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Interest Rates and Crowding-Out During Britain's Industrial Revolution

Published online by Cambridge University Press:  03 March 2009

Carol E. Heim  and
Philip Mirowski
Carol E. Heim
Affiliation:
The authors are Assistant Professor of Economics, University of Massachusetts, Amherst, MA 01003
Philip Mirowski
Affiliation:
Associate Professor of Economics, Tufts University, Medford, MA 02155.
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Abstract

Available evidence on interest rates and government borrowing during Britain's industrial revolution, while limited, does not support the idea that war spending crowded out private investment. This article demonstrates the importance of using data on net receipts from borrowing, rather than changes in government debt. Weaknesses of the crowding-out model concerning capital markets and investment, openness of the economy, and full employment are identified for the historical case. The case raises broader issues of whether conceptions of saving and investment based in neoclassical supply-constrained models are as appropriate as theories of capital accumulation.

Type
Articles
Information
The Journal of Economic History , Volume 47 , Issue 1 , March 1987 , pp. 117 - 139
Copyright
Copyright © The Economic History Association 1987

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References

1 Williamson, Jeffrey G., “Why Was British Growth So Slow During the Industrial Revolution” this JOURNAL, 44 (09 1984), pp. 687–712.Google Scholar See also the relevant discussion in his book, Did British Capitalism Breed Inequality? (London, 1985).Google Scholar In American economic history, see Ransom, Roger L. and Sutch, Richard, “Domestic Saving as an Active Constraint on Capital Formation in the American Economy, 1839–1928: A Provisional Theory”, The University of California Project on the History of Saving,Google Scholar Working Paper No. 1, Institute of Business and Economic Research, University of California, Berkeley (12 1984).Google Scholar

2 The neoclassical model includes, of course, an investment demand function as well as a saving function. But both in full employment models and in more Keynesian models where the interest rate and income level are simultaneously determined, households pursuing utility-maximization (rather than firms engaged in the accumulation of value) are the central agents in the theory. For references on the theory of accumulation, see fn. 44.Google Scholar

3 See for example Ashton, T. S., Economic Fluctuations in England, 1700–1800 (Oxford, 1959), p. 88.Google Scholar

4 Ashton, T. S., An Economic History of England: The 18th Century (London, 1955), p. 251;Google Scholar and Sinclair, Sir John, The History of the Public Revenue of the British Empire (London, 1803), vol. 2, appendix 1, pp. 28–46.Google Scholar

5 For further description of The Course of the Exchange, as a source of financial data, see Mirowski, Philip, “The Rise (and Retreat) of a Market: English Joint Stock Shares in the Eighteenth Century”, this JOURNAL, 41 (09 1981), pp. 559–77.Google Scholar

6 Price indices are taken from Mitchell, B. R. and Deane, P., Abstract of British Historical Statistics (Cambridge, 1962), pp. 468–71. Our Schumpeter-Gilboy consumer price index is from column (a), 1780–1823 (p. 469).Google ScholarOur Schumpeter-Gilboy producer price index is from column (c), 1780–1801 (p. 469), linked with suitable benchmarking to the Rousseaux index, column (c), 1802–1825 (p. 471). Our Gayer-Rostow-Schwartz index is the “domestic and imported commodities” column (p. 470), which runs from 1790 to 1825.Google Scholar

7 It is not our purpose in this paper to attempt to model expected prices, although clearly a range of possibilities exists. One approach which could be pursued would be to construct forecasting equations, arriving at predicted inflation by regressing the inflation rate on past inflation rates and lagged values of other variables. See Mishkin, Frederic S., “The Real Interest Rate: An Empirical Investigation”, Carnegie-Rochester Conference Series on Public Policy, 15 (Autumn 1981), pp. 151–200;CrossRefGoogle Scholar and his A Rational Expectations Approach to Macroeconomics: Testing Policy Ineffectiveness and Efficient-Markets Models (Chicago, 1983).Google Scholar

8 See Dickson, P.G.M., The Financial Revolution in England: A Study in the Development of Public Credit, 1688–1756 (London, 1967), p. 410;Google ScholarFairman, William, An Account of the Public Funds (7th edn., London, 1824), pp. 134–36;Google Scholar and Mortimer, Thomas, Every Man His Own Broker; or, A Guide to the Stock-Exchange (13th edn., London, 1801), pp. 172–73.Google Scholar

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11 Ibid., p. 9, table 4, column 11; and Parliamentary Papers 1868–1869, vol. 35, pt. 1, pp. 182–207, 390–91. The unfunded debt figures in the corrected data are less complete than O'Brien's.

12 Paul Evans argues that in the U.S. case, large deficits during the Civil War and the two World Wars were not associated with high interest rates. See his “Do Large Deficits Produce High Interest Rates?” American Economic Review, 75 (03 1985), pp. 68–87.Google Scholar

13 Annual total nominal debt figures are taken from Mitchell and Deane, Abstract of British Historical Statistics, pp. 401–2. These data are for the United Kingdom rather than Great Britain. We have interpolated the figure for 1800. This is the source from which Williamson constructed his five-year centered averages of funded and unfunded government debt of the United Kingdom, and his two estimates of real annual increase in government debt. To deflate he used an index based on a combination of a cost-of-living index (to 1800) and a wholesale commodity price index (from 1801 on). See notes to his table 1, p. 695.Google Scholar

14 This explanation was proposed by Barry Eichengreen, who also initially suggested investigating the selling of bonds at a discount.Google Scholar

15 P.P. 1868–1869, vol. 35, pt. 2, p. 6.Google Scholar

16 A more general problem with the total debt figures is the possibility that the figures for a portion of the debt were constructed using current interest rates. This procedure would introduce a spurious correlation between total debt and interest rate data.Mitchell and Deane (the source used by Williamson and others for nominal debt figures) arrive at their total debt data by adding together a series of unfunded debt from the 1868–1869 Parliamentary Papers (vol. 35, part 2, appendix 12, pp. 298–311), and a series on funded debt (by far the bulk of the total debt) from a different Parliamentary Paper (P.P. 1890–1891, vol. 48, pp. 71–81). The funded debt figures in the latter P.P. 1890–1891 are the total nominal amount of funded debt remaining at the close of each financial year, calculated by adding the total capital stock created and subtracting the total capital stock redeemed, paid off, and cancelled during each year, beginning from an estimate of the total debt outstanding at 1 August 1786. The potential problem arises from the need to value the stock of government debt at any point in time and the possibility that the interest rate itself was used to do so. If contemporary annual interest rates were used to produce the debt figures, a correlation might appear between government debt and the interest rate; this apparent relationship would not exist with net receipts from borrowing, which are taken from the income and expenditure accounts and involve no use of the interest rate in their construction. While it appears that consols (perpetual annuities) were recorded in debt figures simply as the face value of the bonds at the time they were issued, the public debt also included terminable annuities, which may have been valued using current interest rates. Grellier, J. J. describes such a procedure in his contemporary account, The Terms of all the Loans (London, 1799), p. 45.Google Scholar To determine and compare the terms on which various loans were raised, he argues that: The least objectionable mode appears to be to convert the terminable annuities into perpetual annuities, according to the current rate of interest at the time when the annuities were granted; as it is upon the rate of interest that the proportionate value of an annuity for a certain term, to the perpetuity, depends; and, in forming the following statement, the conversion has been made at the interest produced by money invested in the 3 per Cents. [consols] according to the price of this stock, at the times when the terms of the respective loans were settled.… As Grellier points out, terminable annuities form a relatively small part of the total debt. A systematic relationship with current interest rates, however, would create at least some cause for concern that any use of Mitchell and Deane's figures in models including the interest rate will be problematic. See Grellier, J. J., The History of the National Debt, from the Revolution in 1688 to the Beginning of the Year 1800 (London, 1810), pp. 343–44, 367–68 for accounts of the composition of the national debt in 1786 and 1793.Google Scholar

17 By “scarcity index for capital” we refer to the fact that in neoclassical theory prices, including the interest rate, are viewed as ultimately reflecting supply and demand for scarce physical factors of production. Prices and interest rates can be conceptualized quite differently. Prices can be viewed (as in markup models) as the means by which firms assure themselves funds for continued accumulation. See for example Levine, David P., “Aspects of the Classical Theory of Markets”, Australian Economic Papers, 19 (06 1980), pp. 1–15;CrossRefGoogle Scholar and Ong, Nai-Pew, “Target Pricing, Competition, and Growth”, Journal of Post Keynesian Economics, 4 (Fall 1981), pp. 101–16.CrossRefGoogle Scholar

18 The following discussion of the crowding out argument focuses primarily upon the neoclassical one-for-one version supported by Williamson in Did British Capitalism Breed Inequality? Williamson does consider (pp. 179–83) the possibility of less than one-for-one crowding-out, but appears ultimately to remain with the view expressed on p. 177 that the one-for-one assumption is adequate.Google Scholar We recognize that there exists a variety of possible crowding-out stories, ranging from the pure neoclassical version to variants of the “neoclassical synthesis”, IS-LM systems, and life-cycle models. (For a discussion of the interest rate theories associated with some of these variants, see Leijonhufvud, Axel, “The Wicksell Connection: Variations on a Theme”, in his Information and Coordination: Essays in Macroeconomic Theory (Oxford, 1981), pp. 131–202). We cannot do justice to each of these variants within this paper. But to the extent that they share the assumptions and overall conceptual basis we do discuss, they are subject to the same critique.Google Scholar

19 See for example Chapman, S. D., “Fixed Capital Formation in the British Cotton Industry, 1770–1815”, Economic History Review, 2nd ser., 23 (08 1970), pp. 235–66;Google ScholarCrouzet, Francois, ed., Capital Formation in the Industrial Revolution (London, 1972);Google ScholarKindleberger, Charles, A Financial History of Western Europe (London, 1984), pp. 92–93;Google ScholarMiles, M., “The Money Market in the Early Industrial Revolution: The Evidence for West Riding Attorneys c. 1750–1800”, Business History, 23 (06 1981), pp. 127–46;CrossRefGoogle ScholarMokyr, Joel, “The Industrial Revolution and the New Economic History”, in Mokyr, Joel, ed., The Economics of the Industrial Revolution (Totowa, 1985), pp. 33–38;Google ScholarPollard, S., “Fixed Capital in the Industrial Revolution in Britain”, this JOURNAL, 24 (09 1964), pp. 299–314;Google Scholar and Pressnell, L. S., Country Banking in the Industrial Revolution (Oxford, 1956).Google Scholar

20 See fn. 19. One of us has argued that the conventional wisdom concerning fixed capital requirements is not firmaly founded upon the historical record. See Mirowski, Philip, The Birth of the Business Cycle (New York, 1985), chap. 8.Google Scholar

21 See Mirowski, The Birth of the Business Cycle, chaps. 8–9, and his “What Do Markets Do?” (forthcoming, Explorations in Economic History).Google Scholar

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24 See for example Lee, C. H., A Cotton Enterprise, 1795–1840: A History of M'Connel & Kennedy, Fine Cotton Spinners (Manchester, 1972), p. 147;Google ScholarRimmer, W. G., Marshalls of Leeds: Flax-Spinners, 1788–1886 (Cambridge, 1960), pp. 36–37, 46–47;Google ScholarRose, Mary B., “The Role of the Family in Providing Capital and Managerial Talent in Samuel Greg and Company 1784–1840”, Business History, 19 (01 1977), pp. 37–54;CrossRefGoogle Scholar and Wells, F. A., Hollins & Viyella: A Study in Business History (Newton Abbot, 1968), p. 43.Google Scholar

25 Mirowski and Weiller, “Rates of Interest in 18th Century England”.Google Scholar

26 David Ricardo, who as a financier was well placed to be a credible witness, insisted that “the price of funded property is not a steady criterion by which to judge the rate of interest”, by which he meant private loan rates. See Ricardo, David, On the Principles of Political Economy and Taxation, vol. 1 in Sraffa, P., ed., The Works and Correspondence of David Ricardo (Cambridge, 1951), p. 298.Google Scholar

27 Williamson, “Why Was British Growth So Slow?” p. 691.Google Scholar Surveys of problems with estimating the interest elasticity of investment can be found in Eliott, J. W., “Theories of Corporate Investment Behavior Revisited”, American Economic Review, 63 (03 1973), pp. 195–207;Google Scholar and Helliwell, J. F., ed., Aggregate Investment (Harmondsworth, 1976).Google Scholar A more recent study expressing skepticism about the importance of interest rates for investment is Clark, Peter, “Investment in the 1970's: Theory, Performance, and Prediction”, Brookings Papers, 1 (1979), pp. 73–113.CrossRefGoogle Scholar

28 Williamson, “Why Was British Growth So Slow?” p. 693.Google Scholar

29 Miles, “The Money Market in the Early Industrial Revolution”; Anderson, B. L., “Provincial Aspects of the Financial Revolution of the Eighteenth Century”, Business History, 11 (01 1969), pp. 11–22;CrossRefGoogle Scholar and Anderson, B. L., “Money and the Structure of Credit in the Eighteenth Century”, Business History, 12 (07 1970), pp. 85–101.CrossRefGoogle Scholar

30 Carter, Alice Clare, Getting, Spending and Investing in Early Modern Times (Assen, 1975), p. 39.Google Scholar See also Fairman, William, An Account of the Public Funds, pp. 227, 229–31, on foreign holdings of British public debt. Accoriding to Fairman, foreign holdings decreased considerably between 1762 and 1824.Google Scholar

31 Williamson does mention the possibility of net foreign investment in Did British Capitalism Breed Inequality? (p. 179), but the brief discussion there does not satisfactorily resolve the question. For further treatment of international factors during the period, see Neal, Larry, “Integration of International Capital Markets: Quantitative Evidence from the Eighteenth to Twentieth Centuries”, this JOURNAL, 45 (06 1985), pp. 219–26.Google Scholar

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33 For a Keynesian argument emphasizing utilization of unemployed resources, see Anderson, J. L., “A Measure of the Effect of British Public Finance, 1793–1815”, Economic History Review, 2nd ser., 27 (11 1974), pp. 610–19.Google Scholar This argument is criticized by Mkoyr, Joel and Savin, N. Eugene, whose view of the period emphasizes the impact of supply-side shocks upon an economy with less than perfectly adjustable resources and nonfarm prices. See their “Stagflation in Historical Perspective: The Napoleonic Wars Revisited”, in Uselding, Paul, ed., Research in Economic History, vol. 1 (Greenwich, 1976), esp. pp. 208–9.Google Scholar

34 This interpretation is summarized in Schumpeter, Joseph, A History of Economic Analysis (Oxford, 1954), p. 723.Google Scholar Note also the general disbelief in real-resource theories of the interest rate during the industrial revolution: “The refusal to link the rate of real saving with the rate of interest is the outstanding feature of the interest theory of the Eighteenth Century”; see also Low, J. M., “The Rate of Interest: British Opinion in the Eighteenth Century”, Manchester School, 22 (05 1954), p. 137.CrossRefGoogle Scholar

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37 Williamson raises the issue of the composition of final demand in Did British Capitalism Breed Inequality? (p. 188) but argues that the evidence is sufficiently tentative that he is “forced to assume in what follows that military and civilian expenditures generated pretty much the same distribution of final demand for agriculture, manufacturing, mining and services”. In his discussion of the effects of the method of financing the war (pp. 171–72) government spending unlike civilian capital formation is considered to have a zero social rate of return.Google Scholar

38 Cf. Hobsbawm, Eric, “The Crisis of the Seventeenth Century”, in Past and Present, 5, 6 (1954);Google Scholar and Dobb, Maurice, Studies in the Development of Capitalism (New York, 1963), esp. pp. 177–86.Google Scholar

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40 See O'Brien, “The Impact of the Revolutionary and Napoleonic Wars”, for a balance-sheet approach to assessing the effects of the war in terms of major sectors, industries, and variables in the growth process (e.g., capital formation and labor supplies). Effects of war taxation are considered in Mathias, Peter and O'Brien, Patrick, “Taxation in Britain and France, 1715–1810: A Comparison of the Social and Economic Incidence of Taxes Collected for the Central Governments”, Journal of European Economic History, 5 (Winter 1976), pp. 601–50.Google Scholar

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43 Ibid., p. 243. The particular model to which James is referring is the Williamson-Lindert model in their American Inequality (New York, 1980).Google Scholar Similar points can be made concerning the model employed by Hueckel, Glenn in his “War and the British Economy, 1793–1815: A General Equilibrium Analysis”, Explorations in Economic History, 10 (Summer 1973), pp. 365–96.CrossRefGoogle Scholar

44 See for example Harris, Donald J., Capital Accumulation and Income Distribution (Stanford, 1978);Google ScholarKalecki, M., Theory of Economic Dynamics (1952; New York, 1968 printing of rev. 2nd edn.);Google ScholarLevine, David P., “Determinants of Capitalist Expansion”, Economic Development and Cultural Change, 30 (01 1982), pp. 299–320,CrossRefGoogle Scholar and his “The Theory of the Growth of the Capitalist Economy,” Economic Development and Cultural Change, 24 (10 1975), pp. 47–74;CrossRefGoogle ScholarMarglin, Stephen A., Growth, Distribution, and Prices (Cambridge, Mass., 1984);Google ScholarRobinson, Joan, The Accumulation of Capital (London, 1956);Google Scholar and Steindl, Josef, Maturity and Stagnation in American Capitalism (Oxford, 1952).Google Scholar

45 See Morishima, Michio, “The Good and Bad Uses of Mathematics”, in Wiles, P. and Routh, G., eds., Economics in Disarray (Oxford, 1984), pp. 51–74.Google Scholar