Slouching Towards Utopia?: The Economic History of the Twentieth Century

-VII. From the British to the American Century-

J. Bradford DeLong

University of California at Berkeley and NBER

August 1996

Great Britain's Relative Economic Decline:

But the United States became the world's leading-edge nation-the richest, the most prosperous, the most modern, and the highest technologied-only because Great Britain, the nineteenth-century "workshop of the world" seemed to falter in it economic growth. The story of America's rise to economic preeminence is in many ways simply the reverse of the story of Great Britain's rapid turn of the century relative economic decline.

Great Britain had been the first industrial nation. Its commercial dominance of the seventeenth and eighteenth centuries, coupled with its established sheepherding industry, its plentiful supplies of water power, coal, and iron, and a relatively large pool of wage-workers without traditional rights to occupy the land gave it crucial economic advantages at the start of the industrial revolution. In textiles, steam power, iron production, and canal building Great Britain led the way throughout the 18th and nineteenth centuries. The last years of the nineteenth century saw Great Britain the richest country in the world (save for Australia, the late nineteenth century sheep-raising equivalent of OPEC), with the heaviest industrial base, the most comprehensive railroad network, and ruling over the largest Empire the world had ever seen.

The United States surpassed Britain in productivity at the turn of the century. Yet British productivity has grown more rapidly in the twentieth century than it did in the nineteenth. Britain's relative decline springs from its inability to partake fully of the acceleration of growth in productivity that the twentieth century saw. And American economic preeminence sprang from the American economy's ability to create and ride the wave of this growth acceleration.

Perhaps Britain's advance contained the seeds of its inability to lead the productivity revolutions of the twentieth century. Britain's relative prosperity had been based on a set of technologies that greatly multiplied the productivity of unskilled workers. The poor British educational system, its weak corps of technical engineers, and the easy availability of unskilled Irish and rural British workers were no great handicap as long as the most dynamic edge of the economy intensively used both machines and unskilled workers, but not skilled workers. But technologies that made heavy use of skilled workers would be the locus of industrial development in the twentieth century.

In the last years of the nineteenth and the first years of the twentieth century Britain lost its leading position in new, modern industry after new, modern industry. Organic chemicals became German (and American), British railroads became smaller and slower than those on the continent, the development of the automobile lagged behind France and the United States, the electric power grid was put into place slowly, the telephone network was rudimentary, and so on. Even in textiles, Britain began to be excluded from foreign markets on the basis of too high a price. British levels of productivity remained high. They just failed to grow at the same rate as in the rest of the leading edge of the industrial world. And British companies lost, or failed to develop, market position in what were going to become the leading industries of the first half of the twentieth century.

Britain's loss of market position in the most technologically advanced industries is surprising, for in those industries lies the most natural comparative advantage of the leading industrial nation. The leading industrial nation is the richest, has the most experience with modern technology, and would seem to be the best set up to train and mobilize labor and capital to take advantage of new opportunities. Yet British firms and workers did not do so. In fact, in the thirty years before World War I factors of production behaved as if there was something pernicious about locating in Britain. On net both British capital and British labor left the island for better opportunities elsewhere. As U.C. David economist Gregory Clark puts it, by 1910 you could combine British labor and British capital in the textile city of Fall River, Massachusetts, and obtain 50 percent more output per worker hour and 20 percent more output per machine hour than back in the textile city of Manchester, in England.

In 1903, the British economist Alfred Marshall-John Maynard Keynes' teacher-wrote that "[s]ixty years ago England had…leadership in most branches of industry.…It was inevitable that she should cede much.…It was not inevitable that she should lose so much of it as she has done." While it is not surprising that in the end "…half a continent should raise more coal and make more steel than one small Island," it is surprising that Britain should first lose market share in the highest of high technology industries. Even when Britain did move into the "new" industries of the late nineteenth century, it wound up drawing on foreign expertise to do so. The first public power station in England, in 1881, was built by Siemens. On the eve of World War I, the German electrical manufacturing industry was more than twice as big as Britain's.

Clearly many factors contributed to Britain's relative decline. One of the key factors was Britain's anemic rate of investment in industry. This occurred in spite of a very healthy rate of national savings. It was just that the share of national savings invested at home was small, especially in the years before World War I. Almost as large a share of British savings was invested abroad as was invested at home. And without ample investment in the machines that embody industrial technology, British workers did not acquire skills necessary to utilize and British firms did not acquire the skills necessary to create advanced industrial technologies.

Why was domestic machinery investment so low? There are four candidate reasons: a deficiency in natural resources, the British labor relations system, and the British educational system, and a banking system that failed to mobilize capital for large-scale industrial firms. Of these, resource-based explanations for British relative decline are unsatisfactory. Germany and the United States had superior natural resources. Yet water transportation was very cheap. Britain grew no cotton, yet had no trouble dominating the world cotton spinning and weaving industry for a century. Japan today produces steel in large quantities from Australian iron ore and Brazilian and American coal.

Right-wing analysts have tended to blame Britain's industrial decline on the bloody-mindedness of British unions, unwilling to see firms earn profits or to allow economic readjustment and change to take place. Left-wing analysts have tended to blame Britain's industrial decline on its class structure and deficient educational system. These are not separate causes, but a single interlinked system: unions were bloody-minded and the educational system was deficient because Britain had strong class distinctions. And the deficient educational system and poor labor relations reinforced class distinctions.

Those who governed Britain did not see an educated population as a high priority. As economic historian David Landes wrote, in Britain:

For every idealist or visionary who saw in education … an enlightened citizenry, there were several 'practical' men who felt that instruction was a super_uous baggage for farm labourers and industrial workers. These people, after all, had been ploughing fields or weaving cloth for time out of mind without knowing how to read or write…all they would learn in school was discontent.…Under the circumstances, Britain did well to have roughly half of her [elementary] school-age children receiving some kind of elementary education around 1860.

This was a far lower percentage than found in the United States or in Germany. What was true of elementary education was even more true of technical and engineering education. In Britain, technical education was the business of private firms. But why should they train workers who might well go elsewhere for jobs? And why should they train workers if such training only upped the bargaining power of British unions? Meanwhile, in the United States institutes of technology were founded.

The year 1914 saw close to 40 percent of Britain's national capital stock-of its produced means of production-located overseas. No other country has matched Britain's high proportion of savings channeled to other countries. Britain's overseas investments were concentrated in government debt, in infrastructure projects like railroads, streetcars, and utilities, and in securities guaranteed by the local government.

Britain did not do well out of its overseas investments. In the forty years before World War I, British investors in overseas assets earned low returns, ranging as low to perhaps 2% per year in in_ation-adjusted pounds on loans to dominion governments. Such returns were far below what presumably could have earned by devoting the same resources to the expansion of domestic industry. British industry in 1914, and British infrastructure, were not as capital intensive as American industry and infrastructure were to become by 1929. It is difficult to argue that Britain's savings could not have found productive uses at home if only they could be challenged appropriately and managed productively.

The difference in rates of return between home and foreign investments cannot be attributed to risk: overseas investments were at least as, if not more exposed to risk than were domestic investments. In the final analysis, British investments in Argentina or Australia yield dividends by the export of Argentinian or Australian goods to Britain. In a depression at home-the major risk facing investors in domestic industry-exports to Britain from the periphery of the world economy drop far in both quantity and price. It is difficult to believe that government guarantees would be worth much in a severe depression, and thus difficult to believe that overseas investments-even if guaranteed by the Argentinian government-were in any sense less risky than domestic investments. Overseas investments were thus no safer than domestic investments.

Why, then, did British investors commit their wealth overseas? One possibility is that the high rates of return presumably available at home were not really there: the absence of British engineering skill, and the aggressive wage demands of British unionized workers would have prevented home investments from earning even the small profits earned abroad. A second possibility is that British investors did not understand the framework in which they were embedded. Perhaps they imagined that home investments-even a diversified portfolio of industrial, railroad, and utility corporations-were risky, while overseas investments guaranteed by the local government were safe.

Certainly a contributing factor was the failure of Britain to develop institutions for channeling the savings of thousands into the capital stock of one giant enterprise. How is an individual saver, in an age where the efficient size of an operating corporation is vast beyond his means, to evaluate which industries and companies have good prospects, monitor the management to which he has committed his capital, and control and replace the management when it does not do its job? Such tasks require the growth of financial intermediaries-investment banks of one form or another.

German analysts, especially, criticized the pre-WWI British banking system because of the lack of such a monitoring system: the "complete divorce between stock exchange and deposits...causes another great evil, namely, that the banks have never shown any interest in the newly founded companies or in the securities issued by these companies, while it is a distinct advantage of the German system, that the German banks, even if only in the interests of their own issue credit, have been keeping a continuous watch over the development of the companies, which they founded."

In Britain, without powerful investment banks, no one could expect large, modern companies to be effectively watched and kept from running off the rails. And so few were willing to invest in companies that might become large organizations that contributed to the rapid advance of productivity. Landes, for example, notes that the scarcity of British engineering talent was matched by a scarcity of venture capital-there was plenty of capital for infrastructure or for government debts, but little for the progressive entrepreneur.

In the U.S., in Germany, and in Japan such institutions did develop. And the existence of "finance capitalist" institutions played a significant role in the expansion of managerial capitalism. Investment banker willingness to choose and monitor managers aided founding families that were attempting to withdraw from active management of their businesses and to diversify their holdings. Such investment banks played a key role in transforming corporations into the professionally managed organizations with diversified stock ownership that were to dominate the twentieth century. Chandler's accounts of the slow growth of managerial capitalism in Great Britain stress how long firms remained held together by webs of personal ties of clientage and patronage, and how loath were top executives-even the top executives of would-be conglomerates-to take seriously the problem of choosing appropriate managers.

Thus economic preeminence in the twentieth century appears to have required much more than an initially-rich country and a laissez-faire economic policy. It also required a skilled labor force, a solid corps of technologically-trained engineers, financial institutions to channel savings into the domestic accumulation of the machines that embody industrial technology, a labor movement eager to share in and not to block economic reorganization and technological change, and modern business enterprises to take advantage of economies of scale and to translate scientific knowledge into productive engineering applications. In all of these Britain was deficient. In all of these the United States was-mostly by luck-abundant.