Lessons from the original Industrial Revolution

There is much excited chatter that automation will unleash a Fourth Industrial Revolution, building on earlier upheavals caused by the arrival of steam power, electricity, and semiconductors. Yet in Britain, which gave birth to the first of those transformations, economic growth has stalled. If policymakers wish to escape the low-productivity trap, they should study the conditions that sparked the first period of sustained economic growth some three hundred years ago. These are brilliantly described by Martin Hutchinson, a former Breakingviews columnist, in his new book "Forging Modernity: Why and How Britain Developed the Industrial Revolution".

Perhaps the most striking part of this tale is what it lacks. For a start, there were no government plans to boost growth. Large-scale infrastructure projects, such as toll roads, bridges, canals and later railways, were almost exclusively privately funded. The stock market played little role: For more than a century after the Bubble Act of 1720 it was illegal to establish a joint-stock company without parliamentary consent. Needless to say, entrepreneurs in the 18th century weren't educated at business schools. Nor did the great inventors study science, technology, engineering or mathematics at university. In fact, several pioneers of the Industrial Revolution were self-taught.

There are many reasons why economic growth took off in England. For a start, the country enjoyed both limited government and the rule of law, which held public corruption and rent-seeking in check. After the execution of King Charles I, monarchs no longer granted monopolies to their favourites. The British aristocracy was commercially minded: Charles "Turnip" Townshend improved crop yields, while the Duke of Bridgewater financed the first commercially successful canal. A spirit of scientific inquiry was fostered by the Royal Society, established in 1660. It is from this date that Hutchinson identifies a new spirit of innovation and entrepreneurialism throughout the country.

The Industrial Revolution can be viewed as the world's first successful energy transition. By the early 17th century, England was running out of domestic supplies of wood and demand for coal was growing. Canals, constructed to transport coal, massively lowered energy costs in the new manufacturing centres of Manchester and Birmingham. They also generated huge profits for their early financiers, such as Bridgewater.

The first generation of steam engines were built to pump water out of the coal mines. And the first railway engines were used to transport coal from the mines. As Hutchinson writes, "The makers of the Industrial Revolution took an environmental/resources problem – the increasing shortage of wood – and solved it through technological innovation and, by doing so, increased the productivity of industry."

There were ancillary benefits. Josiah Wedgwood located his porcelain works next to the Trent and Mersey Canal, so that his fragile wares could be brought to market safely and cheaply. As steam engines improved, they found new uses. For instance, driving pumps in Samuel Whitbread's brewery and providing power for Richard Arkwright's textile mills.

All these developments were unplanned and unforeseen, as Adam Smith described in "The Wealth of Nations", published in 1776. The great statesmen of the era, including Prime Ministers William Pitt the Younger and Lord Liverpool, understood their job was not to stand in the way of what Smith called the "invisible hand".

However, this was not an era of unfettered free trade. The Corn Laws impeded the import of foreign grain, protecting domestic agriculture and pushing up the cost of labour. Hutchinson argues that high wages encouraged capital investment, further boosting productivity. Further laws prevented the import of printed cotton, penalising Indian manufacturers. Tariffs on sugar, produced by slaves in the West Indies, contributed a sizeable share of the government's revenues in the early 1800s.

The task of financing the Industrial Revolution fell to banks that were scattered across the country, some 800 in all. These partner-owned "country banks" raised capital for new ventures, financed receivables and paid workers' wages with their bank notes. Hutchinson estimates that most entrepreneurs lived within a day's ride of half a dozen such institutions. "If an idea could work," he writes, "and could be begun on a modest scale, it could be financed. The localism and pluralism of England's country bank system made it a major contributor to the Industrial Revolution."

The government's main financial contribution was to provide sound money, backed by gold, and to promptly pay the interest due on its own debts. Relatively high real interest rates ensured capital was carefully invested. Saving in 18th-century England was both secure and well compensated.

Conditions in 21st-century Britain could scarcely be more different. The rule of law and the application of the scientific method still pertain. But much else has changed. The country banks were long ago swallowed up by a banking cartel that has little interest in financing entrepreneurs. Property rights are more restricted by regulation than in Adam Smith's day. Taxes and inflation erode savings. Interest rates in recent years have been lower than ever. Hutchinson believes easy money sent incorrect signals to both borrowers and lenders, damaging productivity.

Photo: Reuters graphics

Meanwhile, central planning is back. Government plans to wean the economy off hydrocarbon energy entail a thicket of targets, regulations and subsidies. Hutchinson notes that one reason the Netherlands failed to lead industrialisation was because a large installed base of windmills slowed the country's adoption of steam-engine technology.

We are so accustomed to the economic growth sparked by the Industrial Revolution that we tend to view economic expansion as pretty much inevitable. In the late 18th century, Britain's productivity growth averaged around 1.5% per annum. Yet since the financial crisis of 2008, it has fallen to a third of that level. Indeed, Hutchinson expects UK productivity growth to turn negative over the coming years. If that happens, government finances would come under strain and international investors would shun the United Kingdom.

All is not lost. Policymakers seeking to reverse the country's relative economic decline should start by considering the words of the early English economist and merchant, Dudley North: "We may labour to hedge in the cuckow, but in vain; for no people ever yet grew rich by policies, but it is peace, industry and freedom that brings trade and wealth, and nothing else."

Photo: Reuters graphics