We live in a period without precedent in the majority of human history, a period, where we experience per capita growth in our income. This means that each generation is better off than its parents and that our standard of living keeps growing. And yet, as recently as the 19th century the world had never before experienced sustained per capita increases, also known as modern economic growth. What changed so suddenly in our economic history that an explosion of technological progress and rising income became possible? And why did this process start on a small island at the western fringe of the Eurasian landmass, rather than in the mighty and populous Chinese empire?
Human Capital Stock and the Onset of Growth
There is an untold number of theories which aim to explain why growth started. I strongly agree with those which propose the key role of human capital accumulation, and the leading theory in this field is Unified Growth Theory, developed by Oded Galor and David N. Weil in their seminal papers available here and here. In short, as this theory isn’t the subject of the current article, the theoretical proposition of Galor and Weil puts forward the notion that the absolute size of a population was the key determining factor of the pace of technological progress in the Malthusian regime. The Malthusian regime’s key feature was that any technological progress translated into higher population rather than per capita income increases. This, in turn, further sped up innovation, creating a virtuous circle of accelerating progress, ultimately leading to sustained modern economic growth when a certain level of technological progress, and a threshold of corresponding human capital, had been achieved.
Thus the Unified Growth Theory predicts that it should be the most populous (and simultaneously largest) economy of the Malthusian world which should first achieve the critical mass needed for an economic take-off. Up to the Industrial Revolution and for some time after it began, the top spot in economy size was nearly always claimed by China. And yet, it was Europe that first freed itself from Malthusian shackles. In other words, empirical evidence clearly contradicted the central tenets of the leading growth theory used to explain the most important economic phenomenon in history.
The Virtues of Fragmentation
In trying to reconcile empirical data with theory, a new paper by Chiu Yu Ko, Mark Koyama and Tuan-Hwee Sng puts forward a novel explanation.
The authors argue that China’s political centralisation was, paradoxically, the main factor behind Europe’s competitive advantage, as the Old Continent, due to its political fragmentation, was uniquely robust to major external shocks, which in the Chinese case manifested themselves in huge population losses and economic setbacks during times of crisis. Thus, while China’s centralisation favoured quicker technological progress and a larger population during peacetime, political and military turmoil invariably set it back to levels of human capital accumulation not conducive to igniting growth.
The central idea is the following: while a larger population is more conducive to innovation and thus growth, China’s political centralisation meant that at times of large-scale warfare and collapse of central authority, as was the case when Chinese dynasties fell, the Middle Kingdom experienced much larger material and human losses than in the respective conflicts fought by Europe, whose political decentralisation buffered many areas of the continent from crisis. This is confirmed by a figure from the cited paper, which plots the number of deaths in major Chinese and European wars.
As we can see from the two graphs, while Europe had many more military conflicts in the 15th to 18th centuries, their death toll was an order of magnitude lower than in China. This leads us to the conclusion, that it is not only the absolute population size that matters in fostering modern growth, but also its variability.
The Perils of Large-Scale Meltdown
As the authors argue in the paper:
As a result China’s population fluctuated widely during the preindustrial period and this undermined the gradual accumulation of technological knowledge that plays such an important role in generating the transition to sustained growth in the theoretical growth literature.
There are several channels through which we argue negative population shocks in China could have impeded technological innovation. First, technological knowledge was embodied in individuals therefore the large-scale collapses in China’s population were associated with a fall in the stock of technology. Thus a more volatile population will be associated with a lower level of technological knowledge than an equally size but more stable population.
Alternatively, a complementary mechanism is present in the framework Aiyar et al. (2008) develop to explain episodes of technological regress. Aiyar et al. (2008) argue that many technologies require a minimum efficient scale. Therefore negative shocks that cause the extent of the market to contract, including a fall in the population, can bring about technological regress. Both of these explanations are consistent with our argument; if these mechanisms were operative then political centralization did not only make China more vulnerable to negative economic shocks, it also reduced the possibility of modern economic growth emerging in East Asia.
This is a very persuasive explanation for why modern economic growth started in a relatively small but well-connected European state (England), rather than in China. For all its rapid population growth and technological prowess, each time China entered a major crisis, a significant number of its people were wiped out, and with them their human capital. Meanwhile, in Europe, even one state’s failure didn’t collapse the system and lead to significant human capital losses, thanks to the greater robustness of politically fragmented entities. At the same time, transaction costs in trade, while higher than in China, were low enough to create one single European (rather than national) market.
Armed with the human capital stock of the entire European economy and more robust to catastrophic failure, Western Europe prospered. It is significant that one of the European nations most open to trade, with the simultaneous and unique advantage of protection by the seas, was the one where the story of modern economic growth ultimately began. Thus, England rose, while China slept.
This article is an edited version of the original post which first appeared on the author’s blog: www.janfabisiak.com