New Perspectives on the Late Victorian Economy: Essays in Quantitative Economic History, 1860-1914

Through channels both open and concealed, the Victorian economy continues to influence us powerfully. Much economic thinking today gains support from perceptions of how the nineteenth-century British economy worked and how well it satisfied wants. Contemporary oligopolistic industrial structure is contrasted with Victorian self-regulating competition; the gross inequalities of Victorian laissez-faire are compared with support for the needy provided by the modern welfare state; and some regard Victorian values as vital principles of social organisation which should be regained. By examining the behaviour of the British economy between 1865 and 1914, the present work casts light upon some of these views. It does so in a variety of ways. New methods or evidence are deployed to establish accepted conclusions more firmly; unwarrantedly neglected aspects of the economy are analysed with present day concerns in mind; and traditional conclusions are reassessed. The book focusses upon three central themes: industrial organisation and technology, wages and living standards, and the monetary system. These are at the heart of discussions of productivity growth, the standard of living, well-being and poverty; the criteria by which the Victorian economic system should ultimately be judged.

New perspectives on the late Victorian economy

New perspectives on the late Victorian economy Essays in Quantitative Economic History 1860-1914

Edited by James Foreman-Peck Professor of Economic History, University of Hull

The right of the University of Cambridge to print and sell all manner of books was granted by Henry VIII in 1534. The University has printed and published continuously since 1584.

CAMBRIDGE UNIVERSITY PRESS Cambridge New York Port Chester Melbourne Sydney

Published by the Press Syndicate of the University of Cambridge The Pitt Building, Trumpington Street, Cambridge CB2 1RP 40 West 20th Street, New York, NY 10011, USA 10 Stamford Road, Oakleigh, Melbourne 3166, Australia © Cambridge University Press 1991 First published 1991 Printed in Great Britain by Redwood Press Ltd, Melksham, Wiltshire British Library cataloguing in publication data

New perspectives on the late Victorian economy: essays in quantitative economic history 1860-1914. 1. Great Britain. Economic conditions, history I. Foreman-Peck, James 330.941 Library of Congress cataloguing in publication data

New perspectives on the late Victorian economy: essays in quantitative economic history 1860-1914 / edited by James Foreman-Peck. p. cm. The research in the present volume originated as papers given at two of the annual ESRC Quantitative Economic History conferences (Newcastle and Birkbeck)' Pref. ISBN 0-521-39107-5. 1. Great Britain - Economic conditions - 19th century. 2. Great Britain - Economic conditions - 20th century. 3. Monetary policy - Great Britain - History. I. Foreman-Peck, James. HC255.N39 1990 330.94T081-dc20 89-77375 CIP ISBN 0 521 39107 5

CE

Contents

List of contributors List of

page figures

ix x

List of tables

xi

Preface

xv

1

Quantitative analysis of the Victorian economy

1

James Foreman-Peck

PART I TECHNOLOGY AND INDUSTRIAL ORGANISATION 2

Historical trends in international patterns of technological innovation

35 37

John Cantwell

3

Railways and late Victorian economic growth

73

James Foreman-Peck

4

5

Appendix 3.1 Data for the total factor productivity calculation

90

Appendix 3.2 Derivation of the steady state response of income per head to railway technology

91

Emergence of gas and water monopolies in nineteenth-century Britain: contested markets and public control Bob Millward The expansion of British multinational companies: testing for managerial failure

96

125

Stephen Nicholas

PART II DISTRIBUTION 6 A new look at the cost of living 1870-1914 Charles Feinstein

vii

147 151

viii

Contents

1 Poor Law statistics and the geography of economic distress

180

Humphrey Southall

8 Perfect equilibrium down the pit

218

John G. Treble Appendix 8.1

The bargaining model

PART III THE MONETARY SYSTEM AND MONETARY POLICY 9 Money, interest rates and the Great Depression: Britain from 1870 to 1913

241

249 251

Forrest H. Capie, Terence C. Mills and Geoffrey E. Wood

10 The UK demand for money, commercial bills and quasi-money assets, 1871-1913

285

Paul Turner

11

Appendix 10.1

Econometric techniques

300

Appendix 10.2

Data

301

An analysis of Bank of England discount and advance behaviour 1870-1914 Tessa Ogden

Index

305

344

List of contributors

John Cantwell, Department of Economics, University of Reading. Charles Feinstein, All Souls College, Oxford. James Foreman-Peck, Department of Economic History, University of Hull. Terry Mills, Forrest Capie and Geoffrey Wood, City University Business School. Bob Millward, Department of History, University of Manchester. Stephen Nicholas, Department of Economic History, University of New South Wales. Tessa Ogden, European Commission, Luxemburg. Humphrey Southall, Department of Geography, Queen Mary College, London. John Treble, Department of Economics, University of Hull. Paul Turner, School of Economic Studies, University of Leeds. ix

Figures

1.1

Choice of technique

page 36

1.2

Spatial costs and competition

36

2.1

Galtonian regression with the RTA index

50

3.1

Dynamic social savings

86

II. 1 Cost of living measurement with Laspeyres and Paasche 145 indices II.2 Bilateral monopoly in the labour market 148 Cost of living indices with alternative weights, 1900 = 100 161 Comparison of new cost of living index with Bowley's 172 index, 1900=100 6.3 Comparison of separate components of new index with 173 Bowley's index, 1900= 100 6.1 6.2

7.1

7.2 7.3 7.4 7.5 7.6 7.7 7.8 7.9 7.10 7.11

England and Wales 1857-1899: percentage of total population in receipt of poor relief (a) original monthly series (b) detrended and smoothed Unemployment in three trade unions Power spectra: engineers and carpenters Power spectra: ironfounders and Poor Law County pauperage patterns (Total and ABM), January 1868 Total pauperage, January 1909; poor relief per head, 1831 Percentage increase in annual averages on relief by county (Total and ABM), 1866-1868 Percentage of total population on poor relief, Transect Unions, July 1866 Percentage of total population on poor relief, Transect Unions, July 1863 Rate of change in percentage of total population on poor relief, Transect Unions, 1860-1863 Rate of change in percentage of total population on poor relief, Transect Unions, 1866-1869

184

186 187 188 191 194 196 202 204 206 208

List of

figures

xi

7.12 Rate of change in percentage of able-bodied males on poor 210 relief, Transect Unions, 1866-1869 7.13 Bi-annual time series for four Lancashire unions, 1860- 211 1872 (Ashton-under-Lyne, Preston, Liverpool, Ormskirk) 8.1 The pay-off matrix

230

8.2 The extensive form of the game

231

III. 1 A simple monetary economy 9.1 9.2 9.3 9.4 9.5 9.6

9.7

11.1 11.2 11.3 11.4 11.5 11.6

Narrow money: MO Broad money: M3 Interest rates Output Price level Impulse response functions for (QF, MO, PF, RC) (a) Output responses (b) Money responses (c) Price responses (d) Interest rate responses Impulse response functions for (QF, M3, PF, RC) (a) Output responses (b) Money responses (c) Price responses (d) Interest rate responses Bank of England discount and advance activity 1870-1914: TVB, VAOB and VAOS Bank of England discount and advance activity 1870-1914: TVR Bank of England discount and advance activity 1870-1914: TNT, TNAT and TNR Bank of England discount and advance activity 1870-1914: average daily interest rate Actual and fitted compared - TVB: 1890-1899 Residual and SD compared - TVB: 1890-1899

249 261 261 262 262 263 275

277

316 316 317 317 321 321

Tables

2.1 2.2 2.3

2.4 2.5 2.6 2.7 2.8 3.1 3.2 3.3 3.4 3.5 3.6 3.7 4.1 4.2

A list of 30 leading European companies patenting in page 44 the US before 1914 The total number of US patents granted to residents of the 45 major countries of origin Indices of revealed technological advantage for the major 46 industrialised countries in the periods (i) 1890-1912 and (ii) 1963-1983 The results of the regression of RTA in 1910-1912 on RTA 53 in 1890-1892 The results of the regression of RTA in 1963-1983 on RTA 61 in 1890-1912 The results of the regression of RTA in 1977-1983 on RTA 63 in 1963-1969 The strength of the regression effect over the period 64 1963-1969 to 1977-1983 The results of annual and other subperiod regressions of 66 the RTA index over the 1963-1983 period British railway receipts as a proportion of GDP 1865-1910 Railway returns traffic statistics 1870-1910 British railway output components growth estimates British railway output growth estimates British railway employment growth estimates British railway total factor productivity growth and components 1870-1910 The long-run elasticity of national output per head with respect to the national efficiency index

77 79 80 80 81 81 88

Rates of return on gas, water and other UK securities 103 1870-1913 Numbers of gas and water undertakings in the UK 117 1845-1915

xii

List of tables 5.1 5.2 5.3 5.4 5.5 5.6 6.1 6.2 6.3 6.4

Regional distribution of British FDI in production plants Choice of location for British pre-1914 FDI Interwar investment patterns by pre-1914 MNEs Product group composition of British FDI Bunching of FDI in production branches Logit models for the sales branch-production plant decision

xiii 133 133 133' 135 138 140

Allocation of consumers' expenditure 1900 158 Average weekly expenditure of working-class households 159 1900 Rents of private dwelling-houses, Great Britain, reassess- 166 ment years 1877-1910 Cost of living index 1900= 100 170

7.1

Rank correlations between ASE unemployment and 197 pauperage by union counties 7.2 Variables used in stepwise regression 199 7.3 Stepwise regression results, Suffolk-Lancashire transect 205 for 1863 7.4 Stepwise regression results, Suffolk-Lancashire transect 207 for 1869 8.1

Summary statistics of coal industry arbitration

9.1 9.2 9.3 9.4

Univariate ARIMA models 264 Estimated vector AR( 1) models 266 Proportions of forecast error k years ahead accounted by 270 each innovation Selected structural models 272

10.1 10.2 10.3

288 288 294

Deposits of financial institutions as % of quasi-money Changes in structure of financial sector Exclusion restrictions for M3, NBFI deposits and commercial bills equations 10.4 Demand functions for M3, NBFI deposits and commercial bills 10.5 Demand function for quasi-money and ratio of M3 to NBFI deposits 10.6 Income and interest rate elasticities 1871-1980

239

294 296 297

xiv

List of tables

11.1 Governor regression results (TVA) 11.2 Governor regression results (TVB) 11.3 Governor regression results (VAOS)

329 330 331

Preface

The research in the present volume originated as papers given at two of the annual ESRC Quantitative Economic History conferences (Newcastle and Birkbeck). Since they all concerned the same relatively short period of British history, I thought it would be important and interesting to see what they added up to. Normal academic practice is to scatter such papers among a number of scholarly journals. How they affect our interpretation of the past in total then depends upon individual scholars' sampling of this literature or has to wait upon the work of a synthesising textbook writer. For those not primarily concerned with this particular mode of enquiry, thefindingscould easily be overlooked or underestimated. The following chapters provide a more rigorous analysis of a number of established historical questions, present new evidence, and identify new problems for the maturing industrial economy of the later nineteenth and early twentieth centuries. Readers are likely to have different interests; some will be more concerned with the methods, others will focus on the history. For those interested in the methods, but without a great deal of practice in them, each of the three parts of the book is preceded by a brief statement of the unifying economic concepts. To facilitate an appreciation of the techniques, a glossary is combined with the index. In the introductory chapter, for stylistic reasons, I have used the terms Britain and British to refer to the United Kingdom. I have taken a similar licence with the term 'Late Victorian', here assumed to be a period beginning in 1860 and ending in 1914.

xv

Chapter 1

Quantitative analysis of the Victorian economy James Foreman-Peck

Long after all participants have passed on, the Victorian economy continues to exercise powerful influences, both open and concealed, over economic policy and attitudes, as well as through the legacy of economic structure. Perceptions of how the economy worked and how well, form the background to a number of present-day concerns. Economists allude to the Victorian economy as a period of competition in opposition to today's oligopolistic industry, social commentators contrast the provisions of the modern welfare state with the inequalities generated by Victorian laissez-faire, and Mrs Thatcher appeals to Victorian values to provide the social cement necessary to bind society together. The later Victorians were more prone to question their society than their mid-century forebears. British industry was more often described as uncompetitive (Williams 1896, Stead 1901) and social reformers (Mearns 1883, Booth 1902, Rowntree 1902) provided evidence for criticising the distribution of the gains from their expanding industrial society. Criticism has continued ever since. On the side of production, the Victorians have been blamed for dissipating the head start of the industrial revolution, and neglecting opportunities to lay the foundation for an advanced, technological, competitive British economy in the twentieth century. Inadequate attention to education and industry and too much concern with class, leisure and empire slowed economic progress, while the more vigorous Germany and the United States overtook Britain (Wiener 1981, Barnett 1986). Victorian and Edwardian economic structure was a poor inheritance for the later twentieth century (Crafts 1985). An increasing commitment to the world economy concentrated the British economy on the production of goods from a few sectors, the market and technological prospects for which were not bright. With the stagnation and collapse of the world economy in the years between the world wars, the consequence of this overcommitment was persistent mass employment. In turn unemployment cleared the ground for the acceptance of the ideology of the welfare state and Keynesian economics for a generation or more after the ending of the Second World War. According to Olson (1982), reforms 1

2

New perspectives of the late Victorian economy

after the Second World War must have been a form of 'institutional sclerosis', presumably halted by the advent of Mrs Thatcher's economic policies in 1979. Most of these pessimistic judgements have been strongly contested, among others by Pollard (1989) and McCloskey (1981). Sanderson (1988) and Rubinstein (1988) offer an antidote for the condemnation of British education and class. The present volume casts further light on claims about the performance of the Victorian economy and therefore about its relevance as a model for contemporary society. Some of the essays establish accepted conclusions more firmly by deploying new evidence or methods. Others direct our attention to aspects of the Victorian economy which have been unwarrantedly neglected. A third category reassesses traditional views. The picture offered is a complex and varied one. This was a growing economy, dependent on a rather narrow range of technologies, creating institutions in response to changing aspirations and accumulating experience. At least the monetary sector was still controlled by a doctrine pessimistic about the possibilities of state action and by a small number of influential persons.

1.1 Theory and quantification Not only are the following chapters unified by their concern with the later Victorian economy (which is here taken to include the Edwardian economy as well) but also by a method which the subtitle of the book refers to as 'quantitative'. This term is not especially apt but is adopted here because of the name of the study group to which earlier versions of the chapters were presented. That name in turn reflects the peculiar response of British economic historians to the spread of econometric methods and formal economic modelling into the subject from across the Atlantic during the 1960s {History Today 1985), pp. 36-7). In fact the essays are as united by their use of theory as in their application of numbers. It is theory which gives rise to counterfactuals; what would have happened had things been different? The usefulness of a theory in a historical explanation depends upon the correspondence of its assumptions or premises with the salient facts. Therefore in the present chapter which surveys the main results and approaches of the essays in this book, reference must be made to other studies which do net depend upon any explicit theoretical apparatus. In addition because the chapters only partially cover the later Victorian economy, a brief outline is offered of some other recent quantitative and analytical work on the period.

Quantitative analysis of the Victorian economy Theory is closely linked to quantification. The Victorians poured forth an unprecedented volume of official statistics, and businesses and other private organisations greatly augmented these with their records. Each publisher or keeper of statistics at least originally had in mind a purpose which would be served by the information. Company accounts were originally intended to show shareholders that their capital had not been dissipated or mismanaged. Trade statistics were collected because trade was a source of government revenue. Bank of England lending (bills discounted) was published because the stability of the monetary system which the Bank supervised and, in particular, Bank conformity with the 1844 Banking Act, were matters of public concern. This last is a clear example of theory influencing the generation of data. In the other two cases 'theory' may seem a pretentious term for generalisations such as 'the more imports that enter the country the more revenue can be raised at unchanged tariff rates' and 'credits equal debits'. But even identities, statements which are true by definition, such as credits equal debits, are low level theories which may have profound consequences for the way we view the world (for example Baines 1985, Foreman-Peck 1989a). Money supply statistics and national income accounting are cases in point. The Victorians constructed no official figures for national income, expenditure or output, or for broad money, although a few attempts were made to produce numbers for one or two years by private individuals. Money supply aggregates (Capie and Webber 1985) are in the process of changing our perception of the later Victorian macro-economy. Reconstructions (Deane and Cole 1962, Feinstein 1965, 1972, Greasley 1986) of national income and component aggregates for the nineteenth century, in a manner consistent with modern definitions and theory, have already provided the basis for a continuing reassessment of Victorian economic growth. One of the results of the new data has been the claim that the slowing down of economic growth, in manufacturing at least, was Edwardian, not Victorian (Matthews, Feinstein and Odling-Smee 1982). Cross-national comparisons of national income growth have confirmed the earlier more qualitatively based view of the British economy falling behind those of newer industrialising countries (Maddison 1982).

1.2 The macroeconomic approach Interest in national income accounting is based in large part upon the belief that what is being exhaustively measured is the actual or potential production of goods and services that people want for consump-

3

4

New perspectives of the late Victorian economy

tion. But, in the long term, economic development could cause a divergence of measured national income from the flow of goods and services actually desired. Ignorance of buyers as to the performance or the effects of increasingly complex products, elimination of previously free facilities, goods or services, such as quietness, rights of way, common lands, and the need to pay for additional, formerly unnecessary facilities, including water and sewage services for towns which could be dispensed with in small villages, each of these might lead national income per head to overstate wellbeing, even when due allowance had been made for the distribution of that income. Broadly speaking, O'Brien and Keyder (1978) take this position in their comparison of British and French economic growth in the nineteenth century. The United Kingdom only appeared much better off than France. The reality was that Britain's road to development required the production of more intermediate goods, things not required for their own sake, which were mistakenly counted as final products. An even more influential reinterpretation based upon accounting identities has been that of Crafts (1985). (Private) national output is composed of the constituent industry outputs. By examining the composition and industry productivity growth of national output and comparing this with the development patterns of other nineteenth-century European economies, Crafts concluded that the industrial revolution took place on a very narrow front; it was confined to a few industries and never pervasively affected the economy. Otherwise agriculture and mining would have been unlikely to experience the productivity slowdown they did from the 1870s. The service sector already employed 30 per cent of the workforce at the mid century, a proportion that had risen to 45 per cent by the outbreak of the First World War. Productivity growth in services, at 0.45 per cent per annum 1873-1913, was lower than the national average and tends to support Crafts' judgement about the narrow spread of the industrial revolution (Millward 1988). The Panglossian view of the Victorian economy, that 'everything was for the best in the best of all possible worlds', emphasises that the British economy was supply constrained and that other countries were catching up by utilising a backlog of technology, that given her human and natural resource endowments, was not efficient for Britain (McCloskey 1981). The assumption of this view is that the market 'worked'. Conceivably as others have asserted (such as Elbaum and Lazonick 1986), there may have been a failure to establish institutions that would invest adequately in the

Quantitative analysis of the Victorian economy human capital that was so much more important in the new industries of electrical engineering and organic chemistry than in textiles, coal and iron and steel. Because they were more competitive, these sectors of late Victorian industry which employed lower than average proportions of skilled labour tended to export more than did the skilled labour-intensive sectors (Crafts and Thomas 1986). If the market did not 'work' (optimally) because of monopoly or monoposony power, conventional uses of total factor productivity indices (TFP) which underpin many of the above claims (and some of those of chapter 3) can be misleading (Nicholas 1982, Thomas 1985, Nicholas 1985). By assuming that the economy was not working optimally, it is possible to calculate how fast the Victorian economy could have grown if more resources had been committed to those sectors capable of most rapid expansion and technological progress, taking the American economy of the period as a standard of comparison. Supposing industries with strong growth potential - chemicals, engineering, instrument production, paper and printing, electricity, telecommunications, construction and construction materials - expanded by more than in fact they did, requires that resources were notionally taken away from less dynamic areas - textiles, agriculture, net property income from abroad, domestic service and manufactured gas production and distribution. Expanding the highproductivity, high-growth prospect sectors by plausible magnitudes yields a gain of 4.55 per cent of average GNP by these sectors at the expense of the others. The shift in sectoral size would have raised aggregate-growth rates by 0.56 per cent per year from 1870 so that by 1913, output would have been 126.8 per cent higher than it actually was, a level not in fact achieved until 1946 (Kennedy 1987, pp. 58-77). More extreme but plausible structural shifts could have raised incomes per head by 150-200 per cent by 1913 according to this method of calculation. The aggregate or macroeconomic approach to the Victorian economy (recently synthesised by Lee 1986) offers explanations and hypotheses at a high level of abstraction. The papers in this volume extend our understanding of the Victorian economy by a more detailed analysis of sectors or themes. This is an essential test of, and sometimes antidote to, macroeconomic generalisations. Although the chapters do not present a comprehensive coverage of the issues of the late Victorian economy (there is no analysis of the demographic slow down for instance and little on international economic relations) they do cover the three crucial themes of industrial organisation and technology, wages and living standards, and the monetary system.

5

6

New perspectives of the late Victorian economy

Industrial organisation and technology underpin the record of economic growth and productivity increase discussed in the macroeconomic approach. Analysis of the experience with particular technologies andfirmscan offer explanations more fundamental than is possible at the macroeconomic level. The nature and distribution of the gains from productive activity ultimately justify or condemn an economic system. Hence the standard and cost of living, the extent of economic distress especially among the weakest members of society, and the method by which earnings are established, are no less fundamental economic issues than the efficiency of production. Neglected during the years of ascendancy of Keynesian economics, monetary history of the Victorian economy is well represented in the present volume. The monetarist counter-revolution was led by Friedman and Schwartz's Monetary History of the United States. It is therefore appropriate that in this reinterpretation of the Victorian economy detailed attention is given to monetary institutions, the functioning of the gold standard economy, and the influences upon monetary policy. Before surveying the following chapters, some mention must be made of recent quantitative findings in two important fields not otherwise represented in this volume.

1.3 Later Victorian demography Late Victorian deceleration of population growth became a phenomenon of particular interest to the world after 1945. Poorer countries then experienced population explosions on an even greater scale than that of the British industrial revolution, so that fears of a Malthusian crisis revived. Britain perhaps offered hope that population growth in these countries also would soon slow down. A range of apparently competing explanations have been offered for the decline in fertility towards the end of the nineteenth century. One of the more imaginative but untested explanations was that the Victorian decline was due to corsets. These were allegedly so tight that female reproductive ability was impaired. Consistent with the pattern of fertility decline between the social classes, tight corsets began as a middle-class fashion before spreading down the social ladder. A number of other influences upon fertility have been tested however. Crafts (1984) showed that work opportunities for women were negatively correlated with birth rates between 1877 and 1938 because they increased the opportunity cost of children. He emphasised the costs of birth-control technology and used

Quantitative analysis of the Victorian economy illegitimacy as a measure. As birth-control costs proxied by illegitimacy fell, so too did marital fertility. Extramarital fertility was related to the organisation of work. According to Humphries (1987) it was the need to control fertility that accounted for Victorian sexual segregation at work. That is how she explains her negative correlation across regions between her index of sexual segregation and illegitimacy rates in 1851. Alternatively segregation might have taken place because of labour market discrimination against women; it was a means of maintaining male earnings. In this explanation lower illegitimacy was merely another consequence of segregation, not primarily a social adjustment to inadequate birth-control technology. Turning to mortality, the second influence upon population size and growth, income distribution played a role in the late Victorian and Edwardian economy but legislation to improve safety at work probably did not. Haines (1985) found that infant mortality in England and Wales in 1911 was higher than in the United States in 1900 because of the greater income inequality in England and Wales. The larger English proportion of the very rich held their position at the expense of the lives of some very poor children. Adult mortality was apparently not reduced by the penalties under the 1878 Factory and Workshop Act imposed upon culpable employers on whose premises fatal accidents took place. The small number of inspectors and the low level of fines for violators rendered the Act rather ineffective (Bartrip and Fenn 1988). By contrast the Workmen's Compensation Act of 1897 raised reported fatal accidents. Possibly the greater chance of compensation made those at risk take less care, but the most likely explanation is an increased incentive to report. The third influence upon population size and growth is migration. Late Victorian emigration assumed remarkably high proportions. By the 1880s falling shipping costs had sharply increased the proportion of single labourers, who were quite likely to return, at the expense of the permanent family migration of farmers and craftsmen of the 1840s. The majority of emigrants were not born in rural areas and emigration rates from rural counties were only marginally higher than those from urban counties, (the greater number of Late Victorians lived in towns, not in the country) (Baines 1985). Agricultural depression (itself a response to changes in the world economy) then can hardly have been a major force pushing workers overseas. Internal migration in Britain, unlike France and Sweden, did not respond to nominal wages but to urbanisation (Soderberg 1985). Regional variations in money wages were in any case lower in nineteenth-century Britain than in France, Prussia or Sweden.

1

8

New perspectives of the late Victorian economy

Unfortunately, how much of this, if any, stemmed from smaller spatial price variations in Britain is unknown because of the absence of data.

1.4 Trade, empire and fluctuations The late Victorian economy was extraordinarily open, not only in terms of the outward flow of labour, but measured by international movements of goods and capital also. The trade/GNP ratio of 1913 was not achieved again until the 1970s. Rapidly falling shipping costs, with the advent of the ocean-going metal hulled steamship from the 1850s, boosted international trade and specialisation (Harley 1980, 1988). A necessary condition for increasing international openness was political acquiescence. Since trade rose so rapidly, the British government could both receive a rising revenue from tariffs and reduce tariff levels and coverage (McCloskey 1981). Elsewhere in late Victorian Europe acquiescence was not so easy to obtain. Cheap agricultural produce, especially wheat, depressed European farm incomes and rents. Those affected reacted with demands for higher tariffs. In Britain the agricultural sector had already been overshadowed in importance, politically and economically, by manufacturing and services. Consequently complaints from landlords went largely unheeded, legitimated by the widely held belief that free trade maximised national income. Yet had Britain maintained a higher tariff in the 1880s, she might in fact have been able to enhance her income at the expense of the rest of the world, by shifting the terms of trade, forcing down import prices by reducing the volume of import bought (McCloskey 1981). In principle it is possible for shifts in the terms of trade with the expansion of the export sector to make a country poorer. Selling more exports drives down their prices. Conceivably more resources might be absorbed by the exports necessary to buy a given quantity of imports after the price fall than before. For this later period of the nineteenth century it was not this possibility of trade immiserisation but of capital exports making the country worse off than it need have been, that has exercised scholars. Pollard (1989) concluded it was a question of'short termism'; that short-term earnings were maximised at the expense of long-run income generation. Kennedy (1987) pointed to the low investment in British industry and the capital market giving the wrong signal to investors, from the viewpoint of long-term development. Contrary to much popular opinion the bulk of investment diverted overseas did not go to the British Empire. This misconception might be

Quantitative analysis of the Victorian economy traced to the conflation of the eighteenth-century mercantilist empire with the liberal empire of the nineteenth century and the coincidence of the vastness of the empire at its height in 1913 with enormous overseas investment and income. Very few administrators ran the empire and the British government tried unsuccessfully to ensure that it was self-financing (Davis and Huttenback 1986). Whereas viewed from Britain, investment and empire are frequently seen as disadvantages in retrospect, from abroad they are often represented as gains made at the expense of the host regions. Examination of the British balance of payments for this period and the balance of payments of India, the jewel in the imperial British crown, shows little evidence of exploitative returns, broadly defined, to British investment. Indeed the returns seem rather low (Foreman-Peck 1989a). International channels can be sources of fluctuations in economic activity, but long cycles are traditionally given a technological origin. Cycles offiftyyears duration, Kondratieffs, have experienced an upswing in popularity in recent years, promising to place economic history in front of a wider audience by providing some form of prediction (Lloyd-Jones 1987). Actually a twenty-five year building/population cycle seems to fit the facts better since 1850. This Kuznets cycle is also more plausible, given the normal lags in human reproduction between generations and the need to house new families (Solomou 1988). The likelihood of the structure of the economy remaining unchanged over periods of more than a century seems rather small. Cycles may be expected to have variable durations depending on the economic structure.

1.5 Production: technology, industrial organisation and competitiveness Contemporaries at home and abroad were enormously impressed by the achievements of mid-Victorian industry, exemplified by the glittering success of the Great Exhibition of 1851. Yet during the last quarter of the nineteenth century the ability of Germany and the United States to surpass Britain in the development of industrially useful technologies was becoming obvious. Whereas Britain had been in the forefront of telecommunications in the 1840s with the electric telegraph, the telephone was invented in the United States and was introduced into the United Kingdom under American patents. Thanks to a number of innovators of which Stephenson was the best known, the railway was spread around the world by British engineers, but it was in Stuttgart that Daimler and Benz

9

10

New perspectives of the late Victorian economy

produced the first practical motor car in 1885 and it was from France that the early British motor industry drew much of its technology. When motor production did get under way in Britain, in at least one major engineering firm it had to compete with far more profitable defence contracts and failed to do so (Irving 1975). The British environment seemed to have become far less congenial to industrial innovation. True, Britain was still at the frontiers of technology in the invention of the electric light bulb and in the compound steam turbine for the generation of electricity. But the most financially successful electrical company, GEC, was founded by a German immigrant, the British radio industry was begun by an Italian, Marconi, and Ferranti, whose Deptford power station of 1888-91 led the world, brought his company to the edge of bankruptcy by 1903 (Wilson 1988). The financial incentives were to encourage mergers without the reorganisation essential to compete with the large German and American advanced technology based enterprises (Hannah 1983, pp. 20-1, Davenport-Hines 1984). In chemicals too, Britain's early lead is generally judged to have been lost in the last quarter of the nineteenth century. The Leblanc soda producers neglected to switch to the ammonia process patented by the Belgian Solvay, perhaps because of the formation of the monopoly United Alkali Company in 1890 (Lindert and Trace 1971). Britain left the synthetic dyestuffs industry entirely to Germany. Unlike the pharmaceutical industry in Germany and the United States, British pharmaceutical firms failed to establish research and development departments and eventually suffered losses of market position accordingly (Liebenau 1984). Only in fairly low technology industry did Britain remain at the frontier of innovation through private enterprise. With Starley's invention of the safety bicycle in 1884 the bicycle industry took off and established a substantial export trade. The surgeon Dunlop's pneumatic tyre of 1888 clearly supported this boom. The Bowden brake was also the invention of an amateur, a journalist. The most successful saddle was designed by a Chelsea shoemaker and an Irish clergyman devised the spring clip for attaching a pump to the bicycle. Even in bicycles Starley's innovating firm, Rover, proved incapable of maintaining their early lead and abandoned bicycle production for the more profitable cars soon after the twentieth century began (Foreman-Peck 1983). Only the interests of national defence conjured up support for Marconi's radio and thus contributed to a temporary British lead in this field (Pocock 1988). The above brief survey of the literature of Britain's alleged industrial decline is impressionistic. Although it suggests late Victorian British economic development may have been retarded by an unwillingness or

Quantitative analysis of the Victorian economy inability of indigenous entrepreneurs to introduce both innovative and profitable advanced products and processes in a number of sectors, the survey does not cover the full range of industry. Cantwell's contribution (chapter 2) in the present volume is to provide an index that compares British innovative potential across industries, between countries and over time. He takes a very large number of US patents granted to residents of the major countries of origin and computes some indices first used by Soete. Each industry in each country has a revealed technological advantage (RTA) index. The numerator of the index is a country's share of all patents in an industry taken out by foreigners in the US. The denominator is all US patents taken out by residents of the (non-US) country as a proportion of all US patents taken out by foreigners (35 per cent for the UK 1890-2 and 24 per cent 1910-12). Britain's index of 1.76 for industrial engines between 1890 and 1912 therefore implies that the United Kingdom was more likely to take out a patent pertaining to the industrial engines sector than it was in agricultural machinery, which had an index of only 0.43. Perhaps not surprisingly in view of differences in industrial structure, the ranking for Canada was the reverse, with an RTA for industrial engines of 0.53 and for agricultural machinery of 2.35. At first sight the retardation of British agricultural productivity growth after 1870 could have been a consequence of this low innovation rate, but equally foreign competition and decline made a poor market for agricultural machinery and therefore for innovation. German agriculture was protected yet the German RTA in agricultural machinery was also low at 0.52. Moreover British innovation in agricultural chemicals was better than average. Agricultural decline therefore seems unlikely to explain Britain's low RTA in agricultural machinery. British firms possessed, and maintained through to the 1963-83 period, a strong technological advantage in cleaning agents, industrial engines and turbines, shipbuilding, textiles, rubber products (tyres) and coal and petroleum products. Despite a relatively strong performance in food based multinationals (Chandler 1980), Britain's RTA for food products was apparently low, as it was in pharmaceuticals, paints and other chemicals. Further disaggregation changes the picture somewhat. British firms did have a higher RTA in certain subsectors within the food industry, especially in drinks. Some pharmaceutical subsectors improved in the later period. German firms held a favourable position in chemicals in general, but especially in dyestuffs and paints, and also in lighting and wiring equipment.

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New perspectives of the late Victorian economy

British exports, unlike those of Germany, were mainly manufactured in a small number of sectors, suggesting a strong comparative advantage in production in those areas. The British pattern of innovation across industries is different however. The variation is rather less for Britain than for Germany; sixteen British industries have indices greater than one compared with nine German. British distribution of patents reveals a much weaker comparative advantage in innovation than in production, a harbinger for British manufacturing in the later twentieth century. Understanding British experience in manufacturing is helped by the idea of a 'technological trajectory', introduced by Dosi (1984). A technological trajectory is a sort of dynamic production function representing the possibilities for improved performance from particular broad technologies or industries. Countries which have specialised in newer technologies, those in the early stages of their trajectories, will by definition have greater productivity growth than those specialising in mature technologies. By the late nineteenth century Britain is conventionally described as falling in the second category. Cantwell's test of the stability of technological advantage over time casts more light on the usefulness of Dosi's idea for understanding Britain's economic position. Between 1890/2 and 1910/12 the pattern of technological advantage remained fairly stable although it became less specialised. Britain was locked in to generally mature technologies perhaps because of an inability to develop the corporate organisation which would foster the new technologies. Among the more famous of these maturer technologies were the steam engine and the railway. The debate about the impact of railways in England, Wales and Scotland has led to either agnostic or confused conclusions in the literature on Victorian economic development (Mathias 1983, p. 245, Church 1975). Perhaps because much of the output of the industry was intermediate, productivity calculations for macroeconomic purposes have paid railways scant attention. But the methodological question of how the impact of a new technology should be calculated is at the heart of any interpretation of productivity calculations. If railways provided major inputs to certain industries, yet these inputs were excluded from a TFP index, then the growth of the industries' efficiency will be overstated by the index and incorrectly attributed. The concept of social saving, by how much national income is increased by an innovation, can be seen as a simple form of productivity measurement. Chapter 3 offers new social savings estimates for British railways in

Quantitative analysis of the Victorian economy

13

the years 1865, 1890 and 1910. The order of magnitude as a proportion of GNP for 1865 (10-11 per cent) is similar to Hawke's (1970) highest estimate for England and Wales. Unlike Hawke's measure, the social saving figure of chapter 3 is not computed as an upper bound, that is ignoring the adjustment of demand in a world without railways. The link between productivity increases and the economy's gain from railways is then utilised to acquire further information about the social savings generated by railways in the Victorian economy for 1890 and 1910. The savings turn out to be large, but Hawke's productivity index overstates technical progress after 1865 and a new index is constructed to 1910. This yields an upward biassed 1890 social savings figure of 21 per cent and 27 per cent for 1910. These measures are overstatements because they implicitly assume the absence of technical progress in competing transport modes. Nonetheless they do give some idea of the importance of railways and further support for Craft's view of the narrow base of the industrial revolution. If British railways had attained US levels of productivity growth between 1890 and 1910, GDP in the second year would have been 3 per cent higher. Chapter 3 shows that these social savings estimates can be embedded in a fairly simple growth model to compute some indirect effects which earlier economic historians maintained were important but which were not previously taken into account by the social savings index. The likely long-run impact of the extra saving and investment generated by railways is calculated, as is the impact on the growth of the labour force, through migration, although the construction labour force is excluded from consideration on the grounds that they were not there in the long run. In so doing the chapter points to the distinction not often noted in the railway literature that economic growth is concerned with income per head and therefore to the extent that the innovation induced a larger number of 'heads', economic growth can be reduced, even though total income is enhanced. The most probable effect of the induced savings and investment was to increase the impact of railways by about half again, over the static social savings. The dynamic model raises the issue of 'How big is large?' where induced labour force growth is concerned. 0.1 per cent per annum is suggested as the most likely dynamic effect, a proportion that sounds small until it is remembered that labour force growth as a whole was only around 1 per cent per annum. Contrary to much opinion, the later Victorian economy saw an advance in state ownership of industry. Railway nationalisation was mooted as early as the 1844 Railway Act and the telegraph system was

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New perspectives of the late Victorian economy

nationalised under acts of 1868 and 1869 (Foreman-Peck 1989b). Moreover the supply of local services was gradually municipalised. In view of the Thatcher government policy of reversing the tendency towards state ownership, the reasons for the Victorian local government acquisitions of gas and water are of particular interest (Foreman-Peck 1989c). Two general possibilities present themselves: that the market did not work or that the state was captured by interest groups, such as rate payers, who saw an opportunity to enhance their own wellbeing at the expense of others (such as share holders) by state ownership and regulation. Millward (chapter 4) opts for the first alternative. Distribution networks for both gas and water created a high proportion offixedcosts in total costs so that initially unit costs fell, as both customers and the volume of gas or water consumed increased. As the geographical boundaries of the supplier expanded, unit costs eventually began to rise because of the distance the gas or water needed to be piped from the storage point to the household. That created the opportunity for competing suppliers to enter the geographical market and charge lower prices. Competitors' unit costs were lower because they supplied only a portion of the market. The resulting duplication of facilities raised costs and prices above the level they need have been. Private statutory monopoly proved an unsatisfactory solution because armslength regulation did not give the necessary control over quality, safety and price. Regulation was therefore 'internalised' by municipalisation, and public welfare was increased. Millward's account draws upon recent work on 'contestable markets' (Baumol 1982). This focuses upon the threat of entry as a means of holding down a monopolist's price. A contestable market is one in which entry and exit are so easy that the incumbent firm, though a monopoly because of the nature of industry costs, will price as cheaply as a competitive firm of the same size. The contestability literature is dependent upon the incumbent maintaining the same price after a competitor enters as before. That might seem implausible for a profit maximiser who would be more likely to cut prices as low as marginal costs to see off any new competition even if that entailed short run losses. However when the price of the established supplier was regulated, as was likely because of monopoly power, freedom to change prices even downwards could have been curtailed. Even with temporary price competition the resulting industry equilibrium was likely to have higher costs than necessary; there is some evidence of this in the Victorian railways (Foreman-Peck 1987) and in American late nineteenth-century oil industry experience (Telser 1987). Declining competitiveness has been measured primarily in loss of

Quantitative analysis of the Victorian economy export and home market shares and by alleged failures to introduce best practice technology. Nicholas's (chapter 5) study of over 400 multinational enterprises (MNEs), of which over 200 were founded between 1870 and 1914, introduces another dimension into the debate. The ability to establish a successful subsidiary in another country indicates a degree of competitiveness because at least, in developed countries, local firms have the advantage of knowing the environment better and one country's MNE subsidiaries have to compete against those of other countries. Nicholas examines the claim that foreign competition shifted British foreign direct investment (FDI) into the allegedly 'soft' markets of the British Empire. Canada unilaterally introduced Empire tariff preference in 1897. This favouring of British over, say, American imports must have reduced the incentive for the British to undertake foreign direct investment in Canada, since the desire to jump tariff barriers has been a major motivation for establishing multinational subsidiaries. Restrictions on the investment of other countries'firmsin Empire countries will have created a less competitive environment for British MNEs but such restrictions were mainly a phenomenon of the interwar years (Svedberg 1981). Exclusion of British investors by other world powers was a fear that encouraged colonial acquisitions in West Africa towards the end of the nineteenth century. To the extent that there was such exclusion then British MNEs would have been crowded into British territories, rather than choosing them for fear of more intense competition elsewhere. Nicholas's sample shows that 28 per cent of MNE's production plants went to the developed Empire and 6 per cent to the undeveloped empire before 1914. In the more protectionist interwar years the Empire total increased from 34 per cent to 52 per cent. Before 1914, the single most popular first choice for production branches of British companies was Germany and the second was the United States. Of course the economic importance of these markets was greater than any single Empire country, but these new data at least contradict the simple generalisation about inversion of British companies before 1914, that most direct investment went to the Empire. Chemicals was the most important product category upon which British foreign direct investment concentrated, followed by food and textiles. Nicholas's archival evidence shows that FDI 'bunched' into a very few years, which he hypothesised was due to perceived managerial economies in setting up overseas subsidiaries. Nicholas' model seeks to explain the decision in his sample to change from a sales branch overseas to a production branch in terms of production, location and transactions costs variables. Transactions costs are the costs of monitoring and polic-

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New perspectives of the late Victorian economy

ing a particular organisational form of economic relation. They clearly differed between an agency without sole loyalty to the company and a wholly owned production subsidiary. These costs therefore influenced the optimum organisational form. Production costs are those associated with particular technologies. They determine whether a British enterprise will have had an advantage in a particular sector. Location costs include tariff barriers and local market size which influence the desirability of choosing a particular national location for a plant. The qualitative (binary) dependent variable requires the use of logit regression since the dependent variable is bounded between zero and unity, contrary to the assumption of ordinary least squares regression. In addition to the production cost variables which confirmed the competitive advantage in chemicals and food, 'psychic proximity', proxied by whether or not the English language was native, was a significant positive location cost variable, and the number of branches a parent firm operated abroad and product diversification were significant positive transactions costs variables. Each of these influences increased the chances that a production branch rather than a sales branch would be chosen. If Britain had less diversified or fewer multiplant companies than her industrial competitors, as seems likely, then these results explain or predict a lower degree of multinationality of her firms.

1.6 Distribution: wages, the cost of living and the social security system Most people in industrial societies primarily work to live rather than live to work. How industrial and technological changes influenced the possibilities for consumption is therefore of fundamental importance to wellbeing. Recent studies of living standards have concentrated on outward manifestations rather than on problems of measuring dimensions. Thus the impact of greater longevity on generalised living standards has been computed using techniques for estimating the willingness to pay for reductions in risk of death (Williamson 1984). Others have measured increases in height as an indicator of living standards (Floud and Wachter 1982). Estimates of the distribution of money income show Victorian Britain was a land of great inequality of income, wealth and opportunities in comparison with present day Britain (Soltow 1968, 1971, Lindert and Williamson 1982, Williamson 1982, 1985), as well as in comparison with other nineteenth-century European countries and the United States

Quantitative analysis of the Victorian economy

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(Kuznets 1966, pp. 208-11). Skill differentials were wider in the nineteenth than in the twentieth century, although they were being reduced between 1880 and 1911 (Jackson 1987). Studies of inequality are concerned with the interpersonal distribution of income, which in turn is related to the functional distribution. If the functional distribution is tilted towards labour and away from capital and land, the interpersonal distribution will tend to become more equal because capital and land ownership are very unequally distributed. Since the bulk of the population gained their income from labour, there were two principal elements to living standards, money wages and the cost of living. Like all index numbers, the cost of living at best measures only the position of the average family, not those with slightly different tastes or habits, or in different circumstances. Charles Booth's survey of London life and labour, beginning in 1886, postulated a London poverty line based on the bare necessities and therefore effectively proposed using fixed weights, independent of actual expenditure patterns in a cost of living index. Subsequent researchers have preferred a more empirical approach based upon actual consumption patterns. The historical problem has been to obtain a large enough sample of appropriate price series with suitable weights (reflecting expenditure patterns) to make an accurate judgement about changes in the average workers' real purchasing power. That in turn raises questions of appropriately allowing for varying expenditure patterns (which strictly requires changing weights), of allowing for quality change and quality differences in the products consumed, of including new products that enter consumption for the first time within the period of study and of the exclusion of obsolete goods and services. Even the basic items of consumption create difficulties. Bread is a fairly simple case. The average retail price of a 4 lb loaf in London fell from 7-ld in 1880-2 to 5-2d in 1895-7 rising to 5-7d in 1910-12. By contrast, because of changes in fashion and durability, clothing raises far greater problems. Clothing, food, heating and lighting and housing were the bare necessities of life. The Ministry of Labour estimated that in 1914 the average working-class family in the United Kingdom distributed their expenditure across food, fuel and light, rent and clothing in the proportions 15:2:4:3. Although tobacco and alcohol were not necessities they formed a considerable portion of, generally underreported, expenditure which slowly changed with technology, income and attitudes. Beer was an important source of nutrition, sold in a number of forms. In 1890 one brewery charged 4d a quart for 'running ale', 6d for bitter ale, 3^d for

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New perspectives of the late Victorian economy

porter and 5d for light bottled beer (New Survey 1930, p. 95). National British beer consumption in 1882 according to official figures amounted to 27 million barrels of 36 gallons, equivalent to about 220 pints per year for every man, woman and child in the United Kingdom. Or if only one quarter of the population drank beer, almost two and a half pints a day. At the 1899 peak, annual recorded consumption reached 260 pints per head. Tobacco prices after 1900 began to rise with the imposition of taxes but tobacco consumption increased even more rapidly. Tobacco consumption underlines at least one interesting major problem about living standards. Is the consumer the best judge of what constitutes a higher living standard? If so then working-class living standards, measured by this index, must have been rising in Edwardian Britain, unless there was a great deal of substitution away from other products. Elementary school education was not free although it was compulsory after 1880 and therefore in principle entered the working-class budget. Rising subsidies over the nineteenth century increased working-class access to state schools charging fees at levels below comparable private schools (Mitch 1986). From 1891 universal access to elementary schools was made easier by the abolition of fees in the state sector. Feinstein's (chapter 6) reassessment of changes in the cost of living between 1870 and 1913 originated in a concern that his earlier estimates for Edwardian national income and expenditure were too low. The output data show no Edwardian slowdown relative to the last twenty years of the nineteenth century but the income data reveal an extraordinary deceleration and the retardation indicated by the expenditure series is also sharp. The largest single component of the income series is wages and these data imply that money wages rose more slowly in the Edwardian period of rising prices than they had in the previous phase of declining prices, despite an increase in trade union membership. Falling labour productivity in manufacturing, mining and construction was a major contributor. Contrary to Arthur Lewis (1978), movements in the terms of trade do not seem to have been important. In the present work Feinstein revises Bowley's cost-of-living index, which had a limited coverage and related to a low family income. Feinstein uses 1900 household expenditure weights from Prest's (1954) estimate of consumers' expenditure in that year. Feinstein employs a wider range of prices than Bowley, although still mainly from London. The new series does not fall as sharply as Bowley's between 1880 and the mid 1890s (about 6-7 per cent) but there is little difference between the indices in the upswing. When combined with his new wage data (Feinstein 1990a,

Quantitative analysis of the Victorian economy 1990b), Feinstein can show that Edwardian employment real income increased at about 0.6 per cent per annum instead of declining at 0.5 per cent per annum. An important dimension of living standards is not just real wages but the likelihood of unemployment and the conditions and amount of unemployment benefit. A variety of working-class savings institutions, friendly and cooperative societies, savings banks, and industrial life insurance companies, provided afinancialbuffer to absorb the uncertainties of economic life (Johnson 1985). When savings were exhausted, credit was supplied by pawnbrokers, money-lenders and local shopkeepers. Workers needed resources for illness and old age, as well as for unemployment. State old age pensions, introduced in 1909, raised life-time living standards, increasing private savings for retirement. Pensions did not encourage the taking of greater leisure by earlier retirement (Johnson 1984). The effects of state unemployment benefits cannot be judged until the interwar years, since they were only available from 1913. For those permanently unable to work, the chronically sick, the insane, or children under working age, the state social support system was a crucial element in their wellbeing. The Victorian Poor Law nominally at least provided for all these categories, although the able bodied unemployed were supposedly discouraged from seeking Poor Law relief by the infamous principle of iess eligibility' embodied in the 1834 Poor Law Act. By the middle of the nineteenth century conditions were not invariably as bad as Dickensian caricatures suggest. The mentally disturbed agricultural labourer poet John Clare spent a considerable portion of his later life in a Poor Law institution in Northampton where he was encouraged to write, paint and wander round the village. The social stigma of the Poor Law, and the vigilance of the Guardians, was nonetheless sufficient to deter all but the desperate from applying for relief. Southall (chapter 7) turns to Poor Law statistics for evidence of the spatial distribution of economic distress. He is particularly concerned to establish whether Poor Law data confirm his earlier results from trade union unemployment series (Southall 1986, 1988) that a North-South divide already existed in Victorian Britain and did not first emerge in the interwar years. When detrended and smoothed, the Poor Law series resembled the trade union data, with a similar power spectrum despite their different client groups. (A power spectrum indicates for each periodic component of a stationary time series the share of the overall variance in the time series that can be attributed to the periodic components or frequencies.) With only 5 per cent of the population in receipt

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New perspectives of the late Victorian economy

of relief even in depressions and most of these not able-bodied males, it might be questioned whether one ought to expect similar behaviour of trade union and Poor Law series. However in 1868/9 there were riots in Blackburn over the Guardians' policy and therefore a considerable number of able bodied men must have thought themselves eligible for relief. The proportion was however very small. In July 1868 able-bodied males in receipt of relief amounted to only 0.65 per cent of all employable males, although contrary to the mythology of the Poor Law, 85 per cent of these were on 'out-relief, they were not obliged to enter the workhouse. By 1909 the Poor Law had virtually ceased supporting able-bodied males, the task had been assumed by the trade unions, if at all. In January the Amalgamated Society of Engineers alone paid relief to two thirds of the numbers of able-bodied supported by the Poor Law. National time series do show industrial workers and paupers with not dissimilar seasonal and cyclical patterns. Building workers and paupers were greatly affected by the seasons though the metal trades were not. To isolate the regional pattern mainly for the 1860s, Southall employs stepwise regression to identify the sources of pauperdom and concludes from the explanatory power of his trend variable that the policy of individual Boards of Guardians was the major factor. The Lancashire Cotton Famine caused by the Northern blockade of Southern ports during the American Civil War was a break in Poor Law policy. In 1863 10.3 per cent in Lancashire were on relief. In general though, Poor Law relief for able-bodied males was centred in the low wage, wheat growing, rural south; Wiltshire ranked behind Lancashire in 1863 with 7.9 per cent on relief. This observation is consistent with a continuing high degree of local rate-payer control of Poor Law policy. Farmers maintained a pool of labour on relief to ease agricultural labour supply at periods of peak demand especially harvest time. In industrial areas the need was quite different and so were the resources. Merely to preserve order during troughs of severe depressions the Guardians would be obliged to pay relief to the able-bodied unemployed, since the majority were not covered by trade union benefits and in any case union resources would be quickly exhausted. Bargaining institutions can exercise considerable influence over the share of wages in national income as well as over the efficiency with which the economy worked. Nominal wage rigidity fell (Hatton 1988), encouraged by the growth of trade union membership and strength in the late Victorian and Edwardian years; unions were concerned to maintain or enhance real wages, which in periods of rising prices, needed frequent

Quantitative analysis of the Victorian economy

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increases in nominal wages. New statutes gave unions greater ability to bargain their members' wages upwards. Disraeli's government in 1871 and 1875 legislated that unions could legally engage in any actions 4in contemplation or furtherance of a trade dispute' which would not be illegal for individuals. Unions might still be liable for civil conspiracy actions though. During the 1880s an increasing public concern with social problems such as the sweated trades and overcrowding in housing, and the formation of socialist organisations, culminated at the end of the decade in what came to be called the New Unionism, the organisation of unskilled workers. The London dockers' strike, the formation of the Miners Federation of Great Britain by a number of local miners' organisations and the establishment of gas workers' and general labourers' unions all took place in 1889. In response, a Royal Commission sat between 1891 and 1894. The Report of 1894 concluded, largely on the basis of the leading employers' testimony, that industrial relations were at their best when strongly organised trade unions voluntarily negotiated with stable employers' associations. In this way unofficial strikes were avoided. Official strikes and lockouts were inevitably industry wide in such a bargaining regime. The Engineering Employers' Federation lockout of the Amalgamated Society of Engineers in 1897 arose over the introduction of new technology by employers and its resistance by the Union (Lewchuk 1987, pp. 70-7). Unions seemed to employers to be holding back productivity growth (Phelps Brown 1983, pp. 44-6). Trade unions were not incorporated and therefore could not be sued for the damage such restrictive practices or strikes caused until the courts introduced a change of procedure, with the Taflf Vale judgement of 1900, and the House of Lords confirmed that decision in 1901. Immediately after Taff Vale, strikes were less frequent, but the economy was not booming either. Regression analysis of strike frequency in these years shows that strikes increased with business activity and profits, as well as with unionisation (Bean and Peel 1976). A one per cent increase in the rate of change of union membership was associated with a one half per cent increase in the number of strikes, holding other influences constant. The 1906 Act introduced complete immunity for trade unions from actions at tort, against the initial wishes of the Liberal government. The king can do no wrong; neither can a trade union' it was said. Labour militancy reached a pre-war peak in 1912, vividly described by Dangerfield in the Strange Death of Liberal England. Coal was a crucial industry not only as the principal fuel source for

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New perspectives of the late Victorian economy

industry but because, as Britain's productivity growth in manufacturing fell behind that of the newly industrialising states, her comparative advantage shifted towards exploitation of her natural resources where her inability to match the industrial efficiency of Germany and the USA mattered much less (somewhat analogously to the shift towards North Sea oil at the end of the 1970s). Pencavel (1976) calculated that the spread of formal trade unionism on the coal fields from about two thirds of the labour force unionised in 1900 to four fifths in 1913 reduced efficiency through the adoption and maintenance of restrictive practices so that coal output was lower by 2-3 per cent in 1913 than it would have been at 1900 levels of unionisation. Extrapolating his results to compare a completely non-unionised industry with a 100 per cent union membership industry, he concluded output was lowered by 22 per cent by unionisation. Treble (chapter 8) examines the wage bargaining arrangements in this vital industry. There was rent dependent upon the fluctuating price of coal to be divided between the coal mine owners and the workforce. The value of the marginal product of the minprs also varied with the price of coal. Both were potential sources of industrial strife. The arbitration scheme analysed by Treble emerged from the 1893 strike as a means of resolving conflict in a manner that would be mutually advantageous. Such was the economic importance of the coal industry that within two weeks of the breakdown of talks in 1893, the Prime Minister wrote to the parties suggesting that the Foreign Secretary chair another negotiating session. Treble adopts the assumption of neoclassical institutional economics that institutions are optimal responses to the economic environment and seeks to understand what the properties of the arbitration system were. The stability of the bargaining machinery was a measure of success, he maintains. The two parties in the bargaining process had access to different information. This gave rise to a problem of designing bargaining institutions so as to ensure each had incentives to tell the truth even when the other could not know whether the truth was being revealed. The conciliation board functioned as a means of committing the parties and this was part of the solution to the bargaining problem. Whereas the boards were solutions to cooperative games, the second stage was a non-cooperative game, the rules of which were part of the solution to the cooperative problem. The two tier bargaining structure of the rules for the non-cooperative game consisted of, first, the parameters chosen every three years and second, the bargaining over actual agreements with those parameters, when the price of coal changed. Some informal evidence suggesting that perfect equilibrium may have obtained is that there was

Quantitative analysis of the Victorian economy

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usually only one offer and one counter offer in each negotiation. Thanks to the institution of the conciliation board, each player knew the chain of possible actions and reactions that would follow from playing a particular strategy. Therefore the players could and did reach a solution without going through all those moves. In contrast with much neoclassical institutional economics, Treble's analysis has the merit of providing a testable prediction - the number of bargaining rounds - and a test of efficiency or optimality - the number of strikes under the regime. Measured by this last criterion conciliation boards performed well. Frequency of resort to the arbitrator is also a prediction that drops out of Treble's model, when coupled with further information about the possibilities for delay in the arbitration process. The terms of an implicit sliding scale linking coal prices and wage rates were the subject of negotiations. When coal prices rose, employers were able to delay passing on the increase in higher wages in Northumberland and South Wales and therefore there were frequent appeals to the arbitrator. By contrast the Federated Area, Scotland and Durham had few opportunities for delay and low rates of appeal to the arbitrator.

1.7 Money: the gold standard, monetary institutions and monetary policy Around 1873 prices and interest rates began a downward drift which was not halted until the mid 1890s. Then began a rise lasting until the outbreak of the First World War. The first period is often thought of as a depression because of the effects on arable farming, well represented in the House of Lords, but nowadays depression is generally thought to have been confined to monetary variables, the price level and interest rates, not real variables such as output and employment (Saul 1969). There is some evidence of a climacteric in economic growth but on statistical grounds it does not seem robust (Crafts et al. 1989). Although the bulk of money in circulation consisted of bank deposits the period is known as the age of the gold standard, for the Bank of England was legally obliged to exchange its notes for gold. Gold sovereigns, with a weight which defined the pound sterling, were much more widely used than notes. Bank deposits themselves could be exchanged for notes or coin and so the entire monetary edifice rested upon a fairly small stock of gold and widespread confidence that the public would not all at once demand gold instead of other forms of money. If confidence in the convertibility of deposits or notes into gold began to slip, the rising

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New perspectives of the late Victorian economy

demand for gold was known as an 'internal drain'. The corresponding 'external drain' arose when sterling assets were exchanged for foreign assets and the sterling foreign exchange rate slid below the lower 'gold point'. That was the exchange rate at which it was profitable to sell sterling for gold and incur the insurance and transport costs necessary to ship the gold abroad for sale. In the light of the international turmoil between the world wars, the nineteenth-century gold standard regime has long been regarded as a success story, although the evidence points to the 1950-72 regime as more effective (Foreman-Peck and Michie 1986). The fundamental objective of gold standard monetary policy was to maintain convertibility and the principal policy instrument was the Bank Rate, the interest rate at which the Bank of England might be prepared to lend to selected banking institutions which were experiencing temporary difficulties in meeting the drain. Other institutions would also raise interest rates and the greater benefits to be gained from lending, together with the confidence imparted by the Bank's lending, was generally sufficient to restore the status quo. If other assets, such as building society deposits or trade bills, were close substitutes for money, then interest rates on these assets would also rise during a crisis. Contractions of the money supply could be offset by expansion of such 'near money'. The Bank of England's success in preventing external drains sufficient to deplete Bank gold stocks maintained Britain on a fixed exchange rate relative to other gold standard countries. Supporting the external value of the currency was made easier by the United Kingdom's net asset position and the deposits of foreign banks in London, (Collins 1988). On the other hand, measurement of the effective money supply, which should include these foreign deposits, is made more difficult, since their total volume is unknown. World gold stock growth slowed at the same time as there was a scramble for monetary gold, when Germany abandoned silver for gold in 1873 and the US prepared for the return to the gold standard in 1879. Early monetary explanations for the depression of prices often foundered on the parallel movement in prices and interest rates dubbed the Gibson paradox. It was thought that if prices were falling because of monetary scarcity then interest rates should have risen, not fallen. In order to examine this 'paradox' and to cast further light on the working of the late Victorian economy, Capie, Mills and Wood (CMW, chapter 9) construct a four equation model explaining the changes in output, the interest rate, the price level and the money stock in terms of lagged values of these variables. They consider two hypotheses. The first is that the late Victor-

Quantitative analysis of the Victorian economy

25

ian economy was a small country (with a fixed exchange rate) in the sense that prices and interest rates were determined by world conditions, and the British money stock was determined by these and the growth of domestic income. The second hypothesis is that the British economy was large enough to influence world conditions and therefore the growth of the domestic money supply influenced domestic output, prices and interest rates. CMW use an autoregressive system to examine these hypotheses. A descriptive account of such systems can be obtained from an analysis of the system's response to typical random shocks (Sims 1980). The residual in an estimated money autoregression equation has been labelled a 'money innovation' because it is new in the sense that it has not been predicted from past values of the variables. The 'innovation' in, say, money is assumed to disturb all other variables of the system instantly according to the strength of the contemporaneous correlation of other residuals with the money residual. The endogenous variable residual (innovation) is only allowed to affect the endogenous variable in the initial period. Both of the hypotheses give broadly similar results with this method; interest rates do not appear to affect other variables, prices affect interest rates substantially to begin with but as the period wears on, output and money come to be stronger influences upon interest rates. Money and output appear to influence prices, but prices have a weaker effect upon money and output. (For criticisms of Sims's econometric approach see Malinvaud 1988 and Pagan 1987.) On the basis of these innovation accounting decompositions and the coefficient estimates, CMW specify and reestimate two more restricted structural models, one for Mo, the money definition that includes only notes and coin, the other for M3, which in addition includes domestic bank deposits. Contrary to much traditional economic historiography of the period (for example Mathias 1983, p. 367), money did strongly influence prices. Interest rates did influence output. Interest rates responded to M o monetary shocks indirectly through the effects on output and prices. Monetary expansion did not lower interest rates initially unless the effect was over within one year. Irving Fisher's explanation for the Gibson paradox is borne out; that expectations of price declines made lenders willing to accept lower interest rates, since the purchasing power of their money, when it was returned, was enhanced. Turner (chapter 10) addresses the question, to what extent were near money assets substitutes for money in the late nineteenth century? Some of the interest in this question arises because the answer determines the

26

New perspectives of the late Victorian economy

possibilities open for monetary policy to control the economy. Late Victorian Britain was unusual among the more advanced economies of the time in not exhibiting a decline in the ratio of money to income. In the US, Canada, Norway and Sweden the fall in the money-income relationship was due to a shift towards industry, which was an intensive user of money, away from agriculture, which was not, as income grew (Bordo and Jonung 1981). Subsequently in Britain and these other countries the money-income ratio began to rise as money substitutes developed. In fact money substitutes in 1880 accounted for almost one fifth of Turner's definition of broad money (Bank deposits + notes and coin + Trustee Savings Bank (TSB) deposits + Post Office Savings Bank deposits + Building Society (BS) deposits). By 1913 these money substitutes had increased their percentage of the total by 4 per cent. National monetary institutions followed different courses often by historical accident and exercised differing influences upon national economic development. Because owners of the stock exchange building were not brokers in London but were in New York, the nineteenthcentury London stock exchange became a much larger and more influential institution than its New York counterpart (Michie 1987). New York aimed to restrict entry so as to maintain profit margins, London wanted more brokers to bid up rent. British bank deposits and Post Office deposits were growing more rapidly than the British average while TSB and BS deposits grew less rapidly between 1880 and 1913. Each component of near money was supplied by non-profit organisations, a condition which some might suggest would have restricted their growth relative to comparable profit organisations. In other words with a different institutional structure the rise in the money to income ratio might have begun earlier. Alternatively Britain's institutional structure may have been unusually favourable to branch banking, lacking the prohibitions on interstate banking of the United States. Turner finds non-bank financial intermediary (NBFI) deposits were close substitutes for money. Expansion of these NBFI deposits because of institutional innovation therefore carried very similar implications for gold flows as did money. A declining form of near-money, commercial bills, was supplied by private institutions. Turner finds these were not close substitutes for money defined as bank deposits plus notes and coin. He also tests Nishimura's (1971) hypothesis that the decline was a consequence of the spread of the telegraph which enhanced the effectiveness of bank deposits. Hefindsno significant relationship between the volume of telegrams sent and the volume of commercial bills, holding constant

Quantitative analysis of the Victorian economy the volume of world trade, the rate of interest and GNP. Rather, bills appear to be an 'inferior' asset; fewer were demanded at higher levels of incomes. Turner's use of cointegration techniques are explained in his appendix. The key idea is that if there is a stable long-run relationship between two or more variables then the residuals in their (cointegrating) regression must show no trend over time. When such a relationship exists it will be possible to describe the short-run links between the variables by an 'error correction mechanism' (ECM), an equation which explains changes in the dependent variable by means of changes in the independent variables, their lagged levels and lagged values of the level of the dependent variable. The lagged levels variables in the ECM serve to identify the long-run equilibrium relationship. An alternative estimation procedure therefore is to substitute for these variables the lagged residuals from the cointegrating regression. Although the rules of the central bank policy eventually hardened into dogma in the first half of the nineteenth century, the market never knew whether the Bank would follow Bagehot's later maxim and lend copiously in times of panic or internal drain'. Formally, the Bank of England was still a privately owned profit seeking institution. During the 1890s the Bank was competing aggressively for business against the banks that it was supposed to regulate. Yet the Bank of England's monopoly privileges were exchanged for some obligations which extended beyond managing the government's debt. Lovell (1957) has claimed in one of the earliest essays in econometric history that, on the basis of the positive correlation of lending and bankruptcies, the Bank during the eighteenth century began to act as a lender of the last resort in a way which would not be expected of a simple profit maximiser, even though there was no announced policy. As part of an investigation which employs both written primary sources from the Bank archives and a massive weekly data set, Ogden (chapter 11) finds a similar, but not statistically significant, relationship in the years between 1870 and 1914. In this instance she is obliged to use annual data to establish a positive association with bank failures rather than bankruptcies. She reports similarfindingsfor correlations with Bank rate. Her tests raise a question about the meaning of Lovell's correlation and an issue in econometric methodology about the proper treatment of autocorrelation. Autocorrelation in a time series regression equation is the correlation of successive residuals which violates the assumptions of the ordinary least squares statistical model, rendering suspect tests of sig-

27

28

New perspectives of the late Victorian economy

nificance on the estimated coefficients of the equation. Ogden removes the autocorrelation by a method due to Cochrane and Orcutt, and finds that the coefficients are no longer significantly different from zero. Another approach (Hendry and Mizon 1978) is to regard the presence of autocorrelation as a symptom that the equation is not correctly specified. Instead of employing the Cochrane-Orcutt transformation, the proper response, Hendry and Mizon maintain, is to respecify the equation by experimenting with the lag structure and/or introducing new variables. A statistically insignificant relationship in the first approach conceivably may become a significant one with the second. A much larger experiment Ogden conducts is the attempt to identify 'periods of tension', heavy discounting, which are not referred to in the laconic Board minutes. She fits polynomial time trends to data on discounts and identifies twenty-six points more than three standard deviations from the mean as periods of tension. Only five of these can be linked with previously recognised crises in 1873, 1878/9, 1890, 1907 and 1914. A support operation for the Yorkshire Penny Bank constitutes a sixth identifiable period of heavy discounting. Thanks to the rational expectations revolution in economics, the unwillingness to state the circumstances under which the Bank would intervene, or to announce when support had been given, that persisted to the days of Bagehot, may be given a rational explanation (Begg 1982). Commercial banks that could count on the Bank bailing them out when in difficulties would lose incentive to avoid becoming illiquid. Either by its publicly revealed behaviour, its announcements or lack of announcement, the Bank may have wished to convey uncertainty about whether or not it would intervene in a crisis, so as to encourage prudent banking. The City of Glasgow Bank was allowed to fail in 1878 because it was insolvent (asset values were less than liabilities) whereas the Clydesdale Bank in the same year, Barings in 1890 and the Yorkshire Penny Bank in 1911, were rescued because they were merely illiquid (they could not convert their assets into cash quickly enough).

1.8

Conclusion

US patent data point to a British economy locked into a mainly mature technological trajectory which served the country less well as the twentieth century progressed. The economy was heavily reliant upon railways, yet this was a sector with rather low productivity growth, certainly in comparison with American railways. In many respects this

Quantitative analysis of the Victorian economy

29

dependence mirrored that of exports, where cotton was king. Such concentration might indicate that gains from specialisation according to comparative advantage were being reaped, but it also left the economy vulnerable to changing technological and political circumstances, as events of the 1920s were to show. Until the shock of the First World War the economy continued to grow at rates which looked reasonable by historical standards. British firms demonstrated their competitiveness by establishing subsidiaries abroad in large numbers, not merely in protected Empire markets. Nonetheless, dissatisfaction with the workings of Victorian private enterprise in some sectors was sufficient to encourage creeping state ownership, in gas and water for instance. New cost of living data, when linked with a revised wage series, allow the Edwardian period to be reinterpreted as years of growth of real income, rather than decline. Conditions diverged markedly between the industrial North and the rural South (and London was quite different from both). A significant proportion of the agricultural workforce were on Poor Relief in the 1860s because of the seasonal nature of their work. But only during cyclical crises were even small numbers of industrial workers able to exercise any claim on the social security system. Wages were now more rarely set by reference to custom; trade unions increasingly participated in the process. In the coal idnustry, the potentially indeterminate bargain between union and employers' association was rather efficiently resolved by the mechanism of arbitration boards, a neglected area of Victorian institutional success. By contrast with the later twentieth century, the late Victorian economy was untroubled by inflation. Only at the end of the century did prices begin a sedate rise. The domestic money supply did influence the price level though, not merely the balance of payments. The link of the currency with gold, or the accompanying ideology of small, balanced government budgets, underpinned the stability of monetary growth and therefore also the stability of the price level. Most financial transactions were conducted by means of assets other than gold. Continuing financial innovation (rather than the spread of the telegraph) ensured that traditional assets, especially the inland bill, were replaced by newer instruments, such as bank deposits. Control of the monetary sector was, despite this innovation, still vested in a fairly small group of people. That meant that an influential governor at the Bank of England could, by moral suasion, implement monetary policy at a lower cost than when Bank decisions were taken by less powerful men.

30

New perspectives

of the late Victorian

economy

References Baines, D. (1985) Migration in a Mature Economy: Emigration and Internal Migration in England and Wales 1861-1900, Cambridge University Press. Barnett, C. (1986) The Audit of War: the Illusion and Reality of Britain as a Great Nation, London: Macmillan. Bartrip, P. W. J. and Fenn, P. T. (1988) 'Factory fatalities and regulation in Britain 1878-1913', Explorations in Economic History 25: 60-74. Baumol, W. J. (1982) 'Contestability: an uprising in the theory of industrial structure', American Economic Review, 72: 1-15. Bean, R. and Peel, D. A. (1976) 'Business Activity, labour organisation and industrial disputes in the United Kingdom, 1892-1938', Business History, 18: 205-11. Begg, D. K. H. (1982 ) The Rational Expectations Revolution in Macroeconomics: Theories and Evidence, Oxford: Philip Allan. Booth, C. (1902) (ed.) Life and Labour of People in London, London: Macmillan. Bordo, M. D. and Jonung, L. (1981) T h e long run behaviour of the income velocity of circulation of money in five advanced countries, 1870-1975' Economic Inquiry, 19: 96-116. Capie, F. and Webber, A. (1985) A Monetary History of the United Kingdom 1870-1982, London: Allen and Unwin. Chandler, A. D. (1980) T h e growth of the transnational firm in the United States and the United Kingdom: a comparative analysis', Economic History Review, 33: 396-410. Church, R. A. (1975) The Mid-Victorian Boom 1850-73, London: Macmillan. Collins, M. (1988) Money and Banking in the United Kingdom: A History, London: Croom Helm. Crafts, N. F. R. (1984) A time series study of fertility in England and Wales 1877-1938', Journal of European Economic History, 13: 571-90. (1985) British Economic Growth During the Industrial Revolution, Oxford: Clarendon Press. Crafts, N. F. R. and Thomas, M. (1986) 'Comparative advantage in UK manufacturing trade, 1910-1935', Economic Journal, 96: 629^45. Crafts, N. F. R., Leybourne, S. J. and Mills, T. C. (1989) T h e climacteric in late Victorian Britain and France: a reappraisal of the evidence', Journal of Applied Econometrics, 4: 103-17. Dangerfield, G. (1966) The Strange Death of Liberal England, London: Macgibbon and Kee. Daunton, M. J. (1985) Royal Mail. The British Post Office Since 1840, London: Athlone Press. Davenport-Hines, R. P. T. (1984) Dudley Docker: The Life and Times of a Trade Warrior, Cambridge University Press. Davis, L. E. and Huttenback, R. (1986) Mammon and the Pursuit of Empire: the Political Economy of British Imperialism 1860-1912, Cambridge University Press.

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Deane, P. and Cole, W. A. (1962) British Economic Growth 1688-1959: Trends and Structure, Cambridge University Press. Dosi, G. (1984) Technical Change and Industrial Transformation, London: Macmillan. Elbaum, E. and Lazonick, W. (1986) The Decline of the British Economy, Oxford University Press. Feinstein, C. H. (1965) Domestic Capital Formation in the United Kingdom 1920-38, Cambridge University Press. (1972) National Income, Expenditure and Output in the United Kingdom, 18551965, Cambridge University Press. (1990a) 'What really happened to real wages? Trends in wages, prices and productivity in the United Kingdom, 1880-1913', Economic History Review, 43. (1990b) 'New estimates of average earnings in the United Kingdom, 1880-1913' Economic History Review, 43. Floud, R. and Wachter, K. W. (1982) 'Poverty and physical structure: evidence on the standard of living of London boys 1770-1870', Social Science History, 6. Fogel, R. W. (1964) Railroads and American Economic Growth, Baltimore: Johns Hopkins University Press. Foreman-Peck, J. S. (1983) 'Diversification and the growth of the firm: the Rover Company to 1914', Business History, 25: 179-92. (1987) 'Natural monopoly and railway policy in the nineteenth century' Oxford Economic Papers, 29: 699-718. (1989a) 'Foreign investment and imperial exploitation: balance of payments reconstruction for Britain and India 1815-1914', Economic History Review, 42: 354-74. (1989b) 'Competition, cooperation and nationalisation in the nineteenth century telegraph system', Business History, 312: 81-101. (1989c) 'Privatization of industry in historical perspective', Journal of Law and Society, 16: 129-48. Foreman-Peck, J. S. and Michie, R. (1986) 'The performance of the nineteenthcentury gold standard' in W. Fischer, R. Marvin Mclnnis and J. Schneider (eds.) The Emergence of a World Economy 1500-1914, Pt II. London: Franz Steiner. Friedman, M. (1962) Capitalism and Freedom, University of Chicago Press. Friedman, M. and Schwartz, A. (1963) A Monetary History of the United States, Princeton University Press. Greasley, D. (1986) 'British economic growth: the paradox of the 1880s and the timing of the climacteric', Explorations in Economic History, 23: 416-44. Haines, M. (1985) 'Inequality and childhood mortality: a comparison of England and Wales 1911 and the United States 1900', Journal of Economic History, 45: 885-912. Hannah, L. (1983) The Rise of the Corporate Economy, London: Macmillan.

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Harley, C. Knick (1980) Transportation, the world wheat trade, and the Kuznets Cycle, 1850-1913', Explorations in Economic History, 17: 218-250. (1988) 'Ocean freight rates and productivity 1740-1913: the primacy of mechanical invention confirmed', Journal of Economic History, 48: 813-50. Hatton, T. J. (1988)'Institutional change and wage rigidity in the UK 1880-1985', Oxford Review of Economic Policy, 4, 1: 74-86. Hawke, G. R. (1970) Railways and Economic Growth in England and Wales 1840-1870, Oxford University Press. Hendry, D. and Mizon, G. (1978) 'Serial correlation as a convenient simplification, not a nuisance', Economic Journal, 88: 549-63. History Today (1985) 'What is economic history?', 35: 35-43. Humphries, J. (1987) \ .. Most free from objection... the sexual division of labour and women's work in nineteenth-century England', Journal of Economic History, 47: 929-49. Irving, R. J. (1975) 'New industries for old: some investment decisions of Armstrong-Whitworth 1900-1914', Business History, 17: 150-75. Jackson, R. R. (1987) 'The structure of pay in nineteenth-century Britain', Economic History Review, 40: 561-70. Johnson, P. (1984) 'Self-help versus state help: old age pensions and personal savings in Great Britain 1906-1937', Explorations in Economic History, 21: 329-50. (1985) Savings and Spending: the Working-Class Economy in Britain 1870-1939, Oxford: Clarendon Press. Kennedy, W. P. (1987) Industrial Structure, Capital Markets, and the Origins of British Economic Decline, Cambridge University Press. Kuznets, S. S. (1966) Modern Economic Growth: Rate, Structure and Spread, New Haven: Yale University Press. Lee, C. H. (1986) The British Economy since 1700: A Macroeconomic Perspective, Cambridge University Press. Lewchuk, W. (1987) American Technology and the British Vehicle Industry, Cambridge University Press. Lewis, W. A. (1978) Growth and Fluctuations 1870-1913, London: Allen and Unwin. Liebenau, J. (1984) 'Industrial R&D in pharmaceutical firms in the early twentieth century', Business History, 26: 329-46. Lindert, P. H. and Trace, K. (1971) 'Yardsticks for Victorian entrepreneurs' in D. N. McCloskey (ed.) Essays on a Mature Economy: Britain after 1840, London: Methuen. Lindert, P. H. and Williamson, J. G. (1982) 'Revising England's social tables, Explorations in Economic History, 19: 358-408. Lloyd-Jones, R. (1987) 'Innovation industrial structure and the long-wave: the British economy c. 1873-1914', Journal of European Economic History, 126: 315-37. Lovell, M. C. (1957) 'The role of the Bank of England as lender of the last resort in

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the crises of the eighteenth century', Explorations in Entrepreneurial History, 10:8-21. McCloskey, D. N. (1981) 'Did Victorian Britain fail?' in Trade and Enterprise in Victorian Britain: Essays in Historical Economics, London: Allen and Unwin. Maddison, A. (1982) Phases of Capitalist Development, Oxford University Press. Malinvaud, E. (1988) 'Observation in macroeconomic model building', Presidential Address European Economic Association, Bologna. Mathias, P. (1983) The First Industrial Nation, second edition, London: Methuen. Matthews, R. C. O., Feinstein, C. H. and Odling-Smee, J. C. (1982) British Economic Growth 1865-1973, Oxford: Clarendon Press. Mearns, A. (1883) The Bitter Cry of Outcast London, London. Michie, R. C. (1987) The London and New York Stock Exchanges, 1850-1914, London: Allen and Unwin. Millward, R. (1988) 'The UK services sector, productivity change and the recession in long-term perspective', Services Industry Journal, 8: 263-76. Mitch, D. F. (1986) 'The impact of subsidies to elementary schooling on enrolment rates in nineteenth-century England', Economic History Review, 39:371-91. New Survey of London Life and Labour (1930) Forty Years of Change, vol. 1, London: P. S. King. Nicholas, S. J. (1982) 'Total factor productivity growth and the revision of post-1870 British economic history', Economic History Review, 35: 83-98. (1985) 'British economic performance and total factor productivity growth 1870-1914', Economic History Review, 38: 576-82. Nishimura, S. (1971) The Decline of Inland Bills of Exchange in the London Money Market 1855-1913, Cambridge University Press. O'Brien, P. K. and Keyder, C. (1978) Economic Growth in Britain and France 1780-1914: Two Paths to the Twentieth Century, London: Allen and Unwin. Olson, M. (1982) The Rise and Decline of Nations, New Haven: Yale University Press. Pagan, A. (1987) 'Three econometric methodologies: a critical appraisal' Journal of Econometric Surveys, 1: 3-24. Pencavel, J. H. (1976) 'The distributional and efficiency effects of trade unions in Britain', British Journal of Industrial Relations, 15: 137-56. Phelps Brown, H. (1983) The Origins of Trade Union Power, Oxford: Clarendon Press. Pocock, R. F. (1988) The Early British Radio Industry, Manchester University Press. Pollard, S. (1985) 'Capital exports 1870-1914: harmful or beneficial', Economic History Review, 38: 489-514. (1989) Britain's Prime and Britain's Decline: the British Economy 1870-1914, London: Edward Arnold. Prest, A. R. (1954) Consumer's Expenditure in the United Kingdom, 1900-1919, Cambridge University Press.

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Rowntree, B. Seebohm (1902) Poverty: a Study of Town Life, third edition, London: Macmillan. Rubinstein, W. D. (1988) 'Social class, social attitudes and British business life', Oxford Review of Economic Policy, 4, 1: 51-8. Sanderson, M. (1988) Technical education and economic decline: 1890-1980s, Oxford Review of Economic Policy, 4, 1: 38-50. Saul, S. B. (1969) The Myth of theGreat Depression 1873-1896, London: Macmillan. Saxonhouse, G. R. and Wright, G. (1984) 'New evidence on the stubborn English mules and the cotton industry 1878-1920', Economic History Review, 37: 507-19. Sims, C. A. (1972) 'Money, income and causality', American Economic Review, 62, 4: 540-52. (1980) 'Macroeconomics and reality', Econometrica, 48: 1-48. Soderberg, J. (1985) 'Regional economic disparity and dynamics 1840-1914: a comparison between France, Great Britain, Prussia and Sweden', Journal of European Economic History, 14: 273-98. Solomou, S. (1988) Phases of Economic Growth 1850-1973: Kondratieff Waves and Kuznets Swings, Cambridge University Press. Soltow, L. (1968) 'Long run changes in British income inequality', Economic History Review, 21: 17-29. (1971) 'An index of the poor and rich of Scotland 1861-1961', Scottish Journal of Political Economy, 18: 17-29. Southall, H. (1986) 'Regional unemployment patterns among skilled engineers in Britain', Journal of Historical Geography, 12: 268-86. (1988) 'The origins of the depressed areas: unemployment, growth and regional economic structure in Britain before 1914', Economic History Review, 41: 236-58. Stead, W. T. (1901) The Americanisation of the World, London: Review of Reviews. Svedberg, P. (1981) 'Colonial enforcement of foreign direct investment', Manchester School, 39: 21-38. Telser, L. G. (1987) A Theory of Efficient Cooperation and Competition, Cambridge University Press. Thomas, M. (1985) 'Accounting for growth 1870-1914: Stephen Nicholas and total factor productivity measurement', Economic History Review, 38: 560-75. Wiener, M. J. (1981) English Culture and the Decline of the Industrial Spirit 1850-1980, Cambridge University Press. Williams, E. E. (1896) Made in Germany, London: Heinemann. Williamson, J. G. (1982) 'The structure of pay in Britain 1710-1911' in P. Uselding (ed.) Research in Economic History, 7: 1-54. (1984) 'British Mortality and the Value of Life 1781-1931', Population Studies, 38: 157-72. (1985) Did British Capitalism Breed Inequality? London: Allen and Unwin. Wilson, J. F. (1988) Ferranti and the British Electrical Industry, 1864-1930, Manchester University Press.

PARTI

Technology and Industrial Organisation

The idea that 'where you start from determines where you end up' has had considerable currency in theories of technological change. An economy with resources concentrated in one particular industry will gain experience which will allow further improvements in the technology of that industry. In terms of figure I.I ray OA might be the technology for chemicals and ray OB the technology for industrial engines. As drawn chemicals are more capital intensive than industrial engines. For a given state of technical knowledge, points on the rays closer to the origin O, using fewer inputs of capital and labour, produce lower outputs. Technical progress shifts towards O at least one point on the constant output curve joining CD. A technological trajectory (chapter 2) implies that movements down one ray will be easier or faster than movements down another. An interpretation of the problem of measuring the impact of railways is a shift outwards along one ray or even the elimination of one ray (chapter 3). Railways might be ray OA and competing transport modes, OB. At point E railways produce more transport with less need for both labour (F) and capital (G) than the other modes. Abolishing railways would move the economy to D with greater demands for labour (H) and capital (J) to supply the same volume of transport. Capital

0

H

Figure 1.1 Choice of technique 35

Labour

36

New perspectives on the late Victorian economy Costs C

0

A

D

Distance

Figure 1.2 Spatial costs and competition

Competition between firms in space, such as are the concerns of chapters 4 and 5, can be represented in figure 1.2. A is a gas company, the production cost of whose gas is given by the AB. Distribution costs rise with distance from the point of production (BC). How far it is worth extending the distribution network depends upon whether another firm, D, is already supplying gas, or may enter the market at that point. If D does enter, then at all points to the right of E, firm D's costs will be less than firm A's. Since firm A does not know where D will enter the market, A is likely to avoid substantial investment in a large network, because the larger the network, the higher the chance that some portion of it may be rendered redundant by later entry. Where setting up a subsidiary overseas is concerned, company headquarters will prefer lower cost location A to D, other things being equal. With the same distribution costs, A will be able to compete in a larger market, at a given world price. But even though an existing plant D is less efficient than A, it will still undercut A's products in its own market unless A establishes a subsidiary next to D. A measure of the vitality of an economy's industry is the willingness and ability to set up profitable plants like A in foreign locations close to D.

Chapter 2

Historical trends in international patterns of technological innovation John Cantwell

2.1 Introduction It is frequently argued by economic historians that Britain's technological decline relative to countries which industrialised later can be dated to the Victorian period (Habakkuk 1962, Landes 1969).1 One factor which has been suggested to explain this relative decline is the disadvantages which were due to British industry's early start, making a switch to newer methods of production more costly (a theme discussed by Jervis 1947, Frankel 1955, Saville 1961, Kindleberger 1961, Habakkuk 1962, Ames and Rosenberg 1963, Aldcroft and Richardson 1969, amongst others). Generally underlying the early start thesis is the belief that production methods in different parts of an industry or an economy are interrelated, such that it is costly to change one component of a production process or the methods prevailing in an individual sector without complementary changes elsewhere. This idea can be allied to an argument which has become popular more recently in the literature on the economics of technological change. The proposition has been advanced that technological innovation proceeds as a cumulative process, and that as a consequence it tends to iock in' to a particular course, once that course has become established. This proposition has been seen as relevant in a variety of contexts. One suggestion is that where there is competition between rival technologies for adoption it is possible that adopting firms become 'locked in' to a potentially less efficient technology following the choice of the earliest adopters (Arthur 1989). The decisions of the earliest adopters affect the decisions of the firms that come later. One reason is the role of technological interrelatedness, whereby a supporting infrastructure of complementary technologies become better developed, lowering the costs and increasing the benefits of adopting a technology which is already more widely diffused. Other reasons for cumulative gains from adoption are the improvements made through learning by using; the network externalities that are created by a growth in the network of users such that each benefits from a 37

38

New perspectives on the late Victorian economy

greater availability and variety; and the presence of increasing returns in information about the technology as it diffuses. These factors may combine to set in motion a process of cumulative causation in the adoption of one type of technology ahead of another. Despite the technical advantages possessed by alternative systems, the petrol driven motor vehicle won out over the steam driven, and the VHS video recorder is gradually displacing the Sony Betamax (Arthur 1989). David (1985) refers to the locking in of technological development to a particular standard model or design, using the example of the QWERTY keyboard used in typewriters and word processors. These are all illustrations of cumulative or path-dependent processes in technological change, even if their origins lie in small historical events in which chance plays a role. They are path-dependent in the sense that the probabilities (of adoption of a certain kind) are influenced by past decisions which constrain the limits of existing choices, as portrayed in statistical theory by a Markov process or a Polya process (Arthur, Ermoliev and Kaniovski 1987). The choices available may vary with location, according to differences in the past experience of thefirmsbased in each country or area. From this it can be seen that the firms of a given country may find themselves 'locked in' to a path of technological change which ultimately offers them less opportunities than are available to the firms of other countries who have begun along alternative paths, but after a time it is very costly and difficult for them to switch. The proposition that technological change is cumulative is therefore relevant to explaining the historical evidence of differential rates of innovation across countries or national groups of firms. It suggests that innovation is liable to 'lock in' to a particular industrial pattern or configuration in any location, and that this pattern is likely to change only gradually over time since a shift towards sectors in which technological opportunities are rising most rapidly may not be easy to achieve. It is in this context that the proposition of cumulativeness is examined in this paper. The proposition of cumulativeness is examined using historical evidence, by testing the extent of continuity in the industrial pattern of innovation. The issue is whether the sectoral composition of technological activity 'locks in' to a particular course for each national group of firms, and if so over what periods of time this tends to persist before shifts in the pattern of innovation become apparent. This is related to the theory of technological accumulation, which has been most clearly articulated by Pavitt (1987), although similar theories which build upon the idea of

Historicaltrendsininternationalpatternsoftechnologicalinnovation

39

cumulativeness in technological change can be found in other recent literature (most notably Rosenberg 1982, Nelson and Winter 1982 and Dosi 1984). Pavitt argued that technology isfirm-specific,cumulative and differentiated, and consequently that the industrial composition of innovative activity in a given location or amongst a given national group of firms reflects past technological accumulation. This suggests that international patterns of technological advantage, having been established, will remain relatively stable over time at least in the short or medium term. The sectors in which each group offirmsis technologically strongest changes only gradually. In the theory of technological accumulation, the view that innovation is cumulative is just one of three connected but separate propositions. The others are that innovation proceeds incrementally and that it is differentiated between firms and locations as described below. It is the iock in' effect associated with cumulativeness, however, which suggests the hypothesis that the sectoral composition of innovation amongst thefirmsof an industrialised country is by and large stable over periods often or twenty years. This hypothesis is statistically tested here, against the alternative hypothesis that technological change follows a random course, in which the relative strength of innovative activity is likely to regularly switch between industries. The alternative hypothesis would suggest that there are no substantial problems of interrelatedness in switching between different types of technology. In association with these statistical tests, changes over time in the degree of technological specialisation of each national group offirmsare examined using a related statistical procedure. The degree of technological specialisation is a measure of whether the innovation of the firms in question is highly concentrated in a few industries, or more broadly spread across a wider range. It should be noted that the proposition under investigation here refers to the cumulativeness of technological development in terms of the industrial composition of innovation, rather than in terms of its overall rate or rapidity for each national group of firms. The question of why German firms on average enjoyed a faster rate of innovation than British firms at the turn of the twentieth century is only addressed indirectly. The principal issue is the nature of the comparative advantage held by each national group of firms in technology creation, and the stability of that pattern of comparative advantage over time. This may then, as has been argued above, have some bearing on which national group innovates most rapidly if US and German firms historically and Japanese firms today have a comparative advantage in sectors in which technological

40

New perspectives on the late Victorian economy

activity is growing fastest, and each group is 'locked in' to its own particular pattern of comparative advantage. This supplementary issue is also examined in what follows. Which industries offer the greatest technological opportunities is conditioned by the prevailing techno-economic paradigm that characterises innovation in each historical period (Freeman and Perez 1988). The second proposition of the theory of technological accumulation is that innovation develops incrementally, so that firms tend gradually to move between related sectors. Although the underlying technology and skills continue to build upon the past, the industrial applications may gradually change, a particularly extreme case of which may come about with the formation of new industries. This proposition calls for further extensive historical research, and so it is not explored in any depth here, but it is simply noted that it is in line with thefindingsof Rosenberg (1976 and 1982). However, the proposition implies that the industrial composition of innovation amongst each national group of firms may shift over longer historical periods. Statistical tests are conducted to show for which groups of firms this happens and the extent to which it happens in each case. In addition, descriptive evidence is presented on how the sectoral pattern of innovative activity of particular national groups of firms has actually evolved, paying particular attention to historical evidence on the technological development of British firms. The final proposition of the theory of technological accumulation is that innovation is differentiated between firms and locations. That is, the path of technological development followed by a particular firm or in a particular location is distinctive and characterised by elements that are specific to that firm or location. This proposition itself is not examined here, as to do so thoroughly would require intra-industry and microeconomic evidence which lies beyond the scope of the chapter. It is simply noted that even where British firms performed relatively well in innovation, the characteristics of their technological development may well have been different from those of their American or German competitors. Returning, then, to the central proposition of cumulativeness, it is implied that day-to-day adaptation of technology, through an interaction between its creation within a firm and its use in production, has a more pervasive influence than the major technological breakthroughs which give rise to entirely new production processes. Even radically new technologies, once they move beyond the purely scientific and experimental stage, often rely upon or are integrated with earlier technologies in the

Historicaltrends in internationalpatterns oftechnologicalinnovation

41

course of their development (Usher 1954). For this reason, innovation tends to gather a certain logic of its own through the continual refinement and extension of established technologies. As specific technological experience is accumulated, the further development of production within the firm throws up new requirements, which its research and engineering departments must try and meet. Improvements tend to set the stage for their own future problems, which compel further modification and revision through the adaption of production by innovative firms. Until there is a new stream of innovations based on a different set of fundamental discoveries, firms at the existing frontier of progress tend to establish dynamic advantages over others in the same industries. This helps to explain why, for example, German firms in the chemical industry have maintained a strong tradition for a period of at least a hundred years. It may also explain why, despite their failure to move as fast as others into the newer science-based sectors, Britishfirmsat the turn of the century remained dominant in technological development in textile machinery, railway engines and shipbuilding (Walker 1980). They were locked in to areas of innovation which had once ensured the success of British industry, but at a time when technological opportunities had begun to rise more rapidly elsewhere. In any given industry, firms based in certain leading countries where a tradition has been established tend to push forward with a sequence of innovations conditioned by the prevailing technological opportunities. These firms are geared up to problem-solving activity (increasingly through corporate R&D in the twentieth century) and production engineering in areas of technology in which they have accumulated a wealth of practical experience. There is a strong interaction between those responsible for production, who are utilising the latest processes available as they become feasible, and engineering and research support staff. Such firms are capable of generating strong technological advantages, in part through the assimilation of the relevant features of complementary foreign technologies. However, the patterns of technological advantage across national groups offirmscan also be expected to change gradually or incrementally over time. In order to examine statistically the combined significance of cumulativeness and incremental change in innovation, an index of technological advantage was calculated for selected years spanning a period stretching back into the last century. The index was drawn up for each of the major industrialised countries. For a cross section of industries, the index measures the strength of innovative activity of the firms of each

42

New perspectives on the late Victorian economy

country, and it is constructed for the period 1963-83, and for selected years before 1914. It is an index of 'revealed technological advantage', and is calculated in much the same way as the index of 'revealed comparative advantage', familiar from the literature on international trade (see Balassa 1965). In this case the index measures comparative advantage in innovative activity rather than comparative advantage in trade. For the industrial sector of any country, its revealed technological advantage (RTA) is given by the country's share of US patents taken out by foreigners in that sector, divided by its total share of US patents due to non-US residents. Hence, when the RTA index assumes a value greater than one the country concerned is relatively advantaged in that sector, while a number less than one indicates that its firms are relatively disadvantaged. Such an index was first used by Soete (1980). The revealed technological advantage in industry i for the firms of country j is thus defined as RTA;, = (PijttjPijyGiPi/ZZjPtj) where Ptj is the number of US patents in industry / granted to residents of country/

2.2 A description of the data The suitability of patent data as a measure of technological advantage is now quite well documented (for a review of the literature see Pavitt 1985). While it is true that some innovations are never patented, and that some patents either have little qualitative impact or are never used, this leads principally to systematic industry-specific and countryspecific differences, as it seems that firms from the same sector in any country have a similar propensity to patent. Scherer (1983), using US patent data, found that most of the variation between firms in the propensity to patent was to be explained by the extent of their research effort (as measured by R&D expenditure). Once interindustry differences are allowed for, patenting as a measure of innovative output is strongly correlated across firms with a widely used measure of innovative input. Allowing that for thefirmsof a given country certain interfirm intrasectoral differences in the propensity to patent do exist, it seems reasonable to conclude that their variance is systematically lower than intersectoral differences. It can then be hypothesised that on relatively large numbers, the propensity to patent of a given national group of firms cannot be

Historicaltrends in internationalpatterns oftechnologicalinnovation

43

expected to have any systematic bias as compared with a notional industry average. A similar formulation could be applied equally well in the case of intranational group differences in the propensity to patent in a given industry. Here, however, this additional assumption is not required as the RTA index is examined separately for the firms of each country, as will become clear. The RTA index is normalised for both interindustry and intercountry differences in the propensity to patent. The use of foreign patent data is further supported by the findings of Soete and Wyatt (1983), that there is a strong intercountry correlation between foreign patenting and R&D, and a strong interindustry correlation between foreign and domestic patenting. Moreover, the USA as a host to foreign patenting represents an important market for firms from the countries under comparison, so that they regularly take out patents there. The USA grants a higher number of patents to non-residents than any other country. A highly significant correlation between national shares of R&D and patenting in the USA was observed by Pavitt (1982). Data on foreign patenting in the US, organised by industry and country of origin, has been compiled by the Office of Technology Assessment and Forecast (OTAF) for years from 1963 onwards. Before 1963, the US Index of Patents provides a list of all patents granted in the USA by alphabetical order of the patentees, showing their state or country of origin. A brief description of each patent follows, with a patent number, such that if this is inadequate the complete description can be consulted in a separate catalogue. Using this source, US patents granted to foreigners can be allocated to the relevant countries and industries, just as OTAF has done for recent years. For this paper, patent counts were made for the years 1890-2 and 1910-12. Table 2.1 indicates the importance of patenting in the USA to a number of technologically advanced European firms that had interests in the USA before 1914. It has to be admitted that the use of foreign patenting activity in the USA before 1914 in the assessment of technological advantage is likely to be much less reliable than it is when working only with recent data. For a start, the assumption that for the firms of a given country the propensity to patent innovations can be treated over large numbers of observations as varying only with industry-specific factors is much more questionable. Moreover, it cannot be assumed that before 1914 there was the same interindustry correlation between foreign and domestic patenting that exists today. The importance of international activity, and of the USA as a market and a source of competition, may well have varied between firms

44

New perspectives on the late Victorian economy

Table 2.1

A list of 30 leading European companies patenting in the US before 1914

Chemicals Badische Anilin & Soda Fabrik (Germany)** Bauer & Co. (Germany) Bayer (Germany)** Burroughs & Wellcome (UK) Cassella & Co. (Germany)* Deutsche Gold & Silber-ScheideAnsalt (Germany)* Geigy & Co. (Switzerland)* Heyden (Germany)* Kalle & Co. (Germany)* Lever Brothers (UK) Merck (Germany)* Nobel (France) Society of the Chemical Industry (Switzerland)* Solvay (Belgium)* United Alkali Co. (UK)*

Electrical equipment Bosch (Germany) Howard & Bullough (UK)* Marconi (UK)* Orenstein (Germany) Siemens & Halske (Germany)* Smidth & Co. (Denmark) Motor Vehicles Daimler Motor Co. (UK)* Fiat (Italy) Rolls (UK) Rubber tyres Dunlop (Ireland/UK)* Michelin (France)* Textiles Courtaulds & Co. (UK) Linen Thread Co. (UK)

Metals Deutsche Metallpatronen Fabrik (Germany) Metallurgische Gesellschaft (Germany) Notes:

Denotes granted over 10 patents. ** Denotes granted over 100 patents. Source: US Index of Patents, various issues.

in the same industries. Indeed, individual inventors, with no formal affiliation to any firm, played a more prominent role at that time. For these reasons, historical comparisons must be treated with caution. However, it would be unfortunate if a valuable source of evidence on historical patterns of technological advantage were to be entirely ignored for the purposes of statistical analysis. The RTA index can be conveniently compared over long periods of time, providing it is recognised that it is likely to change due to an improved representation of innovative activity, as well as due to actual changes in the sectoral pattern of technological advantage. Dutton (1984) provides evidence that patenting in the nineteenth century was linked to economic activity, since even though individual inventors played a greater role they frequently had links with industry. Table 2.2 sets out the numbers of US patents granted to residents of the

Historical trends in internationalpatterns oftechnological innovation Table 2.2

45

The total number of US patents granted to residents of the major countries of origin

Country of origin

1890-2

%

1910-12

%

1963-83

%

USA

66,766 6,084 2,145 1,378

91.6

95,022 12,285 2,970 3,961 1,673 1,031

88.6 11.4

929,133 416,113 55,028 101,864 22,160 38,956 4,560 4,072 23,733 14,621 5,125

69.1 30.9

Non-US total

UK Germany Canada France Austria (-Hungary) Australia Switzerland Sweden Belgium and Luxembourg Ireland Italy Denmark Netherlands Spain Japan

975 548 198 147 139 101 54 44 31 22 19 17 6

8.4 2.9 1.9 1.3 0.8 0.3 0.2 0.2 0.1 0.1 0.1 0.0 0.0 0.0 0.0 0.0

439 284 310 318 149 37 175 94 56 35 34

2.8 3.7 1.6 1.0 0.4 0.3 0.3 0.3 0.1 0.0 0.2 0.1 0.1 0.0 0.0

309 13,299 2,760 12,317 1,316 94,046

4.1 7.6 1.6 2.9 0.3 0.3 1.8 1.1 0.4 0.0 1.0 0.2 0.9 0.1 7.0

Source: Cantwell (1989b).

major countries of origin in 1890-2, 1910-12 and 1963-83. The ten foreign countries (counting Belgium and Luxembourg together) whose firms were granted the most patents before 1914 are today still all amongst the top thirteen. They are the UK, Germany, Canada, France, Austria, Switzerland, Australia, Sweden, Italy and Belgium and Luxembourg. They have been joined by Japan and the Netherlands, as shown, and by the USSR which is excluded from the analysis as it raises a quite different set of institutional considerations. When considering the most recent period it is also feasible to include the US (for which RTA is calculated as US firms' share of all patents granted, rather than all patents granted to foreigners) and three other EC countries (Denmark, Ireland and Spain). Portugal and Greece are excluded as they have not attained very high levels of patenting in the USA even in recent years. It should be made clear that for the recent period (1963-83), the cross-industry variation in the RTA index for any country predominantly reflects the structure of innovative activity amongst national groups of firms (especially the largest firms including multinationals), rather than that country's domestic industrial structure. This is because in the data on patent counts used for 1963-83, patents were in general registered by and thus attributed to parent companies, irrespective of the location of

Table 2.3

Indices of revealed technological advantage for the major industrialised countries in the periods (i) 1890-1912 and (ii) 1963-1983 UK

Sector

(i)

Food products 0.63 Chemicals, n.e.s. 0.70 Synthetic resins 1.03 Agricultural chemicals 1.21 Cleaning agents 1.47 Paints, etc. 0.17 Pharmaceuticals 0.72 Ferrous metals 1.11 Non-ferrous metals 1.05 Fabricated metal products 0.87 Mechanical engineering, n.e.s. 1.04 Agricultural machinery 0.43 Construction equipment 0.90 Industrial engines 1.76 Electrical equipment, n.e.s. 1.25 Transmission equipment 1.02 Lighting and Wiring 0.90 Radio and TV receivers 1.21 Motor vehicles 1.09 Shipbuilding 1.53 Transportation equip, n.e.s. 1.05 Textiles and clothing 1.34 Rubber products 1.75 Non-metallic mineral products 0.97 Coal and petroleum products Professional instruments Other manufacturing

Germany (ii)

Canada (ii)

France (ii)

Austria

Australia (ii)

Switzerland (ii)

(>)

00

(i)

0.75 0.99 0.77 1.18 1.22 0.65 1.20 0.93 0.93

1.37 0.83 0.00 1.17 1.32 0.09 1.55 1.14 0.76

0.74 0.50 0.48 0.62 0.40 0.92 0.70 2.58 2.00

0.85 0.43 0.00 0.00 0.69 0.00 0.90 1.99 0.40

1.80 0.56 0.55 0.98 0.64 0.99 0.60 1.54 1.52

1.90 1.01 7.87 0.00 1.29 1.78 1.41 0.59 0.74

1.36 1.85 0.78 2.05 1.31 0.93 1.55 0.61 0.73

0.78

1.10

0.97

1.26

1.12

1.66

0.58

0.85

0.96 2.19

1.05 0.34

0.93 1.01

1.09 0.81

1.25 1.20

0.98 3.14

0.99 3.62

1.12 1.18

1.01 1.37

1.18 0.53

1.70 0.70

0.20 0.99

1.06 1.00

1.64 0.67

2.41 0.76

1.47 0.82

1.51 0.93

0.34 0.99

0.85 0.59

0.86

0.95

0.74

1.29

1.11

1.49

0.63

0.64

0.53

0.97

0.68

0.97 1.38 1.72 0.70 0.74

0.90 0.94 0.62 1.20 0.64

0.69 0.40 0.26 1.56 0.72

1.18 1.78 0.60 1.04 2.19

1.29 1.40 0.00 1.35 0.99

1.17 1.13 0.63 1.15 1.29

0.00 1.81 0.00 0.56 0.00

0.47 0.35 0.71 0.80 0.12

1.28 0.53 0.00 1.15 1.11

0.51 0.97 0.28 0.93 1.90

1.60 0.50 0.00 0.89 0.00

0.91 0.64 0.34 0.65 0.47

1.44 1.17 1.03

0.62 0.85 0.62

1.07 1.18 1.06

1.53 0.90 0.60

1.00 0.48 0.93

1.16 0.94 1.21

1.35 0.89 0.94

1.12 0.86 0.44

0.93 0.44 0.92

1.24 1.83 1.19

0.80 0.80 0.97

0.2! 1.26 0.32

0.76 1.64 0.64

1.27

0.99

0.85

1.19

0.84

0.71

1.11

1.89

1.15

1.10

1.13

0.83

0.52

(ii)

(i)

0.96 0.90 0.73 1.11 1.54 0.93 1.02 0.81 1.01

1.26 1.68 0.47 0.28 0.78 2.82 1.41 0.90 1.03

0.61 .18 .29 .06 .02 .24 ().88 13.82 (3.70

0.34 0.27 1.68 1.47 0.99 0.16 0.63 1.03 0.87

1.39 0.62 0.32 0.49 0.30 0.64 0.57 1.01 1.50

1.34 1.22 0.57 0.50 0.19 0.28 0.91 0.78 1.23

1.10

1.01

193

1.45

1.53

0.98 0.95

0.89 0.52

1.12 0.86

0.91 2.35

1.15 1.27

0.89 0.46

0.97 1.06

1.04

0.70

1.10 1.17 0.80 1.02 1.30

(i)

(i)

(i)

1.47

1.48

1.15

0.66

0.17

2.77

0.89

1.32

1.39

0.58

0.00

0.75

0.00

0.25

0.96 0.98

0.84 0.87

0.96 0.90

0.94 0.80

1.02 1.68

0.71 2.26

0.94 0.82

0.84 0.96

0.97 0.82

0.87 1.91

1.14 0.98

1.09 1.74

2.43 0.70

0.94 0.84

(ii)

0)

(ii)

~Belg. & Lux. (i) (ii)

US

(i)

(ii)

Japan (ii)

1Neth. (ii)

Denm. (ii)

Spain (ii)

Ireland (ii)

0.92 1.06 2.02 0.00 2.65 0.14 0.58 0.71 1.02 1.21 1.19 3.48 1.41 2.26 1.05 1.23 1.02 0.00 0.26 0.54 0.84 0.10 0.33 0.57 0.00 1.39 0.62

0.96 0.31 0.08 0.50 0.76 0.30 0.62 .61 .09 .67 .29 .52 .74 .13 ().84 1.22 1.03 0.32 0.99 1.82 1.25 0.40 0.71 1.14 0.38 0.82 1.54

0.44 0.95 0.00 7.64 1.43 0.00 0.63 .31 .92 ().52 .15 1.31 1.53 1.22 1.44 3.56 1.84 3.39 1.40 3.48 1.97 0.45 0.00 0.46 1.13 0.75 0.38

0.71 1.29 1.98 1.21 0.72 0.94 1.50 0.75 0.62 0.85 1.20 0.73 1.06 0.60 0.76 0.94 1.29 0.64 0.80 0.77 0.87 0.95 1.17 0.74 0.63 0.62 1.10

1.80 1.57 0.00 0.00 1.45 0.92 0.00 0.89 0.28 1.12 0.87 0.33 0.78 0.99 1.36 0.90 0.37 0.00 1.43 0.59 0.77 0.34 1.08 2.02 4.60 0.26 0.82

1.08 0.91 0.92 0.84 1.01 1.01 0.79 0.83 0.88 1.10 0.96 1.10 1.04 0.87 1.01 1.03 1.09 0.92 0.94 1.03 0.98 0.92 1.01 1.00 1.26 0.99 1.13

1.06 0.87 1.29 0.75 0.79 1.28 1.02 1.13 1.18 0.74 0.81 0.35 0.46 1.14 1.31 1.05 0.72 2.18 1.06 0.66 0.78 0.99 1.15 1.03 0.65 1.41 0.81

2.32 1.01 1.10 0.76 1.38 0.91 0.69 0.57 0.49 0.94 0.83 1.79 1.22 0.46 1.76 1.18 1.95 2.23 0.31 1.66 0.22 0.64 0.92 1.02 2.72 0.73 0.63

2.86 0.68 0.07 1.10 0.58 0.31 1.39 0.24 0.32 1.36 1.17 1.31 1.21 1.07 0.81 0.92 0.68 0.72 0.35 0.86 0.21 0.91 0.96 1.64 0.55 1.08 1.53

1.72 0.75 0.12 1.52 0.30 0.32 .37 .20 ().55 .37 .29 1.01 0.87 1.08 0.51 0.64 1.75 0.36 1.02 2.60 1.32 0.85 0.67 0.84 0.28 0.55 2.41

3.53 0.00 1.71 0.90 0.66 1.43 0.00 0.00 0.00 1.23 1.19 3.62 1.70 0.84 0.69 0.63 1.45 0.00 1.41 0.88 0.69 0.00 1.34 1.24 0.00 0.91 2.29

Sweden Sector Food products Chemicals, n.e.s. Synthetic resins Agricultural chemicals Cleaning agents Paints, etc. Pharmaceuticals Ferrous metals Non-ferrous metals Fabricated metal products Mechanical engineering, n.e.s. Agricultural machinery Construction equipment Industrial engines Electrical equipment, n.e.s. Transmission equipment Lighting and Wiring Radio and TV receivers Motor vehicles Shipbuilding Transportation equip, n.e.s. Textiles and clothing Rubber products Non-metallic mineral products Coal and petroleum products Professional instruments Other manufacturing

Note: (n.e.s. = not elsewhere specified.)

Italy

0.87 1.11 1.72 1.11 2.50 1.02 1.24 2.16 1.51 0.84 0.92 1.49 0.72 0.18 0.56 0.78 0.83 0.58 0.42 0.21 0.59 1.07 1.27 1.99 1.05 1.53 0.84

48

New perspectives on the late Victorian economy

innovations on which they were based, and because large firms account for a substantial proportion of total patenting activity in the USA. For this reason the-analysis refers to national groups of firms (owned by residents of the country in question), rather than simply national patterns of innovation. In order to calculate the RTA index for years before 1914, each patent granted to a foreign resident in 1890-2 or 1910-12 has been classified to an industry using the description provided by the US Index of Patents. Time and budget constraints prevented the extension of this patent count (which already ran to over 18,000 patents) for the entire period 18901914, or for an additional period in the interwar years, which would have been the ideal. Historical comparisons are reported below for the top ten foreign countries, each of which accounted for over 200 US patents in the years 1890-2 and 1910-12 combined. The relevant values of the RTA index, calculated across twenty-seven industries, are shown in table 2.3. For other countries, the distribution of the RTA index for these early years would be heavily influenced by the small numbers of patents in any category. This is illustrated by the rise in the number of zeros in the index as the number of patents falls. Taking the index for 1890-1912, Italy with 206 patents had three industries with an RTA of zero, Belgium and Luxembourg (203 patents) had four zeros, Denmark (116 patents) eleven zeros, and Japan (40 patents) no less than eighteen zeros. Countries outside the top ten must therefore be excluded from the historical aspect of the study. It may well be that the historical analysis should be restricted to the top three countries (Germany, the UK and Canada), each of which had over 2,000 patents in the early period, and which were the only countries with no zeros in the RTA index for these years. The RTA index can be calculated for any number of consecutive years. Here, it has been calculated for 1890-2, 1910-12, 1890-1912 (from a combination of 1890-2 and 1910-12), 1963-83, 1963-9 and 1977-83. The stability of the RTA index, and changes in the extent of technological specialisation, are examined over different time periods. Section 2.3 describes the statistical methodology used to achieve this end. Sections 2.4 and 2.5 consider the historical evidence, sections 2.6 and 2.7 discuss the results for later periods, each referring to trends in technological advantage over different time span, while section 2.8 discusses some conclusions that might be drawn.

Historicaltrends in international patterns oftechnologicalinnovation

49

2.3 The statistical methodology The proposition that innovation is cumulative would suggest that for the firms of any given country, the sectoral distribution of the RTA index is likely to remain fairly stable over time. This means that if the RTA index is calculated for a national group of firms at two different points in time perhaps twenty years or so apart, then these two sectoral distributions of technological advantage should be positively correlated with one another. However, since the nature of innovative activity will change gradually over time, the degree of correlation is likely to fall, the further apart are the two groups of years under consideration. Over longer periods of time firms on a cumulative path of development may still move across technically related sectors. The relevant statistical methodology is the Galtonian regression model, a statistical technique devised for the analysis of bivariate distributions. This approach was originally applied to economic problems in the context of work on the size distribution of firms by Hart and Prais (1956), and other useful applications have since been developed by Hart (1976) and Creedy (1985) in investigating changes in income distribution in the UK, and by Sutcliffe and Sinclair (1980) in the case of the seasonality of tourist arrivals in Spain. To adopt a similar procedure, the correlation between the sectoral distribution of the RTA index at time / and at the earlier time / — 1 is estimated through a simple cross-section regression of the form RTA,, = a + (3 RTA/,-! + e/7

(2.1)

This is estimated for a particular country, and the subscript refers to industry / at time /. The standard assumption of this analysis is that the regression is linear and that the error term e,, is stochastic and independent of RTA/7_ i. This is valid if the cross-industry index at each point in time approximately conforms to a normal distribution. The regression line will pass through the point of means and in figure 2.1, for convenience of exposition, this is illustrated for the case where the mean of each distribution happens to be the same, the expected values of the distributions being given by E(RTA,) = E(RTA,_i). The analysis does not depend upon the values of the means being identical, but it can be seen that a sizeable difference between them may be indicative of a substantial measure of skewness in one of the indices, which consequently departs significantly from a normal distribution. In figure 2.1, the regression line (2) is drawn in such a way that the estimated coefficient p takes the value of one. This implies not only that

50

New perspectives on the late Victorian economy RTA,

(3)

E(RTA,)

E(RTA,_!) Figure 2.1 Galtonian regression with the RTA index

the ranking of industries remains unchanged (advantaged industries remain advantaged, while disadvantaged industries remain disadvantaged), but also that they retain the same proportional position (advantaged industries do not become any more advantaged, and disadvantaged industries do not become any more disadvantaged). Where P > 1, as in line (3), then there is a proportional shift in which already advantaged industries tend to become still more advantaged, while disadvantaged industries are increasingly disadvantaged. In the case of regression line (1) where p < 1 disadvantaged industries improve their position, and advantaged industries slip back. This is what has elsewhere been termed 'regression towards the mean' (Galton 1889, cited in Hart 1976). Where this is a true representation of 0 < p < 1 then industries remain in the same ranking, but they come closer to one another. The magnitude of (1 - p ) therefore measures the size of what is here called the 'regression effect', and this is the interpretation placed on the estimated coefficient p. In the case of p < 0 then the very ranking of industries would be reversed, contrary to the prediction of cumulativeness in technological change. The expectation that P > 0, such that the RTA index is positively correlated across two points in time, can be readily tested for each country. The relevant test of p being significantly different from zero is the t-test. In a regression equation with only one independent variable the t-test is equivalent to the F-test, which refers to the significance of the correlation of the regression as a whole. The test for whether p is significantly greater than zero is a test of the proposition of cumulativeness against the alternative that sectoral com-

Historical trends in in ternationalpatterns oftechnological inno vation position of innovation is random. However, the second proposition to be set alongside that of cumulativeness in the industrial pattern of innovation is that of incremental change. If firms generally innovate in order to gradually adapt their existing technological strengths, they may still begin to shift the industrial nature of their activity. As the pattern of demand changes, and technology evolves, the sectoral distribution of innovation in a country may change, even though still drawing on a similar set of underlying technological skills. This effect is likely to be more pronounced the further apart the RTA distributions are in time. The condition under which cumulativeness in the industrial distribution of innovation outweighs incremental change is that p > 1. Strictly speaking, if there were a path-dependent cumulative process with no change in the technological relatedness between sectors and therefore no shift in the underlying industrial structure of innovation (no incremental change), it would evolve towards a position where the proportion of innovations accounted for by each industry was stable and fixed (Arthur, Ermoliev and Kaniovski 1987). This would correspond to p = 1, and to a regression effect (1 - (3) exactly equal to zero. The test of whether cumulativeness outweighs incremental change in the period in question is hence the t-test of p not being significantly less than one (equivalent to a regression effect which is negative or not significantly different from zero). Where p is significantly greater than zero but significantly less than one then elements of cumulativeness and incremental change are combined. If cumulativeness dominates initially over relatively shorter periods (P > 1), tests should reveal the length of time that it takes for incremental change to begin to play a significant role (0 < p < 1). What is then also required is that the regression analysis is supported by a more detailed inspection of the actual shifts in the RTA index, to investigate the actual evolution of sectoral strengths and weaknesses, and to decide whether the change really is of an incremental kind. The other feature conveniently arising from the regression analysis of RTA distribution is a simple test of changes in the degree of technological specialisation. The degree of technological specialisation in a country can be measured by the variance of its RTA index, which shows the extent of the dispersion of the distribution around the mean. Pavitt (1987) used the standard deviation of the index, which is the square root of the variance, as a measure of such specialisation. The original work of Soete (1980) also analysed the variance of RTA indices. The procedure for estimating changes in the variance of a distribution over time follows from Hart

51

52

New perspectives on the late Victorian economy

(1976). Taking equation (2.1) above, if the variance of the RTA index at time t is denoted by o>2 then a,2 = p 2 * , - , 2 * ^ 2

(2.2)

Now the square of the correlation coefficient (R2) is given by R2 = 1 -(a e 2 /a, 2 ) = (a, 2 -a e 2 )(l/a, 2 )

(2.3)

Combining equations (2.2) and (2.3) it follows that (x, 2 -a e 2 = p 2 a / _, 2 = RW

(2.4)

Equation (2.4) may be rewritten to show the relationship between the variance of the two distributions as follows: a,2/
(2.5)

Hence the degree of technological specialisation rises where p 2 > R2, and it falls where p 2 < R2. A high variance indicates a high or narrow degree of specialisation, while a low variance indicates that the country has a broad range of technological advantage or a low degree of specialisation. Using the estimated regression values, the extent of specialisation rises where |p| > \R\, and it falls where |p| < \R\. The estimated Pearson correlation coefficient, R, is a measure of the mobility of industries up and down the RTA distribution. A high volume of R indicates that the relative position of industries is little changed, while a low value indicates that some industries are moving closer together and others further apart, quite possibly to the extent that the ranking of industries changes. The magnitude of (1 -R) thus measures what is here described as the 'mobility effect'. It may well be that, even where the regression effect suggests a fall in the degree of specialisation due to a proportional move in industries towards the average (p < 1), this is outweighed by the mobility effect, due to changes in the proportional position between industries (p > R).

2.4 The stability of technological advantage before 1914 The results of the regression of the RTA index in 1910-12 on the index in 1890-2 are reported in table 2.4. Each distribution represented a cross-section of thirty-one industries for the ten major countries patenting in the US before 1914. Because of the problems created by a small number of observations,

Historical trends in internationalpatterns of technological innovation Table 2.4

53

The results of the regression of RTA in 1910-1912 on RTA in 1890-1892

Country UK Germany Canada France Austria-Hungary Australia Switzerland Sweden Italy Belgium and Luxembourg

&

P

0.870 0.493 0.553 0.926 0.865 1.067 1.066 0.726 0.993 0.614

0.262 0.533 0.457 -0.073 -0.004 0.009 0.252 0.047 0.060 0.230

6.06** 4.38** 3.80** 9.23** 5.36** 1.07 2.91** 4.75** 5.86** 3.97**

h

R

Pi

2.13* 5.24** 3.41** -1.75 -0.04 0.01 0.77 0.80 2.92** 2.81**

0.367 0.697 0.535 -0.308 -0.008 0.009 0.141 0.145 0.476 0.462

0.935 0.969 0.962 0.790 0.933 0.858 0.869 0.929

Notes: * Denotes coefficient significantly different from zero at the 5% level. ** Denotes coefficient significantly different from zero at the 1 % level. Number of observations = 31.

alluded to in section 2.2 above, the critical assumptions required by the regression analysis are questionable for all but the top three countries. The assumption that for the firms of a given country the propensity to patent varies more systematically between sectors than within them relies as a minimum on a large number of observations (patent counts). In addition, the assumption that the regression is linear may be invalid if the crosssectoral RTA distributions are not approximately normal. Outside the distributions of the UK, Germany and Canada, the Pearson tests for normality (Pearson and Hartley 1976) reveal that the RTA index for the other thirteen countries is significantly skewed in both 1890-2 and 1910-12, except for Austria-Hungary, Sweden and Belgium and Luxembourg in 1910-12. By contrast, for the firms of the UK, Germany and Canada the only significant measure of skewness occurs in the case of Canada in 1910-12, and here it is still a great deal lower than for most other countries. A total number of patents greater than the minimum required to construct an index that roughly conforms to a normal distribution obtained historically only in the cases of the UK, Germany and Canada. Accordingly, the results shown in table 2.4 are only really trustworthy for the first three countries. In the case of France, which had the fourth largest number of foreign patents in the US before 1914, the negative estimate of the p coefficient is indicative of the fact that the sectoral distribution for France in 1890-2 had a much higher mean value than in 1910-12. The mean value, and the skewness of the distribution, is

54

New perspectives on the late Victorian economy

increased by the RTA of the cleaning agents sector in 1890-2, which reached 11.54. This result arises due both to the relatively small number of French patents in the US, and the relatively small number of all foreign patents in the cleaning agents industry in 1890-2. If the basic assumptions of the regression are not met, then the /-statistics are not valid tests of the significance of the values of the estimated coefficients. However, for the three countries for which the results can be trusted with a reasonable degree of confidence, the findings appear to be broadly in line with expectations. The p coefficient assumes a positive value for all of these three, and indeed for eight out of ten countries, demonstrating a positive correlation between the pattern of technological advantage in the early 1890s and just before the First World War. The t-test suggests that this correlation is significant infiveof these eight cases. With reference to the three countries for which the data are most reliable, the correlation is significant for all three. Where the value of p was positive, the implicit value of p for a one year regression was calculated as Pi in the final column. This is calculated on the assumption that the structure of the relationship was unchanged throughout the period 1890-2 to 1910-12, and is the value of p that year on year would generate the observed p for a twenty year period. Although this procedure must not be taken too far, as the structure of the relationship was not unchanged (that is, the mobility effect or 1 - R was greater than zero), it helps to illustrate that the value of the regression effect (measured by 1 - P) is very much weaker than would be suggested by the estimated value of p if considering periods of less than twenty years. However, while for the three national groups for which there are a sufficient number of observations - British, German and Canadian firms randomness in innovation must be rejected in favour of cumulativeness, it is clear that the sectoral distribution of their technological development was also subject to a degree of change in the twenty years around the turn of the century. The regression effect was positive and significant (P was significantly less than one on a t-test) in all three cases. Although there is some evidence of incremental change during these years, it is difficult to draw conclusions at this level of analysis, given that many firms were only just beginning to establish themselves as US patenters at the time. This must itself account for a certain amount of change in the distribution of patenting activity. For eight out often countries the value of R exceeded p, signifying a fall in the degree of technological specialisation. That is, patenting activity in the USA tended to become broader in its sectoral scope. In part, this

Historicaltrends in internationalpatterns oftechnological innovation

55

result may reflect an improvement in the representativeness of the data, and the number of US patents granted to foreigners rose substantially in the twenty year period in question (see table 2.2). Once again, this also reflects the fact that many firms began patenting in the USA for the first time around the turn of the century. However, as the newer technologies pioneered at this time began to take root, there may well have been a broadening in the sectoral distribution of innovation in the leading industrialised countries. The possibility that the sectoral distribution represented by the RTA index confirms more closely to a lognormal than a normal distribution was also investigated. The major reason for supposing that this might be the case is that while there is a lower bound to the distribution (disadvantaged industries are constrained to take RTA values between zero and one), there is no upper bound. Although there is some evidence which at first glance might support such a view, it in fact only strengthens the case against it. Distributions that are more closely lognormal than normal as judged by the Pearson tests of skewness and kurtosis are found only where the sample of patent counts is really insufficiently large, creating an artifically high degree of dispersion in the index. This is what tends to lead to a skewed distribution, rather than any inherent property of the RTA index itself. Considering the five countries that were excluded from the historical analysis due to lack of data (Ireland, Denmark, the Netherlands, Spain and Japan), all have significantly skewed RTA distributions for both 1890-2 and 1910-12. However, in every case these are distributions in which the longer tail lies towards the lower values of RTA (to the left), which is a consequence of the large number of zeros. In other words, the theoretical justification for expecting a lognormal distribution is that there is no upper bound so it will be skewed to the right, but tests demonstrate the existence of lognormality only in instances where due to the paucity of data the distribution is skewed to the left. Therefore, although assuming a logarithmic rather than a linear functional form in such cases sometimes improved the value of the /-statistic on p, and the estimated correlation coefficient, R, these results are not discussed here. It is worth noting those sectors in which the leading three countries (the UK, Germany and Canada) were strongly advantaged in both 1890-2 and 1910-12 (see also table 2.3). British firms appear to have maintained a strong technological advantage at this time in cleaning agents (mainly in soaps and detergents; the early French strength here mentioned above was in perfumes and cosmetics), industrial engines and turbines, ship-

56

New perspectives on the late Victorian economy

building, textiles, rubber products (tyres) and coal and petroleum products. German firms enjoyed a favoured position in chemicals in general, but especially in dyestuffs and paints, and in lighting and wiring equipment. Canada's strength lay in agricultural chemicals, railways and other transportation equipment, paper products, and other manufacturing (including furniture and wood products). In the case of these three countries at least, as far as can be told, the sectoral pattern of technological advantage remained fairly stable (elements of cumulativeness were present) in the twenty-five years before 1914, although the degree of specialisation fell. Finally, returning to the theme of the opening remarks of the paper, some assessment of the relationship between the industrial composition of innovation and overall technological performance can be made. This concerns the extent of representation of each national group offirmsin the sectors of fastest (or slowest) growing technological activity. For any country j denote the proportion of patents held in industry / by pij9 the share of total world patenting by w7, and the mean value of the RTA index by Mj. That is (supposing there are altogether n industries) PiJ

= PijKjPij

Wj =

%Pi//X^jPu

RTA,7 = The ratio of the mean value of RTA in an earlier period t-\ to that in the next period t is then given by Mjt- xIMJt = (wJt/wJt- iVGiPijittpijt-1)

(2.6)

Now since the regression equation (2.1) must pass through the point of means it is also known that Mj, = d + (W /7 _,

(2.7)

This may be rewritten MJt-XIMj, = (MJt - d)/flW/7)

(2.8)

From equations (2.6) and (2.8) it follows that the lower is (Mjt — a)/$Mjt the slower is the rise (or the greater is the decrease) in the world share of patents (ny) compared with the average proportion held in industries at the chosen level of disaggregation (ZjPy/n). It can be shown that this happens either because the firms in question are particularly advantaged in industries with the slowest growing technological activity,

Historical trends in internationalpatterns of technological innovation

57

or because of a shift in the structure of industry proportions and thus in the cross-industry pattern of RTA (what has been termed above the mobility effect).2 Of British, German and Canadian firms over the period 1890-2 to 1910-12, British firms recorded the lowest value of(MJt — a)/$Mjt, while German firms had the highest such ratio. While this may be partly attributed to a greater mobility effect for UK firms (a lower R), it also suggests that they had their comparative advantage in industries in which fewer new technological advantages were opening up. In other words, to the extent that they were 'locked in' to a particular path of innovation in the twenty to twenty-five years before 1914 this was to their overall detriment, but to the benefit of their German rivals.

2.5 Were British firms 'locked in' to innovation in sectors with fewer technological opportunities? It is worth pausing at this juncture to consider the pattern of technological activity amongst British firms prior to 1914 in greater detail. The RTA index as shown in table 2.3 roughly matches what is known from other historical evidence. British firms in this period continued to develop in a cumulative fashion many of their earlier traditional strengths. They retained their leadership in the fields of shipbuilding, heavy mechanical engineering, armaments and industrial engines (Mathias 1969). They also performed well in branches of the food, drink or distilling and brewing sectors (through Cadbury, Fry, Guinness and Bass), in consumer chemical and pharmaceutical products (through Beecham and Lever), in synthetic fibres (through Courtaulds) and in coal and petroleum products. They built upon an early lead in agricultural chemicals and in radio and telegraphic equipment (through Marconi). However, even in most of these cases it is clear that innovation in British companies was of a rather specialised or differentiated kind, which while it had suited them well in the past became a source of weakness in a newly emerging age of mass production. They concentrated on particular types of electrical equipment (such as the development of the radio and international telegraphic communication) rather than on the broader electrical engineering sector which became responsible for spreading economy-wide electrification. In electric traction, the main underground railway lines constructed in London between 1900-14 were built with American plant and expertise (Mathias 1969). British firms held their place in transport equipment and special kinds of electrical equipment,

58

New perspectives on the late Victorian economy

but did not establish themselves in the operating systems on which they came to depend. Indeed, there is clear argument for saying that the comparative technological advantage of British firms in the motor vehicle sector was far from being a sign of strength. This is a good example of a wide cluster of British family firms which were small, differentiated and emphasised quality and skilfulness losing out to the larger US corporations which went down the route of organising mass production. There were over 200 tiny British firms in the motor vehicles sector, led by competent engineers and producing highly sophisticated and very expensive products (Mathias 1969). By comparison, Ford's greater reliance on production engineering and Taylorist work practices led to a reduction of technical standards on occasions. Organisational innovation may then have brought technological innovation in its wake, but aimed at solving a different set of problems and conditioned by a different set of criteria than the technologies developed by British firms (Freeman, Clark and Soete 1982). US and German firms went down a path of innovation more suited to the needs of mass production and a mechanised age which characterised a new technological system, with a corresponding shift in the types of technological development in which opportunities were greatest. This is another aspect of firms in a particular location 'locking in' to a certain form of innovation. The textiles industry offers a different example of how even a group of formerly strong firms may lose their position when their competitors in other countries make cumulative gains at their expense. Although British firms such as Platts, the supplier of automatic looms, continued to lead the way in textile machinery, British textile firms failed to adopt the new equipment (Mathias 1969). By 1919 half the looms in the US cotton industry were automatic, while British firms had only just begun to introduce them, due in part to a lesser pressure to introduce labour-saving devices (Habakkuk 1962, Aldcroft and Richardson 1969). British firms also had alternatives, not only by being better able to turn to wage cost reductions, but by switching to Empire markets and entering into collusive arrangements with other firms. In these terms the initial introduction of the latest technology may well have been uneconomic and so company decisions can be justified as rational. However, in the medium and longer term, due to the existence of cumulative gains in innovation through learning by doing and learning by using (Nelson and Winter 1982, Pavitt 1987) their failure to adopt meant that they were left behind. As well as falling behind within certain industries, as has been sug-

Historicaltrends in internationalpatterns oftechnologicalinnovation

59

gested above British firms became 'locked in' to innovation in sectors with fewer opportunities. Textiles and shipbuilding remained important in British industrial structure in the early twentieth century, and mechanical engineering was better developed than the electrical industry (Hannah 1976). However, Mowery (1984) argues that the problem was not so much a failure to shift the industrial pattern of output, as a failure to take up innovative activity in the most dynamic sectors (which particularly affects one component of output, namely export performance). British companies were frequently left behind in science-based areas, due to the difficulties of institutional adjustment as well as cumulative technological progress amongst the leaders elsewhere. In industrial chemicals the deficiencies of the educational and training systems and their weak links with industry meant a shortage of highly qualified scientists and technicians (Haber 1958, Liebenau 1984). In heavy engineering the consulting engineer played a particularly important role in British firms which reduced their incentive to invest in corporate R&D and lessened the potential for the development of innovative linkages between firms (Mowery 1984). As a symbol of their lagging behind in science-based fields, it was only in the interwar period that corporate R&D increased substantially amongst larger British firms (Hannah 1976). Where British firms did consolidate or establish themselves in these areas, their scientific traditions tended to lie outside the mainstream. For example, in Pharmaceuticals the British strength emanated from medical and biological research, as illustrated by the Evans Medical Company, the Lister Institute and the Wellcome Company, rather than as in Germany spinning off from the chemicals revolution which began with artificial dyestuffs (Liebenau 1984). This is an interesting case, as it perhaps helps to explain the recent British revival in Pharmaceuticals innovation at a time when opportunities are increasingly coming from biotechnology rather than chemicals (again, building upon past traditions). Likewise, British firms enjoyed an early lead and consolidated their position in agricultural chemicals, the pioneer being J.B. Lawes in superphosphates and other fertilisers (Freeman 1982). In the electrical industry an example of specialised success was provided by Marconi, set up in London by an Italian entrepreneur with British and Irish connections. The technological development of this British company was initially related to communications in shipping, the Royal Navy being the first major purchaser of equipment (Baker 1970). Marconi led an active research team, which successfully competed with German and US groups despite their lead in other types of electrical

60

New perspectives on the late Victorian economy

equipment, due to its emphasis upon international transmissions. It was obliged to concentrate on international communications with the Post Office having a monopoly over land-based telegraphy in Britian, while it was excluded from other national markets. With the German firm Telefunken, Marconi controlled most of the ship- and shore-installations across the world, including those in the USA. In 1912 they reached an agreement on patent rights and cross-licensing. A more detailed analysis of innovation amongst British firms at the turn of the century therefore suggests that cumulativeness in technological development is important in explaining the pattern of their success and failure. It also emphasises the role played by institutional characteristics and constraints, alongside the cumulative innovative and learning activity which builds upon existing technological traditions and experience. The problem was only partly that British firms were 'locked in' to innovation in sectors with fewer opportunities. They were also 'locked in' to dated institutions and organisation practices which adversely affected their technological performance in all sectors, but especially in those with the greatest opportunities, the science-based sectors. This is in addition to the other general considerations affecting Britishfirmsin this period, such as their access to Empire markets and their greater scope for holding down wage costs, factors which have been discussed elsewhere.

2.6 The stability of technological advantage over the last hundred years Table 2.5 shows the results of the regression of the RTA index in 1963-83 on the index in 1890-1912 (the years 1890-2 and 1910-12 combined). These relied on the cross-section of twenty-seven industries given in table 2.3. Of the original thirty-one industries in the historical series, to ensure comparability with the recent data, drink and tobacco were subsumed under food products, leather products were subsumed under textiles, leather and clothing, and paper products included under other manufacturing. In constructing the RTA index for the whole span 1890-1912, the German distribution joined those that were significantly skewed away from normality. This problem arises because of the industrial reaggregation, which causes a number of industries whose RTA values were similar to be grouped together or lost under other headings, such that some information which was important historically is lost in moving to the more recent classification.

Historical trends in internationalpatterns oftechnological innovation 61 Table 2.5 The results of the regression ofRTA in 1963-1983 on RTA in 1890-1912 Country

UK Germany Canada France Austria Australia Switzerland Sweden Italy Belgium and Luxembourg

a.

P

ta

'P

R

Pi

0.803 0.957 1.013 0.912 0.731 0.537 0.901 0.804 0.967 1.066

0.256 -0.147 0.120 0.127 0.241 0.632 0.026 0.163 -0.016 0.125

6.97* 11.22* ' 3.88* 10.41" 3.19" 3.27" 8.02" 5.50" 11.03" 6.66*'

2.48** -0.19 0.50 1.38 1.13 4.44** 0.43 1.43 -0.40 0.10

0.445 -0.037 0.099 0.266 0.219 0.664 0.084 0.276 -0.077 0.063

0.981 0.971 0.972 0.980 0.994 0.951 0.975 0.972

Notes: * Denotes coefficient significantly different from zero at the 5% level. Denotes coefficient significantly different from zero at the 1% level. Number of observations = 27.

A positive correlation between the two distributions was obtained for eight out of ten countries. However, on the whole the extent of this correlation was poor, and it was significant in only two cases. It is the firms of the UK and Australia that appear to have shifted least from the sectoral patterns of technological advantage that prevailed historically. In these cases as well, though, the regression effect is still significant (P is significantly less than unity). It is not terribly surprising that the industrial composition of innovation shifts substantially over long historical periods. The value of Pi generally remains high, but the distributions are over seventy years apart, and it is unrealistic to suppose that the structure of the model has remained unchanged throughout this time. The other noticeable feature of table 2.5 is that the estimated value of a is high for every country, and everywhere significantly different from zero. This might suggest a low value of p and a strong regression effect. However, it seems that what it actually represents is the weakness of correlation between the two RTA distributions, which is associated with a strong mobility effect. Leaving aside the two countries for which correlation was significant and the degree of specialisation fell, in four of the remaining eight countries the mobility effect outweighed the regression effect leading to an apparent rise in the degree of specialisation. For the firms of Germany, Canada, Austria and Belgium a low magnitude of p was offset by a still lower value of R.

62

New perspectives on the late Victorian economy

Of course it might be that these results would be altered if patent counts were made over the full period 1890-1914, rather than for only six years. However, it seems unlikely that this would affect the conclusion that the sectoral distribution of technological advantage has tended to shift quite substantially since the turn of the century. It is possible to say a little on what might be the long-term effects of incremental changes in the composition of innovation. British firms seem to have moved from synthetic resins towards paints and Pharmaceuticals, from ferrous metals towards metal products, and from general mechanical engineering and industrial engines towards agricultural and construction equipment. German firms appear to have improved their position in mechanical engineering, particularly in industrial engines, and in motor vehicles and other transportation equipment. This might be related to traditional strengths in metal products and certain categories of electrical goods. The improvement of the German group in synthetic resins, agricultural chemicals and cleaning agents may be similarly linked to their long-standing overall strength in general industrial chemicals. Shifts in the RTA index for other countries can be determined from an inspection of table 2.3, though they are not as reliably indicated due to the influence of small numbers of patents in the earlier period.

2.7 The stability of technological advantage since 1963 The estimates obtained from the regression of the RTA distribution in 1977-83 on the distribution in 1963-9 are set out in table 2.6. They were derived from the same cross-section of twenty-seven industries listed in table 2.3. The only serious data problem in the recent period arises in the case of Ireland, whose firms had a low level of patenting activity even in the recent period, and which has a sizeable number of zeros in the RTA index for the latest years. As a result, the RTA distribution for Ireland particularly in 1963-9 was substantially skewed. Pavitt (1987) reported on a similar set of correlations for the regression of the RTA index for ten countries in 1975-80 on the equivalent RTA in 1963-8. He also used a twenty-seven industry disaggregation, though he adopted a rather different sectoral classification. The other important difference here is that the original patent data have now being reworked by OTAF, based on a 'fractional' allocation of those patents that had previously been allocated to more than one industrial group. In his study, Pavitt found a positive and significant correlation between

Historical trends in international patterns of technological innovation

63

Table 2.6 The results of the regression of RTA in 1977-1983 on RTA in 1963-1969 Country US Germany Japan UK France Switzerland Canada Sweden Italy Netherlands Belgium and Luxembourg Austria Australia Denmark Spain Ireland

a

P

>«

-0.513 0.341 0.586 1.124 0.758 0.168 -0.143 0.130 0.681 0.327 0.806

1.513 0.642 0.339 -0.216 0.306 0.905 1.141 0.979 0.231 0.712 0.401

-2.97* 2.66* 4.22* 4.15* 3.71" 1.38 -0.77 0.79 6.10*' 1.82 2.82*'

0.399 0.149 0.063 0.384 0.636

0.572 0.794 0.889 0.855 0.543

2.58* 0.77 0.29 1.43 2.01

R

Pi

8.72** 4.85** 2.88** -0.08 1.54 7.49** 7.64** 6.11** 2.36** 5.40** 1.55

0.868 0.696 0.500 -0.017 0.295 0.832 0.837 0.774 0.428 0.734 0.297

1.030 0.969 0.926 0.919 0.993 1.009 0.998 0.901 0.976 0.937

4.55** 5.56** 4.71** 3.30** 2.85**

0.673 0.745 0.686 0.551 0.495

0.961 0.987 0.992 0.989 0.957

Notes: * Denotes coefficient significantly different from zero at the 5% level. Denotes coefficient significantly different from zero at the 1 % level. Number of observations = 27.

the two RTA distributions for nine out of the ten countries. He also found that the sectoral pattern of technological advantage for each country was distinctive, in the sense that there was little association between the distributions of any two countries. A similar state of affairs applies to the sixteen countries listed in table 2.6. A positive correlation holds for fifteen of the sixteen countries, and for thirteen of these it is significant at the 5 per cent level (it is significant for the other two at the 15 per cent level). Only the UK demonstrates little relationship between the distributions characterising the two periods in question, and in this instance the hypothesis of randomness (0 = 0) as against cumulativeness O > 0) cannot be rejected. Unlike in the historical application of the analysis, the estimate of the a coefficient is negative in the case of two countries (the US and Canada), though in the case of Canada it is not significantly different from zero. The corollary, given that the means of the two distributions are not too far apart, is that |3 exceeds unity, implying a negative regression effect, which is particularly strong for the US. Indeed, for eleven of the sixteen countries, despite generally high values of R, the mobility effect (which is measured by 1 - R) exceeds the regression effect (which is measured by 1 - P). This means that there has been a tendency for the degree of

64

New perspectives on the late Victorian economy

Table 2.7

The strength of the regression effect over the period 1963-1969 to 1977-1983

Country

t$

US Germany Japan

2.96** ~2-70** - 5.62**

UK

~4JKl

France —3.49** Switzerland -0.79 Canada 1.07 Sweden -0.13 Italy -7.86** Netherlands -2.18* Belgium and Luxembourg -2.32* Austria - 3.40 Australia —1.44 Denmark -0.59 Spain -0.56 Ireland -2.40* Notes: * Denotes coefficient significantly different from one at the 5% level. Denotes coefficient significantly different from one at the 1 % level. Number of observations = 27 technological specialisation to rise over the last twenty or twenty-five years. In other words, not only has the pattern of technological advantage remained fairly consistent, but advantaged industries have often acquired a stronger position than was the case for high-ranking sectors in the 1960s. The strength of the regression effect over the period is interpreted as indicating the extent of gradual change as against cumulativeness, and it can be separately measured by testing whether p is significantly different from one (which amounts to a test on whether the regression effect, 1 — P, is significantly different from zero). The results of this test are reported in table 2.7. This shows that the regression effect was insignificant for half of the sixteen countries. This includes the case of the US, for which p was significantly different from one, but it was substantially above one, and hence the regression effect was significantly negative. US firms have become increasingly specialised in areas in which they were already advantaged. In the historical analysis the regression effect was everywhere significant, so this helps to demonstrate the way in which it gradually increases over longer periods. However, between the early 1960s and the early 1980s it fails to reach significant proportions for eight

Historical trends in internationalpatterns oftechnological innovation

65

countries. Thus for half the national groups cumulativeness outweighs incremental change over this period. As has been mentioned above, the calculation of pi from the estimated value of p over a longer period is unreliable as it assumes a zero mobility effect, which is known to be untrue. For the recent period the greater level of patenting activity makes it feasible for the firms of some countries to estimate the actual magnitude of successive values of Pi from year-on-year regressions. This was done for the ten countries whose residents were granted over 10,000 patents in the US between 1963 and 1983, each averaging over 500 patents per year. The first column of table 2.8 reports the average value of the estimated slope coefficients from a series of annual regressions for each of these ten countries. Alongside the mean of the annual Pi (denoted by jipr), the standard deviation around the mean (<xp,) is shown in the second column. The regression estimates of Pi are uniformly smaller than the calculated pi of table 2.6, since the annual mobility effect does not always work in the same direction. This implies that for each national group of firms there is to some extent a random short-run fluctuation of industries up and down the ranking of innovative activity, in addition to any gradual but sustained shift in ranking that may be slowly taking place. Of the groups of firms of all countries, Japan is the only one whose pi over the period 1963-83 appears to have been on a significant upward trend over time. Regressing the time series of Pi on a simple time trend, the coefficient on the trend was positive and significantly different from zero at the 5 per cent level for Japan, but insignificant for all other countries. Noting that Japan is one of the minority of countries whose firms have experienced a recent fall in their degree of technological specialisation (p < R in table 2.6), what this suggests is that the broadening of innovative activity by Japanese firms was especially strong early in the period. Further support for this view emerges when dividing the 1963-83 period into three subperiods (1963-9, 1970-6, and 1977-83), and running regressions for consecutive subperiods. The estimate p 7 coefficients from the (seven year period) regression of the RTA index in 1970-6 on that in 1963-9, and of RTA in 1977-83 on that in 1970-6 are also given in table 2.8. It can be seen that they are not tremendously different from the individual year-on-year Pi, and that for most countries p does not change very much over the period as a whole. The only real exception as before is Japan, for which the value of P7 nearly doubles, confirming that p has been on something of an upward trend. It should also be noted that the

66

New perspectives on the late Victorian economy

Table 2.8 Country US

Germany Japan UK

France Switzerland Canada Sweden Italy Netherlands

The results of annual and other subperiod regressions of the RTA index over the 1963-1983period M
(Tp,

p7(1970-6/1963-9)

p7(1977-83/1970-6)

0.967 0.799 0.884 0.746 0.621 0.825 0.893 0.789 0.539 0.744

0.095 0.121 0.107 0.185 0.173 0.273 0.122 0.222 0.168 0.165

1.242 0.746 0.456 0.632 0.654 1.127 1.054 0.872 0.500 0.730

1.194 0.854 0.857 0.647 0.556 0.803 1.139 1.149 0.454 1.008

value of R is very high for Japan in all the subperiod regressions, which confirms that Japanese firms have experienced a widening degree of technological specialisation rather than a major shift in the ranking of industries in terms of the strength of their innovative activity. In this connection, what is also noteworthy from table 2.6 is that the firms of those countries in which innovation, accompanied by industrial restructuring, has been proceeding most rapidly since the early 1960s, have still retained a fairly stable sectoral pattern of technological advantage. Japan, for instance, is not as might have been supposed a counterexample to the notion of technological accumulation, that is innovation through the further development of existing strengths. Japanese firms today retain an advantaged position that was already apparent by the 1960s in non-ferrous metals, electrical equipment in general, and electrical transmission equipment and radio and TV receivers in particular, rubber products, and professional and scientific instruments. They have witnessed an improvement in their innovative capacity in motor vehicles and industrial engines, and a decline in chemicals and shipbuilding; the traditional strength in shipbuilding seems to have led to innovation in metals and electrical equipment, and from there to motor vehicles. The technological advantage of US firms has held up and been strengthened in fabricated metal products, lighting and wiring equipment, coal and petroleum products, and other manufacturing (which in the twenty-seven industry case includes paper, printing and publishing). The position of ferrous metals, radio and TV receivers and motor vehicles amongst US firms have been weakened. German companies have maintained a continual technological strength in chemicals, including synthetic

Historical trends in internationalpatterns oftechnological innovation

67

resins, cleaning agents and paints and varnishes, and in motor vehicles, textiles, and rubber products. They have improved their advantage in certain areas of mechanical engineering, notably in construction and mining equipment, but have slipped back in radio and TV receivers and professional and scientific instruments. The UK, which is not noted for its comparative innovative performance in the last twenty years, is the country whose firms have experienced the greatest 'mobility effect' in terms of the movement of industries around the RTA distribution. The UK industrial groups which have fallen furthest down the distribution are non-ferrous metals, mechanical engineering, radio and TV receivers, motor vehicles, and coal and petroleum products. The sectors in which UK firms have most improved their innovative standing are food products, agricultural chemicals, cleaning agents (though here there is some evidence that the RTA index was unusually low in 1963-9), Pharmaceuticals, agricultural machinery, and non-metallic mineral products. This suggests an interpretation which, if correct, would provide further support for the technological accumulation approach. Where a country is lagging in innovation and productivity growth, the industrial structure of the technological advantage of its firms may well be disrupted, as previously strong firms decline and perhaps even go out of business. Where, on the other hand, innovation and productivity growth is proceeding rapidly (as it has been in Japan and Germany, at least until very recently), then this will in general tend to strengthen and reinforce an existing pattern of technological advantage. The strongest trends in innovation tend to be those that are grounded on a previously attained level of skills and experience in related technology. However, this argument cannot be pushed too far on the basis of the evidence considered here. A cross-national group regression of the measure of the mobility effect (1 - R) on the proportional change in the overall share of patenting in the USA showed the expected negative correlation but it was not significant. By comparison with the historical evidence of section 2.4, in the more recent period Japanese firms have had the greatest value of (Mjt - a) / ($MJt). It thus appears that they have held their greatest advantage in industries with the fastest growing innovation. This confirms the suggestion that the improved performance of Japanese companies is partly attributable to their having held a comparative technological advantage in sectors which have been the leading sources of new increased innovation.

68

New perspectives on the late Victorian economy

2.8 Conclusions and some possible implications The statistical evidence on international sectoral patterns of technological advantage offers support to the idea that innovation tends to unfold as a cumulative process, accompanied by gradual incremental change. The basis for this contention also seems to have become historically stronger. The modern firm relies even less on the external evolution of science and technology, and even more on the internal creation and refinement of new productive methods and new products. For this reason, the sectoral distribution of innovative advantage of the firms of most technologically advanced industrialised countries tends to be correlated over time. However, due to a gradual shift in the nature of technology and the pattern of demand, this statistical link becomes tenuous over longer periods. The sectoral pattern of innovative activity gradually changes as new industries develop and new technological linkages are forged between sectors. Yet this is a slow process which in general only slightly disturbed the pattern of technological advantage held by the firms of the major industrialised countries in the twenty years between the early 1960s and the early 1980s. Historically too, from the early 1890s to the early 1910s there was a systematic element in the sectoral pattern of innovation of British, German and Canadian firms. To the extent that they became 'locked in' to a particular course this seems to have been to the detriment of British companies which failed to switch into newer activities with the greatest innovative potential. By contrast, it was to the benefit of German firms, who made cumulative gains in fields such as industrial chemicals and dyestuffs. More recently, it has been Japanese firms who have gained through their comparative technological advantage in electronics related sectors. This may help to explain historical changes in international technological leadership as the cross-industry pattern of technological opportunities changes, and with them the institutions and organisational forms which are best suited to exploiting them (Cantwell 1989a). At the turn of the century USfirmswere better prepared than the British for the mass production and mechanisation needed to capture economies of scale; today Japanese firms are more adept than the Americans at coordinating contractual networks to capture economies of scope. While much of the recent literature on international technology transfer stresses various features of the market for technology, it may be more to the point to shift the emphasis of discussion towards the characteristics of the generation of technology within the firm. What is possible at any

Historical trends in in ternationalpatterns oftechnological inno vat ion time depends on the pattern of technological capability achieved previously, upon which firms must build. This conclusion is especially pertinent when considering the paths of future innovation that offer the greatest potential to the largest firms of the major industrialised countries. It is these companies, most of which are multinationals, that dominate the patenting statistics today. Such firms are particularly reliant upon innovative activity linked to fundamental research as a means of sustaining a high rate of growth, ensuring a still closer link between technological development and the composition of industrial activity. It has been shown that the degree of technological specialisation generally became wider in the period before 1914. More recently, it is a specific feature of Japanese firms that their degree of specialisation has broadened since the 1960s, despite the fact that the firms of most industrialised countries (eleven out of sixteen) have become more specialised. It has been argued that the firms of each industrialised country tend to move out on a cumulative path in which the creation of new technological advantages depends on the pattern of advantages they have previously established. The existence of technological interrelatedness then allows for skills developed primarily in one sector to be utilised in another, and for a gradual movement between sectors (and equally creates difficulties where attempting to move between unrelated sectors). The broadening of specialisation is thus one of the possible forms of incremental change in the composition of innovation. While historically the firms of most countries became less specialised in the industrial scope of their innovation, this general trend has been reversed in more recent years. Whether countries should actively encourage a broader or narrower degree of technological specialisation amongst their firms depends inter alia on the relative size of the country concerned. Smaller industrialised countries (such as Sweden, Switzerland or Belgium) may wish to concentrate their efforts in areas in which their firms already have an established record. By contrast, the largest industrialised countries (such as the USA or Japan) may wish to maintain the broadest extent of technological specialisation possible. This has in fact tended to happen, as in his analysis of the variance of the RTA index, Pavitt (1987) demonstrated that the degree of technological specialisation is narrowest for the firms of the smaller industrialised countries. The smaller industrialised countries may not trouble themselves too much about areas of decline, in which they are becoming increasingly dependent upon foreign firms whose research facilities are located abroad, providing this helps such countries to restructure their technolo-

69

70

New perspectives on the late Victorian economy

gical and productive activity more effectively in support of their innovative growth industries. Larger industrialised countries may be more inclined to try and avert any process of falling behind, particularly in what are regarded as important technological areas, perhaps with spinoffs elsewhere. This point has been supported by the finding (Cantwell 1989b) that the comparative advantage of a country's firms in total productive activity (including their international production as well as their exports) is related to their specialisation in innovation. This applies at least in the case of the larger industrialised countries, which are homes to the strongest multinationals. Notes 1 The ideas in this chapter are given a more extended treatment in the author's book, Technological Innovation and Multinational Corporations (Oxford: Basil Blackwell, 1989). The author gratefully acknowledges the helpful comments of Keith Pavitt, Mark Casson, Charles Sutcliffe, Peter Hart and James ForemanPeck. The data on US patent counts from 1963-83 used in the paper were prepared with the support of the Science Indicators Unit, US National Science Foundation, by the Office of Technology Assessment and Forecast, US Patent and Trademark Office. The opinions expressed in the paper are those of the author, and do not necessarily reflect the views of the National Science Foundation or the Patent and Trademark Office. 2 In this case the mobility effect represents a shift towards industries that happen to have smaller rather than larger numbers of patents granted in total, as an advantage in 'smaller' industries raises the unweighted average 2^,y. Which industries are larger or smaller is clearly an arbitrary result of the industrial division that happens to be chosen, so the direction of the mobility effect has no economic significance. References Aldcroft, D. H. and Richardson, H. W. (1969), The British Economy, 1870-1939, London: Macmillan. Ames, E. and Rosenberg, N. (1963), 'Changing technological leadership and economic growth', The Economic Journal, 73, 1, March. Arthur, W. B. (1989), 'Competing technologies, increasing returns, and lock in by historical events', The Economic Journal, 99, 1, March. Arthur, W. B., Ermoliev, Y. and Kaniovski, Y. (1987), 'Path dependent processes and the emergence of macro-structure', European Journal of Operational Research, 30. Baker, W. J. (1970), A History of the Marconi Company, London: Methuen. Balassa, B. (1965), 'Trade liberalisation and "revealed comparative advantage" ', The Manchester School, 33, 2.

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71

Cantwell, J. A. (1989a), The changing form of multinational enterprise expansion in the twentieth century', in A. Teichova, M. Levy-Leboyer and H. Nussbaum (eds.), Historical Studies in International Corporate Business, Cambridge University Press. (1989b), Technological Innovation and Multinational Corporations, Oxford: Basil Blackwell. Creedy, J (1985), Dynamics of Income Distribution, Oxford: Basil Blackwell. David, P. (1985), 'Clio and the economics of QWERTY', American Economic Review, 75, 2. Dosi, G. (1984), Technical Change and Industrial Transformation, London: Macmillan. Dutton, H. I. (1984), The Patent System and Inventive Activity during the Industrial Revolution, 1750-1852, Manchester University Press. Frankel, M. (1955), 'Obsolescence and technical change in a maturing economy', American Economic Review, 45. Freeman, C. (1982), The Economics of Industrial Innovation, second edition, London: Frances Pinter. Freeman, C, Clark, J. and Soete, L. L. G. (1982), Unemployment and Technical Innovation: A study of long waves and economic development, London: Frances Pinter. Freeman, C. and Perez, C. (1988), 'Structural crises of adjustment, business cycles and investment behaviour' in G. Dosi, C. Freeman, R.R. Nelson, G. Silverberg and L. L. G. Soete (eds.), Technical Change and Economic Theory, London: Frances Pinter. Galton, F. (1889), Natural Inheritance, London: Macmillan. Habakkuk, H. J. (1962), American and British Technology in the Nineteenth Century, Cambridge University Press. Haber, L. F. (1958), The Chemical Industry During the Nineteenth Century, Oxford University Press. Hannah, L. (1976), The Rise of the Corporate Economy, London: Methuen. Hart, P. E. (1976), 'The dynamics of earnings, 1963-1973', The Economic Journal, 86, 3, September. Hart, P. E. and Prais, S. J. (1956), 'The analysis of business concentration: a statistical approach', Journal of the Royal Statistical Society, Series A, No. 119. Jervis, F. J. R. (1947), 'The handicap of Britain's early start', The Manchester School, 15 Kindleberger, C. P. (1961), 'Obsolescence and technical change', Oxford Bulletin of Economics and Statistics, 23. Landes, D. S. (1969), The Unbound Prometheus, Cambridge University Press. Liebenau, J. (1984), 'Industrial R&D in pharmaceutical firms in the early twentieth century', Business History, 26, 3, November. Mathias, P. (1969), The First Industrial Nation: An Economic History of Britain, 1700-1914, London: Methuen.

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Mowery, D. C. (1984), 'Firm structure, government policy, and the organisation of industrial research: Great Britain and the United States, 1900-1950', Business History Review, 58, Winter. Nelson, R. R. and Winter, S. G. (1982), An Evolutionary Theory of Economic Change, Cambridge, Mass.: Harvard University Press. Pavitt, K. (1982), 'R&D, patenting and innovative activities: a statistical exploration', Research Policy, 11, 1. (1985), 'Patent statistics as indicators of innovative activities: possibilities and problems', Scientometrics, 1, 1-2, January. (1987), 'International patterns of technological accumulation' in N. Hood and J. E. Vahlne (eds.), Strategies in Global Competition, London: Croom Helm. Pearson, E. S. and Hartley, H. O. (eds.) (1976), Biometrika Tables for Statisticians, vol. 1, London: Biometrika Trust. Rosenberg, N. (1976), Perspectives on Technology, Cambridge University Press. (1982), Inside the Black Box: Technology and Economics, Cambridge University Press. Saville, J. (1961), 'Some retarding factors in the British economy before 1914', Yorkshire Bulletin of Economic and Social Research, 13. Scherer, F. M. (1983), 'The propensity to patent', International Journal of Industrial Organisation, 1,1. Soete, L. L. G. (1980), 'The impact of technological innovation on international trade patterns: the evidence reconsidered', paper presented at the OECD Science and Technology Indicators Conference, Paris, September. Soete, L. L. G. and Wyatt, S. M. E. (1983), 'The use of foreign patenting as an internationally comparable science and technology output indicator', Scientometrics, 5, 1. Sutcliffe, C. M. S. and Sinclair, M. T. (1980), 'The measurement of seasonality within the tourist industry: an application to tourist arrivals in Spain', Applied Economics, 12. Usher, A. P. (1954), A History of Mechanical Inventions, Cambridge, Mass.: Harvard University Press. Walker, W. B. (1980), 'Britain's industrial performance 1850-1950: a failure to adjust' in K. Pavitt (ed), Technical Innovation and British Economic Performance, London: Macmillan.

Chapter 3

Railways and late Victorian economic growth James Foreman-Peck

How important railways were to the late Victorian economy may be judged by the closeness with which their operations, rates and fares were hedged around with restrictions by the state, in an economy otherwise favourable to unrestricted private enterprise (Clapham 1963, Parris 1965, Cain 1972, 1980).1 Customers often felt they had no alternative transport facilities to those of an industry which was largely a natural monopoly. Whether or not the industry really was 'essential' in nineteenth-century US economic development became the issue on which the present generation of econometric history, cliometrics, or even quantitative economic history, began (O'Brien 1977, McCloskey 1987, pp. 64^70). The problem came to be formulated as, how much lower would national income have been in a hypothetical nineteenth-century economy without railways (Fogel 1964, 1979, Fishlow 1965, Hawke 1970)? With occasional exceptions (Church 1975) economic historians in Britain have resisted the findings of this 'social savings' research programme initiated by Fogel, asserting but not explaining, that the wider ramifications of railways for economic development defy quantification (O'Brien 1983, p. 14, Gourvish 1980, p. 40, Mathias 1983, p. 245). Moreover Gourvish (1980, 1988) has tried to show that Hawke's estimate for England and Wales in 1865 is, in any case, not robust, principally because of the arbitrariness of the value to be placed upon the speed and comfort of passenger rail travel relative to coaching. No less important a formulation of the economic impact of railways is, how much higher would national income have been if the performance of the railway system had been better. This question has been less studied despite longstanding criticisms of late Victorian British railway operations (Aldcroft 1968, Irving 1978, Foreman-Peck 1987). Closest in spirit is Williamson's (1974, 1980) counterfactual for the US economy 1870-1914 in which he poses the obverse question, how much worse off would the economy have been in 1890 if technical progress in railways had been frozen at 1870 levels? 73

74

New perspectives on the late Victorian economy

The present chapter offers new social savings estimates for British railways in 1865, 1890 and 1910. It shows how poor was TFP growth in the British sector in the four decades before the First World War compared with American railways. The TFP indices are also employed to project estimates of the social savings of railways in 1890 and 1910, when the railway sector was considerably larger than in Hawke's (1970) study, and to check Gourvish's (1980, 1988) conjecture for social savings in 1890. The social savings research programme has rightly been accused of ignoring many consequences of railways. In partial amendment, the final task of the chapter is to estimate for 1865, 1890 and 1910, the impact on national income of investment and labour force growth induced by British railways.

3.1 Productivity indices and social saving Seeing social savings estimates of the impact of railways as total factor productivity indices draws attention to some of their limitations. Social savings calculations produce an index number which shows the increase in productivity between an economy without railways, or another counterfactual possibility, and the actual historical economy. Fogel's (1964) index computes the national income forgone if the economy had to transport the same quantity of goods and people in a given year, but without railways. Williamson's (1974) index compares points of time in the same economy, measuring the effects of improvement in transport efficiency, implicitly assuming that such enhancements were confined to railways and that these or similar would not have spread to water and road transport, improving the ability of these modes to substitute for railways. Both social savings and TFP indices can be measured either in quantities or in prices. The price approach calculates the change in output prices between two states of the world, controlling for changes in profits and input prices, such as wages. The quantity approach measures the increase in the volume of output after making due allowance for alterations in factor inputs, such as labour. These indices may be obtained for sectors, such as railways, or for the whole economy, although ultimately it is the impact on the economy which is the concern of the social savings approach. Fogel's method adopts the price approach, ignoring changes in input prices, placing the weight on differences in the output prices (how much extra it would have cost to transport agricultural output without railways) and upon the size of the railway sector which is needed to gross

Railways and late Victorian economic growth

75

up the effects to the national level. The crucial issue is then by how much railways cut transport rates. Accepting Baxter's (1866) claim that railways in Britain forced canals to cut their rates to one quarter of their former levels as evidence that freight rates would have been 300 per cent higher in the counterfactual world, and multiplying by the 1865 size of the railway freight sector in national income, gives social savings of 3 x 2.4 per cent = 7.2 per cent of Great Britain's national income (calculated from Feinstein 1972, table 54).2 If railways raised wages by 10 per cent and the wage bill was one quarter of railway costs the calculation would be modified to (3 +(0.10 x 0.25)) x 2.4 per cent = 7.26 per cent, not much change; the transport cost reduction dominates the induced factor price change in this instance. A similar result would be obtained from considering true output effects; how much more was produced with railways than without, allowing for induced changes in the capital stock and in the labour force. Of course railways carried passengers as well as freight. The price difference between the actual and the counterfactual world was arguably much greater in this sector. Accepting the Royal Commission of 1867, comparison of first-class coaching at 2s Od a mile with a first-class rail fare of 2d to 3d a mile yields a reduction in price to 0.125-0.083 of the counterfactual fare. However the revenue generated by first-class travel was a fairly small proportion of the total (first- and second-class tickets earned just under 12 per cent of 1913 ordinary passenger revenue) and, more importantly, the elasticity bias is substantial for passenger traffic. (The price elasticity of demand for freight transport would have been low and therefore the bias is small. The price elasticity is approximately equal to the product of the share of transport cost in the total cost of that freight and the price elasticity of the market demand for the freight). The elasticity bias is the overstatement of social saving due to the switching of demand in the counterfactual world away from transport. The more price elastic the demand for transport, the greater this bias. Some experiments in pricing by the Glasgow and Greenock railway in 1842 suggest an estimate of the passenger price elasticity of demand. The third-class fare was halved, from 0.5d to 0.25d a mile at the same time that open third-class carriages were introduced (80 per cent of passengers travelled third class). Although first- and second-class travel declined markedly, gross receipts rose by 15 per cent (Harding 1848, pp. 327-8). A rough estimate, based upon an assumed constant elasticity demand function, shows the price elasticity to have been -1.3.3 Allowing for the

76

New perspectives on the late Victorian economy

Table 3.1. British railway receipts as a proportion of GDP 1865-1910

1865 1870 1880 1890 1900 1910

Passenger train

Goods train

Total

2.0 2.1 2.5 2.7 2.7 2.8

2.4 2.7 3.3 3.3 3.3 3.3

4.4 4.8 5.8 6.0 6.0 6.1

Source: Calculated from Mitchell (1988), Feinstein (1972), table 54, (price index, GB real GDP) for 1920. 1865-1870 GDP movement assumed same as UK. absence of a price change for first- and second-class passengers might raise the (absolute value of the) elasticity to 1.5. The elasticity bias may be eliminated by employing the welfare gain as a proportion of revenue instead of social saving. The welfare gain is the change in consumers' surplus, the change in how much buyers would have been prepared to pay for transport over and above what they did pay. Assuming a ratio of counterfactual to actual fares of 8 and an elasticity of - 1 . 3 gives a welfare change to revenue ratio of 1.54. A fare ratio of 12 yields 1.75. (The formula is (1/b + l)((p/p) b+1 - 1) where p is the counterfactual fare.) With passenger revenue of 2.0 per cent of national income (table 3.1) the social saving is not huge, 3.5 per cent of GDP in 1865, even assuming that all passenger services would have cost twelve times as much to supply in the counterfactual world. For a fare ratio of 8 (from the comparison with first-class coaching), the saving falls to 3.1 per cent of GDP. With an elasticity of - 1 . 5 the two welfare change revenue ratios become 1.42 (12) and 1.30 (8), amounting to 2.8 per cent and 2.6 per cent ofGNPinl865. In short, even supposing all passenger travel was the equivalent of first-class coaching, taking into account the elasticity of demand still yields a total social savings figure for Great Britain much the same as Hawke's upper bound for England and Wales. Undoubtedly the counterfactual fares and freight rates on which the result depends are fragile. But if more credible numbers become available it will be a simple matter to substitute them into the formulas here and to assess whether the conclusion is much altered. To consider social savings (SS) in any other year than 1865, actual and counterfactual prices must be projected. Alternatively total factor

Railways and late Victorian economic growth

77

productivity growth should indicate by how much railway prices fell, holding input prices constant. So long as no change is assumed in the (Williamson) counterfactual world in the new years, then TFP is sufficient for the projection. The expression is SSIR = [(p -p).q]lp.q = (pip) - 1 = {aid) - 1 where a is the efficiency or TFP index and R = p.q is railway revenue. Hawke (1970) calculated that TFP (the net capital measure) between 1865 and 1890 grew by 79 per cent. 6.0 [(alS9olal865)icilS65ld)-

1]

From the SS/GDP already estimated for 1865, a\%65ld can be found. SS189o/GDP189o = 6.0 [(1.79).(3.5) - 1] = 31.6 per cent If 10 per cent instead of 11 per cent social saving is assumed, SSi89o/ GDPi89o = 29.1 per cent. As long as improvements in technology and organisation in competing transport modes do not reduce this figure by more than one sixth, these results support Gourvish's (1980) claim that social savings for England and Wales in 1890 were two or three times the 1865 level, amounting to 25-30 per cent of national income. The upward bias of this approach stems from the fall in counterfactual real transport rates at the same time as railway productivity was improving. Steam power was applied to water transport as well as to railways. Although British canals quickly lost out to railways, the same was not true of coastal shipping. By the end of the nineteenth century railways were losing market shares in the London coal trade to coastal shipping (Cain 1980). More ton miles of freight were shifted by coastal shipping (specialising in longer hauls) than by railways in 1910 (Armstrong 1987). Electric trams from the 1880s offered some suburban competition to railways; the North Eastern railway introduced electrification in suburban Tyneside after the turn of the century to counter the inroads of trams. After 1906 more efficient motor traffic began to displace horse-drawn vehicles but not on long-distance routes before 1914. Presumably in the (Fogel) counterfactual world all these developments would have been accelerated.

3.2 Railway total factor productivity growth 1870-1914 Tight regulation may have accounted for some of the inroads made by coastal shipping into railway markets, but there is evidence of

78

New perspectives on the late Victorian economy

deteriorating railway performance as well. Most recently Dodgson (1989) found a rate of technical progress in British railways between 1900 and 1912 not significantly different from zero (0.3 per cent per annum). Dodgson estimated a translog cost function for fourteen companies from Railway Returns data. In his work, as well as in that reported below, there is some question about whether output has been correctly measured. He qualifies his result by noting the increase in average load over the period. The quality of service improved markedly from the end of the nineteenth century, although it lagged North American practice and foreigners no longer came to Britain to see best practice techniques in operation (Clapham 1963:349). Faster travel required rising coal consumption per train mile, raised wear and tear and necessitated higher manning levels to maintain safety, yet time spent travelling is typically not included in output as it should be. Over the 540 miles between London and Aberdeen, a train in 1890 averaged 63.3 mph and attained a maximum speed of 85 mph, albeit this was a one-off, rather dangerous feat. As a comparison, by 1989, the average speed on this route had been raised to 72.7 mph. The level of comfort increased. Passenger rolling stock began to be lighted by electricity and gas instead of oil and to run on pairs of four-wheel bogies instead of four rigid wheels. Express trains acquired kitchens and toilet facilities, but in general improvements fell behind those in America, despite higher US productivity growth. Carriage heating in the UK at the turn of the century was still by hot water cans in contrast to the North American method of utilising steam from the locomotive's boiler. Productive efficiency was raised by introducing wagons capable of carrying double the 8 or 10 ton capacity of the traditional British wagon of the 1870s, so reducing mineral train mileage. Continuous automatic brakes became obligatory after the Armagh disaster of 1889. Steel rails replaced iron and allowed heavier, more powerful trains. But the US measured average of 2 per cent per annum TFP growth 1870-1910 was achieved without accommodating these improvements in the calculation. How did British TFP growth compare? The concern with the correct measurement of output arises because quantity TFP indices are the difference between output and input change. Railway output has a number of dimensions in addition to those already noted such as time spent travelling. The commonly accepted measure of work done by a railway is freight ton miles and passenger miles. Yet even ignoring the time dimension, shorter hauls or trips are likely to cost more because of the fixed costs associated with each individual load. Ideally each dimension of output, safety, comfort, average speed, haul and trip

Railways and late Victorian economic growth

79

Table 3.2 Railway returns traffic statistics 1870-1910

1870 1880 1890 1900 1910

Passengers m.

Pass, train miles m.

Freight m. tons

Freight train miles m.

322 597 796 1115 1276

81 116 158 210 255

*155 232 299 420 508

80 112 139 175 149

Source; Mitchell (1988). Note: * Obtained by linear interpolation between 1867 and 1871.

length, and total freight and passengers carried, would be included in the output index, weighted by their respective cost elasticities. Even the above indices exclude option demands. The railways were obliged to schedule trains, subject to regulatory restrictions, to best satisfy passenger requirements while minimizing the resources needed. As far as the railways were concerned, their passenger output was the number of trains run, the total of train miles and the number of passengers carried (table 3.2). For freight, timetables were less of a constraint and companies could reduce train miles by better planning and tariffing. In view of the theoretical arguments for the inappropriateness of ton/passenger miles as sole measures of output, together with the uncertainty about many component figures, it is better to use existing passenger series weighted together to construct an output index, than to construct approximations to theoretically inadequate variables. The four official series are therefore combined using revenue weights for freight and passenger services and different cost elasticities for the two component series. The costly activity was the production of train miles. The extra cost of shifting a greater number of passengers for given train miles was relatively small. The most plausible weights for passengers are either the 0.1 or 0.2 on the volume measure, with a greater likelihood of 0.1 being closer (and the two weights on train miles and passengers sum to unity). For freight, Cain's (1980) ton mile and (the reciprocal of) haul length series are used, again with weights summing to one. The assumption is that changes (but of course, not levels) in Scotland mirrored those in England and Wales. Tables 3.3 and 3.4 show the two methods of constructing output growth yield similar results. Growth is much lower than Hawke's between 1870 and 1890, with the implication that his TFP index for this period is

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New perspectives on the late Victorian economy

Table 3.3

British railway output components growth estimates Percentage increase in Passenger output weight on passengers

1870-80 1880-90 1890-1900 1900-10

Freight output weight on haul length reciprocal

0.1

0.2

0.5

0.0

0.1

47.8 35.9 33.6 20.7

52.0 35.6 34.3 20.0

64.5 34.7 36.5 17.9

*42.8 30.0 24.4 **29.9

*38.6 27.0 23.1 **26.6

Sources: Calculated from output variables in Mitchell (1988). Passengers, ordinary journeys only. Freight variables from Cain (1980),* 1871-80,** 1900-11.

Table 3.4

British railway output growth estimates Percentage increase in Aggregate output (base revenue weights)

1870-80 1880-90 1890-1900 1900-10

(a)

annual average

(b)

annual average

45.0 32.5 28.5 25.7

3.7 2.8 2.5 2.3

44.4 30.7 28.1 23.6

3.7 2.7 2.5 2.1

Notes', (a) 0.1 weight on passengers, zero weight on haul length reciprocal, (b) 0.2 weight on passengers, 0.1 weight on haul length reciprocal. biassed upward, as is the social saving figure projected with it for 1890 above. Table 3.5 presents employment growth estimates. When combined with the output estimates, the resulting labour productivity appears to have been falling in the 1870s and 1890s, but shows a strong performance in the first decade of the twentieth century. According to Table 3.6, total factor productivity growth fell in the 1890s and then rose above levels of the previous decades in the Edwardian era, but this conclusion depends upon the Cain revisions of freight output. A faster rate of depreciation lowers the growth of the capital stock and therefore slightly improves total factor productivity growth. Hawke's net capital TFP index shows faster growth between 1870 and

Railways and late Victorian economic growth

81

Table 3.5 British railway employment growth estimates Percentage increase in employment 1870-80 1880-90 1890-1900 1900-10

55.1 25.3 40.8 5.2

annual average 4.4 2.2 3.4 0.5

Source: Calculated from Hawke's (1970) figure for England and Wales in 1890 grossed up by the proportion of Scottish railway employment in selected occupations in 1891 in Abstract of Labour Statistics and total GB railway employment for 1900 in Munby and Watson (1978).

Table 3.6 British railway total factor productivity growth and components 1870-1910 Capital 1870-80 1880-90 1890-1900 1900-10

Labour

26.0 (20.6) 55.1 18.4(13.9) 25.3 18.4(15.4) 40.8 12.7 (9.5) 5.2

Coal

Output

TFP index

29.4 24.5 32.7 11.6

45.0 32.5 28.5 25.7

12.2(16.0) 12.3(13.3) 4.4 (9.6) 14.8(18.7)

Note: The bracketed capital figures are obtained from a 2 per cent depreciation rate for way and works investment, instead of 1 per cent. Sources: see Appendix. Output from column (a) table 3.4.

1890 because of his higher output growth. Over the forty years TFP growth averaged little more than 1 per cent per annum. Over the same period the US railway sector doubled that performance. If British railways had attained a comparable growth in efficiency between 1890 and 1910, the TFP index would have been 50 per cent higher in 1910; efficiency would have improved by one half in an industry in 1910 generating (ordinary fare) revenue amounting to 6.1 per cent of GDP. Instead it was only about 22 per cent higher. The gain from a US pace of efficiency growth by 1910 would have been more than 3 per cent of GDP. If 1 per cent per annum is the more accurate pace of TFP growth after 1865, the increase in efficiency by 1890 is only 28 per cent compared with Hawke's 79 per cent. Upward biassed (Williamson) 1890 social saving falls to approximately 21 per cent of 1890 GDP compared with 31.6 per cent. By 1910 (upward biassed) social saving reaches about 27 per cent of GDP.

82

New perspectives on the late Victorian economy

3.3 Railways as an intermediate service The slow growth of railway total factor productivity between 1870 and 1910 carries implications for the poor performance of the British economy in these years. Earlier improvements in the Victorian postal service were undoubtedly helped by the reorganisation and price cuts, but much must also have been due to railways. Without the railways, the speed and regularity of delivery that so impressed the public by the 1860s would have been impossible (Daunton 1985). Transport was an input to the postal service and postal services were inputs into many other sectors. What proportion of increased Post Office productivity should be assigned to railways rather than to the organisation? The two were inseparable. Possibly Post Office management could have refused to use the new transport media, be it railways or, later, bicycles. Since Post Office management in fact adopted the new technology, then they or their sector should be credited with the productivity increase. But, if railways had not been available, they could not have done so. When the pace of railway advance slowed, so also must have efficiency growth in the Post Office. Between 1856-73 and 1873-1913 there was a particularly large decline in the rate of TFP growth in agriculture, at that time one of the three largest sectors (Matthews, Feinstein and Odling-Smee 1982, chapter 8, especially p. 233). Had agriculture spent 10 per cent of costs (at the market rather than at the farm gate) on rail transport and had TFP growth in railways slowed from the 5 per cent per annum on Hawke's net capital measure for the 1850s to the 1 per cent per annum average on my estimate for 1870-1910, then agricultural TFP would have fallen by 0.4 per cent, most of the 0.5 per cent annual average decline between 1856-73 and 1873-1913. Even larger were the retardations in construction, where TFP barely grew at all between 1873 and 1913, and in mining, where it fell absolutely. Until 1899 the main sources of the national slow down were agriculture and mining. After 1899, there was a significant retardation in manufacturing and construction. Each of these sectors used railway transport for raw materials and products. Each will therefore have registered a decline in TFP growth conventionally measured as a consequence of the slowing of railway TFP growth. Whether or not there was a late Victorian climacteric or failure (Pollard 1989, Crafts, Leybourne and Mills 1987), some of the retardation of TFP growth can be understood as a consequence of the performance of the railway sector.

Railways and late Victorian economic growth

83

3.4 The long-run impact of railways The ultimate impact of Victorian railways upon national income was greater than implied by the static social savings measures discussed above. Had there been no railways or had the railway industry been better organised, national income would have been respectively lower and higher than it was. Higher income would have generated more savings and more investment. Even in the absence of further technical improvements in railways, subsequently there would have been further increases in national income from this source. Supposing the economy's incremental and average capital output ratio was 3, the savings ratio was 0.1 and railways saved 10 per cent of national income. Then this crude Harrod-Domar model predicts that Victorian economic growth would have been higher by (0.1 x 0.1 x 1/3 =0.00333) one third of a per cent per year. Cumulated over half a century (say 1865-1914), that amounts to an extra 17.9 per cent of the base year's income. This large additional dynamic social saving figure is biassed upwards by ignoring diminishing returns to individual factors and factor substitution. Both of these production characteristics are included in the neoclassical model of economic growth.4 The ultimate effects of a counterfactual change, the introduction of railways or an improvement in their organisation, can be assessed by comparing the actual and the counterfactual economies in their neoclassical steady state growths, without conceding that historical economies necessarily ever get close to steady state growth. Rather, the use of the steady state recognises the concept as a ceteris paribus clause; steady state values indicate the long-run effect of a change, abstracting from other influences impinging upon the economy (compare Temin 1973). In the Solow/Swan model the long-run equilibrium or steady state growth is attained when the capital stock of the economy is growing at the same rate as the labour force, for then there is no tendency for relative factor prices to change, inducing alterations in production techniques and setting in motion still further changes. Because constant returns to scale are assumed as afirstapproximation, output also grows at the same rate as the inputs. Defining y as national output per head, k as total capital stock per head, s the proportion of output saved and n the growth rate of the labour force, then the economy has reached a steady state growth when sylk = n

(3.1)

Moreover y depends upon k and, by assumption, separably upon overall efficiency (measured by A) in the economy

84

New perspectives on the late Victorian economy y

=/LA, k) = A ./(*), fk>0Jkk<0

(3.2)

so that the steady state capital-labour ratios can be found as a function of A by substituting for y from (3.2) into (3.1). Thus given the parameters of (3.1) the long-run effects of railway policy on the capital-labour ratio, by enhancing A, can be calculated and the higher long-run output per head is obtained by substituting that ratio back into (3.2). From (3.2) changes between actual and counterfactual national incomes are given by S/y/y = (1 + dfldk . klf. dkldA . Alk) . V AIA

(3.3)

where V is the difference between actual and counterfactual values of a variable. Equation (3.3) shows that by raising A, railways not only have a direct effect (the first term in the brackets), but also an indirect effect through the capital stock (the second group of terms), y and k are defined in units per head and railways in some circumstances may have influenced the size of the national labour force. In the United Kingdom and Italy railways might have reduced emigration and in the United States and the rest of the New World they may have increased immigration. In such cases labour force growth rose as railways bid up wages (w) and improved employment prospects n = «(w), nw > 0 and n = n(k),

nk>0

Migration therefore lowered the capital-labour ratio, wages declined and labour force growth slowed, but the net effect was to increase national income by more than national income per head. The increase in income per head also was less than it would have been without induced labour force growth. Hawke (1970, p. 281) maintained that if railways did increase the labour force of England and Wales the contribution to economic growth would have been insignificant because the workers attracted by immigration were unskilled. But this judgement excludes indirect effects of migration which can only be analysed in a model such as ours. Analogously the savings and investment ratio may have been driven up by railways. The most obvious rise stems from the economising on inventories. Writing in 1848 Wyndham Harding contended that average journey transit times had been reduced from three days to one day in

Railways and late Victorian economic growth

85

Britain thereby saving £600,000 in inventory costs because of the increased rapidity of transport. Certainly the ratio of inventory to fixed capital in the non-farm sector declined between 1760 and 1860 in Britain, from 20 per cent to 11.3 per cent even though the investment ratio apparently failed to rise in the 1840s and railway investment seemed to crowd out investment in housing (Feinstein 1981, pp. 129, 134). In the US the investment-GNP ratio did rise through the nineteenth century from 10 per cent in 1839 to 22 per cent in 1889-98 but all of this increase cannot necessarily be attributed to railways any more than the constancy of the ratio in Britain implies that the ratio would not have fallen without railway investment (Gallman and Howie 1971). Great store has been placed, in qualitative railway economic history, upon the induced development of financial institutions to tap idle savings and channel them into railway investment. Countries with relatively undeveloped financial institutions might then be expected to show the greatest responsiveness of the savings ratio to railways. The savings ratio depends upon the rate of return on capital, r, s = s{r) and investment takes place until the rate of return is driven down to equality with the rate on capital. Railways increase r, expand the capital stock relative to the labour force, which in turn ultimately lowers the rate of return: s = s(k),

sk<0

A graphical approach serves to draw together the above considerations. In figure 3.1 national output per head of the labour force (y) is plotted on the vertical axis, and capital per head (k) on the horizontal axis. The aggregate production function shows that increases in output per head required successively larger increases in the capital-labour ratio. Railways shift the production function upwards. Or put another way, conceptually removing railways from the economy shifts the production function downward and the vertical shift is a measure of the static social saving. When the economy reaches the new steady state equilibrium the capital stock has also contracted so that for this reason also output per head is lower. The consequences of this contraction for output per head may be called dynamic social saving. In general it will be greater the more productive is the capital stock. In the case where factor supplies change in response to railways the steady state growth condition generally shifts and is non-linear. Consequently the contraction in the capital-output ratio is no longer exactly proportional to the fall in the capital-labour ratio. If railways encouraged savings and investment, the gradient of the steady state condition

86

New perspectives on the late Victorian economy National output per head, y

Production function with a < 1

Steady state equilibrium condition

y = actual output per head Steady state condition with induced savings

Actual production function

A A = static social saving

Dynamic social saving

Counterfactual production function

y = counterfactual output per head for n and s constant y when s endogenous

National capital-labour ratio, k Induced contraction in the capital-labour ratio, Ak, with unchanged savings ratio and labour force growth Fall in k with s endogenous

Figure 3.1 Dynamic social savings

increases with k and the dynamic social savings are enhanced, if the elasticity of substitution is greater than one. The greater the elasticity of substitution between capital and labour, the greater will be the dynamic social savings, because the induced capital formation will be able to raise income more without being constrained by labour shortages. If the elasticities of labour force growth and savings happen to be equal, railways do not shift the steady state condition. Although railways raise the marginal productivity of both labour and capital and therefore induce faster labour force growth and more savings, the relationship between labour and capital does not change. The same result is obtained as when there is no induced factor growth. A quantitative assessment of these dynamic effects requires some assumptions about functional forms. We assume a variable elasticity of substitution production function, a restricted form of the translog function.5 The production function is

Railways and late Victorian economic growth lnY=\nA

2

87

2

+ a l n # + (1 - a) \nL + fr (InA) + p 2 (lnL) - p 3 21n/flnL

where F, # and L are respectively, output, capital and labour, and we assume fi\ = p 2 = 03 = P, to keep the model relatively simple. Then 2 lny = \nA + a\nk The elasticity of substitution is

(1 -a)-2p\nk Except when /3 = 0, a varies with k. When £ > 0, a> 1: /? < 0, a< 1. The population/labour force growth equation is assumed to be

n = \\fw€, e > 0 and the savings supply s = ?7ry, y > 0 where r is the rate of return on capital. Setting factor prices equal to their marginal products, the steady state equilibrium output per head and capital-labour ratio of the system can be found. The elasticity of steady state output per head to the national efficiency index is d\ny _ dlnA + y + 1 - (1 + y-e)(a

+ 4/3lnk)

where

*

(l-a)-2/3lnk

a + 2fllnk

The simplest case is where a = 1 so that /? = 0 and therefore = 0. Then d Iny 1 + y d inA "* 1 + y - (1 + y - e)a When the labour force elasticity is zero, diny/dlnA = 1/1 — a; the elasticity of the supply of capital has no effect on the long-run consequences for output per head of a change in the efficiency index. Where < r < l , / 3 < 0 , >0 and dlny/dlnA is reduced relative to the case where <7=1.

When a * 1 and factor growth elasticities are positive but equal, dlny + y + 1 - 2/3lnk dlnA ~ + y - (a + 4/3lnk) + 1

88

New perspectives on the late Victorian economy

Table 3.7. The long-run elasticity of national output per head with respect to the national efficiency index

Capital - output elasticity

Elasticity of substitution 1.3 1 0.6

0.3

0.48

2.41

1.91

1.56

1.30

0.33

1.58

1.49

1.33

1.24

Note: The elasticities are derived from equation (3.4) assuming y=0.65 and e = 0.0125, and choosing units so that lnA: = 1. With cf> = 0 when e = y = 0

dlny 1 - 2/3lnk d\nA 1 - (a Estimates of the long-run consequences of an efficiency shift caused by railways, or by an improvement in the organisation of the railway industry, require empirical estimates of parameter values. Edelstein (1982, p. 198) estimated that y=0.65 for late nineteenth-century Britain and Lee (1979) calculated s= 0.0125 for England and Wales 1539-1839. Greater opportunities for migration in the later nineteenth century might be expected to have raised e; Williamson (1974, p. 236) estimated a wage elasticity of UK migration of 0.376, but migrants were only a small proportion of the population and we therefore adopt Lee's elasticity. (In small host economies like Argentina, Australia or Canada obviously the elasticities would be much greater.) In any event the value of e within a plausible range is sufficiently small for Britain to make very little difference to the steady state outcome, a conclusion which was not obvious from the historical record. Values for the production parameters are possibly even more problematical. Factor shares in the late nineteenth century suggest a high productivity of capital, although monopolistic or monopsonistic behaviour may have caused a divergence between factor shares and factor output elasticities. McCloskey (1970) adopted a capital-output elasticity of 0.48 and assumed a = 1 because factor shares were approximately constant. Provisional work by Hatton (1984) indicates, in common with most econometric estimates for other periods, that a< 1. On the other hand cr was almost certainly higher when the period allowed for adjustment was substantial, as the steady state model implies, and a simple test of whether or^ 1 for the period 1855-1914 could not reject the hypothesis of o~= I.6 Table 3.7 presents a range of estimates for the long-run elasticity of

Railways and late Victorian economic growth

89

output per head with respect to changes in national efficiency for different approximate values of the elasticity of substitution and for different factor shares that would have obtained had factors been paid their marginal products. The qualitative results implied by table 3.7 have already been discussed. The numerical conclusions suggest that on the assumptions of McCloskey (1970) the full effects of railways on output per head were 91 per cent higher than the static social savings measure, although with a capitaloutput elasticity of 0.33 and an elasticity of substitution of 0.3, they were only one quarter greater. The induced growth in the labour force can be computed from dlnn/dlnA = (d In yl d In A).(d In wl d In y).(d In nl d In w). The CobbDouglas case with the parameters of table 3.7 and a = 0.48 yields din nl d\n A =0.0124. If the impact of railways in 1865 was to increase static efficiency by 10-11 per cent then the implication is that labour force growth would have increased by 0.124 per cent per annum. In practice the effect would have been modified by the pace at which railways were introduced overseas. A precise evaluation of dynamic social savings must await more definitive work by economic historians on the key parameters of expression (3.4). However the conclusion of this section is that conventional social savings, either measures of the impact of policy or of the entire technology, are not upper bounds by any means. Perhaps a 50 per cent increase would give a best point estimate, and a doubling would yield a true upper bound on any static measure for nineteenth-century Great Britain. Applying the best guess multiplier to the social savings estimates of this chapter implies that the long-run effect of railways in 1865 was that GDP would have fallen by roughly 15 or 16 per cent if they had been removed, in 1890 the fall would have been about 30 per cent, and in 1910, 40 per cent. The last two figures presuppose no technical progress in competing transport modes after 1865 and so for that reason are biassed upwards. Their magnitudes however accord more closely with the perceived importance of rail transport in the age before the arrival of the motor vehicle than much of the social savings research programme has indicated.

3.5 Conclusion Whether large or small effects of railways on late Victorian GDP are found depends upon the ratio of counterfactual to actual prices and costs, and price elasticities of demand for transport. The present study has

90

New perspectives on the late Victorian economy

offered some estimates based on plausible numbers which show large static social savings, certainly by the beginning of the twentieth century. When linked with dynamic effects, induced savings and labour force growth, the impact increases perhaps by 50 per cent more. In economic history as in other areas, perfect accuracy is unobtainable and unnecessary. The appropriate degree of accuracy can only be assessed in relation to a particular purpose. Here we offer quantitative confirmation that railways were as important to the late Victorian economy as contemporaries thought, and call into question Fogel's claim that railways were only 'essential' in economies like Mexico's or Spain's where water was scarce (Fogel 1979). Because the extent to which other transport modes would have developed, in the absence of railways, is difficult to imagine, let alone model, the Williamson counterfactual is here generally preferred to Fogel's. The chapter has offered some indication of the characteristics of the economy that amplify the indirect effects of railways. A high capital output ratio, a high elasticity of substitution between capital and labour and a low labour force growth elasticity of wages give the greatest gains per head from railways. Total factor productivity calculations show that the pace of efficiency growth in the British railway sector after 1870, at around 1 per cent per annum, was about half of the performance of the US sector. Had Great Britain achieved US rates of productivity growth over the years 1890 to 1910, GDP in 1910 would have been 3 per cent higher. Whether a counterfactual of this sort is sensible may be controversial. (It is similar to the larger exercise conducted by Kennedy, 1987.) The justification is that the late Victorian industry was not efficiently organised, as the results of restructuring after the First World War demonstrated (Cain 1980).

Appendix 3.1 Data for the total factor productivity Calculation Coal Coal consumption reached about 74 lbs per train mile in 1903 and 77 in 1913 (calculated from Mitchell). Hawke estimated 54.8 for 1890 for England and Wales. Interpolating from the annual rate of growth in the 1910 Railway Returns yields a 1900 figure of 72.7, an increase over 1890-1900 of 32.7 per cent. Hawke's numbers for 1870-90riselinearly by about 10 lbs a decade (29.4 per cent 1870-80, 24.5 per cent 1880-90). The 1910 return indicates a 9.6 per cent rise 1900-9 and, in view of the 1910 train mileage increase, over the decade the increment would have been about 11.6 per cent. Coal consumption in any case was a small proportion of total costs, about 4 per cent at the turn of the century, labour accounting for 23 per cent and capital for 73 per cent.

Railways and late Victorian economic growth

91

Capital Decadal capital stock percentage growth is obtained by dividing Hawke's (1970) net capital stock for 1855 between rolling stock and way and works according to the proportions obtained by accumulating (Mitchell 1988) UK nominal investment in these two categories with respectively a 3 per cent and a 1 per cent depreciation rate. The capital series, excluding land, is then constructed from the 1855 figure using the investment series deflated respectively by Feinstein's (1972) railway rolling stock price index and his price index of other construction work, each on a base of 1869, for consistency with Hawke.

Appendix 3.2 Derivation of the steady state response of income per head to railway technology Production Function: ln(—) = inA + a\n{—) + p\ ln(—) L L i L J

(3.1 A)

= n = ft w6,

Population growth:

(3.2A)

dt L where w is the wage rate, ft, e > 0 Savings: — = s = nry

(3.3A)

where r is the rental on capital and s the savings ratio, 77, y > 0 Factor demands:

= ^ f = - f ( l - a ) - 2/31n (^) oL, L, L L, J t9Y Y \ K

(3.4A)

Steady state growth conditions: y = -- = n — — = —

(3.6A)

w

LJ

O LI

S

Substitute (3.4A) and (3.5A) into (3.2A) and (3.3A), then substitute for n and s in (3.6A) and for (y) in 3.6A) from (3.1 A) ft [y{\-a)-2p\nk}Y [y{a+2fflnk}r '* " ^ ft {(1 - a) - 2/?ln£}g _ . I + r _ e , a ( 1 _ e + y ) _ y _ rj' {a+2/3\nk}? 1+ y— e

k (3 ?A)

V'

dink

y - (1 + y - e){a +

'

\(i-a)-2pink

a

—r~7 = a + 2)81nA: from the production function (3.1 A) oink diny _ (f>+ 7 + 1 - (1 + y— e)2 )Slnk _ dinA 0 + y + l — (l + y— e)(a + 4£lnk)

diny dink dink ' dinA

92

New perspectives on the late Victorian economy where = - 2

When ft = 0, = 0, the elasticity of substitution a = 1 and dlny y+ 1 dln,4 y + 1 - (1 + y— e)a K The elasticityJ of substitution a = —„ ^ where R = —r/—r dlnR dL dK from (3.4A) and (3.5A)

dlnR = dln(f)

ll

-tfln(|)

( l ) 2 8 1 ( )

^ - ^

n

( }

7

(a+2/8ln(-)

1/.

Since under perfect competition—^- = (1 — a) — 2/61n(—) J

,

,. .

under those conditions cr =

1

r^

—

t

wL

—, since — = 1 ——

Notes 1 In addition to comments from participants at the Birkbeck meeting of the ESRC Quantitative Economic History Group and other seminars, I have also benefited from suggestions about an earlier draft from John Armstrong, Paul Stoneman, Brian Beavis, John Dodgson and Nick von Tunzelman on an earlier draft. They are not responsible for remaining inadequacies. 2 Baxter's (1866) panegyric was not unrelated to the contemporary debate on railway nationalisation. He had an interest in showing railways were doing a good job. Gourvish (1988) remarks that Baxter reached a similar conclusion about the size of social savings to Hawke (1970) with less work. He does not argue that the methods are equally reliable. 3 Assume the demand function is In q = a + b In p, where b is the price elasticity and p and q are respectively price and quantity. The revenue function is then In R = In p + In q = a + (b+ l)ln p. The elasticity of revenue with respect to price is Z>+ 1, the price elasticity plus unity. The experiment implied that b+ 1 was - 15 per cent/50 per cent = -0.3. Hence b— — 1.3.

Railways and late Victorian economic growth

93

4 Hulten (1979) examines a similar problem in a dynamic growth accounting framework but his approach is not suited to counterfactual analysis because he only aims to measure not to explain the sources of accumulation and growth. 5 This function can be seen as a linear approximation to the CES function. When Q = (JL[5L~P + (1 - b)K~p]~]/p, upon rearrangement, the first two terms of a Taylor expansion yield 2 In I-^ i = In/* + (1 - 8) In I— I - 0.5p(l - 8) ( i n * )

6 There are few estimates of the elasticity of substitution for economies as a whole during the classic railway period. Cain and Paterson (1981) found the degree of capital-labour substitution ranged from 3.8 in tobacco to 0.5 in instrument engineering in US manufacturing in 1860. Hatton's estimate of about 0.3 relates to the period 1855-1913 in Britain. A regression of labour share on GNP, wages and time for 1855-1913 using Feinstein's (1972) data failed to reject the hypothesis of a = 1. References Aldcroft, D. H. (1968), T h e efficiency and enterprise of British railways 18701914', Explorations in Entrepreneurial History, 5: 158-74. Armstrong, J. (1987), T h e role of coastal shipping in UK transport: an estimate of comparative traffic movements in 1910', Journal of Transport History, third series, 8: 164^78. Baxter, R. D. (1866), 'Railway extension and its results', Journal of the Statistical Society of London, 29: 549-95. Cain, L. P. and Patterson, D. G. (1981), 'Factor biases and technical change in manufacturing: the American system 1850-1919', Journal of Economic History, 41: 341-60. Cain, P. J. (1972), 'Railway combination and government, 1900-1914', Economic History Review, 25: 623-6. (1980), 'Private enterprise or public utility? Output pricing and investment in English and Welsh railways 1870-1914', Journal of Transport History, third series, 1:9-28. (1988), 'Railways 1870-1914: the maturity of the private system', in M. J. Freeman and D. H. Aldcroft (eds.), Transport in the Victorian Age, Manchester University Press. Church, R. A. (1.975), The Great Victorian Boom 1850-1873, London: Macmillan. Clapham, J. H. (1963), An Economic History of Britain: Machines and National Rivalry 1887-1914, Cambridge University Press. Crafts, N. F. R., Leybourne, S. J. and Mills, T. C. (1987), T h e climacteric in late Victorian Britain: a reappraisal of the evidence' University of Leeds Discussion Paper, Series A, 87/12.

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New perspectives

on the late Victorian

economy

Daunton, M. (1985), Royal Mail. The Post Office since 1840, London: Athlone Press. Dodgson, J. S. (1989), 'Privatising Britain's railways: lessons from the past?', University of Liverpool Discussion Paper in Economics, 59. Feinstein, C. H. (1972), National Income, Expenditure and Output in the United Kingdom 1855-1965, Cambridge University Press. (1981), 'Capital accumulation and the industrial revolution' in R. Floud and D. McCloskey (eds.), The Economic History of Britain Since 1700, vol. 1, Cambridge University Press. Fishlow, A. (1965), American Railroads and the Transformation of the Antebellum Economy, Harvard University Press. (1972), 'Inland transportation' in L. E. Davis, R. A. Easterlin and W. N. Parker (eds.), American Economic Growth: An Economist's History of the United States, New York: Harper and Row. Fogel, R. W. (1964), Railroads and American Economic Growth, Baltimore: Johns Hopkins. (1979), 'Notes on the social saving controversy', Journal of Economic History, 39: 1-54. Foreman-Peck, J. S. (1987), 'Natural monopoly and railway policy in the nineteenth century', Oxford Economic Papers, 39: 699-718. Gallman, R. E. and Howie, E. S. (1971), 'Trends in the structure of the American economy since 1840' in R. Fogel and S. Engerman (eds.), The Reinterpretation of American Economic History, New York: Harper and Row. Gourvish, T. R. (1980), Railways and the British Economy 1830-1914, London: Macmillan. (1988), 'Railways 1830-70: the formative years', in M. J. Freeman and D. H. Aldcroft (eds.), Transport in the Victorian Age, Manchester University Press. Harding, W. (1848), 'Facts bearing on the progress of the railway system', Journal of the Statistical Society of London, November: 322-43. Hatton, T. J. (1984), 'Rational expectations and labour market equilibrium in Britain 1855-1913', Centre for Economic Policy Research, Discussion Paper No. 23. Hawke, G. R. (1970), Railways and Economic Growth in England and Wales 1840-1870, London: Oxford University Press. Hulten, C. R. (1979), 'On the "importance" of productivity change', American Economic Review, 69: 126-36. Irving, R. J. (1978), 'The profitability and performance of British railways 1870— 1914', Economic History Review, 31: 46-66. Kennedy, W. P. (1987), Industrial Structure, Capital Markets and the Origins of British Economic Decline, Cambridge University Press. Lee, R. D. (1979), 'A historical perspective on economic aspects of the population explosion' in R. Floud and D. McCloskey (eds.), The Economic History of Britain Since 1700, vol. 1, Cambridge University Press.

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McCloskey, D. N. (1970), 4Did Victorian Britain fail?' Economic History Review, 23: 446-59. (1987), Econometric History, London: Macmillan. Mathias, P. (1983), The First Industrial Nation, London: Methuen, second edition. Matthews, R. C. O., Feinstein, C. H. and Odling-Smee, R. (1982), British Economic Growth 1856-1973, Oxford: Clarendon Press. Mitchell, B. R. (1988), British Historical Statistics, Cambridge University Press. Munby, D. L. and Watson, A. H. (1978), Inland Transport Statistics: Great Britain 1900-1970, Oxford: Clarendon Press. O'Brien, P. (1977), The New Economic History of Railways, London: Croom Helm. O'Brien, P. (ed.) (1983), Railways and the Economic Development of Western Europe 1830-1914, Oxford: Macmillan/St Antony's. Parris, H. (1965), Government and the Railways in Nineteenth Century Britain, London: Routledge & Kegan Paul. Pollard, S. (1989), Britain's Prime and Britain's Decline: the British Economy 1870-1914, London: Edward Arnold. Temin, P. (1973), 'Introduction' in New Economic History, Harmondsworth: Penguin. Williamson, J. G. (1974), Late Nineteenth Century American Development: General Equilibrium History, Cambridge University Press. (1980), 'Greasing the wheels of sputtering export engines: midwestern grains and American growth', Explorations in Economic History, 18: 109-217.

Chapter 4

Emergence of gas and water monopolies in nineteenth-century Britain: contested markets and public control Bob Millward

4.1 Introduction The economic organisation of the local utilities in gas, water, tramways and electricity which emerged in the nineteenth century involves issues of natural monopoly as well as of public health and safety. They provoked a stream of outstanding reports by Royal Commissions and Select Committees. There has however been only a small academic literature addressed to questions of economic organisation and two central issues which have, as yet, only been briefly addressed are analysed in this paper: one is the nature of the natural monopolies in gas and water, the other is the form which public control took. There seems to be a broad consensus in the literature that the question of municipally provided services was one assessed in nineteenth-century Britain in pragmatic rather than political or ideological terms. Waller (1983, p. 300) called it municipal capitalism in contrast to municipal socialism which Kellett (1978) and others have associated more with the debate on London government and with the period from the turn of the century. There were specific problems arising in the provision of gas and water supplies in the mid nineteenth century by which time many areas had only one supplier. The monopoly issue was one source of concern, and the 'adequacy' of supplies was another. For Falkus (1977, pp. 145-6) and Robson (1935, pp. 309-10), authors of perhaps the best-known scholarly articles on the economic history of municipal trading, these were the key issues. Other matters raised by these and other writers include the desire to raise local revenue for rate relief, improve the quality of supplies and safeguard public safety and health; for yet others, there were the planning problems arising in long-term large-scale projects as well as the need to coordinate usage of the streets for the laying of pipes and mains.1 Matthews (1986) has argued that the growing concern with gas supply by the 1850s and 1860s was a product of its wider usage following a continuing fall in prices. The large rise in the number of 96

Emergence of gas and water monopolies in nineteenth-century Britain

97

enfranchised consumers was, together with the disappearance of competition, a source of pressure on Parliament and other public authorities. The response of the latter, according to Matthews, was therefore not exogenous, as Falkus (1977) and Chatterton (1972) implied, but rather endogenous to the development of the industry. But all these issues relate to the desire for public control, not why it increasingly took the form of public ownership. Regulation, franchising and other devices are possible and were unambiguously considered and on occasion used. There seems to be no obvious party political line which would explain why some undertakings were brought into municipal ownership and Waller (1983, pp. 298-9), Kellett (1978, pp. 40-1) and others have explicitly played down the role of such electoral issues in explaining the form of the municipal response. The vigour of the municipal response has suggested to some that civic pride was important, but Jones (1983) and Matthews (1986) have suggested that more pragmatic economic issues seem to be explanations enough of the response. Hassan (1985, pp. 357-8) has recently argued persuasively that, in the case of water supplies for the propertied and commercial classes capable of influencing Council policy, it was clearly in their self interest to support municipal endeavour because of the anticipated effects onfire-fightingand health, and the improvement of supplies in both quantity and quality. Again, however, these issues relate only to the desire for public control, not why it took the particular form of public ownership. It is argued in this chapter that the move to public ownership, including its geographic and chronological incidence, reflected the severity of the underlying economic problems and the strain this imposed on the alternative regulatory mechanisms which were used. To understand the specific requirements of public control it is necessary, therefore, to examine more closely the specific problems which had arisen in private company provision of gas and water. This leads to our second issue. That significant externalities in the area of public health and safety were associated with these utilities is recognised in the literature. But, just as important, is to reconsider the classic decreasing cost problem. The distribution networks for gas, water, tramways, electricity, rail and telegraph, have for long been alluded to in the economics literature as illustrating the problems of declining average cost. From John Stuart Mill through A. C. Pigou to modern times, it has been common to refer to the high costs and replication of facilities that would arise from competition 'in the field', and the incentives this gave for the emergence of a monopoly earning abnormal profits (cf. Schwartz 1966, p. 76).

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The view was challenged explicitly in 1968 by Demsetz who, in part echoing Edwin Chadwick a century earlier, argued that an equally plausible outcome was competition 'for the field' leading to the emergence of an exclusive supplier unable, because of the threat of potential competition, to earn more than normal profits. For Demsetz, any need for regulation would arise as much from the externalities associated with the placement of mains and tracks on public highways. Whilst the presence of heavy transaction costs has always been likely to cast doubt on an efficient competition for the field, the recent contestable markets literature provides some further reasons for thinking that an exclusive supplier could be undermined, even when he was doing no more than breaking even.2 It is argued in this chapter that the dissatisfaction by the mid nineteenth century with the quantity and quality of gas and water supplies, arose in part from the fact that the markets served by private companies were not clear natural monopolies, were still being contested, and that this threat of potential competition inhibited an extension and improvement of supplies by the incumbent companies. The organisation of the chapter is as follows. The next section 4.2 analyses market organisation in the early part of the century as background to the two central issues. Section 4.3 sets out the contestable market issues which explain why the private companies often did not have sustainable monopolies. Section 4.4 describes the implications for a regulatory framework, and assesses the effectiveness of the regulation which occurred between 1840 to 1875. Section 4.5 then sets out the forces which prompted public ownership and provides an assessment of the extent to which the available evidence on the incidence of public ownership is consistent with those arguments. A set of conclusions is provided in section 4.6.

4.2 Competition and the emergence of private monopolies At the beginning of the century the demand for gas and water was buoyant, reflecting contemporary industrialisation and urbanisation and also, in the case of gas, its latent illuminating superiority to candles and oil lamps. The direct ownership or self-generation of supplies by users was common, especially for water, but the scale economies from a special supplier developing a common source supported by a distribution network of mains and pipes from the beginning brought government involvement. The heavy capital requirements of such systems prompted

Emergence of gas and water monopolies in nineteenth-century Britain private interests to seek limited liability status which required the approval of Parliament who, in any case, only granted permission for the breaking-up of streets to incorporated enterprises. The procedures accompanying the private Act of Parliament were geared to checking the financial and engineering soundness of the companies. Other than that, however, it seems water and gas were treated as ordinary commodities which could be readily provided by private enterprise. Gas production was an innovation in the early decades, and, for such a speculative venture, private enterprise was seen as the proper institutional form. Collective provision of water has a long history in the UK, but the expansion in the early nineteenth century was left to private undertakings. An 1821 Select Committee remarked on the absence of official channels through which customer complaints could be made, and the position had hardly improved by the time of the public health reports of the 1840s.3 That both production and distribution were subject to decreasing unit costs, at least over some ranges of output, seems to have been recognised. Compared with the small plants operated by consumers, the innovating London based Gas Light and Coke Company achieved scale economies in the size of retorts and the bulk purchase of inputs. The 1821 Select Committee had pointed to the importance of fixed costs in the charging policy of the London water companies, and a later report on Nottingham waterworks showed operating expenses increasing at only one third the rate of output. All observers were conscious of the extent to which consumers could share the use of the gas and water mains and other parts of the distribution network. The water mains often fed standpipes where water was purchased, carried and stored by the poorer classes, and even a street standpipe required a superintendent whose wage bill would not vary a great deal with volume. Moreover, there were certain institutional overheads for large gas and water works, like the costs of obtaining Parliamentary Acts and the establishment of a Board of Directors.4 Such decreasing costs over relevant output ranges suggest that average unit costs are higher with two or more suppliers than one. In so far as different areas of water and gas supply are effectively different product markets, then the multiproduct exclusive supplier has lower (attributable) costs for each product and product group than has the 'stand-alone' supplier. If these were the only considerations relevant to market structure then, following Demsetz, it would be quite reasonable to expect each area to be supplied by only one firm (only one 'in the field'), with profits in the long run constrained to a normal level by the threat of entry. In particular, in the absence of uncertainty and sunk costs, and in the presence of perfect

99

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information, firms would compete 'for the whole field', the successful one being that offering the lowest prices to customers and yet able to break even. Now it is the case that the first half of the nineteenth century saw competition both in and for the field in gas and water, which led by the middle of the century to a system dominated by exclusive suppliers. Organised water sources had for centuries often been collectively arranged, but the early nineteenth century saw many joint-stock companies emerging in response to the growing demands of industrialisation and urbanisation which enhanced what was, by virtue of the vast range of possible water sources, a relatively competitive environment.5 Water was often begged or stolen, and private proprieters supplying largely their own needs outnumbered all other forms of supplier throughout the nineteenth century; springs and other underground sources often meant distribution systems were not needed. In some cases, more than two companies operated the same area. Nottingham and Liverpool were oft-quoted cases. In London at the turn of the century there were three companies - London Bridge, New River and Chelsea - but in the following decade the East London, West Middlesex and Grand Junction Companies were formed, with the encouragement of Parliament that this would promote competition. Direct competition between incorporated undertakings was more widespread in gas, including Birmingham, Brighton, Sheffield, Wolverhampton, Norwich, York, Liverpool, Edinburgh, Tynemouth and Bristol. In London south of the Thames there were two companies operating in the 1820s; in 1833 the South Metropolitan Gas Company was formed. By 1850 over the whole metropolis there were fourteen separate companies operating. In Glasgow a company was incorporated in 1817, but a second company was established in 1843, and a third competitor as late as 1859.6 Competition in the field led, by virtue of the replication of plant and mains, to high costs, poor quality service and low dividends. The 1842 Chadwick report suggested that the duplication of water facilities in parts of London accounted for the low dividend rates of 4-6 per cent, and a general inhibition to the extension of supplies. Chadwick himself felt competition induced 'skimping', and others have attributed the state of pollution of London water supplies and the absence of filtration to competition in the overlapping areas. In Nottingham where competition was strong, the companies were struggling to declare any dividend. In the case of gas, four or five sets of mains existed at one time in some London streets and such competition has been seen by several observers as leading to the neglect of apparatus, the low pressure of the gas, the inaccuracy of

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the meters, and enhancing the risk of escaping gas and the incidence of serious accidents.7 By the middle of the century, however, competition in the field had virtually ceased in the provinces and Parliament was refusing to sanction new companies if this created competition. Now the classic concern with a decreasing cost industry is that a single supplier will be able to restrict output, thereby raising prices above average (and marginal) costs, and raising profits above a normal rate of return. The argument was put most explicitly perhaps by Knoop in his review (1912, p. 20), of the development of municipal trading in the UK in which he singled out gas and water because of their price inelasticity of demand. It clearly also lies behind the description of Falkus (1977, pp. 152-3), Robson (1935, pp. 309-10), Finer (1941, p. 50), and the Balfour Committee (1928, pp. 307-8) of the mid nineteenth-century concern over monopolistic abuse and the need for price regulation. Given the presence of sunk costs exclusive suppliers are certainly in a good position tofightprice wars, and many observers then and subsequently have pointed to indirect evidence of monopoly power in inflated share prices, in charging policies, and in the fact that in the large towns area exclusive suppliers emerged via districting agreements encouraged sometimes by parliament.8 Parliament, however, never legalised exclusive franchises and the potential competition continued. There are, in fact, three types of evidence which support the proposition that monopoly power was curbed by the continuing threat of entry. First, is the evidence of the attitude of the companies and investigatory Commissions. In the 1840s survey offiftytowns by the Commissioners on the State of Large Towns and Populous Districts only two had more than one water company (Nottingham and Liverpool, and in the latter case districting had a long history). The Commissioners nevertheless felt 'the exposure to the risk of competition frequently imposes a salutary check on the conduct of the managers of Companies ... ' (Second Report 1845, p. 53). In a similar vein the 1850 General Board of Health report (p. 297) on the London water supply saw the threat of entry as lowering water charges and company share prices. Potential competition was important in the case of London gas as late as the 1850s, with companies unwilling to come to an agreement on districting which was consolidated only in the 1860 Metropolis Gas Act (Livesey 1894, p. 647, H. Finer 1941, pp. 47-8). Secondly, the direct evidence on profit rates provides no support at all for the view that monopoly power was extensive. Comparisons with other sectors of the UK economy may be made, as in table 4.1, using Edelstein's

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data (1982, chapters 5 and 6). Unfortunately this covers the latter part of the nineteenth century and is thereby open to the argument that gas and water were then regulated. In fact, as will be argued later, the regulatory framework proved largely ineffective. The earliest subperiod identified, 1870-6, was one of relatively high rates of return in the economy and especially for gas. Nevertheless, the latter's rate of return on equity was marginally below that for the manufacturing and commerce sectors taken as a whole and even below the railways. Averaging over the whole period 1870-1913, the equity rates in gas and water (roughly 6.7 per cent) exceeded the railways but lay below the rate of return of each and every identified sector within manufacturing and commerce. The pattern is sustained even when allowance is made for the differential riskiness of each sector. The risk-adjusted rate of return in gas (at ( —)1.28 per cent) was, moreover, below the average risk adjusted return on the equity of other companies in the social overhead category, and even below the returns on the debenture of municipal corporations and on the preference shares of companies in manufacturing and commerce. Finally, the (unadjusted) rate of return on the debentures of gas, water and other utility companies taken as a whole was, at 3.47 per cent, below the average return on debentures and preference shares in manufacturing, commerce and the railways. Thirdly, there are Matthews' recent findings for the London gas companies (1986, pp. 346-53) which suggest that unit costs declined rapidly from 1830 to 1850, and continued falling, albeit more slowly, through to the 1880s, and that gas prices followed a similar path. This is consistent with competitive threats ensuring that cost reductions were passed on to the customer, but absence of hard data on the trend of rate of profit precludes heavy reliance on this pattern.9

4.3 Exclusive suppliers and market structure The continued presence of potential entry in conjunction with the absence of competition in thefieldmight be thought to provide benefits to consumers as well as producers. However by the mid nineteenth century the gas and water services were being heavily criticised in terms of the volume and quality of supplies. This was the case even for gas where, as Matthews' (1986) London evidence suggests, prices fell throughout the century. Now an important source of this concern lay in public health and safety considerations, which we shall discuss later. But what is particularly striking about the deficiencies in supplies is that the companies appeared to be reluctant to develop into profitable areas and this needs

Emergence of gas and water monopolies in nineteenth-century Britain Table 4.1

103

Rates of return on gas, water and other UK securities 18701913 (%) 1870-1913

Sector Gas Equity Water Equity Gas, Water and other social overheads Equity0 Debentures Municipals Debentures Railways Equity Preference Debentures Preference and debentures Manufacturing and commerce Equity* Preference Preference and debentures

1870-6

Risk Number of Unadjusted adjusted Number of Unadjusted securities rates of rates of securities rates of in sample return return in sample return

5

6.69

7 (1870-1903)

6.81

3

11.12

6

7.94

(-)0.96

24

7.15

(-)1.28

40 26 (1878-1913)

3.47

45

3.49

(-)0.76

4

4.69

19 17

4.33 4.52

(-)4.00 (-)0.36

19 4 15

11.19 8.76 6.01

48

3.74 <5.31-13.01 0.23-3.04 5.34 0.89

49 1

11.20 9.38

131 16 56 (1888-1913)

4.00

Notes: a) Unweighted averages of gas, water, telegraph, tramways, omnibus, canals, docks, shipping. The debenture figures include also electricity. b) The building and construction sector data do not start until 1876, food until 1880, retail stores until 1882. These sectors are excluded completely from the risk adjusted rate of return (which also excludes banking at (—) 1.10) and from the 1870-6 figure which is an unweighted average. Source: M. Edelstein 1982, chapters 5 and 6. The data are geometric means of real rates of return relating to dividends, interest and capital gains on publicly traded first- and second-class securities.

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explaining. Thus an influential 1847 Parliamentary report on gas by Surveying Officers was critical of the uncontrolled private enterprise system whatever the degree of competition (Johnes and Clegg 1847, pp. i-iv). They claimed that the growing cheapness of gas had not benefited the poor artisans and shopkeepers. Rather, the companies had preferred to secure a rather limited market favouring lower prices for the main rate-payers, that is large customers who also benefited from the street lighting made available at charges less than cost, and concentrated on the streets of the wealthy.10 In the case of water, a primary issue we shall examine is the delay in the introduction of comprehensive integrated piped systems. But the threat of entry was also felt to be inhibiting more generally an extension of supplies in quantity and quality. A not untypical characterisation of the system was that in many large towns polluted water was transferred from streams and rivers through houses and streets, back to enhance the pollution of the streams and rivers.11 The Commissioners felt they had 'reason to believe that many instances occur where the want of sufficient security against the introduction of rivals prevents the original establishment of works, or deters the adventurers from hazarding further advances of money, to meet increasing demands upon them' (Second Report 1845, p. 53). In 1850 the General Board of Health noted that the London water companies were forced to 'charge for the danger to which they are liable of the intrusion of other capitals into their domain ... ' (p. 296). Why should there have been these inhibitions in extending supplies? Three reasons emerge from an analysis of the ways in which the markets were contested. Firstly, there are grounds for thinking that production and supply conditions were such that the authorised undertakings did not necessarily have a natural monopoly of their geographical area. A natural monopoly position can be meaningfully defined only in relation to a given technology, a specific product range and set of output levels, and can then be said to exist when the single firm's costs are lower than for all conceivable partitions into two or more firms. This would require that costs rise not only if the firm is dismembered into a number of smaller scale versions of itself, or into separate specialist product firms but for all conceivable product groupings. The companies were clearly not always and everywhere necessarily natural monopolies. For gas this issue was important in the early stages when industrial users might generate their own supplies at no great cost disadvantage. In addition the companies experienced significant 'system' effects when supplies were expanded. Leakage was a very important source of gas wastage. Leakage losses

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increased as mains became more loaded, a problem particularly severe when multiple mains ran down the same street. Matthews (1986, pp. 250-3) estimates that on average for the London companies 45 per cent of gas made was unpaid for, of which leakage was a key cause, a figure that was still at 30 per cent by 1850. The scale economies from expansion were therefore limited by such leakage effects. Finally, it is of note that, through a decline in iron prices, the capital costs of new gas plant and networks fell consistently (Rowlinson 1984, p. 174, Matthews 1986, p. 250). This suggests the possibility (and no more) that minimum cost efficient gas volumes and minimum cost efficient distribution networks would be lower since the reduced unit capital costs would be proportionately bigger at smaller outputs. The issue in the case of water was that, depending on the level of technology and size of the market, both domestic and industrial users had cheap access to alternative supplies. Commenting on the water companies' use of the Thames, the General Board of Health in 1850 noted that 'the cost of the pipe-water supply, and the additional expense and inconvenience resulting from the present mode of its distribution, causes the population in some suburban districts to resort for water to open ditches, and in other crowded localities to shallow springs or wells' (p. 313). The city of Bath was in 1845 being supplied by the Corporation, plus seven 'companies' or rather property owners supplying their own tenants (Local Government Board Returns 1915, p. xii). Ignoring for the moment the health hazards, here we have examples where a single source is not necessarily the least cost market structure, though under a different technology (an integrated constant pressure system) it might be. Similarly, in Manchester and Salford only 21 per cent of all commercial and industrial enterprises in 1845 were customers of the water company; the rest sunk their own wells, installed pumps and built reservoirs (Hassan 1985, p. 541). The second problem relates to the economies of customer contiguity in the running and capital costs of the distribution networks. Such economies were an important source of cost advantages for the single gas or water company who would therefore want to capture, in any given area, as many customers as possible. But in some instances, this involved the customer incurring certain transaction costs (cf. meters, sinks). The company, therefore, faced the risk of some customers being unwilling to incur these costs, thus increasing the uncertainties of the company being able to capture the whole market. Evidence on the importance of contiguity can be seen from the experience of small towns. Even where

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consumption was itself necessarily collective, as in the case of street lighting, and where the gas companies bidded for franchise contracts drawn up by Improvement Commissioners or other local authorities, there remained a problem that supply to the smaller towns was not initially viable. By 1821 only towns with populations of 50,000 or more were lit by gas, and it was not until the late 1840s that connections were made to all towns with a population of at least 2,500 (Falkus 1967, section II, and Awty 1975, p. 92). In the case of water, a constant theme of the 1840s reports was the absence of proper supplies in small towns and, within larger towns, the costs of connecting pipes to small subgroups (cf. Commissioners' First Report 1844, pp. xi, xii, and Dickinson 1954, p. 102). And when, later, major long distance water resource projects were involved as in Manchester, Glasgow and Liverpool, the importance of capturing all the inhabitants was vital. The Commissioners' Second Report (1845, pp. 48-51), the General Board of Health in 1850 (1850, pp. 296), and the Royal Commission on the Water Supply in 1869 (pp. 246-8), all noted that switching to finance via the rates had the key advantage of automatically enrolling a large number of water users. In the absence of major differences between rival companies, it is not easy for one company to dominate by its price and service offers; in the early 1850s the Great Central and Surrey Consumer gas companies were established offering massive price reductions, but not all of the customer promises to switch companies materialised and the financial viability of the new companies was undermined.12 The more the customers had to bear costs, the less could a company be certain of capturing the market. Supplying a customer with gas involved the costs of fittings and of the domestic meter (which significantly was often provided without charge) and customers were in any case apprehensive about the safety of gas in the home. However, customer costs were especially important in the case of water companies wanting to extend piped constant pressure supplies to residents previously reliant on street standpipes and cess pools and now faced with the prospect of outlays on sinks and drains. Integrated systems of piped supplies necessitated the connection of a large population, the poorer members of which were undoubtedly not easy to convert. The investigators of the 1840s were convinced that piped supplies were financially attractive to all parties. For many domestic users the system of fetching and carrying from standpipes was costly in time, and the Chadwick report felt it was uneconomic for households whose members were earning at least the minimum wage. The First Report (1844) on the State of Large Towns described both financial and other economic benefits

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which had accrued to households in Preston and Hyde from the provision of piped supplies and the predicted lowering of unit water costs in Southwark and Nottingham. The Commissioners were able to conclude that 'it appears that the practical course of efficient improvement is not incompatible with the reduction of existing pecuniary charges independent of the vast gains in public health, convenience and comfort' (p. xiii. See also pp. xi, xii, the Chadwick Report 1842, p. 143, Commissioners' Second Report 1845, p. 46, pp. 52-3, General Board of Health Report 1851, pp. 295 and pp. 340-1). The unfettered unregulated private companies were very slow in achieving the degree of integration necessary to achieve this standard of service. The outcome in general was that supplies were often limited in quantity and quality with scale and contiguity economies unexploited. Each area then experienced either a vacillating competition in thefieldor, and increasingly over time, there was collusion on market shares leaving the districted incumbents with some monopoly power to restrict volume and quality. There is a third reason why the position of a single supplier could be undermined. As the recent contestable markets literature has suggested, production and supply conditions may unambiguously constitute a natural monopoly, and yet a single firm may not be a stable solution; the natural monopoly, in the jargon of the literature, is not sustainable. Take for example the single case of a firm selling only one product type in one market, and where average costs fall initially, reflecting scale economies, but eventually rise. It is quite possible for the conditions for a natural monopoly to be met even if the chosen output level is in the range where average cost is rising; onefirm(A) could still be cheaper than twofirms(B and C) supplying the market. However, when the partition involves one of the firms supplying more than 50 per cent of the market, such a firm (say B) would clearly have average costs lower than the average costs incurred when a single firm (A) supplied all the market. Of course the other firm, C, in the duopoly case, would have much higher costs so that the natural monopoly conditions would hold; the total costs of B plus C exceed those that would arise if only A supplied the market. But clearly firm B might try to undermine the monopoly position by cutting price and offering to supply a more restricted volume, leaving the rest of the market to its own devices. The situation is not one of equilibrium, but the incentive for the rival B to undermine A clearly exists, and renders the monopoly position unstable. The above considers a single product and/or market. In the more general case of several submarkets (as, for example, supplying different customers and areas with gas and water), the anal-

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New perspectives on the late Victorian economy

ogous proposition is that, if the (attributable) cost of a submarket rises when there is an increase in the number of submarkets supplied, the monopolist is vulnerable to an entrant catering for a smaller range. For the early nineteenth-century gas and water companies this issue is particularly relevant to the prospect of increased unit costs in the face of demands for increased volume and better quality supplies. The problem was again more important for water than gas. For the water companies two developments raised the prospect of rising unit costs. First, by the middle of the century, the demand for good quality water was rising as the result of continuing urbanisation and industrialisation. Increasing usage of existing sources was likely in some cases to lead to higher costs in the sense of a poorer quality of supply. 'After a century of industrial pollution . . . ' , records Hassan (1985, p. 541), 'the streams flowing through the northern manufacturing regions had become contaminated sewers, with pronounced increase in hardness between their headwater and lower reaches.' The alternative was to look further afield for water sources and this became the pattern from the mid nineteenth century, with the schemes for Glasgow, Manchester and Liverpool even more spectacular. The point concerning these longer distant supplies is not that, as both Knoop (1912) and Hassan (1985) have argued, the investment and planning were beyond the scope of private enterprise, but rather that it rendered the private monopolist vulnerable to entry by firms supplying more restricted markets.13 A second key development for the water companies was the demand for comprehensive piped supplies under constant pressure. For much of thefirsthalf of the nineteenth century, the supply from incorporated water undertakings was intermittent in the sense that it was made available only at certain times of the day whether this was via piped supplies or, in the case of poor residents, at street standpipes. Quite apart from the benefits to public health, it was consistently argued in the 1840s government reports that meeting rising consumption by the use of the existing distribution network would only raise prices and that a constant pressure piped system would be to the economic advantage of all parties. Whilst loss of water from leakage or unauthorised consumption did occur with the constant pressure system, overall it was expected to be significantly less than with intermittent supply. The hesitancy of poorer residents to convert, given the anticipated expenditures on sinks and drains, has earlier been raised as a problem facing the water company needing to get wide market coverage. The additional issue relevant to the present context is that a switch to a comprehensive constant pressure system involved a prospective rise in

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costs associated with monitoring the company's service pipes for leakage and misuse in households (sometimes involving landlord and tenants) in a more comprehensive system, and with assessing whether supplies would have to be metered or whether the wholefinancialbasis could be shifted to the rates (cf. 1850 General Board of Health, pp. 314-17, Stern 1954, p. 1001). It is not then surprising that the water companies' performance was criticised in terms of restricting piped supplies to the more easily monitored streets of the wealthy and for the slowness in the introduction of the constant pressure system. The 1852 Waterworks Act compelled companies to give constant pressure service, but this obligation could readily be avoided since it was hedged in with stipulations that the household pipes and fittings be in a proper condition to receive such a supply. The London companies were continually pointing to the problem of monitoring domestic arrangements with respect to waste and leakage and the problems were still there when the Royal Commission on the Water Supply reported in 1869 (pp. 238, 241-3). Leakage and waste at various points in the system were major problems also for gas. Initially in the absence of metering, the system had all the problems which plagued water supply. Gas was supplied by contract at a fee (or 'rent') per burner for so many hours each night and inspectors were appointed to monitor service fittings, ensure that the gas was turned on only in the stipulated periods, and that burner jets had not been opened to enlarge the flame. These problems hastened the introduction of meters which were common by the middle of the century (Livesey 1894, p. 648, Awty 1975, p. 99). Again, however, to the extent that servicing the poorer households in the population would require close monitoring of company equipment and with leakage and waste having system-wide effects, it is again understandable that the private gas companies were cautious in extending supplies to large parts of the population and that, as for water, a central criticism by the middle of the century was that they catered largely for shops and the streets of the wealthier residents.

4.4 Regulation of the private companies The prime public interest in exercising control over gas and water supplies, in terms of the above problems, was therefore to define the relevant economic areas of production, arrange that each area was served by only one producer, and ensure this producer's charges approximated the cost of supply. Where, as in the case of gas, it had already proved

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New perspectives on the late Victorian economy

economic to have metering, it was largely a matter of ensuring that prices corresponded to costs and that the latter were not inflated. None of this on the face of it required public ownership. Incumbent private companies could be confirmed as exclusive suppliers but withfinancialrates of return and the level of costs subject to monitoring. Competition for the field would have to be encouraged at regular intervals. Where, as in water supply, it looked uneconomic to have metered supplies a franchise contract would have to be drawn up by the local authority, specifying the area to be covered and the standard of service; finance would be via the rates, as the Commissioners' Second Report of 1845 proposed (pp. 55-7) and the franchise open for bidding, in terms of fee and service levels, by potential private company suppliers. Gas and water supplies conveyed external effects in their production and consumption so that the public interest extended beyond the issues discussed so far. However, the broad features of the form of public control are not significantly affected by such considerations, though they added to the complexity. In the case of gas, there were three kinds of externality. First, were the noxious fumes and safety issues associated with leaking gas which, as already noted, was a major source of the heavy wastage of gas. Secondly, was the increase in public safety accompanying better lighting; comprehensive street lighting was from the mid nineteenth century added to the set of urban improvements which local authorities were expected to implement, embracing sewers, paving, water supply, lighting, policing. Again, on the face of it, these requirements could be incorporated in the franchise contract, or in whatever legal measure was used to confer the private monopoly. Similarly, all public utilities caused street disruptions through the laying and repair of mains, and some coordination between the various users was clearly needed. This does not necessarily require public ownership as, for example, Kellett implies (1978, p. 42). Once supply is restricted to one firm it is not obvious that coordination between gas, water, tramway and electric companies required that they be publicly owned. There is some evidence in fact that the private gas companies were less disruptive than the municipal companies.14 There was, however, the question of whether the requirements laid on the gas companies arising from all the above issues would be consistent with the earning of a normal financial rate of return. Then the regulatory body is faced on the one hand with a desire to subsidise some activities, by appropriate subventions to the company, whilst at the same time monitoring overall rates of return to prevent the exploitation of a monopoly position.

Emergence of gas and water monopolies in nineteenth-century

Britain

111

In the case of water supply there were additional spillovers of great significance.15 Firstly, a more extensive and better quality supply would directly reduce disease and the associated financial demands on sick charges and Poor Law relief. Secondly, a water supply piped under constant high pressure was required for fire fighting and would reduce the health hazards exacerbated by stagnant water in cisterns and wells under the current arrangements of intermittent supply. Thirdly, was the recognition that water supply needed to be considered in conjunction with drainage and sewage, and that integrated operations were therefore important. What Chadwick and others in the public health movement had stressed was that the link between health and the general condition of urban life was not so much a matter of the quality and size of the buildings as the deficient services to them, drainage, sewage and water supplies in particular. The exclusion of poor streets and poor residents from piped water supplies was significant, precisely because on health grounds these were the areas in most need. However, on the face of it the specific requirements could, again as the 1845 Report spelt out, be incorporated into the franchise contract. Many contemporaries and subsequent observers nevertheless doubted whether the private companies were fit or equipped to deal with the hard core public health problem (cf. Stern 1954, pp. 1001-2). Similar views exist on the more narrow market structure problems. Joseph Chamberlain's statement of 1874 that all monopolies sustained by the state should be in the hands of representatives of the people may, as Falkus (1977, p. 152) argues, have been reflecting public opinion, but this cannot be explained simply in terms of market structure problems.16 The decisive factor was the unsatisfactory experience with arm's length regulation of the private companies, and to this matter we now turn. Certain obligations and limits were imposed on the companies from the very beginning, especially where Parliament was encouraging amalgamation or districting.17 Thus controls on prices and dividends were written into some of the early gas Acts for Nottingham, Oxford, Worcester and Bristol in 1818/19 for example. Following the 1821 Select Committee's revelation that the districting agreement in London had been followed by a 25 per cent rise in water rates, and the 1828 Select Committee's finding that prices were still rising, all special Acts between 1822 and 1845 incorporating water companies included clauses relating to charges, with maximum prices linked to the value of property. The companies had to make supply available to everyone living on a street where a water main was laid. Finally, in recognition of at least one spillover, the companies

112

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had to provide fire plugs on the mains and to supply at will in such an emergency. But the main thrust towards regulation came in the official reports of the 1840s which called for controls on supply and profit rates which Parliament were soon to impose in the face of the emergence of de facto monopolies in for example Sheffield gas, and water supply in Hartlepool and Sunderland. Competition was abandoned as a policy. The 1847 Surveying Officers' report on gas supplies emphasised the need for the remaining single producer, whether public or privately owned, to be accountable to local interests and that price and dividend controls and other limitations needed to be supplemented by the appointment of Inspection Officers (Johnes and Clegg 1847, pp. v, vi). The 1832 Lighting and Watching Act had given relevant enabling powers to local authorities to secure adequate gas lighting, but in water even such a discretionary power was not in the hands of the local authorities. The 1840s health reports demanded, therefore, from the start the imposition of an obligation on local authorities to secure adequate water supplies. In addition they pressed for franchise contracts financed through rates and for the overall integrated management of water supply, drainage and sewage to be in the hands of an independent disinterested body.18 In practice the new legislation was weak and monitoring procedures were almost non-existent. The reasons lie outside the scope of this paper, but perhaps more than anything else there was a fear of the central authority undermining local interests which, though themselves in some disagreement (cf. Water Commissioners, Highway surveyors, Poor Law Commissioners), were united in opposing central interference (cf. Lubenow 1971, pp. 85, 100, Frazer 1933, pp. 60-4). The central feature of the legislation was its permissive nature. The Gas Works and Water Works Clauses Acts of 1847 provided that dividends were to be limited to 10 per cent though this was to be interpreted as taking one year with another, and in addition a reserve fund of up to one tenth of the nominal capital could be accumulated to provide for exceptional circumstances. In the case of water, maximum charges were set in relation to the rateable values of property; maximum prices were also laid down for gas which could vary with local conditions. The Acts also contained regulations for the laying of mains, the conditions of meters and pipes and the prevention of public nuisances, as well as authorising local authorities to issue ordinances safeguarding public interests. But this was only enabling legislation in that it specified clauses which should be inserted in any new bills, and even this was at the discretion of the Private Bills Committee. Similarly the 1848 Public Health Act authorised the establishment of local

Emergence of gas and water monopolies in nineteenth-century Britain

113

Boards of Health, but only if this was recommended by the General Board of Health and if at least 10 per cent of rate payers petitioned for them. The local boards had enabling powers to secure adequate water supply, but again this was not mandatory.19 Regulation of the companies, at least for the period up to the 1870s, was therefore largely ineffective. Even where the 1847 provisions were subsequently incorporated into specific legal measures there was no strong enforcement mechanism. Prior to the 1840s, controls on prices and dividends were not common; in the case of water, dividend restrictions have been recorded only in the Acts for Chester and Leeds. But the early experience with other obligations is instructive. The requirement on water companies relating to the provision of fire plugs excluded any references to minimum distances between them, and to continuity of water supply, so the fire hazard remained a serious problem. The obligation to make supply available to all residents of an area only applied to streets where mains were laid so that the streets with poorer residents never benefited from this provision, and in any case the obligations on a water company only held as long as this did not affect its own customers. The maximum prices inserted into the local water acts from the 1820s seem to have been set at such a level as to leave plenty of scope for the companies (Commissioners Second Report 1945, pp. 47-8, 52-3, Dakyns 1931, pp. 22-4). Matters were not changed by the 1840s legislation since there were no formal procedures for reviewing prices. In the case of gas where technical change was rapid and costs falling, the price ceilings rapidly lost any significance (Maltbie 1900, pp. 544^-6, 549-50, Williams 1981, pp. 41-4, Falkus 1977, pp. 150-1). In any case evasion was possibly by altering meter rents on which the legislation had initially nothing to say. Matters did not improve significantly until the sliding-scale system spread from the middle 1870s; in so far as company dividends were restrained by the legal provisions, the sliding scale provided a relief to the extent that the company reduced prices, thereby giving an incentive to meet the intentions of the legislation. By 1900 half the private gas companies were, however, still on the maximum price system. In any case it was the control of dividends that proved especially difficult. Experience up to the 1870s led to measures to plug certain regulatory gaps, but even by the turn of the century the ability to 'water' the capital base remained a significant problem. The experience of gas where private companies remained important has been recorded in detail (Maltbie 1900, pp. 544^7, Williams 1981, pp. 41-7, Falkus 1977, pp. 150-1). Parliament had initially prohibited the payment of the

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maximum dividend on shares not fully paid up. The ceiling of 10 per cent was a fairly liberalfigureand over time lower ceilings had to be set; in the acts of the 1870s afigureof 7 per cent was often used, and in 1896 a lower rate was generalised and set at 4 per cent. But other methods of evasion of the ceilings were possible. Loan capital could be converted to share capital; this spreading of profits over a nominally bigger base of share capital became illegal only after the early 1870s. In addition, when the yield on gas stocks exceeded other yields, gas companies made new issues which existing shareholders were able to obtain at par value and immediately thereafter make a capital gain. Hence from 1870 the Acts passing through Parliament came to stipulate that new stock issues should be publicly auctioned, a practice which became mandatory in 1872. The stock might then sell above par but the company was not allowed to pay dividends on the premiums. The ability to take profits one year with another and the lack of standardised accounts compounded the problem in effectively restraining profits. Even though from 1871 the former provision was no longer included and companies were obliged to provide standardised accounts, it was to take some time for an effect to be felt. In 1880 a House of Commons Select Committee was still noting the ease with which the dividend limit could be evaded by the water companies being able to take one year with another (Select Committee on London Water Supply 1880, p. v). It was always difficult moreover to monitor the case where gas companies established subsidiary construction companies from whom new plant was purchased at inflated prices, thereby undermining the significance of the quoted profit rate. Finally, in so far as a company's declining cash flow in an activity is due to ageing assets its real rate of return may not be falling. Unless the company writes off capital or creates renewal funds the declared profit rate will be falling and as late as 1900 the American observer M. R. Maltbie (1900, pp. 544-7) still felt this was a problem in monitoring the dividends of the British gas companies. The obligation on companies to provide supplies of good quality also took considerable time to become entrenched. The 1847 Gas Works Act contained nothing on the obligation to supply, nor did it include controls on gas quality. These were introduced on an ad hoc basis so that by 1870 the legal obligation to supply was widespread, as were the procedures for testing gas and setting illuminating standards and both issues were enshrined in the 1871 Gas Works Clauses Act (Falkus 1977, p. 15). In the case of water, we have already noted that the 1848 Public Health Act had not mandated the local health boards to secure adequate supplies, and the 1852 Waterworks Act had qualified the requirement that companies

Emergence of gas and water monopolies in nineteenth-century Britain

115

provide constant pressure service with the proviso that households pipes and fittings were already in a proper condition. Dissatisfaction with the water supplies of private companies was still widespread at the end of the 1860s, especially in London where progress towards an improved and integrated service was slow, and where the companies were explicitly criticised by the 1869 Royal Commission for their neglect in complying with the law with respect to water quality. The 1871 Royal Sanitary Commission noted that promotors of water bills were still being allowed to escape the obligation to provide a constant supply. Not till the 1875 Public Health Act did the country have local sanitary authorities obliged to secure an adequate water supply, and where the adequacy of private company supplies could be tested by arbitration (cf. Royal Commission on Water Supply 1869, paragraphs 238, 241-3, Royal Sanitary Commission 1871, p. 41, Falkus 1977, pp. 143-6, Robson 1935, p. 316, H. Finer 1941, pp. 44^5).

4.5 The reasons for municipalisation Arising from the market structure problems of decreasing cost industries and the spillover effects on public health and safety, the local and central governmental authorities, from about the middle of the nineteenth century, were articulating certain requirements with respect to gas and water supplies. There were two broad ways by which they might secure these requirements. First they could engage in market transactions with private companies who would act as agents of the public authorities. The latter would set out, in varying degrees of detail and complexity, the specifications with respect to supplies and the framework in which the agents would operate. The private companies' revenue would then take the form of franchise fees and subsidies financed from the rates plus, under metered supplies, sales revenue which would place the level of supplies more under the discretion of consumers and suppliers. Second, the public authorities could alternatively themselves employ and direct resources to achieve the specified level of supplies, using some combination of rates and metered supplies as finance. Such an organisational result is equivalent to replacing transactions across markets by transactions within firms, in this case, within publicly owned firms. The second half of the nineteenth century saw an increased tendency to take the second option, as table 4.2 demonstrates. Our hypothesis is that the economic forces behind this were:

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(i) In the period 1840-70 the public authorities had established a regulatory framework within which private companies were allowed to operate with gas and water financed from consumer revenue. As we have seen, the regulation was largely ineffective.20 (ii) Regulation was directed to prices and profit rates as well as certain physical features of production. The standards actually desired by the public authorities were, however, much more complex, especially in the case of high quality water piped under constant pressure. This reinforced the tendency to reject regulation as a solution, given the poor experience so far. (iii) The option of establishing franchise contracts, financed through the rates or other public revenues, and of encouraging private companies to bid for the contracts, does not appear to have been a strong possibility.21 The incidence of municipalisation Data on the incidence of municipalisation are still limited. Only a more comprehensive indication of the geographical and spatial distribution of its incidence will allow a completely satisfactory account including, in some cases, an allowance for the use of the undertakings as a source of rate relief. In the meantime, what is known is consistent with our hypothesis; that is: (a) The view that the establishment of publicly owned utilities was not the only possible institutional device for meeting certain public interests is reflected in the fact that in the early part of the century private companies dominated. For in that period public enterprise was hardly a viable option.22 Public involvement in organised water supplies had a long history, but these powers had been allowed to lapse by the late eighteenth century so that even where the water source was owned by the local authority it had been leased out to contractors as, for example, in Gloucester, Leicester, Leeds and Plymouth. Prior to the 1835 Municipal Corporation Act much local administration was inefficient and capital raising powers were limited. The main rate payers, owners of small freehold and leasehold household property, were opposed to such municipal initiatives. The interest of the municipalities seems to have concentrated more, in the case of gas, on ensuring that, as a quid pro quo for opening up the streets, the companies were obliged to provide a rather restricted range of street lighting. In a similar vein, a comprehensive local government for London was notoriously difficult to achieve, and the emergence of exclusive suppliers and coordination between companies

Emergence of gas and water monopolies in nineteenth-century Britain Table 4.2

117

Numbers of gas and water undertakings in the UK 1845-1915 Public

Private

Gas Water Gas 1845

6

10

1855 1865 1871 1875 1882 1885 1887 1892 1895 1902 1905 1907 1912 1914 1915

16 28

39 61

Authorised companies

Total

Municipal

Water Gas

10 (estimate)

160 (estimate)

Total

Wateir Gas

67

Water

960 (estimate)

147 250

66

127

110

195

128

237

165

306

176

148

352

168 185

384 429

256

454

276 306

495 520

1170

326 786

200

1339

Source: Dakyns 1931, pp. 21-5, Falkus 1967, figure 1 and p. 501, 1977, p. 152 and table III, Finer 1941, p. 41, Robson 1935, pp. 308, 316-19, Williams 1981, p. 27. For data on the net output of the industries in the early decades of the twentieth century, see Balfour Committee Report 1928, pp. 311-12, 324-5. lagged behind the rest of the country, and the public ownership of water supplies was not achieved until the turn of the century. (b) The requirements with respect to quantity and quality of supplies, and the extent to which these diverged from the interests of private companies, was greater, as we have seen, for water than gas. Hence, as table 4.2 shows, municipal and other publicly provided supplies started their significant growth earlier for water (that is in the period 1845-65) than for gas, and during the rest of the century public ownership became more dominant in water supply. On the eve of the First World War there were over 300 publicly owned gas enterprises accounting for nearly 40 per cent of the total of authorised undertakings. In the case of water, the figure was 80 per cent and although there was a very large number of private water proprieters and other unauthorised undertakings, publicly

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New perspectives on the late Victorian economy

owned supplies accounted for some 82 per cent of the net output of the industry. (c) The period of approximately 1845-70 was one where a regulatory framework was emerging and when obstacles to publicly owned plants still existed. The legislation of the late 1840s had given enabling powers to local authorities to set up their own works, but only if this was accompanied by the agreement of the local private company where one existed. Even the 1870 Gas and Water Act enabled a local authority to set up works via the simpler Provisional Order only when a private company was not in existence. By the early 1870s, however, attitudes were changing and by the 1875 Public Health Act the local authorities could establish, lease or purchase works, and the rights of any existing companies were to be respected only where it was providing an adequate supply - with adequacy determined by arbitration.23 These developments in the official attitude to publicly owned works, in conjunction with the already documented unsatisfactory experience with regulating the private companies, explains the various growth rates implied in the table. It was the period after 1870 which saw public supplies growing much more quickly than private. The number of authorised private companies grew by roughly 100 per cent during 1845-70, but in the period 1870-1915 private gas companies grew by only 80 per cent and water by 30 per cent. In contrast, in this later period the number of municipal and other public undertakings rose by 200 per cent. (d) A very detailed description of the geographical pattern of municipalisation has yet to be undertaken. The larger towns, those with rapidly growing populations and those industrialising, faced the more urgent and complex problems in public health and safety. There is some evidence that such towns turned to publicly owned supplies. Thus, the municipal corporations were to be found in the larger towns. In 1865 there were twenty-eight municipal gas corporations and sixty-one municipal water corporations. By 1914 they had grown to 176 and 326 respectively, a rise of about 400 per cent, which was about twice the rate for the public sector as a whole. But the evidence is not systematic with several of the northern industrial towns like Newcastle keeping to private companies.24 In a separate exercise I am assembling more detailed information on municipalisation which will allow an analysis of the role of political factors, including the use of gas profits as rate relief.

Emergence of gas and water monopolies in nineteenth-century Britain

119

(e) Finally, the emphasis on economic matters suggests that municipalisation would not be pursued if the cost was high. This was especially relevant to the situation where a private company had to be purchased. In Scotland from 1876 local authorities were given the power to buy out any gas company not incorporated by Provisional Order or Act of Parliament. This covered practically every town, so that by 1900 all but three were municipal. In England and Wales, in contrast, there never was in the nineteenth century any general legislation enabling a local authority to compulsorily purchase a water or gas company as in the case of tramways and electricity.25 Companies therefore had virtually perpetual franchises, provided their supplies were adequate, and some of the vagaries in the pattern of municipalisation can be attributed to the varying prices which the companies could thereby exact for being expropriated.

4.6 Conclusions In the early nineteenth century the public authorities viewed gas and water as ordinary commodities which were, therefore, a proper activity for private enterprise. Given the presence of decreasing costs, competition in the field led to high costs and low profits, and by the middle of the century exclusive suppliers had emerged. Nevertheless, by this stage there was widespread dissatisfaction with services. A significant characteristic of this dissatisfaction was that, in addition to the generation of spillover effects in public health and safety, there was an unwillingness on the part of the private companies to extend supplies, in both quantity and quality, into profitable areas. This paper suggests that the demand for comprehensive integrated supply systems was frustrated by the inherent contestability factors to which natural monopolies are susceptible. On the face of it, these problems are amenable to arm's length government regulation of the private companies. This could, however, have involved an extremely complex mixture of policy instruments, subsidies in some areas, profit controls in others, and all within a context of publicly supervised franchising agreements. The middle part of the nineteenth century saw increasing regulation of the gas and water companies which proved to be rather ineffective. Hence local authorities, frustrated in achieving their objectives by market transactions with private companies as agents, switched instead to internal transactions, that is, to the employment and direction of resources by public firms.

120

New perspectives on the late Victorian economy Notes

Thanks are due to David Heald, Peter Jackson and James Foreman-Peck for comments on an earlier draft of this chapter. 1 Balfour Committee 1928, pp. 307-8, Smart 1901, pp. 175-6, Finer 1941, p. 50, Knoop 1912, pp. 36-41, Royal Commission on Water Supply 1869, paragraphs 245-50, Howe 1906, pp. 32-^4, National Civic Federation vol. I 1869, pp. 119-20,186-89,Robsonl935,pp.304-10,316,Falkusl977,pp. 145-6,152-3. 2 See Baumol 1977, Baumol et al 1977, Faulhaber 1975, Millward 1986. Panzar and Willig 1977, Sharkey 1981. 3 Select Committee Report 1821, p. 8, Chadwick Report 1842, p. 144, Commissioners' First Report on the State of Large Towns 1844, p. xi, Second Report 1845, p. 46, Dakyns 1931, p. 21, Robson 1935, p. 304, Finer 1941, p. 47. 4 For gas see Falkus 1982, p. 230; on water see the Select Committee Report 1821, p. 3, the Commissioners' Second Report 1845, p. 53, and the 1842 Chadwick Report, pp. 144/5. 5 Select Committee Report 1821, p. 3, Chadwick Report 1842, pp. 136 and 144, Commissioners' Second Report 1845, pp. 48, 52, Finer 1941, pp. 42-3, Dakyns 1931, pp. 22-3, Stern 1954, p. 998. 6 Robson 1935, pp. 304/5, Falkus 1977, pp. 146-7, Livesey 1894, p. 646, Chandler and Lacey 1949, p. 72, Awty 1975, pp. 114-15. 7 For water, see Chadwick Report 1842, p. 144, Commissioners' Second Report 1845, pp. 52-3, General Board of Health Report 1850, p. 292, Chadwick 1859, Section II, Finer 1941, pp. 43-A See also Falkus 1977, pp. 142-3 for the general point about competition and higher costs echoing John Stuart Mill as reported in Schwartz 1966, p. 76. For gas see Livesey 1894, p. 646, Maltbie 1900, p. 554, Balfour Committee 1928, p. 306, Robson 1935, pp. 305-6, Finer 1941, p. 47, Johnes and Clegg 1847, pp. iv, v. 8 For the importance of sunk costs see Baumol and Willig 1981. Moves towards districting in London started as early as 1815 for water and the 1820s for gas. Districting also had a long history in Liverpool which is often quoted as a case where the shares of the two districted water companies, Bootle and Liverpool and Harrington's, rose rapidly. In 1850 the General Board of Health was indirectly pointing to the presence of monopoly power in its complaint that private companies were charging inhabitants not 'the cost of service, but according to the extent of their necessities and to the powers of exaction for supplying them' (p. 293). However, this type of pricing may well be consistent with a second best efficient solution (Baumol et al., 1977). On districting in the case of water see 1821 Select Committee Report, p. 4, Dakyns 1931, pp. 22-3, Robson 1935, p. 314, Commissioners' Second Report 1845, pp. 52-3. In the case of gas companies, Livesey (1894, p. 677) suggested that the dividends which the London companies had been able to pay rarely exceeded 5 per cent, but following the districting agreements confirmed by Parliament in 1860 they rose to 10 per cent. See also Falkus 1977, pp. 146-8, Robson 1935, pp. 304-5.

Emergence of gas and water monopolies in nineteenth-century Britain

121

9 Matthews (1986) implies that competition was facilitated by the fall in unit costs giving new companies an opportunity to cut prices. This implies the competitive threat would, in the absence of the fall in units costs, have been weaker which is perhaps a stronger proposition than is sustainable from his data. A further point of note in these data is the movement of real gas prices. A useful benchmark would have been some indication of how gas prices were moving relative to other prices. Matthews does not, for example, comment on the fact that gas prices in the period 1830-50 were actually rising relative to coal prices, and in the 1850-80 period were falling. 10 Street lighting accounted then on average for about one sixth total production, and was a major source of leakage losses because of the policy of feeding the mains with gas throughout the night. The personal demands of the main rate payers for gas in winter were also very costly in capacity requirements. 11 Cf. Stern 1954, p. 999. 12 Livesey 1894, pp. 646-7. On the problems of overcoming the resistance of domestic consumers to the use of gas in the home, see Chandler and Lacey 1949, p. 76. 13 Knoop 1912, pp. 38-9, saw the benefits of large water resource projects as accruing only over a long period, and doubted whether private enterprise could tolerate a period of low profits. Hassan 1985, p. 545, feels that as well as low pay-back periods, companies had deficient information systems for longterm planning. Large-scale infrastructure investments undertaken by private companies were not uncommon, then, in UK and elsewhere. See also Howe 1906, pp. 32-4, and Robins 1948, p. 198. 14 Cf. Porter 1902, p. 112. Some restraint on unnecessary duplication of mains is provided also by the fact that the rates paid by utilities were in part a function of the numbers of mains laid (Falkus 1977, p. 143, Finer 1941, p. 42). 15 See the Commissioners' First Report 1844, pp. xi, xii, Second Report 1845, pp. 48-51, Chadwick Report 1842, p. 341, General Board of Health Report 1850, pp. 2, 284, 312, 314, 319, 322-3. 16 Analogously, Knoop (1912, p. 40) notes, to view public enterprise profits as an attractive new source of local authority revenue implies the absence of adequate instruments for taxing local companies. 17 Select Committee Report 1821, pp. 8-9, 1828, p. 5, Commissioners' Second Report 1845, p. 47, Dakyns 1931, p. 23, Falkus 1977, pp. 146-7, Finer 1941, p. 47. 18 Select Committee on the Health of Towns 1840, p. xx, Chadwick Report 1842, pp. 148-50, 422-5, Commissioners' First Report 1844, p. xx, Second Report 1845, pp. 50-55, Dakyns 1931, p. 21. 19 See Lubenow 1971, pp. 80-1, Robson 1935, pp.307, 315, Falkus 1977, pp. 144-5, 150, Williams 1981, p. 41, Maltbie 1900, pp. 542-3, Frazer 1973, p. 65, Finer 1941, p. 44, Dakyns 1931, pp. 25-6. 20 Knoop 1912, p. 36 is one earlier writer who lists this as a factor in municipali-

122

New perspectives on the late Victorian economy

sation. Rowlinson 1984, p. 193 also put a stress on this. But neither have developed the point. 21 Chadwick was enthusiastic (S. E. Finer 1952, p. 241) but the General Board of health felt there were not enough suitable contractors (Report 1850, pp. 298-9). 22 Rowlinson 1984, p. 187, Johnes and Clegg 1847, p. iii, Williams 1981, pp. 40-2, Balfour Committee 1928, p. 306, Local Government Board 1915, pp. ii, x, xi, Finer 1941, pp. 47, Robson 1935, p. 304, 311-12, Stern 1954, p. 999, Dakyns 1931, p. 22. 23 Royal Commission on Water Supply 1969, paras. 246-8, Report of the Royal Sanitary Commission 1871, p. 38, Falkus 1977, pp. 143-6, Robson 1935, pp. 315-18, Finer 1941, pp. 44-5. 24 Maltbie 1900, p. 538. See Frazer 1970 for a description of party politics and water supply. 25 See Maltbie 1900, pp. 551-3, Falkus 1977, pp. 152-3, Finer 1941, pp. 48-9. A determined local council could of course negotiate terms and get the approval of Parliament. It could at one stage set up a competing plant. However, the Borough Funds Act 1872 specifically precluded the payment from public funds of the costs of promoting such a Parliamentary bill. The difficulties at least for gas companies were confirmed in a Board of Trade memo of 1899 which made provision for compulsory purchase only of unauthorised undertakings and then only if it could be demonstrated that the gas supply or management was poor. References Awty, B. W. (1975), The introduction of gas lighting to Preston', Transactions of the Historic Society of Lancashire and Cheshire, 125. Balfour Committee on Industry and Trade (1928), Further Factors in Industrial and Commercial Efficiency. Baumol, W. J. (1977), 'On the proper cost tests for natural monopoly in a multiproduct industry', American Economic Review, 67, 3, December: 809-22. Baumol, W. J., Bailey, E. E. and Willig, R. D. (1977), 'Weak invisible hand theorems on the sustainability of multi-product natural monopoly', American Economic Review, 67, 3, June: 350-65. Baumol, W. J. and Willig, R. D. (1981), 'Fixed costs, sunk costs, entry barriers and the sustainability of natural monopoly', Quarterly Journal of Economics, 96, August: 405-31. Chadwick, E. (1842), Report on the Sanitary Conditions of the Labouring Population of Great Britain, M. W. Flinn (ed.), Edinburgh Press, 1965. Chadwick, E. (1859), 'Results of different principles of legislation and administration in Europe: of competition for the field, as compared with competition within the field, of service', Journal of the Royal Statistical Society, 22, Sept-

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Chandler, D. and Lacey, A. D. (1949), The Rise of the Gas Industry in Britain, British Gas Council. Chatterton, D. A. (1972), 'State control of public utilities in the nineteenth century: the London Gas Industry', Business History, 14, 2: 166-78. Commissioners on the State of Large Towns and Populous Districts, First Report 1844, Second Report 1845. Dakyns, A. L. (1931), T h e water supply of English towns in 1846', Manchester School 2, 1: 18-26. Demsetz, H. (1968), 'Why regulate utilities?', Journal of Law and Economics, 11, April: 55-65. Dickinson, H. W. (1954), The Water Supply of Greater London, London: Courier Press. Edelstein, M. (1982), Overseas Investment in the Age of High Imperialism: The United Kingdom 1850-1914, London: Methuen. Falkus, M. E. (1967), T h e British gas industry before 1850', Economic History Review, December: 494-508. Falkus, M. E. (1977), T h e development of municipal trading in the nineteenth century', Business History, 19, 2, July: 134-61. Falkus, M. E. (1982), T h e early development of the British gas industry, 17901815', Economic History Review, 35: 217-34. Faulhaber, G. R. (1975), 'Cross-subsidisation: pricing in public enterprises', American Economic Review, 65, December: 966-77. Finer, H. (1941), Municipal Trading, London: Allen and Unwin. Finer, S. E. (1952), The Life and Times of Sir Edwin Chadwick, Methuen. Frazer, D. (1970), T h e politics of Leeds water', Proceedings of the Thoresby Society, 3: 50-70. Frazer, D. (1973), The Evolution of the British Welfare State, London: Macmillan. General Board of Health (1850), Report on the Supply of Water to the Metropolis. Hassan, J. A. (1985), T h e growth and impact of the British water industry in the 19th century', Economic History Review, 38, 4, November: 531-47. Howe, F. C. (1906), 'Municipal ownership in Great Britain', Bulletin of the Bureau of Labour, 62, January: 1-123. Johnes and Clegg (1847), 'Observations or general report on the existing system of lighting towns with gas, by Johnes and Clegg, Surveying Officers', Parliamentary Papers, 22. Jones, L. J. (1983), 'Public pursuit and private profit: liberal businessmen and municipal politics in Birmingham, 1845-1900', Business History, 25, 3: 240-59. Kellett, J. R. (1978), 'Municipal socialism, enterprise and trading in the Victorian city', Urban History Yearbook. Knoop, D. (1912), Principles and Methods of Municipal Trading, London: Macmillan.

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Local Government Board (1915), 'Return of particulars regarding every water undertaking in every district in England and Wales', Parliamentary Papers, 79. Lubenow, W. C. (1971), The Politics of Government Growth: Early Victorian Attitudes towards State Interventions 1833-1848, London: Archon Books.

Maltbie, M. R. (1900), 'Gas lighting in Great Britain', Municipal Affairs, 4: 538-73. Matthews, D. (1986), 'Laissez-faire and the London Gas Industry in the 19th century: another look', Economic History Review, 39, 2: 244-63. Millward, R. (1986), 'Some implications of the new theory of natural monopoly', Salford Papers in Economics: 86-1. National Civic Federation (USA) (1907), Municipal and private operation of public

utilities, vols. I, II and III. Panzar, J. C. and Willig, R. D. (1977), 'Free entry and the sustainability of natural monopoly', BellJournal of Economics, 8, Spring: 1-22. Porter, R. P. (1902), 'The failure of municipal ownership in England', Street Railway Journal, August and September: 109-14, 216-20. Robins, F. W. (1948), The Story of Water Supply, Oxford University Press. Robson, W. A. (1935), 'The public utility services', in H. J. Laski, W. I. Jennings and W. A. Robson (eds.), A Century of Municipal Progress: The Last

Hundred Years, London: Allen and Unwin. Rowlinson, P. J. (1984), 'Regulation of the Gas Industry in the Early Nineteenth Century, 1800-60', Ph.D. Thesis, Linacre College, Oxford. Royal Commission on Water Supply (1869), Report of the Commissioners. Royal Sanitary Commission (1871), Report. Schwartz, P. (1966), 'John Stuart Mill and laissez faire: London water', Economica, 33, February: 71-83. Select Committee on the Health of Towns (1840), Report, June. Select Committee on the Supply of Water to the Metropolis (1821), Report, May. Select Committee on the Supply of Water to the Metropolis (1828), Report, July. Select Committee on London Water Supply (1880), Report, August. Sharkey, W. W. (1981), 'Existence of sustainable prices for natural monopoly outputs', Bell Journal of Economics, 12, Spring: 144-54. Smart, W. (1901), 'Municipal industries and the rate-payer', Economic Journal, 11,2: 169-79. Stern, W. M. (1954), 'Water supply in Britain: development of a public service', Royal Sanitary Institute Journal, 74. Waller, P. J. (1983), Town, City and Nation: England 1850-1914, Oxford University Press. Williams, T. I. (1981), A History of the British Gas Industry, Oxford University Press.

Chapter 5

The expansion of British multinational companies: testing for managerial failure Stephen Nicholas

The accumulated evidence on the relative decline of the late Victorian and interwar British economy is overwhelming. Whether measured in terms of Britain's international competitiveness, growth of GNP or relative ranking in terms of income per head, the nation which had dominated the world economy mid century was relegated by 1914 to simply one among equals, sharing industrial leadership with America and Germany. Since the late 1960s, little of the historiography on the 1870-1914 period has been untouched by the search for the causes of Britain's poor economic performance. In its modern form, the case for economic failure was popularised by Derek Aldcroft (1964), who argued that Britain's third generation industrialists failed as innovators of new technology and methods, as proponents of technical education, as investors in research and development and as vigorous salesmen abroad. Considerable qualitative evidence, much of it comparative data on American and German practice, was presented to show that individual entrepreneurs and industries failed in each of these areas. But the qualitative evidence was vulnerable to the criticism that it was selective and unrepresentative of the whole economy. Every example of failure had a counter-example of innovating industries and entrepreneurs who adopted the latest techniques, employed scientists and skilled labour and were successful international competitors. Rejecting the qualitative tests of poor British performance favoured by traditional economic historians, the econometric school brought measurement - the total factor productivity index - and a standard to judge success and failure - 'best practice' American technical change - to settle the controversy over whether the British economy failed. The results of the quantitative tests of productivity growth, for iron and steel, textiles, chemical and engineering, and for the whole economy, concluded that the British economy grew as fast as factor endowments allowed (McCloskey 1970, 1973, Floud 1976, Sandberg 1974). The Victorian entrepreneur was exculpated from the charges of incompetence and backwardness. But the 125

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methodology and thefindingsof the econometric historians have not been free of criticism. Sensitive to the underlying theoretical assumptions and the quality of the data, total factor productivity estimates of technical change just as readily point to entrepreneurial failure as to entrepreneurial success (Nicholas 1982, 1985). Since quantitative testing of the rate of technical change has not settled the issue of relative decline, economic historians have sought alternative measures, and explanations, of Britain's indifferent performance after 1870. Martin Wiener (1981), for example, identified a 'decline of the industrial spirit', related to the rise of anti-business culture. In contrast, Coleman and Macleod (1986), in a recent article surveying business failure, reject Wiener's mid century change in 'spirit', seeking the roots of the relative decline as far back as the industrial revolution. But the reasons for the decline, the British educational system with its contempt for the 'mechanical arts', the society's and business's disregard for science, research and development and the mutual suspicions of labour and capital towards each other which held back the introduction of new techniques, were the same reasons as Aldcroft had advanced for entrepreneurial failure over twenty years earlier (Coleman and Macleod 1986, pp. 600-11). In addition, both Aldcroft (1964, p. 163) and Coleman and Macleod (1986, p. 600) identified the structure of British business, which comprised many small, vertically specialised family firms, as a major factor in Britain's poor economic performance. In the size and structure of the British business firm lay the reasons for the slow adoption of new techniques, the disregard for science and research and the poor marketing of goods abroad. Recently, the business firm as the source of Britain's indifferent economic performance has received added support from A. D. Chandler's (1980) comparisons of the growth and structure of British and American transnational firms. Chandler found that the multiunit industrial enterprise administered through a managerial hierarchy appeared much more quickly in the United States than in the United Kingdom. As a result, American firms were bigger, more cost efficient and moved into mass production and distribution before their smaller British counterparts. Delays in building a managerial hierarchy meant that British firms were slow in adopting efficient modern management techniques and recruiting engineers, scientists and graduates from British universities, which had a particularly debilitating effect on technologically advanced industries (Chandler 1980, pp. 409-10). These failures not only affected the performance of individual firms, but the whole economy. Rather than

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entrepreneurial failure, Chandler (1980, p. 410) thought that the failure of British industry to meet foreign competition might better be called managerial failure, identified with the continued existence of the family firm. Developing the case of managerial failure, Elbaum and Lazonick (1986, p. 2) complained that the econometric approach to British decline took existing constraints as given, ignoring the lost opportunity by entrepreneurs to change and innovate in new institutional structures. They identified the weakness of British competitive capitalism with the existence of numerous small, vertically specialised regional firms, each with a small market share and run by owner-proprietors using simple internal organisations. Failing to break existing competitive structures meant that Britain missed out on the new corporate capitalism evolving in Germany, Japan and America, which was characterised by industrial oligopoly, managerial bureaucracy and vertical integration of production (which relied on systematic research and development) and distribution (which depended on managerial and technical personnel) (Elbaum and Lazonick 1986, pp. 2-6). Making a similar point, Crafts and Thomas (1986, p. 643) thought that the neoclassical assertion that Britain grew as fast as factor endowments allowed took no account of investment decisions which could have increased the stock of human capital. The acceptance of existing constraints by British firms condemned Britain to a century of slow decline from her position of mid Victorian industrial dominance as all her major staple industries retreated from the expanding products and markets of the world. The impact on growth of institutional rigidities' is difficult to measure. While Chandler and Elbaum and Lazonick have argued that they were large, the testing has involved largely the qualitative evaluation of industry-level data. Select staple industries have attracted much attention, particularly steel, cotton and the motor industry, where the failure to innovate in managerial bureaucracies has been identified as a major cause of each industry's poor performance (Lazonick 1986, Elbaum 1986, Lewchuck 1986). However, Foreman-Peck (1982, 1985, pp. 143-6) has shown that inappropriate administrative structures during the interwar years did not hold back the multinationalisation of Ford which increased its branch plants from six in 1923 to twenty-nine at the end of 1927. Rather than the lack of managerial bureaucracies, European car makers suffered from the small size of their domestic markets which denied these firms scale economies and standardised products. In a specific test of the managerial failure thesis, Church (1986, pp. 175-7) concluded that family

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New perspectives on the late Victorian economy

controlled and managed firms could be inventive and innovative and that financial factors, and not managerial ones, were mainly responsible for the performance of the European, and British, car industries. In contrast to the industry-level studies of managerial failure of domestic firms, the literature on the origins and growth of British multinational enterprises (MNEs) has addressed managerial failure through case studies of individual firms. In a paper on the experiences of Dunlop, Courtaulds and Cadbury, Geoffrey Jones (1986a) concluded that most British MNEs were not successful in their overseas ventures. The returns on foreign direct investment (FDI) for the three companies was diverse, which led Jones (1986a, p. 109) to conclude that multinational investment was a risky strategy which often went wrong. While conceding that the lack of comparative studies meant that it was impossible to judge whether British firms fared better or worse than American or European multinationals, Jones claimed that British MNEs performed poorly. Besides being vulnerable to competition and lacking competitive vigour, the handicap of unsatisfactory management structures was advanced as the main reason for the poor returns on overseas investments. Unsophisticated management structures, Jones (1986a, pp. 105-9) speculated, had a particularly unfortunate impact on foreign activities, where strong managerial control was required in the face of tough foreign competition. Do low returns justify the charge of managerial failure? Richard Caves (1982, pp. 72-3) has shown that risks and information costs facing novice MNEs strongly affect the process of foreign investment. He argued that 'average profits of new foreign subsidiaries should be low, and the failure rate should be high', a case supported by recent evidence on US MNEs (Caves 1982, p. 73). Since British nineteenth-century investment was a risky venture, profit rates by themselves are not evidence for managerial failure. Indeed, the somewhat fragmentary historical evidence on British multinationals suggests that profit rates tended to increase over time, supporting Caves' (1982, p. 73) proposition that foreign affiliate returns are strongly correlated with age, implying a learning process by MNEs. Using an expanded sample of eight firms (including Dunlop, Vickers, Cadbury-Fry, Sheffield hardware firms, Courtaulds and Glaxo), a group of business historians at the LSE confirmed Jones' conclusion, presenting a virtual compendium of multinational failure. Managerial failure, in the form of family control and the slow development of modern management structures, was again identified as the major cause of the poor performance of British post-1870 MNEs (Jones 1986b). The studies found that parent firms gave their overseas branches a loose and free rein, with

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periodic visits by the least energetic home-based family members the usual form of control. What was really required was tight control, which only sophisticated managerial hierarchies could offer. While these case studies added weight to the hypothesis that the slow development of appropriate managerial hierarchies lay at the root of the poor performance of British MNEs, at least three of the studies were expanded versions of Jones' earlier paper which first advanced the argument that British MNEs failed. Moreover, the LSE studies made no attempt to draw on comparative examples of American and German international performance, which Jones had thought necessary if the relative success or failure of British MNEs were to be appropriately assessed. Nevertheless, the case of managerial failure by British MNEs has been largely accepted, and most research has been directed towards identifying the reasons that British international firms neglected new forms of corporate structure. For example, Mira Wilkins (1986) suggested that the size of the home market explained much of the failure of British MNEs to develop appropriate management structures. In the large American market, American managers of interregional companies learned how to manage multiregional operations by evolving managerial hierarchies to control production, marketing and distribution. Britain's small and homogeneous home market did not offer similar opportunities to British managers, and as Leslie Hannah (1983, pp. 70-89) has shown, British domestic firms only slowly adopted the new central functional department structure which allowed managers to control geographically dispersed operations. It was these new management structures, forced on American managers by the large domestic US market, which served American multinationals so well in their overseas expansion. One area where the failure to innovate in modern management structures was alleged to have been felt most quickly was in selling and marketing. According to Chandler (1980, pp. 401-9) the partial and hesitant vertical integration into marketing at home, with its attendant partial and hesitant growth in managerial hierarchy, left British firms competitively weak internationally. Jones (1986a, pp. 106-7) endorsed this view, identifying marketing and selling as a cause of the poor performance of British MNEs. In the discussion of selling and marketing, the managerial failure case is indistinguishable from the earlier entrepreneurial explanation of British decline which found that Victorian businessmen were bad salesmen. This is best illustrated in Peter Payne's (1974, pp. 53-4) summary of the entrepreneurial failure literature where

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New perspectives on the late Victorian economy

he identified the small size of the family firm as the reason that Britain could not afford vigorous selling and marketing forces abroad. Surprisingly, few detailed case studies of overseas marketing performance exist. In a recent survey of the pre-1914 overseas marketing performance of British firms, Nicholas (1985) found little evidence of poor selling performance or inadequate institutional arrangements (agents, mercantile houses, sales and production branches and travellers) for marketing goods by British relative to American and German firms. Recently, a second group of LSE business historians, including several who had contributed to the earlier study on MNE performance, found many counter-examples of indifferent marketing performance by Vickers, Rowntree, Nettlefold and the Sheffield hardware firms between 1860 and 1939. The editor of the LSE marketing volume, Davenport-Hines (1986a, p. 14), concluded that there was 'evidence of abysmal entrepreneurial failure which could not be discounted'. To assess British MNE expansion and managerial failure before 1939 this chapter addresses two issues. First, the geographical distribution of British FDI is analysed. In particular, the allegation that British FDI 'failed' because it was concentrated in the Empire before 1914 and that there was a shift in the interwar period to 'safe' markets at the expense of the competitive markets of Europe and America is tested. Secondly, the factors behind the decision to invest in production facilities is explored. As evidence of managerial failure, business historians have argued that British MNEs overexpanded and that production facilities, too often formed for purely defensive purposes, were frequently 'unsuccessful'. The economic factor behind the decision to invest in overseas production are specified and tested quantitatively as a first step in evaluating the managerial failure thesis.

5.1 The location of British FDI: evidence of success or failure? Some evidence on the location of British foreign direct investment (FDI) has been marshalled to show managerial failure among British MNEs. Using a sample of fourteen MNEs who were among the largest 100 manufacturing firms in 1970 with pre-1914 overseas investments, John Stopford (1974, p. 314) argued that British MNEs followed the path of least resistance,fleeingthe competitive developed markets for the protected underdeveloped Empire. In the interwar period, the follower firms (those without a FDI before 1914) continued to seek out

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131

Empire markets, particularly the Dominions. Here British MNEs found a haven of sanity and security in contrast to the interwar continental and American markets with cartel arrangements, restrictive government policies and barriers to trade (Stopford 1974, p. 327). The pre-1914 pioneers were an exception. Having crossed the threshold of international experience through their pre-1914 FDIs, these pioneers invested in Europe during the interwar years. But the tendency for British FDI to be concentrated in the Empire was unmistakable, and Stopford (1974, pp. 311-12) explained this concentration through the competitive weakness of Britain's MNEs. Industrial retardation in the home market and the failure of British firms to grasp the technological advantages of the 'second' industrial revolution, weakened the competitive ability of British MNEs, restricting their international involvement to the safe Empire markets. In addition, Stopford (1974, p. 315) thought that British managers had no domestic experience at managing at a distance unlike their American competitors who were learning how to manage on a continental scale. Chandler (1980, pp. 401-9) mustered additional support for Stopford's claims that British firms invested in 'safe' markets while developing the managerial failure thesis as the overriding cause of Britain's poor performance. According to Chandler, British MNEs were restricted to safe white Commonwealth markets rather than the more competitive and difficult markets of continental Europe or India because they lacked the marketing and distribution hierarchy needed to penetrate competitive markets. In the first case study to test whether the Empire was a safe haven, Jones (1984b, 1986b, pp. 114-15) found that the poor performance of Cadbury-Fry was due to severe competitive pressure in Australia and Canada in the 1920s, exacerbated by errors in business strategy and managerial policy. In his summary of the eight LSE multinational case studies, Jones (1986b, pp. 16-20) argued that it was not very helpful to view interwar Empire markets as paths of least resistance. The Commonwealth was not a safe haven; British firms performed poorly both in the competitive developed markets and in those of the protected Empire. Yet the evidence from the eight case studies does not support this conclusion: measuring the number of FDIs in the interwar period, the LSE study found that the eight firms virtually abandoned the American market (where FDI fell by 75 per cent) and Europe (where the fall was 50 per cent) and turned to the Empire (where FDI increased by a factor of four) (Jones 1986b, p. 17). Did British MNEs seek out Empire markets, and, if so, when? Unfortunately, data do not exist which provide an unambiguous answer to the

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New perspectives on the late Victorian economy

timing and distribution of British FDI. However, data on 448 pre-1939 manufacturing multinationals, including the date on which each firm established a sales or production branch, offer a good guide to the geographical spread of British FDI. No consistent data on sales, assets or profits exist for all British MNEs before 1939, so the number of plants, rather than the value of the FDI, was used to measure the geographical distribution of British investment. Of course, counting the number of plants implicitly weights each FDI the same, introducing biases into any attempt to measure the relative importance of different markets. However, data limitations mean that the number of plants is the best available proxy for the distribution of British FDI, and this measure is consistent with that used by Stopford, Chandler and Jones. Table 5.1 shows that developed and undeveloped Europe took 43 per cent of total British FDI before 1914, outstripping the Empire with 32 per cent of total FDI. Looking at Britain's most important overseas markets in Table 5.2, Germany and the US attracted more first time investment in plants than Australia and Canada, and France ranked ahead of New Zealand, India and South Africa as a recipient of British FDI. There is no evidence to support Stopford's case that British firms sought a safe haven and gained experience in the Empire before 1914. Nor did pre-1914 MNEs turn to the European markets in the interwar years as Stopford's small sample implied. Table 5.3 shows that MNEs which invested in the Empire or the rest of the world pre-1914, invested equally in the Empire, rest of the world or both after 1920. Chandler's contention that British MNEs sold first to the white Commonwealth then to the rest of the world also gains little support. British sales branches were as widely spread geographically as British overseas production, and, as table 5.2 shows, Germany, France and America attracted sales branches as readily as the Dominions. Using table 5.1 to test the structure of the regional distribution of British FDI, a x2 test reported no significant change in the pre- and postFirst World War pattern of British investment. However, within the overall pattern of British FDI there were interregional shifts. From table 5.1 it is clear that there was a move to the Empire markets after 1914, with the shift coming at the expense of European markets. Contrary to the evidence from the eight firms in the LSE study edited by Jones, there was no significant move out of the American market, and the retreat from Europe was from the underdeveloped and not the developed regions of the continent. The stable share of the developed European and American markets, where British MNEs faced serious competition during the inter-

The expansion of British multinational companies Table 5.1

133

Regional distribution of British FDI in production plants (%)

Developed Empire USA

Europe Other Subtotal Undevelopeci Empire Europe Other Subtotal

Pre-1914

Post-1914

28 13 23 3 67

41 11 18 1 71

6 20 8 34

11 9 9 29

Table 5.2 Choice of location for British pre-1914 FDI (number) Production branches Choice

Sales branches Choice Total of 1st 2nd 3rd First 6

Total of 1st 2nd 3rd First 6 Germany Australia

19 4 7 12 USA 11 4 Canada 10 4 France 5 0 India 5 1 New Zealand 6 0 South Africa 6 2

9 4 3 1 3 0 1 1

30 27 19 18 11 10 9 9

Australia 13 5 Germany 15 5 France 10 5 Canada 8 2 South Africa 6 4 USA 9 1 India 4 3 New Zealand 2 0

5 1 1 4 2 2 2 2

23 23 18 16 12 12 11 5

Table 5.3 ifnterwar investment patterns by pre-1914 MNEs (% Interwar investment Pre-1914 investment

Empire

Rest of the world

Empire and rest of the world

Empire Rest of the World

31 33

10 17

58 50

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New perspectives on the late Victorian economy

war years, suggests that British firms could compete in the world's markets. Of course, this is not to argue that British FDI in America, or any other region, was 'optimal'. Rather, the stability of the overall geographical pattern of British investment and the interregional shifts disprove the allegation that British FDI shifted towards 'safe markets' at the expense of the competitive markets of America and developed Europe. As a consistency check, my data on the distribution of FDI and the interwar shift to Empire markets, are broadly consistent with the market shares captured by British exports (Ashworth 1963, p. 143, Kahn 1946, pp. 209-11). Clearly a number of different factors worked to shift British FDI (and exports) towards Empire markets, including preferential inducements for British firms to invest, lower levels of political risks, fewer government restrictions, similarities in demand patterns and high per capita income levels. Not unreasonably, British firms responded; to do otherwise would have meant managerial failure. The shift of British FDI from underdeveloped Europe to Empire markets then, does not necessarily reflect any competitive failure on the part of British firms. As shown in table 5.4 British MNEs continued to invest across a wide spectrum of product groups. This ability to invest across a large number of markets spread by Britishfirmscontrasts sharply with the narrower product range and market penetration by American and European MNEs. European firms concentrated on European markets and on a restricted range of products, mostly chemicals, pharmaceuticals and electrical goods; American MNEs, showing a preference for South American countries and Canada, had a comparative advantage in engineering and chemical products (Franko 1976, p. 77, Jones 1986b, pp. 4^5, Wilkins 1970, 1979). While table 5.4 shows no dramatic shifts in the product composition of British FDI, the fall in the share of textiles and the rise in the share of vehicles and electrical engineering after 1914 reflected a competitive awareness of declining and growing product sectors by British MNEs.

5.2 The production plant investment decision While the data on the distribution of British FDI contradict the 'failure school's' claims that British managers shifted their attention to 'soft' markets, they do not provide any direct evidence that managers invested the 'right' amounts in the various markets of the world. Indeed, surprisingly little work, either theoretical or empirical, has been directed

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135

Table 5.4 Product groupcomposition of BritishFDI (%) Product

Pre-1914

Post-1914

Food Drink Chemicals Electrical engineering Mechanical engineering Metal manufacture Shipbuilding Vehicles Metal goods Textiles Leather/fur Clothing Brick/clay Timber Paper/publishing Other manufacturing

17 2 25 9 7 6 1 1 1 15 1 1 3 1 3 11

14 2 24 13 6 7 1 3 5 9 1 1 4 1 4 8

to the investment decision itself. The FDI decision involves two separate decisions, which are made simultaneously: the choice of the form of overseas involvement and the location of overseas activity. Unfortunately, the distinction between the form and the location of British FDI has not always been made explicit by business historians. Generally, the form of FDI is the choice between a sales subsidiary or a production plant, although a few British MNEs entered into joint ventures. The establishment of over 200 pre-1914 manufacturing multinationals, and a further doubling of MNEs during the interwar period, attests to the vigour with which British managers established sales or production facilities abroad. Equally, this rapid growth of overseas branches might conceal weakness, with an overexpansion of British FDI. As discussed above, the view of business historians is that much of the investment in production branches was unsuccessful. The prolific expansion of British MNEs, Jones (1986a, pp. 6-8) thought, reflected the defensive nature of the investment decision and explained why they so frequently ended in failure. What factors, then, explain the decision to invest in overseas production subsidiaries? There are few case studies of the FDI decision; it is usually assumed that the entrepreneur makes the investment decision (Jones 1986b, p. 7, Nicholas 1982, pp. 618-19, Archer 1987). In an archival-based study of Bryant and May, I found that the impetus for overseas investment came

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New perspectives on the late Victorian economy

from a group of managers committed to international expansion, and not from the chairman of the board. This is consistent with experience of today's American business firms where overseas investment decisions get proposed and defined 'down the line'. When more archival studies of the investment decision are undertaken, a clearer picture of the investment process should become available. Irrespective of whether the decision to establish a production branch was made by the 'great entrepreneur' or by a group of lower-level managers, the decision should have been based on economic factors. I develop a model of the decision to invest in a production subsidiary to test for managerial failure in the expansion of pre-1939 British MNEs. Nicholas (1982) found that British MNEs passed through well-defined stages in their overseas expansion, first exporting through merchant houses, then building an agency system, before making the first FDI in a sales branch, and finally establishing a production plant. Therefore, the decision to produce abroad is a choice between competing institutional forms of overseas involvement. There is no theory of the form of overseas involvement. Implicitly, it is assumed that decision makers optimise returns by choosing between a production and sales branch, subject to transaction, production and locational cost constraints. In effect, the variables enter the model ad hoc, and the data problems, discussed below, further restrict the specification and testing of models of the form of FDI. The production and locational cost variables which impact on the choice of a production facilities include: qualitative variables for each two digit SIC product group as a proxy for production costs; MARKET, the percentage of the labour force in manufacturing in 1923, as a measure of market size and relative per capita income levels; DEVELOP, a qualitative variable measuring the level of development; PSYCHIC, a binary variable measured by whether the host country was English speaking; and DISTANCE, a qualitative variable used to measure physical distance and transport costs. PSYCHIC proximity is a measure of the factors which encourage the flow of goods between markets, and it depends upon similarities in the level of economic and social development, education, language and culture and political, institutional and legal systems between home and host economies. Whether English is the 'native' language proxies the degree of psychic proximity, and I expect that costs of investing fall with psychic proximity and rise with psychic distance. The sign of DISTANCE is expected to be negative, while that for MARKET and DEVELOP are hypothesised to be positive. Since country-specific data for allfifty-eightcountries receiving British

The expansion of British multinational companies

137

FDI were required for testing of the model, data limitations severely restricted the variables available to measure the impact of production costs on the choice of form. No adequate data on the conventional production cost factors, such as wage levels, input and energy costs and labour productivity, exist for most pre-1939 host economies. In so far as each industry can be characterised by a unique technology, product group dummies may reflect underlying scale and production cost factors. In recent work on American firms before 1914, economies of scale were significant in the food/drink, chemical, metal and engineering industries, but not in textiles (Atack 1985, pp. 29-52). Of course, these product dummies are also likely to reflect other factors, such as the transportability of the product. In addition, many British multinationals began production on a small scale, using old plant and equipment. Therefore, the product dummies as measures of production costs are not particularly robust, and must be treated with a good deal of caution. The most difficult factor in the production branch investment decision to measure is transaction costs. Transaction costs are costs of operating institutional arrangements, such as markets, intermediate modes - franchises, agents and licences - and firms. In terms of international involvement, managers select the mode which economises on the costs of transactions in goods and services across national boundaries. MNEs are chosen when hierarchy attenuates the costs of bounded rationality and opportunism relative to alternative governance structures, such as markets, long-term contracts and agency agreements. Here we are concerned with the transaction costs savings which impact on the choice between two hierarchical organisations, the production plant versus the sales branch. Archival studies of the timing of plant investments by Wellcome, Babcock, Bryant and May, Callender Cable, Albright and Wilson, and British Insulated Cable, which showed that each firm concentrated its overseas expansion within a very few years, provided the first lead to the role of transaction costs in the production plant decision. For example, Wellcome (1901-2) invested in overseas plant in Australia in 1902, the US in 1907 and made no further FDI until 1930 in Canada. Bryant and May had two main periods of FDI, with three production facilities formed between 1905 and 1907 and a further five branches in 1927. Babcock (Babcock, Bellamy 1985) made three investments between 1906 and 1910 and four between 1920 and 1925. Albright and Wilson (Albright and Wilson) made FDIs in the US in 1896 and Canada in 1902 followed by a gap of thirty years before making a joint FDI in Australia. A similar

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New perspectives on the late Victorian economy

Table 5.5

Bunching ofFDI in production branches

Gap in years

All firms

Firms with 3 + FDIs

0 1- 3 4-10 11-25 26-39 40 +

26 19 21 18 7 7

26 22 19 17 9 8

pattern applies to Dunlop, Courtaulds, Vickers, ICI and Reckitt. The bunching of FDI decisions, shown in table 5.5, was uniform across countries, product groups and firm sizes. The bunching contradicts the popular model that MNEs go abroad in sequential steps, learning about each market in turn before making a new FDI. For example, Caves (1982, pp. 72-3), relying on historical case studies, argued that foreign investors went through a 'process of incremental problem solving' in each host country with a 'sequence of moves from more to less familiar countries'. Transaction cost factors explain the bunching of British pre-1939 FDI. Two types of transaction costs were internalised within a production branch: the rents from production-based knowledge which are not easily codified and patented and scope economies related to managing at a distance. Knowledge of operating multilocational firms had strong learning by doing characteristics and is embodied in human capital organised as teams, such as boards of management (Teece, 1980), p. 228). Such knowledge gives rise to scope economies when the costs of organising joint production in several locations within one firm are less than the costs of organising production in separately owned plants (Teece 1980, Willig 1979). In addition, such knowledge, which is not easily codified, is difficult to transfer through arm's-length markets where there are high costs of recognition and disclosure. The production subsidiary is a contractual arrangement which attenuates these transaction costs. While the transaction cost approach to institutional choice has gained general acceptance among business historians, little progress has been made in measuring them empirically. I employ three proxies to measure transaction costs: NUMBER, which is the number of branches each parent firm operates abroad, DIVER, the number of different two digit SIC product groups for each firm, and RAW, a binary dummy variable measuring whether the parent had backward vertical contracts or backward integration. NUMBER, whose sign is expected to be positive,

The expansion of British multinational companies 139 captures directly the idea that managerial knowledge yields scope economies related to managing numerous branches at a distance. DIVER and RAW proxies managerial expertise related to diversified product lines which encourage simultaneous investment in two or more markets. The hypothesised sign of both these variables is positive. The dependent variable is a qualitative variable taking on the value 1 for a production branch and 0 for firms with only a sales branch. Each firm faced the binary choice of investing in a production plant or operating a sales subsidiary, therefore limited-dependent or qualitative choice models provide an appropriate characterisation of the investment decision. For firm /, given the vector of explanatory variables denoted X,-, we assume the probability of investing in a production plant, Ph can be described by the logistic function.

where p are the coefficients to be estimated. Since many observations are not available for each firm, Pt must be estimated by maximum likelihood techniques rather than by the usual method of sample proportions. For T observations, the likelihood function is /= Y\Pr(i-P)Xyi

(5.2)

/= 1

where

{

1 with a probability Pt 0 with a probability 1 - Pt

which is estimated by the Newton-Raphson iterative procedure for maximising non-linear objective functions (see Formby et al. 1984, Judge et al. 1980). The results of the logit equations are reported in table 5.6, the reference firm (in equations 1-4) produced all product groups other than food and drink and chemicals. In models 1-4 the product dummies are significant, suggesting that, in so far as the dummies captured production costs, these costs increased the probability of forming production facilities. In model 5 a larger number of product group dummies were introduced, but they were not significant. On the basis of a log likelihood chi square test the additional dummies in model 5 can be excluded and models 1-4 are adequate representations of the production cost aspect of the sales branchproduction plant decision. More generally, the hypothesis that all the coef-

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New perspectives on the late Victorian economy

Table 5.6

Logit models for the sales branch-production plant decision 1

Food/drink Chemical

2

3

1.77 (3.27) 1.01 (2.86)

1.44 (2.53) 0.90 (2.48)

1.79 (3.27) 1.01 (2.83)

0.86 (3.29) -0.25 (-0.93)

0.85 (3.28)

0.86 (3.30)

4

5

1.75 (3.21) 1.00 (2.83)

1.70 (2.98) 0.91 (2.33) 0.04 (0.14) -0.39 (-0.85) -0.37 (-1.00) 0.83 (3.16)

Engineer Metal Textile Psychic proximity Distance

0.45 (0.69)

Develop Market Diver Number

0.69 (3.60) 0.18 (2.65)

Raw Constant X2 Likelihood ratio DF Cases

-0.46 (-1.86) 53.08 6 380

0.30 (1.19) 0.17 (2.39) 2.63 (2.51) -0.45 (-1.80) 64.34 6 380

-0.008 (-0.46) 0.66 (2.88) 0.17 (2.62)

0.71 (3.08) 0.12 (1.77)

0.66 (2.94) 0.18 (2.70)

-0.26 (-0.50) 53.28 6 380

0.16 (0.84) 54.49 5 380

-0.37 (-1.29) 54.95 8 380

ficients are equal to zero, implying that all alternatives are equally likely, can be rejected on the basis of the reported likelihood ratio tests for all equations. The location variables returned mixed results. Psychic proximity, PSYCHIC, is positive and significant. The greater the psychic proximity, the greater the likelihood that British MNEs invested in production plants. DISTANCE, is negative and insignificant, but the variable is not particularly robust, and the result may be due to measurement error. The binary measuring the level of development is positive implying that British firms were more likely to invest in production branches in developed markets, but insignificant. MARKET is an imperfect proxy for market size and maturity, but employed because of data limitation on

The expansion of British multinational companies

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variables such as income per head. However, the insignificant result is not inconsistent with the model; if the bunching of FDI is driven by internal scope economies, then market size would not be expected to be as important an explanatory variable as is usually assumed. The economies of scope hypothesis receives statistical support from the transaction cost proxies. NUMBER, DIVER, and RAW are all positive and statistically significant. There is evidence in model 2 of multicollinearity between DIVER and RAW, with a significant change in the coefficient of DIVER when both variables are introduced into the same equation. According to a likelihood ratio test for variable inclusion, RAW should remain in the model, so equation (2) in table 5.6 is the preferred model. The results on the transaction cost proxies support the hypothesis that firms invest in production facilities to attenuate transaction costs related to appropriating production based knowledge and scope economies.

5.3 Conclusion The overseas expansion of pre-1939 British MNE's has received a critical evaluation by business historians. The received view emphasises the concentration of British international firms in the 'safe' markets of the Empire, where they were afforded protection from the competitive vigour of American and European multinationals in the rest of the world's markets. In support of this hypothesis, it is alleged that British MNE's performed poorly, with indifferent profit levels and low rates of return on assets. The alleged failure of British MNEs has been largely explained in terms of deficient management, due to the slow adoption of the new U- and M-form managerial structures pioneered in America. The whole story of failure is based on indirect evidence. There has been no comparisons of British with American or European MNEs; nor have there been clearly defined parameters for what constitutes failure in terms of profits or returns on assets. Managerial failure has not been distinguished from other types of failure, such as technological. Finally, the absence of new organisational structures does not mean that British parent firms did not develop control mechanisms. As yet, there has been no study of the types of monitoring and reporting framework which British firms established between the home firm and the overseas branch which might have provided an alternative means of control to U- and M-form structures. Using a sample of 448 pre-1939 British multinationals, I found that

142

New perspectives on the late Victorian economy

there was little evidence that British MNE's invested in Empire markets at the expense of the rest of the world in the period before 1914. Developed and underdeveloped Europe outstripped the Empire as a location for pre-1914 production plants, and Germany and the United States attracted morefirsttime British investment in plants than Australia or Canada. The same held for sale facilities; British firms established selling branches as readily outside as inside the Empire. During the interwar years, the proportion of British firms investing in the Empire increased. But rather than abandoning the highly competitive developed markets of Europe or America, British firms reduced their involvement in underdeveloped Europe. From the changing location of British FDI, there is little evidence of failure. The decision to invest in production facilities has also received criticism from business historians. It was claimed that British FDI was largely defensive and frequently unsuccessful. There was an overexpansion of British MNEs, revealing a weakness in British FDI. To econometrically test the decision to switch from sales branches to production plants, I constructed a model of the production plant investment decision which included transaction cost variables, as well as locational and multiplant production cost factors. The model hypothesised that the tendency for FDI decisions to be bunched could be explained in terms of economies of scope relating to managing at a distance. The transaction cost variables used to proxy the economies of scope were found to be positive and significant in the logit model, and the locational and multiplant investment factors also contributed to the FDI decision. Coupled with the evidence on the wide geographical distribution of British investment, the results of the FDI model suggest that managers were making investment decisions consistent with economic factors. The quantitative data suggest that British multinationals performed well in the pre-1939 international economy, and there is little evidence to support the traditional interpretation that British MNE's were failures. References Aharoni, Y. (1966), The Foreign Investment Decision Process, Boston: Harvard University Press. Albright and Wilson (1898-1928), Minute Books, Company Archives. Aldcroft, D. (1964), T h e entrepreneur and the British economy, 1870-1914', Economic History Review, 12: 113-34. Archer, H. (1987), T h e role of the entrepreneur in the emergence and development of UK multinational enterprise', University of Reading Discussion Paper in International Investment, 108.

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143

Ashworth, W. (1963), An Economic History of England 1870-1939, London: Macmillan. Atack, J. (1985), 'Industrial structure and the emergence of industrial capitalism', Explorations in Economic History, 22: 29-52. Babcock - evidence from the firm's archives. Bellamy, C. B. (1985), Memoirs of Babcock Australia (private typescript, Babcock Archives). Buckley, P. and Casson, M. (1976), The Future of the Multinational Enterprise, London: Macmillan. Buckley, P. and Roberts, B. (1982), European Direct Investment in the USA Before Word War I, London: Macmillan. Casson, M. (1979), Alternatives to the Multinational Enterprise, London: Macmillan. Casson, M. (1986), 'Contractual arrangements for technology transfer - new evidence from business history', Business History, 28: 5-35. Caves, R. (1982), Multinational Enterprise and Economic Analysis, Cambridge University Press. Chandler, A. D. (1980), T h e growth of the transnational industrial firm in the United States and United Kingdom: a comparative analysis', Economic History Review, 33: 396-^10. Church, R. (1986), 'Family firms and managerial capitalism: the case of the international motor industry', Business History, 28: 165-80. Coleman, D. and Macleod, C. (1986), 'Attitudes to new techniques: British businessmen, 1800-1950', Economic History Review, 39: 588-611. Crafts, N. F. R. and Thomas, M. (1986), 'Comparative advantage in UK manufacturing trade, 1910-1935', Economic Journal, 96: 629-45. Davenport-Hines, R. P. T. (1986a), 'Introduction' in Davenport-Hines, R. P. T. (ed.), Markets and Bagmen: Studies in the History of Marketing and British Industrial Performance 1830-1939, London: Gower. Dunning, J. (1985), 'The eclectic paradigm of international production: an update and a reply to its critics', University of Reading Discussion Paper in International Investment, 91. Elbaum, B. (1986), 'The steel industry before World War Y in B. Elbaum, and W. Lazonick (eds.), The Decline of the British Economy, Oxford University Press. Elbaum, B. and Lazonick, W. (eds.) (1986), The Decline of the British Economy, Oxford University Press. Floud, R. (1976), The British Machine Tool Industry, 1850-1914, Cambridge University Press. Foreman-Peck, J. (1982), 'The American challenge of the twenties: multinationals and the European motor industry', Journal of Economic History, 42: 865-82. Foreman-Peck, J. (1985), 'The motor industry', in M. Casson (ed.), Multinationals and World Trade, London: Macmillan.

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Formby, T. B., Carter-Hill, R. and Johnson, S. R. (1984), Advanced Econometric Methods, New York: Springer-Verlag. Franko, L. (1976), The European Multinationals, New York: Harper and Row. Hannah, L. (1983), The Rise of the Corporate Economy, London: Methuen. Hutchinson, D. and Nicholas, S. (1987), 'Modelling the growth strategies of British firms', Business History, 29: 46-64. Jones, G. (1984a), The growth and performance of British multinational firms before 1939: the case of Dunlop', Economic History Review, 37: 35-52. Jones, G. (1984b), 'Multinational chocolate: Cadbury overseas 1918-1939', Business History, 25: 57-74.

Jones, G. (1986a), 'Multinationals: theory and history', in P. Hertner and G. Jones (eds.), Multinationals: Theory and History, London: Gower. Jones, G. (1986b), British Multinationals: Origins, Management and Performance,

London: Gower. Judge, G., Carter Hill, R., Griffiths, W., Lutkerpohl, H., and Lee, T. (1980), The Theory and Practice of Econometrics, New York: John Wiley. Kahn, A. (1946), Great Britain in the World Economy, London: Pitman.

Lazonick, W. (1986), The cotton industry' in B. Elbaum and W. Lazonick (eds.), The Decline of the British Economy, Oxford University Press.

Lewchuk, W. (1986), The motor vehicle industry' in B. Elbaum and W. Lazonick (eds.), The Decline of the British Economy, Oxford University Press.

Lindert, P. and Trace, K. (1970), 'Yardstick for Victorian entrepreneurs: the chemical industry', in D. McCloskey (ed.), Essays on a Mature Economy, Cambridge, Mass.: Harvard University Press. McCloskey, D. (1970), 'Did Victorian Britain fail?', Economic History Review, 23: 446-59. McCloskey, D. (1973), Economic Maturity and Entrepreneurial Decline: British

Iron and Steel, 1870-1913, Cambridge, Mass.: Harvard University Press. Nicholas, S. (1982), 'Total factor productivity growth and the revision of post1870 British economic history', Economic History Review, 35: 83-98. Nicholas, S. (1983), 'Agency contracts, institutional modes and the transition to foreign direct investments by British manufacturing multinationals before 1939', Journal of Economic History, 43: 675-86.

Nicholas, S. (1985), 'British economic performance and total factor productivity growth, 1870-1940', Economic History Review, 38: 576-82. Nicholas, S. (1986a), The theory of multinational enterprise as a transactional mode' in P. Hertner and G. Jones (eds.), Multinationals: Theory and History, London: Gower. Nicholas, S. (1986b), 'Multinationals, transaction costs and choice of institutional form', University of Reading Discussion Paper in International Business, 99. Payne, P. (1974), British Entrepreneurship in the Nineteenth Century, London:

Macmillan.

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145

Sandberg, L. (1974), Lancashire in Decline: A Study of Entrepreneurship, Technology and International Trade, Columbus: Ohio State University Press. Stopford, J. (1974), 'Origins of British based multinational manufacturing enterprises', Business History Review, 48: 305-35. Teece, D. (1980), 'Economics of scope and the scope of the enterprise', Journal of Economic Behaviour and Organisation, 1: 223—47. Wellcome (1901-2), Correspondence 1901-2, WFMI3, Company Archives. Wiener, M. (1981), English Culture and the Decline of the Industrial Spirit, 1850-1950, Cambridge University Press. Wilkins, M. (1970), The Emergence of Multinational Enterprise, Cambridge, Mass.: Harvard University Press. Wilkins, M. (1986), T h e history of European multinationals: a new look', Journal of European Economic History, 15: 483-510. Willig, R. (1979), 'Multiproduct technology and market structure', American Economic Review, 69: 177-83.

PART II

Distribution

Correctly conceived, changes in real income are changes in the level of subjective well-being. Since this well-being cannot be observed, the obvious measure has been changes in the goods and services that can be consumed. The increase in real income consequent upon a fall in the price of a good or service is then the amount by which money income can be reduced while leaving unchanged well-being as measured by a particular bundle of consumption goods. This figure is the original money income minus the product of the original money income and a price index. The Laspeyres price index (chapter 6) evaluates the reduced cost of buying the former consumption basket at the new prices relative to the old. The Paasche price index measures the reduced cost of buying the new bundle of goods. In general these two indices will give different results. When prices move in opposite directions, the two indices can also move inversely. In figure II. 1 the fall in the price of X shifts the budget constraint outwards along the X axis. Consumption bundle A is replaced by consumption bundle B. The Laspeyres index is represented by the broken line drawn through A, parallel to the new budget line. Increased real income in Ys is Yo minus the point of intersection of this broken line with the Y axis, YL. This understates the improvement in well-being from the price fall (I2-I\ h), this measure overstates the rise in real income. One objection to the pre-1834 Poor Law Speenhamland system was that a subsidy was given to wages and therefore this social security system encouraged idleness. In terms offigureII. 1 roughly Y is leisure and Zis all other goods and services. A wage subsidy shifts the budget constraint outwards along the X axis so that both more goods and more leisure (less work) are taken. In the late-Victorian period (chapter 7) the relatively small numbers on relief in normal times at least in the industrial north 147

148

New perspectives on the late Victorian economy

\

Figure II. 1 Cost of living measurement with Laspeyres and Paasche indices

Wages Marginal cost of labour

Supply of labour

Demand for labour = marginal revenue product of labour Labour

Figure II.2 Bilateral monopoly in the labour market

Distribution

149

shows that this type of substitution was not occurring. Those on relief were not substituting in favour of leisure because they had no alternative. Wage setting in markets with only one buyer and only one seller used to be thought indeterminate in economic analysis. Apparently economics had nothing to say about the outcome of collective bargaining beyond what is represented in figure II.2. The employer would aim to hire labour until the addition to revenue from further hiring (the demand for labour curve) is equal to the extra cost (not only the wage which is bid up by further hiring, but the increased wage bill for those employees who were prepared to work for a lower wage). At this level of employment L\, the wage is W\. The union may be expected to want to raise wages above W\, and can do so if it can prevent anybody working for less than the union wage. In enforcing this restriction the union transforms the employer's marginal cost into the union wage, as long as that is above the free market wage. At wage We, the union can maximise employment if the employer will accept its terms. At any wage between W2 and W\ the union can increase employment above that which a profit maximising employer would choose in a free market, subject to the same caveat. The range within which the two parties might settle is therefore W2 — W\ but there is no reason in the model why the employer should settle at the union's preferred wage nor why the union should settle at the employer's. The concept of perfect equilibrium can resolve this indeterminacy by introducing a time dimension to the bargaining process and perfect foresight on the part of the protagonists (chapter 8).

Chapter 6

A new look at the cost of living 1870-1914 Charles Feinstein

6.1

Introduction

The dominant influence on the progress of living standards in late Victorian and Edwardian Britain was not the rise in nominal incomes but the long-run movement in the cost of living.l During the last quarter of the nineteenth century the principal source of the sustained rise in the general standard of living of the working class was the strong downward trend in the cost of food, fuel and other necessities. And at the end of the century, when the steady improvement of the late Victorian period gave way to what Beveridge (1923, p. 463) called 'the cramped, uneasy, envious, but not impoverished age of Edward', it was the abrupt transition from falling to rising prices which precipitated the turnaround in real incomes. For many years now the standard source for the quantification of these trends in wages and prices has been the careful work of Bowley (1904, 1920, 1937) and Wood (1909). According to Bowley, real wages improved by some 55 per cent from 1873 to the turn of the century, and four-fifths of this advance was accounted for by the bonus of lower retail prices, leaving only one-fifth attributable to higher money wages (Bowley 1904, p. 459, 1937, pp. 30 and 122). The significance of this partitioning is that it meant that a generous windfall was immediately available to all those in receipt of some source of income, and did not have to be won through acquisition of skill or struggles with employers. In the subsequent phase, it was again the change in prices which was primarily responsible for the adverse trend in real incomes: as prices increased, they outpaced the small rise in money wages, and real wages deteriorated by some 7 per cent. Both the initial gains and the subsequent worsening of living standards have important implications for the history of the period, and, if the political and social impact of these trends is to be reliably assessed, the movement of wages and prices must be accurately measured. There is, furthermore, a major statistical problem in the interpretation of the sudden check to the growth of real wages in the Edwardian era. Stripped of complications, it is this. If the estimates of a fall in real wages are 151

152

New perspectives on the late Victorian economy

correct there are essentially three possible explanations for the failure of wages to keep pace with prices. It could have been the result of a corresponding check to the progress of productivity (output per worker), or of a shift in the distribution of income in favour of profits, or of a deterioration in the terms on which the United Kingdom imported goods and services in exchange for exports. However, the existing statistics of real output per worker reveal no appreciable slackening in the rate of growth of productivity after the turn of the century; the estimates of income show that wages and salaries were actually gaining in this period at the expense of profits, and the terms of trade were effectively stationary. Could it then be that the estimates of real wages are defective? The view that there was at the very least a sustained pause in the advance of living standards is not solely dependent on the evidence of the underlying wage and price statistics. It is supported indirectly by the abnormally high level of industrial unrest which marked the last phase of this period, with almost 14 million days lost in disputes in the years 1908-14. And many well-informed contemporaries, writing both before the war and in the early 1920s, were quick to link this to the stagnation of real wages indicated by well-publicised estimates compiled at the time by the Board of Trade and by private investigators. However, this testimony cannot be taken as conclusive evidence, and the unanimity of informed opinion may owe more to their reliance on a common source than to independent observation.2 There thus seems to be a strong case for a thorough reexamination of all the relevant data if we are to achieve a satisfactory interpretation of these contrasting phases of the pre-1914 era. The aim of this chapter is to investigate one crucial aspect of these trends in living standards from 1870 to the First World War: the changes in the price of goods and services purchased by working-class households. In companion papers a similar exercise is undertaken for the estimates of money wages (Feinstein 1987, 1990b), and an attempt made to assess the most probable resolution of the conflict of evidence summarised above (Feinstein 1990a). Section 6.2 of this chapter outlines the nature of the cost of living indices compiled by Bowley and Wood, and indicates why there may now be a case for an alternative index. The principles on which the new index is constructed, and the methods used to weight the constituent price indicators, are explained in section 6.3, and the procedures and sources used to obtain annual price indicators for the years 1870— 1914 are described in section 6.4. The paper ends with the presentation of the new measure of the changes in the cost of living in section 6.5 and a

A new look at the cost of living 1870-1914

153

comparison with the indices previously constructed by Bowley, Wood and other scholars.

6.2 Existing estimates of the cost of living Bowley made a number of preliminary attempts to measure changes in the cost of living (1911, 1926), and his final index was published in 1937. From 1880 onwards it is a weighted average of series for five categories: food, rent and rates, clothing, fuel, and sundries (Bowley 1937, pp. 118-21). For food and fuel he relied on the extensive collection of retail prices by the Labour Department of the Board of Trade (1903b, 1904), and he also used their information on rent and on clothing for 1880-1900. In order to complete his index Bowley took the wholesale price of textile materials to represent the movement in cost of clothing after 1900, and for rents he decided that 4In the absence of evidence of any change it seems best to assume stationariness from 1900 to 1914'(1937, pp. 119-20). For the whole period 1880-1914 the changing cost of the small residual category of miscellaneous goods ('sundries') was measured by Sauerbeck's general index of wholesale prices.3 Bowley combined these constituents in a Laspeyres (fixed-weight) index with 1900 as the base year. The weights are based largely on budgets for expenditure on food in 1904 collected by the Board of Trade (1904) from working-class families in urban areas. The average weekly household income of these families was 36s lOd, and they were recorded as spending 22s 6d (61 per cent) on food. No data were collected for their expenditure on other items, although some information was available in less representative budgets compiled at various dates by private and official investigators.4 Bowley (1937, p. 120) estimated the appropriate weights for 1904 as food, 60; rent, 16; clothing, 12; fuel, 8; and sundries 4.5 In terms of the prices of 1914 he estimated that this corresponded to an outlay on food of 18s 9d out of a total family expenditure of 31s 3d. He noted that the quantities of the various foods this would provide were above the minimum standard used by Rowntree, but that the allowance for the four other items was 'at the bare minimum' (1937, pp. 31-2). Finally, Bowley estimated the movement of retail prices in the years before 1880 by regressing the index for 1880-1914 on the Sauerbeck indices of wholesale prices for food and raw materials, and then applying the resulting coefficients to the wholesale indices for 1846-80. The two most striking features of Bowley's procedure are the low level of family income to which his weights relate, and the very limited scope of

154

New perspectives on the late Victorian economy

the categories included. On the first point, his own estimates put the average level of earnings for an adult male worker at 32s in 1914 (1937, p. 53). Since most families would have more than one breadwinner a family budget of only 31s 3d would lie well below the average.6 Bowley was, of course, aware of this and described his index accordingly: we may apply this index to the index of money wages to obtain an estimate of the change of real wages of the urban working class whose wages were not far from the general average; that is to the more regularly employed of unskilled labourers and to moderately skilled labourers ...

(1937, p. 32, italics in original) He further noted that: The measurement of the change of purchasing power on this basis is definitely not applicable to the agricultural labourer whose budget of expenditure is different and who depended on allowances and payments in kind to a greater extent in 1860 than in 1914. (1937, p. 35)

Despite these warnings, the absence of any reliable alternative has meant that Bowley's index has been widely used as an appropriate cost of living index for all workers. Secondly, nothing is included in this budget for alcohol or tobacco, for travel to work, for furniture, china or other household goods, or for insurance, health care, recreation or other services. According to the calculations described below beer and other alcohol accounted for some 16 per cent of working-class expenditure, and the other omitted categories for almost as much again. In a defence of similar omissions from an earlier version of his index Bowley (1926, p. 801) observed that: 'inaccuracy results only in so far as the omitted prices differ in their movements from those included'. However, no attempt was ever made to test this important assumption. It is possible that the omission of items such as alcohol and tobacco also reflected an implicit moral judgement that such purchases ought not to form any part of a worker's budget, in line with Rowntree's familiar distinction between primary and secondary poverty. It would thus seem appropriate to investigate the effect on the index of including the full range of goods and services, and adopting a pattern of expenditure closer to the average for all working-class families, urban and rural. Furthermore, consideration of the price series which Bowley used for the categories that were included from 1880, also indicates that it would now be possible to improve on these in various ways. Before turning to this task we may note briefly two other early attempts which were made to measure the movements in the cost of living over this

A new look at the cost of living 1870-1914

155

period. Wood (1909) constructed an index for the period 1850-1902, but with little information given about his sources and methods.7 For commodities, his index was based on material collected by the Board of Trade (1903b) and a variety of other sources, including his personal enquiries. He described it as 4an unweighted mean of a series of index-numbers for all commodities of ordinary consumption for which records are obtainable'.8 For rent, Wood attempted to estimate the increase between 1850 and 1902 in the cost of accommodation in a house of fixed standard and amenities (including those provided through the rates); he assumed that this increase occurred at a uniform rate. His series for commodities and rent were then combined with changing weights, the ratio falling from approximately 4 to 1 in 1870, to 2.7 to 1 in 1902. The resulting index is compared with Bowley's and with the present estimate in section 6.5 below. The Labour Department of the Board of Trade published their own index for 1880-1900, based on the four series for food, rent, clothing and fuel. From 1900 until the outbreak of the war they published separate indices for London food prices, coal and clothing, but no overall index {Abstract of Labour Statistics, Board of Trade 1926, vol. 18, pp. 136-8).9

6.3 Weighting the new index Provided that suitable data can be found for expenditure in the base year, and for the annual movement of prices relative to that year, there is no good reason for following Bowley and the Board of Trade in restricting the coverage of the index. The first objective for the new index, therefore, is to include at least some indication of price changes for all the main categories of working-class expenditure. Given this principle, it is necessary to decide: (i) the method by which the index is weighted, (ii) the choice of base year(s) and (iii) the pattern of expenditure used to determine the weights. It is now generally accepted that a Laspeyres (fixed weight) index is the most appropriate and convenient form for a cost of living index.10 For consistency with other estimates in the national accounts it is desirable to adopt 1900 as the base year.11 This also has the advantage that it enables us to exploit a considerable body of data which is not available for any earlier year. The general stability of the pattern of expenditure appears to be sufficient to justify the simplification of a single base year, without

156

New perspectives on the late Victorian economy

using a chain index. Bowley argued that, over the period from the mid 1890s to 1914, 'habits of consumption and the size of the family were changing slowly', and were thus too small to affect the index.12 He also showed that for the earlier period (1880 to 1894), when prices were falling, the results obtained by reweighting his index to allow for probable changes in the pattern of expenditure on food did not differ significantly from those obtained with 1900 weights (Bowley 1937, pp. 32-3). Base-year weights could, in principle, be derived from information on the pattern of working-class consumption obtained either from family budget studies or from aggregate estimates of consumers' expenditure. For the period in question neither type of source provides precisely what is required. The two main inquiries into working-class budgets during this period were the 1903^ survey by the Board of Trade (1904, pp. 1-28) of expenditure on food by 1,944 families in urban districts of the United Kingdom; and data collected by the United States Commissioner of Labour (1891) on expenditure on food, rent, fuel, clothing and sundries in 1890 and 1891 by 1,024 families in selected industries in Great Britain.13 The former is probably the more reliable of the two, but covers only expenditure on food; the latter covers a larger part of the total budget, but is still far from complete, and the selection of industries is not entirely representative.14 Both relate only to urban workers. It thus seems desirable to consider an alternative source: total consumers' expenditure. Prest (1954) has compiled careful and detailed annual estimates of aggregate expenditure from 1900 onwards. His data are more comprehensive, and more representative of the working class as a whole, than the budget studies, but also cover all middle- and upperclass households. If these estimates are to be used, therefore, it is first necessary to allocate the total expenditure between working-class and other households. As a first step towards this allocation an estimate was made of the total number of households in the United Kingdom in 1901.15 A rough division of this total by income group was then made so as to distinguish workingclass from middle- and upper-class households. The resulting estimate gives some 6,600,000 households in the former category and 2,300,000 in the latter.16 When related to the estimated wages-bill in 1901 this yields an average family income per working-class household of approximately 43 shillings per week.17 An overall budget was then estimated for this average household by starting from the estimate of total consumers' expenditure in 1900 (Prest 1954) and allocating each separate category of spending between working-class and other households.

A new look at the cost of living 1870-1914

157

For the major categories this was based partly on consideration of actual estimates of average working-class expenditure per family, and partly on a rough judgement about the most likely ratio of expenditure per household (or per adult) for working-class compared with middleand upper-class families.18 For food, fuel and light, and clothing valuable information on actual expenditure was available from the family budgets noted above; from Bowley (1937, pp. 31-6); and from estimates by the Ministry of Labour (1920, p. 119). For rent, one house was assigned to each of the working-class households on the assumption that all the houses they occupied were at the lower end of the rental distribution, and the corresponding rentals (gross annual values) for those houses were taken from the Inhabited House Duty Returns for 1900-01.19 Rates were added pro rata to rents. For beer, spirits, wine and tobacco, estimates of expenditure by various income groups were made for 1903-4 and 1913-14 in the course of studies on the incidence of taxation by Lord Samuel (1919, pp. 167-70) and by the Colwyn Committee (1927, pp. 85-92, 222-6, and Appendices, X, pp. 53-64). There are also estimates of working-class expenditure on alcohol by Rowntree and Sherwell (1899, pp. 7-20). For the railways there is information on receipts from thirdclass tickets. For funeral expenses, Prest (1954, pp. 147-8) provides the basis for a differential allocation of expenditure. The middle and upper classes were assumed to employ all the domestic servants and to account for 90 per cent of the expenditure on such items as books, miscellaneous goods, education, hotels and restaurants. This leaves only a few items, notably health care, where the proportion which should be allocated to the working class was perhaps more significant, but the most that could be done was to make a rough guess. In this way a separate allocation was made for over thirty components of Prest's estimates of consumers' expenditure in 1900, and the outcome of the exercise is summarised in table 6.1. Unfortunately, the familiar discrepancy between the income and expenditure-based estimates of national income creates a further difficulty at this point.20 The estimate of working-class consumption in table 6.1 corresponds to a household outlay of approximately 49 shillings per week and is thus significantly higher than the estimate derived from the income of wage earners. The expenditure allocated to the middle- and upper-class households similarly exceeds their income. Some form of adjustment is needed, therefore, to reconcile the income and expenditure data. The precise pattern of adjustment will then turn on two factors: the alternative level of expenditure which is adopted, and the selection of

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New perspectives on the late Victorian economy

Table 6.1

Allocation of consumers' expenditure 1900 (£ million) Middleand

WorkingupperTotal class class expenditure expenditure expenditure (2)

(3)

(4)

532 134 43 153 69 22

381 52 17 83 47 9

151 82 26 70 22 13

72 39 39 54 68 41

58 48 112 60 23 27 40 47 60

27 5 85 35 6 16 32 3 0

31 43 27 25 17 11 8 44 60

47 10 76 58 26 59 80 6 0

16 35

9 13

7 22

56 37

32 115

8 15

24 100

25 13

1,626

843

783

52

(1)

Food Rent Rates and water Clothing and shoes Fuel and light Laundry, soap, etc. Furniture, pottery, hardware, etc. Other goods Beer Spirits Other drink Tobacco Railways and trams Cars and other travel Domestic service Life assurance and funeral expenses Medical services Entertainment and betting Other services Total

Workingclass expenditure as % of total

Source: (1) See Prest (1954), with adjustment to coal, (2}-(3) see text.

components assumed to be responsible for the discrepancy. Some illustrative outcomes for the derivation of the required expenditure weights can be considered. If it is assumed that Prest's expenditure estimates are correct, the weekly expenditure per working-class household would be as shown in (1) of table 6.2, with the corresponding percentage weights in column (2). If it is assumed that the total is incorrect, but that all the expenditure categories are equally in error and should be adjusted pro rata, then the weights are unaffected by the discrepancy, and would again be as in column (2). Alternatively, it might be assumed that the true level of working-class expenditure lies midway between the expenditure and income estimates,

Table 6.2

Average weekly expenditure of working-class households 1900 Expenditure of 49s per week * Error class

Food Rent and rates Clothing Fuel and light Cleaning materials Drink and tobacco Furniture and other goods Travel Other services

Shillings (1)

Per cent (2)

Expenditure of 46s per week **

Shillings (3)

Per cent (4)

Expenditure of 43s per week **

Shillings (5)

Per cent (6)

B B C C C B

22.2 4.0 4.8 2.8 0.5 8.3

45.1 8.2 9.9 5.6 1.1 16.9

22.2 4.0 3.6 2.1 0.4 8.3

48.3 8.7 7.8 4.6 0.9 18.0

22.2 4.0 2.4 1.4 0.3 8.3

51.6 9.3 5.6 3.3 0.7 19.3

C B C

1.8 2.0 2.6

3.8 4.1 5.3

1.4 2.0 2.0

3.0 4.3 4.3

0.9 2.0 1.5

2.1 4.7 3.5

49.0

100.0

46.0

100.0

43.0

100.0

Notes: * The percentages in column (2) would be the same for any other level of expenditure if all categories are adjusted pro rata. ** Assuming that the adjustment to the lower level of expenditure is made proportionately to those categories in error classes C and D only. Source: See table 6.1 and text.

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New perspectives on the late Victorian economy

making a household outlay of 46 shillings per week. Two estimates were compiled on this basis. For the first, it was assumed that only some of the expenditure categories are incorrect, and the downward adjustment was confined to those categories to which Prest gave reliability grades of C or D.21 The result on this basis is shown in shillings in column (3) of table 6.2 and as a percentage in column (4). For the second (not shown in the table), food was added to the categories which were subject to the proportionate downward adjustment. Finally, it might be assumed that the entire error arises on the expenditure side, i.e. that the actual expenditure per household was only 43 shillings per week. If it is also assumed that only the less reliable expenditure categories should be adjusted, the results would be as shown in columns (5) and (6) of table 6.2. Alternatively the level of expenditure on food might also be revised downwards. We thus have five possible patterns of expenditure as the basis for the required weights. Each of these was used to construct a cost of living index incorporating the price indicators described in section 6.4 below. It was immediately evident that the sensitivity of the index to the precise pattern of weights was relatively low. After consideration of the results of this exercise the weights finally adopted were the set derived from the compromise level of expenditure, with adjustment to the categories assigned C or D grades (see column (4) of table 6.2). This index is shown as a solid line infigure6.1. The broken line is the index which differs most from this, obtained using weights based on the level of expenditure determined by the income estimates, and with the larger adjustment thus required made pro rata to the Prest estimate for food as well as to the less reliable categories. It will be seen that for the most part the two indices track each other very closely. From the early 1880s the two can barely be distinguished, before that the alternative index is at a slightly lower level and thus falls fractionally less between the peak of 1873 and the trough in the mid 1890s.

6.4 The price indicators and the overall index Ideally, the indicators should always refer to retail prices, and should be representative of the prices actually paid in working-class shops and of trends in all parts of the United Kingdom. In practice the available data seldom measure up to all these requirements. Retail prices are used whenever available, but for some commodities and some parts of the period it is necessary to rely on wholesale price indices or on import and

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161

125 -

90

1870

1880

1890

1900

1910

Figure 6.1 Cost of living indices with alternative weights, 1900 = 100

export average values. Details are given in the following notes on the nine separate categories which make up the new index. These notes are designed to provide a short description of the main sources used for each of these categories, and to comment on any relevant conceptual problems. Where appropriate a brief comparison with other indicators is included. Except for food (described separately below) the weights for subcategories were derived from aggregate consumers' expenditure on the same basis as those for the main categories. The price series for the nine separate categories are set out in table 6.4 below. Food For 1892-1913 the Labour Department of the Board of Trade {Seventeenth Abstract of Labour Statistics 1915, pp. 102-4)

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New perspectives on the late Victorian economy

published separate indices for the retail prices in London of twenty-three foods, and an overall index weighted on the basis of the pattern of expenditure on food in 1904 of working-class families of various incomes and in all parts of the United Kingdom (Board of Trade 1904, pp. 3-28). According to Bowley (1937, p. 115) the data were collected: 'mainly from large stores, where the movement may have differed from that in shops in working-class districts'. He also commented: There is no certainty that the movements in the provinces were the same as in London, especially at the earlier dates; but at the one relatively recent period at which comparison is possible, namely from 1905 to 1912 [Board of Trade, 1912] the increases in food prices were nearly the same in London (12 per cent) and in the average of provincial towns (13 to 14 per cent).

The twenty-three items, and their weights (which sum to 360), are: Bread (50), flour (20), rice (3), tapioca (1), oatmeal (5), and potatoes (18); Beef: British and imported (24 each), mutton: British and imported (12 each), pork (15), and bacon (19); Milk (25), butter (41), eggs (19), and cheese (10); Tea (22), coffee (2), and cocoa (4); and Sugar (19), jam (4), treacle (2), marmalade (4), currants (3), and raisins (2). For 1870-92 new series were compiled for the same twenty-three items covered from 1892 onwards. For many of these commodities London retail prices were available on broadly the same basis as for the later years for all or part of the earlier period (Board of Trade 1903a, pp. 232-3 and 1903b). The relative weights for imported and British meat were obtained by assuming that no beef was imported before 1875, and that its share rose steadily to 50 per cent in 1900; and similarly that the share of imported mutton was zero until 1882. Where retail prices were quoted for several varieties, e.g. for meat, those listed by the Board of Trade (1903a, p. 231) were chosen. For years in which retail prices were not available, wholesale prices (Sauerbeck 1886) or average import values were used. The main items for which this was necessary were meat (beef, mutton and pork), eggs and cheese, in each case for the years before 1886; and potatoes, for all years from 1870. Four of these items (beef, mutton, bread and potatoes) were among the nine commodities included in thefirstBoard of Trade index of retail food

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163

prices for the years 1877-1901 (1903a, p. 233), but I have preferred not to use those series for the pre-1892 index: for beef and mutton, because the decline shown by the Board's indices between 1877 and 1892 is much larger than is indicated by any of the other evidence (London meat market prices or import average values); for bread because an alternative series is available which includes retail prices for additional qualities of bread and is thus consistent with the data used from 1892 onwards; and for potatoes, because the index given by the Board was derived from the contract prices of one institution and I thought this was likely to be less representative than the wholesale market price. Previous cost of living indices (Bowley 1937, p. 115, and Williamson 1985, p. 221) have relied on the 1903 Board of Trade series for these nine foodstuffs for 1877-91 (though with reweighting), and the present index thus differs both because of these changes and because of the enlarged coverage. The Board of Trade list omits three items from the pattern of workingclass expenditure recorded in 1904, and additional series were included to cover these items, bringing the sum of the weights to 400. The three series and their weights are: Fish (20): for 1870-87 based on the average export value of herrings; thereafter on the average price of wet and shell fish landed in the United Kingdom (Board of Trade, Statistical Abstracts). Fruit (15): to 1900 based on the average value of apples, oranges and lemons, and other imported raw fruit (Board of Trade, Statistical Abstracts', then Prest 1954, p. 63). Condiments (5): for 1870-1902 the average export values for salt (weight 4) combined with retail prices for vinegar (1) and pepper (1) (Board of Trade 1903b); thereafter the series for salt only. Rents and rates This is a weighted average of separate indices for rents (weight 5) and for rates (1). The rent index is a new addition to an already large collection of indices, and was constructed in an attempt to get a more appropriate coverage of working-class houses. There are two general procedures which have been used previously to estimate movements in rents, both derived from assessments of gross annual values (rentals) made for purposes of taxation. In thefirst,changes in rent are calculated on the basis of the increase revealed in years when all rents were reassessed for taxation under Schedule A of the income

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New perspectives on the late Victorian economy 22

tax. Details of the periodic revaluations, and of their effects on the assessments are given in Stamp (1916, pp. 31—6d). This was the procedure used by Singer (1941), by Feinstein (1988), and in a slightly different form by Cairncross (1953, pp. 212-15). In the second, the average annual value is calculated from tax data on the number and total annual value of assessed dwellings. This was the route taken by the Board of Trade (1904, pp. 34^51) and later by Prest (1954, p. 96) and Weber (1960, pp. 232-7, 1961, p. 64); and is the method used for the present estimates. One important difference between the two procedures is that the first measures only the changing rent of buildings of given quality; the second also includes the effect of improvements in the average size and quality of houses (see Feinstein 1988, pp. 405-7). The various indices differ both for this reason and in respect of the type of building covered. None is entirely satisfactory. The Singer index covers all buildings and, as has been shown elsewhere (Feinstein 1988, p. 406), the rents of shops, factories and other business premises rose very much more rapidly over the period than those of residential dwellings. An alternative index, for dwellings only, was constructed by Feinstein on the same basis as Singer's, but that still covers all dwellings, not just those inhabited by the working class. This objection applies also to the linked indices derived from Weber and Prest which are incorporated in the Williamson (1985) and Gazeley (1989) indices. As we show below, the distinction between working-class houses and others turns out to be more important than has been appreciated hitherto. The index used by Bowley (1937, pp. 118-19) for 1880-1900 is based on the estimates made by the Labour Department of the Board of Trade (1904). This was a direct attempt to measure rents for working-class houses, defined as those with a gross annual value of less than £50 in London and £20 in provincial towns. However, in making its estimates the Board elected to combine the estimates for London with those for twenty large provincial towns, rather than for the whole of Great Britain outside the Metropolitan area. The reason given by the Board (1904, p. 35) for this was that the estimates for the wider area 'take into account not only the rise of rent due to improved accommodation and to increased cost of housing, but also the rise in the general average caused by the increasing proportion of urban rents included in the total'. But, since the primary purpose of a cost of living index is to deflate an index of money wages which over this period itself reflects the rise in average wages resulting from migration from rural to urban occupations, it could be argued that the cost of living index should do so as well. If this is accepted,

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165

it not only changes the estimate for the area outside London, but also makes the difference between the increase in rents in London and in the rest of Great Britain more significant, so that it is not appropriate merely to take an unweighted mean of the two estimates. Other problems with the index are that it is based on data for only six years, with the remaining years obtained by interpolation; and that, for the final period 1900-14, Bowley simply assumed that rents were stationary. The remaining indices which should be mentioned are those constructed by Cairncross (1953) and Wood (1909). The former is based on an ingenious but rather approximate procedure relating only to houses of less than £10 annual value in England and Wales (excluding London) and is probably rather less reliable than the other indices. Wood gave no details about his sources or methods and, as noted above, assumed a uniform rate of increase - for a house of standard quality - from 1850 to 1902. The present index is confined to working-class houses, defined as those of less than £50 gross average value in London and less than £20 in the rest of Great Britain. The basic procedure was to calculate the average annual value from the Inhabited House Duty returns of the number and total annual value of private residential dwellings with an average annual value below the specified limits. Adjustments were made for the effect of the periodic reassessment years. This is essentially the same as the procedure adopted by Weber (1960) and Prest (1954), but with the exclusion of houses outside the metropolis above £20. As noted above, this procedure effectively incorporates the cost of improvements in the size and quality of the houses, but the extent of such improvement was quite modest over the late Victorian and Edwardian periods.23 The effect of confining the coverage (outside London) to houses below the £20 limit is surprisingly large. The average value of houses above £20 - and thus of all houses - was being continually pulled down by an increase in the proportion of houses immediately above the £20 level, relative to those of higher values. Between 1890 and 1910, for example, the number of houses in the range £20-40 increased by 90 per cent, whereas the number above £40 increased by only 39 per cent. This was due partly to rent increases moving existing dwellings across the £20 boundary, and partly to additional building of new houses for the middle classes at the lower end of the above-£20 range. As a result of this process the average rent of houses over £20 was actually falling over the whole period. This striking contrast between the movement in rents for the two

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New perspectives on the late Victorian economy

Table 6.3 Rents of private dwelling houses, Great Britain, reassessment years 1876-1910 (Index numbers, 1900 = 100)

Year beginning 1st April

1876 1879 1882 1885 1888 1893 1898 1903 1910

Gross annual value under £20

Gross annual value £20 & over

Total

(1)

(2)

(3)

81.7 84.2 86.0 88.3 89.9 93.3 97.9 103.3 106.2

116.1 112.6 110.5 109.6 108.6 106.1 101.4 98.0 95.3

87.0 89.2 91.4 92.8 93.3 94.7 98.2 102.8 104.0

Source: Inland Revenue, Reports ofH.M. Commissioners of Inland Revenue.

categories of dwelling house is shown for reassessment years in table 6.3. The estimates in column (1) are the basis for the present index for working-class dwellings, those in column (3) match almost exactly the Weber-Prest index for all dwellings, and the declining series for houses under £20 in column (2) explains why the two estimates differ. The Inhabited Duty information required for this index is only available for 1876-1910. Extrapolation at the beginning and end of the series was based on the Cairncross index. The second component of this series is the index of rates. Rates were effectively paid by occupiers, though typically included in rents and collected from the property-owner. Two possible objections can be raised to their inclusion in a cost of living index. The first is that the incidence of rates fell on the owner, not the occupier.24 This is clearly not true in all periods and in all areas.25 Even if it were, it would not be a valid objection to the inclusion of rates in a cost of living index. If, for example, there was a rise in rates which landlords were forced to bear in full themselves, our estimate of rents would not stay unchanged but would show a corresponding decline. This would occur because the Inland Revenue assessment of annual values on which the rent estimates are based are calculated net of rates (Stamp 1916, pp. 15-21, Offer 1981, p. 291). In order to give an accurate reflection of the amount paid by the tenant it is thus essential to cover both rents and rates.

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167

The second objection to the inclusion of rates is the one advanced by Bowley (1937, p. 29): Rates are in part the payment for the amenities of town life, in part payment for education and other services, in part of the nature of taxation. So far as the increase of rates corresponds to better services to the payer it ought not to be included in the cost of an unchanged standard of living, as intended to be measured by the index. Bowley's formulation of the problem has a certain attraction, but this approach is not applied to any other form of indirect tax (for example, the duties on drink and tobacco) and is not the customary practice in modern indices. I have therefore preferred to include the full extent of the increase in rates, while recognising that the resulting measures of real wages will not allow for the improvement in services provided by the public authorities. This issue is of some importance, because expenditure by local authorities out of rates was increasing very rapidly during this period - most notably for education and for public health programmes. In England and Wales, for example, average rates per working-class dwelling increased by over 150 per cent between 1880 and 1913. This was the product of a doubling of the rate in the £ levied by local authorities (from 3s 4.5d to 6s 8.9d) and a rise of about 26 per cent in average rentals per house. The corresponding figures for the subperiod 1900-13 are an overall increase of 42 per cent, caused by an increase of 32 per cent in the rate in the £ and of 8 per cent in average rentals. 26 Clothing andfootwear For 1880-1913 this is the index compiled by the Labour Department of the Board of Trade (1904, pp. 52-65, 1913a, p. 307, and Eighteenth Abstract of Labour Statistics, p. 138). For 1900-13 it agrees well with the index given by Prest (1954, p. 123) and the Department's series was preferred on grounds of continuity. The index was criticised by Bowley (1905, p. 179), and more recently by Gourvish (1979, p. 16), but there is nothing better available. It was extrapolated back to 1870 by a series based on the average export values of cotton piece goods (weight 5), woollen cloths (5), and leather boots and shoes (2). Fuel and light This is a weighted average of four price series: coal (weight 15), gas (2), oil (2) and candles (1). The series for coal is an unweighted average of the London retail prices for three qualities (Derby Brights, Kitchen and Nuts) collected by the Board of Trade (1904, p. 71

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New perspectives on the late Victorian economy

and Eighteenth Abstract of Labour Statistics, p. 138). For gas, oil, and candles the sources are the Board of Trade (1904, p. 73) and Prest (1954, pp. 102, 115-16). Cleaning materials For 1870-1903 this combines the London retail price indices collected by the Board of Trade (1903b) for soap (weight 5), starch (1), and washing soda (1). For 1903-13 it is based only on the average export value of soap. Alcohol and tobacco This is a weighted average of prices for beer (weight 6), spirits (3) and tobacco (2), each from Prest (1954, pp. 76, 79, 85-6 and 89-91). In each case Prest gives one set of prices for 1870-99 and another for 1900-13; in order to link these an additional estimate (based on Board of Trade, 1903b) was interpolated for 1900 on a basis consistent with the earlier series. Furniture and other goods The main components of this miscellaneous collection of goods are furniture and furnishings, pottery, glassware and hardware. Small outlays on books, cameras, watches and stationery are also included. The only price indicator which could be constructed for this heterogeneous collection related essentially to furniture and furnishings, but this was thought to be a more appropriate indicator for the remaining items than any of the other series available. The index is a weighted average of three series: furniture wage rates (weight 2), based on the series compiled by Wood (1909, p. 93); the average import value of mahogany and other hardwoods used for furniture (1); and the average export value of woollen cloths (1). Travel From 1878 onwards this is a weighted average of price series for railways (weight 85) and tramways (15). For 1870-8 only railways are included. The index for working-class rail travel is based on average receipts per third-class passenger journey, calculated from data in the annual Board of Trade Railway Returns on the number of thirdclass passenger journeys (excluding holders of season tickets) and the corresponding gross receipts. It is not possible to make a reliable adjustment for any changes which may have occurred in the average length of journey.27 The series for tramways is similarly derived from data in the Statistical Abstracts for gross passenger receipts and number of passenger journeys.

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Other services This covers a variety of miscellaneous services such as life assurance and funeral expenses, medical services, entertainment, betting and subscriptions. It has simply been assumed that the cost of these services was stable over the whole period. This is unsatisfactory, but appears consistent with such very limited information as is available, for example on medical fees (Peterson 1978, pp. 209-21) and on funeral expenses (Prest 1954, pp. 148-9).

6.5 A new cost of living index The price series for each of these nine categories of expenditure are set out in table 6.4, with the weights derived in section 6.3 (see column (4) of table 6.2) reproduced at the head of each column. The overall cost of living index for an average working-class family is given in the final column. The new index is compared with Bowley's in figure 6.2. The old series starts at an appreciably higher level in the 1870s, and drops faster to a lower level in the mid nineties. On the new index the reduction in prices between 1873 and 1896 is only 23 per cent, compared with the fall of 31 per cent recorded by Bowley. There is also a small difference in the pace of the subsequent upswing, with a price rise of 17.5 per cent on the new index, against 22 per cent shown by Bowley. In the initial discussion of existing cost of living indices (p. 154) three reasons were suggested for undertaking the construction of a revised index: use of weights more representative of the pattern of expenditure for the working class as a whole, inclusion of the full range of goods and services, and improved price indicators for the categories covered in the previous indices. It has already emerged from the comments in section 6.3 that the index is not particularly sensitive to the precise choice of weights. The differences between the new series and Bowley's thus arise largely from the second and third factors. The importance of the categories omitted by Bowley will depend partly on their relative weight in the index, and partly on the extent to which the movement of their prices deviates from those of the categories included. The former effect can be gauged from comparison of the weights adopted for table 6.4 with those used by Bowley (see note 5). Thus food has a weight of 58 per cent in Bowley's index, but only 48 per cent in the present index; and the weight for rent and rates is reduced from 16 to 9 per cent. In contrast, the items entirely omitted by Bowley have a weight of as much as 30 per cent in the new index.

Table 6.4 Cost of living index 1900 = 100

Food 48.3

Rent and rates 8.7

Clothing 7.8

Fuel and light 4.6

Cleaning materials 0.9

104.1 103.6 118.5 131.0 112.8 106.2 110.4 102.0 92.3 88.1

145.5 142.1 147.2 148.9 145.5 143.8 149.3 135.9 135.9 130.5

Furniture and other goods 3.0

Travel 4.3

Other services 4.4

Total 100.0

97.3 97.6 97.8 97.8 97.9 97.9 97.9 97.8 98.1 98.3

92.0 100.1 109.3 113.5 107.4 104.7 102.3 103.1 99.1 96.1

126.2 126.7 127.2 130.7 130.0 127.5 123.1 122.1 119.9 116.8

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

113.1 116.3 121.2 122.1 116.6 114.8 115.1 115.0 111.5 106.5

Drink and tobacco 18.0

1870 1871 1872 1873 1874 1875 1876 1877 1878 1879

125.3 131.6 138.3 138.2 129.4 126.7 128.2 129.8 124.1 115.5

71.6 71.6 72.2 73.4 74.2 74.7 76.1 77.0 77.8 78.7

129.5 128.9 135.7 136.1 132.5 131.2 124.5 119.8 116.8 110.7

1880 1881 1882 1883 1884 1885 1886 1887 1888 1889

120.5 117.7 118.7 118.5 111.4 104.1 102.9 99.2 98.8 100.4

79.5 80.5 81.1 81.6 82.3 83.3 84.1 84.7 85.3 85.7

111.3 108.5 107.5 105.1 102.7 102.1 102.2 102.2 100.8 100.4

80.1 83.4 77.5 80.0 79.4 79.8 78.1 75.1 76.5 76.5

135.9 124.4 129.9 128.2 128.1 117.0 103.6 99.3 96.5 96.8

98.4 98.4 98.5 98.4 98.4 98.5 98.5 98.2 97.9 98.1

98.7 98.5 99.5 103.3 102.6 100.0 98.8 98.1 99.1 100.1

114.9 114.0 114.6 113.1 113.0 111.4 109.0 108.9 108.7 108.8

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

108.7 107.3 107.5 107.5 103.8 100.2 99.3 97.3 97.1 97.9

1890 1891 1892 1893 1894 1895 1896 1897 1898 1899

100.2 102.1 102.8 98.1 94.0 91.8 90.9 94.8 98.3 95.4

86.0 86.3 87.2 89.3 91.1 92.6 93.8 95.4 97.1 98.6

101.8 101.9 101.0 100.3 99.1 97.8 98.6 98.2 97.0 96.2

81.3 79.8 79.4 84.5 74.4 72.5 74.3 74.0 73.8 79.7

95.4 97.1 101.2 102.6 97.9 87.7 89.4 83.6 82.5 94.9

98.5 98.5 98.5 98.3 98.4 98.6 99.0 99.0 98.8 98.9

100.7 100.2 99.9 100.9 98.5 95.4 96.0 96.8 97.3 96.0

109.2 108.6 107.8 107.9 105.5 105.0 103.3 101.1 100.8 100.4

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

98.3 99.1 99.5 97.6 95.0 93.7 93.5 95.4 97.1 96.1

1900 1901 1902 1903 1904 1905 1906 1907 1908 1909

100.0 99.6 99.8 101.4 100.4 101.0 100.5 102.7 104.9 105.1

100.0 101.7 103.8 106.3 107.7 108.4 108.9 109.1 109.8 110.6

100.0 100.6 99.9 99.7 102.3 103.0 104.5 106.2 107.1 108.4

100.0 94.0 89.3 88.3 86.3 84.8 85.8 92.7 90.7 87.8

100.0 98.1 99.8 100.7 101.5 97.1 100.7 109.2 107.8 108.0

100.0 100.7 100.6 100.5 100.5 100.5 100.9 100.9 101.2 101.8

100.0 97.3 98.2 100.7 97.7 101.1 100.5 99.5 102.6 100.8

100.0 99.2 98.6 98.7 98.5 97.8 96.8 97.1 97.1 96.4

100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0 100.0

100.0 99.7 99.7 100.8 100.4 100.8 100.7 102.3 103.6 103.8

1910 1911 1912 1913 1914

107.2 107.0 111.9 112.9 114.8

111.9 112.6 113.5 114.8 115.0

110.7 112.4 115.5 115.9 117.4

84.8 85.2 88.3 91.9 89.4

112.0 111.7 110.0 111.4 117.2

107.3 107.6 107.7 107.6 117.5

102.4 104.8 106.1 105.9 107.0

96.7 97.1 100.0 100.2 100.7

100.0 100.0 100.0 100.0 100.0

106.0 106.3 109.3 110.0 112.8

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New perspectives on the late Victorian economy 135 -

- Bowley's index

1870

1880

1890

1900

1910

Figure 6.2 Comparison of new cost of living index with Bowley's index, 1900 = 100

The extent to which price trends for these four additional categories deviated from those for the other items is shown dramatically in figure 6.3. The solid line shows the present estimates of the movement in the prices of the categories previously included: food, rent, fuel, clothing and cleaning materials. The broken line shows the very different trend in the price of alcohol and tobacco, furniture, travel and other services. It is immediately evident that Bowley's implicit assumption that the two sets of prices behaved in similar fashion was substantially incorrect. Whatever uncertainty there may be about the precise movement in the prices of these additional items, there is no doubt that they did not experience the same steep downward trend as food, fuel and clothing, but were broadly stable until a sharp increase in duty raised the price of spirits in 1910.

A new look at the cost of living 1870-1914

173

135 Bowley's index

130

125

120

Same five components, new index

115

110

105

100

95 Additional components, 901— new index 85 1870

I

1880

I

I

1890

I

i

1900

i

1910

Figure 6.3 Comparison of separate components of new index with Bowley's index, 1900 = 100

Figure 6.3 also indicates the scale of the remaining source of disagreement between the old and new indices: revisions made to the price indicators for the five categories common to both. As the movement of the solid and dotted lines shows, the net effect is relatively small. A more detailed comparison can be made only for the years after 1880: from there to the mid 1890s the present index for food falls slightly less and the index for rent and rates rises slightly more. However, these discrepancies are marginal and it is clear that the main source of the difference between the two indices is the relatively large weight and the very different trend of the four additional categories included in the new index. The alternative series compiled by Wood (1909) is much closer to the present index than Bowley's. As previously noted little is known about its

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New perspectives on the late Victorian economy

components or the sources from which they were derived, but it seems that Wood's index is broadly reliable, and might thus be preferred for the period 1850-70 if it is desired to extend the present index to cover these years. Finally, we refer briefly to two modern indices. Williamson (1985, pp. 220-2) compiled a cost of living index for 1877-1914, but adopted exactly the same weights and the same five categories as Bowley. For food, and for clothing and fuel before 1900, his indicators were taken directly from Bowley. For 1900-14 the prices for the non-food items are from Prest (1954), and for 1880-99 the index for rent is taken from Weber (1960). The resulting index differs only marginally from Bowley's, and need not be considered separately. More recently, Gazeley (1984, 1989) has compiled an index with a different set of weights, based on the 1890-1 budget studies collected by the United States Commissioner of Labour, and with some revisions to Bowley's indicators. Unfortunately, the published version does not start until 1886 and so provides no indication of movements in the period of greatest change in prices. After 1886 it differs little from the present index. The main conclusion of this paper is that the index published by Bowley in 1937, and generally used since then as the preferred measure of changes in the cost of living, overstates both the fall in prices from the peak of 1873 to the mid 1890s and the subsequent rise to the eve of First World War. The present revision does, therefore, weaken the sharpness of the turnaround in the progress of real wages discussed at the outset of this paper.

Notes 1 The main research for this chapter was done in 1987 while I was a Visiting Scholar at Harvard University. I am indebted to Jeffery Williamson for making it possible for me to enjoy the superb facilities of the Harvard libraries; and to Anne Digby, James Foreman-Peck, Ian Gazeley and Avner Offer for helpful comments. 2 This is suggested by Gourvish (1979, p. 16) in a valuable discussion of the issues. 3 Bowley nowhere specified which goods were covered by his index for 'sundries', but the expenditure on which the weight allocated to this category was based related essentially to cleaning materials. 4 Many of these budgets were assembled and published by the Board of Trade (1903a, pp. 216-17,235-48). 5 Bowley (1937, p. 120) extrapolated these 1904 weights to 1900 by means of the

A new look at the cost of living 1870-1914

175

respective price indices. The 1900 weights actually used for the index were thus: food, 58.5; rent, 15.9; clothing, 11.0; fuel, 10.1; and sundries, 4.5. 6 For further information on the number of earners per family see note 16 below. 7 An extension of Wood's index to 1911 was 'roughly calculated' by Webb (1913, p. 220). 8 Bowley (1937, p. 123) suggested that it seemed to be based principally on food and commented: The data are fragmentary and most of them are not stated, so that it is impossible to criticise them in detail'. According to Frances Wood (1913-14, p. 2) the data on which George Wood's index was based 'were obtained, for the most part, from Board of Trade publications'. 9 In their first cost of living index the Board of Trade (1904, p. 32) adopted the following 'approximate proportions' for weighting the four items: Food, 7; Rent, 2; Clothing, 2; and Fuel and Light, 1. This was later amended to 7.5, 1.5, 2 and 1 (Board of Trade, Eighteenth Abstract of Labour Statistics 1926, p. 138). 10 P. Hill (1988, p. 144), based on an ILO survey of the methods currently used for consumer price indices in 149 countries. Even among OECD countries only four actually use a chain index, although this uniformity is probably based on pragmatic rather than theoretical considerations. However, in the present case it can be shown that a chain index would make no significant difference; see note 12. 11 See Feinstein 1972, pp. 3-4. For coal 1900 is clearly not the ideal choice for a base year because of the distorting effect of the war in South Africa, and prices of adjacent years were substituted for those of 1900. The internal weights for the important food component are based on the budget studies of 1903-4, but are unlikely to differ to any appreciable extent from those which would be derived from 1900 prices. 12 The Sumner Cost of Living Committee (1918) took essentially the same view, and reported that it was fairly certain that, apart from an increased purchase of margarine, 'no considerable changes took place in the mode or standard of living' between 1904 and 1914. To confirm that this would still hold for the pattern of expenditure on the wider range of items covered by the present index (and so take account of the fall in purchases of alcohol), I constructed an index with 1913 weights derived on exactly the same basis as the 1900 weights used for the final version of the present index (see p. 160). For the period 1900 to 1913 the movement of the two indices is almost identical. 13 For a more detailed account of these and other family budget studies available for this period, see Gazeley 1984, pp. 129-81. 14 The selected industries were cotton, woollen, glass, iron, steel and coal. Only 455 of the budgets were for normal families, defined as those which have no boarders or dependants, do not own their own dwelling, include both husband and wife and have not more than five children, the eldest of whom is under fourteen years of age. The main results for these families were conveniently summarised by the Board of Trade 1903a, p. 235.

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New perspectives on the late Victorian economy

15 This was based on Census of Population data for the number of tenements ('any house or part of a house separately occupied by the owner or by a tenant') in England and Wales, and for the number of families in Scotland and Ireland. 16 This calculation was first made for 1911. The total of upper- and middle-class income-earners was taken from the estimate in Bowley (1919, p. 11) and it was assumed that the number of occupied persons per household would be marginally lower for middle- and upper-class than for wage-earners' households. The ratio for all households works out at 2.09 (total occupied population in 1911 divided by total number of households). A ratio of 1.80 was adopted for upper- and middle-class households, thus giving 2.19 working-class earners per household. In making these estimates some limited guidance was obtained from corresponding ratios given in Booth (1902-4, Industry, 5, pp. 38-9), Bowley (1921, p. 103), and Prais and Houthakker (1955, p. 185). The total number of households in 1901 was then divided between working and middle class in the same proportions as for 1911. 17 From estimates of the composition of the wage-earning population in 1911 (Feinstein, 1987) it can be calculated that the 2.19 wage-earners in the average working-class household consisted of 1.26 adult males, 0.51 adult females, 0.29 boys, and 0.13 girls. The corresponding figures found (also for 1911) by Bowley (1921, p. 103) from an actual sample of households in twelve English towns or boroughs was: males, 1.07; females, 0.52; boys, 0.25; and girls, 0.06. 18 Reliable information on class differentials in expenditure did not become available until the end of the interwar period when two large surveys were conducted. These were later carefully analysed by Prais and Houthakker (1955). For the years before 1914 information is much more limited, but there are some clues in an exercise undertaken in 1882 by Leone Levi and others for the British Association (1883, pp. 297-306; the main results are reproduced in Levi 1885, p. 69), and in budget studies in Cornhill Magazine (1901, 'A Workman's Budget', p. 455, 4A Lower-middle-class Budget', p. 666, and an 'Eight hundred a year budget', p. 797), in Mackenzie (1921, pp. 223-9), and in Banks (1954, pp. 48-102). 19 45th Report of H. M. Commissioners of Inland Revenue 1902, pp. 150 and 158. 20 Feinstein 1972, pp. 12-18. 21 Prest 1954, p. 182. These grades indicate that it was thought that there was a 95 per cent chance that the margin of error for these components was more than 10 per cent. The categories are: fuel and light, other home expenses, clothing, amusements, other goods and other services. 22 Or for Inhabited House Duty. The distinction is immaterial since the assessments were identical, but the House Duty provides a more detailed classification by type of building. 23 See Feinstein 1988, p. 407 for an estimate indicating an improvement for all houses of only 8 per cent between 1873 and 1910. See also ibid., p. 382.

A new look at the cost of living 1870-1914

177

24 See Gazeley 1984, pp. 74-6 and Wood 1913-14, p. 21. 25 See Offer 1981, pp. 291-2 for the changing situation in London. 26 Rates in the £ were obtained from the Local Government Board's Annual Local Taxation Returns, and from the Fowler Report on Local Taxation 1893, appendix A, table IV. 27 Hawke (1970, p. 51) estimates that the average journey was about ten miles in 1870 and had declined to nine miles by 1890. An equally approximate and roundabout calculation based on Acworth (1923, p. 207) suggests an average length for 1912 of some eleven miles. Given the margins of error in these estimates the assumption of a constant journey length does not seem unreasonable. References Acworth, W. M. (1923), The Elements of Railway Economics, Oxford: Clarendon Press. Banks, J. A. (1954), Prosperity and Parenthood, London: Routledge. Beveridge, W. H. (1923), 'Population and unemployment', Economic Journal, 33. Board of Trade (annual), Statistical Abstract for the United Kingdom. Board of Trade (annual), General Report to the Board of Trade in regard to the Capital, Traffic, Expenditure and Net Profits of the Railway Companies of the United Kingdom. Board of Trade (1903a), British and Foreign Trade Industry, First Series of Memoranda, Statistical Tables and Charts, Cd. 1761. Board of Trade (1903b), Report on Wholesale and Retail Prices in the United Kingdom, B.C. 321. Board of Trade (1904), British and Foreign Trade and Industry, Second Series of Memoranda, Statistical Tables and Charts, Cd. 2337. Board of Trade (1912), Report of an Enquiry into Working-class Rents and Retail Prices in Industrial Towns of the United Kingdom in 1912, Cd. 6995. Board of Trade, (1915, 1926), Abstract of Labour Statistics of the United Kingdom; Seventeenth, 1915, Cd. 7733; Eighteenth, 1926, Cmd. 2740. Booth, C. (1902-04), Life and Labour of the People in London, Second Series: Industry, 1-5, London: Macmillan. Bowley, A. L. (1904), Tests of national progress', Economic Journal, 14. Bowley, A. L. (1905), 'Notes on economic and statistical works', Journal of the Royal Statistical Society, 68. Bowley, A. L. (1911), Daily News, 9 October. Bowley, A. L. (1919), The Division of the Product of Industry, Oxford: Clarendon Press. Bowley, A. L. (1920), 77?^ Change in the Distribution of the National Income, 1880-1913, Oxford: Clarendon Press. Bowley, A. L. (1921), 'Earners and dependants in English towns in 1911', Economic a, 2.

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New perspectives on the late Victorian economy

Bowley, A. L. (1926), 'Changes in nominal and real wages in the United Kingdom since 1850', Palgrave's Dictionary of Political Economy, 2nd edn. Bowley, A. L. (1937), Wages and Income in the United Kingdom since I860, Cambridge University Press. Cairncross, A. K. (1953), Home and Foreign Investment, 1870-1913, Cambridge University Press. Colwyn Committee (1927), Report of the Committee on National Debt and Taxation, Cmd. 2800. Cornhill Magazine (1901), 'Family budgets', 83, January-June, articles by A. Morrison (p. 446), G. S. Layard (p. 656) and G. Colmore (p. 790); and 84, July-December, articles by Mrs Earle (p. 48) and Lady Agnew (p. 184). Feinstein, C. H. (1972), National Income, Expenditure and Output of the United Kingdom, 1855-1965, Cambridge University Press. Feinstein, C. H. (1987), 'A new estimate of total wages in 1911', unpublished paper. Feinstein, C. H. (1988), 'National statistics, 1760-1920' in C. H. Feinstein and S. Pollard (eds.), Studies in Capital Formation in the United Kingdom, 17501920, Oxford: Clarendon Press. Feinstein, C. H. (1990a), 'What really happened to real wages? Trends in wages, prices and productivity in the United Kingdom, 1880-1913', Economic History Review, 43. Feinstein, C. H. (1990b), 'New estimates of average earnings in the United Kingdom, 1880-1913', Economic History Review, 43. Gazeley, I. (1984), The Standard of Living of the Working Classes, 1881-1912: The Cost of Living and the Analysis of Family Budgets, unpublished D.Phil. Thesis, University of Oxford. Gazeley, I. (1989), 'The cost of living for urban workers in late Victorian and Edwardian Britain', Economic History Review, 42. Gourvish, T. R. (1979), 'The standard of living, 1890-1914' in A. O'Day (ed.) The Edwardian Age: Conflict and Stability, London: Macmillan. Hawke, G. R. (1970), Railways and Economic Growth in England and Wales, 1840-1870, Oxford: Clarendon Press. Hill, P. (1988), 'Recent developments in index number theory and practice', OECD Economic Studies, 10. Inland Revenue (1902), 45th Annual Report of H. M. Commissioners of Inland Revenue, Cd. 1216. Levi, L. (1883), 'Report of the Committee . . . on the present appropriation of wages, and other sources of income', Report of the 52nd Meeting of the British Association for the Advancement of Science, Southport, 1882. Levi, L. (1885), Wages and Earnings of the Working Classes, London: John Murray. Lewis, J. Parry (1965), Building Cycles and Britain's Growth, London: Macmillan. Local Government Board (annual), Annual Local Taxation Returns (England and Wales).

A new look at the cost of living 1870-1914 Local Government Board (1893), Report of the R. Hon. H. H. Fowler ...on

179 Local

Taxation, H.C. 168, PP 1893^4 LXXVII. Mackenzie, W. A. (1921), 'Changes in the standard of living in the United Kingdom, 1860-1914', Economica, 3. Ministry of Labour (1920), 'Retail price statistics, scope and method of compilation', Ministry of Labour Gazette, 28. Offer, A. (1981), Property and Politics, 1870-1914, Cambridge University Press. Peterson, M. J. (1978), The Medical Profession in Mid-Victorian London, Berkeley: University of California Press. Prais, S. J. and Houthakker, H. S. (1955), The Analysis of Family Budgets, Cambridge University Press. Prest, A. R. assisted by A. Adams (1954), Consumers' Expenditure in the United Kingdom, 1900-1919, Cambridge University Press. Rowntree, J. and Sherwell, A. (1898), The Temperance Problem and Social Reform, London: Hodder and Stoughton. Samuel, H. (1919), T h e taxation of the various classes of the people', Journal of the Royal Statistical Society, 82. Sauerbeck, A. (1886), 'Prices of commodities and the precious metals', Journal of the Royal Statistical Society, 49, and annually thereafter. Singer, H. W. (1941), 'An index of urban land rents and house rents in England and Wales, 1845-1913', Econometrica, 9. Stamp, J. C. (1916), British Incomes and Property, London: P. S. King. Sumner Committee (1918), Report of the Committee . . . increase since June 1914 in the Cost of Living to the Working Class, Cd. 8980. United States Commissioner of Labour (1891), 6th Annual Report of the Commissioner of Labour, 51st Congress, 2nd Sess., 1890-91, Exec. Doc. No. 265, Washington: Govt. Printing Office. See also 7th Report. Webb, A. (1913), 'Consumption of alcoholic liquors in the United Kingdom', Journal of the Royal Statistical Society, 76. Weber, B. (1960), 'A new index of house rents for Great Britain, 1874-1913', Scottish Journal of Political Economy, 7. See also 8, 1961, p. 64. The index is reproduced in Lewis (1965), p. 370. Williamson, J. G. (1985), Did British Capitalism Breed Inequality! London: Allen and Unwin. Wood, F. (1913-14), 'The course of real wages in London, 1900-12', Journal of the Royal Statistical Society, 47. Wood, G. H. (1909), 'Real wages and the standard of comfort since 1850', Journal of the Royal Statistical Society, 72.

Chapter 7

Poor Law statistics and the geography of economic distress Humphrey Southall

7.1

Introduction

This chapter forms part of my continuing research on the antecedents of the 'North-South' divide in Britain, a division defined most commonly, in economic terms and for policy purposes, in terms of unemployment; it first became generally recognised in the form of the 'depressed areas' of the inter-war period. My earlier research has studied the regional distribution of unemployment between 1851 and 1914, using the records of trade union unemployment insurance schemes. These are arguably a very reliable source for trade union members, but clearly cover only a small fraction of the working population; existing analyses are further restricted to three principal trade unions: the Amalgamated Society of Engineers (ASE), the Amalgamated Society of Carpenters and Joiners (ASC&J), and the Friendly Society of Ironfounders (FSIF). The results of these studies point consistently to the concentration of high levels of unemployment in the north of England, contradicting various authors who have asserted that the First World War marked a turning point, and hence that the 'Depressed Areas' dated only from the inter-war period (Southall 1984, 1986, 1988). Given the significance of these findings for an understanding of the genesis of the British regional problem, there is a need for confirmatory analyses of economic distress concerned with a larger part of the population. The Poor Law, in contrast with the trade unions, notionally provided relief for the entire population, and therefore provides the obvious base for such a wider study. The Poor Law has generated a very substantial literature but this is concerned principally with the development of policy at a national level and its implementation by individual Boards of Guardians, or groups of Boards (for a guide to the literature, see Fraser 1976, pp. 195-204). The latter have drawn attention to the enormous variations in local interpretation of centrally issued directives (see, for example, Brundage 1978, chapter 5) but this institutional approach has led to a general neglect of the very substantial body of 180

Poor Law statistics and the geography of economic distress

181

statistics produced by the Poor Law Board and its successor, the Local Government Board; the principal exception to this is in an otherwise epistemological study by Williams, where a statistical appendix provides a thorough reworking of national-level statistics (1981, pp. 145-233). Somewhat surprisingly, this chapter is among the first systematic investigations of spatial variations in Poor Relief at a national scale. An early study by Dessauer (1940) presents county figures for adult male able-bodied paupers for 1848-59 and notes a concentration in areas where the Outdoor Relief Prohibitory Orders were not in effect, notably Lancashire, the West Riding and Middlesex. An interesting comparison is made with the trade union unemployment percentage nationally but discussion is brief, the period considered short and no adjustment is made even for variations in county population size. Blaug's studies of the old Poor Law (1963, 1964) concern a much earlier period but appear to be unique in that a map is included; these are further discussed below. More recently, Levitt's brief analysis of the Poor Law and Pauperism (1986) explains geographical patterns of pauperage entirely in administrative terms. In a recent Ph.D., Driver's central concern is with the workhouse, rather than with the system as a whole. His analysis of the Workhouse Expenditure Authorisation Registers shows firstly a great surge of construction in the late 1830s; then a slow trickle of building in the 1840s and 1850s by laggard unions, mainly in the northern industrial centres and in London; and finally a new wave of building, of children's and special wards, in the 1860s. The geographical pattern shows that many of the northern industrial unions which had been most reluctant to erect workhouses took the lead in providing for children and the sick. His analysis of the distribution of indoor pauperism, which includes use offiguresfor all unions for January 1872, emphasises the role the statistics played within the administrative system. The central authorities interpreted a low ratio of paupers on 'outdoor relief to those admitted to the workhouse as indicating efficient administration; Driver finds that unions where a high proportion of paupers were relieved outside the workhouse tended to have a high overall level of pauperism (1987, chapter 6, 1989). The closest parallel to the present study is research by MacKinnon (1986, 1987). This argues for the validity of Poor Law statistics as a guide to the real incomes and employment possibilities of the very poor, and attempts to show how levels of relief responded to economic changes. Given that it is possible to disaggregate the trade union unemployment percentages spatially, some of MacKinnon's claims for Poor Law statis-

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New perspectives on the late Victorian economy

tics are unnecessary. Further, any attempt to estimate 'policy-constant' rates of pauperism must be highly problematic in a system so pervaded by questions of policy. However, in examining the impact of various economic factors, and in particular through relating levels of pauperism to trade union unemployment, MacKinnon's work and the present study usefully complement one another: MacKinnon's central study relates time series of the level of pauperism in each region to, first, policy measures and demographic statistics for the region and, secondly, economic indicators which generally refer to the country as a whole; this study presents estimates of cross-sectional relationships and focuses on a shorter period. These differences inevitably affect the variables employed and the results, but the conclusions are broadly compatible. This chapter has limited objectives, and in particular it must be stressed that the central aim is to compare Poor Law statistics with trade union figures. The chapter begins by presenting national time series, whose behaviour is then investigated using spectral techniques, and so compared with trade union indices; the use of long monthly series permits identification of seasonal and cyclical effects. A cyclical component of surprising strength is shown to behave similarly to other cyclical indicators. The sheer volume of data, together with the bi-annual reporting intervals, makes direct replication of this analysis at union level impractical, but an analogous decomposition is used to isolate a comparable cyclical component in series for all union counties, in section 7.3, and for all individual unions on a transect from Suffolk to Lancashire, in section 7.4. The spatial analysis is largely restricted to the 1860s, partly because of the subsequent impact of policy changes, partly because of the sheer bulk of the data.

7.2 The dynamics of pauperism at the national level Given a central concern with levels of unemployment, Poor Law statistics inevitably provide only an indirect measure: although, in principle, the Poor Law offered support in hardship to the entire population, that support was offered on such penal and stigmatic terms that most workers, particularly 'respectable' artisans, would make use of it only in the most desperate of circumstances (Crossick 1978, pp. 110-13, 136). The statistics of the system therefore record very few of the unemployed but in other ways its scope was too broad for our purposes; it provided schooling for pauper children, hospitals for the ill and accommodation for the old. During the latter half of the nineteenth century, increasing

Poor Law statistics and the geography of economic distress

183

efforts were made to exclude the 'able-bodied' from relief but, simultaneously, facilities for the orphaned, sick, and old expanded and made an important contribution to the later development of the Welfare State, particularly the Health Service (Fraser 1976, esp. chapters 2 and 3, Crowther 1978, Fraser 1981). These points can be illustrated from the centrally compiled report for England and Wales covering July 1868, a month central to the depression of the late 1860s; the following figures are taken from the 21st Annual Report of the Poor Law Board for 1868-9 (pp. 260-3). A total of 971,387 were in receipt of relief on 1 July, or 4.88 per cent of an estimated population of 19,886,104. However, 766,472 of these (78.8 per cent) were women or children under 16. Of the adult males, 79.5 per cent were either 'lunatics' or 'not able-bodied', the latter category consisting overwhelmingly of the elderly or the permanently disabled (Digby 1976, pp. 157-8, MacKinnon 1988, pp. 6-11). This left at most 45,653 men who might have been available for employment, representing 4.7 per cent of all on relief or an estimated 0.65 per cent of all employed males.1 It should also be noted that 85 per cent of all paupers, and the same proportion of able-bodied males, were on outdoor relief; the spectre of the workhouse has tended to distort popular understanding of the Poor Law system. Finally, if relief of the unemployed was a minor function of the system in 1868, by the early twentieth century it had become insignificant. On 1 January, 1909, a month of deep depression, c. 20,600 ablebodied men were relieved who were in 'want of work' and 'in health' (Williams 1981, p. 183); simultaneously, five major trade unions were paying unemployment benefit to 26,438 men, the ASE alone accounting for 13,114.2 As these bodies contained only 14 per cent of the total membership of benefit-paying trade unions in December 1908 (see Southall 1984, table 2.6), it is quite clear that, despite their 'narrow' coverage, the trade unions as a whole were a more important source of relief. It can be suggested that Poor Law outdoor relief, both historically and functionally, is best seen as a precursor of the modern Supplementary Benefit system, catering to a relatively narrow client group whose problems were only partly economic in derivation. Hence, although variations in their numbers are of interest, the relationship with unemployment was indirect. As Hubert Llewellyn Smith,firstCommissioner for Labour, put it: It does not always follow that you can estimate the distress from the unemployed or [vice-versa], because distress is the result of complex causes to which scarcity of work and other causes contribute. For example, it is largely influenced by the prevalence of sickness, quite also (sic.) by the severity of the weather, quite apart from an increase in the

184

New perspectives on the late Victorian economy England & Wales 1857-1899: percentage of total population in receipt of poor relief (a) Original monthly series

,i 1857 1860

1880

1870

1890

1900

Year

1.5 1—

(b) Detrended and smoothed Centred 12 month moving average

0.5 -

0—

0.5 1

1857 1860

1870

' ' I ' 1880 Year

1890

Source: 29th Report of the Local Government Board 1899-1900 Figure 7.1 England and Wales 1857-1899: percentage of total population in receipt of poor relief (a) original monthly series (b) detrended and smoothed

1900

Poor Law statistics and the geography of economic distress

185

number of the unemployed. Another point that is sometimes not sufficiently borne in mind is that distress, which may be said to be due to a given amount of scarcity of work, will be more acute towards the end of a cycle of depressed trade ... owing to the gradual exhaustion ... of savings and resources. (S. C. on Distress from Want of Employment, Third Report, PP 1895 IX 1-, p. 61,Q.4677) Figure 7. l(a) plots the monthly number on Poor Relief, as a percentage of total population, over much of our period.3 The most obvious features are a general slow decline and a sharp drop in the 1870s. Both were essentially administrative in origin, the latter following from the establishment of the Local Government Board in 1871, which sought to restrict numbers on outdoor relief (Fraser 1976, p. 17, MacKinnon 1987). However, a more recognisable pattern is found when we remove these effects: figure 7.1(b) presents the residuals from a model fitted to the original series which contained both a long-run time trend and a dummy variable for a 'Local Government Board effect'. The Board's impact following its establishment in January 1871 was gradual, hence the dummy increases linearly from 0 in December, 1870, to 1 in December, 1876 and continues as 1 thereafter; the end date was chosen by experimentation. The model gave an R-square value of 0.934. The dominant element visually is seasonal, and this is confirmed by the spectrum in figure 7.2, but the cyclic component is equally strong and is brought out by the moving average, used here for purely descriptive purposes. The depression of 1863 is particularly marked, reflecting special relief measures introduced for the Lancashire Cotton Famine (Rose 1977), but those of 1868, 1879, 1886 and 1894 are also apparent. For comparison, figure 7.2 shows monthly unemployment time series for three principal trade unions, again including a centred twelve month moving average (for sources and calculation, see Southall 1984, chapter 4). Figures 7.3 and 7.4 show the power spectra for all four series. In simple terms, these permit us to examine the contribution which oscillations over different periods of time make to the total amount of variation in the series (see Chatfield 1975, chapter 5).4 The intention here is purely descriptive, to clarify the relationship in each series between cyclical and seasonal components, the latter being difficult to distinguish in conventional plots because of their length.5 These series are among the longest monthly economic time series in existence; the frequency of observation permits identification of the seasonal effect while the length is necessary to capture the cyclical effect (Chatfield 1975, p. 164). This gives the results presented here wider interest.

186

New perspectives on the late Victorian economy Engineers unemployment 1851-1914

1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 Year

Source: A.S.E. monthly returns

Carpenters and joiners unemployment 1863-1914 15

- Centred 12 month moving average

10-

5-

1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 Year

Source: A.S.C. & J. monthly returns

Ironfounders unemployment 1854-1914 Centred 12 month moving average

1855 1860 1865 1870 1875 1880 1885 1890 1895 1900 1905 1910 1914 Year

Source: F.S.I.F. monthly returns

Figure 7.2 Unemployment in three trade unions

Poor Law statistics and the geography of economic distress Engineers unemployment 1853-1914: power spectrum Source: A.S.E. monthly returns (m = 7) 25-

20-

15-

1 year

6 months

4 months

Carpenters and joiners unemployment 1873-1914: Source: A.S.C. & J. monthly returns (m = 7)

3025 20-' 15 :

5:

10 5 years

1 year

6 months

Figure 7.3 Power spectra: engineers and carpenters

4 months

187

188

New perspectives on the late Victorian economy ,

Ironfounders unemployment 1854-1914: power spectrum (w = 5) Source: F.S.I.F. monthly returns

6 months

4 months

Poor relief 1857-1899: Power spectrum of detrended series (w = 5) Source: 29th Report of the Local Government Board (1899-1900)

0.125

0.1

0.075

0.05-

0.025-

105 years

1 year

6 months

Figure 7.4 Power spectra: ironfounders and Poor Law

4 months

Poor Law statistics and the geography of economic distress

189

With the partial exception of the ASC&J, variation in all series considered here is highly concentrated into two bands, the 'cyclic' lying between six and twelve years and the seasonal, highly concentrated around twelve months. Outside these, the response is almost flat; the apparent subsidiary peaks are harmonics of the two main effects (Chatfield 1975, p. 164). In the case of the ASE and the FSIF, the dominance of cyclical unemployment is very obvious. The pattern for the ASC&J is more complex; the concentration of power at the lowest frequencies suggests the effects of the long-run trend in the data but this was not apparent from inspection, while analysis of the residuals from a linear time trend yielded an almost identical spectrum. One explanation would be a longer periodicity, such as the Kuznets cycle. In addition, the seasonal effect is much greater than for the other trade unions. However, despite the appearance of the original series which is dominated by the isolated high values for January, seasonality remains subsidiary; even in an industry particularly dependent on the weather, the trade cycle was the dominant determinant of distress. This analysis of the national series suggests that essentially the same components were present in the experience of industrial workers and paupers, but their relative importance differed. All series are remarkably regular, being dominated by cyclical and annual variation. It is clear that the metal trades, as contrasted to building workers or paupers, were little affected by seasonality; conversely, the Poor Law statistics on first examination appear dominated by a seasonal effect. However, the value of the more complex analysis of the Poor Law time series is to bring out the considerable cyclical component; it is this which the remainder of this paper will seek to locate geographically.

7.3 Inter-county variation in pauperage 1831-1909 In discussing the available material for a spatially disaggregated study, it should first be noted that quite different legal frameworks and supervisory bodies existed in Scotland and Ireland, hence all that follows is limited to England and Wales (Paterson 1976). Further, although the most detailed records are those of individual unions, any attempt to discuss national patterns must be restricted to material gathered centrally at the time, and therefore, in effect, to the compilations of the Poor Law Board from 1848 to 1870, and the Local Government Board from 1871 onwards. Even so, the volume of data available is very substantial, if not entirely suited to our task. The most detailed tabulations, by union, were

190

New perspectives on the late Victorian economy

given in the Board's returns to Parliament, discussed in the next section. A separate 'Monthly Statement' by the* Board gave the numbers of paupers relieved on the last Saturday of the relevant month for the five districts of London and the eleven Census Divisions of England and Wales.6 The monthly tabulations are too crude for present purposes while analysis of the figures for individual unions is a substantial exercise in data processing, hence for full national coverage information in the Board's Annual Reports must suffice. This includes tables of expenditure, by county and, up to the Eighth Report of the Local Government Board, for 1878-9, also by union. These tables cover the half-years to Michaelmas and Lady Day. Most categories of expenditure given were administrative and only spending on 'In-Maintenance' and 'Out-Relief are of much value. Given the variation in local practices and costs of provisions, figures for the actual number of paupers relieved are of greater interest. These are listed by county only and appear regularly from the First Annual Report, for 1848, onwards. Up to 1903-4, the total relieved was finely categorised: indoor and outdoor; able-bodied, not able-bodied, lunatics and vagrants; men, women and children under sixteen, and relates to the first days of January and July. From 1904-5, only the number of indoor, outdoor and lunatic paupers in each county were listed. The units used are 'Union Counties', broadly similar to the Registration Counties employed by the Census. Given the fine classification of types of pauper, a wide range of indices can be calculated. Two measures are used in the following analyses: first, the total number of paupers relieved as a percentage of the total population of a county; secondly, the number of able-bodied adult male (ABM) paupers, whether indoor or outdoor, expressed as a percentage of employed males in a county.7 The latter figure is an attempt to approximate as closely as possible to a conventional measure of unemployment; the 'able-bodied' include the 'temporarily disabled' but it has been suggested that many rural unions provided outdoor relief to the unemployed, despite the various prohibitory orders issued by the Board, by listing them as sick (Digby 1976, pp. 157-8). Further, the term 'able-bodied' was never properly defined, in respect of either age or health (Rose 1966). Figure 7.5 maps these two indices for England and Wales for January 1868, part of a depression which union statistics show to have been almost as concentrated into the North West as the earlier Cotton Famine.8 These figures obviously contain a large seasonal element but this has relatively little effect on the overall pattern; the rank correlations between the

% of total population on poor relief January 1868

Source: Poor Law Board Annual Report

Able-bodied men as % of all employed male January 1868

Source: Poor Law Board Annual Report

Figure 7.5 County pauperage patterns (Total and ABM), January 1868

192

New perspectives on the late Victorian economy

January and Julyfiguresfor 1868 are 0.981 and 0.940 for total and ABM pauperage respectively. It is immediately.apparent that high levels of 'distress', however defined, were concentrated in very different areas from engineering unemployment. In particular, Lancashire, with 11 per cent ASE unemployment at the end of March, had the fourth lowest percentage of the total population on relief in January, while in general the industrial north had low levels. The pattern of ABM pauperage was somewhat different, the rank correlation between the two measures being 0.697. High rates of ABM pauperage were very concentrated into a belt across southern England, notably including London, while certain industrial counties ranked somewhat more highly. The pattern of overall male pauperage, including the 'not able-bodied', was also examined and found to be very similar to that for total pauperage. The patterns of total pauperage for the troughs of the two adjacent depressions are similar. That for 1863 does correspond to other evidence in that Lancashire, severely affected by the Cotton Famine, had the highest level; a remarkable 10.3 per cent of the population were receiving relief. However, the next highest level was in Wiltshire, with 7.9 per cent, and the remainder of the top quintile were entirely agricultural areas; the West Riding and Derbyshire appear in the lowest category. A similar pattern was found for ABM pauperage: Lancashire ranked first, with 4.75 per cent, followed by Cambridgeshire; significantly, Cheshire was third but then came Essex, Suffolk and Buckinghamshire. For 1863, the differences between winter and summer were striking; in most counties the decline was small but in both Cheshire and Lancashire the level of ABM pauperage in July was half that in January. The year 1879 is of interest because other evidence points unambiguously to a concentration of the depression in the north. However, a very similar pattern for total pauperage emerges here as for the earlier depressions: the lowest quintile includes Lancashire, Cheshire, the West Riding and also London. The distribution of ABM paupers was somewhat different, the top quintile including Staffordshire, Lancashire and Westmorland, together with a cluster of southern counties similar to that found for 1868. The actual percentages relieved were by then very low, reflecting the campaign by the Local Government Board to curb outdoor relief. The highest percentage of ABM paupers in January, 1879 was 0.79, in Staffordshire. The percentages of the total population relieved were of course higher, reaching 5 per cent in Dorset, but this was mainly composed of groups outside the labour market. Taken as a whole, these patterns of 'distress' for the major mid-

Poor Law statistics and the geography of economic distress

193

Victorian depressions show a remarkable consistency between different dates but very little relation to trade union unemployment; this latter point is further developed below. The industrial areas tend to rank slightly more highly if relief to able-bodied males alone is considered but the highest levels according to this measure were still more highly concentrated in a band of rural counties stretching across southern England from Dorset to Norfolk. The great exception to these conclusions was the Cotton Famine, when Lancashire's problems overwhelmed the rural southern bias of the Poor Law; what seemed one of a sequence of not too dissimilar depressions in the trade union evidence appears here as much more of a unique event. Figure 7.6 shows the extent of the stability of the geography of pauperism and points to an explanation. The first map shows the equivalent percentage of paupers for thefinalpre-war depression year of 1909,9 while the second shows, principally, expenditure on Poor Relief per capita for 1831, under the old Poor Law (Blaug 1963, pp. 178-9). A broad similarity to each other and to the mid-Victorian patterns will be apparent; the rank correlation between the two is 0.513, significant at the 99.9 per cent level.10 The Poor Law Report of 1834, which led to the new Poor Law, blamed the high cost of the system, as well as the demoralization of the poor, on the so-called Speenhamland system of granting allowances-inaid-of-wages. Superimposed on the map of relief expenditure in 1831 are Blaug's conclusions concerning the geographical extent of this system, based on an earlier survey of 1824; there was a clear correspondence between the Allowance system and high levels of relief, although a later study by Blaug suggests that, at least by 1832, the principal expense was not direct payments to labourers but aid to their families (Blaug 1964, pp. 238-9). He concluded that 'the Old Poor Law ... was, in essence, a device for dealing with the problem of surplus labour in the lagging rural sector of a rapidly expanding but still underdeveloped economy' (Blaug 1963, pp. 176-7). In particular, it provided support for casual agricultural labour in the wheat growing areas, only fully employed at harvest. This system was supposedly swept away by the reforms following 1834 but in practice relief in aid of small and irregular earnings survived long after, through the ineffectiveness of the prohibitions on outdoor relief for the able-bodied. As Digby puts it, in a study of the eastern Counties (see also Rose 1966, Digby 1976, p. 158): The persistence of rural under-employment after 1834 meant that the relief provisions of the New Poor Law altered only the format by which the objectives of continuing social policy were realized. (Digby 1975, p. 83)

% of total population on poor relief January 1909

Poor relief per head 1831 Expenditure (s.d) 20.0 16.0 12.0 8.0 4.0 __. Payment of |s\^-. ] wage supplements " particularly prevalent Speenhamland counties

Source: Local Government Board Annual Report Figure 7,6 Total pauperage, January 1909; poor reliefper head, 1831

(Source: Blaug, 1963)

Poor Law statistics and the geography of economic distress

195

Thus far, attention has focused on patterns of pauperage in depression years. However, the above argument explains the basic geography of the system in terms of rural underemployment, particularly in the low-wage wheat growing areas of southern England, a problem endemic to these areas and largely unrelated to the economic cycle. An analysis of the two main indices for 1866, a year of relative prosperity between the troughs of 1863 and 1868, shows an extremely similar pattern according to both measures, although absolute levels in 1866 were slightly lower. It should be clear from this that the maps presented so far show not the spatial impact of cyclical depressions but rather the outcome of more persistent socio-economic forces. Used crudely, levels of pauperage are of little value as a spatial economic indicator. However, the analysis of the national series presented above showed that a cyclical component could be distinguished once seasonal factors and an administratively determined downwards trend were removed. A full equivalent of this treatment for the county data would require the construction of similar long time series so as to identify the trend component, there being no reason for assuming identical timing or rates of decline in all areas. Fortunately, this downward trend was only clearly established after 1870 and a simpler procedure can be used to isolate a cyclical component in the Poor Law data for the depressions of the 1860s. Figure 7.7 was obtained by first averaging the January and July figures, so as to smooth out seasonal variation, and then calculating the percentage change from 1866 to 1868. The resultant spatial distributions are very different from those in figure 7.5. Many of the counties with the highest levels in 1868 had had very similar levels in 1866, while most of the largest increases were concentrated in the industrial areas; the percentage of ABM pauperage, which scarcely altered in Wiltshire (2.5 per cent decline) and Norfolk (2.8 per cent increase), rose by 48 per cent in the West Riding, 49 per cent in Lancashire and, most strikingly, 106 per cent in London. This tends to confirm suggestions made elsewhere of a peculiar crisis in east London pauperism in the late 1860s (Stedman Jones 1976, pp. 242, 246, Rose 1981, pp. 54^5). These maps of cyclical change are obviously rather closer to the patterns found in the trade union figures and this similarity was explored more formally. Table 7.1 presents rank correlation coefficients calculated between various county indices. The principal problem is the small number of counties containing sufficient ASE members for calculation of meaningful unemployment rates at these early dates; in April 1868, 71.7 per cent of the total 'eligible' membership of the ASE in England and

Percentage increase in annual averages 1866-68 % of total population on poor relief % of employed males on able-bodied relief Quintiles 105.7 35.3 17.5 7.5 8S 0.2 -12.319

Source: Poor Law Board Annual Report(s)

&*^

Source: Poor Law Board Annual Report(s)

Figure 7.7 Percentage increase in annual averages on relief by county (Total and ABM),

1866-1868

Poor Law statistics and the geography of economic distress Table 7.1. Rank correlations between ASE unemployment and pauperage by union counties Index of distress % of total population on poor relief

Able-bodied male paupers as % of employed males

January/July 1879 average of crude rates with ASE unemployment for April 1879

- 0.48

-0.21

January/July 1868 average of crude rates with ASE unemployment for April 1868

- 0.20

-0.07

1868 average of crude rate with % change in average rate 1866-8

-0.16

-0.05

0.20

0.27

Correlation

% change in average rate 1866-8 with ASE unemployment for April 1868 Sources'. See text.

Wales were in Cheshire, Lancashire, the West Riding and London. Consequently, even by merging certain counties and accepting units with as few as 100 members, only twenty-five observations were available for 1868. Many of the unemployment rates must be somewhat dubious, while many of the rural counties with the highest levels of pauperage had to be excluded from the analysis. For 1879, with a larger and somewhat more dispersed trade union membership, there is a significant negative correlation between the trade union figures and total pauperage, confirming earlier comments. The correlation with the ABM percentage is weaker but still negative. For 1868, the same negative pattern is observed but neither result is significant. The third pair of correlations tend to confirm the reversal in the pauperage patterns produced by calculating cyclical changes while the final pair show a positive relationship between the unemploymentfiguresfor 1868 and cyclical change in pauperage. The lack of statistical significance of these results and their corresponding sensitivity to which particular counties are included must limit their value but the broad pattern would tend to confirm the interpretation developed here.

197

198

New perspectives on the late Victorian economy

1A Pauperage at the union level, 1860-71 The county-level analysis in the previous section has two obvious weaknesses: the union rather than the county was the administrative unit, and this is of particular importance if administrative factors were a significant and possibly autonomous source of variation in levels of relief; and the county level is too coarse a scale if we wish to explain variations in relief in terms of the fortunes of particular industrial sectors. Even in the extreme case of Lancashire, a high level of pauperage might reflect the experience of rural unions such as Fylde or Garstang, while Liverpool proves to have behaved very differently from the cotton districts. This section therefore presents a limited analysis of the Board's returns to Parliament, which provide data at union level in essentially the same format as the county-level reports in the Annual Reports, listing, for 1 January and 1 July in each year, the number of paupers relieved in each of over 600 unions.11 The total relieved wasfinelycategorised as before, and for some dates further information was given as to cause, such as a classification of the able-bodied into 'in health' and 'temporarily disabled'. Given that twenty-four distinct counts are listed for each union, some selectivity of coverage is unavoidable, and a transect stretching from Suffolk to Lancashire was selected for analysis; this includes perhaps the two most studied areas of the system for the mid-Victorian period, East Anglia and the cotton districts, as well as providing a cross-section through the axis of high relief running from Dorset to Norfolk noted in the previous section. The most obvious criticism is the exclusion of London, but the metropolitan Poor Law can be seen as a special case, albeit a very large one. A somewhat different statistical treatment was adopted here. Data for registration districts were taken from the published census reports for 1861 and 1871, giving the population by sex in five year age bands. Numbers of adult (sixteen to sixty-four) and old (sixty-five up) men and women, plus children (males and females under sixteen) were calculated for each registration district for each census date, and then the number at the time of each Poor Law return estimated using a weighted geometric mean.12 These population estimates were used as divisors in the subsequent analyses, which involved linking statistics from up to four returns and two censuses. Where this linkage could not be made, an area was excluded, and this was a significant problem in much of the West Riding, where the union system was not yet clearly established.

Poor Law statistics and the geography of economic distress Table 7.2

199

Variables used in stepwise regression

Poor Law indices %T Percentage of the total population on all forms of Poor Relief %M All male paupers aged 16 or over (including all vagrants) as a percentage of male population aged 16 or over %ABM Able-bodied male paupers as a percentage of male population aged 16 to 64, inclusive %C Child paupers (both sexes, aged 0 to 15), as a percentage of the population aged 0 to 15 %O Paupers on out-relief as a percentage of all paupers Explanatory factors POP-GROW % Change in total population 1861 to 1871 ELDERLY % of 1861 population aged 65 or over WA-MALES Males age 16 to 64 as % of 1861 population (DOMESTIC) % of 1861 adult population in 'domestic' occupations COMMERCE % of 1861 adult population in 'commercial' occupations AGRIC % of 1861 adult population in 'agricultural' occupations INDUST % of 1861 adult population in 'industrial' occupations AG-LAB Male agricultural labourers as % of males aged 16 to 64 COTTON Males employed in cotton manufacture as % of males aged 16 to 64 ENGINR Males employed in engineering and machinebuilding as % of males aged 16 to 64 (EASTING) National Grid-based coordinates of principal town, measured (NORTHING) in kilometres, and using an arbitrary origin south-west of Ireland TREND EASTING - NORTHING (i.e. Lancashire low, East Anglia high) Bracketed variables were excluded from the final stepwise regression analyses. As with the county statistics, the available data permit the calculation of an enormous range of indices; five were selected for investigation, and these are listed in table 7.2; only two are discussed here in detail, the overall level of pauperage (%T) and the rate for able-bodied males (%ABM). The rates for all males (%M) and children (%C) persistently closely followed %T, while the behaviour of the fraction on outdoor relief (%O), while distinct and of obvious interest, yielded unclear and inconclusive results. While MacKinnon concentrates almost entirely on indoor paupers, it was felt that this emphasis was inappropriate for a study of the 1860s. Also as before, both crude percentages and the rate of change between annual means was calculated. By moving to the consideration of the actual decision-making unit, the individual union, it becomes possible to investigate the factors determining the level of relief. Studies of the variation in levels of unemployment

200

New perspectives on the late Victorian economy

within a single county, or over short periods of time, can take the administrative framework as given: it provides an operational definition of the object of study, but is not in itself a source of variation, hence we assume that variations in the numbers in receipt of relief are a direct response to differences in the state of the labour market. Such an assumption cannot be made for the Poor Law, where the number on relief in a given union at a particular date reflect not only the numbers of economically distressed individuals but also their degree of desperation and the policy of the guardians. The last was in turn affected by an enormous range of factors: the often limited financial resources of the union, the private interests of the guardians, the directives received from the Poor Law Board, which varied between unions, and wider political factors, such as the degree to which claimants could be blamed for their condition, or the risk of riot if relief were denied. These filtering factors had complex effects: they prevented many experiencing economic distress from applying for relief, or from receiving it, and so meant that paupers were a small fraction of the distressed; but they also created time lags in responses to economic fluctuations, as individuals exhausted their savings and sources of credit before having final recourse to the guardians; and they caused discontinuities, as with the cotton famine where extreme depression and the risk of severe disorder led to the temporary adoption of quite different temporary relief measures, far more acceptable to potential claimants. Detailed microeconomic modelling of the 'production of paupers', in which an initial input of the economically dependent fraction of the population, determined by demographic processes and the state of the labour market, is filtered through a model union whose behaviour is controlled by economic and political factors may well be impossible; it is certainly beyond the scope of this chapter. However, a consideration of the factors involved suggests the possible relevance of a wide range of explanatory variables to an understanding of systematic spatial variations in levels of relief. Note, however, that we may well be left with a large residual which can only be explained in terms of'local political factors'. The use of Poor Law unions as census enumeration districts obviously provides us with a range of demographic and, via the census occupational tables, economic indices. Very full demographic data for the transect unions were used to provide divisors in the calculation of pauperage rates; full analysis of the occupational statistics is not justified in this essentially exploratory analysis, but convenient summaries are included in the 'Returns to Parliament', giving percentages in 'domestic', 'commercial',

Poor Law statistics and the geography of economic distress

201

'agricultural' and 'industrial' occupations; three specific groups of male workers, agricultural labourers, cotton manufacturers and engineers, were included from the full census statistics. The demographic and economic indices used in the analysis are listed in table 7.2. Note that while demographic factors proved of little relevance in MacKinnon's analysis of divisional time series, these variables were little more than time trends and can play a significant role only in cross-sectional analyses; this is even more true of measures of occupational structure (MacKinnon 1986, p. 321). Conversely, many of the explanatory variables used by MacKinnon are either intrinsically national or not available at the union level. In addition, there is such an obvious spatial trend to variation in relief within the transect that the geographical location of each union was included in the analysis. A simple first-order trend surface model was fitted to the various Poor Law indices which gave, unsurprisingly, high R2 statistics. Looking at the overall totals (%T) for July 1866, a non-depression date, R2 was 0.629 and the fitted relationship was: %T = 0.674 + 0.01004 (EASTING) - 0.0095 (NORTHING) Other results gave somewhat greater weight to NORTHINGs, but it seemed reasonable to simplify the two coordinates to a simple NW — SE trend, hence: TREND = EASTING - NORTHING While the behaviour of a given Board of Guardians may well have been affected by that of adjacent Guardians, there was no obvious process within the Poor Law system which would have given rise to a consistent trend over a considerable distance, interpretable as a spatially autoregressive effect. The spatial trend must therefore be seen as a proxy for unknown explanatory factors. Note that some of the more obvious explanatory factors are included explicitly in the analysis, such as population growth (rp with TREND = - 0.463), an ageing population (rp = 0.676), and percentage employed in agriculture (rp = 0.431). Note also that the inclusion of a trend variable somewhat reduces the effects of spatial autocorrelation, with which these data are obviously rife. Given the range of factors which might affect the behaviour of the Guardians, and the exploratory nature of this paper, a formal modelling strategy is inappropriate. However, collinearity among the explanatory factors necessitates some selectivity, and the principal results presented here derive from stepwise regressions, using a simple stepwise search strategy, default criteria for inclusion and exclusion, and a simple linear

Figure 7.8 Percentage of total population on poor relief, Transect Unions, July 1866

Poor Law statistics and the geography of economic distress

203

specification. Given that the precise search algorithm used in stepwise regression can significantly affect the results, a program which calculated R2 for all possible models containing a given number of independent variables was also run, and if this discovered a 'better' model this was used as the starting point for a new stepwise search. The number of observations is generally large, meaning that even trivial effects appear as statistically significant, while parameter values are of limited interest, other than direction. The following presentation therefore concentrates on correlation and partial correlation values, together with whether associations are positive or negative. July 1866 is presumed to have been unaffected by cyclical distress. Figure 7.8 shows the percentage of the total population on relief (%T), and the trend across the transect is obvious.14 The best model to explain this pattern found by the stepwise search gave R2 of 0.7490 (N= 143), and the variables included were: Variable: TREND AG-LAB COTTON POP-GROW AGRIC ENGINR

Sign + + -

Partial R2 0.6288 0.0616 0.0156 0.0252 0.0102 0.0075

The directions of the relationships, with the exception of AGRIC, are as expected but the dominance of the purely geographical trend over the economic and demographic factors is interesting. Looking at %ABM, TREND is the only variable included in the model; the next most strongly correlated variable is ELDERLY but this is strongly correlated with TREND. Figure 7.9 shows %T for January 1863, at the peak of the Cotton Famine; the high levels in East Anglia are again present, but the highest levels are now in Lancashire and Cheshire. Table 7.3 gives results from the regression analysis; COTTON, unsurprisingly, makes the largest contribution while the positive association with TREND and the negative association with POP-GROW help explain the high East Anglian levels. Figure 7.10 examines the rate of change in numbers on relief (A%T), high levels being entirely concentrated in the North West. Among the highest increases were in Hayfield (959 per cent) and Saddleworth (555 per cent), in Derbyshire and the West Riding respectively, but both close to Ashtonunder-Lyne (1,370 per cent), well known as the union most severely

Figure 7.9 Percentage of total population on poor relief Transect Unions, January 1863

Table 7.3 Stepwise regression results, Suffolk-Lancashire transect for 1863

All paupers R2 N

% 1/1863

A%T 1 8 6 ^ 3

0.6143 138

0.6285 135

Partial Sign

r2

!

0.4316 0.1502 0.0207

+

r2

0.5808

1 1

COTTON TREND POP-GROW ELDERLY COMMERCE ENGINR

Sign

0.0146 0.0208

+

Variable:

Partial

0.0123

0.0118

Able-bodied males R2 N

0.3101 132

0.6403 135

Partial

Partial Variable: COTTON TREND ELDERLY POP -GROW WA-MALES

Sign

r2 0.5738 0.0294 0.0137 0.0142 0.0092

Sign

r2 0.3101

affected (Rose 1977). The use of quintiles, while necessary for comparisons, obscures the very large variation within the highest quintile, between Ashton-under-Lyne and Fylde (57 per cent). The regression analysis yielded a higher R2 than did the simple cross section, and the bulk of the explanation comes from COTTON. In 1860-3, the increases in %ABM were, of course, quite extraordinary, the extreme example being Hayfield in Derbyshire with 27,049 per cent. The mapped pattern closely resembles that in figure 7.10 and is not presented here. The regression results, given in table 7.3, are also similar, although the R2 value for A%ABM is notably lower. The results for 1866 to 1869 are more critical to the argument of this paper, and the pattern shown is harder to summarise. The simple cross-

Change in January/July average percentage on relief for total population, 1860 to 1863

56.18 -

1374.22

13.88 -<

56.18

3.79 -<

13.88

- 0 . 5 9 -<

3.79

Source: Poor Law Board, Returns to Parliament Figure 7 JO Rate of change in percentage of total population on poor relief Transect Unions, 1860- J863

Poor Law statistics and the geography of economic distress Table 7.4

Stepwise regression results, Suffolk-Lancashire transect for 1869

All paupers R2 N

%Ti/i8 6 9

A%T1866 _69

0.7546 143

0.1503 139

Partial

Variable: TREND AG-LAB COMMERCE POP-GROW COTTON AGRIC ELDERLY ENGINR

Sign + + + — — — +

Able-bodied males R2 N

r2 0.6357 0.0538 0.0257 0.0124 0.0148 0.0072 0.0050

Partial

+

r2 0.0355

+

0.0346

+

0.0133 0.0669

Sign

0.5076 143

0.1033 139

Partial

Variable: TREND COTTON ENGINR

207

Sign +

r2 0.5076

Partial Sign

r2

+ +

0.0853 0.0181

sectional pattern for January 1869 closely resembles that for July 1866, as do the regression results, presented in table 7.4; TREND dominates. Figure 7.11 presents changes in total pauperage and a systematic pattern is hard to discern, although the highest increases were in the industrial north; the top five were Birkenhead (28 per cent), Manchester (33 per cent), Stockport (39 per cent), Preston (47 per cent) and Leeds (47 per cent). This represents a very large shift from the simple rankings for January 1869, where Liverpool is the only union in the top quintile not from East Anglia, and no other north-western union appears in the top two quintiles. However, many north-western unions had amongst the lowest increases, including some textile centres which the trade union evidence suggests were very severely affected by the slump, such as Blackburn, and the regression results for A%T point to no clear pattern.

11.54 -

49.68

4 . 6 3 -< 11.54 0 . 8 3 -<

4.63

- 5 . 9 6 -<

0.83

- 4 3 . 3 5 -< - 5 . 9 6 Figure 7.11 Rate of change in percentage of total population on poor relief Transect Unions, 1866-1869

Poor Law statistics and the geography of economic distress

209

One possible explanation is that the pauperage statistics, which seem generally to have rather lagged unemployment, were still affected by the famine in 1866; the time series discussed below provide some support for this. The statistics for able-bodied males, presented in figure 7.12, show rather greater rates of increase, Preston experiencing a 213 per cent increase as compared with 47 per cent in total pauperage, and there is a slightly greater emphasis on the north west. The regression results are simple: % ABM is best explained in terms of TREND, while A% ABM is significantly, albeit weakly, associated with COTTON and ENGINR. The simple correlation coefficients (rp) are of interest, the following variables being significantly associated with A%ABM: COTTON (0.2920), AGRIC ( - 0.2382), TREND (-0.2116), INDUSTRY (0.2100), ELDERLY (-0.2062), AG-LAB (-0.2000), and ENGINR (0.1812). Although weak, the direction of the relationship is in all cases as we would expect if the depression was concentrated in the north-western industrial districts. The strength of the 'trend' variable in many of the regression results is somewhat puzzling and disturbing. The most obvious interpretation is that it is serving as a proxy for some underlying economic or demographic factor, but many of these have been included; the analysis is rejecting such factors as a predominantly agricultural workforce or a stagnating population, features found in parts of the north of England as well as in the south. This perhaps suggests that broader cultural factors were perhaps at work, although it would be desirable if data on particular types of agriculture, such as grain farming versus pastoral, could have been included. Lastly, complete bi-annual time series were constructed for Lancashire unions between January 1860 and July 1872, and four examples are shown in figure 7.13; in each case, the upper line is %T and the lower %ABM. Ashton-under-Lyne was the epicentre of the Famine, and this is clearly reflected in the series, a small increase in the late 1860s being barely distinguishable. In the case of Preston, the later depression is much more obvious, although not comparable with the Famine. Liverpool has a very different pattern, the Famine having no apparent impact while there was a marked increase in %ABM in 1867-8; %T had a sustained level far higher than for other northern towns. Lastly, rural Ormskirk appears to have been unaffected by events in the urban economy, although the absolute level of relief is far below similar areas in south-eastern England.

48.35 - 220.20 25.67 -<

48.35

9.81 -<

25.67

-8.07 -<

9.81

-66.16 -<

-8.07

Figure 7.12 Rate of change in percentage of able-bodied males on poor relief, Transect Unions, 1866-1869,

Poor Law statistics and the geography of economic distress Levels of pauperage in four Lancashire Unions, 1860-71

Ashton-under Lyne Union

1870 Liverpool Union All on relief as % of total population

5-

1865

1870 Ormskirk Union

1860

1865

Able-bodied males on relief as % of male population of working age

1870

Date Source: Poor Law Board, Returns to Parliament Figure 7.13 Bi-annual time series for four Lancashire unions, 1860-1872 (Ashton-under-Lyne, Preston, Liverpool, Ormskirk)

211

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New perspectives on the late Victorian economy

7.5 Conclusion The limited and exploratory nature of this paper limits any broad conclusions concerning the geography of pauperism. It is clear that, by comparison with the trade union returns, the Poor Law statistics do not provide us with direct evidence of the spatial impact of cyclical depressions. Manipulation of these data would seem to point to similar conclusions as did the trade union data: a concentration of cyclical distress in the industrial areas. However, these findings derive from study of only two depressions while the method used must be open to question; note that coverage of the later depressions of the nineteenth century would be much more difficult given the steady downward trend in numbers on relief, while by the Edwardian period numbers of able-bodied male paupers, in particular, are so small as to lack economic significance. Further, bold claims at this point are unnecessary, as I am about to start a much larger study of economic distress in late Victorian and Edwardian England which will, in particular, explore the relationship of both trade union unemployment and Poor Law statistics to population and employment statistics at Registration District level in much greater detail than could be attempted here.15 Nevertheless, it is tentatively suggested that the general neglect of the spatially disaggregated national statistics in existing studies of the Poor Law is not altogether justified. First, they help emphasise the extreme conservatism of the system. Secondly, existing local studies stress the variation of the actual practices of individual Boards of Guardians from those laid down by the central authorities, but fail to observe the very clear spatial trends in that variability. Finally, this analysis suggests that, at least for the 1860s and 1870s, the system played a major economic and social role principally in the rural counties of the south and east, but that the cyclical peaks in relief were due to events elsewhere. Rose (1966) catalogues a whole series of disputes in the industrial areas, noting that' ... Boards of Guardians, objected to having their cherished powers of discretion bridled ... ' (p. 611) and that 'It was in the north of England, that the central authority had least success in checking allowances to able-bodied men' (p. 614). The above argument would explain the clear disparity between this emphasis on the north and the actual spatial pattern of relief to able-bodied men. These conclusions are broadly compatible with those of MacKinnon: Explainable variation in male able-bodied pauperism in northern divisions is largely due to trade cycle effects. For males in the south, and

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able-bodied females throughout the country, the trade cycle had some impact, for not-able-bodied women very little indeed. Although trade union unemployment affects pauperism in the south, it does so to a considerably smaller extent than in the north. (1987, pp. 316-20) Further, if we accept MacKinnon's estimates of policy-constant pauperism, these support the broad findings from the analyses of the trade union percentages: that the north of England was already experiencing severe economic difficulties before 1914 (1987, pp. 332-4). Recent studies of urban unions in the north of England similarly note the impact of cyclical depression (e.g. Gregson 1985). In conclusion, Poor Law statistics represent a tantalising challenge to the quantitative historian; although they rarely tell us quite what we want to know, and both the sheer bulk of the data and the influence of administrative factors weigh down on us, they remain perhaps the only source concerning the economic condition of a significant part of the population and we have little choice but to peer darkly. Even so, this study perhaps tells us more about the nature of the Poor Law system than about the mid-Victorian economy: that manipulating the rules to aid underemployed farm labourers was in some sense legitimate while similar measures to help unemployed urban workers were not. It was therefore only rarely that the geography of crisis in the modern sector of the economy interrupted what remained essentially a system of support to the underpaid in the traditional sector. If we wish to understand that evolving industrial economy and its crises, we must ultimately look elsewhere for data, despite the apparently narrow coverage of the alternatives such as the trade union percentages of unemployment. The principal conclusion of this paper is that the evidence of the Poor Law as to the geography of economic distress, correctly interpreted, can be reconciled with that of these more directly relevant sources. Notes 1 This total includes all vagrants (7,946), for whom age and sex were not given. Afigureof 6,976,468 employed males is obtained by linear interpolation from figures given in Lee 1979. 2 Taken from the reports for January 1909, of the ASE, ASC&J, FSIF, Associated Iron Moulders of Scotland, and the Steam Engine Makers' Society; these all refer to the end of December. Thisfigureincludes men outside England and Wales; in April 1909, 75.6 per cent of the ASE's unemployed were within that area. The memberships of the five unions are given in the same reports as 203,549.

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3 Most series in the Board Annual Reports are bi-annual, the only extended monthly tabulation being given in the 29th Annual Report of the Local Government Board for 1899-1900 (pp. 372-7). The figures refer to the last day of the last week contained within each month and give only the indoor, outdoor and overall totals; lunatics and vagrants are excluded. The estimated population given in the report is used here but was reestimated for individual months by interpolation and a new set of percentages calculated. 4 The SEM was excluded here because of its similarity to the ASE. Owing to breaks in the available series, the following periods (all inclusive) were used: ASE January 1853-December 1914. ASC&J January 1873-December 1914 (the isolated missing value for December 1893 wasfilledby interpolation using adjacent months). FSIF January 1855-December 1914 (N.B. no attempt was made to correct for the strike-induced peak in 1897-8). 5 It should be noted that, because the seasonal component operates entirely on a wavelength of twelve months while the cyclic effect is spread over a broader band, the somewhat subjective choice of spectral window has a marked effect on the shape of the final spectra. These were calculated by smoothing the periodograms, the program used permitting direct specification of both the width and shape of the window. Rectangular windows with a relatively narrow width of approximately a hundredth of the total length of the series were used in all cases (i.e. m = 5 or m = 7 according to case). For a discussion of how to choose m, see Chatfield 1975, pp. 153-5. A further problem is that the cyclical and seasonal components may combine multiplicatively rather than additively, i.e. seasonal unemployment may be more marked in a slump. 6 Here and below 'the Board' refers to both the Poor Law Board and the Local Government Board; the change of title, although significant for policy, did not affect the information given in reports. 7 The Board's Reports list only the county populations at the previous census. All population and employment figures used here were taken from Lee 1979, and were estimated for the relevant dates by linear interpolation between adjacent censuses. The Board and Lee used different combinations of counties for Wales and therefore equivalentfigureshad to be calculated for the Board's three units from the original Census Reports for 1851, 1861, 1871 and 1881. In estimating total employment, the various categories defined by Lee as 'not employed' were summed and, where the resultant total for Wales as a whole differed from his, any difference was distributed proportionately between areas. N.B. the second, 'able-bodied' measure involves dividing male paupers over sixteen by all employed males; figures for adult employed males could only have been calculated with great difficulty, if at all, but employed males under sixteen were a relatively small and declining group and, proportionately, should not have varied greatly in number between counties. 8 The following sequence of maps displays quintiles rather than absolute per-

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centages so as to permit comparisons in the presence of a long-term decline in levels of pauperage. 9 As noted above, much simpler county tabulations were given in the Board Annual Reports after 1904, hence an analysis equivalent to those for 1863, 1868 and 1879 was not possible. The populations used here as divisors were those listed for mid 1909 in the Report itself. 10 Excluding London and treating Wales as a single unit. 11 The returns to Parliament appear to be little known or used, perhaps because of their bulk and their lack of a clear, constant title. Reports for the study period appear in the following volumes of Parliamentary Papers: 1859-60 1860-1 1861-2 1862-3 1863—4 1864-5 1865-6

1859 XXIV 1 - . 1860 LVIII 1 - . 1861 LIII 1 - . 1862XLVIII 1 - . 1863 LI 1 - . 1864 LI 4 8 3 - . 1865 XLVIII 3 1 9 - .

1866-7 1867-8 1868-9 1869-70 1870-1 1871-2

1866 LXII 1 4 5 - . 1867 LX 3 7 5 - . 1867-8 LX 5 7 7 - . 1868-9 LIII 3 8 9 - . 1870 LVIII 3 1 1 - . 1871 L I X 5 3 - .

12 MacKinnon also uses 65 as the age dividing the able-bodied from the not able-bodied; see 1986, p. 33In. 13 This and subsequent maps at the union level are themselves the result of a substantial piece of research. The original base map is for the equivalent Registration District system and was very generously supplied by Richard Lawton. It was digitised using the ARC/INFO system at the Department of Geography, Birkbeck College, converted into a GIMMS polygon file, and transferred across the JANET network to the Micro VAX in my own department; I am grateful to Vincent Andrews and Nick Green at Birkbeck for their assistance. At QMC, the SAS system used for the rest of the analysis generated GIMMS command files containing the percentage values to be mapped, which were then run to call the GIMMS mapping package and so use the polygon files. The version of GIMMS used was developed by David Mitchell and myself at Queen Mary College in collaboration with GIMMS Ltd. and generates output as programs in the PostScript page description language; this permits, in particular, true half-toning rather than the pen-drawn crosshatching usual in automated cartography. In the course of the research, the PostScript programs were executed on our own Apple LaserWriter to create draft maps, but the maps presented here were produced by transferring PostScript files across JANET to the University of London Computer Centre and generating output on their higher resolution Linotronic typesetter. While this system is proving of wider utility, my own original interest in computer mapping came from the practical problems of interpreting lengthy statistical tables for Poor Law unions whose names meant little.

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14 The Leverhulme Trust are funding a two-year project on The Origins of the Depressed Areas: Growth and Fluctuations in British Regional Economies, 1860-1914'; a major element in this project is the construction of a databank of regional and subregional economic indicators, including Poor Law data, which it is hoped to make available to other researchers on-line. References Blaug, M. (1963), The myth of the old Poor Law and the making of the new', Journal of Economic History, 23: 151-84. (1964), The Poor Law Report reexamined', Journal of Economic History, 24: 229^5. Brundage, A. (1978), The Making of the New Poor Law 1832-39, London. Chatfield, C. (1975), The Analysis of Time Series: Theory and Practice, London, chapter 7. Crossick, G. (1978), An Artisan Elite in Victorian Society, London. Crowther, M. A. (1978), The later years of the workhouse 1890-1929', in P. Thane (ed.), The Origins of British Social Policy, London, pp. 36-55. Dessauer, M. (1940), 'Unemployment records, 1848-59', Economic History Review, 10: 38-43. Digby, A. (1975), The labour market and the continuity of social policy after 1834: the case of the eastern counties', Economic History Review, II, 28:69-83. (1976), The rural Poor Law', in D. Fraser (ed.), The New Poor Law in the Nineteenth Century, London. Driver, F. (1987), The English Bastille: dimensions of the workhouse system, 1834-1884', unpub. Ph.D. dissertation, University of Cambridge. (1989), The historical geography of the workhouse system in England and Wales 1834-1883', Journal of Historical Geography, 15: 269-86. Fraser, D. (ed.) (1976), The New Poor Law in the Nineteenth Century, London. Fraser, D. (1981), The English Poor Law and the origins of the British welfare state', in W. J. Mommsen (ed.), The Emergence of the Welfare State in Britain and Germany, London, pp. 9-31. Gregson, K. (1985), 'Poor law and organised charity: the relief of exceptional distress in north-east England, 1870-1910', in M. Rose (ed.), The Poor and the City: the English poor law in its urban context, 1834-1914, Leicester,

pp. 93-131. Lee, C. H. (1979), British Regional Employment Statistics 1841-1971, Cambridge University Press. Levitt, I. (1986), Toor law and pauperism', in J. Langton and R. J. Morris (eds.), Atlas of Industrializing Britain, London, pp. 160-3. MacKinnon, M. (1986), Toor Law policy, unemployment, and pauperism', Explorations in Economic History, 23: 299-336. (1987), 'English Poor Law policy and the crusade against outrelief, Journal of Economic History, 47: 603-25.

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(1988), Poor Law statistics and how to use them\ Historical Methods, 21:5-19. Paterson, A. (1976), The Poor Law in nineteenth century Scotland', in D. Fraser (ed.), The New Poor Law in the Nineteenth Century, London, chapter 8. Rose, M. E. (1966), The allowance system under the new Poor Law\ Economic History Review, II, 19: 607-20. (1977), "Rochdale man and the Stalybridge Riot: the relief and control of the unemployed during the Lancashire cotton famine', in A. P. Donajgrodzki (ed.), Social Control in Nineteenth Century Britain, London, chapter 7. (1981), The crisis of Poor Relief in England, 1860-1890', in W. J. Mommsen (ed.), The Emergence of the Welfare State in Britain & Germany, London, pp. 50-70. Southall, H. R. (1984), 'Regional unemployment patterns in Britain 1851 to 1914', unpubl. Ph.D. dissertation, University of Cambridge. (1986), 'Regional unemployment patterns among skilled engineers in Britain', Journal of Historical Geography, 12: 268-86. (1988), The origins of the depressed areas: unemployment, growth, and regional economic structure in Britain before 1914', Economic History Review, 11,41:236-58. Stedman Jones, G. (1976), Outcast London, Harmondsworth, Middlesex. Williams, K. (1981), From Pauperism to Poverty, London.

Chapter 8

Perfect equilibrium down the pit John G. Treble

Towards the end of the nineteenth century, British trade unions reached a condition in which they could write a contract concerning wages and conditions of employment and also have equal recourse with employers to the law in enforcing such a contract. The route to this state of affairs had been long and tortuous. The acts of 1799 and 1800 made combination illegal and made provision for legally binding arbitration. They were intended to operate in the spirit of laissez faire, by ensuring the enforceability of a contract between an individual employee and his employer, and by providing a quick and cheap method of resolving disputes between these parties as to the interpretation of their contract. The experience of the operation of this system of law indicated that it imparted an advantage to the employers, who could combine with impunity to enforce low wage rates, and a disadvantage to the employees, who were apparently forbidden even to claim protection under the law by means of a large number of individually brought suits. Such actions were regarded as evidence in themselves of combination or conspiracy and were therefore deemed illegitimate. In 1824 the system underwent a complete reform, the Combination Acts were repealed, the Arbitration Acts were repealed. Simultaneously, new arbitration machinery was set up using the existing system of justices of the peace. There ensued a surge in the level of strike activity which resulted in a reimposition of anti-combination legislation in the following year. The new circumstances are not easy to assess. In some respects the trade unions' position was improved. In particular (and most importantly) combinations concerned with wages and hours of labour were not outlawed by the 1825 Act. Thus the Webbs were able to claim that 'the right of collective bargaining, involving the power to withhold labour from the market by concerted action, was for the first time expressly established'. On the other hand, all other trade combinations were once again rendered unlawful, and the list of offences punishable under the Act was expanded from three items ('threats, intimidation and violence') tofiveby the addition of'molestation and obstruction'. Thus trade union 218

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members could be successfully prosecuted if their actions could in any way be interpreted as not being relevant to a dispute over wages or hours, or if they engaged in any of the five listed offences (all of which proved to be open to very broad interpretation). While combination and arbitration acts sought to regulate the behaviour of parties in negotiating and writing contracts, another body of law sought to regulate the performance of contracts. These were the Master and Servant Acts, which bore unequally on the two parties to a labour contract. 'Masters' were liable to be sued for damages, whereas 'servants' could be prosecuted under the criminal law. 'Masters' could give evidence on their own behalf, 'servants' could not. In 1875 the whole apparatus of combination laws and Master and Servant Acts was repealed and replaced. The result of this reform is described by the Webbs as follows: Henceforth master and servant became, as employer and employee, two equal parties to a civil contract. Imprisonment for breach of engagement was abolished. The legislation of Trade Unions was completed by the legal recognition of their methods. Peaceful picketing was expressly permitted. The old words 'coerce' and 'molest', which had, in the hands of prejudiced magistrates, proved such instruments of oppression, were omitted from the new law, and violence and intimidation were dealt with as part of the general criminal code. No act committed by a group of workmen was henceforth to be punishable when the same act by an individual was itself a criminal offence. Collective bargaining, in short, with all its necessary accompaniments was, after fifty years of legislative struggle, finally recognised by the law of the land. (1920, p. 291.) In the meantime developments had also taken place in the use and nature of arbitration in labour disputes. In 1856 a House of Commons Committee concluded that the 1824 Act was a failure, for the following three reasons. Firstly, the use of magistrates lent an air of criminality to proceedings under the Act. Secondly, the arbitrators were appointed only after a dispute was referred to arbitration. Therefore, the identity of the arbitrators was unknown to the parties at the time that they were making their decisions. Thirdly, magistrates in manufacturing districts were unlikely to be unconnected with manufacturers, which carried a strong implication of bias. The establishment of the legality of collective bargaining in 1825 and the unsatisfactory nature of the official arbitration procedures led, in some industries (despite the continuing disabilities under which trade unions operated), to the construction of joint contracts and to the establishment of committees of workmen and employers to agree such con-

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tracts and to oversee their operation. Exactly what functions boards had, exactly how their constitutions were worded, and what procedures were followed in the event of disagreement is not known. Evidence to the Select Committee on Handloom Weavers (1834) 'referred to the successful operation of boards in the textile trade in Glasgow and Paisley, which had been elected, consisting of employers and workpeople in equal numbers. These boards at the beginning of each year mutually revised or readjusted prices for the ensuing year.'1 Whatever the constitutions may have been like, they do not seem to have been sufficiently robust to survive for long.2 Some seem to have had arbitral proceedings available to them, but whether their proceedings were used as part of the process leading to the formulation of a contract or whether they were restricted to the interpretation of an existing contract is not clear, and probably varied from industry to industry and from town to town. Nonetheless, it is clear that the experience of these years did not go unheeded. The principle of voluntarism in the setting up of arbitration machinery rather than an appeal to legal machinery became established, and eventually in the 1860s workable constitutions that enabled bargaining machinery to function in a fairly satisfactory manner were developed, and legislation giving voluntary organisations certain legal abilities was introduced. From this time until the First World War, legislative interference in arbitral bodies can largely be disregarded, although there were several Acts devoted to the subject. In 1867, after many attempts dating back to 1858, the Councils of Conciliation Act was passed. This enabled the Home Secretary to license boards of conciliation or arbitration if employers and employees agreed to the formation of such a board. Lord Amulree remarks that 'not only is there no record of anything being done under (the Act), but also it appears that no one took the faintest interest in it'. The main reason for the lack of interest in legislative enactments was that boards of the type envisaged by the Act were already in existence and were operating successfully in several industries without the benefit of a licence from the Home Secretary. Subsequent legislation was of a similar type enabling boards to be formed and various government departments to assist in various ways. The first arbitral body to be adjudged successful was Mundella's Board for the Nottingham hosiery trade,3 the structure of which was incorporated into the provisions of the 1867 Act. This board maintained peace in its trade for at least six years4 and finally broke down about twenty years after its inception.5 The success of Mundella's Board was followed by the creation of further boards both in Nottingham6 and elsewhere. In Wol-

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verhampton in 1864, Sir Rupert Kettle was invited to preside over a 'board of arbitrators' formed with a view to settling an impending strike of carpenters. Kettle rejected any recourse to the existing law and instead assisted the parties in formulating a written constitution for a permanent Board of arbitration.7 The construction of written and agreed rules was an important innovation that was to a large extent responsible for the spread of collective bargaining institutions of the type being discussed here into other industries, and for their adoption as means of regulating wages and hours of large numbers of men. The spread of institutions of this type is chronicled elsewhere.8 We have established two important facts about the state of industrial relations in the middle of the 1870s. Firstly, the ability of trade unions to negotiate collectively and to use the familiar weapons of industrial conflict to back up their negotiations were as well established as the ability of employers and employees' associations to do these things. Secondly, the idea of conciliation and arbitration, and models of successful institutions were well known and available for the use of negotiators if they found such institutions helpful. This chapter discusses labour contracts that were negotiated in the British coal industry between 1870 and 1914. These contracts are of interest for several reasons: first, a great deal of information is available about their terms, contemporary opinion concerning them and the way in which they operated; secondly, the coal industry was not an insignificant employer of labour during this period. Thirdly, the organisation of wage negotiations into several areas (corresponding to different coalfields) provides an opportunity for comparison; fourthly, some of the arbitral techniques used are currently being revived and a study of this period and the coal industry's experience with a variety of arbitral procedures is likely to yield information relevant to modern policy problems. This chapter is intended to make two main points. The first is argued in section 8.1. It is that the conciliation boards can be viewed as optimally designed institutions, whose constitutional rules provide a rational solution to a bargaining problem induced by a particular industrial environment. The reasons for the creation, success and demise of such institutions must be sought within the environment to which they are a response. The second point is that, if the conciliation boards are viewed in this light, then there are consequences for the analysis of the record of their operations. This record should provide us with the means of testing the rationality of the institutions. This is argued in section 8.3 following some preliminaries in section 8.2.

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The argument relies both on observed features of the conciliation boards and their operation, and also on certain propositions derived from the recently developed theory of optimal labour contracts. In this theory, bargainers are assumed to reach agreements in a context of asymmetric information. This means that only one party has access to certain relevant facts about the environment, so that these facts cannot be verified independently by the other party. If this is the case, the only source of information available about these facts is the other party, who may have an interest in misinterpreting them during the bargaining. In addition, the uninformed party knows that he is uninformed in this way, thus any contract that they can feasibly arrive at has to be drawn up in such a way as to satisfy the uninformed party that the informed party has no incentive to lie. Why should one suppose that conciliation boards were mechanisms of this sort? Firstly, they were, by any standards, extremely successful. They lasted as long as the First World War and its labour market consequences permitted, and during the twenty or so years of their life, they were remarkably uncontroversial. No strikes were experienced as a consequence of these institutions or their decisions. Secondly, there existed in the coal industry important informational asymmetries. This point was made forcibly by a Northumberland miners' negotiator in 1907: Do the owners mean to say they cannot afford to pay 10% . . . the owners are a dark side . . . We have an idea that they have 63.78% '(increase in profits over what they were in the base year)'... we think 35% '(increase in wage rates over the base year)' is little enough while the owners are getting 64%. (Northumberland Record Office document NCB/C2/5 6th April 1907)

Thirdly, we can write down a simple model in which contracts are state dependent as were the conciliation board contracts, and in which arbitration emerges as a way of inducing truth-telling at low cost. Thus an optimal contracting model is able to mimic two important features of the conciliation boards. Suppose that we accept that conciliation boards are optimal mechanisms. How does this help us to understand them? The argument made in section 8.3 of this chapter is that the mechanism design problem can be viewed as the first stage of the solution to a cooperative game. If this view is taken the rules of the conciliation boards, as laid down in their constitutions and implied by their practice, were designed to make the quarter-by-quarter negotiations over the wage rate as close to a noncooperative game with full information as possible. The negotiations themselves thus should be analysed by exploiting well-established

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principles of game theory. The 'rules of the game' are the constitutions of the board. Using these rules, we should be able to deduce what the optimal behaviour of the parties should have been, and check this predicted behaviour against the observed behaviour. A small step along this road is taken in section 8.4.

8.1 The Conciliation Boards as Mechanisms As mentioned above formal collective bargaining institutions are usually dated from 1860, at the Nottingham hosiery factory of A. J. Mundella. The scheme that Mundella set up was a conciliation board, in which equal numbers of representatives of employers and employees met under the chairmanship of Mundella himself. Decisions were taken by a show of hands, with the chairman having a casting vote in the event of a tie.9 The fact that this scheme survived successfully for about ten years probably says more for the benignity of Mundella than for the robustness of the scheme's constitution, but, nonetheless, the success of the arrangement inspired industrialists and unionists in other industries and towns to set up similar schemes. By the early 1890s there had been wide experience in British industry of negotiation and interest arbitration using institutions with a similar structure to Mundella's original. Two major improvements became common. The first was the use of a formal procedural agreement or constitution, which was pioneered by Sir Rupert Kettle in the Wolverhampton building trade. The second was the use of an independent chairman, umpire or arbitrator, in place of a chairman with a clear interest in the outcome of the negotiations. Several options regarding the chairmanship were tried in different industries: some had a team of arbitrators in place of a single one; some had an arbitrator who was present throughout the negotiations, others had to call a special meeting; some had an arbitrator permanently appointed, others called in the arbitrator ad hoc when they could agree to do so; some retained the casting vote as a restriction on thefieldof action of the arbitrator, others permitted him to make a compromise between the negotiators' final positions. By the 1890s, then, there had been extensive experimentation with different forms of these institutions, and it might be supposed that whatever the merits and demerits of particular institutional details might have been they had been fully considered and discussed by union functionaries and employers' negotiating teams. By the 1890s, too, A. J. Mundella had become Secretary to the Board of Trade, and was therefore

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in a position to know and to inform others of what was viable, feasible and desirable in an institutional structure.10 Meanwhile, in the coal industry trouble was brewing. Since the 1870s most coalminers in Britain had had their wages regulated by a sliding scale, which specified a predetermined relationship between the price of coal and the wage rate. The sliding scale system involved two levels of negotiation: a local level, at which relative wage rates were set, and a district level, at which absolute wage rates were set. Local agreements took the form of price lists specifying a rate of wages for each job that might be undertaken in the mine. These price lists were expressed in monetary units that determined only the relativities between the rates and not their absolute values, and were referred to as 'basis wage rates' or simply 4the basis'. The basis can be thought of as the starting point of an index of wage rates. Absolute wage rates were set by choosing a percentage mark-up on this base index number. The percentages were determined at coalfield level by sliding scales that were negotiated every three years or so and which specified a schedule of percentage wage rate mark-ups related to the average price of coal. A sliding scale, once agreed, therefore worked automatically. An average coal price was calculated by accountants (subject to checking by accountants acting for the union), and reported to the sliding scale committee who read off the appropriate percentage mark-up from the predetermined schedule. In order to make the system work, two parameters had to be set. The first of these, /?, was an equivalent price to the basis wage rate, which specified the average price of coal that would cause wage rates to be at their basis level. The second, r, was a ratio specifying the increment in the wage rate that would be payable for an increment of a given size in the average price of coal. These parameters were the subject of negotiations at intervals of around three years, but were often left unchanged for longer periods. The sliding scale negotiations were not conducted under an arbitral regime, but ad hoc arbitral procedures were quite often invoked in the event of a failure to agree. This system broke down seriously in 1892, when the employers in the Midland coalfields tried to reduce wages in accordance with a defunct sliding scale. The result was one of the most acrimonious and lengthy strikes in British history, which brought about bloodshed in Featherstone, a break in the long-established record of non-interference in industrial relations by government and what can perhaps best be described as a hollow victory for the Miners' Federation of Great Britain.11 The settlement, which was arrived at in the full glare of press publicity,

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was finally reached in a meeting at the Foreign Office chaired by Lord Rosebery, but apparently masterminded by Mundella.12 It involved the setting up of a conciliation board with a similar structure to the Nottingham Lace Industry board of 1860, but with an 'independent' chairman,13 and written constitution. This board would regulate the rate of wages for the Midland coalfield. The other major coalfields (with the exception of South Wales) soon followed suit, but all these efforts to establish conciliation boards in the coal industry failed quite quickly. Successful boards were finally established in 1900. These had almost identical constitutions to the 1893 boards, and continued to operate with these same constitutions up to 1914. The South Wales coalfield established its board in 1903 and it, too, operated continuously up to the start of the First World War. The conciliation board system emulated the sliding scale system in that it involved two stages of negotiation. In the first-stage negotiations the boards' constitutions were at stake, although they were rarely changed in anything other than minor detail. The only important issue in these negotiations was the setting of limits above and below which wage rates would not move during the currency of the board. I have argued elsewhere that these limits were, in fact, the most important innovation of the conciliation boards, from the point of view of the pattern of bargaining outcomes. From an industrial relations point of view, however, the installation of a second stage of bargaining was also important. There were no longer overt sliding scales under the conciliation board regime.14 Instead the quarterly report of the average price of coal was used as the basis of a negotiation over what the wage rate was to be, conducted under an arbitral regime. The arbitrators were appointed on an annual retainer and were usually law lords, or retired politicians who undertook the task out of a sense of public duty rather than as a way of making an income. The annual appointment was by mutual consent of the parties and was by no means a rubber-stamping exercise. If an arbitrator was not seen to be just, fair and unbiased he would be dropped with little ceremony. We have presented a sketch of the machinery that characterised collective bargaining in the British coal industry between 1893 and 1914. At this stage, I want to make a claim. It is that the stability of this form of bargaining machinery is the hallmark of its success. The conciliation boards were remarkably durable, they continued without interruption for almost two decades, and would maybe have continued for longer had it not been for the upheaval caused by the First World War and the introduction of close government supervision of labour relations in the

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coal industry. Furthermore, during their currency, the conciliation boards were never the focus of strike activity.15 I interpret the longevity of the conciliation boards and the industrial peace that characterised their activities as signs that the arrangements were broadly satisfactory to both sides of the collective bargaining relationship. This does not mean that there was no conflict, or that both sides were always content with the outcomes generated by the conciliation board system. What is meant is that the conciliation boards, viewed as a mechanism for resolving industrial disputes, attracted considerable support from employers and unions alike. They were regarded as a good way of handling the fundamental conflicts generated by a necessarily difficult industrial relations environment. The question asked in the remainder of this chapter is: 'Why?' A fundamental problem in economic theory is the problem of incentive compatibility.16 Put simply, an allocation mechanism is incentive compatible if its rules are such that the agents involved in the mechanisms have no incentive to violate them. The importance of the concept can be illustrated by the fact that the Fundamental Theorems of Welfare Economics are no longer always true if agents do not take prices as given. This means, for instance, that the 'invisible hand' does not work, when the only information that is common knowledge is information about prices. One reaction to this problem has been the development of a literature about the design of mechanisms that are incentive compatible, and it is the contention of this chapter that the coal industry conciliation boards can be viewed in just this light. We view the fundamental problem facing the negotiators as the division of the net proceeds from the sale of coal. These were not known in advance by either party, and even ex post they were private information of employers. We therefore treat the amount to be divided as a random variable which is to be shared between workers and thefirm,and our problem is to investigate the nature of contracts that will maximise the joint utility of the union and the firm (we treat the individual utilities as additive), but that at the same time ensure that incentive compatibility is satisfied. This last requirement boils down to a requirement that the firm does better by revealing the truth about the net proceeds, than it would do if it lied. In the model which is described and analysed in the appendix both parties are regarded as risk averse, and in order to get a sharp result we also assume that the firm's utility exhibits strictly decreasing absolute risk aversion. The theorem in the appendix shows that, under the assumptions made, the optimal contract will have two important features. Firstly, the

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division of the rent will be state-contingent. This means that the amount of the wage-bill will depend on the realised, ex post value of the random variable representing the net proceeds. If a contract contains provisions that depend on the outcome of a process that is observed by only one party to the contract, then the contract must ensure truthful revelation of that outcome. The constraints imposed by this may imply a second important feature of the contract. That is, it may involve some form of randomisation. This is an example of the phenomenon described by Hart (1983) who remarks (Remark 6; p. 11) that an incentive compatible contract that specifies state-contingent wages and employment can perhaps be achieved more cheaply if some randomness is introduced into the functions defining the state-contingency. Hart continued: At first sight, the idea of introducing randomness seems curious. Since both parties are risk averse, it seems that this would only make things worse. This is not the case, however. For this is a second-best world, and the firm and workers are concerned not only with optimal risk-sharing, but also with the truth-telling constraints ... It turns out that lotteries may be useful in allowing these constraints to be met at lower cost. In the present model, randomisation occurs when the mineowners have an incentive to claim that the output market is in a good state, when in fact it is bad. If this is the case, then, since the mineowners dislike risk more in the bad state than in the good, randomisation in the good state part of the contract can make this incentive less strong, because it makes a declaration that the state is good less attractive. A similar result can be obtained if the mineowners are more risk averse in the good state than in the low, and if they have an incentive to claim that the output market is bad when it is in fact good. What institutional form could such randomisation take? The theory suggests nothing, except that the distribution of the outcome should be specified a priori in some way by the contractors. One way in which such a specification may be arrived at is by means of a constrained arbitrator. In all the conciliation board agreements the arbitrator is explicitly constrained in a number of ways. Most obviously he was constrained in his choice of outcome by a rule that gave him a casting vote only. Thus the formal rule binding these arbitrators was similar to the one that has recently been resurrected in the US and UK under the name of'final offer' or 'pendulum' arbitration. More subtle perhaps is the way in which these constitutions constrained the probabilities that the arbitrator used in choosing one or the other claim. This was achieved by the selection and dismissal rules, which gave

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both negotiating parties the right to veto the selection of a particular arbitrator, or his reselection at the end of his annual appointment. It was therefore necessary for both parties to believe that a candidate for election as arbitrator was likely to make fair decisions. In addition, if their expectations were not borne out, either party could dismiss an arbitrator at the end of a year's tenure. Although arbitrators received no greatfinancialreward from their position, it was a position of some prominence, and dismissal would have been regarded as ignoble at the least. Most arbitrators were prominent politicians or lawyers close to the end of their careers. For instance, the South Wales arbitrator for much of the duration of the board was Sir Michael Hicks-Beach (Lord St Aldwyn), an ex-Chancellor of the Exchequer. The Federated Area arbitrators were a succession of law lords. Our argument so far is that the conciliation boards can be regarded as a mechanism designed to solve a problem of asymmetric information in the market for coal-mining labour. This view has implications for how we should set about assessing and analysing the operations of the boards, and we turn to these tasks in section 8.3. Section 8.2 sets the scene by discussing possible approaches to the analysis of bargaining institutions and introduces the idea of commitment.

8.2 Theory In this section I intend to discuss two different approaches to the analysis of bargaining: the game-theoretic approach which is currently a major concern of economic theorists, and the more descriptive industrial relations literature. A recent literature which takes a synthetic approach has also started to develop. The leading example of a bargaining model in the game theoretic tradition is Rubinstein's (1982), in which two parties have to decide on the division of a cake of known size. Both parties prefer to have a larger share of the cake for themselves than a smaller share and they both have a positive rate of time preference, so that, for any given partition of the cake, an early decision is Pareto superior to a late decision. This structure constitutes a neat theoretical device by which the cooperative issues in bargaining (the size of the cake) are separated from the non-cooperative issues (the division of the cake between the bargainers). In addition to the assumptions about preferences given above, Rubinstein imposes some technical conditions (which are not detailed here) that ensure that the payoffs of the game induced by the bargaining are well-behaved, and some simple rules:

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(i) Players alternate in making offers, (ii) Once a player has made an offer his opponent must accept or reject it. (iii) Making an offer does not limit the set of possible future offers, (iv) Acceptance by one player of his antagonist's offer ends the bargaining, (v) In the event of perpetual disagreement payoffs are zero. Rubinstein's assumptions enable him to prove a theorem to the effect that there exists a unique optimal partition of the cake, which depends on the relative rates of time preference of the parties. The bargaining in this world will proceed as follows: the first player will offer the optimal partition at the start of the bargaining. The second player will immediately accept it, and the bargaining will therefore end. The process of bargaining in this model therefore takes no time at all and the Pareto optimal outcome is secured. This result, which is perhaps most strikingly thought of as a solution to the bilateral monopoly problem, uses the idea of perfect equilibrium as its concept of optimality. This idea is a refinement of the concept of Nash equilibrium17 and is particularly useful in extending game theory into the analysis of extensive games. It is therefore a natural candidate for a model of sequences of offers. A Nash equilibrium of a non-cooperative game exists when each player's chosen strategy is an optimal response to the equilibrium strategies of the other players. Consider a particular player. For a given set of strategies of the other players, there will be a strategy that he can choose that will make him better off than any other strategy. If each player chooses such a strategy, so that their chosen strategies are all optimal responses to the chosen strategies of all the other players, then the chosen strategies constitute a Nash equilibrium. Another way of thinking of the Nash equilibrium is to imagine that the players have come to an agreement to play a particular set of strategies. This agreed set of strategies will form a Nash equilibrium if there is no incentive for any player unilaterally to renege on the agreement. To see how this works consider the following simple example.18 There are two players, each of whom can move either left or right. The payoffs that they receive depend on the combination of strategies played, and are displayed infigure8.1.19 In each cell, the first number refers to Player 1 's payoff, the second number refers to Player 2's payoff. We can check any pair of strategies to see if it constitutes a Nash equilibrium or not. Consider (L,L). If the players agree to this, neither of

230

New perspectives on the late Victorian economy Player 1 L L

1, 1

R

1, 1

R

"1,-1

Player 2 2,0

Figure 8.1 The pay-off matrix

them would gain by reneging. Player 1 would get - 1 instead of 1; Player 2's payoff would be unaffected if he broke the agreement. Therefore (L,L) constitutes a Nash equilibrium. Now consider (L,R) (bottom left-hand corner). Once again, Player 2's payoff would be unaffected if he were to renege. Player 1 would receive 2 instead of 1 and therefore has an incentive to break the agreement. (L,R) is not a Nash equilibrium. It turns out that this game has two Nash equilibria (L,L) and (R,R). We are now going to represent the game in a different way and be explicit about the sequences of moves that lead up to the final payoffs laid out in figure 8.1. This form of representation is called the 'extensive form' of the game and is displayed in figure 8.2. Here Player 1 moves first, and chooses either left or right. If he chooses left the game ends immediately with both players getting payoffs of 1. If he chooses right, Player 2 has a move which results in the payoffs indicated at the bottom of the figure. It should be clear that the normal form of this game is the structure given in figure 8.1. We have established that the Nash equilibria of the game are (L,L) and (R,R). But do these solutions make sense as descriptions of how the game should be played, now that we have more information about the dynamic structure of moves? The answer is clearly no. There seems to be no reason at all why Player 1 would ever choose L as his strategy. Why not? Because he can predict that if Player 2 has a move she will always choose R. (R,R) gives Player 1 a larger payoff than (L,-), and consequently it makes sense to suppose that the only reasonable behaviour for 1 is to play R. Why then is the Nash equilibrium concept unable to distinguish between the 'reasonable' strategy pair (R,R) and the 'unreasonable' strategy pair (L,L)? Observe that when we consider a candidate for Nash equilibrium we assume serially that one player considers reneging and the other does not.

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-1,-1

Figure 8.2 The extensive form of the game

When we think of equilibrium in the normal form this makes sense. Each player is responding optimally to the optimal decisions of the other. Switching to the extensive form, however, when Player 1 considers reneging from (L,L) he is able to predict that Player 2 will not abide by the agreement. Thus the Nash concept fails because it bounds the rationality of the players to an unacceptable extent. Player 1 does not try to predict what would actually happen if he were to embark on a non-equilibrium path, he instead assumes that Player 2 will abide by the agreement. In the circumstances illustrated in figure 8.2, this is a distinctly odd thing to do. The idea of perfect equilibrium solves this difficulty directly by assuming that Player 1 looks at all the decision nodes in the game and asks what the optimal behaviour at each node will be. In effect, in a perfect equilibrium, a player deciding what strategy choice to make will look not just at the terminal payoffs available to him (normal form), he will also consider what would be optimal play at all nodes that might be reached in the future course of the game (extensive form). For a perfect equilibrium to exist strategies have to be in Nash equilibrium at every node on the equilibrium path. There are other ways of thinking of perfect equilibria, in terms, for instance, of credible threats or taking account of the possibility that errors might be made in play. We have chosen the present form of exposition because it bears most closely on the main theme of this chapter. In particular, as Rubinstein shows, it has the power to produce a

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determinate solution to the bargaining problem; and it suggests an appropriate analytical technique for solving problems in bargaining. It suggests that the correct way to tackle problems in bargaining is by backwards induction as in dynamic programming.20 This, after all, is what Player 1 has to do in our little illustration to figure out what his appropriate move is. After this long digression let us go back to Rubinstein's model and ask how we might introduce an arbitral regime into it. One way that we might think of modelling the arbitrator is as an 'outside option'. What is meant by this, is that an additional rule is added enabling the player whose move it is to have the option of leaving the negotiation and imposing payoffs yielded by some exogenous process (e.g. a negotiation with some other party, the disagreement outcomes, or, in our case, the decision of an arbitrator). Attempting to model the arbitrator as an outside option leads to rather disappointing results. Without going into painful detail, it is difficult to obtain a prediction that the arbitrator will be called in, without further modification to the assumptions of the Rubinstein model.21 An appropriate modification is suggested by the industrial relations literature. This literature makes a sharp contrast with the Rubinstein approach, particularly with respect to rule (iii) ('Making an offer does not limit the set of possible future offers'). The role of this requirement in the Rubinstein framework is to ensure that the game repeats through time. That is, if Player 1 has a second opportunity to make an offer, the problem confronting him is identical to the problem that he had in formulating his initial offer. The assumption renders the analysis of the bargaining considerably easier than it might otherwise be. Rule (iii) is not, however, commonplace in the industrial relations literature. It conflicts particularly sharply with the idea of 'good faith' in negotiations.22 This is discussed by Stevens (1963, pp. 56 and 106), and amounts to a moral obligation for bargainers not to make commitments to which they do not intend to be held. The idea of commitment (that is, that one should not renege on previously held positions) is not only a crucial part of the concept of good faith in industrial relations, but it also seems to be central to recent attempts to explain the occurrence of disagreement in bargaining.23 Indeed, Schelling (1956), in a classic paper, characterises the entire bargaining process as a struggle by the parties to commit themselves to positions from which they will not retreat. This theme is taken up by Crawford (1982), who constructs a simple model to show how commitment can generate disagreement as to perfect equilibrium outcome. Crawford's model of commitment is purely abstract (if a party backs down

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from a commitment it has to pay a fee), but it captures the essence of the idea very neatly. In the real world commitments can be enforced in many different ways: by force of law, by moral codes or by the threat of violence. One such method is to agree (prior to the negotiation) that some commitment enforcing agent can be appealed to by one side if he believes that the other side has got out of line. Parties to a negotiation can in this way set up their own local legal subsystems. I want to suggest below that the conciliation boards, with all their trappings of accountants, arbitrators, secretaries, rules and regulations, were just such entities, set up by the coalowners and the union negotiators to provide appropriate incentives for agreement and decision in the context of a complex environment. The argument above raises two important issues: first, what form did commitments take in the conciliation board structure and secondly, how might one tackle the task of modelling the boards in order to interpret their behaviour? The remainder of this section is taken up with a discussion of the first of these issues. The final section of the paper tackles the second. We can identify four levels at which commitment took place in the conciliation board structure. Commitment to a constitution The showpieces of late nineteenth-century industrial negotiations were the negotiations over the constitutions of bargaining institutions. We have seen that such negotiations took place under both the sliding scale and the conciliation board regimes. The outcome of the negotiations was a written constitution to which both parties subscribed. It is not clear how commitment to these agreements was enforced. Commitment to the terms of the constitution The terms of the conciliation board constitutions were often quite complex. I therefore only discuss an example of the way in which the terms implied commitment. A feature of several of the conciliation board agreements (and all the sliding scale ones) was an agreement (implicit or explicit) that the price of coal would be reported to the board. This implied a commitment by both sides to recognise this statistic as relevant to the determination of the wage rate. In coalfields where this commitment was not present (Federated Area) or where the statistic was open to obvious manipulation by one side (South Wales) the conciliation board arrangement seems to have worked less well. The enforcement mechanism for this was a procedural

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rule under which the accountant's report was presented to the meeting at the start. Commitment to offers This is an aspect of 'good faith', but the enforcement mechanism was not simply some kind of moral code. If an offer was made it could be enforced either by acceptance, or by calling in the arbitrator. I regard this enforcement role as one of the major functions of the arbitrator in these institutions. The other I take to be what Crawford24 calls the 'safety net' role. There is very strong internal evidence from the records of the boards that this was in fact one of the major uses of the arbitrator. The evidence consists of attempts by one party or the other to renege on a previous offer, after the arbitrator had been called in. These attempts were unsuccessful, being deemed unconstitutional by the arbitrator.25 Commitment to statements We owe the survival of the conciliation board records to the final class of commitment. There were two reasons for keeping these records. The first was for the benefit of the arbitrator, or chairman. When arbitration was necessary the record would be sent to the arbitrator beforehand so that he could be fully briefed on the course of the negotiations so far. This meant that statements made when the arbitrator was not present could be interpreted by the arbitrator as commitments of the negotiators. The second reason for keeping the records was to ensure that statements made by the parties could be accurately recalled. Often one side would assert that a commitment had been made by the other in the form of an offer or as part of a particular argument in support of a position. By reference to the verbatim record such an assertion could be either confirmed or refuted. This seems to have been the main use to which the records were put. In this section of the paper we have surveyed some ways of modelling bargaining behaviour and have argued that an important element in explaining resort to the arbitrator is the presence of commitment. We have outlined the major forms of commitment present in the conciliation board structure. It is important to note that, except for the constitution itself, all of these forms of commitment were subject to enforcement by some endogenous technique. The verbatim records and the chairman played important roles in this respect. In the next section we attempt to formalise a model of the conciliation

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boards, and argue that the considerations that led to the setting up of the constitutions are irrelevant to the analysis of behaviour within the constitutional framework. This is important from an analytical point of view because it means that we can take the rules of the boards as given, and ask what would be optimal behaviour subject to those rules. The question of why the boards were set up the way they were and how the rules relate to the broader bargaining environment are posterior questions whose answers depend on resolution of the question as to how the rules operated. Thus analysis of the conciliation board reports is a prerequisite to analysis of their constitutions and must be deferred for further research.

8.3 The Rules of the Game The main purpose of section 8.2 was to introduce the idea of commitment, and indicate how the conciliation boards were constituted complete with commitment enforcement devices. In this section we argue that it is fruitful to model the conciliation boards as mechanisms in the sense of the theory of mechanism design. This theory characterises institutions as methods of solving cooperative games. Our argument is that if we view the conciliation boards in this light, we can treat the second stage negotiations as a non-cooperative subgame, the rules of which are determined as the solution to the mechanism design problem. Since the mechanism constitutes part of an equilibrium of the system, it is appropriate to treat the second stage negotiations as if they were in equilibrium. In fact, we show at the end of this chapter that a perfect equilibrium theory has the ability to explain the main features of the data generated by the conciliation boards. Whether or not the explanation is convincing, I intend to find out with a later empirical study. We have seen that the economic theory of optimal contracts indicates that, even when information is asymmetric, state contingent contracts are still feasible as long as incentive compatibility (or truth telling) constraints are satisfied. These constraints ensure that the firm has no incentive to misrepresent the truth to the workers. What form should state-contingency take? In much of the optimal contract literature, the imperfect information is represented by a single parameter. In the nineteenth-century British coal industry, things were more complicated. Workers had partial information on profits, revenue, output and prices, because of declarations of dividends, public reports of shipments, and public reports of coal prices on the spot market. (Prices on the large contract market were generally private information of the firms.)

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It is difficult to understand exactly why output prices rather than revenues should have formed the basis of the contract. One reason might be that, since price was the only variable about which workers had good independent information, it could have been in the employers' interest to provide them with information about the whole of the output, rather than have them be misled by the information emanating from the spot market. However this might be, it is clear that a prerequisite for a solution of the overall contracting problem depends on the analysis of the second-stage negotiations. If, as we believe, the conciliation boards were a mechanism designed to handle a cooperative game, then analysis of the mechanism should proceed by backwards induction. Furthermore, if these institutions had any optimal properties at all, then any subgame structure within the institutions should also have optimal properties. We can therefore treat the second-stage negotiations as a cooperative subgame of a larger cooperative game structure. We take the 'rules of the game' (i.e. the constitutions) as given, because, according to the mechanism design argument, they constitute part of the solution to the cooperative problem. We can thus analyse the second-stage negotiations by investigating the nature of optimal behaviour according to the rules of the game. This can be done by applying an appropriate optimality principle to the game. We intend to use the principle of perfect equilibrium, and the remainder of this chapter is devoted to this task. A description of a game in extensive form consists of six separate elements (see Kreps and Wilson 1982). These specify: (i) (ii) (iii) (iv)

the physical nature of play, the choices available to a player whenever it is his turn, rules for determining whose move it is, a description of the information a player has whenever it is his turn to move, (v) the payoffs, (vi) initial conditions that begin the game. The constitutions of the conciliation boards (together with some less formal rules that can be inferred from a reading of the records of the negotiations) enable us to write out in extensive form the games that they induce. Some of the characteristics listed above are easily extracted from the constitutions. Others are more difficult to determine. We take them in turn. (i) The constitutions of all the conciliation boards specified that their purpose was to 'set the general rate of wages'. Thus we may take it that

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the nature of play in the institutions was that the parties would make various suggestions and counter suggestions as to what the wage rate should be. These could be rejected or accepted by the other party, as they wished. (ii) The choices available to each side of the conciliation boards at each stage of the game can be summarised as: acceptance of the other player's current offer, the making of a counter-offer more moderate than the current player's previous offer, or rejection of the other player's current offer without modification of the current player's previous offer. The last alternative was limited in its availability because an arbitrator was available to avoid stalemates. Thus repeated rejection of the same offer from one's opponent without modification of one's own offer was not possible. The arbitrator would be called in to resolve the situation. Once the arbitrator had been suggested by a player, the other player's possible moves were modified, and he could either accept the current offer of his opponent, make a counter offer more moderate than his own previous offer, or accept the arbitration. (iii) The rules for determining whose move it is at any particular time are not very clear. Suffice it to say that, almost without exception, the parties involved took turns to respond to each other's offers. We have therefore incorporated this as a feature of the rules of the game, even though it may be a feature of optimal play, rather than a rule. (iv) Both parties have complete information at all stages of the game as to how the game has been played up to the current stage. Information about the state of the market for coal, the state of the labour market, and the financial status of the employing firms is rather more difficult to discuss. The only piece of information that was reported formally and on a regular basis to the conciliation boards was the average price of coal in the previous time period. This was audited according to known procedures, and in some constitutions could be verified by auditors employed by either side. Remaining information was probably only imperfect and was certainly asymmetric, with the employers knowing a good deal more about the profitability of their own enterprises than the union representatives did. However, it seems unlikely that this information, or the extent of the asymmetry, would have changed substantially during the course of the negotiations. (v) The discussion of payoffs is deferred until later in the chapter. We

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assume for the time being that the payoffs at agreement are linear increasing functions of the wage offers. (vi) The game was played every quarter, usually on a prespecified date. Whether or not an opening move was made was determined by one of the parties on the basis of an observation of the price of coal. If the price of coal had risen, the union was entitled to make a claim for an increase in the general rate of wages. If the price of coal had fallen, the employers were entitled to make a claim for a decrease. Of course, neither party was required to make a claim in either circumstance. It is perhaps worthwhile stressing the means by which the arbitrator can enforce commitments in this framework. At each stage, the player whose turn it is to make an offer can enforce the other player's last offer (or elicit a further concession) by calling in the arbitrator. If the other player were to respond by making a more extreme offer, the arbitrator would ignore this and use the more moderate offer in assessing his decision.

8.4 Applications In seeking to explain the pattern of behaviour observed in actual wage negotiations in the British coal industry, we suggest in this chapter that the perfect equilibrium concept is of some use. The two tier bargaining structure that was put in place under the conciliation boards suggests that the cooperative rent division problem was solved by setting up rules under which a non-cooperative game could be played. If this idea is right then it is appropriate to analyse the non-cooperative negotiations separately from the cooperative ones. Indeed, according to the perfect equilibrium method, analysis of the later stages of the institutional arrangements is a prerequisite to an analysis of the earlier stages. One puzzle that we might hope to solve by an analysis of the operation of the conciliation boards is posed in table 8.1. The statistics presented there have been abstracted from the verbatim reports of the conciliation board meetings. Two facts emerge very clearly. Firstly, the proportion of appeals to the arbitrator (row 2) varies very widely from coalfield to coalfield. Over the five bargaining units the proportion of arbitrated settlements varies from 57.14 per cent in South Wales to 11.76 per cent in the Durham coalfield. In the contiguous Northumberland coalfield the proportion is 56.60 per cent. The Durham and Northumberland concili-

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Table 8.1 Summary statistics of coal industry arbitration, 1873-1914 Federated area Number of settlements under arbitral regime

23

Number of 6 arbitrated settlements (%) (26.09) Mean number of rounds in negotiation (st.dev.) to agreed 2.41 settlement (1.19) 2.00 to arbitrated settlement (0.00)

South Wales

28

Scotland

30

Durham

51

Northumberland

53

16 15 (57.14) (50.00)

6 (11.76)

53 (56.60)

2.57 (1.24) 2.26 (0.68)

2.11 (0.88) 3.00 (1.41)

2.23 (0.79) 2.37 (0.66)

1.58 (0.86) 2.62 (1-32)

Sources'. National Library of Scotland (DEP 227/1-8, NF 791a). Mitchell Library, Glasgow (338.272 Sco,Tu 331.88122330942 MIN). Northumberland County Record Office (NRO 759/35-37;NCB/C2/3-7). Durham County Record Office (D/DCOMPA/135,137;D/EBF 37; NCB/I/CO 67,73; D/DMA 81). University College of Swansea (H1-121; Hubert Jenkins 2-4; MFGB minutes). National Union of Mineworkers, Sheffield (MFGB minutes).

ation boards, although they had some members in common, also had important differences in their rules that may be thought to have generated this widely divergent behaviour. In particular, the Northumberland arbitrator was always present at the negotiating sessions from the beginning, whereas the Durham constitution specified that thefirstmeeting would take place without the arbitrator and, if no agreement was reached, there would be an adjournment of the meeting. The reconvened meeting would include the arbitrator. This rule implied that the costs of arbitrating a settlement were considerably higher in Durham than in Northumberland, and we might therefore expect to observe a lower proportion of arbitrated settlements in Durham. Unfortunately, this argument doesn't hold much water, because the South Wales arbitrator also had to be called in to a reconvened meeting, and this did not deter the Welsh negotiators from calling him in even more frequently than the Northumberland negotiators called in theirs.

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Secondly, the third and fourth rows of table 8.1 show the length of negotiations in terms of numbers of rounds. What is meant by a round in this calculation is a single offer or counter offer. The interesting feature of the data is the small size of the numbers in these two rows. They are all fairly close to 2, a count which indicates that an offer was made, then a counter offer, which was either accepted or rejected. The brevity of these negotiations contradicts the popular view of what happens in bargaining with the parties making frequent and gradual concessions as they converge to an agreement. The brevity of the sequences of offers also belies the length of the negotiations in terms of clock time. The transcripts typically take up some thirty to forty pages of typescript. The time spent in the negotiations was not time spent making offers, it was time spent discussing data, precedents and concepts of equity. The usual format was for the opening side to make a prepared speech culminating in their bid. There would then be a long discussion followed by a counter offer and rapid acceptance or rejection. That this pattern is not universally adhered to is plain from the fact that not all the standard deviations listed are zero. Nonetheless, it is an acceptable generalisation to claim that sequences of offers and counter offers were typically short. To summarise, there are two striking features of the summary statistics in table 8.1. First, there is a large variance in the proportion of cases going to arbitration.26 Why did the frequency of appeal to the arbitrator vary so much between boards? Was this, as Ashley (1903) suggested, due to differences in personality or were there differences in the constitutions of the boards that led the negotiators to behave differently in one area from another? The answer that we put forward in a companion paper27 is that the different capacities for delay provided for in the constitutions were potentially an important source of variation in behaviour between the boards. We show that Nash equilibrium in boards where strategic delay was permitted (Federated Area, Durham and Scotland) is qualitatively different from that where it was not (South Wales and Northumberland). The qualitative difference is the right kind to explain a higher rate of appeal in the latter two areas. Secondly, the number of rounds in the negotiation is small. This is again consistent with a perfect equilibrium interpretation. As we have seen, Rubinstein's model predicts that the number of rounds should be exactly two. While this is not wholly borne out by table 8.1, the numbers reported there are much lower than the popular view of how negotiations proceed would suggest.

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The thesis put forward in this chapter is that our understanding of wagesetting institutions such as the conciliation boards and the sliding scales can be advanced by the use of recently developed techniques of economic theory. These techniques attempt to explain institutions as methods by which the agents involved can handle the environment in which they are placed. In particular, they are seen as handling informational deficiencies. Thus, the evolution of economic institutions could be explained as a response to a changing informational environment. We have shown in this chapter how this can be done for the conciliation boards, and we have indicated that there is some extra mileage to be obtained from the approach taken here, in that it suggests certain hypotheses that can be tested against the records of the institutions. Future work will attempt to formulate such hypotheses and test them. A longerterm research programme would take on the task of linking changes in institutional structure to the changing pattern of access to information.

APPENDIX 8.1: The bargaining model This appendix describes the model used in section 8.1, and proves the main result. We assume that the mineowners are faced with the problem of dividing a rent 6 whose size is unknown ex ante. For a simplicity, we assume that 0can take on only two possible values: 6L with probability /?, or 0H with probability 1 - p. Furthermore, 0H> 6L> 0. The payoff in monetary terms to workers is a quantity c which may be stochastic. The most general form of contract states that

_ (cLif0=0L '~[cHif6=0H where ?,-, i = L, H is a random variable with distribution

If /, = /2, we say that c, is degenerate and denote it as ch The payoff in monetary terms to the mineowners is the remainder of 0, namely: 0,-c,, / = L, H. The parties are endowed with utility functions denoted U" and UM for workers and mineowners respectively. These functions have the following properties which embody the properties mentioned in the text: Workers: Vw = V»(x) Vw > 0 VH < 0 Mineworkers: UM = VUx) VM > 0 VM < 0

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and

— - -jr-

We assume that the contract is designed to maximise the joint utilities of the workers and the mineowners, and capture this idea by specifying a maximand which is a weighted average of their individual utilities: Problem: max Z = XEUW + (1 - X)EUM where A is a constant 0 < A < 1. or

max Z = XpEV^Cd + A( 1 - p)E VW(CH)

L

- cL) + (1 - A)(l - p)EVM(eH

- cH)

where 8 is observed by the employer only. The incentive compatibility constraints which guarantee that the contract contains incentives for truthful revelation of whatever 6 is high or low by the mineowners are L - cH) - cH) > EV^SH - cL)

C\ C2

THEOREM: At an optimum cL is degenerate and cH is non-degenerate i.e. //, < H2 and L, = L2. The proof requires three lemmas which we now state and prove: LEMMA I: At an optimum one and only one constraint is binding. Proof (a) Suppose neither constraint is binding. Then

- cL) > EVJ,BL - cH) EVM(0H-CH)>EVM(0H-CL)

Now define a new random variable K,{e), i = L, H with distribution p| £,(£) = / , + - \ = q,

eH such that There exists an

Perfect equilibrium down the pit

and

243

qH H,+ (l- qH) EV^OL - cL) EVM(OH-kl£eH))>EVM(OH-cL)

Furthermore

and since

EVM(eH-kH(eH))>EVM(0H-cH) Var (AT^e,,)) < Var (?„) Var ($H - #„(«„)) < Var (0H - cH)

and

E(KH)) = E(cw)

and both Vw and KM are strictly concave. Therefore cL, K^(eH) is Pareto superior to cL, cH which contradicts the hypothesis that cL, cH is optimal. (b) Suppose both constraints are binding, then EVU0L and

- h) = Evj,eL

-

~cH)

EVUOH - cH) = EVM{0H - cL)

Let cu denote the non-random allocation for which

VM ~ cv) = EVM - cj) i,j = L, H. Then - cu.) ~ VM(dL - cLH)

= vM(eH - cHH) - vM(0H - cHL) = o which contradicts the assumption of strictly decreasing absolute risk aversion. Q.E.D. LEMMA II: (a) If cH is non-degenerate at an optimum, then constraint C\ is binding. (b) If cL is non-degenerate at an optimum, then constraint C2 is binding. Proof: The proofs of (a) and (b) are the same, (a) Suppose not. Then EVM(dL - cL) > EVM(0L - cH)

C\

244

New perspectives on the late Victorian economy and replacing cH by KH {eH) increases Z without violating either constraint. Q.E.D.

LEMMA III: (a) If constraint C\ is binding at an optimum, then cH is nondegenerate. (b) If constraint C2 is binding at an optimum, then cL is nondegenerate. Proof: The proofs of (a) and (b) are the same, (a) Suppose not. Then c\ eL - cL) = EVM(eL - cH) ^6H - cH)> EV^BH - cL) C2 Replacing cL by KL(€L) increases Z without violating either conStraint

-

Q.E.D.

Proof of theorem Because of strictly decreasing absolute risk aversion, we know that the risk premium associated with 6H — cL is less than the risk premium associated with 6L - cL. That is cLL — EcL > cHL - EcL > 0.

It follows that cLL > cHL and 6L — cLL < 0L -

cHL.

Suppose cL is non-degenerate, then C2 is binding by Lemma II b). Therefore, - cL) > EVJ,eL - cH) Consider replacing cL by cHL\n this system. C2 is still satisfied (by construction) and C\ is still satisfied, since

Furthermore, the resulting allocation is Pareto superior since VACHL) > VUEcL) > EVJcL) and VJ,6L - cHL) L - cL). Thus cL is degenerate. But Lemma III(b) then implies that C2 is non-binding, Lemma I implies that C\ is binding, which in turn implies that cH is non-degenerate (Lemma III(a)). Q.E.D.

Perfect equilibrium down the pit

245

Notes Thanks are due to V. V. Chari, Kalyan Chatterjee, Eric Evans, John Sutton and especially Simon Vicary for useful conversations, and to Gary Tennant for able research assistance. Earlier versions of this work have been given at seminars at' Northwestern, Hull, Queen Mary College (London), Sheffield, London School of Economics and the ESRC Quantitative Economic History Conference at Newcastle-upon-Tyne (September, 1987). The ideas in the paper were mainly developed during a year's visit to Northwestern University in 1984-5. The research underlying the paper could not have been done without the cooperation and help of the archivists whose holdings I have used. These are listed in the sources for Table 8.1. The work would have been impossible, too, without financial support from the ESRC (Contract No. F00232382) and the British Academy. My thanks to everyone involved. Any errors are mine. 1 Quoted by Amulree (1929), p. 55. 2 A board in the Macclesfield silk trade lasted for three or four years (1849-52). 4 So long a period of peace was regarded as unexampled and remarkable' Amulree (1929), p. 57. 3 See Amulree (1929), Chapter X, Hicks (1930), and Cuthbert (1960). 4 Amulree (1929), p. 83. 5 Hicks (1930). 6 Cuthbert (1960). 7 Many writers observe the confusion of terminology. Boards were sometimes involved in conciliatory activity (i.e. attempting to reach an agreement by discussion with a third party making suggestions as to possible ways in which an agreement may be achieved). While others were involved in arbitration (i.e. calling on a third party to determine an undecided issue). Boards of Arbitration sometimes engaged in conciliation: Boards of Conciliation sometimes engaged in arbitration. It is interesting to note that recent game theoretic literature is subject to similar terminological confusion. Kalai and Rosenthal (1978) refer to an arbitrator as an agent who designs a non-cooperative game for parties who are unable to come to an agreement in a cooperative game. Myerson (1984) defines an arbitrator in the context of non-cooperative games as 4an outside individual who uses his authority or power of suggestion to help the players to select among multiple equilibria' and a mediator as kan outside individual who communicates with the players in order to enlarge the set of equilibria'. 8 Particularly important are the articles by Hicks (1930), Allen (1964) and Porter 1970. 9 A fuller description of the board can be found in Cuthbert (1960) and Hicks (1930). 10 The history of conciliation and arbitration in this period is discussed by Hicks (1930), Allen (1964) and Porter (1970). 11 The story is told in detail by Arnot (1949), whose view of the outcome is highly

246

New perspectives on the late Victorian economy

controversial. The literature on the costs and benefits of the victory is large and is summarised by Church (1986). 12 Armytage (1951) hints at this. 13 Lord Shand, whose appointment to the position was greeted by The Times with an account of his qualifications for the post: 'Lord Shand is a pure Scotsman. He is a lawyer of eminence who became a judge at a comparatively early age, and who retired from the Bench after the statutory period of service while his faculties and his capacity for the enjoyment of life were still unimpaired. He has taken no prominent part in politics and has shown none of the qualities or the defects of a partisan. He has even resisted the temptation to which many eminent persons have yielded to pose as an authority upon questions of political economy. Lord Shand has never promulgated a theory of currency, still less has he rushed in where angels might fear to tread by offering a definition of wealth, enumerating the duties of capital, or formulating the rights of labour. We are not aware that even the fascination of the bimetallic controversy has seduced him from his customary attitude of sagacious reticence. He stands equally aloof from the cast-iron pedantries of Stuart Mill and from the delinquescent sentimentality of Mr. Ruskin. Yet no one who knows him will doubt for an instant that his opinion upon any practical question of social morality is at least as valuable as that of the most copious theorist who ever tried to measure the universe with his private foot-rule, or to evolve a system of absolute ethics out of the contents of his library. Consequently, this hard-headed Scots lawyer proves equally acceptable to both parties in a contest which has called forth all the tenacity and stubbornness which Shakespeare recommends to those who elect to enter upon a quarrel.' (The Times leader 26 January 1894). The Times' enthusiasm was misplaced. Lord Shand turned out to be a very poor choice of chairman, his partisanship causing the early collapse of the board. 14 Except in Scotland, where 'wages agreements' mimicked sliding scales closely. 15 There were, of course, many strikes in the coal industry in this period. What I mean is that none of these strikes resulted from impasses in the first- or secondstage negotiations of the conciliation boards. 16 See Ledyard (1987) for a readable introduction to the idea of incentive compatibility. 17 The idea of Nash equilibrium is fundamental to game theory. For a lucid exposition, see Binmore and Dasgupta (1986). 18 Drawn from Kreps and Wilson (1982), but not, I think, original to them. 19 The table in figure 8.1 is called the normal form of the game. It shows only terminal payoffs and is not explicit as to how the game can be played to yield those payoffs. 20 There are two books on my shelf which illustrate this point quite neatly, one is C. Stevens (1963). Stevens gets himself in a terrible tangle because he begins his analysis with the start of the bargaining. He observes that bargainers often

Perfect equilibrium down the pit

247

begin a negotiation by making a large demand. Unable to offer any rationale for this, he is forced to assume it to be a rule of the negotiation. Had he started his analysis from the end of the bargaining this unconvincing argument would have been unnecessary. The other book is called Bobby Fischer teaches chess Fischer, et al. (1972). The Introduction explains the board, the pieces and the moves. Chapter 1 is called 'Elements of Checkmate'. 21 This remark applies particularly if the parties are risk averse. The basic problem is that the risk aversion creates a contract zone of negotiated settlements that are preferred by both parties to the arbitrated settlement (see Farber (1980)). The perfect equilibrium solution picks out one element of the contract zone, so that the arbitrator is never called in. The exact solution depends on relative degrees of risk aversion, degrees of time preference, and the process by which the arbitrator makes his decision. 22 Unfortunately, the words 'good faith' and 'commitment' have recently acquired technical meanings among game theorists rather different from their vernacular senses. 23 For a survey, see Chatterjee (1985). 24 Crawford (1985), section 17.4. 25 See, for example, the negotiation July 6th 1907 in Northumberland (Northumberland Record Office NCB/C2/5 and NRO759/33). 26 This was noted by Ashley (1903): 'In Durham, for reasons which are not apparent, and which can only be conjectured as personal, the two parties on the board ... have managed to agree on each of the long series of quarterly changes ... without calling in an outsider.' 27 Treble (1988). References Allen, V. L. (1964), 'The origins of industrial conciliation and arbitration', International Review of Social History, 9: 237-54. Amulree, Lord (1929), Industrial Arbitration in Great Britain, London: Oxford University Press. Armytage, W. H. G. (1951), A. J. Mundella 1825-1897: The Liberal Background to the Labour Movement, London: Ernest Benn. Arnot, R. Page (1949), The Miners: A History of the Miners Federation of Great Britain 1889-1910, London: G. Allen and Unwin. Ashley, W. J. (1903), The Adjustment of Wages, London: Longmans, Green & Co. Binmore, K. and Dasgupta, P. (1986), 'Game theory: a survey' in K. Binmore and P. Dasgupta (eds.), Economic Organisations as Games, Oxford: Basil Blackwell. Chatterjee, K. (1985), 'Disagreement in bargaining: models with incomplete information' in A. E. Roth (ed.), Game-theoretic Models of Bargaining, Cambridge University Press, chapter 2.

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New perspectives

on the late Victorian

economy

Church, R. (1986), The History of the British Coal Industry, Vol. 3: 1830-1913: Victorian Pre-eminence, Oxford University Press. Crawford, V. P. (1982), 'A theory of disagreement in bargaining', Econometrica, 50: 607-37. (1985), The role of arbitration and the theory of incentives' in A. E. Roth (ed.), Game-theoretic Models of Bargaining, Cambridge University Press, chapter 17. Cuthbert, N. H. (1960), The Lace Makers' Society: A Study of Trade Unionism in the British Lace Industry, 1760-1960, Amalgamated Society of Operative Lace Makers and Auxiliary Workers, Nottingham. Farber, H. S. (1980), 'An analysis of final-offer arbitration', Journal of Conflict Resolution, 24: 683-705. Fischer, B., Margulies, S. and Mosenfelder, D. (1972), Bobby Fischer Teaches Chess, Bantam, New York. Hart, O. D. (1983), 'Optimal labour contracts under asymmetric information: an introduction', Review of Economic Studies, 50: 3-35. Hicks, J. R. (1930), The early history of industrial conciliation in England', Econometrica, 10: 25-39. Kalai, E. and Rosenthal, R. W. (1978), 'Arbitration of two-party disputes under ignorance', International Journal of Game Theory, 7: 65-72. Kreps, D. M. and Wilson, R. (1982), 'Sequential equilibria', Econometrica, 50: 863-94. Ledyard, J. O. (1987), 'Incentive compatibility', California Institute of Technology, mimeo. Myerson, R. B. (1984), Two-person bargaining problems with incomplete information', Econometrica, 52, 2: 461-88. Porter, J. H. (1970), 'Wage bargaining under conciliation agreements 1860-1914', Economic History Review, 2nd Series, 23: 460-75. Rubinstein, A. (1982), 'Perfect equilibrium in a bargaining model', Econometrica, 50:207-11. Schelling, T. C. (1956), 'An essay on bargaining', American Economic Review, 46: 281-306. Stevens, C. M. (1963), Strategy and Collective Bargaining Negotiation, New York: McGraw-Hill. Treble, J. G. (1988), 'Interpreting the record of wage negotiations under an arbitral regime: a game theoretic approach to the coal industry conciliation boards, 1893-1914', University of Hull Labour Economics Unit Discussion Paper No. 88/2. Webb, B. and Webb, S. (1920), The History of Trade Unionism, London: Longmans, Green and Co.

PART III

The Monetary System and Monetary Policy

For many years the fundamental notion employed to understand the pre-1914 Gold Standard was the Quantity Theory of Money, one form of which is represented infigureIII. 1. The money supply, Ms, depended on the quantity of gold and the willingness of the financial system to create assets, such as bank deposits, on that monetary base. Excessive credit creation drove up prices. That meant profits could be made by buying gold in the UK, and selling in another gold standard country where prices had not risen so much. If goldflowedout of the country, Ms shifted down to Ms\ and nominal income contracted. The Bank of England was expected to maintain confidence in the monetary system so that there were no massive panic contractions in the supply of assets created by the private sector. (In a panic Ms shifts to Ms\ and nominal income falls to PY\. Most probably both prices and real income would decline.) Money demand, Md, increased with nominal income by a proportion k. If interest rates rose, perhaps because of an increase in the Bank's discount rate, k fell as the cost of holding money for transactions purposes increased. The same increase in interest rates also tended to reduce Ms.

Money

, Md = kPY

-Ms -MsY I PYl

PY

Nominal income = price level X real income = PY

Figure III. 1 A simple monetary economy 249

250

New perspectives on the late Victorian economy

Implicitly the above analysis has assumed that the UK was an economy either closed to international trade or large enough to influence world prices. If instead the economy was small, a world price taker, monetary expansion raised real income and not prices, drawing in imports and creating a balance of payments deficit. Equally if the economy was small in the above sense, raising the Bank's discount rate would be ineffective, unless UK assets were not perfect substitutes for those of other countries, because the Bank would be unable to influence returns on world assets. The money supply would be determined by the level of UK economic activity rather than by the Bank of England. Chapter 9, among other points, shows the UK was a large economy. Chapter 10 draws attention to the range of assets that were substitutes, and therefore influenced the possibilities open to monetary policy. Chapter 11 identifies a large number of panics which the Bank damped down and distinguishes the ease with which different Bank Governors were able to fulfil their obligations.

Chapter 9

Money, interest rates and the Great Depression: Britain from 1870 to 1913 Forrest H. Capie, Terence C. Mills and Geoffrey E. Wood

Introduction In this chapter we examine the impact of changes in the quantity of money on aggregate economic variables in Britain over the years 1870 to 1913. This subject has been examined by two of the present authors (Capie and Wood 1984) but the statistical techniques used were fairly rudimentary, and the analytical framework within which hypotheses were tested was set out rather sparsely. This chapter sets out to remedy these deficiencies. Its structure is as follows. Section 9.1 outlines the historical background of the period; it gives an account of what is currently the conventional view of macroeconomic developments in this era. Section 9.2 sets out the analytical framework we use to organise the empirical work. This analytical framework is the traditional model of the impact of money on real and nominal interest rates. This framework has two advantages for the present purpose. It provides a most detailed account of the effect of money on key macroeconomic variables, and, secondly, it lets us consider various explanations of the Gibson Paradox, a phenomenon which, although certainly noted and discussed before this period, was named and came to prominence as a result of examination of data from the years examined in this volume. The data themselves are then described. This prepares the way for the statistical work. The chapter then concludes with a discussion of the results of that work, focusing first on the Gibson Paradox and then on how the results contribute to an understanding of the role of money in Britain in the late nineteenth and early twentieth centuries.

9.1 Historical overview The view that is most widely held on Britain during this period is of an economy increasingly under pressure and beginning to struggle for position in the income per capita league: a tough competitive climate was developing, as a result of the United States, Germany and others emerg251

252

New perspectives on the late Victorian economy

ing as major industrial powers. Many recent accounts of Britain's poor economic performance have dated the origins of relative decline from the 1870s; see, for example, Kirby (1981), Sked (1987), and Elbaum and Lazonick (1986). Much of this account of decline did, however, rest on a less than robust data base and this is reflected in the long debate over if, and when, a climacteric occurred. Some placed the climacteric in the 1870s, Coppock (1956), for example: others, notably Phelps Brown and Handfield Jones (1952), set it in the 1890s. Feinstein's (1972) aggregate output data helped clarify some issues and the publication of Matthews et al. (1982) and the companion paper, Feinstein et al. (1982), presented a picture of growth in slight but steady decline from the 1850s through to a nadir in the Edwardian era. Annual average growth rates fell from around 2.5 per cent in the 1850s to around 1 per cent in the 1900s. Questions have been raised, however, about the reliability of even these data. Greasley (1986) suggested that Feinstein's income series was mismeasured because of the poor quality of the underlying wage data, and proposed a revised estimate of aggregate output based upon a corrected income series. Although Greasley's criticisms appear to have considerable merit, his revised series has been itself the subject of a severe and apparently damning attack by Feinstein (1987) who, nevertheless, accepts that his original data are in need of revision. The empirical work on estimating trend rates of output growth reported by Feinstein et al. and Greasley has recently been superseded by the research of Crafts et al. (1989a and b), who use structural time series models to isolate and estimate both the trend and cycle components of a variety of output and production series for this period. Their finding for aggregate output is of only a slight fall in trend growth during the years 1899 to 1913, the period favoured by Feinstein et al. for exhibiting the climacteric, and no evidence at all of a climacteric in the 1870s. Indeed, when industrial production is considered a steady decline in trend growth is found to start in the mid nineteenth century and to continue through most of the third quarter of the century before levelling off, i.e. the decline began before the so-called 'Great Depression' and well before the dates usually assigned to the climacteric. This changes substantially what needs to be explained. Where once it was accepted that the period 1873 to 1896 was one long period of stagnation, the 'Great Depression', this would now appear not to be the case: there was no great depression and neither was there any climacteric. Interestingly, histories of almost all the developed, and some of the

Money, interest rates and the Great Depression

253

developing, world have accounts of a long depression in this period. Whether these accounts will hold up when the data base is strengthened is not clear, but the suspicion is that they will not. It seems that, at least for several cases, while there was a long downswing in prices, or a long deflation as it tended to be called, there was little setback to output. These falling prices were thought to indicate a long-lasting depression because in the business cycle all macroeconomic variables moved together, and falling prices meant contraction. But did this hold for a secular trend? There was some evidence apparently confirming that it did. Firstly, agriculture was still important in many countries and certainly suffered in this period. The agricultural interest was politically vocal and still powerful. It promoted the idea that there was a depression and sought help, often in the form of tariff protection. Secondly, there was a severe and longer lasting cyclical downturn in either the 1870s or 1880s in many countries. But that apart, depression was being read from price behaviour. Even Kondratieff's cycle was essentially a price cycle. There was certainly a clear long downswing in prices. Prices in Britain fell from the 1870s to the mid 1890s and rose from then until 1914. The extent of the fall and rise, though, has been considerably modified from that thought at the time. While between 1873 and 1896 wholesale prices (the original indicator used) fell by 39 per cent and rose by 40 per cent from then until 1914, Feinstein's deflator fell by only 20 per cent and rose by 17.6 percent. Two strands developed in the literature to explain this long swing in prices, one real and the other monetary. The real explanation rests essentially on the extension of arable farming in the new world and on the transport revolution. These conjoined to produce tumbling prices of agricultural goods in Britain - an important part of the world market and in the rest of Europe. This, the argument goes, lowered prices because in any index these were highly significant. Note, however, that the argument rests on prices falling more and more each year for many years. Bordo and Schwartz (1981) cast considerable doubt on this line of argument in a specific and rigorous test of the hypothesis. The real explanation, say its opponents, confuses relative prices with the general price level. Those advancing the monetary explanation do not dispute the fall in agricultural prices. There is nothing to dispute; that there was a fall in agricultural prices and in the general price index is a well-established fact. What they reject is the idea that agricultural prices brought the price index down, i.e. lowered the general level of prices. Only a scarcity of money in relation to output could do that. Had there not

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New perspectives on the late Victorian economy

been such a scarcity, falling agricultural prices would have been offset in their effect on the general level of prices by rising prices elsewhere. Proponents of the monetary explanation argue that there was a scarcity of money relative to output and that it resulted from the fact that from 1870 onwards the world economy was developing rapidly while at the same time the main industrial countries were adopting the gold standard. There was therefore a shortage of gold base money per unit of output as these countries acquired reserves of gold. Prices thus fell steadily until the scarcity was corrected by the gold discoveries of the early and mid 1890s in Australia, South Africa and the Klondike. Cagan (1965) pointed out that, whereas in the 1850s the world's monetary stock was growing at 8 per cent per annum, in the critical years 1875-87 the rate of growth dropped to 1 per cent per annum. And since Cagan demonstrated that money determined prices in the United States, he argued 'the same explanation must hold for all countries, including England, that were on the gold standard and had close commercial ties with the United States' (p. 250). From the gold discoveries onwards there was actually a small surfeit of gold in relation to output, and prices thus crept steadily upwards. As is now well established, deficient monetary data led to a confused picture for Britain, but the deficiencies are now in good part removed. A detailed account is given in Capie and Webber (1985) of the deficiencies of the old data, and of how the series used in this paper (and also in Capie and Wood (1984)) were constructed. We return to these data below. It is now necessary to set out the analytical framework of the present paper.

9.2 Analytical framework Money, interest rates and prices In this section we set out the traditional analysis of the effects of a once and for all shift from one steady rate of money growth to another. We are, because of data limitations, particularly concerned with the effects of such a shift on the nominal yield of a nominal asset, but we do at points note also the behaviour of certain other yields. The monetary change is unanticipated, but, when it occurs, it is fully perceived. For expository simplicity, it is assumed that the price level is initially constant, and is expected to remain so. On the assumption that the general level of prices is slower to change than both nominal interest rates and real income, the effects of such a monetary change can be divided into four stages. First there may be a loanable funds effect. This is succeeded by a liquidity effect. Real income

Money, interest rates and the Great Depression

255

then starts to move; this affects interest rates. And then there is an effect on the general level of prices, and on price level expectations; this latter in turn produces the ultimate impact of the monetary change on the nominal yield on nominal assets. These various stages are described in order. Loanable funds effect This comes about because revenue accrues to the issuers of new money. This revenue may be spent on consumption goods, in which case the first impact of the money growth is on the prices of these goods. To use the example given by J. S. Mill (1848), if the money growth were the result of a gold discovery, the initial effects would be on the wages of goldminers and on the prices of what these miners buy. But, if the revenue is used to augment wealth, there is an increase in the supply of loanable funds. This affects all yields - real and nominal, ex post and ex ante, on real and on nominal assets - because it is so far being assumed that inflation expectations do not change, and that the money growth was unanticipated. Liquidity preference effect This effect is also an initial effect of the changed rate of money growth but, unlike the loanable funds effect, does not depend on choices concerning the disposition of the revenue from money creation, and produces a sustained decline rather than an immediate drop in rates (again, because of the above noted assumptions, rates however defined). Rates behave in this way because we have moved to a higher growth rate of money. So long as no variable except interest rates can change, there is a continually rising ratio of real (and nominal) money to real income. To induce this to be held, the opportunity cost of holding real cash balances (the nominal rate of interest) has to fall and it keeps on falling until the third effect comes into play. The income effect We now have lower real and nominal interest rates on all types of asset. The prices of the services of assets have therefore risen relative to the prices of the assets which supply these services. Nominal expenditure rises, and as prices (including money wages) have not yet changed, so does nominal output. This increases the quantity of real cash balances demanded at every opportunity cost, and, hence, as income rises the nominal yield on nominal assets also rises, gradually reversing the liquidity effect. (As price expectations have by assumption not yet changed, real yields on real assets, and real yields on nominal assets, ex post and ex ante, also rise.) All these rates rise until they are back at their

256

New perspectives on the late Victorian economy

pre-monetary expansion level, for only then is the stimulus to expenditure dissipated. But the process does not end thtfre. Price expectations A higher rate of money growth has been superimposed on an unchanged real economy. Hence, the only way, since no real variable changes, that the increased nominal money stock will be held is if prices rise. They rise eventually at the same rate as the growth of money.1 When prices are rising at this rate, if price expectations have not changed, realised real rates of interest on all assets fall again. Price expectations must change. Ultimately the inflation is fully anticipated. At this point, nominal yields on nominal assets (both ex ante and ex post) have risen by an amount equal to the inflation rate; while real yields, ex ante and ex post, on real and nominal assets, are unchanged. Our empirical work is in part addressed to considering whether this full process can be observed in the UK from 1870 to 1913. As it is also, however, concerned with the existence (sometimes challenged), and possible explanation, of the Gibson Paradox, it is necessary next to survey the principal literature on this phenomenon, so as to summarise the questions it raises. The Gibson Paradox Over the period 1870-1913 there appears to be a positive association between the nominal interest rate and the level of prices - an association which Keynes (1930) called the Gibson Paradox, after A. H. Gibson, who first drew attention to the relationship.2 This association between the price level and some measure of the nominal interest rate is clearly not deducible from any standard classical model. Double the money supply (and thus the price level), and all real variables, including the rate of interest - which is a variable having the dimension £ per £ per time - are homogenous of degree zero with respect to such a comparative static change in the nominal variables. What, then, can explain the association between the price level and the interest rate? The answer most in accordance with the theory outlined above was first advanced by Irving Fisher (1907, 1930) and later given qualified support by Friedman and Schwartz (1982). They argued that because a move from one fully anticipated inflation rate to another would (even with the real return on physical capital unchanged) alter the nominal yield on nominal assets, the appearance of a relationship between nominal yields and the level (as opposed to the rate of change) of prices could be produced. This

Money, interest rates and the Great Depression

257

relationship would appear if inflation expectations adjusted to inflation with a lag, so that the longer inflation persisted (and thus the higher the price level rose), the higher would the nominal yield rise, until it stabilised when the inflation became fully anticipated. The correlation between nominal interest rates and the price level is close if the period it takes people to adjust their expectations is about as long as the swings in prices. That is not, however, the only explanation that has been offered. Wicksell, and later Keynes, offered an explanation which was also within the traditional framework, but posited a movement in the real rate of return on physical assets. According to both Wicksell (1907) and Keynes (1930), nominal rates on nominal assets were pulled down by a downward drift in the natural rate of interest, the real return on real assets, reflecting a decline in the marginal physical productivity of capital. This occurred in the first half of the period, and was replaced in the second half by a rise as the American mid and far west were opened up. Price level movements were in turn induced because the market rate lagged behind the actual rate. Although different from the Fisher explanation, that is within the same analytical framework. Some explanations, however, entirely reject the framework by denying the influence of money on prices. Mathias (1983, p. 367) wrote as follows: Many vital factors do not fit the thesis. Bullion dealers reported no shortage of gold: the reserves of the Bank of England stayed high ... Furthermore - a key fact - interest rates on Lombard Street stayed low consols were under 3 per cent per annum yield and the discount rate between 2 and 3.5 per cent per annum. These depressed interest rates ... suggest an exactly contrary thesis to the monetary one - that excess savings were seeking investment outlets; that money was overplentiful in relation to investment opportunities of every sort. Throughout that quotation there is a confusion, made explicit in the last sentence, between money and credit. But what seems to be implied is that there was a persistent abundance of money (an excess supply?), but that nominal interest rates stayed low because of real factors, with money not affecting prices. What then did determine prices? Phelps Brown and Ozga (1955) advanced an explanation, which was taken up by Coppock (1961). Phelps Brown and Ozga argued that, when industrial production grew more slowly than production of primary goods, primary goods prices fell, and exerted a downward cost-push on prices; and the converse happened when the growth rate of industrial production exceeded that of primary production. Coppock adopted this view, and explained the

258

New perspectives on the late Victorian economy

co-movement of prices and interest rates as the result of a slowing of Britain's growth in the 1870s not being offset in its impact on world industrial production until the German and American growth of the 1890s. These explanations have no role for money. If money enters at all, it is passive, and interest rates and the price level behave as they did because of real factors. Subsequent to these explanations, monetary forces came back into favour. Hughes (1968) supported the Keynes-Wicksell view. Hicks (1967) and Paish (1966) advance an explanation which is, if not monetary, certainly financial; they ascribe the fall in long rates to a shortage of high quality long assets in the market. Three comparatively recent studies take the view that money growth determined the trend of prices, and that the behaviour of interest rates has to be reconciled with that. These are Sargent (1973), Harley (1977), and Friedman and Schwartz (1982). These all start from Irving Fisher (1907, 1930), who argued that the underlying relationship was between interest rates and inflation, and the observed relationship the result of inflationary expectations (which Fisher argued depended on past inflation) changing very slowly. But, as Sargent put it, this explanation of the Gibson Paradox may be 'really only a redefinition of it'; for Cagan had earlier (1972) pointed out that the mean adjustment lags estimated by Fisher do seem remarkably long - ten to thirty years (Shiller and Siegel (1977) advance this same criticism of the Fisher explanation). After an extensive and complex analysis, and like empirical work, Sargent reached the following main conclusions: within the context of bivariate models, interest and inflation appear mutually to influence one another. One implication of thisfindingis that Irving Fisher's explanation of the Gibson Paradox, which posits an unidirectional influenceflowingfrom inflation to interest, is inadequate. Sargent (1973, p. 447) The next, and penultimate, study to be examined is that by Knick Harley (1977). Harley robustly supports a 'Fisherian' explanation. He argues that 'the money market adjusted to price expectations, and there was little effect on real interest rates' (p. 73). And again, 'the decline in the market rate of interest in the 1870s can be fully accounted for by price expectations and is fully consistent with a monetary explanation of the price trends' (p. 73). He supports this by an equation which relates interest rates to the ratio of money to income, gold reserves at the Bank of England (published weekly and an indicator of near term market conditions widely used by

Money, interest rates and the Great Depression

259

contemporary observers), price expectations, and unemployment (as an indicator of the business cycle phase which, he argued, was an influence on price expectations).3 Turning to the long rate (that on consols), he finds this to be well predicted by 'assuming that the long rate was dependent on the expected short rate and that the expectations of the short rate were generated by a geometrically weighted distributed lag of past short interest rates' (p. 83). Finally in this section we come to Friedman and Schwartz (1982). Here we simply summarise their findings on the Gibson Paradox; their work is turned to again below. At the beginning of their chapter (chapter 10) on money and interest rates, they remark, 'we are left with no single satisfactory interpretation of that supposedly well-documented empirical phenomenon' (p. 479). Fair, but there is more than that to what they find. First, they deduce analytically the length of lag for Fisher's explanation to be correct. 'A close correlation between rising prices and rising interest rates requires that the time it takes for people to adjust their anticipations must be roughly comparable to the duration of long swings in prices' (p. 547). They go on to observe that the Gibson Paradox seems to be a phenomenon of particular periods (a point reinforced by Dwyer's (1984) study). Following a suggestion of Klein (1975), they remark that Fisher effects had reason to emerge more quickly in recent years, as in fact they had; for as the price level became more volatile, so did the reward to forecasting it increase. Friedman and Schwartz remark that reliance on past prices to forecast future prices is far from always sensible. They do nevertheless tend to support Fisher's explanation for the Gibson Paradox - partly by noting that the studies which rejected the explanation actually included in their data sets periods when the paradox did not occur; partly by rejecting (on Cagan's grounds4 and also by use of their own series for the real rate) the Wicksell explanation; and partly by finding shorter lags than Fisher on price expectations. Their explanation of the end of the Gibson Paradox is consistent with this - a change in the monetary standard, which produced greater incentives to forecast future price movements. In other words, 'Gibson' was replaced by 'Fisher' as lags shortened, and lags shortened because there was an incentive for them to do so. That brief survey of the literature points to four questions, answers to which would help discriminate among these explanations of the paradox. Did money affect prices? (as Mathias and others denied). Can we confirm Sargent's finding on the relationship between prices and the rate of

260

New perspectives on the late Victorian economy

interest? Does money growth affect interest rates as Harley found? And does it lead to a Fisher effect on the nominal rate? And there is one final question on the issue of the Gibson Paradox. Benjamin and Kochin (1984) have denied its existence; they claim it is the chance product of wars producing both high interest rates and high prices. It is clear that the above list of questions corresponds rather closely to the effects which the traditional theory of the effect of money on interest rates leads one to seek in the wake of a monetary impulse. The empirical work can thus readily address both issues. The next stage, therefore, is to describe the data. The way is then clear for the empirical work.

9.3 The data The previous studies which have been mentioned used a variety of money supply definitions, each of which has a number of important defects. With the publication of Capie and Webber (1985), however, many of these defects were removed; this volume (tables I.I and 1.3) was the source of our money stock data. Because the relationships between money and the other variables could perhaps be influenced by the definition of money used, two series are considered here: the narrow, money base, definition, denoted MO, and the broader series, M3. For exact definitions of these two series, see Capie and Webber (1985). The interest rate employed is the yield on Consols. This has almost exclusively been used as the measure of the long-term rate of interest in this period. Series for short rates of course also exist, but these are not well suited to the examination of hypotheses about, or depending on, the Fisher effect. The usual Consol yield series, denoted here as RC, is that given in Capie and Webber (1985, table III. 10). However, as Harley (1976) points out (see also Capie and Webber (1985, pp. 316-20)), this series has traditionally been miscalculated for the years 1880 to 1903. It overestimates the true yield on Consols for two reasons. The price of Consols in this period rose above par, thus increasing the possibility of redemption at par and decreasing the true yield; and the details of Goschen's conversion of the National Debt in 1889 affected the way in which Consol yields were calculated. We therefore also use a revised Consol yield series, that given in the Appendix to Harley (1977) and denoted here as RH. The real output series that is used is, as has become traditional, that of

Money, interest rates and the Great Depression

261

240

120 1870

1875

1880

1885

1890

1895

1900

1905

1900

1905

1910

1915

Year

Figure 9.1 Narrow money: Mo 1200r

500 1870

1875

1880

1885

1890 1895 Year

1910

1915

Figure 9.2 Broad money: M3

Feinstein (1972); and hence his implicit GDP deflator is used as the price series. These series are denoted QF and PF, and were taken from Capie and Webber (1985, table III. 12). Annual observations for all series are available from 1870 to 1913, except for M3, whose initial (1870) observation is missing. The two monetary series, M0 and M3, are graphed in figures 9.1 and 9.2; the two interest rates, RC and RH, are graphed in figure 9.3; the output series, QF, is shown in figure 9.4 and the price series, PF, in figure 9.5.

262

New perspectives on the late Victorian economy

3.4

3.1

V"\,

i"

R .C

2.8

2.5

\ \

2.2

1

1.9

1870

1875

,

1

,

1880

1

,

1885

1

.

1890

1

^

1895

/RH / .

1

1900

.

1

,

1905

1

,

1910

1915

Year

Figure 9.3 Interest rates

40 1870

1875

1880

1885

1890 1895 Year

1900

1905

1910

1915

Figure 9.4 Output

MO and M3 display roughly similar evolutions over the data period, with both series increasing in level from 1889, although pronounced cyclical movements do occur. Before 1889 the levels of the series are both roughly constant. The Consol yield traces out a distinct 'U' shape, with the trough occurring in 1897. (Harley's recalculated series has a much steeper decline than the conventional series, the 1897 minimum values being 1.96 per cent and 2.45 per cent respectively.) The output series displays a marked upward movement with variability around trend

Money, interest rates and the Great Depression

80 1870

1875

1880

1885

1890

1895

1900

1905

1910

263

1915

Year

Figure 9.5 Price level

appearing to increase with level. The price deflator traces out an approximation to a 'U' shape. It is useful at this point to set out more formally some of the statistical characteristics of these series. They all display non-stationarity of mean; the money and output series having a predominantly increasing mean level, the interest rate and price series having mean levels that are non-constant, but without any overall trend. Moreover, for both money and output, and possibly prices, variability tends to be roughly proportional to level, suggesting non-stationarity in variance. This implies that univariate models fitted to these series (an essential starting point for multivariate modelling) would require both logarithmic transformation and first differencing, so that (continuous) growth rates were modelled. For interest rates, however, only first differences, without any logarithmic transformation, would seem to be necessary. The need for first differencing of all series is confirmed by a number of criteria: by inspection of the sample autocorrelation functions for the levels, first and second differences of the logarithmically transformed series (except interest rates), by using the conventional Box and Jenkins (1976) identification approach, by the minimum sample variance criterion (Anderson 1976), and by formal tests for unit roots (Dickey et al 1986). The univariate ARIMA models chosen for each series are shown in table 9.1, where lower-case letters denote logarithms of upper-case variables, e.g. m0 = log(M0).

264

New perspectives on the late Victorian economy

Table 9.1

Univariate ARIMA models

AmO, = 0.014 + 0,+ 0.329a,_,, (0.006) (0.150)

cr= 0.0286

Q6(4) = 4.07

Am3,

= 0.011 + 0.446Jm3,_, + at, (0.004)+ (0.144)

cr= 0.0216

Q6(4) = 1.15

ARC,

=

O.489dRC,_,+0,, (0.139)

a-=0.0688

Q6(5) = 4.11

JRH, =

0.500JRH,_,+tf,, (0.136)

5-= 0.0961

G6(5) = 4.77

Aqft

= 0.019 + a,, (0.004)

cr= 0.0284

Q6(5) = 8.12

Apft

= 0317 Apt., + a,, (0.159)

o-= 0.0248

(?6(5) = 2.38

e: Figures in parentheses are estimated standard errors; a is the estimated equation standard error; Qk(v) is the Ljung-Box (1978) portmanteau statistic for testing model adequacy using the first k residual correlations and is distributed as X* with v degrees of freedom.

The money series, MO and M3, follow ARIMA(O,1,1) and ARIMA( 1,1,0) processes respectively, with average growth rates of 1.4 and 1.97 per cent per annum and residual standard errors of 2.86 per cent and 2.16 per cent respectively. Both interest rate series are ARIMA( 1,1,0) processes with almost identical autoregressive parameters, but the residual standard error of RH, at 0.096 percentage points, is considerably larger than that of RC, which is 0.069 percentage points, this being a consequence of the far greater variability of the former series. The output series is a random walk, with a drift (growth rate) of 1.9 per cent per annum. The price series follows an ARIMA( 1,1,0) process. Having thus described the series, it is now possible to proceed to the empirical work.

9.4 The empirical work The natural extension of univariate ARMA modelling, which was undertaken in the previous section for the purposes of data description, is to build a vector ARMA model of the relationship between output (q), money (ra), the price level (/?), and the interest rate (R). As there are

Money, interest rates and the Great Depression

265

two money and interest rate series available, there are four possible combinations of variables, each of which has been investigated. The vector ARM A representation of a multivariate process, in our case y = (q,m,p,R), is a very general one and can be used to represent a wide class of data generation processes (see, for example, Hendry et al. (1984)). It has become standard practice to transform the individual series, usually through differencing, to ensure that the vector y is jointly stationary. This is to allow standard identification, estimation and testing procedures to be applied, for non-stationarity leads to difficult inferential problems, as analysed by Phillips and Durlauf (1986). We have seen in section 9.3 that all series are individually nonstationary, each requiring first differencing and all but the interest rates also needing a logarithmic transformation. However, as shown in a pure time series context by Lutkepohl (1982) and Tjostheim and Paulsen (1982), it is not the case that individually differencing component series that are separately non-stationary is necessarily required for the multivariate process to be jointly stationary. Moreover, and of greater relevance for econometric analysis, linear combinations of these series may be stationary without them being differenced. This is the concept of cointegration analysed, for example, in Engle and Granger (1987), and the implications of which for econometric modelling appear to be far reaching. There is strong evidence, however, that differencing of individual series is required. Examination of schematic plots of the sample cross correlation and partial autocorrelation matrices for each four dimensional vector, in the manner proposed by Tiao and Box (1981), suggested very strongly that first differencing is required for each series, even in this multivariate setting. (We did not consider inducing stationarity by detrending using a polynomial in time, as was done by Dwyer (1985), in a related study. This was because the work of Nelson and Kang (1981, 1984), amongst others, has shown the deleterious effects of such a procedure in terms of producing innovations falsely exhibiting pseudoperiodic behaviour and in finding spuriously significant regression relationships.) Furthermore, standard tests for cointegration between the variables in y found little conclusive evidence to reject the hypothesis of non-cointegration (but see note 8 below). Additional evidence is also provided by estimating vector ARMA models containing just first differenced series. The specification, estimation and testing of such models is still in its infancy, with no general consensus having been reached as to the best modelling procedure to employ. The approach taken here, primarily

266

New perspectives

Table 9.2

on the late Victorian

Estimated vector AR(1)

economy

models

(i) (QF, MO, PF, RC) Aqf, AmO,

ARC,

•

0.224 0.273 0.130 (0.130) (0.155) (0.054) 0.303 0.100 0.113 0.085 (0.156) (0.147) (0.176) (0.061) 0.385 0.274 0.308 -0.000 (0.122) (0.115) (0.137) (0.047) 0.383 - 0 . 1 0 4 0.541 0.432 (0.391) (0.368) (0.441) (0.152) 0.060 (0.138)

V2r

0.727 -0.003 0.441 0.275 0.591

V3r

ARC,.X I

P= 4.555

T

4P/.-.

•

0.565 0.097 -0.087 -0.233

•

Vi,

v4, •

1 0.15 -0.17 -0.15

i

1 -0.01 1 0.15 0.42

F= 11.53 (0.073)

(ii) (QF, M3, PF, RC) Aqft Ami,

ARC,

0.088 -0.132 0.303 (0.152) (0.188) (0.186) 0.343 0.301 0.111 (0.120) (0.148) (0.146) 0.338 0.143 0.192 (0.142) (0.175) (0.173) 0.342 0.184 0.482 (0.420) (0.519) (0.514) 0.606 0.088 0.375 -0.155 0.112 0.527 -0.208 0.096 0.605

-0.164 (0.054) -0.022 (0.043) 0.037 (0.050) 0.420 (0.150)

4.645

1 0.18 -0.27 -0.12 = 15.11 (0.019)

•

1 0.25 0.07 0.39

Money, interest rates and the Great Depression Table 9.2 (cont.) (iii) (QF, MO, PF, RH) •

0.040 -0.301 0.263 (0.138) (0.126) (0.159) 0.157 0.282 0.138 (0.161) (0.147) (0.185) 0.277 0.401 0.265 (0.122) (0.112) (0.141) 0.502 0.096 -0.003 (0.558) (0.511) (0.643)

AmO,

ARH,

-0.100 (0.039) 0.026 (0.045) 0.017 (0.034) 0.519 (0.156)

AmO,.,

0.555 0.069 -0.071 -0.340

0.754 -0.004 0.438 0.300 1.012

1 0.11 -0.14 -0.15

1 -0.01 0.11

v2, _l_

v3, ARH,., •

i

I

Vi,

v4,

I

•

•

•

9.122

1 0.51 K= 14.47 (0.025)

(iv) (QF,M3,PF,RH)

Am3t

JRH,

0.097 -0.299 0.438 (0.149) (0.193) (0.199) 0.341 0.148 0.269 (0.119) (0.153) (0.159) 0.343 0.204 0.118 (0.139) (0.180) (0.186) 0.337 0.843 -0.452 (0.585) (0.757) (0.782)

-0.136 (0.041) -0.026 (0.033) 0.048 (0.038) 0.574 (0.161) •

0.586 0.077 -0.131 -0.273

/>=

1 0.16 -0.24 -0.12

0.372 0.118 0.514 -0.168 1.009

1 0.27 -0.09

•

W.-i

•

Vi,

v2, _|_

I

4P/.-I

V3r

4RH,_,

V4/ •

9.078

1 0.47 F= 20.50 (0.002)

•

•

267

268

New perspectives on the late Victorian economy

dictated by computing resources, was to employ the statespace technique of Akaike (1976).5 As it turns out, no moving average parts were found in any of the models, so that all are pure vector AR processes; in fact, all models are of order one (vector AR(1)). This is additional evidence in favour of non-cointegration, for, if the series were indeed cointegrated, this would be revealed by the presence of (non-invertible) moving average components in the model (Engle and Granger 1987). The models so obtained are set out in table 9.2, and are reported in the form m


m

qt-i

Vl,

mt Pt-\

Pt Rr


041


Rr-l u

m

y4tm

044

where P is the contemporaneous correlation matrix of innovations obtained from 2, the contemporaneous covariance matrix of V/ = (vi,,. • -,V4,).6 These multivariate models reduce the residual standard errors of all the variables when compared with the univariate models of table 9.1: the best fitting models reduce the residual standard errors of the output and price series by approximately 30 per cent, that for MO is reduced by 15 per cent and that for M3 by 20 per cent, and the residual standard error for the Consol yield as traditionally constructed is reduced by 7 per cent and for Harley's alternative it is reduced by 3 per cent. Moreover, the marginal significance levels attached to the V statistics (see note 6), shown in parentheses under the values, reject the null hypothesis of zero contemporaneous correlation between the innovations vit in all models. Interpretation of the vector AR(1) models is hampered by the individual coefficients often being correlated and imprecisely estimated, for even in systems of this relatively small size, twenty-six parameters (sixteen autoregressive coefficients plus ten contemporaneous covariances) are being estimated from forty-three observations. We therefore follow Sims (1980) in analysing the properties of each model by supplementing direct

Money, interest rates and the Great Depression

269

interpretation with the examination of innovation accounting decompositions and impulse response functions. These measure the proportion of the A>step ahead forecast variance of a variable explained by innovations in other variables, and the dynamic response of a variable to an innovation in the others, respectively. To undertake such analysis, orthogonalising triangularisations have to be performed if the 2 matrices are nondiagonal, i.e. if the model innovations are contemporaneously crosscorrelated. Such transformations provide a reordering of the variables so that the (transformed) innovations are contemporaneously uncorrelated and thus ensure that the influence of an innovation on a variable can be uniquely identified. That this is the case has been shown above by the significant V statistics for each model. In particular, every model has a large, positive contemporaneous correlation between the price level and interest rate innovations. Hence triangularisation is required. One theme of Learner's (1985) criticisms of vector autoregressive model building is that any such triangularisation should not be arbitrarily chosen but should be based on considerations of economic theory. Dwyer (1985) suggests two hypotheses concerning the behaviour of the United Kingdom during this period that are of help here. The United Kingdom had afixedexchange rate relative to gold, and, if an economy is small relative to the rest of the world, events within the economy will not have any discernible effect on the price level or on the interest rate in that part of the rest of the world which is on the gold standard. If shocks within the economy are also uncorrelated with those in the rest of the world, then neither the price level nor interest rate will show any influence of these domestic shocks. Hence, under this 'small country' hypothesis, the price level and the interest rate may be regarded as 'predetermined', in the terminology of Cooley and Leroy (1985), with respect to money stock and output. The alternative hypothesis suggested by Dwyer is that of the 'representative economy', which has the money stock predetermined with respect to output, the price level and the interest rate. These alternative hypotheses lead us to consider two triangularisations: the 'small country' ordering of (P,R,Q,M), which also embodies the 'Gibson Paradox' relationship between the price level and the interest rate plus the exogeneity assumptions used by Mills and Wood (1982) in analysing the demand for money during this period; and the 'representative economy' ordering of (M,Q,P,R). Table 9.3 presents innovation accounting decompositions (see Sims (1980) and Doan et al. (1984)) for both orderings. Wefindthat the majority of decompositions are robust, in

270

New perspectives on the late Victorian economy

Table 9.3

Proportions of forecast error k years ahead accounted by each innovation

(i) (QF, MO, PF, RC) Forecast error in

'Small country' ('representative economy') Triangularised innovation in

k PF

PF RC QF MO

1 5 1 5 1 5 1 5

1(0.98) 0.87(0.82) 0.64(0.57) 0.61(0.47) 0.02(0) 0.09(0.09) 0.02(0) 0.08(0.05)

RC 0(0) 0(0) 0.36(0.33) 0.12(0.11) 0(0) 0(0) 0.01(0) 0.01(0)

QF 0(0) 0.10(0.16) 0(0.03) 0.26(0.37) 0.98(0.98) 0.86(0.85) 0.03(0) 0.13(15)

MO 0(0.02) 0.03(0.02) 0(0.07) 0.01(0.05) 0(0.02) 0.05(0.06) 0.94(1) 0.78(80)

(ii) (QF, MS,PF, RC) Forecast error in

'Small country' ('representative economy') Triangularised innovation in

k PF

PF RC QF M3

1 5 1 5 1 5 1 5

1(0.81) 0.88(0.72) 0.57(0.57) 0.53(0.41) 0.08(0) 0.22(0.13) 0.07(0) 0.09(0.04)

RC 0(0) 0(0) 0.43(0.43) 0.14(0.11) 0(0) 0(0) 0(0) 0(0)

QF 0(0.07) 0.09(0.18) 0(0) 0.24(0.47) 0.92(0.95) 0.75(0.75) 0.04(0) 0.08(0.10)

M3 0(0.11) 0.03(0.10) 0(0) 0.09(0.01) 0(0.05) 0.03(0.12) 0.89(1) 0.83(0.86)

(iii) (QF, MO, PF, RH) Forecast error in

'Small country' ('representative economy') Triangularised innovation in

k PF

PF RH QF MO

1 5 1 5 1 5 1 5

1(0.98) 0.86(0.82) 0.84(0.78) 0.50(0.47) 0.01(0) 0.09(0.12) 0.04(0) 0.11(0.07)

RH 0(0) 0(0) 0.16(0.15) 0.11(0.09) 0(0) 0(0) 0(0) 0(0)

QF 0(0.02) 0.11(0.16) 0(0.02) 0.37(0.40) 0.99(0.99) 0.85(0.83) 0.02(0) 0.11(0.13)

MO 0(0) 0.03(0.02) 0(0.04) 0.02(0.04) 0(0.01) 0.06(0.05) 0.94(1) 0.78(0.80)

(iv) (QF, M3, PF, RH) Forecast error in

'Small country' ('representative i economy') Triangularised innovation in

k PF

PF RH QF M3

1 5 1 5 1 5 1 5

1(0.82) 0.86(0.72) 0.79(0.67) 0.45(0.31) 0.06(0) 0.33(0.20) 0.13(0) 0.17(0.08)

RH 0(0) 0(0) 0.21(0.13) 0.04(0.03) 0(0) 0(0) 0(0) 0(0)

QF 0(0.06) 0.08(0.16) 0(0.01) 0.03(0.07) 0.94(0.96) 0.55(0.54) 0.03(0) 0.07(0.11)

M3 0(0.12) 0.06(0.12) 0(0.19) 0.48(0.59) 0(0.04) 0.12(0.26) 0.84(1) 0.76(0.81)

Money, interest rates and the Great Depression

271

the sense of remaining reasonably stable, to the alternative orderings and in all cases responses are virtually complete within five years. Where differences do occur, it is in the response of interest rates to output and monetary innovations, although even here the orderings give broadly consistent results. The distinctive features of these decompositions are threefold: (i) there is virtually no feedback from interest rates to the other variables, although more detailed analysis, to be discussed below, has isolated a feedback into output, (ii) price innovations initially explain a large proportion of the variance of interest rates, but this proportion decreases over time as output and monetary innovations become more important, and (iii) there appear to be important feedbacks from money and output innovations to price innovations, but price innovations have a somewhat weaker effect on output and money. These innovation accounting decompositions, when allied with analysis of the accompanying impulse response functions (not shown here) and the coefficient estimates of the vector AR(1) models, led us to specify and estimate two classes of structural models, distinguished by which definition of money is employed. The form of the structural model for the MO definition of money is Aqt = ao + a2XAm0t- x + a3lAptAmOt = /3xxAqt-X + €2t Apt = 7o + y\\Aqt-\ + y2XAm0,-X ARt = SioApt + <54i ARt-! + €4t.

x

+ 041 AK,_ 1 + eu (9.1) + e3t

For the M3 definition of money the structural model is Aqt = ao + O4\ARt-x + eXt Am3t = /3l0Aqt + /3nAqt- x + p2XAm3r-.x + e2t Apt = yi0Aqt + y u Aqt- x + y3XApt- x + e3t ARt = o^oApt 4- S4XARt-! + £4/,

(9.2)

where, in both models, the eit are both serially and contemporaneously uncorrelated. The specific models estimated for each combination of variables are shown as table 9.4. No variable is strongly exogenous in either system; and in the MO models only the interest rate cannot be assumed to be predetermined (see Cooley and Leroy 1985 for the distinction between strong exogeneity and predeterminedness and the importance of this distinction in models of this type). A greater degree of simultaneity exists in the M3 system, where only output can be assumed to be predetermined. Identical models are obtained for the two interest rate series, which have a

Table 9.4

Selected structural models

(i)(QF, MO, PF, RC) Aqf,

=

0.022 (0.004)

AmO, = Apf,

=

ARC,

=

-

0.272 J/nO,_, (0.137)

0.1134RC,_, (0.052)

£ = 0.0247

0.31\ Aqf,., (0.130) -0.010 (0.004) \.\StApf, (0.386)

£=0.0279 +

0.313Aqf,-l (0.126)

+

0.442JRC,_, (0.129)

+

0.280J»i0,_, (0.116)

+ 0.3274p/,_, (0.139)

£=0.0215 £ = 0.0634

, Mi, PF, -

0.019 (0.004) Am3, Apf,

=

0.139JRC,_, (0.052)

a= 0.0259

OASOAqf, + (0.085)

0322Aqf,., (0.094)

+

0.351Jw3,_, (0.103)

£=0.0163

-O.nOAqf, + (0.110)

0.344^,-, (0.112)

+

0.305Jp/,_, (0.140)

o-=0.0212

1.3594p/, (0.416)

+

0.432JRC,_, (0.129)

-

0.297 AmO,., (0.134)

cr= 0.0632

, MO, PF, 0.022 (0.004)

AmO,

ARH,

=

0.31\Aqf,_l (0.130)

=

-0.010 (0.004)

=

0.0784RH,.,, (0.035)

o-=0.0247

cr= 0.0279

(0.126) +

1.8634p/, (0.525)

0.280Jw0,_, (0.116)

0.321Apf,.u (0.139)

o-= 0.0859

0.439 JRH,_, (0.123)

(iv) (QF, M3, PF, RH) Aqf,

=

0.019 (0.004)

Am3,

=

OASOAqf, (0.085)

-

0.091 JRH,_, (0.037) (0.094)

Apf,

=

-QllOAqf, + 0.344Aqf,., (0.110) (0.112)

ARH,

=

2A56Apf (0.560)

+

0.426JRH,_, (0.122)

o-=0.0215

, o-=0.0261 0.351 J/w3,_,, o-=0.0163 (0.103) 0.3064p/,_,, (0.140)

o-=0.0212 ,

£=0.0849

274

New perspectives on the late Victorian economy


(i) response of q to m < (ii) response of q to p < (iii) response of q to r J

Years 0.4

0.2

11111111111

0.3

:

I 0.1 r / 0.0

A // \»\ \\\ \ (ii)"* .....

-0.1

(i) response of m to q • (ii) response of m to p (iii) response of m tor A

• A

(iii)

^ ^

1. . . . . . . . .

. 1

1 .

0

2

3 Years

(i) response of p to q • • (ii) response of p to m A A (iii) response of p to r o — o

•

I . . . . . . . . .

I

1

Money, interest rates and the Great Depression

275

(i) response of r to q o(ii) response of r to m A (iii) response of r to p • -

0.0
,—

-^

T

1 Years

Figure 9.6 Impulse response functions for (QF, MO, PF, RC) (a) Output responses (b) Money responses (c) Price responses (d) Interest rate responses

direct feedback only on output. The structural parameters in all models are fairly precisely estimated, but, because of the considerable feedback present in each system, detailed analysis is again best performed using impulse response functions. However, now that we have been able to make identifying assumptions of predeterminedness, the e/s in models (9.1) and (9.2) can be regarded as exogenous shocks and hence impulse response functions do have precise structural interpretations. Figures 9.6 and 9.7 show the impulse response functions for the two models containing the RC interest rate: virtually identical response functions, apart from scaling, were obtained for the models containing RH. The four systems are distinguished by important differences in the response to monetary shocks. M0 shocks have an initial once-for-all negative impact on output, a similar but positive effect on the price level, and a positive impact, that is spread over a number of years, on interest rates. Note that the interest rate response to a monetary shock is an indirect one, with the effect running from money, through output and prices, to interest rates. M3, on the other hand, is purely passive, with no feedback to other variables in the system. The impacts of output and price shocks are crucially dependent on the monetary series used. The output series, QF, has a positive impact on both M0 and M3, but for the former series the response is quick, being virtually completed within two years, while for the latter it is both

276

New perspectives on the late Victorian economy

(a) o.C

-

- •

-

(i)

-0.05 o

I -0.10 :

\

\ • (i) response of q to m • (ii) response of q to p o — — o A (iii) response of q to r A

-0.15 -0.20

• i

0

i

i

i

i

. . . 1,

I , , ,

2

, ,, 1

3 Years

(b)

0.4 0.3

2 o

(i) response of m to q •— (ii) response of m to p A— (iii) response of m to r o—

0.2

I

(C)

3=: (i) response of p to q • (ii) response of p to m A (iii) response of p to r o1

Years

1

1

Money, interest rates and the Great Depression

277

(i) response of r to q (ii) response of r to m (iii) response of r to p

-0.4 fc.

, , , I

Years

Figure 9.7 Impulse response functions for (QF, M3, PF, RC) (a) Output responses (b) Money responses (c) Price responses (d) Interest rate responses

stronger and longer lasting, taking aboutfiveyears to complete. Shocks to QF have an overall positive effect on the price level, PF, which takes roughly four years to work out, but when the M3 definition of the money supply is used, a QF shock has a contemporaneous, negative impact on PF, whereas with MO there is no such effect. A similar response is found with the interest rate: when M3 is used as the monetary variable, QF shocks have little effect, apart from a contemporaneous negative one, whereas with MO the response of interest rates is large and positive, taking about five years to complete. Interest rates respond immediately and positively to a price shock, the response being powerful, roughly exponential in decline, and with much of the response being completed within four years. PF also has a negative effect on output and both definitions of money. All responses are basically completed within a maximum of five years, with the most powerful effects being observed in the first two years.

9.5 The findings This chapter started by briefly setting out the traditional theory of the impact monetary fluctuations have on various variables before dissipating themselves in rising prices, and then linked this analysis with a series of questions prompted by the substantial body of work on the

278

New perspectives on the late Victorian economy

Gibson Paradox. It is convenient to follow that order in summarising the results. First, and worthy of emphasis, there is no initial negative effect of either definition of money on the observed nominal yield on nominal assets. This does not mean there is no such effect, but it does mean that, if there is, it is over within our unit of observation, one year. (Data limitations preclude using a shorter period of observation.) This result has the most interesting implication that any deviations from the aggregate supply curve produced by monetary disturbances were, within this period, completed within one year.7 Second, there is a positive effect of money growth on interest rates. At first glance this seems puzzling. Money growth should ultimately leave interest rates unchanged, unless it produces expectations of inflation. Why should it produce such expectations under a commodity money standard? Benjamin and Kochin (1984) accept this, and argue that there were no price trends under the gold standard. In a sense this is true; the price level in Britain stood in 1914 where it had been in 1870. But this does not mean that there were not long swings in prices. In his comment on Benjamin and Kochin, Cagan (1984) noted the presence of such swings in the USA and suggested that the gold standard delivered price level stability only over half-centuries. It took that long for a price swing to end and reverse. And in the UK a Royal Commission was established to look into the causes of the price level decline from 1870: the trend in prices was clear to contemporaries, notwithstanding its subsequent reversal. So, although an individual with afiftyyear time horizon might not have displayed a Fisher effect in his capital market transactions, it is perhaps not surprising that others did. This has a bearing on the questions prompted by the study of the Gibson Paradox, so we turn next to these. First, and most important, a positive relationship between the level of prices and that of interest rates remains. There is a clear confirmation of the Gibson Paradox - its existence does not depend, as Benjamin and Kochin (1984) claim, on the eye being fooled. Secondly, MO affects prices (M3 responds purely passively to nominal income, according to these results. Possible explanations of this are discussed in note 8).8 Thirdly, we reject Sargent's (1973) claim that prices are affected by interest rate shocks, and so remove one of his principal objections to Fisher's explanation of the Gibson Paradox. Fourthly, in confirmation of Harley (1977), money growth does affect interest rates.

Money, interest rates and the Great Depression

279

To what explanation, if any, of the Gibson Paradox does that pattern of results point? Crucial to the Fisher explanation is that money affects prices, which it does.9 Crucial too is that interest rates display a Fisher effect in response to monetary change - which they do. That MO be exogenous to the system is inconsistent with the Keynes-Wicksell explanation. Accordingly, then, we conclude that our results are more consistent with Fisher's explanation than with any other. Turning now to a broader question, where do these results leave us in relation to what is known about the British economy in the late nineteenth century? How is our understanding of the role and behaviour of money affected? In an open economy under a gold standard, traditional monetary theory predicts that income should influence money. We find it does; it has a positive effect on broad money and the effects are worked out over a period of five years. Output also has an effect on the monetary base, although here the effects have worked out inside two years. But the causality runs both ways, for the monetary base has a clear positive impact on prices and so of course on nominal income. In addition, we note that shocks to output have an effect on prices and that they work through within four years. No part of monetary theory suggests that money affects real output in the long run, and it is the long-run behaviour of the British economy that has been traditionally debated. Thefindingsof this chapter on the causes and consequences of monetary fluctuations lend support to a monetary interpretation of the long price deflation. The 'depression' of the first half of this period was, so far as Britain as a whole was concerned, confined to nominal variables. Real depression was essentially confined to agriculture. One problem that has stood in the way of widespread acceptance of this monetary explanation has been the 'Gibson Paradox'. If the fall in the general price level was a consequence of deficient monetary growth then, the argument went, there should have been a rise in interest rates. But in fact interest rates fell with prices. The explanation of the Gibson paradox that our results support is therefore crucial in underpinning the monetary explanation of the price decline. Our explanation of the paradox is consistent with a monetary explanation of prices; indeed, it depends on it, and it depends also on there being long swings in prices, as in fact there were. We therefore conclude that the long decline followed by a long rise in prices in the period 1870-1913 is, for the UK as for the US, a resultfirstof

280

New perspectives on the late Victorian economy

a scarcity of and then a small surfeit of money, not of an abundance of agricultural products. The results of this study fully support the traditional view of the role of money in the economy. The behaviour of the general level of prices over a long period was a monetary phenomenon in this period, and the behaviour of nominal interest rates was exactly as such a conclusion would lead one to expect. Notes 1 There must at some point be a jump in the price level, or a rise at faster than its equilibrium growth rate, as individuals adjust to the higher cost of holding real cash balances. This implies that there is in fact a real change, since the total utility yield on money falls. But the above discussion refers to conventional measures of real income, which exclude that yield; and it looks beyond that price level transition to its equilibrium inflationary path. 2 An admirable, and brief, survey of explanations of the paradox can be found in Cagan (1984). 3 The conditions under which the cycle phase adds information are discussed in Neftci(1986). 4 Wicksell had attributed the decline in the real rate in the first part of the period to an expansion in bank-created money increasing the supply of savings. But Cagan (1965) found that, at any rate in the US, changes in the monetary base dominated money growth. 5 This uses the PROC STATESPACE routine in SAS/ETS (SAS, 1985). The procedure begins by fitting a sequence of vector AR models using the YuleWalker equations and selects the order for which Akaike's Information Criterion is minimised. This criterion is based upon the residual variance of an estimated model, which is then 'corrected' by a penalty factor that is proportional to the number of parameters that have been estimated. This selected order is then taken as the number of past lags to use in a canonical correlation analysis which then determines the form of the model, which may contain a moving average part. Once the form has been decided, the free parameters are then estimated by maximising a likelihood function based on the sample autocovariance matrix. 6 Also shown is Anderson's (1984, chapter 9) statistic V- -Alog|P|, which is distributed as ^(f) on the null hypothesis that P is the identity matrix, and where K= T- (2/? + 11)/6 and/= lAp(p - 1), Tbeing the number of observations and p being the dimension of P. Here 7 = 4 3 and/? = 4, so K= 239/6 a n d / = 6 . 7 Whether this is quick or slow depends on one's prior expectations. But it is striking support for the finding of Friedman and Schwartz (1982) of no effect of money on output in the UK. This latter finding was of such great surprise to two of the book's reviewers, Charles Goodhart and David Laidler, that the former replicated the econometrics before accepting the result (1982), while the latter argued that it was a chance product of carrying out estimation over a period

Money, interest rates and the Great Depression

281

combining different exchange rate regimes (1982). For a further discussion of these arguments, see Capie and Wood (1989). 8 That M3 is purely passive may seem puzzling. It may, indeed, be an accidental by-product of the statistical manipulation; see Wood (1984) for an examination of this possibility in a similar context. It may well, however, be the product of the openness of the British economy combined with the exchange rate regime. In such a setting, the result is fully consistent with a monetary explanation of price level trends: see Mills and Wood (1978), and the discussion of that paper in Friedman and Schwartz (1982). However, recent work by Mills and Wood (1989) has now isolated a feedback effect running from M3 to the other variables. This comes via error correction terms in the system containing M3, these appearing as a consequence of cointegration being detected by very recently developed maximum likelihood techniques. Nevertheless, the impact of M3 is still only small and does not alter the basic conclusions of this paper. 9 It should be noted that the above quoted views of Mathias, which this finding decisively rejects, are from the most widely used text book of the past twenty years on British economic history, and, it should be added, from the latest (1983) edition. References

Akaike, H. (1976), 'Canonical correlations analysis of time series and the use of an information criterion', in R. Mehra and D. G. Lainiotis (eds.), Advances and Case Studies in System Identification, New York: Academic Press. Anderson, O. D. (1976), Time Series Analysis and Forecasting: The Box-Jenkins

Approach, London: Butterworths. Anderson, T. W. (1984), An Introduction to Multivariate Statistical Analysis,

second edn, New York: Wiley. Benjamin, D. K. and Kochin, L. A. (1984), 'War, prices and interest rates: a martial solution to Gibson's paradox', in M. D. Bordo and A. J. Schwartz (eds.), A Retrospective on the Classical Gold Standard, 1821-1931, University

of Chicago Press for NBER, 587-604. Bordo, M. D. and Schwartz, A. J. (1981), 'Money and prices in the nineteenth century: was Thomas Tooke right?', Explorations in Economic History, 18: 97-127. Box, G. E. P. and Jenkins, G. M. (1976), Time Series Analysis: Forecasting and

Control, revised edn, San Francisco: Holden-Day. Cagan, P. (1965), Determinants and Effects of Changes in the Stock of Money

1875-1960, New York: Columbia University Press for NBER. (1972), The Channels of Monetary Effects on Interest Rates, New York:

NBER. (1984), 'Mr. Gibson's paradox: was it there?', in M. D. Bordo and A. J. Schwartz (eds.), A Retrospective on the Classical Gold Standard, 1821-1931,

University of Chicago Press for NBER, pp. 604-10.

282

New perspectives on the late Victorian economy

Capie, F. H. and Webber, A. (1985), A Monetary History of the United Kingdom, Volume 1: Data, Sources, Methods, London: George Allen and Unwin. Capie, F. H. and Wood, G. E. (1984), 'Gold, empire, and crises: some explorations in U.K. monetary history', Centre for the Study of Monetary History, Discussion Paper 13, City University Business School. (1989), 'Anna Schwartz's perspective on British economic history', in M. D. Bordo (ed.), Money, History, and International Finance: Essays in Honor of Anna Schwartz, University of Chicago Press for NBER. Cooley, T. F. and LeRoy, S. F. (1985), 'Atheoretical macroeconometrics: a critique', Journal of Monetary Economics, 16: 283-308. Coppock, D. J. (1956), The climacteric of the 1890s: a critical note', Manchester School, 24: 1-31. (1961), The causes of the great depression', Manchester School, 29: 205-32. Crafts, N. F. R., Leybourne, S. J. and Mills, T. C. (1989a), The climacteric in late Victorian Britain and France: a reappraisal of the evidence', Journal of Applied Econometrics, 4: 103-17. Crafts, N. F. R., Leybourne, S. J. and Mills, T. C. (1989b), Trends and cycles in British industrial production 1700-1913', Journal of the Royal Statistical Society, Series A, 152: 43-60. Dickey, D. A., Bell, W. R. and Miller, R. B. (1986), 'Unit roots in time series models: tests and implications', American Statistician, 40: 12-26. Doan, T. A., Litterman, R. B. and Sims, C. A. (1984), 'Forecasting and conditional projection using realistic prior distributions', Econometric Reviews, 3: 1-100. Dwyer, G. P. Jr. (1984), The Gibson Paradox: a cross-country analysis', Economica, 51: 109-27. (1985), 'Money, income and prices in the United Kingdom: 1870-1913', Economic Inquiry, 23: 415-35. Elbaum, B. and Lazonick, W. (eds.) (1986), The Decline of the British Economy, Oxford: Clarendon Press. Engle, R. F. and Granger, C. W. J. (1987), 'Cointegration and error correction: representation, estimation and testing', Econometrica, 55: 251-76. Feinstein, C. H. (1972), National Income, Expenditure and Output in the United Kingdom, Cambridge University Press. (1987), 'Wages and British economic growth: a comment', mimeo, Harvard University. Feinstein, C. H., Matthews, R. C. O. and Odling-Smee, J. C. (1982), The timing of the climacteric and its sectoral incidence in the UK', in C. P. Kindleberger and G. di Telia (eds.), Economics of the Long View, Volume 2, Part 1, Oxford: Clarendon Press, pp. 168-85. Fisher, I. (1907), The Rate of Interest, New York: Macmillan. (1930), The Theory of Interest, New York: Macmillan. Friedman, M. and Schwartz, A. J. (1982), Monetary Trends in the United States and the United Kingdom, University of Chicago Press.

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Goodhart, C. A. E. (1982), 'Monetary trends in the United States and the United Kingdom: a British review', Journal of Economic Literature, 20: 1540-51. Greasley, D. (1986), 'British economic growth: the paradox of the 1880s and the timing of the climacteric', Explorations in Economic History, 23: 416-44. Harley, C. K. (1976), 'Goschen's conversion of the national debt and the yield on consols', Economic History Review, 2nd Series, 29: 101-6. (1977), T h e interest rate and prices in Britain, 1873-1913: a study of the Gibson Paradox', Explorations in Economic History, 14: 69-89. Hendry, D. F., Pagan, A. R. and Sargan, J. D. (1984), 'Dynamic specification', Chapter 18 of Handbook of Econometrics, Volume 2, Z. Griliches and M. D. Intrilligator (eds.), Amsterdam: North-Holland, pp. 1023-100. Hicks, J. R. (1967), Critical Essays in Monetary Theory, Oxford: Clarendon Press. Hughes, J. R. T. (1968), 'Wicksell on the facts: prices and interest rates, 1844 to 1914', in J. N. Wolfe (ed.), Value, Capital and Growth: Papers in Honour of Sir John Hicks, Edinburgh University Press, pp. 215-55. Keynes, J. M. (1930), A Treatise on Money, London: Macmillan. Kirby, M. W. (1981), The Decline of British Economic Power Since 1870, London: George Allen and Unwin. Klein, B. (1975), 'Our new monetary standard: the measurement and effects of price uncertainty, 1880-1973', Economic Inquiry, 13: 461-83. Laidler, D. (1982), 'Friedman and Schwartz on monetary trends: a review article', Journal of International Money and Finance, 1: 293-305. Learner, E. E. (1985), 'Vector autoregressions for causal inference?', CarnegieRochester Conference Series on Public Policy, 22: 255-304. Ljung, G. M. and Box, G. E. P. (1978), 'A measure of lack of fit in time series', Biometrika, 65: 297-303. Lutkepohl, H. (1982), 'Differencing multiple time series: another look at Canadian money and income data', Journal of Time Series Analysis, 3: 235-43. Mathias, P. (1983), The First Industrial Nation: An Economic History of Britain, 1700-1914, London: Methuen. Matthews, R. C. O., Feinstein, C. H. and Odling-Smee, J. C. (1982), British Economic Growth 1856-1973, Oxford: Clarendon Press. Mill, J. S. (1848), Principles of Political Economy, London: Parker, Son and Bourn. Mills, T. C. and Wood, G. E. (1978), 'Money, income and causality under the gold standard', Federal Reserve Bank of St. Louis Review, 60: 22-7. (1982), 'Econometric evaluation of alternative money stock series, 1880-1913', Journal of Money, Credit and Banking, 14: 265-77. (1989), 'Money and interest rates in Britain from 1870 to 1913', Midland Montagu Centre for Financial Markets, Discussion Paper 9, City University Business School.

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Neftci, S. (1986), i s there a cyclical time unit?\ in K. Brunner and A. H. Meltzer (eds.), Carnegie-Rochester Conference Series on Public Policy, 24: 11-48. Nelson, C. R. and Kang, H. (1981), "Spurious periodicity in inappropriately detrended time series', Econometrica, 49: 741-51. (1984), 'Pitfalls in the use of time as an explanatory variable in regression', Journal of Business and Economic Statistics, 2: 73-82. Paish, F. W. (1966), Long-Term and Short-Term Interest Rates in the United Kingdom, Manchester University Press. Phelps Brown, E. H. and Handfield Jones, S. J. (1952), The climacteric of the 1890s\ Oxford Economic Papers, 4.3: 266-307. Phelps Brown, E. H. and Ozga, S. A. (1955), 'Economic growth and the price level\ Economic Journal, 65: 1-18. Phillips, P. C. B. and Durlauf, S. N. (1986), 'Multiple time series regression with integrated processes', Review of Economic Studies, 53: 473-95. Sargent, T. J. (1973), interest rates and prices in the long run', Journal of Money, Credit and Banking, 5: 385^49. Shiller, R. J. and Siegel, J. J. (1977), The Gibson Paradox and historical movements in real interest rates', Journal of Political Economy, 85: 891-907. Sims, C. A. (1980), 'Macroeconomics and reality', Econometrica, 48: 1-48. Sked, A. (1987), Britain's Decline, Oxford: Blackwell. SAS (1985), SAS/ETS User's Guide, Version 5 Edition, Cary, NC: SAS Institute Inc. Thornton, H. (1802, 1978), An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, Fairfield, N.J.: Augustus M. Kelley. Tiao, G. C. and Box, G. E. P. (1981), 'Modelling multiple time series with applications', Journal of the American Statistical Association, 76: 802-16. Tjostheim, D. and Paulsen, J. (1982), 'Empirical identification of multiple time series', Journal of Time Series Analysis, 3: 265-82. Wicksell, K. (1907), The influence of the rate of interest on prices', Economic Journal, 17:213-20. Wood, G. E. (1984), 'Comment on "real output and the gold standard years" by Stephen Easton', in M. D. Bordo and A. J. Schwartz (eds.), A Retrospective on the Classical Gold Standard 1821-1931, Chicago University Press for NBER.

Chapter 10

The UK demand for money, commercial bills and quasi-money assets, 1871-1913 Paul Turner

10.1 Introduction This chapter is concerned with the development of the financial sector and the availability of close money substitutes in pre-1914 Britain. The financial sector is important to economic historians for a number of reasons. Firstly it is widely believed that an adequatefinancialsystem is a necessary, but not a sufficient, condition for the process of industrialisation and growth. The late Victorian/early Edwardian periods are frequently characterised as years of relative economic decline. It is therefore interesting to examine to what extent this might be explained by the failure of suitable financial instruments to develop. For example, this could be the case if the institutions which were capable of channelling small savings failed to develop, thus reducing the savings rate and lowering capital growth. A second source of interest derives from one of the great policy debates of the early nineteenth century, that between the Currency and Banking schools. Collins (1978) has argued that the central proposition of the Banking school was that expansion of the stock of close money substitutes would frustrate any attempts to enforce strict monetary discipline. Thus the extent to which such substitutes were available is of interest. Finally a number of studies of the macroeconomics of the Victorian era have made use of the demand for money function as a central part of the analysis. The best-known example of this is McCloskey and Zecher's (1976) analysis of the pre-1914 gold standard. It is therefore important to assess to what extent the correct monetary aggregate has been chosen and whether or not the functions used are adequately specified. The income velocity of circulation has been used as a way of comparing the stages of financial development achieved by various countries. Bordo and Jonung (1981) discuss the comparative pattern of development of the monetary sector for five industrial countries, the UK, USA, Canada, Norway and Sweden. They look at lengthy time series on the income velocity of circulation for a broad money measure and conduct an 285

286

New perspectives on the late Victorian economy

econometric investigation of the trends observed. In general a very clear pattern emerges. Income velocity declines throughout the late nineteenth century but flattens out and begins to rise at some stage during the twentieth century. The UK is the only country which does not follow this pattern, in that the initial decline in velocity is not discernible, although the subsequent upward trend is present. The trends evident in the data are argued to be the result of a common pattern of institutional development across countries. Initially the downward trend in velocity is the result of a change in the structure of production away from agriculture towards industry, i.e. towards a sector that makes more intensive use of monetary transactions. Parallel to this trend is the spread of the banking infrastructure which draws previously non-monetary transactions into the monetary arena. The subsequent increase in velocity is the result of increasing financial sophistication, which leads to the creating offinancialinstruments which are close money substitutes, and increasing economic stability which leads agents to economise on their holdings of money balances. In this chapter I examine the exception to the secular trends observed by Bordo and Jonung, the UK economy in the period 1870-1913. Here velocity failed to decline as it did elsewhere. My argument is that the development, and increasing use, of close money substitutes can be detected even at this early stage. The chapter is divided up as follows. In thefirstsection I discuss the historical and institutional background relevant to the modelling offinancialmarkets in the late nineteenth century. The development of the banking sector and that of closely relatedfinancialinstitutions are discussed in detail. In the second section I develop a theoretical framework for the analysis of thefinancialsector. This enables a theory of the demand for money to be derived from a general portfolio equilibrium analysis of the financial sector as a whole. It also generates a range of empirically testable hypotheses. The third section presents estimated demand functions for three groups of assets and tests a series of restrictions on the form of these functions. Following this I compare the demand functions for the pre-1914 period with those obtained for later periods. The final section contains an overview and conclusions. Detailed discussions of econometric methods and data are contained in appendices.

10.2 Financial institutions 1870-1913 The development of financial institutions during the late nineteenth century should be seen as part of a longer-term process which had

The UK demandfor money

287

begun during the industrial revolution. Kindleberger (1984) identifies the second half of the eighteenth century as a period of most rapid expansion in the number of English banks. The subsequent decline began early in the nineteenth century. During the late eighteenth and early nineteenth centuries commercial bills circulated as an alternative means of exchange to bank notes, particularly in Lancashire. This practice would seem to have largely died out early in the nineteenth century due to the imposition of Stamp Duty on small bills of exchange (cf. Ashton 1945). Therefore after 1870 any substitutability between bank deposits and bills would have arisen through their roles as alternative sources of trade credit rather than as a means of payment. In this section of the chapter the discussion concentrates on the development of the financial sector of the economy after 1870, since this is the period for which econometric equations will be estimated. Traditional analysis of the monetary sector has been confined to the clearing banks, in that the most commonly used definition of the money supply is the sum of their deposits and notes and coins in circulation with the public (M3). However it is by no means clear why this should be the case. During the late nineteenth century the deposits of Savings Banks and Building Societies possessed similar liquidity characteristics, although they tended to cater for different groups of customers. Savings Bank and Building Society accounts were very similar to deposit accounts, i.e. accounts against which cheques could not be drawn but which were capital safe and could be quickly redeemed for cash. This chapter therefore examines the effects of using a broader definition of money which includes clearing bank deposits and the deposits of the other financial institutions listed above. This aggregate is termed quasi-money. Turning to table 10.1 it can be seen that deposits with the clearing banks formed by far the largest fraction of total quasi-money, rising from 67 per cent in 1880 to 70 per cent in 1913. Building Society and Trustee Savings Bank deposits declined slightly in importance while Post Office Savings Bank deposits more than doubled their share. The final component of quasi-money, notes and coin in the hand of the public, declined throughout the period. The almost constant share of quasi-money taken by bank deposits is somewhat surprising since there were fundamental structural changes within this sector during the period under consideration. As table 10.2 shows, the secular decline in the number of banks which had begun in the early nineteenth century continued, and in 1913 the figure stood at less than 20 per cent of its 1871 value. This decline in the number of banks was

288

New perspectives

Table 10.1

on the late Victorian

economy

Deposits of financial institutions as % of

Bank Deposits TSB Deposits POSB Deposits BS Deposits

quasi-money

1880

1890

1900

1910

1913

67 7 5 7

68 6 8 7

69 5 12 5

69 5 13 5

70 5 13 4

Notes: JSB = Trustee Savings Bank, POSB = Post Office Savings Bank BS = Building Society. Sources: Capie and Webber 1985, Home 1947, Sheppard 1971.

Table 10.2 Changes in structure offinancialsector

No. of Banks Av. Offices per bank No. ofTSBs No. of BSs

1871

1880

1890

1900

1910

1913

363 4.5 489 n.a.

341 6.5 442 1853

281 10.8 324 4472

164 27.9 230 2286

84 70.6 219 1723

70 93.9 202 1550

Note: n.a. = not available. Sources: Nishimura 1971, Home 1947, Sheppard 1971.

accompanied by a rapid expansion in the average number of offices per bank. Note that although the number of Trustee Savings Banks and Building Societies also declined this was on nothing like the same scale as in the clearing bank sector. Essentially what happened was that the old system of many local country banks servicing a particular area was superseded by a system of relatively few joint stock banks with extensive branch networks. Changes in the structure of deposit-taking institutions were not the only important changes in the monetary sector during this period. Nishimura (1971) documents a decline in the use of commercial bills from 1870 onwards. Between the cyclical peaks of 1873 and 1882, the real value of commercial bills (Nishimura's estimate deflated by the GNP deflator) fell by 10 per cent while the real value of M3 increased by 17 per cent. Conventionally this has been argued to be the result of the growth in the branch banking system described in the previous paragraph. However, as Nishimura argues, the main period of decline is prior to the most rapid period of increasing concentration in the banking sector. Instead he argues that it can be better explained by a reduction in the need for firms to maintain inventories. This in turn was due to the widespread adoption

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289

of faster and cheaper transport of goods, based on the steam engine, and improved communications due to the telegraph. What is surprising about the decline of the commercial bill market is that such a major change in the means of transactions did not produce a decline in velocity comparable to that observed in other advanced economies during the period.

10.3 A theoretical framework for analysis of the financial sector In most industrialised countries the development of the financial sector can be seen to have followed a common historical pattern. This involves a very rapid increase in the size of this sector relative to national income and wealth during the period of industrialisation, followed by a levelling off as the economy reaches maturity. Goldsmith (1969) defines the stage offinancialdevelopment in terms of the 'financial interrelationships ratio', i.e. the ratio of the aggregate market value of all financial instruments to the value of net tangible wealth. During the process of industrialisation this increases because of a growing separation of savings and investment decisions between different economic groups. Even when the relative size of the financial system as a whole has reached its limit important changes continue to take place within it. In particular the banking system, which originally provides the impetus for the growth of finance, begins to decline as new institutions offering close substitutes for its assets begin to appear. These new institutions vary according to the economy being studied, but savings banks, building societies, life insurance and pension funds are common to many of them. These institutions are collectively referred to as non-bank financial institutions (NBFI's). The relationship between the Goldsmith view of the evolution of the financial system and the conventional demand for money function can be illustrated using the following simple model. At any date in time there exists a certain stock of financial wealth consisting of the sum of the values of allfinancialinstruments in existence, as shown by equation (10.1). WF=2Fj

(10.1)

The aggregate real wealth of the economy (WR) can be defined in terms of an infinite discounted sum of permanent income (YP) as shown by equation (10.2). WR = p-xYP where p is the discount rate.

(10.2)

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Goldsmith's measured financial interrelationships ratio can be thought of as an empirical attempt to estimate the ratio of WF to WR. In a steady state there will be some fixed proportional relationship between real and financial wealth. In principle therefore it should be possible to derive a set of portfolio balance equations linking the demand for each asset with the rates of return on all assets, permanent income and the rate of time discount. When it comes to empirically implementing this type of theory there are a number of obvious problems. First direct observation of permanent income and the rate of time discount is not possible. This need not be a major drawback, since the rate of time discount is likely to remain reasonably constant through time and the level of permanent income can be estimated by taking some form of distributed lag on past real incomes. A second problem is that data on a number of financial assets are not available. Again this need not be a problem for the estimation of demand functions for the assets on which data are available, providing there are data on the rates of return (r,-) on the missing assets. This enables the demand for any single asset to be written as in (10.3). Fj=fjirur2,...rN9YP)

(10.3)

For example the textbook money demand model can be interpreted as defining financial wealth as consisting of money plus bonds. The single rate of interest is then set so that the fixed stocks of these assets are willingly held. Even if data on the stock of bonds were not available it would still be possible to estimate a single equation demand for money function. In all but the simplest financial sectors there exist a large number of possible groupings of assets consistent with the identity (10.1). For example currency is normally aggregated with bank deposits to form a monetary aggregate. Such groupings are somewhat arbitrary, often determined by the data collection methods of statisticians, or the priorities of other researchers, rather than any underlying economic rationale. A less ad hoc procedure might be to seek a decomposition of total financial assets into subgroups for which the demand functions are homogeneous of degree one in permanent income. This means that the portfolio composition is fully determined by the relative rates of return on different assets and is independent of the absolute size of the portfolio. Another way of thinking of this is that if this condition does not hold then a type of substitution between assets is taking place which is not being captured by any sort of economic model.

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In empirical work the restriction of a unit elasticity is frequently made without being tested. This is especially the case given the widespread use of the error correction mechanism formulation. When estimating an error correction model an econometrician uses homogeneity restrictions to define a long-run equilibrium state and then models the short-run dynamics of the variable of interest around the imposed long-run solution. Recent papers on the pre-1914 demand for broad money by Capie and Rodrik-Bali (1985) and Mills and Wood (1982) use an error correction formulation for their demand functions which has the effect of imposing a steady state income elasticity equal to one. Whether a decomposition of the portfolio into groups of assets with a unit elasticity can be found or not is ultimately an empirical question. However a number of theoretical points can be made before such an attempt is made. The first, and most obvious point, is that the search can be narrowed by grouping together assets with similar liquidity characteristics. A second important point is that in the early stages of financial development, as discussed by Goldsmith, the elasticity of demand for all assets will exceed unity, since the ratio between the financial and real wealth variables will be increasing. Thus the decline in the velocity of circulation observed by Bordo and Jonung, in countries with a developing financial sector, is not inconsistent with their broad money measure forming part of a valid decomposition of financial wealth. This type of framework can also be related to the currency/banking school debate of the nineteenth century, or its modern equivalent seen in the debate between the monetarist and Radcliffe Report views of the world. The monetarist argument would be that a stable decomposition of financial wealth can be found empirically (which enables 'money' to be separately identified from other financial assets). The Radcliffe view would be that any decomposition is so arbitrary, and vulnerable to the creation of new financial instruments, that it will remain stable only so long as no attempt is made to formulate policy using it as a basis. How does this analysis relate to thefinancialsector of the UK economy prior to the First World War? The first point to note is that there seems strong evidence that, alone among the world economies, the UK had already reached financial maturity by this stage (cf. Bordo and Jonung). Thus the monetisation process cannot be the reason for income elasticities being found to be greater than one. It would therefore be reasonable to look for groupings of assets which have a unit elasticity. I consider three types of asset: money, quasi-money and commercial bills. The main hypotheses to be considered can be stated as follows:

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New perspectives on the late Victorian economy (1) Money and quasi-money assets possess such similar characteristics that there is no valid reason to differentiate between them and they should be aggregated together. The demand function for the joint asset thus defined should exhibit a unit income elasticity. However the income elasticities for M3 and NBFI's should be less than, and greater than, one respectively. (2) Commercial bills constitute a different type of asset in that they were held mainly for transactions purposes and, by the end of the period, were dominated by the demand for credit to finance overseas trade. (3) The decline in the use of commercial bills can be explained by the increasing speed with which information could be transmitted due to the telegraph, along with faster and cheaper transportation of goods. These factors jointly reduced the need for firms to carry inventories and therefore reduced the demand for short-term credit instruments. Although Nishimura uses this to explain the decline of the inland bill only, there is no reason to suppose that similar economies in the use of overseas finance were not available.

The next section goes on to show how these hypotheses can be made testable within a system of estimated demand functions for the three assets.

10.4 Empirical results In order to test the hypotheses outlined in the previous section I begin by setting out a very general system of demand equations for the assets under consideration as shown by (10.4). ax(L) Ft = ao + a2{L) Y + a3(L) rB + a4(L)rD + as{L)rc + a6(L) W + aHL)T+et (10.4) where Ft is the /th financial asset, Y is Gross National Product, rB, rD, rc are the rates of interest on long-term government bonds, bank deposits and commercial bills respectively, W is an index of world trade, T is an index of the number of telegram messages and e is a stochastic error term. All variables are in logarithmic form. Details of data sources can be found in appendix 10.2. The theory of the previous section did not indicate a role for the world trade variable in the M3 and NBFI deposits equations.

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However it has been included here in the belief that theoretical restrictions of this kind should be subjected to empirical testing wherever possible. Another reason for including the world trade index in the M3 equation is that under the pre-1914 gold standard sterling was the major world currency. It is therefore possible that it played a vehicle currency role in financing trade similar to that played by the dollar in the modern world economy. The telegram index is included to capture the shift away from commercial bills towards money as a result of improved communications. An index of the quantity of telegrams sent is appropriate here since the cost of sending messages hardly changed throughout the period. The first stage of the statistical analysis was to run a series of general regression equations containing the current value and a one period lag on each variable. I then used a series of F-tests of exclusion restrictions to see which variables could be legitimately omitted from each equation. The results are reported in table 10.3. The commercial bills variable includes both inland and foreign bills. However, as Nishimura (1971, p.5.) notes, the distinction between these was not clear cut, with inland bills frequently being used to finance foreign transactions. While it would certainly be preferable to treat inland and foreign bills separately, separate estimates for the two categories are not available for the period 1871-92 which constitutes a major period of interest, i.e. the decline of the bill market described by Nishimura. The own rate of interest on NBFI deposits has not been included since no consistent series is available. However this may not bias the results seriously since the evidence suggests that rates on this class of deposits tended to move very little. The Post Office and TSBs were subject to legal restriction on interest paid while the one series I could find for Building Society rates (Home 1952) showed only two changes during the whole period. For the M3 equation the only exclusion restriction to prove significant is that for GNP, while for the commercial bills equation the only significant F-test is attached to the world trade index. This supports the hypothesis that the demand for these two assets can be characterised as deriving from domestic and external sources respectively. The equation for NBFI deposits is interesting in that both the above variables, plus the telegram index, yielded significant F-tests. A possible explanation for these findings will be discussed later. None of the exclusion restrictions associated with interest rates proved significant, though this may simply be due to the presence of three highly correlated rates in each equation. The next stage of the analysis was to examine the form taken by the

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New perspectives on the late Victorian economy

Table 10.3 Exclusion restrictions for M3, NBFI deposits and commercial bills equations

DOF = 26

NBFI deposits DOF = 1 9

Commercial bills DOF = 26

0.48 0.78 0.62 4.35 ** 0.71

3.90 ** 1.01 11.25*** 13.97*** 1.95

4.59 ** 1.78 1.04 1.25 0.37

M3

World trade index Commercial bill rate Telegram index GNP Deposit and bond rates

Note: All statistics show F-tests for HQ.P\ = p2 = Av = 0 where the /3, are the coefficients on the variables listed in the left-hand column. Each statistic is therefore distributed as F(N,D) where D is the number of degrees of freedom for the equation. *, **, and *** indicate significance at the 10, 5 and 1% levels respectively.

Table 10.4 Demand functions for M3, NBFI deposits and commercial bills

GNP Bond rate Deposit rate Bill rate World trade index

M3

NBFI deposits

Commercial bills

0.8962 (.0305) -0.3245 (.0906) 0.0839 (.0168) -

2.3741 (.5062) -0.5093 (.1578) -0.1609 (.0545) -

-0.6809 (.2338) -

-

Telegram index Dates R2 Durbin-Watson LM(1) LM(2) ARCH(l) HSQ

1873-1913 0.9933 2.302 1.95(1,34) 0.42(1,34) 0.01 (1,33) 0.59 (10,24)

-0.2678 (.1577) -0.4509 (.1867) 1882-1913 0.9959 1.978 0.00(1,24) 0.56(1,24) 0.27(1,23) 0.59(12,12)

-0.0549 (.0275) 0.6047 (.0886) 0.0222 (.0499) 1875-1913 0.8816 2.122 0.24(1,31) 0.04(1,31) 0.26(1,30) 1.52(12,19)

Note: All coefficients are equilibrium elasticities derived from a general dynamic model. Standard errors are given below the coefficient estimates. The numbers in brackets next to test statistics indicate the degrees of freedom on which these statistics are based.

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demand equations. Table 10.4 shows the equilibrium elasticities derived from general dynamic models for each asset. The method used to derive these elasticities is described in appendix 10.1. In each case I began with two lags on each variable in the regression and then successively eliminated those variables with the lowest t-ratios attached to their coefficients until all those remaining in the regression had a t-ratio greater than 1.7. It was necessary to eliminate some variables on the basis of a priori information in order to have enough degrees of freedom to carry out the specification search. On the basis of table 10.3 I left out the bill rate from the M3 and NBFI deposits equations and the bond and deposit rates from the commercial bills equation. The test statistics below each equation show that no systematic component is present in the error terms. The expected signs on the long-run elasticities are as follows: income and world trade should be positive, rates of interest on alternative assets should be negative and the telegram index should be negative in the bills equation and positive in the other two equations. The sign of the deposit rate in the M3 equation is more problematic since a large fraction of this variable was non-interest bearing. It is possible that this variable may capture the cost of bank loans rather than the return on bank deposits and may therefore take on a negative sign. There is similar ambiguity over the sign of the bill rate in the commercial bills equation. The hypotheses that the income elasticities for M3 and NBFI deposits should be less than and greater than unity respectively are supported by the evidence in table 10.4. T-tests for each of these hypotheses yield values of 3.4 and 2.7 respectively, both significant for a one-tailed test at the 1 per cent level. The bond and deposit rates prove significant and negative in the M3 equation, though the world trade index was eliminated during the specification search. The relationship between the NBFI deposits and commercial bills elasticities deserves further comment. In the NBFI deposits equation the income elasticity is positive and the trade elasticity is negative while the reverse holds for the commercial bills equation. What may be happening is that NBFI deposits increased when world trade was low due to an influx of working capital which would otherwise have been employed in financing trade. Similarly it could be the case that the negative income elasticity in the commercial bills equation reflects the 'crowding out' of exports as GNP rises and therefore a reduction in the demand for bills. Finally the results of including the telegram index are somewhat disappointing from the point of view of the Nishimura hypothesis. It proved to be insignificant in both the M3 and the commercial bills equations and

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New perspectives on the late Victorian economy

Table 10.5 Demand function for quasi-money and ratio of M3 to NBFI deposits Total quasimoney

Ratio of M3 to NBFI deposits

Telegram index

0.8735 (0.09) -0.3123 (0.11) -0.1210 (0.02) 0.0395 (0.05) -

-1.9344 (0.47) 0.3567 (0.28) -0.0094 (0.03) 0.3785 (0.14) 0.4871 (0.13)

Dates R2 Durbin-Watson LM(1) LM(2) ARCH(l) HSQ

1882-1913 0.9556 1.76 0.36(1,24) 0.88(1,24) 0.97(1,23) 0.34(12,12)

1882-1913 0.9738 2.09 0.12(1,22) 1.92(1,22) 0.26(1,21) 0.52 (16,6)

GNP Bond rate Deposit rate World trade index

although it is significant in the NBFI deposits equation it has the wrong sign if it is to be interpreted as capturing a shift from commercial bills to other financial assets. What may be happening is that better communication caused a shift from small NBFI institutions towards the clearing banks with large networks of branches.1 My argument so far has been that M3 and NBFI deposits should be aggregated together to form the most appropriate monetary aggregate. In order to test whether this is permissible I estimated equations for the sum of the two assets and for their ratio. If aggregation is appropriate then the sum of the two assets, quasi money, should have a unit income elasticity and a negative elasticity with respect to the bond rate, while the sign of the deposit rate remains uncertain. The equation for the ratio of the two assets should exhibit a negative income elasticity but the interest rates should be insignificant. This is because interest rates should determine the portfolio choice between the aggregate asset and all other assets, but should not affect the proportions of quasi-money held in different subassets. The results given in table 10.5 are consistent with these initial hypotheses. Although this does not contradict the theoretical argument it should be noted that the point estimate of the elasticity is actually lower

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Table 10.6 Income and interest rate elasticities 1871-1980 (plus cointegration test statistics) Pre-1914

Interwar

Post 2nd WW

0.8874 -0.3410 2.64 0.15

0.7995 -0.5310 3.70 1.02"

0.9491 -0.4238 2.53 1.28**

1.7300 -0.5874 2.35 0.17

Quasi-money definition 1.3339 -0.3910 Bond rate DF test 2.75 DW test 0.17

1.0344 -0.5283 4.09* 0.98*

1.3634 -0.6586 2.10 0.98*

1.8581 -0.5187 2.47 0.11

Whole sample

M3 definition of money GNP Bond rate DF test DW test

GNP

Note: *, ** and *** indicate significance at the 10, 5 and 1% levels respectively as given in Engle and Yoo (1986). The interwar sample size is below the minimum they report so the critical values used are for samples size 50.

than that for M3 alone. The reason why it is not significantly different from one is that the standard error has risen considerably.

10.5 Comparisons with later periods Throughout the pre-1914 period the monetary authorities adopted a consistent policy centred around the maintenance of the gold standard. Such consistency is not a feature of subsequent periods in which financial innovation has frequently been stimulated by government policy changes. It is therefore interesting to examine the performance of money demand functions for these later periods and compare them with those estimated for the pre-1914 gold standard era. Most studies of the demand for money function using data for over a century scale the money and income series by population to avoid heteroscedasticity in the residuals cf. Bordo and Jonung and Friedman and Schwartz. This procedure has been adopted to obtain the results given in table 10.6 which reports the equilibrium income and bond rate elasticities for M3 and quasi-money over the whole sample and for the three peacetime periods. Only one interest rate has been included but this is unlikely to impart any serious bias to the results since the bond and deposit rates tend to move together over the long run. Dummy variables were included in the whole sample estimates to allow for the war years and the exclusion of Southern Ireland from the data after 1920.

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New perspectives on the late Victorian economy

For the sample as a whole the income elasticity is insignificantly different from unity for either definition of money. However for the pre-1914 period the pattern which emerged earlier remains true for the scaled data, with an income elasticity for M3 significantly less than unity, while that for quasi-money is very close to unity. In the later periods the income elasticities for both definitions are insignificantly different from unity. Thus it appears that the composition of quasi-money stabilised after 1914. One notable feature is the poor performance of the equations for the post-Second World War period, with large standard errors on the elasticities making these insignificantly different from zero. One argument is that the post-war results could be distorted due to the inclusion of the immediate post-war years 1946-52 which were characterised by an extensive system of controls over the economy. However eliminating these years from the sample does not improve the performance of the model significantly. Instead the main reason for the poor performance of the model after the Second World War seems to be a secular decline in the stock of real money balances per capita from 1946 to 1958 under both definitions of money. This is despite the fact that real income per capita was increasing throughout this period. These results contrast with those of other researchers over the post-war period since most such work has made use of quarterly data starting in the early 1960s. Thus the whole of the 1950s, in which the anomalous results I find have their origin, are eliminated from such data sets. However Friedman and Schwartz (1982, p.246) calculate estimates of the income elasticity using annual data in terms of changes and obtain negative values. A fundamental problem with the post-1914 data derives from the frequent regime shifts that took place. Changes in the exchange rate regime are particularly important in that they alter the money supply process. However changes in the monetary rules adopted by the policy authorities may also have had effects. The Lucas (1976) critique of econometric analysis argues that such policy changes will produce instability in estimated equations. However the types of regime shift described above are more likely to have affected the dynamics of the equations estimated rather than their steady-state properties. Therefore, to the extent that the equations presented here focus on the steady-state, they are relatively immune to such criticism. The DF and DW statistics reported in table 10.6 are tests for whether the demand for money function can be regarded as a valid equilibrium function. These are derived from the recent literature on cointegration described in appendix 10.1. The evidence for cointegration of real money

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balances per capita and the explanatory variables seems to be much stronger for the pre-1914 period than for any other. However see appendix 10.1 for a discussion of the power of these tests.

10.6 Conclusions In this chapter I have examined several hypotheses concerning financial markets in pre-1914 Britain. The first of these concerned the degree of substitutability between various forms of financial asset. While there is little evidence to suggest that bank deposits and commercial bills were substitutes, as would be indicated by the Nishimura hypothesis, there does seem to be considerable evidence that bank and NBFI deposits were very good substitutes. This indicates that adequate financial instruments existed for the channelling of small savings into productive investment and therefore a lack of such instruments cannot be cited as an explanation of the relatively poor performance of the UK economy during this period. The second main hypothesis examined concerned the long-run income elasticity of demand for money. The importance of the income elasticity lies in the fact that it provides an indicator of the stage of financial development of the economy. Here I found evidence that the UK income elasticity was significantly less than unity when the monetary aggregate was defined as notes and coins in the hands of the public plus the deposits of the banking system. This is in sharp contrast to the elasticities found by other researchers, for other countries, during this period. I have also argued that, for afinanciallymature economy, it is important to choose a monetary aggregate which has an income elasticity equal to unity. This is because without this condition a form of substitution is taking place which is not being modelled. This may have serious consequences if the financial aggregate concerned is being used as a measure of the general state of liquidity of the economy. For example, in McCloskey and Zecher's analysis of the gold standard, gold flows are determined by the difference between the incremental demand for money and domestic credit expansion. The results presented here indicate that the demand for extra money balances could also have been met by an expansion of NBFI deposits. Further work is needed to see whether the results derived from studies using the M3 definition would be changed significantly if a more appropriate aggregate was used. Evidence for the post-1914 period indicates that money demand functions estimated using either definition perform relatively badly. The main

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New perspectives on the late Victorian economy

structural difference post-1914 is the frequency of monetary regime shifts after the maintenance of the gold standard became impossible. Thus the poor performance of the demand functions may be due to financial innovation particularly that stimulated by government intervention. This is the kind of breakdown of empirical relationships discussed by Lucas (1976). There is no supporting evidence for the hypothesis that commercial bills were close substitutes for M3. This conflicts with the results obtained by Collins for an earlier period (183(M4) which indicated that substitution possibilities did exist. One reason for this could be that by this period the bill market had become dominated by overseas rather than internal bills. However little evidence was found for the Nishimura hypothesis that a major factor in the decline of the internal bill market was improved communication due to the telegraph. This does not mean that this hypothesis should be rejected since the number of telegrams is a somewhat imperfect proxy for the improvement in communications and no account has been taken of the changes in the transport infrastructure occurring simultaneously. Despite the lack of substitution between bills and money the Currency School-Radcliffe Report view that monetary policy could be frustrated by the development of new financial assets remains valid. However the type of assets involved are different from those considered by Collins.

Appendix 10.1 Econometric techniques In this paper I have used two relatively novel econometric techniques. This appendix gives a brief description of each of these. Firstly there is the use of cointegration analysis. The recent literature on cointegration is described by Granger (1986). Consider the error term (w) from a static regression equation containing variables between which there is a hypothesised relationship. Cointegration tests focus on the properties of this error term. If an equilibrium relationship does exist then the error term should follow a stationary autoregressive process even if the variables are themselves non-stationary. Dickey and Fuller (1979) propose a test for the stationarity of the error term by use of an auxiliary regression of the form (Al). Aut = put.i + vt

(Al)

The test statistic here is the 't-ratio' for p. However this statistic does not follow the conventional t-distribution and it is therefore necessary to rely on the empirically determined significance levels reported by Engle and Yoo (1987). The 't-ratio'

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test described above is based on the null hypothesis that the error term follows a random walk with drift. The Durbin-Watson statistic from the original regression provides an alternative test statistic. This can be seen intuitively since DW can be approximated as 2(1 -p), where p is the autoregressive parameter from an AR(1) process. Therefore if DW is close to zero then the residuals are close to a random walk. Empirically determined critical values for this test can also be found in Engle and Yoo. While the cointegration literature provides a useful framework for the analysis of equilibrium relationships there is not yet any consensus of the power of the tests described. Hendry (1986) has pointed out that the possibility of accepting a false hypothesis, i.e. p= 1, may be very high when the true p is close to unity. Thus rejection of the null hypothesis is strong evidence that an equilibrium relationship exists but acceptance of it is not equally convincing evidence that a relationship does not exist. The second novel technique is the use of the Bewley (1979) transformation to estimate long-run elasticities. This procedure can be summarised as follows: Consider a simple dynamic equation of the form yt = axxt + a&t-i + ut

(A2)

where u is a white noise error, implying that ordinary least squares is an appropriate estimation technique. This equation can be reparameterised as yt = M , + 02Ay, + et

(A3)

where Pi = a\ (l-a 2 )~ l is the long-run multiplier on JC. The introduction of the Ay, term on the right-hand side means that ordinary least squares is not an appropriate estimation technique but it can easily be shown that a set of instruments exists which permits instrumental variable estimates of the parameters which replicate the values obtained from OLS estimation of the original equation, cf. Wickens and Breusch (1988).

Appendix 10.2 Data This appendix gives details of the data used in this study along with the sources. M3

Notes and coins in circulation with the public plus net sight and demand deposits, £ 000. 1871-1969 Capie and Webber 1985, table 1(3), pp. 76-7. 1970-80 average end of quarter data Capie and Webber 1985, table 1(7), pp. 109-10.

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New perspectives on the late Victorian economy

Savings Banks deposits Deposits of Post Office Savings Banks, Trustee Savings Banks and Birmingham Municipal Savings Bank, £ 000. 1880-1966 Sheppard 1971, table (A) 3.3, pp. 182-3. 1967-80 Financial Statistics various issues. Building Society deposits Building Society Shares and Deposits, £ 000. 1880-1966 Sheppard 1971, table (A) 3.3, pp. 182-3. 1967-80 Financial Statistics various issues. Commercial bills Estimated amount of bills, £m, 1871-1913. Nishimura 1971, table 15, p. 23. Gross National Product Gross National Product at factor cost current prices, £m. 1871-1969 Capie and Webber 1985, table 3(12), pp. 535-6. 1970-80 Blue Book. Rate of interest on Bonds Yield on Consols. 1871-1980 Capie and Webber 1985, table 3(10), pp. 494^-5. Rate of interest on Commercial Bills Market rate of discount on three month bank bills, 1871-1913. Nishimura 1971, table 28, p. 112. Rate of interest on Deposit Accounts Interest rate on deposit accounts, 1871-1913. Capie and Webber 1985, table 3(10), p. 494. Population United Kingdom mid year population, 000s 1871-1965 Feinstein 1972, table 55. 1966-80 Annual Abstract of Statistics various issues Price index GNP price deflator 1913 = 100. 1871-1969 Capie and Webber 1985, table 3(12), pp. 535-6. 1970-1980 Blue Book. Index of telegram messages Index of total number of telegraphs, 1872-1913. Statistical Abstract of the United Kingdom various issues, corrected for inclusion of telegrams sent by submarine cable after 1894. World Trade Index Index of volume of world trade. Tinbergen 1951. Where data series have been drawn from different sources they have been spliced by taking a regression of the form y = a xp, where y and x are the overlapping data points from the two series, and transforming

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the data from the later source accordingly. For example there were seven overlapping data points from 1963-9 with which to splice the pre-1969 to the post-1969 M3 data. The test statistics reported are as follows: R2 DW LM(0

= = =

ARCH(/)

=

HSQ

=

DF

=

standard coefficient of determination Durbin-Watson statistic F-Form of the Lagrange multiplier test for /th order serial correlation. F-Form of the Lagrange multiplier test for /th order autoregressive conditional heteroscedasticity. F-Form of the Lagrange multiplier test for heteroscedasticity due to the squares of the regressors. Dickey Fuller test for co-integration.

All equations were estimated using PC-GIVE version 4.0. Note 1 I am indebted to James Foreman-Peck for this suggestion. References Ashton, T. S. (1945), T h e bill of exchange and private banks in Lancashire, 1790-1830', Economic History Review, 15. Bewley, R. A. (1979), 'The direct estimation of the equilibrium response in a dynamic model', Economic Letters, pp. 357-61. Bordo, M. D. and Jonung, L. (1981), T h e long run behaviour of the income velocity of circulation of money in five advanced countries, 1870-1975: an institutional approach', Economic Inquiry, 19. Capie, F. and Rodrik-Bali, G. (1985), T h e money adjustment process in the United Kingdom, 1870-1914', Economics 52: 117-22 Capie, F. and Webber, A. (1985), A Monetary History of the United Kingdom 1870-1982, London: Allen and Unwin. Collins, M. (1978), 'Monetary policy and the supply of trade credit', Economica, 45: 378-89. Dickey, D. A. and Fuller, W. A. (1979), 'Distributions of the estimators for autoregressive time series with a unit root', Journal of the American Statistical Association, 74: 427-31. Engle, R. F. and Yoo, B. S. (1987), 'Forecasting and testing in co-integrated systems', Journal of Econometrics, 35: 143-59. Feinstein, C. H. (1972), Statistical Tables of National Income, Expenditure and Output of the UK 1855-1965, Cambridge University Press.

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Friedman, M. and Schwartz, A. J. (1982), Monetary Trends in the United States and the United Kingdom: Their Relation to Income, Prices and Interest Rates,

1867-1975, University of Chicago Press. Goldsmith, R. W. (1969), Financial Structure and Development, New Haven: Yale University Press. Granger, C. W. J. (1986) 'Developments in the study of co-integrated economic variables', Oxford Bulletin of Economics and Statistics, 48: 213-28.

Hendry, D.F. (1986), 'Econometric modelling with cointegrated variables: an overview', Oxford Bulletin of Economics and Statistics, 48: 201-13.

Hobson, O. R. (1953), A Hundred Years of the Halifax, London: B. T. Batsford Ltd. Home, H. O. (1947), A History of Savings Banks, Oxford University Press. Kindleberger, C. P. (1984), A Financial History of Western Europe, London: Allen and Unwin. Lucas, R.E. Jr (1976), 'Econometric policy evaluations: a critique', in K. Brunner and A. H. Meltzer (eds.), The Phillips Curve and Labour Markets, Carnegie-

Rochester Conference Series on Public Policy, 1, Amsterdam: NorthHolland, pp. 19-46. McCloskey, D. N. and Zecher, J. R. (1976), 'How the gold standard worked', in J. A. Frenkel and H. G. Johnson (eds.), The Monetary Approach to the Balance of Payments, London: Allen and Unwin. Mills, T. C. and Wood, G. E. (1982), 'Econometric evaluation of alternative money stock series, 1880-1913', Journal of Money, Credit and Banking, 14:

265-77. Nishimura, S. (1971), The Decline of Inland Bills of Exchange in the London Money

Market 1855-1913, Cambridge University Press. Sheppard, D. K. (1971), The Growth and Role of UK Financial Institutions 1880-

1962, London: Methuen and Co. Tinbergen, J. (1951), Business Cycles in the United Kingdom 1870-1914,

Amsterdam. Wickens, M. R. and Breusch, T. S. (1988), 'Dynamic specification, the long run and the estimation of transformed regression models', Economic Journal, Conference Volume, 89-205.

Chapter 11

An analysis of Bank of England discount and advance behaviour, 1870-1914 Tessa Ogden

11.1 Introduction This chapter sets out to throw light on the evolving role of the central bank in Britain in the late nineteenth century.1 The structure is as follows: first, there is a brief outline of the theoretical issues involved; second, a more specific discussion is provided of the historical period and the approach the study takes, and third, the empirical work carried out on a data set retrieved from the archives of the Bank of England is discussed. The underlying aim is to determine whether the Bank of England, explicitly or implicitly, altered its behaviour with respect to the financial system in the latter portion of the nineteenth century. This may have come about as a result of a general acceptance of its duty to provide the system with liquidity in the event of need. If it did change its behaviour, how and why did this arise?2 The question of the appropriate policies a central bank should take in the face of afinancialcrisis is one which has great significance in both an historical and current context. In the hundred years previous to 1870 financial crises occurred frequently,3 and thus there was much discussion as to the correct solution to the problem of the lack of stability apparent in thefinancialsystem. In the course of its evolution the Bank of England had taken on many of the characteristics associated with a Lender of Last Resort (LLR), although this process had been slow and uneven, and it is important to establish what the Bank felt was the extent of its responsibilities. The question of the role and limits of a LLR is one which has great contemporary significance and cannot therefore be consigned to the category of 'problems solved by Bagehot in the 1870s'. The role of the domestic LLR has once again become very pertinent, not just in academic circles but also in the financial and non-financial press: in the UK the aftermath of the Bank of England's rescue of Johnson Matthey Bankers (JMB) refused to disappear from the public eye for several years after its 305

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initial problems were reported. In the US bank failures have been extremely high in the last few years, and not all these failures have involved small, uninfluential banks: in the autumn of 1984 the Federal Reserve stepped in to help Continental Illinois, the fifth largest bank in the States, and in September 1987 the US authorities were involved in the second largest bank rescue in American history with the First City Bancorporation of Houston, Texas, being taken over by the Federal Deposit Insurance Corporation, the latter committing nearly $lb of Federal funds to the troubled bank. Thus it is obvious that the problem of financial crises and the appropriate policies of a LLR cannot be regarded as an irrelevancy, a problem resolved in 1873 when Bagehot laid down his two rules telling central bankers how to react to a financial crisis.4 In this paper we will consider both the theoretical issues involved and the implications these have for the study of the late nineteenthcentury financial system in the UK.

11.2 The theory of last resort lending Why are bank failures important? Why should the failure of banks be treated any differently from failures of other institutions? If we decided that banks were no different from other types of business unit then the whole question of the LLR would be resolved: in general we are not concerned with the failure of commercial enterprises, aside from considering the possible unemployment effects and other externalities. In fact, optimal resource allocation theory suggests that banks should certainly fail in order that the system should become more efficient. However, the possibility of a bank failure seems to be so serious that the Bank of England felt it was justified in stepping in and purchasing, for a nominal sum, an insolvent licensed bank, Johnson Matthey Bankers, which many people had never heard of. Why should banks be treated in such a different way? The major reason proposed for the differential treatment of banks and other financial institutions is that this group is alone in having creditors that are able to withdraw funds on demand. Depositors are acting rationally if they remove funds from an institution they fear is about to fail, since if they do nothing they may be faced with a loss. However, the net result of many depositors following this course of action may be a suspension of payments by the institution concerned, after it has been forced to sell assests at loss-making prices. For the financial system as a whole, a sequence of events such as this, without offsetting action by the

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central monetary authority, can provoke a panic-induced collapse in the money stock as depositors in many, most or all institutions rush to liquidate their deposits. This follows as a result of the fact that the commercial banking system is built on fractional reserves, i.e. each institution holds only a small proportion of their liabilities in the form of cash and thus the stability of the system as a whole depends critically on maintaining confidence and on the avoidance of the fear of financial catastrophe.5 Illiquidity versus insolvency The classical rationale for central (bank or government) intervention in the banking system revolves around the acceptance of the 'domino' analogy of a shock: that the failure of one financial institution may damage financial confidence to such an extent that failures of the other institutions, hitherto solvent, may then ensue.6 Since the publication of Walter Bagehot's Lombard Street in 1873, the accepted form for such central action has been for the LLR to provide large cash injections into the financial system in order to preserve its liquidity: to temporarily increase the monetary base in order to offset falls in the money multiplier. However, the issues are not as clear as one might think: whereas Bagehot's case for last resort intervention revolved around the central bank giving aid to the market as a whole, there are numerous examples of failed institutions being bailed out by the central bank, irrespective of the reasons why they failed. The fact that it has come to be fairly well accepted in policy terms that particular institutions, rather than the market as a whole, can receive aid from the LLR has raised the issue of illiquidity versus insolvency: whether central bank aid should go solely to institutions that are solvent, or whether there are instances when action to avoid the failure of a specific (insolvent) institution is justified.7 The problem arises if large-scale aid, in the form of cash injections, is to be given to one particular institution, since it can be argued that aid should not be given if the institution is already insolvent. However, there are difficulties in determining the solvency position of institutions, especially when the market price of assets is lower than their book price. Benston et al. (1986) have proposed a new approach to this problem utilising 'fire sale' definitions of the value of assets, thus making it easier to determine whether or not an institution is solvent.8 The main problem with rescuing insolvent institutions, or even solvent ones, aside from the obvious social costs involved, is that it increases the incidence of moral hazard: that bankers are less conservative in their risk-taking behaviour, feeling themselves to be protected from

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failure by the existence of the LLR. This means that banks may engage in activities which, although very profitable, may not be optimal for society as a whole due to the excessive risks involved. Alternatives to the LLR More information It is possible, theoretically at least, for the whole issue of the contagion effects of bank runs to be avoided through the existence of a more complete information set on financial institutions (Beenstock 1987). If completeness of information existed bank runs would not be a problem, since people would be able to distinguish between problem banks and ones that are under no insolvency threat and thus mass panic would not occur, as it would then be irrational for withdrawals to be made from banks considered to be safe. However, it is obvious that the information set that exists in western financial systems is far from complete, and it is questionable whether a state of complete information could ever be achieved, since even if financial institutions were forced to publish the sort of detailed balance sheet information that would be needed to distinguish a sound institution from an unsound one, there would inevitably be a time lag before its publication and then a further one before its dissemination. Furthermore, the present level of financial sophistication means that enormous sums of money can be shifted in a matter of seconds, making it possible for any available figures to be almost immediately out of date. Increasing the amount of information available would be one method of decreasing the risk of the contagion effects of the failure offinancialinstitutions, but we need to further consider whether in fact contagion is likely in the context of financial markets, both currently and in the nineteenth century. In reality, would there be a wholesale movement into cash if the stability of thefinancialsystem was threatened? The alternative would be that people fearing for the solvency of one bank would redeposit their funds in an institution they felt to be free of suspicion: it is hard to envisage a situation when all deposit-taking institutions are judged to be so unsafe that people would give up the advantages of possessing a bank account for the relative insecurity of holding possibly large amounts of cash. If in fact the public's reaction to a financial crisis is to redeposit their funds with institutions they feel have a low likelihood of failure attached to them, a Bagehotian LLR becomes redundant, since in theory the LLR exists only to provide cash injections to the financial system if there is a mass movement into cash.

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Deposit insurance A much cited solution to the problem of financial failures is to institute a system of deposit insurance. This takes the form of a premium paid into a central fund by member institutions, the fund then administered by a central body, which has the task of settling claims made against it in the case of failure. This agency may sometimes, although not always, be charged with the extra responsibility for the regulation of the financial system, as is the case in the USA with the Federal Deposit Insurance Corporation (FDIC). Friedman (1959), among others, has argued that deposit insurance has rendered the banking system 'panic proof, making the existence of the LLR no longer necessary.9 This is surely an oversimplification however: in the case of an en-masse liquidation of deposits any deposit insurance fund would soon be bankrupt, thus leaving the LLR as the only possible agency that could create sufficient liquidity.10 In addition in an attempt to reduce the effects of moral hazard (Flannery 1982), most deposit insurance systems do not include 100 per cent cover of all deposits.11 Another method of reducing the moral hazard effects of deposit insurance is to make the premiums payable dependent on portfolio risk, but there are various problems, such as lack of knowledge and agreement as to what consitutes excessive risk, which render it extremely difficult to implement such a policy (Kareken 1983).

11.3 The historical background and approach taken The established view in the literature12 is that the Bank of England accepted its role as a LLR sometime around 1870.13 During the Overend-Gurney crisis (1866), the Bank had ient freely' without any backsliding, and it seemed that from this point onwards there would be no doubt as to the appropriate policies for the Bank to pursue when a financial crisis threatened. However, it took the publication of Lombard Street (written by Walter Bagehot) in 1873 for this institutional practice to become an established theoretical proposition, since there was a considerable amount of dissent from the view that the Bank's duties towards the financial system were any greater than those of other commerical banks.14 The starting point for the analysis in this chapter is 1870.15 Around this time there was a change from the previously rather 'ad hoc' behaviour of the Bank with respect tofinancialcrises towards a full recognition of what Bagehot had to say on this subject. Policy decisions in this area had

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hitherto been taken somewhat arbitrarily, and any successful policy stance had been arrived at largely as a result of trial and error. The first formulation of a set of 'rules' concerning what action should be taken up by the central bank during a financial crisis that attracted any attention came, as previously discussed, from Bagehot, although Henry Thornton had been advocating very much the same sort of policies three-quarters of a century earlier. He, though, did not possess the advantage of being editor of one of the most important vehicles for the dissemination of commerical and financial information at the time, The Economist, and thus Thornton's ideas did not receive the same level of recognition as did Bagehot's. The nineteenth century in the UK was characterised by a series of financial crises: 1825, 1836, 1847, 1857 and 1866. A common feature of all the crises up to 1866 was the inconsistency apparent in the actions of the Bank of England. People were never sure how the Bank was going to react when faced with the threat of afinancialcrisis, since on several occasions it changed its policy in the course of the crisis itself. For example, in 1825 the Bank first refused to lend and then lent freely, and in 1836 and 1847 it refused to lend on certain types of securities, which served only to add fuel to the panic, forcing it to revert to discounting and advancing freely. The 1847 crisis came soon after the passing of the 1844 Bank Act which split the Bank into two departments: Banking and Issue, and which defined the fiduciary issue, held in the Issue department, as being £14m. There was much contemporary criticism of the Act, since it was felt that as the reserve approached thefiduciarylimit apprehension would increase due to the fear that the Bank would not be able to aid the market in excess of this limit. This, it was feared, would increase the likelihood of a reduction in business confidence developing into a fully blown financial crisis. The practical solution to this problem, although not specified explicitly in the Act, was for the government to issue the Bank of England with a 'Letter of Indemnity' when the fiduciary limit was approached. This, interestingly enough, was normally enough to quell the panic: of the three times a Letter was issued (1847, 1857 and 1866), only in 1857 was the fiduciary limit broken.16 When discussing the role of the Bank of England in any sphere in the period prior to 1914, but particularly with regard to its role as a LLR, one must always be aware of the fact that during this time some of its actions had important consequences for the international gold standard. According to Bloomfield (1959), a central bank's role in playing by the 'rules of the Gold Standard game' in this respect implied that it should 'lower its

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Discount Rate in the face of persisting gains of gold (and other external reserves) and raise them when there were persisting losses'.17 This had obvious relevance for the Bank of England's role as a LLR, since it is easy to envisage a situation where high levels of domestic Bank Rate, implemented perhaps in an attempt to stem an internal drain, could be detrimental to the maintenance of international equilibrium. In fact, Bloomfield concluded that, on the basis of a comparison of annual data on international and domestic interest earning assets, central banks did not play by the 'rules of the game'.18 During the period 1870-1914 there were no major financial crises, at least not on the scale of the Overend-Gurney crisis in 1866. The major question that has to be addressed is thus why there was this absence of crises as compared with the experience of the preceding century. In terms of the analysis of the LLR we are left with two possibilities: either there were no problems in thefinancialmarkets needing the Bank of England's intervention, or the Bank's behaviour changed to allow for the implementation of policies that would either prevent crises from arising, or would mitigate the effects of them once they arose. Since it is unlikely that there was a complete absence of periods of tension we can pursue the second hypothesis, that the Bank's behaviour somehow altered in order to take account of what many contemporary bankers, economists and politicians felt to be its 'duty': to provide an injection of liquidity into the financial system in times of financial crisis. At the outset it would appear that there are two methods which could be utilised to determine how the Bank of England may have changed its behaviour. The first of these involves starting from a macro-economic viewpoint and studying how the behaviour of the Bank might have changed with respect to changes occurring in the rest of the financial system. The second takes the form of a qualitative investigation and involves an detailed study of all the records of the period. Since all good history involves a combination of these two approaches, I have tried, to combine the two: the starting point of the analysis is the relationships between the Bank and the rest of the system, but in addition to using a data-based approach I have also attempted to integrate information derived from historical sources such as the archives of the Bank of England and other commerical banks. Once we pursue the hypothesis that the Bank's behaviour did change we then have to consider the ways in which it is likely to have done so. This relates mainly to two different types of event: first, policies pursued in order to prevent crises from taking place, and secondly policy measures

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taken as an immediate reaction to the possibility of a financial crisis occurring, in order to reduce its secondary effects. Thus, we need to look at two different types of policy: (a) those dealing with the Bank of England's relationship with the markets in general and with the Discount Market in particular, at all times: how the Bank was shaping its regulatory environment in an attempt to prevent the failure of financial institutions, rather than dealing with them once they had arisen, (b) the Bank's policy and reactions with respect to moments of financial tension, when it is actually faced with the possibility of having to act as a lender of last resort. The obvious source of information regarding the behaviour of the Bank of England is the Bank's archives. Although there is a great deal of statistical information available in the Bank, there is a dearth of material describing why the Bank took particular actions at particular times. Changes in Bank Rate, for example, were agreed upon by the Committee of Treasury, but the minutes reveal no discussion as to the reason for the change. The most depressing sentence found in bank archives in my experience, repeated with annoying regularity, is 'after a full and frank discussion, it was decided that ...'. Sources which at the outset appear promising, for example the minutes of the Committee of Treasury of the Bank, prove not to contain anything of interest, in this case because there was no secretary in attendance at meetings and thus the Governor was able to reveal only that which he chose. Of course, in an ideal world we would not have to surmise what policies the Bank was pursuing at certain times and for what reasons, since policy documents would be available that told us how and why the Bank was acting. Unfortunately, these are not readily available, and so we have to be content with considering the options that were open to the Bank at certain times. We will do this through a consideration of its behaviour both at times when it was under a certain amount of pressure in the financial markets, and at times that could be regarded as being 'normal'. As outlined above, one of the issues that is always addressed when considering the LLR in a contemporary context, but is frequently overlooked in historical studies, is the regulatory environment in which it (normally, but not exclusively, a central bank) operates. This is an important area since it involves prevention rather than cure. Formal bank regulation is a comparatively recent development, occurring as a result of the advent of the increasingly sophisticated financial systems of the late

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1960s and early 1970s, and in policy terms is associated with the implementation of monetary policy. However, the Bank of England has for many decades used what informal powers it possessed to influence the behaviour of the financial sector, through the use of'moral suasion': the exertion of influence on the commercial banks and other institutions in order to persuade them that their best course of action was to follow the Bank's 'advice' and do as they are told. The ways in which moral suasion was implemented, together with its effectiveness in the 1870-1914 period, are issues which will be considered at a later point. Apart from moral suasion, the Bank's only other method of imposing its will on the markets involved the regulation of its discount and advance operations. Thus, in order to determine the extent to which these operations were used as a regulatory device we need to know, for example, how the eligibility requirements for bills were decided on, and whether they were ever relaxed, either in times of tension or perhaps for the Bank's own customers at other times. We also need to be aware of how effective Bank Rate was as a control weapon, and to determine from what time it could said to be effective, if indeed it ever was. The effectiveness of Bank Rate has obvious relevance for the study of Bank of England policy in these years, since its manipulation was the Bank's major tool in influencing the flow of funds in order to ensure the smooth operation of the gold standard. The other aspect of changes in Bank of England behaviour, and the one that we will concentrate on here, is its reactions to financial crises. Although, as already mentioned, in the period 1870-1914 there were no major financial crises, this does not mean that there were no moments at which the Bank acted in order to prevent a failure, in itself possibly a relatively minor event, from developing into a fully blown financial crisis. The first step in a study of these times is to identify them, an exercise that will be described at a later point. Then, individual episodes are studied in order to determine the Bank's role in each of them, since with hindsight we know that there were no major crises and therefore any minor points of tension must either have been quelled by an outside agency or have faded away of their own accord. The type of questions needing answering in this area are those concerning the Bank of England's discount and advance policies at specific moments of tension: what was the pattern of its transactions over the period - was the average size of transaction large (implying market concentration in the demand for discounts) or small (implying the diffusion of pressure)? Did the Bank, for example, discount more freely to one

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particular institution than another? We also need to address the question of whether the Bank adhered to Bagehot's first 'rule' (i.e. to 'lend freely at high interest rates' in the case of an internal drain19). Were the interest rates charged by the Bank on discounts and advances sufficiently high to promote an efficient allocation of funds? The implication of this is that high interest rates would deter any person or institution from borrowing at the Bank if they were able to obtain funds elsewhere at a lower rate. In this way the Bank would really be acting as a last resort lender rather than one of the first resort. The answers to these two sets of questions will tell us first the extent to which the Bank of England was aware of the possibilities open to it in the field of the prevention offinancialdistress, and to what extent it made use of the options open to it. In addition, once the answers to the second set of questions have been resolved we should be in a position to know whether the Bank did actively intervene in the financial markets in order to quell any possibility of widescale financial disruption. The juxtaposition of these two aspects of the problem will enable us to answer the underlying question of whether the Bank altered its behaviour towards the financial system, and if so in what way.

11.4 Empirical analysis We will now move on to a consideration of the data collected from the Bank of England archives and the empirical analysis carried out using these data. This analysis can be divided into two main types: the indication of the presence of a LLR and polynomial analysis, which we will consider in turn. First, however, we will discuss the data source itself and the uses to which these data will be put. The data There is a vast amount of data available in the Bank of England's archives, although much of the material is subject to restricted access. At an early stage it was decided that the best way of obtaining detailed information about the Bank's discount and advance operations was to collect data available in the Daily Discount Books.20 These data are presented in the form of the original Al size ledger books, with one page allocated to each day. Trading occurred six days a week, with fewer public holidays than now, giving a total of approximately 305 trading days per year, and thus a total number of observations of approximately 13,700. The average number of transactions per day was about 8-10, although there would be occasional days when there would be none (especially

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during 'quiet' years such as 1895), and others when more than one page would be needed to cover the day's business. The sheer volume of data caused considerable collation and estimation problems. Ideally, there would have been no aggregation of the data since the essence of this data set is that it appears in a daily form, but it was decided that due to the large number of observations the data would be aggregated on a weekly basis, thus reducing the number of observations from approximately 13,700 to 2,340. Initially, data were also aggregated into an annual form in order that a complete picture of Bank of England discount and advance behaviour during the period could be presented in graphical form. These can be seen in figures 11.1-11.4. The variables on which data were collected as shown here: TVB TNT R VAOB VAOS TNAT TNR TVR

-

total value of bills discounted total number of discount transactions interest rate for the advance and discount transactions total value of advances on bills total value of advances on securities (from 1894) total number of advance transactions total number of refusals total value of refusals

Uses of the data One of the prime uses of these data is to identify periods of market pressure, times when the banks,financialinstitutions and other commercial companies were coming to the Bank of England for discount facilities in the latter's capacity as a LLR. The easiest way to achieve this objective is to trace the pattern of the Bank's discount and advance operations in order to distinguish any abnormal changes that are not explained elsewhere. The principal alternative to this approach would be a painstaking search through all the written records of the Bank, such as Court and Committee of Treasury minutes and other records in an attempt to pick out odd facts that when pieced together might present perhaps only a partially complete picture of the whole story. In addition, the main problem with such an approach is that initially we have no idea of the information that might be available and thus have no idea of how complete a final picture we might gain. The literature on certain moments of crisis between 1870 and 1914 is extensive, for example on the Baring crisis of 1890 and the American crisis of 1907.21 Whilst attempts were made to uncover new information about these particular periods, it was of greater interest to reveal the existence of any other moments when the Bank of England acted in a way that could

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1870

1876 1873

1882 1879

1888 1885

1891

1894 1900 1906 1912 1897 1903 1909

Source: BE Archive Ref C28/30-C28/74

Figure 11.1 Bank of England discount and advance activity 1870-1914: TVB, VAOB and VAOS

1870 1873

1876 1882 1888 1894 1900 1906 1912 1879 1885 1891 1897 1903 1909

Source: BE Archive Ref C28/30-C28/74

Figure 11.2 Bank of England discount and advance activity 1870-1914: TVR

An analysis of Bank of England discount and advance behaviour

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5

4 3 O xi

I I

1870 1873

1876 1882 1888 1894 1900 1906 1912 1879 1885 1891 1897 1903 1909

Source: BE Archive Ref C28/30-C28/74 Figure 113 Bank of England discount and advance activity 1870-1914: TNT, TNATandTNR

a Average daily interest rate

i . , i . , i , . i , , i . . i b, i . . I . . I . . I , , I i .

1876 1873

.

1882 1888 1894 1900 1906 1912 1879 1885 1891 1897 1903 1909

Source: BE Archive Ref C28/30-C28/74 Figure 11.4 Bank of England discount and advance activity 1870-1914: average daily interest rate

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be described as being a LLR, or occasions when the Bank's actions were actually more far reaching than was at first thought. Analysis of discount and advance data thus provides a means of studying events rather more closely than might otherwise be achieved, and enables the closer study of episodes that seem to be of greater interest. The analysis undertaken is directly related to the aims of the research project as a whole: to determine whether the Bank of England changed its discount policy at the end of the third quarter of the nineteenth century with respect to its role as a LLR and its relationship with the market. If the Bank did alter its behaviour, was it as a result of Bagehot's proclamations on what the Bank should and should not do, or as a result of its cumulative experience in dealing with crises over the preceding half century, or, perhaps the most likely case, resulting from a combination of both these factors? Thus, the analysis undertaken in an attempt to prove or disprove these possibilities must centre on the Bank's handling of any moments of financial tension and on its relationship with the discount market. If any periods of tension can be found that were previously unknown, then by definition the Bank must have altered its behaviour, since with hindsight we are fully aware that these moments of tension did not develop into fullblownfinancialcrises. However, if no 'mini crises' are discovered then the situation is rather more complicated. In this case there are two possibilities: either the Bank was faced with no tests, which would make this period totally different from the years which preceded it which were crisis-ridden, or, more interestingly, it responded so quickly and so efficiently that it curbed any crisis before it got underway. Linked to this last point is the question of the time consistency of policy actions (how much faith people have in the governing body's ability to carry out a stated policy) and the level of confidence in its actions that the Bank of England had managed to instil in the system. Bagehot's main criticism of Bank Directors was that they were not prepared to say definitely how they would react to a financial panic. His solution was for the Bank to state categorically that it would act as a LLR, since panics occurred for the very reason that people did not know how it would react. Uncertainty was thus greater than it needed to be. It is possible that over a number of years the Bank had gained such a large degree of confidence in its ability to handle moments offinancialcrisis that it was able to curb any period of dangerous speculation or loss of confidence induced overtrading before it reached the panic stage.

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Indication of the presence of a LLR At the simplest level, a simple positive correlation of the total amount of discount business at the Bank of England with Bank Rate would be enough to say that the LLR function existed, since if financial institutions were utilising the Bank's discount and advance facilities purely in 'normal' times,22 then we would expect there to be a negative relationship between the two variables. If a significant positive relationship exists, then even if the explanatory power of the regression is not very high it is at least an indication of the presence of a LLR. This is a relatively simple operation to carry out using annual data. It was found that there was a positive relationship, both between Bank Rate and the total volume of discounts and advances as separate variable, and when they were aggregated together to form one 4LLR facilities' variable.23 This result suggests that the Bank of England was acting as a LLR during this period, although as already mentioned any analysis carried out on annual data has a major disadvantage in that it loses a great deal of detail.24 Polynomial analysis25 The main approach used in an attempt to identify moments of abnormal activity in the demand for discount and advance facilities at the Bank of England was to estimate polynomials covering the time period under consideration. This involved plotting the trend apparent in the data and then identifying deviations from this trend.26 In order to plot the trend in the data a polynomial was specified of the form: Yt = Po + P i ^ + £2T2t + £3T3t + ... + */ where:

Yt = dependent variable (discounts or advances) Tt = time variable et = error term

Various specifications were estimated, the data deciding which one was used.27 This method was particularly appropriate in this case because of two characteristics possessed by the data: they displayed no cycle, but there was a large degree of variation. Neither moving average nor straight regression methods were therefore appropriate, the former because it did not capture the best line representing trend, and the latter because the trend apparent in the data could not be represented by a straight line. The data were split into four ten year and one five year sections: 1870-79, 1880-1889, etc, and 1910-1914,28 for two reasons: first due to

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computer memory limitations (most statistical packages are not capable of handling a time series of over 2,000 observations), and secondly because, as discussed above, the trend effects of the data imply that comparison over ten-year periods is more efficient in recognising periods of unusual activity, since the standard deviation of the period 1870-1914 is greater than even two or three standard deviations of some of the sub-periods.29 Initially polynomials were estimated for advances and for discounts. The aim of this process is to identify unusually large outliers from trend which could then be used as indicators of financial tension. The residuals were plotted against one, two and three standard deviations: one standard deviation represents the 68 per cent confidence interval, two and three standard deviations represent 95 per cent and 99 per cent respectively. Thus, any residual that exceeds two or three standard deviations can be regarded as significantly different from the 'trend' since the likelihood of it occurring is less than 5 or 1 per cent respectively. This then gives us an indication of points at which an unusually large amount of activity was taking place; it does so on a basis that is rather more rigorous than visually identifying the points. Once the appropriate polynomial for each data set had been specified, graphs were produced of actual and fitted values, and residuals from the regression and standard deviations. Examples of these graphs (for discounts only: 1890-99) are shown in figures 11.5 and 11.6. Only residuals that exceeded three standard deviations in value were considered to be of interest. The upward trend in the data is evident in the difference in the scales of the graphs: the maximum on the vertical axis (size of residual) in 1870-9 is 500,000, in 1880-9 170,000, in 1890-9 500,000, in 1900-9 700,000 and in 1910-14 4m.30 For TVB, the volume of discounts variable, twenty-six points were identified as being of interest. Of these, five can be readily accounted for (1873: Continental crisis, 1878/9: City of Glasgow Bank, 1890: Barings, 1907: American crisis and the outbreak of World War One in the summer of 1914). This leaves twenty-one where there is no obvious explanation for the increase in market activity. Further investigation into these points was then undertaken, in order to give a qualitative back up to the analysis. One of the sources used was the Bank of England archives, which were not without problems. The Bank is very sensitive about releasing information that is 'customer sensitive' if it comes within their 100 Year Rule.31 They are thus reluctant to release any information that might be detrimental to the reputation of particular customers. In addition, sources other than the Daily Discount Books in

An analysis of Bank of England discount and advance behaviour

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500

1890

1891

1892

1893

1894

1895

1896

1897

1898

1899

Figure 11.5 Actual and fitted compared - TVB: 1890-1899 DUU

tp • Residuals

400 -

§

300

[

i T

3SD 1 cP

II LlSD |

yp

-100 1890

1891

J1V

1892

J

T

2 SD 1

nnll 1 0(

1

J tp

200

Residuals

£

I

[i

If

ml LJ LBLBIIJTIC]

1893

1894

klUIJ 1895

1896

1897

illii. 1898

Figure 11.6 Residual and SD compared- TVB: 1890-1899

1899

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New perspectives on the late Victorian economy

the Bank are interestingly barren in their coverage of the financial markets in the late nineteenth century,32 and so sources outside the Bank had to be utilised.33 One of the most interesting episodes of the period concerns the City of Glasgow Bank failure in October 1878. This bank failed as a result of gross mismanagement (some of the directors were actually imprisoned for fraud), and the Bank of England refused to give it direct aid. Accounts of the English effects of this failure found in the commercial banks' archives talk of the 'terrible panic which overwhelmed the country' and of the 'abatement of confidence being severely felt'. However, this incident does not show up to any great extent in the Daily Discount data, although there is a noticeable increase in both the currency:deposit and reserve:deposit ratios and a slight fall in the money supply.34 There were two instances in November 1878 whenfirmsreceived discounts of over £100,000: £140,000 to the Bank of New Zealand and £102,000 to the Yorkshire Banking Company, which was itself experiencing a run on deposits. On 9 November the Clydesdale Bank received £315,000 in discounts. Bank Rate at this point was 6 per cent, but advances were being charged at 7 or even 8 per cent. The policy of the Bank of England at this point seems to have been to charge high rates to choke off demand: or rather to force institutions to go elsewhere if it was possible to obtain accommodation at lower rates. High rates also had the advantage of drawing in gold from abroad, especially from France, and thus adding to the reserve. This does not explain however why there seemed to be no real pressure at the Bank of England, even though the country pressure was considerable: Lloyds Bank, based at this time in Birmingham, reported a decline in its liabilities on current and deposit accounts of 20 per cent,35 and Collins (1987) writes that, in his opinion, 'a general panic was but a hair's breadth away'.36 The other two interesting episodes of the period concern Baring Brothers and the Yorkshire Penny Bank. The failure and subsequent rescue of Barings in 1890 has already been well documented in the literature and I do not propose to dwell on it here, except to point out that Barings were technically solvent at the time their problems were announced, even though it took four orfiveyears for their affairs to show an excess of assets over liabilities.37 The Yorkshire Penny Bank got into difficulty in July 1911 with deposits of £18.5m and 700,000 accounts. A guarantee was organised by Edward Holden, of the London City and Midland Bank, with the cooperation of the Bank of England, which was again one of thefirstguarantors with £250,000. The bank was reconstituted and continued to operate under the name Yorkshire Penny Bank Limited.

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Detailed analysis of the results of these investigations is not possible here,38 but the main implication of the analysis was that it appeared that in the 1870-1914 period the Bank of England was prepared to act as a LLR when the market as a whole was short of liquidity by increasing the volume of bills discounted and the advances that it granted. In addition, it was also prepared to provide specific institutions which were experiencing problems with liquidity injections, often by forming a Guarantee fund. The Bank would only undertake this however if the institution concerned was suffering liquidity rather than insolvency problems. Thus, the Clydesdale Bank, Barings and the Yorkshire Penny Bank were rescued whilst the City of Glasgow Bank was allowed to fail. Tests for 'Runs' and Kurtosis In addition to tests based on confidence intervals, the residuals from the polynomial regressions were subjected to a 'runs' test and to tests for kurtosis. A runs test was carried out in order to determine whether there was an unusual number of runs of positive and negative residuals in the sample. The occurrence of a smaller number of runs existing than if the sample was random would indicate that there was prolonged negative or positive deviations from trend apparent in the data.39 The test statistic for kurtosis indicated whether or not the distribution of the residuals is peaked: a normal distribution will have a kurtosis statistic of zero. Since we would expect that there would be fewer than normal runs in the sample (indicating prolonged periods of discounts which are higher or lower than trend), it was no surprise to find that all five sample periods failed a runs test fairly convincingly.40 For the same reason, we would also expect the distribution to show a marked degree of kurtosis, which was again borne out by the results.41

11.5 Other aspects of discount and advance operations As discussed earlier, one aspect of the Bank of England's regulation of financial markets involves the prevention of problems before they occurred. In the late nineteenth century, moral suasion did not exist in any readily identifiable form, although there were many informal links between Bank Directors and heads of Cityfirms.However, to what extent were the Bank of England able to exert their influence on sometimes unwilling, even hostile markets? One thing that could not have worked to the Bank's advantage in

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New perspectives on the late Victorian economy

implementing its will on the system was the rather unfavourable way its behaviour was viewed in many parts of the City. When looking at primary source material it is difficult to find any praise for the Bank of England as an institution: iazy Old Lady' was one phrase that was used. Bank Directors seemed generally (with some notable exceptions) to be viewed as being somewhat inept, and until well into the twentieth century there was little continuity in its management since Governors were appointed for a fixed term of two years. There are many examples of contemporary views of the Bank's behaviour and management: Whitburn, of Reeves, Whitburn & Co., made this comment about the management of the Bank: The feeling is general in the City that there is a want of competency in the management of the Bank of England. What they require is a strong man with a large salary who would be above suspicion. They do some very queer things there, for instance, the other day they agreed to an advance against the Debentures of a Colliery with a guarantee of Lord Masham.42 Tritton, of Brightwen & Co., expressed very strong views about the Governor of the Bank in 1900:43 The present Governor is unfortunately very self-opinionated and will have his own way, and his idea is to run the Bank on purely mercantile lines, just as he would with his own business. He would not, for example, increase the price of gold though all his Co-Directors were against him in this, and this went on for a long time. The management of the Bank is of course on a very silly basis - there is no continuity in it - and how we shall fare when the next Governor comes in I do not know. He is a member of a declining firm which is doing no good, and he has never shown any grasp, though in other respects he is decent enough.44

It seems clear then that there was a feeling in the City that the behaviour of the Bank of England left much to be desired. How widespread this view was however is not clear. From the Bank's point of view it seemed to be increasingly difficult to attract able men to serve on their Court of Directors, as voiced in the following quote from Lidderdale, in answer to a question as to whether or not he favoured the idea of a permanent Governor: it is difficult enough to get good men as Directors: if we deprived them of the chance of the Chair, a coveted distinction, we would probably get even less good men to the Bank.45

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Bagehot of course wanted there to be a permanent Deputy Governor who would be a paid employee of the Bank, in order that some continuity could be maintained. This person would be a trained banker and would thus be able to advise Governors, who are merely 'Cautious merchants, not profoundly skilled in banking'.46 In this way some of the problems of having a continually changing management of the Bank could be resolved. In addition to general complaints about the management of the Bank there were also specific disputes between bankers and the Bank of England. One of the most serious of these concerned the touting for business by Bank Agents at the Branches in the mid 1890s. The Bank was making strenuous efforts to increase its income in order that its dividend should not fall too far behind those of the Joint Stock banks. Much of the bulk of these efforts were concentrated in the provinces at the branches, much to the dismay of country bankers. According to Faber, of Faber, Backett & Co., Leeds, in a letter to the Central Association of Bankers in 1896, the Bank's Agent's instructions appeared to be 'Get business at fair tates if you can, but get business'.47 The problem was that the Bank was undercutting the country banks with respect to the rates they were offering potential borrowers, and Faber's point was this: We do not complain about fair competition but this is fostered by free money costing the lender nothing at all. How can we country bankers who pay well for our deposits meet such competition as this? Our loans are taken from us; our bills no longer exist in our cases and our current accounts are 'touted' for.48 Many other country bankers strongly supported Faber's views, but his proposals (that the banks should start their own clearing house and keep their own reserve independently of the Bank of England) proved to be too revolutionary for most people, and it was decided that the Bank would be approached for their views on the matter. Over the next few years however the problem resolved itself since the Bank was not so aggressive in its search for new business at the Branches as soon as the concerns over its income became less serious in the early years of the twentieth century.

11.6 The influence of the Governor on bank policy How important was the particular Governor who held the 'Chair' for the conduct of Bank of England policy? This is an interesting question, because if we can show that certain Governors were very

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New perspectives on the late Victorian economy

important in shaping the Bank's policy at particular times, it is clear that it did not have a coherent policy to deal with the markets and with financial crises. In essence, the issue here is to what extent the Bank of England's actions at particular times can be accounted for by the coincidence of certain Governors' terms of office. The idea that some Governors were more important than others in terms of the Bank's policy in difficult situations is not one which, in the words of a recent writer, is 'fashionable among economists' since it 'undermines the idea of constitutional continuity and stability'.49 However, it is an important concept and one which is deserving of further study. At the outset we would probably believe that most Governors have little impact on Bank policy, but that some have a disproportionate influence. To examine this idea in greater detail we first need to take a brief look at the means by which men became Governors. The election to the Bank's Court of Directors was made fairly early in a man's career: in 1900, the average age of Directors' when first elected to the Court was thirty-seven,50 and once elected to the Court eventual promotion to the 'chair', as the Governorship was known, was virtually automatic after a certain length of time, normally around twenty years, had been served. Since Governors were in effect chosen twenty years in advance, and the eventual appointment to the Chair was dependent on age and seniority rather than on ability, it is not therefore surprising that many Bank of England Governors were slightly lacking in personality, in the sense that their Governorship was to them simply the culmination of a perhaps distinguished career, and not their chance to make a mark on Bank of England policy-making. There were exceptions of course, Lidderdale being the most obvious one: primary sources suggest that all the impetus for intervention in the Barings affair came from him, and without him perhaps the Bank would not have intervened. In an attempt to test whether certain Governors had a greater impact on Bank of England policy than others, equations were estimated which utilised dummy variables to represent Governors who, a priori, seemed to be more important than others. Although certain value judgements are involved in this estimation procedure, we can frame an initial hypothesis about the way in which the Bank's Governor affects the Bank's discount and advance operations. We can postulate that the volume of discounts will be a function both of the interest rate associated with discount and advance operations, and of a dummy variable representing the Governor, which takes the value 1 when there is a Governor in office whom we

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consider to be influential, and 0 for the others. In addition, we can add other dummy variables to represent other qualitative factors which we consider to be important in determining the value of the dependent variable. In this case two other dummy variables were included: one to represent financial crises, and another to represent the six-monthly seasonal pressure apparent in the data. In terms of symbols, the hypothesis for each of the variables is: TVB = TVA = VAOS = where: R DGOV DSEAS DFINCR

/(R, DGOV, DSEAS, DFINCR) /(R, DGOV, DSEAS, DFINCR) /(R, DGOV, DSEAS, DFINCR) = = = =

Interest rate on discount and advance transactions Dummy variable representing Bank Governors Dummy variable representing Seasonality Dummy variable representing Financial Crises

Note above that these estimations were carried out using weekly data for discounts and both advances variables, TVB, VAOB and VAOS, the first two for the whole time period (2,340 observations), and the latter for the period 1894—1914 (1,092 observations). The dummy variable in which we are most interested in is that representing Bank Governors. It is this variable which is most subject to value judgements, since at the outset we have to decide which Governors are most important, and thus should have the value 1 assigned to them, and which are not, thus carrying a zero value. This task was executed using prior knowledge of what the Bank was doing at certain times. For example, we know that in 1878 the Bank of England did not intervene to save the City of Glasgow Bank. The decision not to intervene must have been taken inside the Bank, either collectively or independently, and we can postulate that the governor of the time, Edward Howley Palmer, had some input into the decision, especially since Clapham (1944, p. 309) states that Bank rate was 'jerked up to 6[per cent]' by the Governor. Thus, the period covering Palmer's office is assigned the value I. 51 Other Governors given this value were Lidderdale, 52 W. M. Campbell53 and W. Cunliffe. We have already mentioned the role played by Lidderdale in the Barings' affair,54 but the inclusion of the other names warrants further discussion. Campbell was included because the Bank came through the problems of 1907 without any serious problems, an experience totally different from that of the US in the same period, where the crisis was admittedly more severe but was also dealt with less efficiently. Cunliffe, of course, was at

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New perspectives on the late Victorian economy

the helm during the crisis that developed in the summer of 1914 on the outbreak of the First World War. In addition to these names, A. F. Cole, Governor between 1911 and 1913, was included because of his actions during the problems of the Yorkshire Penny Bank, when, guided and influenced by Edward Holden, the Bank of England formed (and contributed to) a guarantee fund to rescue this bank. In setting up the rescue Holden used all the contacts and influence available to him.55 Holden's persistence was rewarded, and the Governor of the Bank of England met with the Chancellor, and agreed to the Bank's plans, although the Chancellor was keen that the government itself should not get involved unless it was absolutely necessary. The seasonal dummy was included for obvious reasons. Again, careful study of the data reveals clear six-monthly moments of increased activity, and this pattern can be explained by the commercial bank's practice of 'window dressing' (Goodhart 1972). It took a value of 1 in the last week of June and of December, and zero everywhere else, throughout the estimation period. The dummy variable representing financial crises was included in the estimation because it is clear that the volume of discounts and advances increases when a financial crisis is in progress. Again, in defining the periods when this dummy would take a non-zero value, qualitative evidence was considered, particularly that contained in the secondary literature, since it is not acceptable to use the data that are to be used in the analysis to define the periods when dummy variables should be operative. There were thus four occasions when the dummy variable representing financial crises took a non-zero value: 1873 (autumn), 1890 (November), 1907 (March, August and November) and 1914 (July and August). Results The regression results for two out of three estimated equations were fairly good, and are displayed in tables 11.1,11.2 and 11.3, one for each variable. We will briefly discuss these results before going on to consider their qualitative implications. The top half of the tables give the results for the initial ordinary least squares (OLS) estimations. For all three variables, the explanatory power of the regression (R2) is not very high, at just over 0.2. This implies that there are factors other than those included here which are important in the determination of the dependent variable. However, most of the 't' statistics are significant, indicating that the variables which are included are important. Although most of the variables in these estimations are significant, in

An analysis of Bank of England discount and advance behaviour

Table 11.1

329

Governor regression results (TVA) = = = = = = = =

Dependent variable Number of observations Mean of dependent variable Std. dev. of dependent variable R squared Adjusted R Squared F-statistic (4, 2335) Durbin Watson statistic Variable Coefficient Constant R DGOV DSEAS DFINCR

- 2534 13295 40670 41495 588344

Std Error

t-ratio 5

(0.11 x 10 ) 3194 8339 (0.18X10 5) (0.27 xlO 5 )

TVB 2340 60810.86 190496.54 0.2140 0.2127 158.94 0.84 Sig.level

-0.24 4.16 4.88 2.28 21.81

0.79580 0.00006 0.23333 0.02176 0.00000

t-ratio

Sig.level

Adjusted results after AR1 Estimation NewDW = 2.09 Variable Coefficient Constant R DGOV DSEAS DFINCR

- 20203 19627 41632 30235 482898

Std Error 5

(0.15X10 ) 4355 (0.16X105 ) (0.13X105 ) (0.37 xlO 5 )

-1.32 4.51 2.65 2.40 13.05

0.18816 0.00001 0.01652 0.01652 0.00000

all three estimations they are biased due to the presence of serial correlation in the residuals, as shown by the low Durbin-Watson statistics. Because of this bias, additional estimations were undertaken in order to eradicate the (first-order) serial correlation. The results obtained using a different procedure are shown in the bottom half of the tables.56 These results give slightly lower 't' statistics than previously, although the Governor dummy variable is still significant for TVB and VAOS. The Durbin-Watson statistic for all three variables is very much improved, standing at slightly over two for all three equations, indicating that the problem of first-order serial correlation has been more or less eradicated. A summary of the results for all the variables is as follows:

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New perspectives on the late Victorian economy

Table 11.2

Governor regression results (TVB)

Dependent variable Number of observations Mean of dependent variable Std. dev. of dependent variable R squared Adjusted R squared F-statistic (4, 2335) Durbin Watson statistic

= = = = = = = =

TVA 2340 67442.36 183697.11 0.2660 0.2647 211.54 1.65

Variable

Coefficient

Std Error

t-ratio

Sig.level

Constant R DGOV DSEAS DFINCR

-29032 25244 -18.19 459035 6900

9767 2977 7771 (0.17X105 ) (0.25 xlO 5 )

-2.97 8.48 -0.002 27.02 0.27

0.00314 0.00000 0.94658 0.00000 0.77460

t-ratio

Sig.level

-3.84 8.73 -0.09 27.66 0.44

0.00013 0.00000 0.92487 0.00000 0.65942

Adjusted Results after ARl Estimation NewDW = 2.03 Variable Constant R DGOV DSEAS DFINCR

R:

Coefficient -43433 29955 -876.2 452611 0.1799

Std Error 5

(0.11 xlO ) 3431 9291 (0.16 xlO 5 ) (0.20 xlO" 5 )

Significant in every equation, with consistently high (positive) coefficients and't' statistics. This is as expected, since it seems logical that the interest rate will be very important in determining the demand for discounts and advances. DGOV: Significant on OLS and AR1 estimations for TVB and VAOS, but not for TVA, where the 't' statistics are very low. DSEAS: Consistently significant, displaying high 't' statistics. DFINCR: The only equation where the 't' statistic on the dummy variable representing financial crises was significant both before and after the application of the ARl process was that for discounts. This is somewhat surprising, since we would expect the incidence of financial crises to be very important in determining the time path of both discounts and advances and, according to these equations at least, it appears not to be the case.

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Table 11.3

331

Governor regression results (VAOS)

Dependent variable Number of observations Mean of dependent variable Std. dev. of dependent variable R squared Adjusted R squared F-statistic (4, 2335) Durbin Watson statistic Variable

Coefficient

Constant R DGOV DSEAS DFINCR

- 26070 53530 -115463 437152 -105454

= VAOS = 1092 = 112168.29 = 251651.51 = 0.2155 = 0.2126 = 74.64 = 0.85 Std Error 5

(0.21 x ) 6692 (0.16X105 ) (0.36 xlO 5 ) (0.47 xlO 5 )

t-ratio

Sig.level

-1.29 8.00 -7.31 12.29 -2.24

0.19357 0.00000 0.00000 0.00000 0.02408

t-ratio

Sig.level

-1.03 6.87 -4.28 17.94 -0.86

0.30386 0.00000 0.00002 0.00000 0.38884

Adjusted Results after AR1 Estimation New DW = 2.20 Variable

Coefficient

Constant R DGOV DSEAS DFINCR

-21 Ml 53660 -123194 452685 -53139

Std Error 5

(0.26 xlO ) 7813 (0.29 xlO 5 ) (0.25 xlO 5 ) (0.62 xlO 5 )

Implications The implications of these results are interesting, although we must take care not to construe too much from what is, after all, a series of fairly basic regressions. Firstly, it comes as no surprise to find that the interest rate is significant in all of the regression equations, since, as mentioned earlier, we have already identified the positive relationship which exists between the volume of discounts and advances and the interest rate, and concluded that this relationship gives some indication that the LLR function is operative. This then is simply confirmation of what was already thought to be the case. In addition, the same comment can be made of the consistently significant dummy variable representing seasonality; the seasonal element in the data is obvious even to the naked eye, and thus it is expected that a dummy variable representing seasonality would be significant.

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New perspectives on the late Victorian economy

Of greater interest than these two are the results obtained on the dummies for financial crises and for the Governor. As mentioned above, the results for financial crises were rather surprising, in that a priori one would have expected this dummy variable to be very significant, and it transpires that it was rarely so, except on discounts, when it was very strong.57 In addition, prior data analysis undertaken on the Daily Discount data did not suggest that there was little or no relationship between periods of crisis and the volume of advances granted by the Bank of England. These results indicate that the Governor is important in determining the Bank of England's discount and advance policy, at least for discounts and for advances on securities, since the dummy variable representing the Governor is significant in the regressions with these as dependent variables. In some ways this significance is surprising, since in essence this is a weak test relying on qualitative assumptions,58 and uses a time series with a large number of observations.59 In addition, of course, the finding that individual Bank Governors seem to be important for Bank policy-making runs contrary to much of the perceived wisdom, which holds that the Bank was engaged in institutional rather than individual policy-making, especially as regards policy towards financial crises. However, there are major problems involved with this type of empirical testing using dummy variables. One of these is that, as might be expected, the analysis only picks up those events which actually affect the dependent variable. Thus if, as actually occurred in this period, the Bank of England took extraordinary measures in order to avoid what may have resulted in a financial crisis, such as happened with Barings and also with the Yorkshire Penny Bank, the discount data are not affected and thus these actions would not show up in this type of analysis. The implication of the above problem is that empirical testing using dummy variables is perhaps not the most efficient method of analysing whether the Bank of England showed a consistent policy towards financial crises, or whether the policies adopted by the Bank were almost totally dependent on the personality and capability of the individual who was currently in 'the Chair'. However, given that it is not possible to utilise other methods in this case, we cannot ignore the statistical analysis carried out above which indicates the importance of the Governor. Taken in conjunction with qualitative evidence, it points strongly towards the conclusion that the Bank's Governor was potentially important in

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Bank policy-making, but in fact only if the man in question showed a sufficient grasp of monetary affairs and of the problems faced by the Bank.

11.7 Conclusions Since there were no major policy announcements made in the 1870-1914 period,60 any change in the Bank of England's behaviour in the latter part of the nineteenth century occurred implicitly rather than explicitly. It was for this reason that a detailed investigation of the Bank's discount and advance operations was undertaken, as described earlier in this chapter, in order that a picture of any implicit changes could be obtained. Throughout these years the Bank was becoming more conscious of the conflict between its position as a private bank, aiming at profit maximisation, and its role as a central bank, holding the country's gold reserve. Other contemporary bankers were aware of this conflict, and it was in their interest for the Bank of England to concentrate on its role as a central bank and undertake less private business. This of course would have the effect of removing a source of competition from their markets. The pattern of the Bank's interventions infinancialcrises seems to have been that it intervened directly in the affairs of troubled financial institutions or in situations wherefinancialcrisis threatened only when there was a 'lock up' of funds involved rather than the insolvency of the institution concerned. Thus, since both Barings and the Yorkshire Penny Bank were involved in a situation of illiquidity rather than insolvency, the Bank was involved in setting up guarantee funds for both of them. However, the Bank was willing to intervene in 1878 (the City of Glasgow bank failure) only to the extent of providing extra liquidity to the firms affected by the failure, and so the Clydesdale and the Yorkshire Banking Co. were both granted discount facilities. Two things can be concluded from the study of the role of the Bank's Governor and of moral suasion. Firstly, it appears that it must have been very difficult for the Bank to utilise moral suasion to any great extent in this period, particularly in the late nineteenth century, because of the lack of respect it commanded among the banking community. Secondly, it seems that the Governor of the Bank of England did have some significant impact on Bank policy-making at certain points in this period, but that this was only so when the individual concerned was sufficiently able and charismatic to do justice to his position.

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New perspectives on the late Victorian economy

One aspect of the role of the Governor that has not been addressed in this study is whether Governors who appear to be more influential were inherently gifted at central banking, or whether external problems which occurred brought out the best in them. If the latter is the case, there are strong arguments suggesting that almost any of the Governors could have been influential had events forced them to act in a decisive manner on important issues. However, testing whether Governors have greatness thrust upon them is not easy. In effect we are questioning whether the causality runs from a particular Governor being capable of solving a particular problem, or from a problem bringing out the best in a particular Governor. This is intrinsically very difficult, and would in fact require a major study in its own right. Thus, it can be argued that many of the Bank of England's actions at this time depended on the personalities that were around at the time. As mentioned previously, Lidderdale was the initiator of the Barings guarantee scheme, and it was Holden who provided the leadership in the later case of the YPB. It is possible that had Lidderdale not come up with the idea of forming the guarantee fund that enabled Barings to recover from their difficulties, the City of London would today be without one of its more famous names. Notes 1 Thanks are due to Forrest Copie, Geoffrey Wood, James Foreman-Peck and Steve Broadberry for comments on an earlier draft of this chapter. It is based on my Ph.D. work, the title of which is The Development of the Role of the Bank of England as a Lender of Last Resort, 1870-1914'. 2 One way of examining whether or not the Bank altered its behaviour is to determine whether there are any moments in this period when the Bank took actions to prevent a period of financial tension developing into a fully blown crisis. This possibility will be discussed at a later point. 3 There were ten major crises between 1770 and 1870: 1772-3, 1782-3, 1793, 1797, 1825, 1836, 1839, 1847, 1857 and 1866. 4 Bagehot's two 'rules' were 'Lend freely at a high rate' (for an internal drain) and 'Protect the reserve' (for a drain that was external in origin). 5 It can be argued that the existence of bank branching on a large scale reduces the need for a LLR in that banks are more able to absorb losses sustained by particular branches. In the period under consideration there were widescale amalgamations in the UK leading to a higher level of branching. In the US at present however, where until recently commercial banks have been prevented from having branches outside state boundaries, there are many examples of banks which are concentrated in their sphere of influence failing because of the

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depressed state of the industries on which they rely (for example farm, oil banks, etc.). 6 The extent to which the domino analogy in terms of asset prices may apply to today's financial markets was well illustrated by the October 1987 collapse in world stock market prices when, although firms were not failing, price falls were quickly, and sometimes irrationally, transmitted from one market to another. 7 If Bagehot's view of the form last resort intervention should take is accepted, the distinction between illiquidity and insolvency is irrelevant, since any institution coming to the central bank with "good paper' can receive discounts or advances. 8 A 'fire sale' asset price is the price that can be obtained if the asset has to be sold immediately, taking into account the lack of time available for search efforts and information costs. In terms of the definition of solvency, the financial position of an institution requesting aid, having suffered a run, should be judged with respect to its position at the time of the initiation of the run and in terms of equilibrium, rather than fire-sale, prices. 9 Friedman 1959, p. 38. 10 If coverage is 100 per cent then it can be argued that in itself deposit insurance is an implicit LLR, since the motive for holders of bank accounts to withdraw deposits and thus engender a bank run has been removed. 11 In the US, coverage is 100 per cent of the first $10,000. In the UK it is only 75 per cent of the first £10,000. 12 For example, Clapham 1945, Feaveryear 1963, Fetter 1965, Morgan 1943, Sayers 1957, Sayers 1976. 13 For example, Fetter states that The Bank of England as a lender of last resort was, like the Gold Standard and the freedom of deposit banking, accepted as the foundation of monetary and banking orthodoxy' (p. 275). 14 This dissent came mostly from Thomson Hankey, supported by G. W. Norman, both influential Bank of England Directors. In 1867 Hankey published a lecture first given in 1857, to which he added a new preface. In this he referred to the idea that the Bank should stand ready to aid the financial system in times of need as being 'the most mischievous doctrine ever broached'. 15 Although the starting date of the thesis is 1870, it includes a discussion of pre-1870 events concerning the development of the Bank of England and of the financial system. The events which led to Bagehot's policy prescriptions of how the LLR should react to a financial crisis were of course the numerous crises that occurred earlier in the century. 16 By approximately £lm. 17 Bloomfield 1959, p. 47. 18 The results for the Bank of England were slightly more ambiguous than for other central banks. See Bloomfield for further details.

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New perspectives

on the late Victorian

economy

19 A problem with Bagehot's rules, first identified by Rockoff (1986), is that, whilst Bagehot clearly states the two rules, he gives us no objective criterion by which to judge the state of the market and thus to decide which rule to apply. Political pressure may force a central bank to define a period of market tension as an internal drain, leading it to Mend freely', when with hindsight the drain may have been external in origin and thus a better policy would have been to 'protect the reserve'. 20 Bank of England Archive Reference: C28/30 - C28/74. 21 Lovell (1957) addressed the question of whether the Bank of England was acting as a LLR during the crises of the eighteenth century. Using annual data he tests whether the liquidity injections into the market made by the Bank are high when market conditions are tight (as proxied by the number of bankruptcies occurring), and when there is a downturn in the economy as a whole (as indicated by falls in industrial production). He finds a significant positive relationship between the volume of discounts and the number of bankruptcies, and from this concludes that the Bank was acting as a LLR in this period. Duplication of this analysis for the 1870-1914 period was carried out using data from the Daily Discount books and from the same source as Lovell (Hoffman, 1955). The results obtained however were rather different. Instead of finding a positive relationship between the volume of bills discounted and the level of bankruptcies, a negative relationship was found, implying that the volume of bills discounted falls as the number of bankruptcies increases. This apparent anomaly was corrected when a series representing bank failures rather than business failures in general was substituted into the equation, but this (positive) coefficient was not significant. Do we then conclude that the Bank was not acting as a LLR in the later period? I think not: rather that because the analysis undertaken uses annual data it misses much of the day-to-day activity at the Bank, and thus perhaps ignores more than it picks up. 22 When there was no significant increases in market tension. 23 The estimated equations were as follows: TVB, = -29600024 + 14300205BR, (-1.78) (2.98) R2 = 0.15 DW = 0.94 R2 = 0.17

(1)

TVA, = -5342900 + 1266902BR, (-0.17) (1.38) R 2 = 0.02 DW = 0.50 R2 = 0.04

(2)

DIS + AD, = -34942923 + 26970107BR, (-0.95) (2.54) R2 = 0.13 R2 = 0.11 DW = 0.66 ('t' statistics in parentheses)

((3)

An analysis of Bank of England discount and advance behaviour

337

24 The other problem with these estimations, as is obvious from the equations above, is that they are suffering from a high degree of autocorrelation of the residuals, as evidenced by the low Durbin-Watson statistics. One remedy for this is to reestimate the equations using the Cochrane-Orcutt technique, which includes an autoregressive term in the equation. The equations resulting from this estimation are as follows: TVB, = 68434868 + 3529128BR, (0.16) (0.83) R2 = 0.31 DW = 1.63 R2 = 0.35

(1)

TVA, = 18098902 + 6144540BR, (0.63) (0.95) R 2 = 0.59 R 2 = 0.57 D W = 1.93

(2)

DIS + AD, = 29884429 + 11150744BR, (0.77) (1.32) R2 = 0.53 R2 = 0.51 DW = 1.97

(3)

(V statistics in parentheses) As is obvious from these results, although the inclusion of an AR term improves both the DW statistic and R2, the kt' statistics become insignificant. Conclusions have to be 'two-handed' therefore: Bank Rate is important as an explanatory variable in these regressions (explaining between 30 and almost 60 per cent of the variability in the dependent variable) although it is not statistically significant. 25 Before polynomial estimations were undertaken, an attempt was made to estimate an ARIMA (Autoregressive Integrated Moving Average) model for the data. The aim here was to separate foreseen from unforeseen components of the Bank of England's behaviour: by definition, if a particular event was foreseen and thus accounted for in the Bank's actions it could not be a crisis, for a crisis by its very nature is unexpected. Thus, the procedure was to estimate an ARIMA model for the whole time series (45 years = 2,340 observations) and then to split the sample and start a one step ahead forecast, that is, to estimate the model for 1870-9, obtain values for the autoregressive and moving average parameters, and then add a year at a time obtaining a forecast for the variable in each period. It would then be possible to compare actual and simulated values for the variables and thus the difference between the two series would be an indication of the unexpected component of Bank of England policy. Unfortunately, things did not work out this way in practice, due mainly to the length of the time series, with the associated problem that the frequency of the data is weekly: initial Box-Jenkins estimations gave results displaying extremely high Q2 statistics. The chi squared test tests the hypothesis that all

338

New perspectives on the late Victorian economy

the autocorrelations are equal to zero, i.e. that the series is white noise. With a sample this large the test expects to find little or no serial correlation since the sample size should be approaching the population size. One way to reduce the extent of the serial correlation would be to include a large number of AR lags, which since the data was weekly and consists of a large number of observations, seems appropriate: a 52 period lag is only equivalent to one of four quarters when dealing with quarterly data. However, computer packages do not in general have enough memory to deal with such a high number of lags, and so any further estimation had to be undertaken with a reduced sample. 26 In this paper we will consider only the estimations carried out on the discounts variable, TVB. The thesis from which this is derived however includes analysis of both discount and advance variables. 27 See Pindyck and Rubinfeld 1981, p. 108 and Granger and Newbold 1986, pp. 33-6. In essence, the procedure followed was to estimate the polynomial using T, T2, . . . , T8, retaining only those terms which had significant 't' statistics attached to them. Ts was the highest time component used because of computer memory limitations: the large number of observations meant that the numbers involved (1-520 for most of the estimations) became too large for the computer to handle. 28 Since Advances on Securities (VAOS) were not brought into the Discount Office at the Bank of England until 1894, a polynomial covering the period 1894-1914 was estimated for this variable. 29 Examples of standard deviations for the various periods (TVB): 1870-1914 SD Mean

= 190,456 = 60,809

1870-1879 SD Mean

= =

61,405 51,400

1880-1889 SD Mean

= =

17,127 17,154

30 This illustrates the earlier point about the efficiency of comparison over ten year periods. 31 That is, anything less than 100 years old is subject to restricted access. 32 For example, the Minutes of the Committee of Treasury, which at the outset seemed to be a valuable source, soon proved not to be. The reason for this, as previously mentioned, can be found in Sayers 1976, vol. II, p. 630: the Secretary of the Bank of England acted as secretary to the Committee of Treasury, but did not attend meetings, and so the Minutes of the Committee consisted of what the Governor chose to record. 33 Such as the commercial bank archives and the British Museum. 34 C/D increased from 0.180 at the end of 1877 to 0.203 at the end of 1878, and R/D from 0.110 to 0.120. It should be noted however that the increase in the

An analysis of Bank of England discount and advance behaviour

35 36 37

38 39

339

reserve-deposit ratio could be part of the general secular increase occurring in the period as a whole, as commercial banks increased reserves and started to publish balance sheets. The money supply (as measured by M3) fell by 7.73 per cent between June 1878 and June 1879. Source: Capie and Weber 1985, table 1(3), p. 82. Howard Lloyds' Reminisences, p. 36. (Lloyds Bank Archive Reference 10/29). Collins 1987, p. 4 This provides a good example of the difficulties inherent in distinguishing between illiquidity and insolvency. When Barings presented their problems to the Bank of England in November 1890 the Bank despatched two people to determine what state their business was in. The report that came back was that there was in fact a surplus of assets over liabilities. It took until 1895 however for this surplus to materialise, and when it did it was not as high as had been expected (Bank of England Archives, Baring Papers, file 4, folio 177). It can be argued that in many cases the division between illiquidity and insolvency in many cases comes down to the length of time needed to regain liquidity. The results are discussed in detail in chapters 6 and 7 of my Ph.D. thesis. For this test: Ho: the order of the positive and negative residuals is random. Hp the order of the residuals is not random. Z (the deviation of observed values from the population mean when the SD of the population is equal to 1) is calculated according to the formula:

Z = J2nxn2{2nxn2-nx - n2) (nx +n2)2(nx +n2- 1) where: r = number of runs nx = number of negative residuals «2 = number of positive residuals. The rejection region for this test consists of all values of Z which are so extreme that the probability of their occurrence under Ho is equal to or less than the significance level, 0.05, and thus this rejection region includes all values of Z > + / - 1.96 (Siegel 1956, table A, p. 247). 40 The Z statistics were: 1870 - 79: Z = -7.154 1880 - 89: Z = -3.18 1890 - 99: Z = -3.296 1900 - 09: Z = -6.475 1910 - 14: Z = -8.331 In all cases, Z > + / - 1.96, and thus the null hypothesis is rejected and we can conclude that the order of the negative and positive residuals is not random.

340

New perspectives

on the late Victorian

economy

41 Kurtosis statistics: 1870 - 79: 14.14 1880 - 89:27.10 1890 - 99:5.65 1900 - 09:8.62 1910 - 14:33.00 With a sample of 520 in each of the first four periods and 260 in the fifth, the critical values at the 5 per cent level are 3.37 and 3.52 respectively, and thus all the periods fail a normality test indicating the presence of kurtosis. See Pearson and Hartley 1970, table 34, for further details. 42 Midland Bank Groups Archives, reference Ml53/47/4 (Business Reports of the Liverpool Manager of the North and South Wales Bank, T. R. Hughes, 12-14 May 1897). 43 The Governor of the Bank in 1900 was Samuel Steuart Gladstone. Following him, from 1901 to 1903, was Augustus Prevost. 44 Midland Bank Group Archives, reference Ml53/62/2 (Business reports, as above, 9-11 May 1900). 45 Source: The Diaries of Edward Walter Hamilton, 8 January 1891. Held at the British Library, Department of Manuscripts, reference Add 48,654. 46 Bagehot 1873, p. 223. 47 Quoted in a letter from Faber of Faber, Beckett & Co., Leeds, to the Central Association of Bankers, 14 May 1896. (Midland Bank Group Archives, reference M222/2: George Rae's Papers) 48 Ibid. 49 Fay 1987, p. 30. 50 Sayers 1976, vol. II, p. 595. 51 The changeover in Bank Governors took place in April of every second year, and thus the Governor dummy for Palmer, for example, is equal to 1 from week 14 of 1877 until week 13 of 1879. 52 Between week 14 of 1889 and week 13 of 1892: Lidderdale's term of office was extended in order that he could continue negotiations he was involved in with Goschen, the Chancellor of the Exchequer, concerning the amounts the Bank charged the government for, among other things, the management of the National Debt. 53 Governor between April 1907 and April 1909. 54 Several sources indicate that Lidderdale was one of the most energetic of the Governors in this period, and that he provided the whole inspiration for the Bank's actions in the Baring affair. In the words of two contemporaries: 'the endeavour seems to have come completely from Lidderdale, without much seconding or more than tacit support from his colleagues. If my informant is correct then Mr. Lidderdale is the sole and courageous author of the endeavour which appears to have rescued the City temporarily or otherwise from the formidable embroilment that would have followed the failure of Barings.'

An analysis of Bank of England discount and advance behaviour

341

(Contained in a letter from Howard Lloyd to Hoare, dated 18 November 1890. Held at Lloyd's Bank Archive, reference 4050.) T h e Government and commercial world at large cannot congratulate themselves too much on how lucky they are to have Lidderdale at the helm' (diaries of Sir Edward Walter Hamilton, 15 November 1890). It seems that it was rare for a Governor to take his position as seriously as did Lidderdale; Sayers (1976, p. 640) reports that he had been so fully occupied by the affairs of the Bank that when his term as Governor ended the business from which he had previously gained the major part of his income was not in a strong position. 55 For example, on 27 July 1911, soon after the bank's problems had become evident, he wrote to the Chancellor, Lloyd George, asking for his help: T h e Governor of the Bank of England and I have been working day and night for a week trying to prevent the most awful catastrophe of the institution I discussed with you coming down. Up to last night we had hopes, but this morning I despair. I think you and Mr. A(squith) should know exactly what the position is as some help from you may enable us to pull through' (Letter from Holden to Lloyd George, 27 July 1911. Midland Bank Group Archives, Edward Holden's Private files, YPB). And then, two days later, he used a slightly more desperate note: fcI know you are very much engaged with policy affairs, but I should like to point out to you that the matter I wrote to you about is equally important. If this debacle comes it will lay in ashes the whole of Yorkshire and a great deal of Lancashire. I cannot help but think it would do a great deal of damage to the Government in these districts.' (29 July). 56 The computer package used to carry out these regressions was LIMDEP, chosen because it was capable of handling a larger number of observations than other packages. The autoregressive procedure used by LIMDEP is the Prais-Winsten method. This is similar to the Cochrane-Orcutt method, but includes an extra transformation on the first observation. 57 In some ways this result is slightly worrying in terms of the analysis already carried out since the primary hypothesis underlying the data analysis was that the volume of discounts and advances increases when a financial crisis is in progress. The evidence here is not sufficient for us to abandon this hypothesis, but we must bear these results in mind. 58 In essence, the major problem with this analysis is that in initially identifying the Governors thought to be important, and then assigning them the non-zero dummy, we are already assuming that these are the Governors in whom we should be interested, and so a bias is introduced. However, the only alternative to this sort of approach would be to put in one dummy variable for each Governor (twenty-two in all), and then to see whether any of them were significant in a similar regression to that which was carried out. The problem here again is in terms of computer memory: few packages would be capable of running a regression which included around twenty-five regressors, on a

342

New perspectives on the late Victorian economy

sample of 2,340 observations. Splitting the sample would be one solution to this problem, but would not be appropriate in this case, because we are interested in how the variables relate to each other over the whole time period. 59 The relevance of the long time series is that we might not expect dummy variables which cover relatively short spans to be significant when they are immersed in such a long data run. 60 The only place where the Bank commented directly on its behaviour is in its evidence to the American Monetary Commission in 1910, and even then it gave very little away. (US National Monetary Commission, Senate Document 405, 61st Congress, 2nd Session, 1909-10.) References Bagehot, W. (1873), Lombard Street, New York: Arno Press (reprint of the 1915 edition). Beenstock, M. (1987) 'Comment on the theory of last resort lending' in Res and Motamen(eds.)(1987). Benston, G., Eisenbeis, R. A., Horvitz, P. M., Kane, E. J. & Kaufman, G. C. (1986), Perspectives on Safe and Sound Banking: Past, Present and Future, Cambridge, Mass.: MIT Press. Bloomfield, Arthur I. (1959), Monetary Policy Under the International Gold Standard, 1880-1914, New York: Federal Reserve Bank Capie, F. & Webber, A. (1985), A Monetary History of the United Kingdom, 1870-1982, London: Allen & Unwin. Capie, F. & Wood, G. E. (eds.) (1986), Financial Crises and the World Banking System, London: Macmillan. Clapham, J. (1944), The Bank of England, London: Macmillan. Collins, Michael (1987), The banking crisis of 1878', University of Leeds, School of Economic Studies Discussion Paper Series A: 8719. Collins, Michael (1988), Money and Banking in the U.K.: A History, London: Croom Helm. Fay, Stephen (1987), Portrait of an Old Lady - Turmoil at the Bank of England, London: Viking. Feaveryear, A. (1963), The Pound Sterling, London: Oxford University Press. Fetter, F. W. (1978), The Development of British Monetary Orthodoxy, New Jersey: Augustus M. Kelly. Flannery, M. J. (1982), 'Deposit insurance creates a need for bank regulation', Federal Reserve Bank of Philadelphia Business Review, Jan/Feb, 17-27. Friedman, M. (1959), The demand for money: some theoretical and empirical results', Journal of Political Economy, June, 327-51. Goodhart, C. A. E. (1972,86), The Business ofBanking, 1891-1914, London: Gower. Granger, C. W. J. & Newbold, P. (1986), Forecasting Economic Time Series, London: Academic Press. Hankey, Thomson (1867), The Principles of Banking, London: Wilson.

An analysis of Bank of England discount and advance behaviour

343

Hoffman, Walther G. (1955), British Industry 1700-1950, Oxford: Basil Blackwell. Karenken, J. H. (1983), 'Deposit insurance reform is the cart not the horse\ Federal Reserve Bank of Minneapolis Quarterly Review, Spring. Lovell, Michael C. (1957), The role of the Bank of England as lender of last resort in the crises of the eighteenth century', Explorations in Entrepreneurial History, 10, October, pp. 8-21. Morgan, E. Victor (1943), The Theory and Practice of Central Banking, London: Cambridge University Press. Pearson, E. S. & Hartley, H. O. (1970), Biometrica Tables for Statisticians, Cambridge University Press. Pindyck, R. S. & Rubinfeld, D. L. (1981), Econometric Models and EconomicForecasts, New York: McGraw-Hill. Pressnell, L. S. (1968), 'Gold reserves, banking reserves and the Baring crisis of 1890', in Whittlesley and Wilson (eds.) (1968). Res, Z. & Motamen, S. (eds.) (1987), International Debt and Central Banking in the 1980's, London: Macmillan. Rockoff, H. (1986) 'Walter Bagehot and the theory of central banking', in Capie and Wood (eds.) (1986). Sayers, R. S. (1957), Central Banking After Bagehot, Oxford: Clarendon Press. (1976), The Bank of England, 1891-1944, Cambridge University Press. Siegel, Sidney (1956), Nonparametric Statistics for the Behavioural Sciences, New York: McGraw-Hill. Thornton, H. (1802), An Enquiry into the Nature and Effects of the Paper Credit of Great Britain, London: Allen & Unwin (this edition 1939). Whittlesley, C. R. & Wilson, J. S. G. (eds.) (1968), Essays in Money and Banking, London University Press.

Index

Agriculture decline of productivity, 4, 5, 82 innovation in, 11 relative decline of, 8, 253, 279, 280, 286 Akaike's Information Criteria. A model selection criterion based on the residual variance of an estimated model, which is then corrected by a penalty factor that is proportional to the number of parameters that have been estimated. 268 Amalgamated Society of Carpenters and Joiners, 180, 186-7, 189 Amalgamated Society of Engineers, 180, 183, 186-7, 189 Arbitration, see Conciliaton Boards Arbitration Acts, 218, 219 ARIMA model, 263-4 See ARMA and ARIMA models ARMA and ARIMA models. Models for representing a single time series in terms of past values of the series itself (the autogregressive or AR part) and current and past values of unpredicted shocks to the series (the moving average or MA part). ARIMA models are used when the series requires differencing prior to modelling. Vector ARMA models are multivariate extensions of these univariate models. 264-5 Assets, see Demand for assets Australia, 131, 137, 142,254 Autocorrelation function. The set of 344

correlations between the current value of a time series and successive lagged values of the series. The sample autocorrelation function is the set estimated from single observed series, while the partial autocorrelations measure the correlation between the current value of the series and a lagged value with all intervening lagged values held constant. The cross correlation function is the set of correlations between the current value of one series and the future, current and past values of a second series. Balance of payments Britain and India, 9 deficit, 250 Banking deposit insurance theory, 309 lack of complete information in, 308 reasons for differential treatment, 306-7 Banking Act 1844,3 Bank of England, 23, 24, 27-9, 305-34 as lender of last resort (LLR), 305-9 changing role, 309-14 methods for assessing, 311 types of policy, 312 empirical analysis, 314-23 influence of Governors on policy, 29, 325-33 test for influence, 326-31 results and implications, 331-3

Index and the gold standard, 310-11 See Banking, Financial institutions Best practice, 125 Bicycle industry, 10 Bowley's cost of living index, 151, 153-4

criticism of, 154 price indicators of food, 162 rent, 164-5 rates, 167 See Cost of living British economy, decline of, 3, 125 and institutional rigidities, 127 and railways, 82 limited domestic market, 127, 129, 251-53 British Insulated Cable, 137 Broad money, 260 See Monetary approach to British price decline Bryant and May, 135-6, 137 Business organisation, 126-7 Cadbury-Fry, 128, 131 Campbell, W. M., 327 Canada, 131, 137, 142 Empire, tariff preference, 15 investment in agriculture, 11 monetary sector development, 286 Chemicals, 5, 10, 15, 59, 125, 134 Close money substitutes, availability of, 285, 286 See Demand for assets Coal Industry, government intervention, 225 output and unionism, 22 wage bargaining, 22-3, see Conciliation boards, Collective bargaining wage rates, sliding scale, 224-5 Cointegration. A set of series are said to be cointegrated if they are individually nonstationary but a linear combination of them is stationary. See Stationarity Cole, A. F., 329

345

Collective bargaining, 148, 149, 218-41 establishment of, 218-19 in Coal industry, 221-41 models game theory, 228-32 industrial relations literature, 232-5 mechanism design theory, 235-41, proof 241-5 See Conciliation boards Combination Acts, 219 Commercial bills, 26-7, 287, 293 decline in use of, 288-9 elasticity of demand of, 292 See Demand for assets Comparative advantage, 12, 22, 70 technological, 39, 42 of United States, 134 Conciliation boards, 22-3, 218-41 arbitrators constrained, 227-8 cost of, 240-1 variation in role, 239 behaviour of and perfect equilibrium, 238-41 brevity of negotiations, 240-1 commitments of, 233-5 constitutions of, 223, 233-4, 236-8 establishment of, 219-20 optimal contracts of, 226-8, 235-41 optimally designed institutions, 222-3 success of, 222 in coal industry, 225-6 See Collective bargaining Construction industry, 5, 82, 223 Consumer expenditure, inquiries into, 156 alcohol, 154, 157 food, 160 healthcare, 157 tobacco, 157 travel, 157 patterns, 17-18, 155-7, 158, 159 and discrepencies with consumer income, 157-60

346

Index

Contestable markets, 14, 96-119 Cooperative and non-cooperative Games. A game is cooperative if the possible outcomes include Pareto inferior alternatives. It is non-cooperative if all the outcomes are Pareto optimal, so that any allocation that is preferred by one party is not preferred by another. This means that the game requires some element of cooperation if a Pareto optimal outcome is to be reached. One classic example is where players have to decide on the division of a cake which shrinks every time a player makes a move in a game. Here, if a division is decided, it is in the interests of all players to agree it as soon as possible. In this respect the game is cooperative. However, for a given size of cake, increasing the share of one player will diminish the share of at least one player. All divisions are Pareto optimal, and the problem of dividing a cake of a given size is a non-cooperative one. See Game theory. Costs, distribution, 35-6 location, 16, 35-6, 136 production, 16, 136 decreasing, see Gas industry, Water industry See Transactions costs Cost of living, 17-19, 151-74 indices Bowley's, 151, 153^ Wood's, 151, 155 new index price indicators of, 161-8 weighting of, 155-60, 161 comparison with Bowley's, 169-73 comparison with Wood's, 173—4

comparison with other indices, 174 See Bowley's cost of living index, Wood's cost of living index Cotton famine, 190, 192, 193, 200, 203, 209 Councils of Conciliation Act 1867, 220 Courtaulds, 128, 138 Cunliffe, W., 328-9 Demand for assets, 285-303 demand functions, 294, 296 comparison with later period, 297-9 elasticity of demand, 291, 294, 295-6 money, 292 quasi money, 292 commercial bills, 292 See Financial sector, institutions Demand for money, 285-303 function, 285, 289 See Demand for assets, Financial institutions Dunlop, 128, 138 Economic cycles, see Economic distress Economic distress pattern of, 180-213 See Poor relief Education, 125, 126, 136 Electrical engineering, 5, 59-60, 134

Engineering Productivity growth, 125 US comparative advantage, 134 Entrepreneurial failure, 125-6 See Management failure Error correction mechanism. A functional form used in the estimation of econometric relationships which assumes that changes in the dependent variable are determined partly by the deviation from some long-run

Index steady state relationship with one of the dependent variables. Extensive form, see Normal and extensive form Factory and Workshop Act 1878, 7 Fertility, decline of, 6-7 Financial institutions, 23-4, 26 and railway investment, 85 historical development of, 286-9 See Bank of England Financial sector, developments in, 285-300 theoretical framework, 289-92 indices, 292-3 empirical results, 292-7 comparison with later periods, 297-9 econometric techniques, 300-1 data, 301-3 See Demand for assets Fisher effect, 259, 260, 278-9 Food industry, 11, 15, 67 Foreign direct investment (FDI), 15, 125-42 cost of, 136-7 decision making, 134-5, 142 location of, 130-4, 140 measure of, 132 product composition of, 134, 135 transaction costs of, 15, 136, 137, 138-41 and tariff barriers, 15 See Multinational Enterprises (MNEs) France comparison with Britain, 4 migration, 7 motor car industry, 10 regional wage variation, 7 Friendly Society of Ironfounders, 180, 186, 188, 189 Game theory. Game theory studies the behaviour of rational agents in situations where the outcome depends on the action of all

347

agents. See Collective bargaining models Gas industry, 5, 14, 96-119 contestable market, 102, 107-9 externalities, 96, 97, 102, 110 municipalisation growth of, 118 incidence of, 116-19 reasons for, 115-6 natural monopoly, 104-5 payment of dividends, 113-14 price elasticity of demand, 101 private ownership competition, 100-2 deficiency of supply, 102, 104-9, 114-15 incorporation, 98-9 regulation, 109-15 rates of return, 102, 103, 104 Gas and Water Act 1890, 118 Gas Works Act 1847, 114 Gas Works Clauses Act 1871, 114 Gas Works and Water Works Clauses Act 1847, 112 Germany business organisation, 127 chemical industry, 41 comparative advantage, 39, 66 marketing, 130 multinational enterprises (MNEs), 129, 141 technological advance, 9-12, 39 Gibson Paradox, 251, 256-60, 269, 278-9 See Monetary approach to British price decline Glaxo, 128 Gold Standard, 23-4, 249, 254, 278, 310 Great Central Gas Company, 106 Hosiery trade and conciliation boards, see Mundella's board Impulse response function. An impulse response function measures the dynamic response of

348

Index

one variable to a shock in another variable. 269, 271, 274-7 Incentive compatible. A set of rules is said to be incentive compatible if they create no incentive for the agents governed by them to break the rules. In recent economic literature where information is assymmetric, the term has been used in a more specialised sense to mean that the agent who has access to private information has no incentive to lie to the other agents. Income average working class, 153, 156 and expenditure, 157-60 effect, 255 real, see Cost of living velocity of circulation, 285-6 Innovation British decline, 10-12 technological, 37-70 See Technological innovation, Revealed technological advantage Innovation accounting. The decomposition of a forecast error variance of a variable into proportions accounted by itself and other variables. Instrumental variables. An estimation technique for econometric models in which one of the explanatory variables is correlated with the error term. Interest rates, 251-80 Investment in British industry, 8, 128 in human capital, 4-5, 59 overseas, 8-9, see Foreign direct investment and crowding out, 11, 85 and railways, 85 Iron and steel, managerial failure, 127 productivity growth, 125

Japan business organisation, 127 comparative advantage, 39, 67 innovative activity, 65, 67, 69 Johnson Matthey Bankers, 306, 307 Kondratieffs cycle, 254 Kuznets cycle, 189 Labour force growth, 13 Laspeyres price index. A base weighted price index. 147, 148, 153, 155 Lidderdale, 328 Lighting and Watching Act, 112 Liquidity preference, 256 Living standard, see Standard of living Loanable funds, 256 Local Government Board, 181, 185, 189, 192 Management failure, 126-42 Marketing, 129-30 Masters and Servants Acts, 217 Mechanism. A mechanism is a set of rules for a game which are designed to generate specified desirable characteristics of the outcomes. Thus an incentive compatible mechanism is one that ensures truthful revelation of private information. Metropolis Gas Act 1860, 101 Miners Federation of Great Britain, 224 Migration effect on population growth, 7 social savings of, 13 and railways, 84, 88 Mining, 4, 82 Monetary approach to British price decline, 251-80 analytical framework, 254-60 Gibson paradox, 256-60 data, 26(M empirical work, 264-77 findings, 277-81

Index Money supply, 250, 256 impact of changes in, 251-80 definition 287 Monopoly, see Natural monopoly, Gas industry, Water industry Moral hazard, 307 Mortality, 7 Motor car industry, 9-10, 58 constraints to growth, 127-8 raise in share of FDI, 134 Multinational Enterprises (MNEs), 15, 125^2 competitive weakness of, 131, 134, 142 Empire markets, 130-4 low returns of, 128 management failure, 128-9 in marketing 129-30 production branches, 135-8 production versus sales branches, 132, 133, 135, 139^42 Mundella's Board, 220-5 See Conciliation boards Municipalisation, see Gas industry, Water industry Narrow money, 260-6, 261 See Monetary approach to British price decline Nash equilibrium. A set of strategies constitutes a Nash equilibrium if each player's strategy yields him the largest possible payoff, given the equilibrium strategies of the other players. 229-31 Natural monopoly. An industry in which one firm can produce an output at a lower unit cost than two or more firms, 96, 104 See Gas industry, Water industry Non-Bank financial institutions, 289, 292, 293 See Demand for assets Non-cooperative game, see Cooperative and non-cooperative games Normal and extensive form. These are

349

alternative ways of representing a game. The normal form consists of a matrix whose rows and columns represent the strategies that are available to each player. The cells of the matrix contain the payoffs that will be yielded by the relevant combination of strategies to payoffs without specifying move-by-move how the game may be played. The extensive form includes this move-by-move information. Optimal labour contracts, 222 Orthogonalising transformation. A method of recording the variables in a vector ARM A model so that the shocks to each series are contemporaneously uncorrelated. Paasche price index. A current weighted price index. 147, 148 Palmer, E. H., 328 Paper and printing industry, 5 Pareto superior. A Pareto improvement is made to an allocation when one party is better off, without any worsening of any other party's position. Pauperism regional variation, 181-2 county analysis, 189-97 transect Poor Law Union analysis, 198-209 behaviour of Unions, 199-200 data used, 198-9 demographic indices, 200-1 occupational indices, 199, 200-1 See Poor relief Payoff. The payoffs of a game are the amounts received by the players when the game is over. Payoffs will depend on the strageties chosen by all the players in a game. 229 Perfect equilibrium. A refinement of

350

Index

Nash equilibrium in which the strategies played in every subgame of the extensive form, form a Nash equilibrium. 231 Periodogram. The modulus-squared of the finite Fourier transform. The periodogram was introduced early in the development of time series methods, and is appropriate to the analysis of processes involving the superimposition of a few simple periodic phenomena, such as the motions of planets. However, spectral analysis is better suited to the analysis of pure stochastic processes. 214 Pharmaceutical industry, 10, 11, 59, 67 Poor Law, see Poor relief Poor relief and economic distress, 180-213 % of population receiving poor relief, 183, 196 seasonal variation, 185-9, 195 cyclical variation, 185-9, 195-7 impact of, 212-13 and trade union statistics, 185, 186-8, 195-7, 209 Poor Law statistics, 19-20, 181-3, 190, 191, 192,212 value of, 212-13 See Pauperism Population growth, decline of, 6-8 Postal service, 82 Power spectrum, see spectrum Predetermined. In a structural model a variable is said to be predetermined if all its current and past valves are independent of all current shocks to the model and if these shocks are themselves independent of each other through time. Price movements, See Cost of living, Monetary approach to British price decline

Private information. Information is private if one agent has free access to it and it is not possible for some other agent or group of agents independently to verify the truth. An important implication of this definition is that even, if the agent having the private information reveals the truth, other agents are unable to recognise it as such. Hence the importance of incentive compatibility constraints, which ensure that the agent with private information will reveal the truth in his own interests. 226 Prussia, 7 Public health, 96, 97, 102, 110 Public Health Acts 1842, 112-13 1848, 114 1875,115-18 Quasi money, 287, 288 elasticity of demand for, 292 validation of, 296-7 See Demand for assets Quantity theory of money, 249 Railway Act, 13 Railways, 9, 12,35,41,73-92 investment, 85 labour productivity, 80 long run impact on economy, 83-9 performance, 78-9 price elasticity of demand, 75-6, 89-90 social savings of, 13, 73-7, 85, 89 Randomisation. A contract is randomised if its outcome under specified circumstances is not predictable. The most common forms of randomised contracts arise in gambling and insurance. Once the stake has been laid at the craps table, the outcome of the contract is determined by the

Index throw of dice. Treble's chapter argues that one can view arbitrators in this light, since, at the time that he is called in, the arbitrator's decision will not be known with certainty by either party in a negotiation. 227 Random walk. A special case of an ARIMA model in which the changes of a series are uncorrelated with each other through time. Rates, increases in, 167 Reckitts, 138 Rent movements in, 165-6 Representative economy hypothesis, 269 Research and Development (R&D), 41,42,43,59, 125, 126, 127 Revealed technological advantage (RTA), 11,41-67 old vs new industries, 56-7, 68 Britain iocked into' old industries, 57-60, 68 index of, 11,41-67 statistical methodology, 49-52 Risk averse. An agent is risk averse if he refuses a fair gamble. Note that risk aversion does not mean that the agent will avoid all risks. If a game is biased in his favour, a risk averse agent may well prefer it to the certain alternatives. 227 Rowntree, 130 Sauerbecks wholesale price index, 153 Saving and investment ratio, 84-5 Selling, see Marketing Service sector, 4 Shipbuilding, 41 Small country hypothesis, 269-70, Social savings, 12-13 See Railways Spectral window. Effectively, a smoothing function applied to the periodogram of a series to derive

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the power spectrum. Different methods of spectral analysis apply different windows. Where computer software permits the precise specification of the window, selection of the most appropriate set of weights is analogous to the choice of class intervals when constructing a histogram. 214 Spectrum. Spectrum or sometimes 'power spectrum': synonymous with 'spectral density function', this is a function of a time series which represents the contribution to the total variance of the series made by different frequency components. A peak in the spectrum indicates an important contribution to variance at frequencies in this region. 185, 187-8 Speenhamland System, 147, 193 Standard of living, 6, 16-19, 151 See Cost of living State-contingent. A contract is state-contingent if its outcome depends on the occurrence of certain specified and unpredictable events. Thus the completion date of a life insurance policy, and often its beneficiary, is dependent on the date of death of the insured person. The wage contracts under coal industry sliding scales specified that the wage rate would be set according to the average price of coal. Thisfigurewas not known at the time the contracts were signed. 227 State ownership, 13-14 See Municipalisation Stationarity. A time series is stationary if its mean and variance remain constant through time and its autocorrelations

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Index

depend only on the lag between the observations and not on time itself. Steady state growth, 83 Strategy. A strategy is a move (or sequence of moves) that a player in a game may make. Strong exogeneity. A variable is said to be strongly exogenous if it can be treated as being both determined outside of the model being investigated and fixed in repeated samples. Surrey Consumer Gas Company, 106 Sweden migration, 7 monetary sector development, 187 regional wage variation, 7 Tariffs, 8 Technology, 6, 9-12, 16 Technological, advantage, 39 measures of, 4 2 ^ stability of, 52-7 See Revealed technological advantage decline, 37 innovation, 35, 37-70 cumulativeness, 37-9, 41, 49, 64, 69 incremental change, 39, 41, 51, 54, 64, 69 sectoral pattern, 40, 44, 51-2, 61-3, 66, 68 specialisation, 39, 48, 51-2, 54, 56,61,69-70 randomness, 39, 51, 54, 63 trajectory, 12, 35 Telecommunications, 5, 9, 13-14, 26-7, 60 Textile industry, 5, 41, 58 foreign direct investment, 15, 134 management failure, 127 productivity growth, 125 Total factor productivity (TFP). Total productivity indices are ratios of

outputs to all associated inputs, measuring net savings in resource costs, and therefore improvements in efficiency. Strictly, TFP measures output net of intermediate products and the resulting real value added is related to factor inputs. At the national level, total productivity and TFP indices are identical, 5, 12, 74, 125-6 of agriculture, 82 of construction industry, 82 of mining, 82 of railways indices, 74, 76, 78-9 growth, 77-81,90 Trade, 8-9, 189 Trade unions, 18-23 changes in laws concerning, 218-20 See Collective bargaining, Conciliation boards, Poor relief Transaction costs, 15 andMNEs, 136, 137, 138^1 and natural monopolies, 98, 104 Transect. A line, or strip, along which a survey is made or an analysis carried out; in so far as variation over a study area may be represented by a transect across it, techniques drawn from time series analysis may be applied to the analysis of spatial data. 198-209 See Poor Relief Transport improvements, 253, 289 Trend surface model. A trend surface model is a regression model in which the independent variables are the geographical coordinates of the points for which the dependent variable is measured. There is a direct analogy with simple time trend models, and a first-order trend surface model is one where the dependent variable is a simple linear function of the

Index coordinates: y = Po + Pi (Northing) + p 2 (Easting) United States, agriculture, 253 comparative advantage, 39, 66 distribution of income, 16 domestic market, size of, 129 monetary sector development, 285 mortality, 7 MNEs, 128, 129, 134, 141 patent policy, 43 railways, 73, 85, 90 technological advantage, 9-11, see Revealed technological advantage Unit root. A time series is said to contain a unit root if it requires first differencing to be stationary. Vickers, 128, 130, 138 Wages decline 151-2 rate, sliding scale, 224-5, 233 regional variation, 7 setting, 149 and standard of living, 16-17, 151-74

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Water industry, 14, 96-119 contestable market, 102, 107-9 externalities, 96, 97, 102, 110 municipalisation growth of, 118 incidence of, 116-19 reasons for, 115-16 natural monopoly, 105 payment of dividends, 113-14 price elasticity of demand, 101 private ownership competition, 100-2 deficiency of supply, 102, 104-9, 114^15

incorporation, 98-9 regulation, 109-15 rates of return, 102, 103, Water Works Act 1852, 109-14 Wellcome, 137 Wood's cost of living index, 151, 155 price indicators of food, 162-3 furniture, 168 rent, 164-5 See Cost of living Workmans Compensation Act 1897, 7 Yorkshire Penny Bank, 28, 322, 328, 333