Economic Shifts: Industrial Revolution & Growth Models

Posted on Mar 29, 2025 in Business Administration and Management (BAM)

Economic Shifts and Growth Models

Structural Change

A structural change represents a shift or change in the fundamental way an economy functions. As income grows, literacy and education levels rise. Governments invest in public schools to enhance workforce qualifications. A key difference between pre-industrial and modern industrial societies is the reduced role of agriculture. Modern agriculture’s increased productivity feeds a large non-agricultural population. Efficiency gains lead to fewer people employed in agriculture, with a rise in the secondary sector (mining, manufacturing, and construction). People migrate from agriculture to industry and services, often through internal migration from rural to industrial areas. This results in:

  1. A shift in population density from southeast to northwest.
  2. Increasing urbanization.

Increased income leads to decreased infant mortality due to better maternal diets and healthier children, improving living standards. Fertility rates decrease as families no longer need many children for survival, and women delay childbearing.

Production Function

The production function measures inputs (labor, land, capital) used to create outputs (goods and services = national income). Output growth occurs through increased factor inputs or more efficient use of existing inputs. Classical economics classifies production factors as labor, land, and capital. An economy’s total output depends on the quantity of production factors employed, subject to certain assumptions. Changes in technology and social institutions are dynamic sources of economic development, transforming resource utilization possibilities and raising living standards.

Technological Change and Growth

Pre-industrial economies based growth on accumulating productive factors. Modern economies combine factor accumulation with technological improvements. Increased technology leads to sustained growth and more efficient factor use, boosting productivity. Sectors like agriculture improve through technology, becoming more efficient and supplying larger populations. Industry also benefits from technological advancements.

The Industrial Revolution: An Institutional Approach

Factors explaining growth:

  1. Transport Revolution: Mid-19th century, increased market sizes and returns to scale (e.g., steam engines for ships/railways, Suez Canal).
  2. Human Capital: Skills and qualifications embodied in the labor force (literacy, schooling, on-the-job learning).
  3. Literacy & Education: Economic growth increases literacy rates and schooling; higher income leads to more literacy and schooling; governments provide public schools.

Investment in Human Capital

Output increases through increased input quantity or increased efficiency (productivity). Labor productivity is real economic output per hour or worker (O/L), depending on capital per worker (K/L) or skills per worker (H).

Law of Diminishing Returns

If one input is fixed, adding more of other inputs increases output by progressively smaller increments. Increasing labor in the long term yields diminishing output. If land is fixed, output per unit of other factors decreases as their use increases.

Markets

Places to buy or sell goods and services, determined by supply and demand. Labor market prices are wages. An integrated market has uniform prices across geographic areas.

Savings and Investment

As income grows, savings and investment also grow. Higher salaries allow for spending, investment, or saving. Economic growth encourages investment in shares for returns. Confidence in financial institutions is crucial for connecting those who demand and supply investment money. More workers and capital increase wages; delayed working and educated children increase taxes.

Opportunity cost, terms of trade (PP of X in terms of M), comparative advantage (producing goods/services more efficiently with lower opportunity cost), tariffs (taxes on imports), elasticity, and principal-agent problems are important concepts.

Fertility and Infant Mortality

As GDP increases, fertility and infant mortality decrease. Reduced infant mortality results from economic growth (better conditions/living standards). Fertility decreases because lower infant mortality reduces the need for many children.

Modern Economic Growth

Since 1980, there have been increases in production, population, real GDP per capita, and life expectancy (doubled), with a decrease in household work.

HDI measures life expectancy at birth, education, and GDP per capita.

Sources of Growth

  1. Proximate: Technology increasing productivity, natural resource exploitation, capital inputs (+K), labor inputs (+L).
  2. Ultimate: Pro-growth institutions, reliable payment methods, high-quality labor and human capital, large markets, and low trade barriers (lower tariffs).

Institutions

Institutions shape a society’s incentive structure, with political and economic institutions determining economic performance. They consist of formal constraints (rules, laws, constitutions), informal constraints (norms, conventions, codes of conduct), and their enforcement. The interaction between institutions and organizations shapes economic evolution. Institutions are the rules, while organizations are the players.

Economic historians must consider organizations (guilds, corporations, governments, legal systems) and informal institutions (mental models, culture) that govern individual responses and influence organizational effectiveness in creating and sustaining economic growth.

Malthusian Model

An inverse relationship between population size and living standards.

Idea: Adding labor and capital to a fixed piece of land generates successively smaller output increases.

Assumptions:

  1. Birth rates increase with material living standards.
  2. Material living standards decrease as population increases.
  3. Death rates decrease as living standards increase.

Increased population leads to lower wages and living standards.

This inverse relationship causes the Malthusian trap; pre-industrial economies were Malthusian. Technological breakthroughs in pre-industrial economies were short-term and medium-term.

Malthusian Trap

  1. Increased population related to increased living standards.
  2. Increased living standards lead to increased food prices, resulting in increased output (+land to produce).
  3. Decreased real wages (food is essential).
  4. If food prices increase, real wages decrease, then death rates increase (poor diet, health conditions).
  5. If food prices increase, real wages decrease, then initially a decrease in marriage, followed by a stationary state.
  6. Decreased marriage leads to decreased birth rates.

Result: Decrease in population.

Escaping the Malthusian Trap requires introducing more capital into the production function. Pre-industrial economies were Malthusian. During the pre-industrial period, there were several technological innovations like new crops from America and windmills, but it was not enough in the long-term without more capital.

New Models of Growth

  1. Solow (Classic): Based on a production function with diminishing returns to capital and exogenous TFP (technological change drives growth). Y=f(N,L,K)+TFP. Capital affects productivity growth, depending on exogenous forces. Marginal product decreases with increased average capital per worker.
  2. Extended Solow: Y=f(L,N,K,H)+A(TFP). H is broad capital (physical + human capital) incorporated as a growth source; diminishing returns on capital are much lower than in the classic model. Marginal product constantly increases.
  3. Elastic Supply of Labor (Lewis): Structural change in Europe leads to moderate salaries, corporate profits, and increased investment. Assumptions: Two sectors with differences in labor productivity—agriculture (low) and industry (high). Elastic labor supply moves from agriculture to industry. Closely related to structural change, the fall in employment and GDP generated by agriculture, and the increase in the industrial sector.
  4. Export-Led: Links productivity increases and the growth of the export sector. To export, competitiveness in the international market is needed, requiring high productivity in the export sector.
  5. American Model: Interchangeable pieces.
  6. French Model: Large share of the labor force employed in agriculture.

Growth Models in the 19th Century

Advanced Economies: Great Britain, France, Germany, Belgium, United States.

Backward Economies: Sweden, Norway, Denmark, Netherlands, Switzerland, Italy, Spain, Portugal, Russia, Austro-Hungarian Empire, Japan.

Agriculture’s Contribution to Economic Growth

  1. Increased agricultural output (increased production levels; needs to produce more food).
  2. Market for manufactured goods (increased industrial sector demand).
  3. Source of financial capital.
  4. Increased labor supply (agriculture creates an elastic supply for industry).
  5. Increased volume of agricultural exports (to import technology).
  6. Increased productivity.

Agriculture helps industry develop. In continental Europe, modern economic growth and the industrial process have specific features: later commerce to development (slow growth) = Gerschenkron Model.

Inability of market forces to create necessary conditions for economic growth: Lack of industrial prerequisites and substitutes for the prerequisites.

The Role of the State (Liberal Revolution 1833-68)

  1. Industrial Impact: Land disentailment (forced expropriation of land and property from the church and municipalities and its sale to public auctions by the government to pay back debt securities). Consequences: Impact on production (chronic fiscal debt, creation of a market for land, 40% of arable lands changed hands and new owners increased output), public deficit remained, agriculture was responsible for backwardness, failure in the release of labor force, low levels of production per worker (O/L) and high number of workers per hectare (H/L), weak domestic demand for manufactured goods.

Fiscal reform (Mon-Santillan 1845): Spanish tax reform system where every taxpayer has to pay. Principles: legality, sufficiency, and generality with a single unified system to eliminate barriers to economic growth.

  1. Direct Taxes: Territorial contribution (land & property), industrial and trade contribution (commercial & merchant activities). Problem: controlling wealth, cadastral issues.
  2. Indirect Taxes: Consumption (taxes on transport, monopolies, special monopolies + lottery).

Expenditures: 1/3 of total expenditure = payment of interest to tenants of public debts, military and police expenditure, sustenance of culture and clergy.

Consequences: Equity, flexibility, not enough sufficiency, deficit, debt to public finances, ways of funding = foreign trade, bankruptcy of the estate, lack of confidence in international lenders. Result: Vicious circle (constant public deficit).

  1. Direct Impact: Railways: Main objective = have the network as fast as possible. Law 1855 = the estate guaranteed a minimum return to investment/subsidy for each km; the railway company granted tax exemptions for the imports needed for 10 years; the estate guaranteed foreign investors no confiscations or seizure even in case of war.

This was the right choice for the Spanish government as it was crucial to lower transport costs. The reason we know it is right is social savings (the loss of GDP necessary for constant maintenance of the railways level of activity).