Fruit of the Boom: The Impact of the Industrial Revolution on Economic Growth

Introduction

An economist, an inventor, and an entrepreneur walk into a town… While that sounds like the intro to a somewhat familiar joke, it is the beginning of one of the most important stories in history, which can teach valuable lessons about some basic economic concepts: the impact of economic growth, marginal product of labor, and productivity on workers and employers. Our tale begins in the United Kingdom about three centuries ago….

Economic Growth Throughout History

Historians and economists, including B. Ravikumar of the St. Louis Fed, will point out that for most of human history there has been no economic growth. One of the best and easiest ways to measure this is through per capita gross domestic product (GDP): Per capita means per person, and GDP means the total market value of all final goods and services produced in an economy in a given year.

Figure 1 below shows real GDP per capita growth in the U.K. from 1000 to 1995. For close to 800 years there was no significant improvement in real GDP per capita, leading researchers to conclude that the standard of living for most citizens was stagnant for eight centuries. Starting in the eighteenth century, per capita GDP dramatically increased—doubling by 1900 and increasing another 10 times by the end of the millennium.

Figure 1: Index of Real GDP per Capita in the U.K., 1000-1995

SOURCE: Maddison Project Database, 2020 and authors’ calculations.

Researchers commonly believe that technological advancement was responsible for this period’s sudden shift in economic growth. However, numerous technological advances, such as the plow and the printing press, had existed long before 1700 and likely did not contribute to this period of growth. So what changed?

The Economist: Thomas Malthus and Modern Economic Growth

Born in England, Thomas Malthus was a leading writer and thinker who developed a theory to describe his homeland’s economy and how it changed during his lifetime. Malthus believed that before 1700 the British economy was stagnant, even with some technological advances, because of two elements—the type of production most workers did in England and the size of the national population.

Most workers in the U.K. before the eighteenth century were connected to agriculture; it was an agrarian economy. Technological advances were supposed to improve farmers’ production overall, leading to economic growth and all the benefits that come with that—increased wages, better standard of living, and ultimately a larger population—but Malthus realized that wasn’t the case. The problem wasn’t a lack of technology or people’s willingness to work hard—it was the type of work they did that kept England economically stagnant.

Malthus used the theory of marginal productivity, or the measure of how much one additional worker produces when they are added to the workforce. Think about one worker on one acre of land who produces one unit of agricultural output. If another worker were added to that same acre of land, the productivity would be less because each one has only one-half acre of land to produce goods. Table 1 below breaks down these figures.

In an agrarian economy, the marginal productivity of each new worker declines. It would not be logical, then, for a landowner to increase pay for additional employees, as they would produce less; and, laborers would not want to work if they were offered lower wages than the most-established workers. Malthus concluded that this economic growth trap was where the U.K. had been for most of the previous millennium. Something big would have to change this trajectory.

The Inventor: John Kay and the Flying Shuttle

As Malthus studied his country’s economy during the early 1700s, a fellow Englishman was working on a solution to a perplexing problem. John Kay wanted to reduce the time it took to weave, which until then was a handmade process of lacing sets of thread together to make fabric. In 1733 Kay applied for a patent from the government for his invention. He called it the flying shuttle, and it would be the U.K.’s first step to break out of the Malthus “productivity trap.”

Kay’s tool was transformative. It allowed workers to produce far more textiles than they could make by hand, with just a minimal amount of training. And, instead of most workers’ only option for employment being toiling in the fields to produce agricultural products, a potential new type of work was available, thanks to Kay’s weaving machine.

Examine Figure 2 below showing the allocation of workers in the U.K.’s eighteenth century economy. In the pre-Renaissance era, the number of workers was low and land was plentiful, leading to high marginal productivity (and decent wages) with each additional farm laborer. That rapidly decreased as new workers were added, indicated by the downward sloping curve.

Figure 2: Marginal Productivity for Agricultural Workers in the U.K., 1700s

SOURCE: Authors’ calculations.

John Kay’s flying shuttle invention created opportunities for workers to produce something tied not to the amount of land, but to what they could produce using machines. The potential for a productivity revolution was in place.

The Entrepreneur: Richard Arkwright and the Industrial Revolution

No one individual is responsible for the Industrial Revolution, but Richard Arkwright’s contributions have earned him the title “father of the modern industrial factory system” in many history books. Similarly to John Kay, Arkwright wanted to harness the power of water to create simple machines that reduced the time it took laborers to produce textiles. After receiving a patent from the government for his water frame, Arkwright opened a small mill in Cromford, England, in 1771. The factory, and its impact on labor, was born.

The consequences were almost immediately seen in the British economy. Arkwright had created an industrial firm. As his water frame machines were rather small, many could be placed in a relatively confined space, and, with hydropower accelerating the process, workers could be more efficient and could all produce the same amount. Marginal productivity per worker became constant, as there was a machine available for every new worker. Table 2 below shows a theorical example of marginal productivity per worker in Arkwright’s mill.

With industrialization, a new opportunity arose for English workers. Refer to Figure 3 below. Recall that the downward sloping line shows diminishing agricultural productivity as more workers attempt to produce using the same amount of land. However, the horizontal line shows that, with industrialization, the productivity of workers in a factory is constant. Simply put, the U.K.’s eighteenth century workforce would organically divide into two segments— (1) an appropriate amount of agriculture workers producing a certain amount of products and (2) a group that migrates to work in the new factories producing more products, leading to overall sustained economic growth.

Figure 3: Marginal Productivity for Agricultural and Industrial Workers in the U.K., 1700s

SOURCE: Author’s calculations.

Workers had an incentive to switch to factory jobs: If every additional worker is as productive as the previous one hired, a factory owner can, and should, pay every machinist the exact same wage, as their productivity will be equal; there is no diminishing land constraints as in an agriculturally based economy. Examine Figure 4 below showing the average weekly earnings per person in the U.K. for 1710-1810. Prior to Kay’s and Arkwright’s inventions in the mid-1700s, weekly pay hovered around £0.20 for about 150 years. By 1800, just 40 years after these new capital equipment inventions became popular, the income of the average worker more than doubled, and it would double again in the nineteenth century.