International Trade, Gold Standard, and Industrial Revolutions

Posted on Apr 2, 2025 in History

1. The Free Trade Area

Factors such as the diffusion of technological innovations, migration, international capital flow, the increase of foreign trade per capita, and the first economic Globalization (1870-1914) caused the dissemination of industrialization.

There were two kinds of obstacles to international trade:

  • Natural obstacles, like transport means or routes.
  • Institutional obstacles, like the ancient regime or mercantilism.

There are also two theoretical foundations of free trade:

  • The absolute advantage, by Adam Smith, refers to the ability of a party (an individual, firm, or country) to produce a greater quantity of a good, product, or service than competitors, using the same amount of resources. Smith argued that it was impossible for all nations to become rich simultaneously by following mercantilism because the export of one nation is another nation’s import. Instead, he stated that all nations would gain simultaneously if they practiced free trade and specialized in accordance with their absolute advantage.
  • The comparative advantage, by David Ricardo, supports that, in an economic model, an agent has a comparative advantage over another in producing a particular good if he can produce that good at a lower relative opportunity cost or autarky price, i.e., at a lower relative marginal cost prior to trade. The closely related law or principle of comparative advantage holds that under free trade, an agent will produce more of and consume less of a good for which he has a comparative advantage.

Britain had a great struggle for free trade, with the repeal of the Corn Laws (duties on imports to support the prices of British domestic grain against the competition of imports) in 1846 and the Navigation Acts (series of laws that restricted the use of foreign ships for trade between the colonies and any country except Britain or, in other words, laws created by England to limit their colonies’ trade with other countries).

2. The Gold Standard

This standard started with an increase of gold since 1700 and a new exchange rate to avoid the exit of silver.

Silver also ceased to be legal currency for transactions over 25 pounds and for small transactions.

The issue of banknotes in Britain also had a lot to do with it – Goldsmiths and the Bank of England. In the 18th century, banknotes in circulation were more abundant than coins in the UK. The Bank of England “suspended payment” in 1797.

The gold standard also had some rules:

  • No restrictions on the import or export of gold.
  • The Bank of England was obliged to exchange banknotes and deposits into gold.
  • The amount of gold determined the Money Supply of the country.

The economy with the gold standard was a little bit complex. David Hume said that with the gold standard and free trade, the economy regulates itself. But it was not so automatic (adjustment by deflation is costly and slow) and had a lot of problems:

  • Fall in prices and salaries, bankruptcies, unemployment.
  • If prices don’t fall in the exporting sectors, the trade deficit persists.
  • Influx of gold provokes inflation and exit of gold, deflation.

So, the gold standard had pros, like monetary discipline, it facilitates trade, has price stability… But also had cons, like inflexibility in monetary policy, no anti-cyclical measures, and those kinds of things.

And countries in the gold standard learned monetary policy:

  • Plenty of gold = monetary “sterilization.”
  • Gold loss = increase interest rate, ask for loans, pressure on exporters, …

The main countries (Germany, USA, France, Russia, Japan…) adopted the gold standard since 1870.

The classical gold standard (1880-1914) was a remarkable period in world economic history. It was characterized by rapid economic growth, the free flow of labor and capital across political borders, virtually free trade and, in general, world peace. These external conditions, coupled with the elaborate financial network centered in London and the role of the Bank of England as umpire to the system, are believed to be the sine qua non of the effective operation of the gold standard.

3. The Great Depression of the 19th Century

We first find the paradox of the 19th century:

Long period of price deflation, and deflation = unprecedented economic and demographic growth (although in other centuries meant depopulation and economic crisis). The demand expanded and prices fell, but… how was this possible?

There are 2 principle causes: the technological improvements and the gold standard. The supply of goods and services grew faster than its monetary demand.

The most drastic deflation took place in 1873-96 – Prices decreased 30%.

This caused the crisis of 1873.

  • Financial boom in Germany (credit inflation).
  • Financial panic in Germany first, then Vienna and New York, and then in the rest of Europe. This increased the interest rate, the bankruptcies and the unemployment, and decreased the money supply and prices.

The crisis originated a protectionist movement (farmers and industrialists). Free trade agreements were repealed in many countries, but the UK and others (Netherlands, Belgium, Denmark) maintained free trade.

The new gold mines increased prices in many places, like Canada, Siberia, Alaska…

Between 1896 and 1914, the Belle Époque supposed an economic growth and increasing political frictions.

4. The Second Industrial Revolution

An economic expansion based on the new technologies. Diffusion and improvement of the First Industrial Revolution’s innovations.

A new wave of inventions from the mid-19th century onwards and science applied to production.

There were also great technological innovations (improvements in steam power, the hydraulic turbine, electricity, petroleum, cheap steel, communications, and chemistry).