All Quiet on the Investment Front

Did Britain Sacrifice the Industrial Revolution to Defeat Napoleon?

Two of the central stylized facts of the British Industrial Revolution seem to fit together: a low rate of investment and an even lower rate of output growth. By the standards of the Third World in the twentieth century, Britain’s industrialization effort was exceptionally laggard. Per capita income grew at a rate of .42 percent from 1759 to 1801, for example, while the developing countries worst-buffeted by the shocks of the 1970s ran at 3.2 percent per annum—nearly ten times as fast. Industrial expansion was little faster than the overall rate of product growth, delaying full structural transformation until the middle of the nineteenth century. One major hindrance to British growth was the poor rate of capital accumulation, a lackluster 1.5 percent from 1780 to 1800 and 1.6 percent in the following thirty years. This in turn was the result of perilously low saving: just 9 to 10 percent in 1760. For context, Meiji Japan saved at 14.8 percent from 1910 to 1916, the Third World on average at 20.1 percent circa 1977, and nineteenth-century America at 28 percent (1890-1905). Whereas most subsequent industrial revolutions were driven by capital accumulation, Britain’s mostly depended on the fragile reed of TFP growth.

Even compared with labor-intensive industrializers, then, Britain’s take-off involved little investment and next to no capital deepening. This is a puzzle. Why weren’t the British investing? To answer the question, Jeffrey Williamson (1984) revived an old specter strangely peripheral in most economic accounts of the period: Britain’s overseas conflicts. Of the 60 years from 1760 to 1820, Britain was at war in 36—fighting the Seven Years’ War, the Revolutionary War, and the Napoleonic Wars on fronts and sea lanes extending from Western Canada to Southern India. The expense of the struggle was enormous, and Britain was forced to dramatically expand fiscal collection in order to pay the price. By 1815, tax receipts exceeded 18 percent of the national income and had more than tripled in real terms since 1760. But additional military expenditures were so vast that new outlays required increasing levels of debt finance. The real national debt quintupled during the first sixty years of the Industrial Revolution, and during the 1790s, net additions to that figure amounted to 11.5 percent of the national income—numbers equivalent to Civil War America or the Meiji regime during the Sino- and Russo-Japanese wars, but extended over six decades. The debt-to-GDP ratio, meanwhile, likely reached 2 by the 1820s. This was worse than the 1.3 reached by the United States in 1946, just after the conclusion of World War II, and makes today’s exceptional 1.25 pale by comparison. Williamson argued that if one added net additions to the public debt to civilian reproducible capital formation, Britain turned out not to be a low saver at all—the rate was 18.1 percent (not 11.4 percent) from 1761 to 1820.

Williamson’s broader point was that the Industrial Revolution had been “crowded out” by national debt issuance. Government debt replaced private assets in investor portfolios, and the difference would be used to fund military spending. The rates of return on private assets would be increased by the shrinkage of the capital stock, reducing investment demand, especially in critical sectors like urban housing and infrastructure. Cities failed to provide sufficient public goods or homes for industrial workers and entrepreneurs, raising rents and creating “disamenities.” Williamson argued that the situation was worsened by the existence of usury laws limiting the rates of return on mortgages and bonds—but not public debt, rent charges, or land—to 5 percent; once the rate of return exceeded this upper bound, crowding out would be essentially one for one. “Such high interest with government security,” wrote a contemporary commentator, “evidently makes it extremely difficult, if not quite impossible, for individuals to borrow any money, upon legal interest, either for the extension of commerce and manufacture, or the improvement of agriculture.”

Using a general equilibrium model, Williamson estimated the effects of crowding out, along with manpower mobilization and price distortions, on the growth of the British economy from 1760 to 1810 and from 1790 to 1815. He found that, in the counterfactual absence of war, Britain would have seen real income grow .96 percent faster in the former period and 1.5 percent faster in the latter—a truly astonishing depression by comparison with the growth figures discussed above. Manufacturing output would have risen 2.3 percent quicker while agricultural might actually have shrunk, with Britain able to export more as a result of smoother commercial conditions and better terms of trade. Real wages would have increased .84 percent faster per annum had 1760-1810 been peaceful, amounting to 65 percent higher living standards by the end of the period. Considering the slow growth experienced by the British economy during the second half of the eighteenth century, these were substantial welfare losses. Williamson added that the post-war jump in output growth—by at least 1 percent per year—could be solely attributed to the opening of the Pax Britannica. The growth miracle of the Industrial Revolution was not imaginary; rather, it had been spent by the Empire to win British geopolitical hegemony.

The suggestion that military conflict accounted for most of Britain’s slow growth up to 1820 was immediately controversial. Heim and Mirowksi (1985) suggested in the following year that the sectors hit hardest—residential housing, social overhead, and land improvements in farming—were marginal to the Industrial Revolution, and that machinery really mattered. But social overhead capital and the housing stock are direct inputs into industrialization, and absent investment the costs of urban labor increase, cutting into the profits of industrial firms. As Williamson (1987) replied, “In short, crowding out did seem to have its biggest impact on long-term fixed investment, and it must have suppressed economic performance just as surely as if it were those machines which were crowded out.” Joel Mokyr (1987) and Larry Neal (1990) argued that Williamson overstated the size of the national debt by using the face value, not the market price, and thus exaggerated the extent of crowding-out. The rise in interest rates, moreover, would have also augmented savings. Williamson acknowledged that these two factors might have implied a 22 to 38 percent reduction in his estimates, but held that the remainder was still significant given the magnitude of the effects in his model. Clark (2001), however, recalculated market values to account for several excluded factors and found that the divergence vanished during the Napoleonic Wars, when the debt-to-GDP ratio was highest. Mokyr also argued that Ireland had picked up many of the British government’s assets, reducing the “effective” size of the debt by 9 percent. But Williamson sharply replied that Britain actually exported capital from 1791 to 1820, so on net foreign investors were not subsidizing the imperial war machine.

The more pressing critique, however, is the fact that interest rates do not appear to have been sensitive to the size of the national debt. Clark, examining a variety of asset classes from 1727 to 1840, found no effect of the stock of national debt on real rates of return and that sales of debt for deficit finance only modestly affected nominal rates. At first blush, this would appear to be a devastating empirical blow to the Williamson thesis. But how could capital markets have been so insensitive to the actions of the biggest player? Clark reviewed three potential rationalizations: that government borrowing brought forth additional private saving in anticipation of future taxes through Ricardian Equivalence; the Mokyr claim on Irish investment; and capital market segmentation, such that new debt issues led to “crowding in” by investors who’d previously lacked safe places to put their funds. On the first count, the middling savers who backed government bond issues would have had little way of computing the size of either the national debt or the real tax burden. We have already dealt with Williamson’s rejoinder to the Ireland argument, but Clark added further that foreign debt holding from 1801 to 1816 was “pitiably small,” less than 3 percent of the total, and the proportion had been shrinking since the 1750s. He finally discounted the last option on the grounds that government debt had existed as an accessible safe asset by 1740, so that additional increases to the total should hardly have elicited a greater mobilization of funds. His Charity Commission data also showed no evidence of idle cash sitting around waiting for a productive investment vehicle.

Clark provided his own explanation. Imports of foodstuffs and raw materials from the Americas, Ireland, and Eastern Europe cut into farm rents after 1780, lowering its share in national income from 27 to 18 percent. Assuming consumption smoothing, this increased the demand for other kinds of investment assets just as the British government was issuing vast tranches of debt. As Clark wrote, “rates of return on private capital in Britain might have been going to decline in the absence of the large public debt, and that is why the huge debt issues do not show up as any tightness in the private capital market. In a sense, crowding out may have taken place, but is not observable from private rates of return because of the underlying trends in private rental incomes.” But perhaps looking at interest rates was altogether misguided. Temin and Voth (2013) argued that usury laws, which prevented private borrowers from competing with the state on price, made the returns data misleading, and that quantities should be analyzed instead. Using Child’s, Duncombe & Kent, and Hoare’s Bank as proxies, they found that government borrowing led to “massive reductions in private credit, which coincided with periods of slower growth in industrial output.” Britain would have grown “markedly faster” without the conversion of investment funds into weapons of destruction.

The long-run picture might not have been quite so bleak. Britain’s wars were not exactly bereft of economic rationale; control of the seas safeguarded her merchant vessels, and the defeat of France opened up new colonial and international markets to her shipping and industry. The eighteenth-century world was a dangerous, violent place, and Britain had to fight tooth and nail to win a spot for her merchants and industrialists. O’Brien and Palma (2020), for example, have recently argued that the effects of crowding-out were short term and static, reducing growth in the present, but widened Britain’s future opportunities by developing a more sophisticated system of financial intermediation (which increased liquidity). But that’s no condemnation of the chief historical implication of crowding out—that the Industrial Revolution in Britain might not have been inherently slow. Instead, perhaps, growth was suppressed by the external commitments and extraordinary fiscal capacity of the government, and that the expansion which ensued after 1820 was merely waiting for the establishment of something unprecedented: a peaceful international world order.