Iskander, a devoted EconLog reader, sent me a fascinating question. With his permission, I reprint his original email and a followup.
Original Email
Dear Professor Caplan,
I was reading through some old Econlog posts, and I saw one about Hong Kong (“Statist at Heart”) where you attribute rapid post war growth to the free market policies of the British. I tend to agree with this, however I do wonder about why growth was only rapid after 1950. There was next to no institutional/political change as far as I know, yet per capita output growth was not that large in the century beforehand. I can see why wages might be held down by elastic labour supply from mainland China, but not output per capita.
In many ways the British Empire acted as if it was ruled by a cabal of free market economists. It should have led to rapid global convergence as modern technology and goods were free to flow from Europe to the rest of the world and it made sure property rights were protected. Not only European property rights, as there were a large number of Indian, Chinese, Jewish and Parsi merchants and businessmen who flourished. If a Indian merchant wanted to set up a modern factory there were very few impediments from the government, which has not been the case post 1947.
In addition, taxation was low (India’s tax to GDP ratio was around 5% in the 1920s) and it usually came in forms with low deadweight loss (lump sum land taxes, excise taxes on goods with inelastic demand).
The exceptions to this were the settler colonies which were the most badly behaved (especially in South Africa) in terms of economic freedom.
Why do you think all this led to very little growth pre-1950, if these policies made Hong Kong rich post-1950?
Followup
Dear Professor Caplan,
I’m not able to find a totally convincing answer to the question myself. That said I can imagine that economic freedom has benefits even if it doesn’t lead to rapid growth.
I think that the area of China near Hong Kong was spared from most of the fighting until the 1940s (It was the base of the Kuomintang), even then Hong Kong could have produced goods for more stable South East/ South Asia (or Europe/America given the low level of wages).
At least in India, the British only moved away from free trade after WW1. A rearguard action by pro-free trade civil servants meant that tariffs were originally given only if an Industry made the case that it would raise productivity and eventually be weaned off protection, called “discriminating protection”. Under this scheme, perhaps the only successful case of Indian “infant Industry” actually growing up came about, Tata Steel. By the 1930s the rise of nationalism and fiscal pressures (The government was on the edge of bankruptcy) led to the decline of the discriminating part of protection.
The Bombay cotton textile industry was being beaten in its home market by Japanese textiles despite cotton being shipped from India to Japan, processed there and shipped back even with 50% tariffs. An interesting thing is that both industries were using the same machines but the Japanese firms had managed to raise productivity thrice as fast as the Indian firms (as far as I can remember, this is from the work of Gregory Clark and Susan Wolcott). This was a inglorious end for the first modern textile Industry in Asia (The imperial connection and an open economy meant that India’s first modern factory came thirty years before Japan’s).
Perhaps good economic policies can only go so far without widespread change in attitudes and aspirations.
Personally, I’m tempted to blame the chaos in China from the overthrow of the Manchus until the Korean War, but I’m not married to that story. Iskander’s knowledge of colonial economic policy seems better than mine, but if I were researching this in earnest I would start by nailing down the facts.
In any case, what’s the best response to Iskander’s challenge?
READER COMMENTS
Phil H
Oct 28 2020 at 12:59pm
This is a suggestion entirely from a position of ignorance, but wouldn’t extractive policies be the answer? These were all the hinterlands of an extractive empire, after all. Britain was never going to let another colony get uppity after that nasty incident in the West Atlantic…
Iskander
Oct 28 2020 at 1:19pm
British policies were on the whole not extractive, not by 1840 anyway.
Phil H
Oct 28 2020 at 7:28pm
The problem here is that I don’t have anything like enough historical knowledge to get into the figures on this. But, for example, I remember figures suggesting that India was poorer at the end of its colonial age than it was at the beginning. For 200 years, *someone* was skimming off all of India’s excess output.
I don’t have the figures to make a full argument, but what you’re saying sounds fantastically unlikely. Why would Britain maintain an empire if not to extract stuff from it? And as you say, if it was all about free trade, how come at the end of the colonial period, Britain was a rich country (and the one part of the empire to break away was also a rich country) and all the rest remained poor? The idea that Britain wasn’t doing something to extract wealth runs so strongly counter to the surface appearance that… I’d need a lot of convincing. I’d suggest that if tax figures don’t show the extraction, it’s much more likely to be a problem with the tax figures than it is that Britain didn’t extract wealth.
Alexander Turok
Oct 29 2020 at 12:06am
Post hoc ergo propter hoc, also wrong as British North America was richer than the rest of the world in 1776 too.
By this logic, America must be getting rich off of Iraq and Afghanistan.
Well, are there any “figures” that you wouldn’t just dismiss as contradicting your “surface appearance?” Is a rational discussion going to be possible here?
Iskander
Oct 29 2020 at 3:00am
The issue here is the low level of Indian output per capita.
It is not the case that output was high but consumption low because the evil imperialists were shipping all the output away. Indeed, if this were the case we would see higher per capita output as labour supply would be higher via the income effect.
Why would the generation that abolished slavery be happy to supposedly immiserate a whole subcontinent?
The problem with extraction/institutional arguments is that they have to work through specific policies and there is very little evidence of policies which give bad incentives to the private sector in that time, which is not true of the recent past.
murmur
Oct 29 2020 at 3:12am
The British hardly ran the colonies (especially India) following a free market ideology. As the parent commenter points out the British rule was extractive in nature (e.g. see the Indigo revolt). There were a lot of punitive taxes like the salt tax. Internal trade was also not free as there were customs barriers within India. Such restrictions often were the focal point of nationalist agitation, e.g. Gandhi’s Dandi March. Such statist rule well explains why the British colonies stayed poor.
Iskander
Oct 29 2020 at 11:09am
Indigo revolt was due to contractual disputes and anything a planter did was no different to how Indian landlord treated their tenants. See Tirthankar Roy’s work.
The salt tax has low dead weight loss as demand should be rather inelastic. Revenue small relative to the size of the economy. How does it affect the profitability of running a business?
Internal customs barriers, with the exception the salt barrier/great hedge, had been abolished in North India by 1836. They were abolished in Bombay in 1838, and finally madras in 1844. Compare this to the situation where each zamindar/local notable levied his own tariffs, cumulate over time.
The great hedge was abolished in the 1870s anyway.
Indeed, thanks to the nationalists ,India is split into three separate portions each with their own tariffs barriers, Hindus used to be able to trade freely with Lahore and Dhaka.
The nationalists were very good at public relations, and attacking the salt tax when the government was almost bankrupt was good politics but it is unlikely that there was another tax with lower distortions.
More importantly, how does the salt tax taxes drive a wedge between Marginal product and what the producer receives? That’s what affect incentives to produce, not the size of practically a lump sum tax.
Henri Hein
Oct 28 2020 at 2:55pm
I can’t speak for India, but I suspect local policies would disqualify its economy from the laissez-faire designation. I have no reason to believe India would fare better than Persia or Brazil, with or without British rule. Free trade is great, but it can only do so much to compensate for poor domestic policies.
As for Hong Kong, remember that it was a small 8,000 person fishing village when the British took it over. It didn’t reach a million people until well into the 20th century, and then WWII and the Japanese occupation hit. Given this demographic history, it makes sense to me that the laissez-faire policies would really kick in after the war.
Also bear in mind that Hong Kong has always enjoyed large rates of immigration. I am as big a fan of immigration as Caplan, but each newcomer fairly consistently has lower assets and income than the residents. That hurts aggregate numbers, if you look at those, even though both groups are better off. This effect is potentially large when the domestic population is small and only marginally better off than the surrounding areas from which the immigrants arrive, which would have been the case in the first at least 50 years of Hong Kong history.
Iskander
Oct 28 2020 at 3:01pm
What do you mean by local policies?
Small towns in Europe achieved higher per capita output than Hong Kong did, despite a favorable location and a greater population.
Henri Hein
Oct 28 2020 at 8:24pm
I’m not that familiar with Indian history to give a detailed answer. That was my point. I would be looking for answers to questions like: were property rights secure? Were tax burdens moderate and even? How easy was it to start a business? Looking at British policy in isolation does not tell us.
Of course. The question is, when? Hong Kong was a small fishing village in 1842, subject to Chinese policies and technical progress. By the 21st century, its economy was rivaling that of cities like Milan, Vienna and Rotterdam. Naturally there was a long period in which the Hong Kong economy was trailing that of comparable cities in Europe.
Iskander
Oct 29 2020 at 10:51am
Regarding security of property rights and taxation it’s worthwhile to look at land and the rest of the economy separately.
For land security of property rights was low and taxation was initially high, a legacy from the condition of the country after the collapse of the mughals, but as the capacity of the state increased land rights were made more secure (not perfectly mind you) and land taxation was reduced starting from the 1840/50s and pretty much continued to fall from then on.
I will add that in Bengal land taxation was fixed in nominal terms in 1793 and continued at that level until independence, despite the real level declining as the price level rose. The government acknowledged the importance of credibility
Elsewhere, Property rights for merchants and businessmen were secure and they were lightly taxed, which is why these groups supported the British during the mutiny.
The Raj had the rule of law and according to a book I read recently the government lost half of the cases it fought.
That said, more important than the magnitude of taxation is it’s dead weight loss and land taxation does not have dead weight loss.
Iskander
Oct 29 2020 at 10:54am
Just to clarify:
I mean that land security was initially low then improved.
By “cases it fought” I mean fought in a court of law, not with weapons (“Would you rather be ruled by the pen or the sword?”)
john hare
Oct 28 2020 at 8:42pm
I speculate that there was a lot of competition for Hong Kong prior to WW2. Shanghai and the like with somewhat better access to the Chinese markets and producers. After mainland China, with all its’ trade ports ceased to compete after 1950, Hong Kong was able to dominate the local free trading. And be a magnet for entrepreneurial types from the region. Again, this me speculating.
Iskander
Oct 29 2020 at 3:03am
Competition can harm a nation by affecting its terms of trade. But the issue is not that Hong Kong was productive but poor due to low prices, it is that productivity was low.
England had a large fall in the terms of trade during the industrial revolution, but as productivity was growing it didn’t affect the value of output that much.
john hare
Oct 29 2020 at 4:33am
As I said, I’m speculating that opportunities opened up in the import-export arena that didn’t exist prior. With influx of profits and mindset from that fueling general growth and per capita productivity.
Alexander Turok
Oct 28 2020 at 11:56pm
Pseudoerasmus has an article about this:
https://pseudoerasmus.com/2017/10/02/ijd/
Iskander
Oct 29 2020 at 3:28am
I’ve read it before but as usual from Pseudoerasmus that’s a really interesting article.
Why didn’t we see Bengal have industrial growth like Japan if the provincial government was willing to suppress labour more than in Bombay presidency?
It’s especially surprising considering the on-going Malthusian crisis in the countryside. Just export industrial goods to import food, it’s something that Bangladesh has only recently realised it can do.
Milos Kamiński
Oct 29 2020 at 5:27am
I found this opinion:
“Rapidly rising wages, activity workers and recurrent labor shortages suggest that China, whose economic recovery depends on the supply of a large labor force with low wages, will soon enter during a period of widespread labor shortages.
When China crosses the line from an economy with an abundance of cheap labor to an economy with better paid workers, the consequences for both China and the global economy can be large-scale. For China, this transformation is likely to meanthat his model of extensive growth, which is largely is based on an increase in the number of people employed in production workers cannot be saved. As a result, the world’s second largest economy is likely to transition to an intensive growth model,
which uses resources more efficiently and reorients growth from investment to private consumption.”
E. Harding
Oct 29 2020 at 10:57am
Isn’t the simple and obvious answer transportation costs? It was straightforward to transport ideas across the Empire, much less straightforward to ship goods. The Global South could only take off with the spread of the shipping container and automobile. Also, it is true that Hong Kong and Shanghai were indirectly held back by China’s backward agricultural sector. According to the Maddison Project Database, Hong Kong saw growth slightly faster than Britain as a whole from 1870 to 1950 -pretty good for the time, given these great constraints.
Iskander
Oct 29 2020 at 12:17pm
Transport costs were low enough for inputs to be shipped from Asia to Europe, processes there, and shipped back to consumers. So I see no problem for Hong Kong there.
Chinese agricultural stagnation should have provided a cheap labour supply for Hong Kong and food could be paid for by exporting to rice abundant Burma, Thailand and Southern Vietnam.
E. Harding
Oct 29 2020 at 1:07pm
“Transport costs were low enough for inputs to be shipped from Asia to Europe, processes there, and shipped back to consumers. So I see no problem for Hong Kong there.”
Do you think Hong Kong would have had the same level of income pre-1950 had it been located with the same institutions, but in the middle of Britain, rather than on the other side of the world? Catch-up growth was simply less of a general phenomenon pre-1950 throughout the world. I can think of no notable example other than perhaps mid-nineteenth century Germany. This seems to be much more of a technological, rather than an institutional phenomenon. Even Japan did not begin to experience substantial catch-up to the leading economies until the 1930s, which is precisely when Stalinist Russia -far from a free market exemplar- experienced substantial catch-up growth to the leading economies. Hong Kong pre-1950 was about as rich as Italy, Japan, and the Philippines, which is high for Asia. Cheap labor held Hong Kong’s per capita back, as it generally means labor directed toward less productive uses.
Iskander
Oct 29 2020 at 5:27pm
I like the thought experiment you make about if HK had been on the other side of the world.
I might just be repeating myself but from a market perspective HK *was* as if it was next to the UK, because transport costs had fallen by 1900. From a cultural perspective it probably was very different to the UK.
For one thing, we can ask what were the barriers to technology adoption? Japanese and Indian firms managed to purchase a lot of machinery from England, there were no tariffs on machine imports in HK, and HK was on the coast.
I can see cheap labour leading to production methods with lower output per worker but the factor price + substitution argument is not sufficient, in my view, to explain the vast gap in output per capita.
Imagine a firm where workers were paid HK wages but had English levels of labour productivity and used English technology. Even with transport costs, capitalists could have made a killing.
Mark Z
Oct 29 2020 at 3:08pm
All of the successful east Asian countries seem to follow this trend. Per capita GDP starts taking off around the 60s. I know each has various proposed idiosyncratic explanations, but the timing is interesting.
john hare
Oct 29 2020 at 5:12pm
Still speculating. Could it be that circumstances created a critical mass of entrepreneurs one location? Silicon Valley success only makes sense with a critical mass concept. Financial centers of previous centuries might demonstrate this as well, New York and London.
Iskander
Oct 29 2020 at 5:16pm
I think there is something to this idea, as many smart/skilled immigrants fled from revolutionary China into HK.
Henri Hein
Oct 30 2020 at 1:29pm
That is part of what I was trying to get at above, with my point about population size. It’s not just entrepreneurs: scientists, engineers, artisans. They all perform best once they reach a certain group size. Market mechanisms also don’t work well in small populations.
Comments are closed.