Economic history

Kragen Javier Sitaker, 02021-06-25 (updated 02021-07-27) (17 minutes)

(Originally posted at https://news.ycombinator.com/item?id=27639177.)

Money doesn’t objectively exist; it’s purely a figment of people’s imagination. This ten-trillion-Zimbabwean-dollar bill isn’t money anymore, even though it used to be, and it isn’t physically changed in any relevant way. The only thing that changed was how people thought of it.

It might seem strange to say that a purely imaginary thing like money could be “the driver/catalyst for everything” in industrialization, but many strange things are true. I’m writing you this note in letters of lightning far too small to see, which are persistently trembling within a few tiny slivers of quartz that can thus contain the lightning because the vital air has been removed from it—stranger still, but true, because that is how DRAM chips work.

Still, let’s see if we can analyze how industrialization happens in terms of objectively existing reality rather than shared hallucinations like money—surely the picture will be partial, but it may still be useful. Industrialization itself seems to be objectively observable: it doubles people’s life expectancy at birth.

Let’s start with an outside view of economic production as a whole. How would we explain it to a Martian?

People work, planting and harvesting and preparing food. If they do not eat food, they die in a few months from lack of various molecules crucial to their biochemistry and energy (collectively “nutrition”). They expend energy and water and damage their bodies by working, damages which they repair automatically if they have time to rest, but which will otherwise eventually kill them. So their capacity for work is limited. Not everyone has to work, but if the people collectively produce too little food from their work, then they will start dying from lack of nutrition, and pretty soon they will all die. One old book of poetry sums this up by saying, “In the sweat of thy face shalt thou eat bread.”

On the other hand, if they can make a lot of food despite their limited work capacity, more than they need to survive—a “surplus”—many of them will live for decades, they will reproduce, and their population will increase, typically by about 4% per year. Groups that manage to do this come to vastly outnumber groups that do not.

(There are some other material necessities for human survival and reproduction besides food, but none of them are different in relevant ways, so for the time being I’ll stick to food.)

The other conventional factors besides labor that affect productivity are land and something called “capital”. Some land yields a lot of food and is easy to plant and harvest; other land yields very little. By “capital” is conventionally meant not money but durable goods that increase labor and land productivity, such as hoes and waterwheel-driven mills for making flour. If people don’t need to spend their entire labor capacity on making enough food to survive, they can instead devote some of it to making these durable goods: cords, needles, ropes, bows and arrows, shoes, knives, hoes, axes, pots, and so on. Cords and ropes enable you to climb palm trees, hang meat over a fire, or bridle a horse; needles enable you to make clothing and all manner of sturdy, flexible fiber goods; bows and arrows enable you to kill dinner at a distance; shoes enable you to walk or run longer distances; knives and axes make cooking and woodworking much easier; hoes allow you to plant much more land; pots enable not only cooking but food storage and the storage of other goods; and so on.

So these are “capital goods”: once you have a surplus, then by spending some of your work creating durable goods instead of satisfying basic necessities for survival, you thenceforth multiply their possessors’ future production, or at least until the durable goods stop enduring. But a hoe or a blast furnace is produced in the same way as a vegetable garden: people work to turn raw materials into the desired end product, directed by their skills and knowledge. Instead of hoeing the field today, perhaps they’re hammering the hoe blade into shape or molding bricks from fireclay. Most capital goods are more or less specialized to a particular sort of production—you cannot harvest more corn by dumping blast furnaces or gristmills into the cornfield—though some are more versatile than others.

I haven’t mentioned skills and energy before, but they’re crucially important. A person is skilled when they can direct their work to produce their intended results with ease and precision, and labor specialization develops skill much more highly.

Energy is a fundamental physical quantity which can be converted between many different forms, including heat and kinetic energy; many kinds of work require a lot of kinetic energy and a lot of heat, and this has historically often been the limiting resource for work productivity, particularly when all the relevant kinetic energy came via people’s muscles from their food, and all the relevant heat came from firewood.

The available kinetic energy for production has greatly expanded five times in the past: ox-yokes (6000 years ago), horse-collars (1500 years ago, in the Sui), the steam-engine (250 years ago), and electric dynamos and motors (140 years ago). Photovoltaic cells seem at long last to be adding a sixth item to this list now that they have finally become cheaper than steam-engines.

The available heat energy for production has greatly expanded three times: fire (400,000 years ago), oil drilling (2300 years ago), and deep-shaft coal mining (250 years ago). Again, photovoltaics are probably a huge factor here today.

So, in these terms, we can analyze industrialization as a set of several major synergistic shifts.

First, enormously increased specialization, which would have been counterproductive to effective productivity in the absence of the worldwide markets created by the British Empire and by cheaper transport via canals. The ten workers in Adam Smith’s pin factory could produce 48000 pins a day, far more pins than a village could use, or maybe even a city—perhaps each household might ruin five or six pins in a day as they repaired their clothing. Without easy shipping, the tonnes of pins thus produced would be as worthless as an asteroid belt converted into paperclips.

Second, enormously increased use of capital goods enabled by that specialization—only a few decades after Smith observed his pin factories of ten or eighteen men, the whole operation became automated by cam-driven pin-making machinery, further decreasing the labor per pin, and of course the rise of the spinning-machines and jacquard and other automated looms is even more notorious.

Third, as improved capital goods like the cotton gin and the combine harvester became abundant, the planting and harvesting of larger and larger amounts of land required less and less labor, so smaller and smaller amounts of farming work per person sufficed to prevent mass starvation. This surplus manifested as a mass population migration from the countryside to the cities, where increasingly specialized capital-intensive production of all kinds was carried on by large crews of people harnessing steam power, rather than by individual farmers plowing behind teams of horses.

Fourth, invention became central to economic production in the newly industrializing countries, as it had been a thousand years before in the Song; we can think of an invention as a skill that has been digitized, expressed in words or pictures so that it can be copied, rather than having to be learned by practice. New notions of precision, innovation, specification, tolerances, and standardization became central to work in a way entirely foreign to previous generations. New notions of measurement and metaphors of clockwork universes allowed the implicit to become explicit, legible, and reproducible.

Fifth, the advent of the steam-engine, which permitted pumping water out of deep-shaft coal mines, which provided a vastly increased fuel supply.

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In none of the above do we find any money, or for that matter any elites or banks or other corporations. All of it could, at least hypothetically, have happened through Stakhanovite altruism or telepathic mind control, if human nature contained such possibilities. The investment of surplus production capacity in capital goods which thenceforth further increase the production surplus, faster than the human population can increase, combined with labor specialization, urbanization, and invention, creates industrialization, and that is what creates the profligate material abundance and extended lifespans we are struggling to cope with today.

But of course it is not enough that such a pattern of changes improves the overall welfare; if the status quo ante is a Nash equilibrium, anybody who unilaterally attempts to automate pinmaking, invent cotton gins, or move to a city might merely impoverish themself and their family. Indeed, if you merely specialize in pinmaking, surely you will have made more pins than your family needs within only a few weeks—and how will they eat this winter if you’ve spent the whole planting season making pins instead of plowing? Even if your aunts and uncles will plow for you, they probably don’t need that many pins either.

And this is where money comes in: trade gamifies work by allowing you to cooperate productively with people you don’t trust, breaking the Nash equilibrium that keeps everybody poor, and money enormously simplifies trade. You can ship a box of pins from your French pin factory to Spain or England or some godforsaken place like Connecticut, and receive gold in return, which you can use to buy both potatoes and better pin-making machinery. As you said, it’s a lubricant.

Modern capitalism largely arose in the Industrial Revolution as a form of gambling. Many entrepreneurs can bootstrap: a machinist can buy a lathe, a drill, a work-bench, a file, dividers, a square, etc., with his wages as a machinist’s apprentice, and as long as he has a “production surplus” (now, as measured in the collective hallucination of money, rather than in the increased harvests of the farmers using his machinery) he can keep improving and buying machinery to increase his productive capacity and thus his surplus, and perhaps begin to hire workers—not apprentices for a limited term, now, as in pre-capitalist craft production, but employees for life. But a competing machinist who sells her business to capitalists (whether a few wealthy investors or many subscribers) suddenly has enormously more money with which to buy such tools, and perhaps she can win customers away from the bootstrapped entrepreneur, producing superior goods at a lower price because of her superior tools.

Effectively the capitalist is offering the worker a deal: the capitalist provides the tools, the worker provides the labor, and each receives part of the value produced. In capitalism qua capitalism, the worker is an employee and receives a fixed wage, while the capitalist receives a variable profit, but of course there are lots of other variations; the machinist might take a loan from a bank or rent the tools, precisely reversing the roles, or someone who’s nominally merely an employee might receive most of their compensation in the form of incentive stock options.

From the point of view of economic development, these questions of how the pie is divided are minor, but they matter enormously to the participants. This division depends mostly on cultural expectations and on the negotiating positions and skills of the parties; in an industrialized economy, the capitalist has a very strong negotiating position, since capital goods like drill presses and rail locomotives are very commonly the critical limiting factor in productivity. For many expensive products that can be cut on a lathe, there are fewer lathes that can turn them than machinists skilled enough to turn them. The machinist without a lathe must resort to backyard aluminum casting and hand scraping before he can start to turn parts.

Ultimately, though, the money is just a scorekeeping device, a lubricant. What makes the machine shop more or less productive is not the money, but the tools it bought, which were necessarily produced by the production surplus of the existing economy. If suddenly machine shops as a whole attract a hundred times as much investment, it won’t make their productivity skyrocket by bringing a hundred times as much tools into existence—it will just drive up the price of the tools. Pretty soon it will drive up the prices of the machine shops’ products, too, since if their management doesn’t deliver a respectable return on that investment, it will be replaced, and if that doesn’t fix it, the company will be shut down. These higher prices will tend to decrease the market for the products.

When we’re talking about international capital flows, we also have the well-known resource curse or Dutch disease: investing a lot of money from England in US companies will tend to devalue the pound relative to the dollar, which makes US products less economically competitive and/or UK products more economically competitive. This is precisely the opposite of driving US industrialization.

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So if some Englishman sent a bunch of money across the Atlantic to invest in nascent industrialization, that wouldn’t speed up the industrialization—unless a bunch of that money went back across the Atlantic to buy the capital goods needed for industrialization. Maybe it did! From 01780 to 01824 artisans were forbidden to emigrate from Britain, and exportation of metalworking or glass manufacturing equipment was likewise forbidden; but these prohibitions were widely flouted, and at any rate they excluded steam-engines, and they ended in 01843. A lot of the machinery and artisans during this time went to the US. The “American System of Manufacturing” was the world’s most advanced manufacturing technology by the mid-01850s.

More likely, though, if someone in England was investing in US industrial firms in the 01800-01850 period, they weren’t meaningfully promoting a flow of needed capital goods from England to America; they were just giving the American firms they invested in a leg up on competing American firms, and perhaps other sectors of the US economy, like the slave plantations.

But where does Junius Morgan come into all this? Well, it turns out that Junius S. Morgan was born in Massachusetts in 01813; his father was a Revolutionary War veteran and one of the founders of Aetna in 01819. Junius Morgan was a partner in various US banks from 01833 to 01853, inheriting his father’s fortune in 01847 and then becoming a partner in London’s leading American bank in 01854. So that was when he started funneling British investors’ money into American industrial companies by selling things such as railway bonds. J. P. had nothing to do with it! He started working with his father in London in 01857 and acting as his father’s overseas agent in the US in 01860.

Moreover, by this point it was no longer a question of “driving industrialization” in America. The US had already been the world’s leading industrial power for decades. The B&O railroad opened in 01830, using a US-built locomotive; by 01861 it had 236 locomotives, 3451 rail cars, and 826 km of railroad, and it had many domestic competitors. In 01830 the Liverpool and Manchester Railway, the first intercity railway and the first to be powered entirely by steam, also opened. The US had power looms from 01815, milling machines by 01816, small arms with interchangeable parts by the 01830s, 2000 steam engines by 01838, cloth exports from the 01830s, electric telegraphs from 01844, and invented the Corliss steam engine in 01848.

So, Morgan was far too late to drive industrialization in the US. He certainly did make a lot of money from it, though. And he arguably got a lot of other people to invest in its expansion—US industry expanded a lot in the second half of the 19th century.

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