Content introduction：

Speaker:Yi Wen 

(Economic Professor，Assistant Vice President of the Federal Reserve Bank of St. Louis)

Topic: State Capacity & Industrial Revolution―The Origin of National Wealth and End of “Neoliberalism and Utopian Marketism”

Prof. Wen Yi’s keynote speech explains the origin of national wealth in 16-19 century Europe, and reveals the political-economic mechanism behind the Industrial Revolution.

Prof. Wen opens his talk by asking the following intriguing and long-standing questions: (1) Why are some nations poor and others rich? (2) Why did the Industrial Revolution take place in the West instead of the East? (3) What is the secret recipe of the rise of Europe? (4) Why is economic reform successful in China but not in Russia and other Eastern European nations? (5) Why is India lagging behind China despite democracy and better private property right and legal system?

In a popular book “Why Nations Fail?” MIT economist Acemoglu argues that nations fail in economic development because of the lack of inclusive democratic institutions and well-protected property rights. However, Professor Wen use large amount of historical evidence to show that the secret of Europe’s rise since the 15^th century was war and state-led commerce, rather than democratic institutions or better protection of private property rights than before or anywhere else in the world.

Through centuries of bloody wars, 15-16 century European monarchies mastered the means to conquer the world, including weapons of mass destruction and the state capacity. Relying on such state capacity, they engaged in the most brutal, most greedy, most calculated oversea commercial expansion in human history, thus established the largest global markets for commodities, slaves, and raw materials. 300 hundred years of such primitive accumulations and fierce competitions finally set off the Industrial Revolution around 1800, which features mass-production of light commodities such as textile goods. This global market made large-scale production and distribution technologies (such as the Spinning Jenny and railroads) profitable and sustainable. In this militarized commercial process of global competition for wealth, only around 20 nations survived out of original 400 nations.

Whoever controlled weapons of mass destruction controls global trade and global wealth. This national policy is still implemented by today’s United States – the most advanced navy force and largest commercial empire in world history.

European powers’ superior trade position was based on their superior military status, which in turn was achieved through repeated bloody wars. For example, 44 large-scale wars took place in the 14th century, including the famous hundred-year war between France and England; 60 wars took place in the 15 century and 62 wars in the 16 century with average length of 8 years. Between 1500 and 1700, 95% of time in Europe was in war.

Wars created huge demand for gun powders. In 1440s, France alone used 20,000 pounds of gunpowder. This number increased by 25 times a hundred year later. Spain had 200,000 army soldiers in 1600, at 2.5% of its population; France had 400,000 soldiers in 1700, at 2.1% of its population. According to this ratio, Qing dynasty China needed 8-10 million army force to fight against European powers and join their rank in global colonization. But China had absolutely no such fiscal and state capacities to support and mobilize such a large military force. In 16-19 century Europe, every citizen was a soldier, and every soldier was a merchant.

In other words, 300 years before the Industrial Revolution, the economic foundation and state capacity of European nations have already experienced fundamental transformation, which produced modern national bureaucracy, specialized military force, supply-chains for guns, cannons, uniforms, and infrastructure (cannel system).

Large-scale military operations and navy forces called for new forms of taxes and national fiscal management systems. So European powers’ fiscal system evolved from feudal and decentralized forms into standardized and centralized authoritarian systems. This is the only way to maintain large-scaled recurrent military spending. Such fiscal demand stimulated creation of modern government finance and debt markets.

The need to effectively collect and create tax revenues forced European powers to adopt commerce-based economic model and abandoned agriculture-based economic model. But taking this road requires a strong state, which can facilitate militarized global trade and commerce with the support of powerful navy force and chartered companies.

Tax revenues accounted for 10% of GDP in the UK around 1700 and 25% of GDP around 1820. Government debt often accounted for more than 100% or even 200% for many European nations during the Industrial Revolution in Europe. In sharp comparison, tax revenue accounted for only about 4% of GDP in 18-19 century China, which is called an extractive state by Acemoglu.

It is based on such frequent and large-scaled wars, such forms of weapons of mass destruction and organized army, such ability of resources mobilization, such state capacity and government budget, such extend of global colonization and slave trade, such monopolized trade profits, that enabled the European powers to conquer the world, to steal global resources to support their manufacturing and industrialization.

In other words, long before the Industrial Revolution, Europe had already conquered the world for 200-300 years without any forms of “democracy, rule of law, liberty and equality.” Universal suffrage was the by-product of industrialization, not its cause or precondition.

For this reason, economic historian Sven Beckert points out: “The first industrial nation, Great Britain, was hardly a liberal, lean state with dependable but impartial institutions as it is often portrayed. Instead it was an imperial nation characterized by enormous military expenditures, a nearly constant state of war, a powerful and interventionist bureaucracy, high taxes, skyrocketing government debt, and protectionist tariffs—and it was certainly not democratic.”

Economic historian Joel Mokyr also points out that British society provided little “law and order” to protect industrial “properties” and human “rights” before the Industrial Revolution and it had a “surprising quantity of robbers…. Local rioting, either for economic or political grievances, was common.” “[It] had no professional police force comparable to … that emerged after 1830, and the court system was unwieldy, expensive, and uncertain. Britain depended on the deterrent effect of draconian penalties because it had no official mechanism of law enforcement, prosecution was mostly private, and crime prevention was largely self-enforcing, with more than 80 per cent of all prosecutions carried out by the victims.”

Hence, “private property right protection” is not the reason for Europe’s rise. Before and during the Industrial Revolution, European nations’ property right protection was nothing significantly different from that during the Middle Ages, and worse than many of today’s developing nations.

Europe’s rise was not due to “the rule of law” either. Many of today’s legal forms and laws we see in advanced countries (such as contract law, company law, accounting law, antitrust law, intellectual property law), were either non-existent or highly imperfectly implemented in 16-19 century Europe. Laws were set up to protect the fruits of industrialization. They can always be modified and changed based on changing national interests.

Hence, the reason for Europe’s rise to global supremacy was not because they were “civilized,” but rather because they were “barbaric.” Even Adam Smith failed to acknowledge that much of the international commercial “laws” and trade order in his days were created by European merchants’ monopoly power and military force backed by their state governments, as wrote by the famous Dutch merchant and warrior Jan Pieterszoon Coen to the Dutch Monarch: “Your Honors should know by experience that trade in Asia must be driven and maintained under the protection and favor of Your Honor’s own weapons, and that the weapons must be paid for by the profits from the trade; so that we cannot carry on trade without war, nor war without trade.” Such a “war and trade” feedback loop was the secret weapon of all European powers to conquer the world before, during, and after the Industrial Revolution.

So, historically speaking, generations of British monarchs and merchants (e.g., the British East India Co.) helped create for England the world’s largest textile market, cotton supply chains, and trading networks that kick-started the Industrial Revolution. Today, however, developing nations no longer have that “privilege” and the time to nurture such a powerful merchant class. Hence, government, especially local governments, must play a bigger role in market creation.

Professor Wen also described the economic logic of market creation, or how to create markets for industrial goods sequentially according to the right order. Otherwise, even if developing countries obtained the necessary state capacity to foster economic development, they may still fail in setting of their own industrial revolution.

According to Prof. Wen, industry revolution is characterized by mass production, but mass production requires a unified mass market. Yet such a market is a public good which can be created only by the state through several distinctive stages.

For example, to establish a mass market for heavy industrial goods, one must first establish a mass market for light industrial goods. In other words, the ability to mass produce textiles and other labor-intensive light consumer goods must proceed the ability to mass produce steel and other capital-intensive heavy industrial goods such as machinery. But the ability to mass produce and distribute light consumer goods started with even more primitive rural industries aiming at long-distance trade (such as China’s village-township industries in the 1980s).

Prof. Wen held the view that the fundamental reason behind the rapid rise of China is that China, through a pragmatic and experimental approach, instead of following Western economic doctrines, has finally rediscovered the “secret recipe” of the Industrial Revolution, which is to utilize state capacity to create mass markets to render firms’ adoption of mass-production technologies profitable. But such a process takes several stages to accomplish, even when based on a nations’ comparative advantages.

In contrast, most developing countries are too eager to leap forward, to start industrialization by building advanced capital-intensive industries, or by setting up modern financial systems, or by erecting modern political institutions. But such top-down approaches violate the historical sequence of the Industrial Revolution, and the principle that “supply does not create its own demand.”

So the key challenge for economic development is not the lack of technology and knowledge per se to set up a few modern factories, but rather the lack of state capacity and correct industrial policies to create markets sequentially to render firms’ mass-production technologies profitable, viable and internationally competitive.

Professor Wen also points out that ownership is not always the key for a firm’s competitiveness. The key is to impose competitive pressure and good management. The same principle applies to national management: At the national level, democracy cannot function without industrialization; yet industrialization is impossible without a strong and commerce-oriented state that can design and implement correct industrial policies based on a nation’s comparative advantages and the principle of sequential market creation.

Written by: Lan Zhu

Proofread by: Pro.Yi Wen

Zirong Yang