The World Economy by the OECD Development Centre

International Trade and Capital Movements

International trade was important in the economic ascension of Western Europe, and much less significant in the history of Asia or Africa. Venice played a key role from 1000 to 1500 in opening up trade within Europe (to Flanders, France, Germany and the Balkans) and in the Mediterranean. It opened trade in Chinese products via the caravan routes to ports in the Black Sea. It traded in Indian and other Asian products via Syria and Alexandria. Trade was important in bringing high value spices and silks to Europe, but it also helped the transfer of technology from Asia, Egypt and Byzantium (silk and cotton textile production, glassblowing, cultivation of rice in Italy, cane sugar production and processing in the Venetian colonies of Crete and Cyprus). To a significant degree the maritime expansion of Venice depended on improved techniques of shipbuilding in its Arsenal, use of the compass and other improvements in navigation.

Institutional innovations — the development of banking, accountancy, foreign exchange and credit markets, creation of a solvent system of public finance, creation of a competent diplomatic service were all instrumental in establishing Venice as the lead economy of that epoch. Venice played an important part in fostering the intellectual development of Western Europe. It created manuscript libraries and pioneered in book publishing. Its glass industry was the first to make spectacles on a large scale. It played a leading role in the Renaissance by making Greek works known in the West. The University of Padua was a major centre of European learning, with Galileo as one of its distinguished professors.

Venetian contacts with Asia were eventually blocked by the fall of Byzantium, the rise of the Ottoman Empire, the collapse of the crusader states in the Levant and the Mameluke regime in Egypt.

In the second half of the fifteenth century, a much more ambitious interaction between Europe and the rest of the world had started in Portugal. Portugal played the main role in opening up European trade, navigation and settlement in the Atlantic islands, in developing trade routes around Africa, into the Indian Ocean, to China and Japan. It became the major shipper of spices to Europe for the whole of the sixteenth century, usurping this role from Venice. Its navigators discovered Brazil. Its diplomacy was astute enough to persuade Spain to endorse its territorial claim there, and to let it have a monopoly of trade with the Moluccan spice islands and Indonesia. Although Spain had a bigger empire, its only significant base outside the Americas was the Philippines. Its two most famous navigators were Columbus who was a Genoese with Portuguese training, and Magellan who was Portuguese.

Portugal had major advantages in developing its overseas commerce and empire. There was a clear strategic benefit in being located on the South Atlantic coast of Europe near to the exit of the Mediterranean. Deep–sea fishermen provided an important part of the Portuguese food supply and developed an unrivalled knowledge of Atlantic winds, weather and tides. The value of these skills was greatly enhanced by crown sponsorship of Atlantic exploration, research on navigation, training of pilots, and documentation of maritime experience in the form of route maps with compass bearings (rutters) and cartography. Portuguese shipbuilders in Lisbon and Oporto adapted the design of their ships in the light of increasing knowledge of Atlantic sailing conditions. The biggest changes were in rigging. At first they concentrated on lateen sails, then added a mix of square sails and lateen for deeper penetration into the South Atlantic, with further changes for the much longer route round the Cape. Another element in Portuguese success was the ability to absorb “new Christians” — Jewish merchants and scholars who had played a significant role in Iberia during Muslim rule. They were driven out of Spain, but many took refuge and increased the size of the community in Portugal. They were required to undergo proforma conversion and were subject to a degree of persecution, but they provided important skills in developing Portuguese business interests in Africa, Brazil and Asia, inscientific development, as intermediaries in trade with the Muslim world and in attracting Genoese and Catalan capital to Portuguese business ventures.

Portugal was responsible for transferring cane sugar production and processing technology into the Atlantic islands of Madeira and Sâo Tomé, and later to Brazil. It inaugurated the slave trade to provide a labour force for the industry in the New World. It carried about half of the slaves who were shipped to the Americas from Africa between 1500 and 1870. In the fifteenth century, sugar was a very rare and expensive commodity in Europe; by the end of the eighteenth century it was an item of popular consumption, having grown much more in volume than trade in any other tropical product.

At the time Portugal was pioneering these worldwide linkages, trade relations between different arts of northern Europe were intensified by the phenomenal development of Dutch maritime activity. In 1570, the carrying capacity of Dutch merchant shipping was about the same as the combined fleets of England, France and Germany. Per head of population it was 25 times as big as in these three northern countries.

Development of shipping and shipbuilding, the transformation of Dutch agriculture into horticulture, the creation of a large canal network, use of power derived from windmills and peat made the Netherlands the most dynamic European economy from 1400 to the middle of the seventeenth century. It pushed international specialisation much further than any other country.

Shipping and commercial services provided a large part of its income. It imported cereals and live cattle, exported herring and dairy products. In 1700 only 40 per cent of the labour force were in agriculture. Until 1580 the Netherlands was part of a bigger political entity. It included Flanders and Brabant — the most prosperous industrial area in Europe and a centre for banking, finance and international commerce which was a northern counterpart to Venice. The whole area was under Burgundian control until the late fifteenth century, then fell into the hands of the Habsburgs who were also rulers of Spain. The Dutch revolted against their predatory empire because of its excessive fiscal demands, political and religious repression. They created a modern nation state, which protected property rights of merchants and entrepreneurs, promoted secular education and practised religious tolerance.

Most of the financial and entrepreneurial elite and many of the most skilled artisans of Flanders and Brabant emigrated to the new republic. The Dutch blockaded the river Scheldt and the port of Antwerp for more than 200 years, and destroyed the Iberian monopoly of trade with Africa, Asia and the Americas. Dutch experience from 1580 to the end of the Napoleonic wars provides a dramatic demonstration of the way in which Western Europe interacted with the world economy in that epoch.

The initial economic success of the Dutch Republic, and its maritime and commercial supremacy, depended to a substantial extent on success in war and beggar–your–neighbour commercial policy in competition with Portugal and Spain. By the eighteenth century it had lost this supremacy, because two new rivals, England and France, had greatly increased their maritime strength, and used the same techniques to push the Dutch out of the markets they sought to dominate. The volume of Dutch foreign trade dropped 20 per cent from 1720 to 1820. During this period, UK exports rose more than sevenfold in volume, and French by two and threequarters. From 1700 to 1820, Dutch per capita income fell by a sixth, British rose by half and French by a quarter.

Britain had faster growth in per capita income from the 1680s to 1820 than any other European country. This was due to improvement of its banking, financial and fiscal institutions and agriculture on lines which the Dutch had pioneered, and to a surge in industrial productivity at the end of the period. It also derived great benefits from its rise to commercial hegemony by adroit use of a beggar– your–neighbour strategy.

Sixty years of armed conflict and the restrictive Navigation Acts pushed competitors out of the markets it sought to monopolise. It took over the leading role in shipping slaves from Africa to the Caribbean and created an overseas empire with a population of about 100 million by 1820. Other European powers were losers in the British struggle for supremacy. By the end of the Napoleonic wars, the Dutch had lost all their Asian territories except Indonesia. The French were reduced to a token colonial presence in Asia, and lost their major asset in the Caribbean. Shortly after the war, Brazil established its independence from Portugal. Spain lost its huge colonial empire in Latin America, retaining only Cuba, Puerto Rico and the Philippines. Britain took over what the French and Dutch had lost in Asia and Africa, extended its control over India, and established a privileged commercial presence in Latin America.

Other losers included the former rulers of India, whose power and income were usurped in substantial part by the servants of the British East India Company. Under their rule, from 1757 to 1857, Indian per capita income fell, but British gains were substantial. Between 1820 and 1913, British per capita income grew faster than at any time in the past — three times as fast as in 1700–1820. The basic reason for improved performance was the acceleration of technical progress, accompanied by rapid growth of the physical capital stock and improvement in the education and skills of the labour force, but changes in commercial policy also made a substantial contribution. In 1846 protective duties on agricultural imports were removed and in 1849 the Navigation Acts were terminated. By 1860, all trade and tariff restrictions had been removed unilaterally. In 1860 there were reciprocal treaties for freer trade with France and other European countries. These had most–favoured nation clauses which meant that bilateral liberalisation applied equally to all countries. Free trade was imposed in India and other British colonies, and the same was true in Britain’s informal empire. China, Persia, Thailand and the Ottoman Empire were not colonies, but were obliged to maintain low tariffs by treaties which reduced their sovereignty in commercial matters, and granted extraterritorial rights to foreigners. This regime of free trade imperialism favoured British exports, but was less damaging to the interests of the colonies than in the eighteenth century, when Jamaica could only trade with Britain and its colonies, Guadeloupe only with France. The British policy of free trade and its willingness to import a large part of its food had positive effects on the world economy. They reinforced and diffused the impact of technical progress. The favourable impact was biggest in North America, the southern cone of Latin America and Australasia which had rich natural resources and received a substantial inflow of capital, but there was also some positive effect in India which was the biggest and poorest part of the Empire.

Innovations in communications played a major part in linking national capital markets and facilitating international capital movements. The United Kingdom already had an important role in international finance, thanks to the soundness of its public credit and monetary system, the size of its capital market and public debt, and the maintenance of a gold standard. The existence of the empire created a system of property rights which appeared to be as securely protected as those available to investors in British securities. It was a wealthy country operating close to the frontiers of technology, so its rentiers were attracted to foreign investment even when the extra margin of profit was small. From the 1870s onward, there was a massive outflow of British capital for overseas investment. The United Kingdom directed half its savings abroad. French, German and Dutch investment was also substantial.

The old liberal order was shattered by two world wars and the collapse of capital flows, migration and trade in the beggar–your–neighbour years of the 1930s. Between 1913 and 1950, the world economy grew much more slowly than in 1870–1913, world trade grew much less than world income, and the degree of inequality between regions increased substantially, the setback being biggest in Asia.

By 1950 colonialism was in an advanced state of disintegration. With one or two exceptions, the exit from empire was more or less complete by the 1960s. The British imperial order was finished, as were those of Belgium, France, the Netherlands and Japan. In the West, the United States had emerged as the hegemonial power competing with the Soviet bloc for leverage in the newly independent countries of Asia and Africa.

The world economy grew very much faster from 1950 to 1973 than it had ever done before. It was a golden age of unparalleled prosperity. World per capita GDP rose nearly 3 per cent a year (a rate which implies a doubling every 25 years). World GDP rose by nearly 5 per cent a year and world trade by nearly 8 per cent a year. This dynamism affected all regions. The acceleration was greatest in Europe and Asia. There was also a degree of convergence between regions, though a good part of this was a narrowing of the gap between the United States and the other advanced capitalist countries (Western Europe and Japan).

There were several reasons for unusually favourable performance in the golden age. In the first place, the advanced capitalist countries created a new kind of liberal international order with explicit and rational codes of behaviour, and institutions for co–operation (OEEC, OECD, IMF, World Bank and the GATT) which had not existed before. There was a very serious East–West split from 1948 onwards, but the split reinforced the harmony of interest between capitalist economies, so the beggar– your–neighbour behaviour of pre–war years did not recur. The United States provided a substantial flow of aid for Europe when it was most needed, fostering procedures for articulate co–operation and liberal trading policies. Until the 1970s it also provided the world with a strong anchor for international monetary stability. North–South relations were transformed from the colonial tutelage of pre–war years to a situation where more emphasis was placed on action to stimulate development. The huge expansion of trade in the advanced capitalist economies transmitted a dynamic influence throughout the world economy.

The second new element of strength was the character of domestic policies which were self–consciously devoted to promotion of high levels of demand and employment in the advanced countries. Growth was not only faster than ever before, but the business cycle virtually disappeared. Investment rose to unprecedented levels and expectations became euphoric. Until the 1970s, there was also much milder inflationary pressure than could have been expected in conditions of secular boom.

The third element in this virtuous circle situation was the potential for growth on the supply side. Throughout Europe and Asia there was still substantial scope for “normal” elements of “recovery” from the years of depression and war. Additionally and more importantly, was the continued acceleration of technical progress in the lead country. Furthermore, the United States played a diffusionist role in the golden age in sharp contrast to its role in the interwar years.

Since the golden age, the world picture has changed a great deal. Per capita growth has been less than half as fast. There has been much greater divergence in the performance of different regions. In Western Europe and Japan, per capita growth fell well below that in the golden age, but was appreciably better than in 1870–1913. In the countries of “resurgent Asia”, which have half the world’s population, the success was quite extraordinary. Their per capita growth was faster after 1973 than in the golden age, and more than ten times as fast as in the old liberal order.

If the world consisted only of these two groups, the pattern of world development could be interpreted as a clear demonstration of the possibilities for convergence. By success in mobilising and allocating resources efficiently and improving their human and physical capital to assimilate and adapt appropriate technology, the countries of resurgent Asia achieved significant catch–up on the advanced capitalist group.

However, there is another group (168 countries, with about a third of the world’s population) where the deterioration in performance since the golden age has been alarming. In Africa there has been no advance in per capita income in the past quarter century. In Eastern Europe and the former USSR, average per capita income in 1998 was about threequarters of that in 1973. In Latin America and in many Asian countries, income gains have been a fraction of what they were in the golden age.

The economies of this heterogeneous group of “faltering economies” have been falling behind instead of catching up. Most of them have not been able to adapt successfully to an international economic order which has changed considerably from that in the golden age.

The way in which postwar order now operates is analysed in detail in Chapter 3. The structure of the analysis is based on Table 3–5 which summarises the comparative performance of the major regions.