On Robert Allen’s defense of the High-Wage Economy hypothesis

The high-wage economy thesis is a topic I have blogged about many times before as I think it is an important debate among economists and economic historians (see notably here and here, see also this contribution of mine to the Journal of Interdisciplinary History). For those unfamiliar with this thesis, here is a simple summary of the idea advanced by Robert Allen: high wages relative to capital units was a key force in the industrialization of Britain and thus it explains why the Industrial Revolution was British before if was anything else.

As I have explained in the aforementioned blog posts, I am unsure of where I stand regarding this idea. I tend to be skeptical, but I have stated the evidence needed to convince me of the opposite. In the past year or so, there has been an avalanche of articles on the topic including this article by Humphries and Weisdorf, a follow-up working paper by the same authors, another paper by Judy Stephenson and a working paper by Stephenson (bis). Today, Robert Allen replies to his critics in this working paper.

I find that some of the points are convincing, however I must take issue with a particular point that falls into my ballpark as Allen mentions my work on wages in France (the aforementioned article in Journal of Interdisciplinary History). In my research, I pointed out that Allen’s computations underestimated wages outside Paris. With the correct computations, the rest of France does not appear as poor relative to England as Allen suggests. Allen concedes this point but then goes to state the following:

Geloso (2018) has pointed out that the Strasbourg unskilled wage series for 1702-64 is low in comparison to that of comparable towns, and workers may have received food, which has not been taken into account.  This is a perceptive point, but its implications are limited. The most important use I make of the Strasbourg evidence is in calculating the ratio of the wage to the user cost of capital. If the Strasbourg wage in this calculation is raised to that of neighbouring towns, the wage-capital cost ratio does rise but only by a small degree. The reason for this somewhat surprising result is that the wage is also an argument in the formula for the user cost of capital–building workers have to build the machines and the mills that house them–so the denominator of the ratio increases as well as the numerator, although to a lesser extend.

This is a incorrect characterization of my argument. First, I did not state that wages in Strasbourg did not account for in-kind payment. I stated that in-kind payment was evidence that the wages did not pertain to Strasbourg! The wages from the primary sources were for a city some 70 km away from Strasbourg, they did not concern unskilled workers and they included large in-kind compensation. To correct for this problem, I compared agricultural wages in England with those around Strasbourg that had been collected by Auguste Hanauer. What I found was the the lowest wages in farming were equal to 74% of farm wages in Southern England (as opposed to 64% with Allen’s stated wages). While I did not report this in the article because I had doubts, it is worth pointing out that the high bound of farm wages in Strasbourg is above the level reported for Southern England (which acts a proxy for England – see table 2 in my paper). As Strasbourg is a proxy for living standards outside Paris, my finding suggests a much smaller gap in living standards. It also entails a much more important change in the cost of capital to labor (wages are in the range of 50% above those suggested by Allen and sometimes they are higher by more than 100% which would mean a halving of the relative cost of capital! These are not peanuts to be thrown on the sidewalk!

Second, I ought to point out the nature of my argument. I was not trying to prove/disprove the high-wage hypothesis. My point was much more modest. The mirror of the question as to why the industrial revolution was British is why it was not French. France had a large population offering large returns to scale (in both economic and political organizations) and an array of navigable rivers that facilitated internal trade. It also key pockets of Lancashire-like industrialization such as Normandy (for textile) and Mulhouse (the French Manchester). As such, it is an entirely reasonable endeavor to try to situate living standards in France relative to Britain. If France was massively poorer than England, then Allen has a greater likelihood of being correct. If it was closer to an equal footing (I do not believe that anyone places France above England in circa 1750), then Allen’s critics have a greater likelihood of being correct.* However, regardless of the answer, the data does not infirm/confirm the high-wage hypothesis. It merely situates relative likelihood. As I point out that wages were quite above those postulated by Allen, I am merely stating the extent of the reasonableness of being skeptical of the high-wage hypothesis.

Finally, it is worth pointing out that the work of Leonardo Ridolfi is absent from Allen’s reply. The latter’s work is very important as it echoes (in a much richer manner) my point that wages outside Paris were not as low as cited by Allen.**

*As I assume a greater equality of capital returns across both countries, the smaller the wage gap, the smaller the relative differences in capital/labor costs ratios.
** Ridolfi shows France had incomes equal to 64% of English incomes circa 1700. However, I am skeptical of this figure. This is because, while I trust the index produced by Ridolfi, I am unconvinced about the benchmark year to convert the index into international dollars.

Wars and Presidents: Avoiding the Power-Display Bias

This week on EconTalk, Russ Roberts interviewed Bruce Bueno de Mesquita on how presidents who took the United States to war find themselves higher in the rankings of “Great Presidents” (see this paper by Henderson and Gochenour on the issue)  For some time now, I have found myself in agreement with that contention as wars are generally momentous events that stand out in history. In contrast, the man who sits by and does nothing except preventing a war or making it easier for people to trade, that is harder to observe.  But why would evaluating Presidents be associated with such a premium? Individuals are aware that wars are bad, so why are they praising this? On other metrics, how do Presidents fare?

On the power-display bias 

In my forthcoming book on Canadian economic history (published by Palgrave McMillan as part of their Studies in Economic History), I reviewed some pantheons and counter-pantheons of Presidents (which I will present below) and I felt I had to offer my argument regarding these pantheons:

The established pantheon and the counter-pantheon differ mostly due to people’s bias towards positively assessing outward signs of power. When he wrote to one of his correspondents that “absolute power corrupts absolutely,” British historian Lord Acton was not only speaking of politicians, but also of those would retroactively judge them: Acton was referring to a general human tendency – accentuated amongst historians – to be more forgiving of those who hold power, because the powerful are judged by their actions. Indeed, it is easier to size up a politician who undertook significant reforms – regardless of the results obtained thereby – than to evaluate the achievements of one who passively held the line. If the reformer fails, it can be said that at least he tried. Moreover, a given president’s place in the pantheon is closely linked to how many Americans he killed during the military conflicts that defined his reign. The more Americans killed per capita overall, the higher a given president’s ranking in the list of “greats.”

Economic history teaches us, however, that the most proactive presidents may not be the most beneficial to their country, on the contrary. For several years now, Franklin Delano Roosevelt (1933-1945) has been the subject of increased criticism in the economic literature for his interventionist economic policies between 1932 and 1939. Economists Albrecht Ritschl, Monique Ebell, Lee Ohanian and Harold Cole have determined that FDR’s interventionist policies in fact served to prolong the Great Depression.

In other words, the bias we have when evaluating men with power is that we evaluate based on the exercise of displaying the use of power. Those who refrain from using it are, properly, not recorded as historical events are conflicts/tensions/oppositions. This I think is generally a bias that is easily to fall prey to. I am not immune to that even if I happen to have libertarian leanings. I often see in one politician or another in history a man/woman that I wish would be here today to “save the day” (one of my childish belief). But each time I dig around that person, I am less enthused. For example, I used to be an admirer of William Pitt the Younger – a fierce one. After all, he had assisted Wilberforce in ending the slave trade, he had instituted a sinking fund to repay the British public debt (he had willfully tied his hands) and he he had been moderately sympathetic to the American revolution. I saw his role in the wars against France as a contest of circumstances. But, that was the point, I was ready to discount the war. In addition, as I read the work of Jane Humphries on child labor in industrializing Britain (here and here), I discovered more unsettling things.  During the French Wars, the build-up of the British state did lead to some crowding-out on factors markets, notably the labor market. Upon complaints of manufacturers, Pitt proposed to “Yoke Up the Children”. More precisely, he proposed the use of orphan in the public care to work as pauper apprentices to firms at pences on the shilling (bad pun of pennies on the dollar). He “lent” orphans to private firms and its hard to assume that they consented to work (as Humphries’s use of oral histories makes clear). If a person with libertarian leanings like me was willing to excuse such a man before, it is quite telling of how limited knowledge shores up the reputations of powerful men. This is because their use of power overshadows all the rest. Their use of power is like the joke about economists looking where the lamppost is: we evaluate them on what their use of power has illuminated.

Other Metrics

So, are there any other metrics that are less subjected to our inherent power-display bias? Obviously, anything that has a subjective element will be biased. However, evaluating the evolution of living standards under their rule is one way to go at it. Mark Zachary Taylor, in an article published in PS: Political Science and Politicsproposed an economic ranking of US Presidents since 1789. Whichever way you cut it, there is a weak rank correlation between the rankings of presidential greatness and the ranking of economic grades.

Ranking.png

There is another type of ranking, which is more subtle. It measures how much Presidents refrained from expanding federal power. This exercise was made by Richard Vedder and Lowell Gallaway (two great economic historians) who measured presidents based on their changes to the size of government and inflation. This measure alone (see table below) is not sufficient to be convincing, but taken as part of a constellation of rankings, it provides a key piece of evidence. This is really a counter-pantheon to the rankings of presidential greatness. In fact, one could see it as the cost for societies of presidential greatness.

presidentialgreatness

When comes the time to evaluate great rulers, being aware of our biases is crucial (as Lord Acton, I think they should rarely be excused based on flimsy excused like circumstances – the virtue of being an historian/economic historian is that we have enough hindsight to say how terrible certain choices were).  And that awareness should lead us to develop a “dashboard” of rankings to properly weigh the impact of such rulers.

Testing the High-Wage Economy (HWE) Hypothesis

Over the last week or so, I have been heavily involved in a twitterminar (yes, I am coining that portemanteau term to designate academic discussions on twitter – proof that some good can come out of social media) between myself, Judy Stephenson , Ben Schneider , Benjamin Guilbert, Mark Koyama, Pseudoerasmus,  Anton Howes (whose main flaw is that he is from King’s College London while I am from the LSE – nothing rational here), Alan Fernihough and  Lyman Stone. The topic? How suitable is the “high-wage economy” (HWE) explanation of the British industrial revolution (BIR).

Twitter debates are hard to follow and there is a need for summaries given the format of twitter. As a result, I am attempting such a summary here which is laced with my own comments regarding my skepticism and possible resolution venues.

An honest account of HWE

First of all, it is necessary to offer a proper enunciation of HWE’s role in explaining the industrial revolution as advanced by its main proponent, Robert Allen.  This is a necessary step because there is a literature attempting to use high-wages as an efficiency wage argument. A good example is Morris Altman’s Economic Growth and the High-Wage Economy  (see here too) Altman summarizes his “key message” as the idea that “improving the material well-being of workers, even prior to immediate increases in productivity can be expected to have positive effects on productivity through its impact on economic efficiency and technological change”. He also made the same argument with my native home province of Quebec relative to Ontario during the late 19th century. This is basically a multiple equilibria story. And its not exactly what Allen advances. Allen’s argument is that wages were high in England relative to energy. This factors price ratio stimulated the development of technologies and industries that spearheaded the BIR. This is basically a context-specific argument and not a “conventional” efficiency wage approach as that of Allen. There are similarities, but they are also considerable differences. Secondly, the HWE hypothesis is basically a meta-argument about the Industrial Revolution. It would be unfair to caricature it as an “overarching” explanation. Rather, the version of HWE advanced by Robert Allen (see his book here) is one where there are many factors at play but there is one – HWE – which had the strongest effects. Moreover, while it does not explain all, it was dependent on other factors that contributed independently.  The most common view is that this is mixed with Joel Mokyr’s supply of inventions story (which is what Nick Crafts has done). In the graph below, the “realistically multi-causal” explanation is how I see HWE. In Allen’s explanation, it holds the place that cause #1 does. According to other economists, HWE holds spot #2 or spot #3 and Mokyr’s explanations holds spot #1.

hwe

In pure theoretical terms (as an axiomatic statement), the Allen model is defensible. It is a logically consistent construct. It has some questionnable assumptions, but it has no self-contradictions. Basically, any criticism of HWE must question the validity of the theory based on empirical evidence (see my argument with Graham Brownlow here) regarding the necessary conditions. This is the hallmark of Allen’s work: logical consistency. His work cannot be simply brushed aside – it is well argued and there is supportive evidence. The logical construction of his argument requires a deep discussion and any criticism that will convince must encompass many factors.

Why not France? Or How to Test HWE

As a doubter of Allen’s theory (I am willing to be convinced, hence my categorization as doubter), the best way to phrase my criticism is to ask the mirror of his question. Rather than asking “Why was the Industrial Revolution British”, I ask “Why Wasn’t it French”. This is what Allen does in his work when he asks explicitly “Why not France?” (p.203 of his book). The answer proposed is that English wages were high enough to justify the adoption of labor-saving technologies. In France, they were not. This led to differing rates of technological adoptions, an example of which is the spinning jenny.

This argument hinges on some key conditions :

  1. Wages were higher in England than in France
  2. Unit labor costs were higher in England than in France (productivity-adjusted wages) (a point made by Kelly, Mokyr and Ó Gráda)
  3. Market size factors are not sufficiently important to overshadow the effects of lower wages in France (R&D costs over market size mean a low fixed cost relative to potential market size)
  4. The work year is equal in France as in England
  5. The cost of energy in France relative to labor is higher than in England
  6. Output remained constant while hours fell – a contention at odds with the Industrious Revolution which the same as saying that marginal productivity moves inversely with working hours

If most of these empirical statements hold, then the argument of Allen holds. I am pretty convinced by the evidence advanced by Allen (and E.A. Wrigley also) regarding the low relative of energy in England. Thus, I am pretty convinced that condition #5 holds. Moreover, given the increases in transport productivity within England (here and here), the limited barriers to internal trade (here), I would not be surprised that it was relatively easy to supply energy on the British market prior to 1800 (at least relative to France).

Condition #3 is harder to assess in terms of important. Market size, in a Smithian world, is not only about population (see scale effects literature). Market size is a function of transaction costs between individuals, a large share of which are determined by institutional arrangements. France has a much larger population than England so there could have been scale effects, but France also had more barriers to internal trade that could have limited market size. I will return to this below.

Condition #1,2,4 are basically empirical statements. They are also the main points of tactical assault on Allen’s theory.  I think condition #1 is the easiest to tackle. I am currently writing a piece derived from my dissertation showing that – at least with regards to Strasbourg – wages in France presented in Allen (his 2001 article) are heavily underestimated (by somewhere between 12% and 40% using winter workers in agriculture and as much as 70% using the average for laborers in agriculture). The work of Judy Stephenson, Jane Humphries and Jacob Weisdorf has also thrown the level and trend of British wages into doubts. Bringing French wages upwards and British wages downwards could damage the Allen story. However, this would not be a sufficient theory. Industrialization was generally concentrated geographically. If labor markets in one country are not sufficiently integrated and the industrializing area (lets say the “textile” area of Lancashire or the French Manchester of Mulhouse or the Caën region in Normandy) has uniquely different wages, then Allen’s theory can hold since what matters is the local wage rate relative to energy. Pseudoerasmus has made this point but I can’t find any mention of that very plausible defense in Allen’s work.

Condition #2 is the weakest point and given Robert Fogel’s work on net nutrition in France and England, I have no problem in assuming that French workers were less productive. However, the best evidence would be to extract piece rates in textile-producing regions of France and England. This would eliminate any issue with wages and measuring national productivity differences. Piece rates would perfectly capture productivity and thus the argument could be measured in a very straightforward manner.

Condition #4 is harder to assess and more research would be needed. However, it is the most crucial piece of evidence required to settle the issue once and for all. Pre-industrial labor markets are not exactly like those of modern days. Search costs were high which works in a manner described (with reservations) by Alan Manning in his work on monopsony but with much more frictions. In such a market, workers may be willing to trade in lower wage rates for longer work years. In fact, its like a job security argument. Would you prefer 313 days of work guaranteed at 1 shilling per day or a 10% chance of working 313 days for 1.5 shillings a day (I’ve skewed the hypothetical numbers to make my point)? Now, if there are differences in the structure of labor markets in France and England during the 18th and 19th centuries, there might be differences in the extent of that trade-off in both countries. Different average discount on wages would affect production methods. If French workers were prone to sacrifice more on wages for steady employment, it may render one production method more profitable than in England. Assessing the extent of the discount of annual to daily wages on both markets would identify this issue.

The remaining condition (condition #6) is, in my opinion, dead on arrival. Allen’s model, in the case of the spinning jenny, assumed that labor hours moved in an opposite direction as marginal productivity. This is in direct opposition to the well-established industrious revolution. This point has been made convincingly by Gragnolati, Moschella and Pugliese in the Journal of Economic History. 

In terms of research strategy, getting piece rates, proper wage estimates and proper labor supplied estimates for England and France would resolve most of the issue. Condition #3 could then be assessed as a plausibility residual.  Once we know about working hours, actual productivity and real wages differences, we can test how big the difference in market size has to be to deter adoption in France. If the difference seems implausible (given the empirical limitations of measuring effective market size in the 18th century in both markets), then we can assess the presence of this condition.

My counter-argument : social networks and diffusion

For the sake of argument, let’s imagine that all of the evidence favors the skeptics, then what? It is all well and good to tear down the edifice but we are left with a gaping hole and everything starts again. It would be great to propose a new edifice as the old one is being questioned. This is where I am very much enclined towards the rarely discussed work of Leonard Dudley (Mothers of Innovation). Simply put, Dudley’s argument is that social networks allowed the diffusion of technologies within England that fostered economic growth. He has an analogy from physics which gets the point across nicely. Matter has three states : solid, gas, liquid. Solids are stable but resist to change. Gas, matter are much more random and change frequently by interacting with other gas, but any relation is ephemeral. Liquids permit change through interaction, but they are stable enough to allow interactions to persist for some time. Technological innovation is like a liquid. It can “mix” things together in a somewhat stable form.

This is where one of my argument takes life. In a small article for Economic Affairs, I argued (expanding on Dudley) that social networks allowed this mixing (I am also expanding that argument in a working paper with Adam Martin of Texas Tech University). However, I added a twist to that argument which I imported from the work of Israel Kirzner (one of the most cited books in economics, but not by cliometricians – more than 7000 citations on google scholar). Economic growth, in Kirzner’s mind,  is the result of entrepreneurs discovering errors and arbitrage possibilities. In a way, growth is a process of discovering correcting errors. An analogy to make this point is that entrepreneurs look for profits where the light is while also trying to move the light to see where it is dark. What Kirzner dubs as “alertness” is in fact nothing else than repeated and frequent interactions. The more your interact with others, the easier it becomes for ideas to have sex. Thus, what matters is how easy it is for social networks to appear and generate cheap information and interactions for members without the problem of free riders. This is where the work of Anton Howes becomes very valuable. Howes, in his PhD thesis supervised by Adam Martin who is my co-author on the aforementioned project (summary here), showed that most innovators went in frequent with one another and they inspired themselves from each other. This is alertness ignited!

If properly harnessed, the combination of the works of Howes and Dudley (and also James Dowey who was a PhD student at the LSE with me and whose work is *Trump voice* Amazing) can stand as a substitute to Allen’s HWE if invalidated.

Conclusion

If I came across as bashing on Allen in this post, then you have misread me. I admire Allen for the clarity of his reasoning and his expositions (given that I am working on a funded project to recalculate tax-based measures in the US used by Piketty to account for tax avoidance, I can appreciate the clarity in which Allen expresses himself). I also admire him for wanting to “Go big or go home” (which you can see in all his other work, especially on enclosures). My point is that I am willing to be convinced of HWE, but I find that the evidence leans towards rejecting it. But that is very limited and flawed evidence and asserting this clearly is hard (as some of the flaws can go his way). Nitpicking Allen’s HWE is a necessary step for clearly determining the cause of BIR. It is not sufficient as a logically consistent substitute must be presented to the research community. In any case, there is my long summary of the twitteminar (officially trademarked now!)

P.S. Inspired by Peter Bent’s INET research webinar on institutional responses to financial crises, I am trying to organize a similar (low-cost) venue for presenting research papers on HWE assessment. More news on this later.

England circa 1700: low-wage or high-wage

A few months ago, I discussed the work of my friend (and fellow LSE graduate) Judy Stephenson on the “high-wage economy” of England during the 18th century. The high-wage argument basically states that high wages relative to capital incite management to find new techniques of production and that, as a result, the industrial revolution could be initiated. Its a crude summary (I am not doing it justice here), but its roughly accurate.

In her work, Judy basically indicated that the “high-wage economy” observed in the data was a statistical artifact. The wage rates historians have been using are not wage rates, they’re contract rates that include an overhead for contractors who hired the works. The wage rates were below the contract rates in an amplitude sufficient to damage the high-wage narrative.

A few days ago, Jane Humphries (who has been a great inspiration for Judy and whose work I have been discretely following for years) and Jacob Weisdorf came out with a new working paper on the issue that have reinforced my skepticism of the wages regarding England. A crude summary of Humphries and Weisdorf’s paper goes as such: preindustrial labor markets had search costs, workers were willing to sacrifice on the daily wage rate (lower w) in order to obtain steady employment (greater L) and thus the proper variable of interest is the wage paid on annual contracts.

While their results do not affect England’s relative position (it only affects the trend of living standards in England), it shows that there are flaws in the data. These flaws should give us pause before proposing a strong theory like the “high-wage economy” argument. Taken together, the work of Stephenson (whom I am told is officially forthcoming), Humphries and Weisdorf show the importance of doing data work as the new data may overturn some key pieces of research (maybe, I am not sure, there is some stuff worth testing).