vocational$education$and$apprenditiceship$training$produced$workers$with$the$
specialized$knowledge$to$identify$the$technological$challenges$facing$their$employers$and$the$skills$needed$
to$devise$solutions.$Firms$that$might$have$been$reclutant$to$invest$in$onQtheQjob$training$for$fear$of$losing$

29

SARA$TACCONE$
$

workers$to$their$competitors$were$reassured$by$the$existence$of$cohesive$empolyers$associations$that$
discouraged$poaching.$$
$
In$Europe$the$advantages$of$scale$and$standardization$were$no$longer$so$dominant$since$Europes$strenght$
lay$in$small$and$middleQsize$companies$using$mediumQtech$methods$and$in$skilled$labor$with$longQterm$
attachments$to$a$particular$employer.$Moreover$the$demand$for$high$quality$consumer$and$producer$
goods$was$not$as$sensitive$to$business$cycle$fluctuations$as$the$demand$for$massQproduced$family$sedans$
or$coldQrolled$steelm$which$was$advantageous$in$a$period$when$business$cycle$fluctuations$returned$with$
a$vengeance.$This$flexibility$also$gave$firms$the$capacity$to$move$into$industrial$subsectors$sheltered$from$
weakening$demand.$$
$
Compared$with$other$European$countries,$the$UK$and$Ireland$took$relatively$quickly$to$the$computer.$They$
had$marketQbased$financial$systems,$and$their$greater$emphasis$on$general$education$may$have$had$
something$to$do$wiht$the$special$aptitude$of$the$labor$force$for$the$more$freewheeling$work$environment$
that$comes$with$information$technology.$From$this$we$can$notice$that$the$same$institutitons$that$were$
weel$suited$to$the$golden$age$of$extensive$growth$may$have$been$less$conducive$to$iinovation$and$
productivity$growth$subsequently,$but$also$that$Europe$had$always$been$characterized$by$a$good$deal$of$
institutions$diversity.$$
$
UNEMPLOYMENT''
'
The$greater$part$of$Europe$had$been$a$fullQemployment$economy$for$nearly$two$decades;$unemplyment$
had$fallen$to$below$American$levels$but$after$1973$the$rates$concerning$unemplyment$began$rising$(from$
2%$to$more$than$5%).$$
The$sources$of$this$increase$in$unemplyment$are$the$following:$$
$
The$rise$in$oil$price$was$a$shock$to$consumer$and$investor$confidence$and$weak$demand$clearly$
created$problems$for$the$labor$market;$
Higher$input$prices$that$squeezed$profitability$depressed$the$demand$for$labor;$$
Wage$inflation$showing$little$tendency$to$subside,$labor$became$more$expensive.$$
$
Grubb,$Leyard$and$Symons$(1984)$estimated$a$set$of$wage$and$price$euqtions$showing$how$the$rise$in$
import$prices$can$explain$a$good$deal$of$the$adverse$shift$in$the$inflationQunemplyment$relationship.$$
$
In1980s$we$dealt$with$a$second$increase,$after$inflation$accellerated$beyond$acceptable$levels,$the$
chairman$of$the$Board$of$Governors$of$the$Federal$Reserve,$Volcker,$and$the$British$prime$minister$
Margaret$Thatcher,$resorted$to$higher$interest$rates$to$bring$it$down.$In$fact$by$increasing$the$iser$cost$of$
capital,$they$discouraged$capital$formation$and$slowed$the$accumulation$of$cooperating$factors$that$would$
have$raised$productivity$and$labor$demand.$$
$
Two$aspects$of$the$environment$that$may$be$relevant$here$are$social$norma$and$economic$volatility.$
Althought$governments$had$long$provided$generous$unemplyment$and$disability$benefits,$workers$may$
have$been$loath$to$use$them$in$the$period$of$full$employment.$When$jobs$were$easy$to$find,$those$drawing$
unemplyment$and$disability$compensation$for$an$extended$period$were$suspected$of$gaming$the$system.$
But$when$unemployment$rose$due$to$the$oil$and$disinflation$shocks,$the$stigma$of$the$dole$was$removed.$
When$someone$remained$out$of$work$for$an$extended$period,$it$was$no$longer$presumed$that$he$was$
exploiting$the$generosity$of$the$system.$It$was$the$interaction$among$the$institutions$of$the$labor$market$
and$the$severity$of$postQ1973$shocks$that$transformed$Europe$from$a$lowQunemployment$to$a$highQ
unemployment$economy$and$this$interaction$can$explain$a$considerable$fraction$of$the$variation$in$
unemployment$rates$across$countries$and$over$time.$But,$on$the$other$hand,$theres$no$direct$evidence$that$
changes$in$socially$acceptable$behaviour$produced$the$change$in$laborQmarket$outcomes.$Here$an$
important$role$is$played$by$the$interaction$of$institutions$and$volatility$in$fact$an$unemployed$individual$
had$more$reason$to$turn$down$a$job$offer$in$the$hope$that$a$better$one$would$come$along.$$
$
There$was$an$increase$in$the$variance$of$earnings$in$the$1970s,$consistent$with$the$notion$of$faster$
structural$change$but$this$increase$could$have$many$explanations.$There$was$a$tendency$for$a$larger$
fraction$of$unemplyment$to$be$longQterm$unemployment$concentrated$among$former$manufacturing$
workers$with$industryQspecific$skills.$$

30

SARA$TACCONE$
$

STABILIZATION'IN'BRITAIN'
'
Initially,$central$banks$responded$to$the$rise$of$wages$and$prices$by$expanding$money$supplies$and$by$
doing$so$they$accomodated$the$inflationary$shock.$$
$
The$explosion$of$inflation$meant$that$when$Europe$was$disturbed$by$the$second$increase$in$oil$prices$in$
1979,$it$was$more$difficult$to$respond$againg$with$monetary$stimulus.$Since$expectations$had$adopted,$it$
was$no$longer$feasible$to$bring$down$real$wages$and$unemployment$with$a$monetary$surprise.$Constraints$
ahad$also$tightened$on$the$fiscal$side.$Public$employment$had$been$boosted$in$response$to$the$previous$
recession.$Moreover,$inflation$having$broached$doubleQdigit$levels,$delay$in$addressing$the$problem$
became$increasingly$costly.$Rapidly$rising$prices$threatened$to$demoralize$investors$and$cause$socialQ
democratic$cooperation$to$break$down.$$
$
The$inflation$problem$was$addressed$by$the$UKs$new$prime$minister$Margaret$Thatcher$in$fact$Thatchers$
government$announced$a$fourQyears$declining$path$for$the$growth$of$the$broad$money$supply,$backed$by$a$
supporting$path$for$government$borrowing$(=public$sector$borrowing$requirement,$PSBR).$$
Thatcher$moved$to$eliminate$labor$involvment$in$the$design$of$macroeconomic$and$industrial$polices$and$
limit$government$intervention$in$the$labor$market.$She$abolished$the$Pay$Comparability$Commission$that$
had$been$established$in$an$effort$to$coordinate$publicQsector$pay$settlements.$Her$government$scaled$back$
the$legal$immunities$enjoyed$by$the$unions.$It$abolished$legal$restrictions$on$the$hiring$and$firing$of$
temporary$workers.$EarningQrelated$supplements$to$the$basic$unemployment$benefit$were$eliminated$in$
1982$and$benefits$were$made$subject$to$taxation.$The$government$reaffirmed$its$dedication$to$financial$
deregulation$by$removing$the$regulations$known$as$the$corset$that$had$limited$the$growth$of$interestQ
bearing$deposits.$$
With$a$credible$monetary$stabilization$in$place$and$market$forces$free$to$operate,$pressure$in$the$labor$
market$was$supposed$to$moderate.$$
$
With$wage$and$sterling$M3$growth$slow$to$moderate,$price$increases$slowed$only$modestly.$Inflation$came$
down$only$to$11%$in$the$first$half$of$1981.$The$main$effect$of$higher$interest$rates$was$a$dramatic$
appreciation$of$sterling,$since$financial$markets$did$not$display$the$same$intertia$as$labor$markets.$$
This$loss$of$competitiveness$made$recession$unavoidable;$all$components$of$aggregate$demand$declined,$
excepting$only$government$consumption$and$the$rate$of$unemplyment$doubled.$$
This$stress$on$the$labor$market$was$partily$wanted$from$the$Thatcher$government$which$favored$anything$
that$might$weaken$the$hand$of$a$union$movement$that$had$exercised$and$effective$veto$on$economic$
reform.$The$government$also$saw$more$flexible$labor$market$sas$the$key$to$the$creation$of$more$flexible$
economy.$Bowing$to$political$realities,$the$government$shifted$in$1981$toward$a$looser$monetary$policy$
and$a$tighter$fiscal$policy$in$the$effort$to$continue$disinflating$without$placing$additional$upward$pressure$
on$sterling.$$
$
Backing$away$from$the$monetarist$formula$and$tinkering$with$the$policy$mix$did$not$enhance$credibility.$
And$allowing$taxes$to$rise$in$1981$in$the$theeth$of$a$global$recession$only$renforced$the$collpase$of$
demand.$As$a$consequecne,$the$output$and$employment$costs$of$disinflation$did$not$fall$as$anticipated.$$
$
Thatcher$was$the$first$British$prime$minister$to$preside$over$a$oneQdollar$pound.$Interest$rates$were$
therefore$reached$up$to$14%,$their$highest$level$since$1981.$British$industry$suffered$another$blow;$the$
mass$privatization$done$gained$some$purchase$in$fact$it$created$a$sizeable$shareholder$class.$$
The$1979$Banking$Act$and$the$1988$Financial$Service$Act,$which$deregulated$British$capital$markets,$
further$broadened$the$consitutency$for$reform.$They$made$it$harder$for$future$governments$to$reverse$
Thatchers$measures$by$making$the$politiciand$hostage$to$the$markets.$$
$
Thatecherism,$whatever$its$strenght$and$weaknesses,$was$not$transplantable$to$other$countries.$The$
British$electorate$was$willing$to$vote$into$office$an$economic$radical,$for$that$was$what$the$prime$minister$
was,$because$of$three$decades$of$disappointing$economic$performance.$'
$
$
$
$
$
$

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SARA$TACCONE$
$

TOPIC'8:'ECONOMIC'POLICY'AND'WELFARE'STATE'
'

PERSSON,'K.'G.'[2010];'An'Economic'History'of'Europe,'ch.'10'
ECONOMY'AND'POLITICS'AT'THE'END'OF'THE'19th'CENTURY'
'
At$the$end$of$the$19th$century$a$number$of$countries$started$to$catch$up$with$Britain$and$experienced$a$
period$of$modern$economic$growth.$This$period$was$marked$by$the$minimal$state.$$$
QThe$role$of$the$state$was$essentially$limited$to$setting$rules$of$the$game,$i.e.$enacting$laws$and$regulation$
for$industry$and$trade.$$
QGovernment$ spending$ was$ low$ (around$ 10%$ of$ GDP).$ Defense,$ law$ and$ order$ and$ civil$ administration$
took$the$main$share$of$expenditure.$Education$and$poor$relief$were$a$minor$voice.$
Even$ though$ unemployment$ insurance$ was$ introduced$ in$ some$ countries,$ it$ was$ mainly$ due$ to$ political$
pressure$from$trade$unions.$
$
The$ orthodoxy$ of$ the$ LaissezQFaire$ first$ broke$ down$ in$ the$ interwar$ period,$ as$ the$ WWI$ disrupted$
established$trade$routes$and$the$gold$standard$was$suspended.$$$
Adopting$ the$ preQwar$ parity$ implied$ that$ currencies$ were$ now$ overQvalued.$ After$ the$ wartime$ inflation,$
deflation$was$now$required,$often$to$unrealistic$levels.$Countries$believed$that$the$downward$flexibility$of$
wages$ and$ prices$ would$ have$ eventually$ restored$ purchasing$ power$ parity.$ However,$ the$ social$ and$
political$ system$ prevailing$ after$ the$ WWI,$ with$ the$ spread$ of$ democracy,$ socialism$ and$ powerful$ trade$
unions,$made$the$downward$revision$of$wages$almost$impossible.$The$equilibrating$mechanism$of$the$gold$
standard$failed.$Excessively$high$prices$and$wages$did$not$adjust,$leading$to$imbalances$that$remained$at$
the$outbreak$of$the$Great$Depression.$$
Countries,$like$France,$which$returned$to$gold$at$parities$lower$than$the$prewar$level,$gained$a$competitive$
advantage$ on$ those$ economies,$ like$ Britain$ or$ Scandinavia,$ which$ rigorously$ applied$ the$ preQwar$
conversion$ rates.$ France$ ran$ huge$ current$ account$ surpluses$ and$ accumulated$ an$ enormous$ share$ of$
reserves.$This$helped$France$to$fare$comparatively$well$during$the$Great$Depression.$
$
The$ only$ cure$ to$ the$ Great$ Depression$ seemed$ to$ be$ abandoning$ the$ gold$ standard.$ In$ fact,$ the$ Great$
Depression$was$associated$with$a$fall$in$prices,$while$wages$remained$at$their$preQcrisis$level.$This$led$to$
higher$real$and$product$wages,$which$meant$mounting$costs$for$firms$that$threatened$their$survival.$$
Abandoning$ gold$ allowed$ countries$ to$ devaluate$ their$ currency.$ Deflation$ turned$ into$ mild$ inflation.$
Inflation$eroded$real$and$product$wages,$loosening$the$grip$on$firms$and$tackling$unemployment.$Inflation$
also$ reduced$ real$ interest$ rate,$ thus$ stimulating$ investment.$ Devaluation$ gave$ domestic$ industries$ a$
competitive$edge$in$home$markets$and$eased$foreign$market$penetration.$$
In$1931,$Britain$was$the$first$to$abandon$the$standard,$followed$by$the$Scandinavians.$$Britains$recovery$
was$slow.$The$Scandinavians$performed$well$in$the$30s$instead.$$
Monetary$ policy$ was$ now$ less$ constrained$ as$ the$ gold$ standard$ was$ abandoned.$ However,$ economic$
reorientation$ was$ incomplete.$ The$ new$ ideas,$ which$ eventually$ laid$ the$ ground$ for$ modern$
macroeconomics,$had$few$practical$implications$for$the$management$of$the$Great$Depression.$In$fact,$quite$
a$few$governments$reacted$to$falling$tax$revenues$by$increasing$taxes,$thus$worsening$the$crisis.$
$
Continental$Europe$remained$a$bastion$of$economic$orthodoxy,$leading$to$dismal$economic$performance$
in$France$and$eventually$to$political$disaster$in$Germany.$
France$ was$ the$ last$ major$ economy$ to$ leave$ the$ gold$ standard$ (19369$ after$ years$ of$ deflation$ and$
stagnation.$$
On$ the$ other$ hand,$ in$ Germany$ the$ gold$ standard$ played$ a$ crucial$ role$ in$ gaining$ the$ confidence$ of$
international$ investors,$ after$ years$ of$ hyperinflation$ in$ the$ early$ 20s.$ The$ inflows$ of$ foreign$ capital$
allowed$Germany$to$sustain$the$Reparation$payments,$but$the$mounting$debt$became$an$issue$when$the$
great$ depression$ shocked$ export$ earnings.$ Germany$ responded$ with$ austerity$ measures$ that$ reduced$
economic$ activity$ and$ imports,$ but$ drove$ unemployment$ to$ skyQhigh$ levels,$ 25%$ of$ the$ labor$ force.$$
Historical$data$show$that$such$enormous$levels$of$unemployment$provided$the$electoral$base$that$led$to$
the$instauration$of$the$Nazi$regime.$
$
$
The$main$merit$of$the$Keynesians$was$showing$that$expansionary$fiscal$policies$worked$and$had$a$largerQ
thanQspending$ effect$ on$ national$ income.$ Their$ theory$ of$ the$ counterQcyclical$ policy$ (the$ original$
conviction$ that$ fluctuations$ were$ manageable$ through$ fiscal$ and$ monetary$ policies)$ advocated$ not$ only$

32

SARA$TACCONE$
$

stimulating$ economy$ during$ an$ unemployment$ crisis,$ but$ also$ reducing$ activity$ if$ demand$ was$ hitting$
production$capacity.$$
The$ active$ opposers$ of$ economic$ policy$ intervention$ reQsurfaced$ in$ the$ 70s$ and$ 80s,$ a$ period$ of$ high$
unemployment$ and$ stagflation.$ According$ to$ this$ New$ Classical$ critique,$ technological$ shocks$ were$ the$
source$of$economic$fluctuations,$and$markets$had$the$capability$of$working$out$the$necessary$adjustments.$
Keynesian$showed$that$prices$are$not$fully$flexible$in$a$market$structure$where$competition$is$not$perfect.$
This$gives$room$to$the$central$bank$to$influence$the$real$interest$rate,$which$is$what$matters$for$investors.$
However,$ Keynesian$ neglected$ the$ problems$ of$ inflation$ that$ arise$ when$ firms$ and$ unions$ anticipate$
governments$demand$management.$Moreover,$politicians$were$always$more$willing$to$increase$spending$
during$crises$than$to$raise$taxes$in$good$times.$
$
Keynesian$ principles$ were$ not$ fully$ accepted$ immediately$ after$ the$ WWII.$ The$ postQwar$ macroeconomic$
mantra$ was$ full$ employment.$ Average$ unemployment$ in$ the$ 50s$ and$ 60s$ was$ around$ 5%,$ but$ this$ is$
now$seen$as$an$exceptional$period$of$lowQunemployment$driven$by$other$causes.$Unemployment$rose$back$
to$levels$between$5Q10%$in$the$80s.$$
Detailed$demand$management$failed$because$of$a$problem$of$timing.$The$annual$budget$approval$was$not$
adequate$ for$ fineQtuning.$ Moreover,$ since$ workers$ and$ trade$ unions$ began$ anticipating$ the$ policy$
responses,$fineQtuning$worked$only$in$a$political$environment$of$centralized$TUs,$which$showed$restraints$
and$were$forward$looking.$The$success$of$demand$management$in$the$Golden$Age$depended$on$the$elastic$
supply$of$raw$materials,$immigration$and$on$the$reallocation$of$labour$from$agriculture.$
The$ fast$ economic$ growth$ of$ the$ golden$ age$ seemingly$ had$ other$ sources.$ Trade$ openness,$ increased$
technological$transfers,$high$profit$and$investments$granted$high$TFP.$$
The$ build$ up$ of$ the$ Welfare$ state$ and$ the$ extension$ of$ unemployment$ benefits$ introduced$ automatic$
stabilizers,$ which$ partly$ solved$ the$ problem$ of$ getting$ the$ timing$ right.$ Increases$ in$ unemployment$
automatically$ cut$ government$ revenues$ and$ increase$ expenditures:$ the$ labor$ market$ determines$ the$
timing.$
$
In$the$early$70s,$the$social$contract$of$the$Golden$Age$broke$down.$The$system$no$longer$restrained$wages$
in$exchange$for$secure$jobs$and$investments$in$technology$that$would$secure$future$wage$increases.$
$
In$the$70s$both$unemployment$and$inflation$soared,$and$nations$accommodated$imbalances$with$repeated$
devaluations.$ By$ the$ 80s,$ the$ main$ preoccupation$ of$ governments$ became$ tackling$ high$ inflation.$ Full$
employment$was$now$subordinated$to$price$stability.$Thus,$an$increasing$number$of$European$countries$
(including$ Italy$ and$ France)$ pegged$ their$ currency$ to$ the$ German$ mark$ (given$ its$ recent$ history$ of$ low$
inflation),$ de$ facto$ abdicating$ from$ an$ independent$ economic$ policy.$ The$ reason$ for$ the$ high$ level$ of$
unemployment$might$be$that$generous$unemployment$insurance$schemes$prolong$the$job$search$period.$
$
Karl$Marx,$eveloped$a$theory$of$history$with$a$surprising$lesson$for$the$socialist$economies,$an$economic$
experiment$that$ultimately$failed,$since$he$argued$that$social$systems$thrive$and$expand$only$if$they$can$
develop$technologies$and$sustain$an$increase$in$material$welfare.$Marx$criticised$capitalist$society$but$
never$denied$the$dynamic$advantages$of$capital$and$looked$upon$it$as$a$necessary$stage$in$the$pursuit$of$
the$final$stage$of$communism.$Therefore,$he$would$probably$have$been$surprised$to$hear,$if$he$had$had$the$
chance,$that$the$first$socialist$economy,$Russia,$was$a$predominantly$agrarian$economy$and$something$of$a$
backwater$in$terms$of$technological,$intellectual$and$economic$development.$$
$
By$the$end$of$1930s,$despite$some$attempts$to$introduce$a$mixed$economic$system,$Soviet$Union$leaned$
towards$a$centrally$planned$economy,$whose$main$characteristics$were$the$abolition$of$private$ownership$
of$resources$and$the$means$of$production,$a$very$high$investQ$ment$ratios,$a$strong$bias$towards$
investment$in$capital$goods$industries,$and$the$absence$of$consumer$goods$production.$
$
Despite$having$some$competitive$advantage$in$agriculture,$Soviet$countries$were$not$able$to$exploit$them,$
and$in$general$compared$to$Spain$and$Portugal,$which$also$suffered$from$authoritarian$but$conservative$
rule,$the$annual$growth$of$GDP$per$capita$was$two$percentage$points$lower$in$Eastern$Europe$from$1950$
to$1973,$despite$the$fact$that$the$ratio$of$investment$to$GDP$was$1015$percentage$points$higher$in$
Eastern$Europe.$This$was$mainly$due$to$the$misallocation$of$investments,$and$the$fact$that$the$visible$
hand$of$the$State$is$less$effecient$than$the$invisible$hand$of$the$market,$driven$by$price$mechanisms.$
$
In$the$first$decade$of$the$twentieth$century,$government$spending$rarely$exceeded$10$per$cent$of$GDP$and$

33

SARA$TACCONE$
$

most$of$that$spending$was$directed$to$basic$state$functions$such$as$law,$infrastructure$investment$and$
defence.$Most$European$nations$provided$elementary$schooling$and$some$poor$relief,$but$the$combined$
costs$amounted$to$only$a$few$per$cent$of$GDP,$until$the$1970s,$when$public$spending$has$risen$to$25/35$%$
of$GDP$in$most$West$European$countries.$The$Welfare$State$system$is$meant$to$be$an$interQgenerational$
transfer$of$resources,$since$the$underprovision$of$some$services,$such$as$schooling,$could$lead$to$the$
deterioration$of$a$country$human$capital,$thus$leading$to$a$lower$aggregate$level$of$welfare.$
$
Finally,$we$could$argue$how$the$Welfare$State$is$essential$in$prefenting$market$failures,$since$phenomena$
like$the$adverse$selection$that$would$naturally$arise$in$an$unregulated$state.$Moreover$individuals$tend$to$
be$irresponsible$and$prefer$to$give$to$the$state$the$responsibility$for$holding$their$savings$through$taxes,$
thus$justifying$the$need$for$a$pensionistic$system.$$
The$lifeQcycle$transfer$is$an$implicit$contract$between$generations:$net$conQ$tributors$will$become$net$
receivers$and$vice$versa,$and$the$reciprocity$is$essenQ$tial$for$the$stability$of$the$system.$

TOPIC'9:'CENTRALLY'PLANNED'ECONOMIES'
'

BEREND,'I.T.'[2006],'An'Economic'History'of'TwentiethWCentury'Europe:'Economic'Regimes'
from'LaissezWFaire'to'Globalization'(Cambridge'University'Press),'ch.4,'pp.133W189'without'
boxes'

'
'
THE'CENTRALLY'PLANNED'ECONOMIC'SYSTEM'
'
The$centrally$planned$system$was$the$most$extreme$version$of$economic$dirigisme$in$fact$it$was$a$special$
system$to$achieve$a$forced$maximum$economic$growth$and$selfQsufficiency.$$
$
MARXIST'THEORETICAL'LEGACY,'LENIN'AND'THE'BOLSHEVIK'PROGRAM'
'
According$to$Marx,$capitalism$historically$opened$the$road$toward$a$stormy$development$of$productive$
forces,$technology$and$organization$but$meanwhile$led$to$a$polarization$of$society.$Marx$believed$that$
economically$interpreted$history$and$political$economy$were$the$master$sciences$to$understand$and$
influence$social$development.$He$used$the$Hegelian$dialectic$and$shared$a$teleological$concept$of$history,$
believing,$as$all$the$children$of$the$age,$in$progress$as$a$law$of$nature.$As$expressed$in$the$foreword$of$Das$
Kapital,$historical$progress$is$realized$by$class$struggle$and$revolutions.$Social$harmony$ia$s$natural$law$
but$attainable$only$through$continual$struggle$$beyond$capitalism.$$
$
Marxs$point$of$departure$was$Ricardos$labor$theory$of$value,$but$he$transformed$it$by$distinghuising$
between$the$labor$value$of$the$product$of$labor$and$the$value$of$the$workers$labor$power.$Labor$was$
considered$as$a$special$commodity$which$produced$more$labor$value$than$required$for$its$reproduction;$
from$his$point$of$view,$workers$were$working$only$part$of$the$workday$for$themselves$while$the$other$part$
of$the$workday$was$unpaid$and$prodiced$a$surplus$value.$Capitalist$economy$consequently$led$to$a$
permanent$concentration$of$capital$and$the$destruction$of$smallQscale$independent$enterprise.$$
$
Marxiand$analysis$and$critique$of$capitalism$produced$an$extraordinary$impact,$opening$a$new$chapter$in$
history$and$influencing$the$entire$150$years$that$followed.$$
$
Marx$and$Engels$noticed$that$the$basic$contraddiction$of$capitalism$$collective$production$and$provate$
expropriation$$constituted$an$obstacle$for$further$development.$Private$ownership$would$thus$be$
replaced$by$collective$public$ownership.$In$the$Communist$Manifesto$(1848)$they$states$that$the$first$step$
in$the$revolution$by$the$working$classi$s$to$raise$the$proletariat$to$the$position$of$ruling$class.$$
$
In$the$Communist$Manifesto$there$wasnt$a$blueprint$for$peasant$agriculture$since$they$believed$that$it$was$
already$been$destroyed$by$the$development$of$the$industry$and$this$belief$was$based$on$the$British$
historical$experience.$In$fact$Marx$noticed$that$the$peasant$of$today$would$become$the$worker$of$
tomorrow.$Even$if$in$the$long$run$he$was$certainly$right,$all$over$Europe,$the$peasantry$remained$a$
significant$layer$of$society.$$

34

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$

$
Capitalism,$in$Marxs$analysis,$creates$a$high$degree$of$organization$within$the$firms,$but$anarchy$
characterizes$the$relations$among$the$firms$in$a$chaotic$market$that$would$be$eliminated$by$planning$
based$on$collective$ownership.$$
$
Marx$and$Engles,$in$the$German$Ideology$(1847),$defined$communism$as$an$ideal$to$which$reality$will$have$
to$adjust$itself.$$
$
After$Marxs$death,$two$kinds$of$revisionism$emerged$simultaneously;$in$the$West$the$RightQRevisionism$of$
Eduard$Bernstein$and$his$followers,$gained$ground,$while$in$the$East,$the$LeftQrevisionism$of$Vladimir$I$
became$dominant.$$
RightQRevisionism$led$to$the$concept$of$organized$capitalism$via$parlamentary$reforms,$social$legislation$
and$socialism$in$distribution.$The$Right$revisionists$rejected$proletarian$revolution$and$the$
expropriation$of$expropriators.$$
$
LeftQrevisionism,$however$preserved$the$Marxian$idea$of$proletarian$revolution$but$rejected$and$revised$
some$other$basic$assumptions$and$ideas$of$Marx$and$Engles$that$stated,$in$the$German$Ideology,$that$
socialism$would$emerge$only$in$the$most$advanced$countries.$LeftQrevisionism,$which$emerged$in$Russia,$
rejected$the$main$concept$of$Western$RightQrevisionism$on$parliamentary$reformism.$$
Leon$Trotsky$revised$Marx$in$his$Itogi$i$persoektivy$(Results$and$Prospects)$of$1906;$he$introduced$the$
concept$of$permament$revolution$and$argued$that$bakwardness$was$the$prerequisite$for$proletarian$
revolution$and$that$russian$workers$would$be$forced$to$carry$out$a$revolution$and$might$gain$power$more$
easily$than$their$counterparts$in$the$advanced$countries.$$
Lenin$argued$similarly$to$Trotsky$and$added$the$the$victory$of$the$proletarian$revolution$was$possible$only$
in$backward$or$semiQdeveloped$countries.$They$both$believed$that$the$revoulution$would$spread$to$
advanced$countries.$$
$
In$the$Soviet$type$of$economic$regime,$state$capitalism$was$indeed$repleaced$by$state$socialism,$
originating$with$the$most$sophisticated$German$war$economic$system$amd$taken$to$extrems$by$the$
Stalinist$command$economy.$State$socialism$was$both$a$modernization$dictatorship$and$a$totally$isolated$
war$economy.$The$Soviet$political$system$combined$with$electrification$of$the$country$were$the$key$factors$
for$entering$the$Promised$Land:$communism.$$
The$Bolsheviks$enthisastically$welcomed$the$introduction$of$communis$since,$as$Bukharin$underlined,$the$
increasing$depreciation$of$the$currency$was$seen$as$an$expression$of$the$annulment$of$monetary$values.$$
Wages$were$paid$in$kind,$and$public$transportation$and$municipal$services$were$provided$gratis.$Private$
trade$was$made$illegal$and$in$Aprile$1919,$firme$employing$five$or$more$persons$were$nationalized.$$
A$food$dictatorship$was$introduced:$armed$detachments$seized$food$from$the$peasants$and$a$compulsory$
delivery$system$was$born.$In$addition$to$this,$we$also$had$the$introduction$of$a$militarized$system$called$
War$Communism.$$
In$March$1919$there$was$the$introduction$of$a$Party$Program$which$advocated$the$transformation$of$
private$onwership$of$the$means$and$distribution$into$social$ownership.$There$was$also$the$willingness$to$
find$Soviet$farms.$$
$
War$Comunism$undermined$the$Russian$economy$even$more$and$the$system$failed.$The$economic$
situation$in$1921$grew$tragic$and$on$February$1921$peasant$revolts$engulfed$the$countryside.$Hence$in$
1921$th$New$Economic$Policy$(NEP),$was$introduced.$$
$
FORCED'INDUSTRIALIZATION'AND'CENTRAL'PLANNING:'SOCIALISM'IN'ONE'COUNTRY'
'
The$postitive$economic$consequences$of$the$instroduction$of$the$NEO$were$unquestionable.$Industrial$
output$doubled$in$only$two$years,$but$at$the$Twelfth$Party$Congress$in$April$(1923),$Trotsky$launched$a$
harsh$attack$against$the$NEP$and$spoke$about$its$liquidation.$The$NEP$was$openly$condemned$in$a$
declaration$in$the$Pravda$in$October$1923$and$a$centrally$planned$dictatorship$of$industry$was$demanded.$$
$
Lenin$died$in$1924$and$not$few$were$the$problems$related$to$the$choice$of$his$successor$but$the$evident$
successor$was$found$in$Trotsky$but$the$main$architect$of$the$new$economic$concept$was$an$ally$of$Trotsky,$
Preobrazhensky.$He$explained$that$the$central$problem$was$to$achieve$an$high$rate$of$capital$accumulation$
an$investments,$generate$a$most$rapid$economic$growth$and$reach$an$high$level$of$growth.$He$added$that$
om$a$backward$peasant$country,$the$only$way$to$increase$accumulation$was$the$exploitation$of$the$

35

SARA$TACCONE$
$

peasantry$by$a$forced$accumulation$in$the$hands$of$the$state$of$material$resources$mainly$and$he$defined$
that$perioda$s$the$period$of$primitive$socialist$accumulation.$Preobrazhensky$argud$that$it$would$be$
possible$to$siphon$resources$from$the$private$peasant$economy$to$the$states$accumulation$fund$for$
industrial$investments$through$the$mechanism$of$a$price$scissors$of$artificially$low$agricultural$prices$
coupled$with$artificially$high$industrial$prices$set$by$the$state.$Additionally,$an$high$protectionism,$based$
on$the$monopoly$of$foreign$trade,$would$serve$as$extra$taxtation$of$the$population,$including$the$wages$of$
workers$in$the$state$sector.$This$system$required$the$destruction$of$the$market$and$market$prices$and$
their$replacement$by$a$centrally$planned$and$stateQdirected$economy.$The$program$offered$a$policy$of$
forced$capital$accumulation$and$industrialization;$a$dramatically$new$economic$model$was$invented,$a$
nonmarket$economic$system,$a$road$to$catchin$up$with$the$industrialized$West.$$
$
Trotskys$leadership$was$considered$unacceptable$in$fact$he$was$accused$of$ultraQindustrialization$and$
he$was$rejected.$Bukharin$argued$that$Trotskys$policy$would$destroy$the$domestic$market.$$
$
However,$in$the$harsh$struggle$for$succession$in$the$year$of$Lenins$death,$Stalin$offered$his$original$
revision$of$Marx;$he$announced$that$not$only$yhr$revolution$but$also$the$building$of$socialism$would$be$
possible$in$Russia.$The$concept$of$$socialism$in$one$country,$though$without$a$theoretical$argumentation,$
was$a$powerful$slogan$and$Stalin$offered$his$leadership$to$its$realization.$However$even$if$Stalins$program$
was$attractive$for$many,$it$lacked$a$practical$program$for$its$realization.$$
$
The$practical$realization$of$socialism$in$one$country$was$forced$capital$accumulation,$industrialization$
and$the$destruction$of$the$market$economy.$A$quiet$strangulation$of$the$private$sector$began:$the$supply$
of$raw$materials$was$stricly$limited$and$surcharges$on$transportation$were$introduced$for$private$traders$
and$entrepreneurs,$while$an$amendment$to$the$criminal$code$brought$in$severe$punishments$for$evilQ
intentioned$price$increases.$Emplyment$of$labor$also$became$illegal.$$
$
At$the$Moscow$Party$Conference$of$January$1925$Stalin,$using$Bukharins$ideas,$argued$that$that$industry$
is$to$rest$on$the$home$market,$the$peasant$market.$$
$
Stalin$began$his$industrilization$in$1927Q28,$he$formed$allies$against$Trotsky$and$the$majority$of$the$
Fifteenth$Party$Congress$voted$down$the$program$of$rapid$industrialization.$He$destroyed$all$his$enemies$
and$in$December$1929$became$the$unchallenged$ruler$of$Bolshevik$Russia$at$the$head$of$the$new$political$
economic$system.$$Beyween$1929$and$1934$Stalin$realized$his$second$revolution,$an$unprecedent$terror$
regime.$The$second$revolution$included$the$liquidation$of$kulaks$as$a$class$physically$eliminated$around$10$
million$people.$The$Soviet$Union$became$a$dispotic$police$state$and$behind$the$shiedl$of$dictatorship$and$
terror,$the$collectivization$of$agriculture$and$ultraQindustrialization$campaigns$were$launched.$$
$
From$December$1927,$the$First$FiveQYear$Plan$was$under$constant$preparation,$several$drafts$were$
prepared$and$the$targets$always$increased.$In$the$spring$of$1929$the$FiveQYear$Plan$of$National$Economic$
Construction$of$the$URSS$was$accepted.$By$1932$Russia$marched$toward$the$realization$of$the$goal$of$selfQ
sufficiency.$A$triumphant$Stalin$reported$to$the$Seventeenth$Party$Congress$in$January$1934$that$the$
Soviet$Union$had$eliminated$backwardness$and$medeivalism.$$
$
FROM'AND'ISOLATED'SOVIET'SYSTEM'TO'THE'SOVIET'BLOC'
'
In$the$summer$of$1941,$Hitler$attacked$the$Soviet$Union$and$in$a$few$months$nearly$conquered$the$
European$half$of$it.$$
$
Between$the$summer$of$1944$and$the$spring$of$1945,$the$central$Europe$was$liberated$from$German$and$
local$fascit$rule$but$the$population$was$decimated.$The$international$situation$also$changed$radically;$the$
victorious$great$powers$sought$to$guarantee$their$own$and$international$security$and$to$maintain$the$
wartime$alliance$but$these$proved$to$be$conflicting$goals.$$
$
In$March$1947,$the$Truman$Doctrine$established$the$soQcalled$containment$policy$by$supporting$free$
peoples$who$resist$attempted$subjugation$by$armed$minorities$of$by$otuside$pressures.$$
The$Marshall$Plan$aimed$at$furthering$European$economic$reconstruction,$but$most$of$all,$to$develop$a$
bloc$of$states$which$would$share$similar$political,$social,$economic$and$cultural$values$to$those$which$US$
uphold$and$it$also$aimed$to$force$the$European$nations$to$accept$and$integrate$Germany$into$the$bloc.$$
$

36

SARA$TACCONE$
$

On$the$opposite$side,$an$opposing$bloc,$the$Cominform,$was$established$in$October$1947$to$cordinate$the$
activities$of$the$communist$parties$and$fight$imperialist$expansionism.$The$victorious$powers$became$
unable$to$agree$on$the$solution$of$the$German$question$and$each$side$undertook$unilateral$action.$$
The$Western$powers$created$Trizoni$from$the$three$occupation$zones$and$introduced$a$new$currency$in$
June$1948.$The$Soviet$Army$closed$the$roads$between$the$Trizonia$and$the$Western$zone$of$Berlin.$
Germany$was$separated$into$two$states.$$
$
Europe,$as$well$as$Germany,$$was$divided$and$the$two$parts$for$a$while$were$hermetically$isolated.$$
Paradocxically$the$cold$war$era$proved$to$be$a$long$period$of$stability$and$peace$in$Europe.$$
A$creeping$cold$war$and$rising$conflic$between$the$victorious$allies$became$manifest$in$1947Q8$when$Stalin$
did$not$hesitate$to$sovietize$the$entire$Central$and$Eastern$European$region,$including$the$Soviet$
occupation$zone$of$Germany.$$
$
The$satellite$communist$parties$and$governments$obediently$followed$the$Soviet$ukaz$and$in$1947Q8$they$
introduced$the$same$nonQmarket,$centrally$planned$economic$regime$that$Stalin$had$arranged$20$years$
before.$Nationalization$of$nearly$the$entire$economy$was$realized$between$1946$and$1948.$$
The$aim$of$copying$the$Soviet$model$was$to$reach$the$full$collectivization$within$five$years$after$1948$but$
they$failed$because$of$the$strong$resistence$of$the$peasantry.$$
$
THE'CHARACTERISTICS'OF'THE'CENTRALLY'PLANNED'ECONOMIC'SYSTEM'
'
Economic$dirigisme$went$further$and$built$up$huge$stateQowned$economic$sectors.$The$SovietQtype$nonQ
market$system$was$based$on$state$ownership$of$the$entire$economy,$the$private$sector$represented$not$
more$than$the$3Q4%$of$the$national$economy$and$foreing$trade$became$monopoly$of$the$state.$$
$
Although$most$of$the$agricultural$enterprises$were$not$formally$state$owned,$collectivization$created$the$
kolkhoz,$a$cooperative$farm$with$elected$management$and$chairman$but$in$the$reality$kolkhoz$was$only$a$
pseudoQcooperative$with$almost$no$independence$since$the$memebers$did$not$have$the$right$to$choose$the$
form$of$cooperation$but$had$to$follow$the$centrally$decided$model.$The$state$procurement$organizations$
controlled$the$production$activity$of$the$kolkhoz.$$
$
The$essence$of$the$stateQdirected$kolkhoz$system$was$to$serve$state$accumulation,$the$exploitation$of$
peasantry$and$to$restructure$the$labor$force$from$agriculture$to$construction$work$and$industry.$$$
$
Based$on$state$and$collective$ownership,$the$entire$economy$was$subordinated$to$and$directed$by$a$central$
plan$and$a$hierarchical$Soviet$state$bureaucracy.$The$Soviet$planning$institutions$treated$each$company$
like$a$branch$unit$of$a$gigantic$megaQtrust,$the$stateQowned$national$economy.$The$headquarters$of$the$
megaQtrust$planned$and$directed$each$branch$and$the$branch$units$delivered$to$each$other$accordingly$
without$selling$and$buying.$Hence$producers$had$no$connection$whatsover$with$the$market$and$were$
totally$dependend$on$central$orders$regarding$the$assortment,$technological$parameters$and$quality$of$
their$products.$$
$
The$banking$system$was$centralized$and$the$national$bank$became$practically$the$only$banking$institution$
for$providing$credtirs$and$controlling$firms$accounts.$Commercial$banking$was$abolished,$although$a$few$
specialized$banks$assisted$the$central$bank$and$a$network$of$savings$banks$for$population$savigns$and$
credit$was$established.$$
$
Central$authorities$distributed$labor$the$way$they$distributed$investments,$raw$materials,$energy$and$
other$production$factors.$The$labor$market$was$abolished.$Work$was$mandatory$and$workers$were$not$
allowed$to$change$work$places.$Trade$unions$lost$their$genuine$function$and$became$a$transmission$
organization$of$the$party.$$
$
All$prices$were$fixed$and$changed$by$central$authorities$according$to$policy$requirement$and$this$made$
basic$supply$and$consumption$affordable$for$the$population.$$
$
Production$and$distribution$were$planned$by$the$method$of$physical$balances$where$sources$and$uses$
had$to$be$balanced.$These$balances$considered$all$the$sources$such$as$domestic$production$and$imports$
and$uses$such$as$input$to$production,$exports$and$population$consumption.$$
$

37

SARA$TACCONE$
$

The$central$plan$also$detailed$the$exact$targets$for$technological$development,$the$kind$of$new$
technologies$and$the$fields$in$which$they$would$be$introduced$and$the$sector$responsible$for$their$
production.$$
$
For$what$concerns$the$administrative$arrangements,$at$the$top$we$found$the$leading$bodies$of$the$party$
(the$Politburo$and$Central$Committee)$together$with$their$executive$branch$(=$the$government).$In$the$
economic$arena$government$consisted$of$a$set$of$institutions,$at$the$top$stood$the$political$decisionQmaking$
body$of$the$Supreme$Economic$Councile$and$the$Central$Planning$Office;$at$this$level,$each$sector$of$the$
economy$was$directed$and$controlled$by$a$ministry.$$
$
State$companies$received$their$plan$and$the$required$resources$from$above$and$were$free$from$concerns$
about$marketability,$cost,$quality$or$whther$their$products$were$up$to$date.$Their$only$incentive$was$to$
fulfill$the$plan.$This$was$both$compulsory$and$profitable$because$wages$and$bonuses$were$dependent$on$
plan$fulfillment.$$
Plan$indexes,$which$specified$quality,$raw$material$content,$and$assortments$to$be$produced,$were$also$
important$especially$because$fulfilling$and$overQfulfilling$the$global$production$plan$was$easier$if$they$
were$ignored.$Plan$indexes$were$provided$for$the$companies$by$ministires$and$companies$had$to$report$
their$fulfillment$to$the$ministires.$Reports$were$processed$and$immediate$direct$intervention$followed$if$
necessary.$$
$
The$planning$regime,$strictly$hierarchical$as$it$was,$required$the$collaboration$and$participation$of$the$
firms$in$the$planning$procedure.$$
$
For$what$concerns$the$foreign$markets,$fixed$prices$and$planning$for$exports$and$imports$was$not$possible$
because$world$market$prices$in$the$course$of$a$fiveQyear$plan$were$unpredictable$and$the$solution$was$s$
special$price$equalization$mechanism$by$which$foreign$trade$prices$became$hermetically$isolated$from$
domestic$prices.$$
$
SAFEGUARDING'AND'ATTEMPTS'TO'LEGITIMIZE'THE'REGIME''
'
Patriotic$propaganda$helped$legitimize$the$suffering$of$the$population$in$the$Soviet$Union.$$
$
State$socialism,$however,$could$not$be$built$with$national$and$communist$enthusiasm$alone,$low$incomes$
had$to$be$compensated$by$various$social$measures$made$possible$by$the$nonQmarket$system.$$
Important$welfare$institutions$were$also$introduced$and$it$guaranteed$full$emplyment,$free$education$at$all$
levels$to$university$and$free$health$care$to$every$citizen.$$
$
REGIONAL'INTEGRATION'SYSTEM'OF'PLANNED'ECONOMIES'
'
Centrally$planned$state$socialist$economic$systems$with$their$nonQmarket$mechanisms$were$the$most$
potectionist$regimes$of$all.$SelfQsufficiency$was$a$central$tenet$of$the$Soviet$Union$and$even$the$small$
Central$European$countries$followed$that$pattern$but$none$of$these$countries$was$able$to$realize$selfQ
sufficiency.$For$these$reason$there$was$the$creation$of$a$regional$integration$organization,$COMECON$
(1949).$$
$
Comecon$was$an$umbrella$on$over$a$set$of$bilateral$trade$agreements$that$the$Soviet$Union$and$the$other$
bloc$countries$signed$with$each$other.$$
It$repleaced$market$and$money$relations$by$trade$in$kind$and$a$clearing$system$of$payment.$Hard$currency$
was$excluded$and$the$member$countries$paid$each$other$with$deliveries$of$goods.$All$of$these$countries$
were$interested$in$adjusting$foreing$trade$prices$to$fixed$domestic$prices$and$this$made$fiveQyears$
planning$easier$and$more$reliable.$$
During$the$extreme$world$market$price$increases$in$the$years$of$the$Korean$War,$Comecon$introduced$
fixed$prices$in$trade$among$member$countries$(prices$were$kept$fixed$until$1957).$
$
According$to$the$Bucharest$Agreement$in$1958,$COMECON$prices$were$adjusted$every$fifth$year$to$the$
average$of$the$worlds$market$prices$of$the$previous$five$years$but$after$the$oil$shock$in$1973,$Comecon$
prices$were$adjusted$annually$to$the$previous$fiveQyear$average$world$price$level.$$
$
THE'GOAL'AND'BALANCE'SHEET'OF'THE'CENTRALLY'PLANNED'ECONOMY'''

38

SARA$TACCONE$
$

'
The$model$was$planned$to$create$the$possibility$of$frced$capital$accumulation.$Poor$agricultural$countries$
with$low$income$levels$had$a$traditionally$low$accumulation$rate.$Some$governments$made$efforts$to$
increase$exporta$and$invest$from$the$income,$as$well$as$assist$development$through$state$interventions.$$
$
Low$prices$paid$for$agricultural$products$and$high$prices$for$goods$sold$to$the$peasants,$the$so$called$price$
scissors$led$to$an$unprecedent$jump$in$the$rate$of$accumulation$in$the$poor$peasant$countries.$$
$
Although$investment$efficicency$was$rather$low,$capital$accumulation$still$generated$rapid$growth.$High$
investment$was$combinated$with$extremely$high$labor$input$for$nearly$two$decades.$$
$
The$forced$investment$and$industrialization$policy$brutally$and$radically$transformed$the$traditional$
societies$of$the$region.$Millions$of$uprooted$peasants$left$the$countryside$and$moved$to$urban,$inudstrial$
workplaces.$For$at$least$two$decades$high$social$mobility$generated$a$more$modern$social$structure.$$
$
The$drastic$elimination$of$the$old$elite$was$accompained$by$a$sharp$economic$leveling$of$society.$The$
traditional$hierarchical$class$society$was$replaced$by$a$homogeneous$society$which$destroyed$nealry$
casteQlike$social$differences.$Income$differences$narrowed$sharply.$$
$
RAPID'GROWTH'AND'INDUSTRIALIZATION''REPRODUCED'BACKWARDNESS'
'
The$centrally$planned$economy$was$an$efficient$model$for$backward$agricultural$countries$in$the$early$
stage$of$industrializations$because$of$its$lack$of$modern$specialization,$weak$services$and$relatively$
backward$technology.$Furthermore,$demographic$trends$changed$and$population$growth$slowed$down,$
stopped$and$then$decreased.$$
$
REFORM'ATTEMPTS'THAT'FAILED''
'
The$only$route$to$futher$development$would$require$retooling$the$growth$paradigm$to$a$soQcalled$
intensive$model$of$productivity$growth,$based$on$imporved$services$and$technology.$$
$
The$death$of$Stalin$in$March$1953$was$followed$by$the$New$Course$but$real$changes$occurred$with$the$deQ
stalinization$trend$under$Khrushchev.$$
$
Reforms$followed$and$became$unstoppable$in$some$countries$and$the$pioneer$was$the$Yugoslavia$with$two$
important$waves$of$economic$reforms:$
$
June$1950:$firms$independent$of$central$authorities$and$managed$by$elected$workers$councils$
1965:$prices$were$further$liberalized$and$nearly$half$became$free$market$prices.$
$
Reform$in$the$Yugoslav$direction$became$attractive$and$reforn$initiatives$were$generated$by$crises$in$the$
other$countires$as$well.$$
$
CRISIS'AND'COLLAPSE''
'
The$turning$point$in$the$history$of$the$Soviet$bloc$occurred$in$1973$because$of$the$inability$to$follow$
modern$economic$transformation.$$
$
Its$important$to$underline$also$that$the$fast$economic$growth$was$followed$by$stagnation$or$decline$
during$the$last$quarter$of$the$twentieth$century.$The$gap$between$Central$and$Eastern$Europe$and$the$
West$increased.$$
$
TechnologicalQstructural$modernization,$imported$capital$and$knowQhow$led$to$significant$imporvements$
from$the$early$to$mid$1990s.$Poland$and$Hungary$showed$the$highest$increase$in$labor$productivity,$
roughly$10%$per$annum$from$1992$onward.$The$changes$in$postQ1989$Central$and$Eastern$Europe,$in$
sum,$triggered$an$adjustment$process$of$the$former$centrally$planned$state$socialist$countries$and$they,$in$
turn,$have$become$closely$connected$with$an$integrated$Europe.$Adjustment,$however,$has$been$uneven$
and$far$from$complete.$The$Western$rim$of$the$region,$eight$countries,$were$accepted$by$the$European$
Union$by$2004,$while$twoQthirds$of$the$region$continues$to$lag$far$behind$late$twentiethQcentury$economic$

39

SARA$TACCONE$
$

modernization.$The$cenQ$trally$planned$economy,$though$transitorily$rather$successful,$terminally$failed$at$
the$end$of$the$century.$

40