The End of Economic History?

Author(s): Christina D. Romer

Source: The Journal of Economic Education, Vol. 25, No. 1 (Winter, 1994), pp. 49-66
Published by: Taylor & Francis, Ltd.
Stable URL: http://www.jstor.org/stable/1182896
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Content Articles in Economics

In this section, the Journal of Economic Education publishes articles concerned with substantive issues, new ideas, and research findings in economics that may influence or can be incorporated into the teaching of economics.
HIRSCHEL KASPER, Section Editor

The

End

of

Economic

History?

ChristinaD. Romer
The title that I chose for this survey of recent developmentsin economic history,"TheEnd of Economic History?",is one thatI haveregrettedmanytimes. It
is one of those choices that sounded so clever late at night when I mailed it off,
and in the harshlight of day,soundedsomewherebetween ridiculousand meanspirited.There is a logic, however,to the title. It is a not very subtle play on the
title of Francis Fukuyama's(1989) article, "The End of History?",which discusses the stateof internationalrelationsandthe prospectsfor worldpeace. Fukuyama arguesthat the cold war is over and the good guys won. The whole world
now agrees that democracyis the right form of governmentand capitalismis the
right form of economic organization;all that remainsto be done is to put these
institutionsinto place everywhere.
My view of recent developments in economic history is that the war is over
and the good guys won. More concretely, the field of economic history is no
longer a separate,and perhapsmarginal,subfieldof economics, but rather,is an
integralpart of the entire discipline. In this regard,economic history has come
full circle from where it was, say, a centuryago. Economichistory was once just
a part of economics: economists tried to understandwhat happenedin the past
and used the past to understandthe present.Then, in the 1950s, 60s, and 70s, the
"new economic history"struggledto show that economic history was just like
any other subfieldof economics. It used economic theory and econometrictechniques to answer specific and well-posed questions about slavery, economic
ChristinaD. Romer is a professor of economicsat the Universityof California,Berkeley.Thisarticle
is based on a lecturedeliveredat the AmericanEconomicAssociationAnnual Meeting in Anaheim,
Calif, on January 7, 1993. The lecture was part of the annual series on "RecentDevelopmentsin
Economics."TheauthorthanksDavid Romerand Peter Teminfor helpfulcommentsand suggestions,
and MatthewJonesfor researchassistance.

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49

growth, and a host of other historicaltopics, in the same way that a laboreconomist might use these tools to answer questions about the effect of unions or the
determinantsof wages. Although this was an importantstep towardmaking the
study of historyas rigorousand sophisticatedas the study of any othereconomic
problem,it seemed to isolate economic history somewhat.The field became the
purview of people who called themselves economic historiansand publishedin
economic historyjournals.
The most exciting recent developmentin economic history in the last decade
or so is that the rest of the profession has startedto join in the study. Perhaps
because the new economic historiansshowed thathistoricaltopics could be analyzed with the same tools other economists use, researcherswho might think of
themselves as macroeconomistsor internationaleconomists have begun to focus
on historicaltopics. At the same time, the workof economic historianshas begun
to find a wider audienceamong specialists in other subfieldsof economics. The
result is thateconomic historyhas come back to being a partof all of economics,
ratherthanjust a separatepiece.
In this article,I describesome of the accomplishmentsof this meldingof economic historywith the rest of economics. I discussjust a small piece of the excellent researchdone by economic historians,and those who would call themselves
probablyanythingbut economic historians,because in a shortarticleone cannot
hope to cover much of the fine workthathas been done in the last decade. I focus
mainly on developmentsin Americaneconomic history,which is my specialty.I
hope to show thatin recent years our understandingof a wide rangeof historical
topics has advancedimmeasurablyand that those advanceshave fed back to the
rest of economics.
THE GREAT DEPRESSION
No area illustratesmy theme betterthan researchon the GreatDepression.In
the last decade, the 1930s havebeen a topic of extensive study by both economic
historians and macroeconomists.This fruitful collaborationhas not only advanced our understandingof this puzzling and frighteningevent, but has also
served as a spawninggroundfor much recentwork in macroeconomictheory.
Two excellent books, Temin (1989) and Eichengreen(1992), have resurrected
the gold standardas an importantpartof the storyof the GreatDepression.Temin
points out a crucial asymmetryin the gold standard:a country is free to run a
more restrictivepolicy than the rest of the world because this will cause gold to
flow in; but a more expansionarypolicy than one's neighbors will cause gold
outflowsand, dependingon the initial size of a country'sgold reserves,a possible
confrontationwith gold reserve limitations.Because of this asymmetry,Temin
shows that deflationaryshocks were passed from the United States to the rest of
the world by the system of fixed exchange rates that was in place in the 1920s.
For example, when the FederalReserve decided to increase interestrates in the
United States in the late 1920s in an attemptto stem stock marketspeculation,
the rest of the world either had to go along with the restrictivepolicy or devalue
to preventmassivegold outflows.Eichengreen(1992) and Eichengreenand Sachs
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(1985) point out that as long as countrieswere determinedto remainon the gold
standard,they were largelyhelpless to unilaterallyconfrontthe worldwidedecline
in outputin the early 1930s with expansionarymonetarypolicy.
Against this institutionalframework,various authorshave analyzed the possible shocks thatpushedthe United States into decline and were then transmitted
to the rest of the world throughthe gold standard.Hamilton (1987) shows that
tight monetarypolicy was an importantsource of the onset of the recession that
startedin the United States in the late summerof 1929. He points out that the
growthrate of Ml and M2 in 1927 and 1928 was much lower thanit had been on
averagein the five years before. This slowdown in the growthrate of the money
supply was a deliberatepolicy on the partof the FederalReserve,which hoped to
curb speculationin the U.S. stock market.Hamiltonfinds that the consequence
of the tight monetarypolicy was that both nominal and real interestrates in the
United States rose in the late 1920s, and this appearsto havereducedthe kind of
spendingthatusually respondsto high interestrates.
Temin (1976) shows that, althoughmonetarypolicy may have been important
in cooling off the hot U.S. economy of the late 1920s, the tremendousacceleration
of the decline in real outputthat occurredat the end of 1929 and in 1930 almost
surelyhad nonmonetarysources.Teminarguesthis with elegant simplicityusing
the IS-LM model that is taughtin intermediatemacroeconomics.He points out
that if monetaryforces were crucial,thatis, if there was a large shift back in the
LM curve,interestratesshouldhaverisen. In fact, however,they fell quite sharply
at the end of 1929 and remainedlow until the financialpanics began in late 1930.
Macroeconomistssometimes look at Temin'sstory with a criticaleye because
it fails to draw a distinctionbetween real and nominal interest rates. For fixed
expectations of future inflation or deflation, a negative monetary shock will
clearlyraisenominalinterestrates.However,if the monetarypolicy affects expectationsof futureprice movements,this will also shift the IS curve,which depends
on the real interestrate. In the case of the GreatDepression,it might be argued
that tight monetarypolicy caused expectations of deflation, which caused real
interest rates to rise and thus shifted back the IS curve. Thus, nominal interest
rates could fall, but the shock, in some fundamentalsense, would, nevertheless,
be monetaryin origin.
This understandingof the role thatprice expectationsmight have playedin the
Great Depression has generatedseveral studies of the behaviorof expectations
and real interestrates in the 1930s. In a 1992 issue of the AmericanEconomic
Review,StephenCecchettiandJamesHamiltoneach havearticleson price expectations.Cecchettiuses a techniquepioneeredby FredericMishkinto estimatereal
interestratesat the startof the GreatDepression.Underthe assumptionof rational
expectations,if one regressesthe ex post real interestrate on lagged information
aboutvariablessuch as prices, output,and nominalinterestrates,the fittedvalues
of this regressionprovide an estimate of the ex ante real interestrate. Cecchetti
finds, in Temin'sdefense, that the monetarycontractionof the late 1920s generated expectations of only modest deflation in late 1929 and early 1930. Thus,
Temin'sconclusion that something other than tight monetarypolicy must have
been depressingthe U.S. economy in 1929 and 1930 seems to hold up.
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Hamilton,using a somewhatdifferentapproachto analyze price expectations,

arguesthattradedfuturesprices for commoditiessuch as corn, oats, and rye may
providea directway of assessing price expectationsin the early 1930s. Although
Hamilton'sevidence agrees with Cecchetti that in the first year of the GreatDepression there was not much expectation of deflation, the two studies disagree
about the course of expectationsduring 1931 and 1932, the most extremeyears
of the Great Depression. Cecchetti'sregressionestimates indicate that the huge
deflationof this periodwas expected;Hamilton'sfutures-pricesmeasureindicates
that much of this deflation was unanticipated.The reconciliationof these two
points of view is clearly an importanttopic for futureresearch.
Because both studies of price expectationsconfirmTemin'sview thatthe onset
of the Great Depression had nonmonetaryorigins, much researchhas been devoted to identifyingjust what these nonmonetaryfactors might have been. One
approachseeks to link the stock marketcrash of 1929 with the rapiddecline in
outputin late 1929 andearly 1930. In the QuarterlyJournalof Economics(1990),
I arguethatthe extremevolatilityof stock pricesin the fall of 1929 andthroughout
much of 1930 made consumersand producersvery uncertainaboutthe course of
futureincome. This uncertainty,I suggest, explains why consumersstoppedbuying irreversibledurablegoods and firmsstoppedinvestingin plantandequipment
right after the stock marketcrash. To bolster this theory,I look at contemporary
forecasts made by five forecastingservices aroundthe time of the GreatCrash.I
find more dispersion than usual across the five forecasts and the forecasters
seemed less sureof theirforecaststhanin otheryearsof the 1920s. Thus,the crash
appearsto have made professionalforecastersmore uncertainaboutthe future.I
then look at the usual relationshipbetween stock marketvolatilityand consumer
spendingon durablegoods duringthe four decadesbefore the GreatCrash.I find
that stock marketvolatilityhas a significantlynegativeeffect on consumerspending on durables.Furthermore,this estimatedeffect is large enough that the tremendous rise in stock marketvolatility in 1929 can explain all of the peculiar
drop in consumptionthatoccurredin 1930.
In this article,I can see clearlythe benefitsof the mergingof economic
history
and the rest of economics thatis my theme. Much of my thinkingaboutthe effect
of the stock marketcrash on real spendingwas influencedby a theoretical
paper
by Bernanke(1983a) on the impactof uncertaintyon irreversibleinvestmentexpenditures.In response to my article, macroeconomistshave begun to examine
whether stock marketvolatility or other measures of uncertaintyshould be included in modem forecasting equations for consumption.In this case, as I am
sure is true in a multitudeof othercases, historicalresearchwas both influenced
by modem researchand had an influenceon work aboutrecent conditions.
AlthoughI thinkthatthe stock marketcrashcan explain why the recessionthat
startedin the United States in the summerof 1929 took a very nasty turnat the
end of 1929 and during 1930, it cannot explain why the economy got
progressively worse during 1931 and 1932. The best explanationof the continuingdecline is the financialpanics emphasizedby Friedmanand Schwartz(1963). They
show thatthe four waves of bankfailuresbetween the fall of 1930 and the winter
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of 1933 caused enormousdropsin the money supply.These dropsare surelypart

of the explanationfor why real outputfell so disastrouslyin 1931 and 1932.
However,one of the most importantdevelopmentsin economic history in the
last decade is Bernanke's(1983b) argumentthatthe financialpanics also affected
the economy in ways unrelatedto the supply of money. Bernankeargues that
when banks failed in the 1930s, all of the specific knowledge that those banks
possessed aboutthe credit-worthinessof local borrowerswas lost. As a result, it
became more expensive for the remainingbanksto make loans to the small businesses thatcould only get creditthroughbanks.This rise in what Bernanketerms
the cost of creditintermediationeitherraisedthe cost of borrowingto small businesses or made it more difficult for such firms to get loans. In either case, Bernanke suggests that investmentspendingby small firms probablyfell following
the waves of bank failures. Bernankebacks up this insight about the effects of
financial panics by simple regressions of industrialproductionon the unanticipatedchangesin the money supplyand on the assets in failed banks.He findsthat
movementsin the money supply only explain abouthalf of the movementin real
outputduringthe 1920s and 1930s. Bank failures contributesubstantiallyto the
explanatorypower of the regressionand enter with a large and significantnegative coefficient.
Although Bernanke'sempiricalevidence is probablytoo limited to prove conclusively that bank failures had a large impact during the Great Depression
throughtheireffect on the cost of credit intermediation,the idea and the application to the GreatDepressionhas had a tremendousimpact on both macroeconomists and economic historians.Bernanke'scommon sense discussion of the role
of bankfailuresis quite likely an importantsourceof the voluminousrecenttheoretical literatureon the effect of credit market imperfections.It also probably
stimulateda varietyof empiricalstudiesof the specialnessof bank loans and the
role of bank lending in the transmissionof monetaryshocks to the real economy.
In this way,a piece of historicalresearchhas had a majorimpacton the research
agendafor the field of macroeconomics.
Bernankealso stimulateda great deal of furtherhistoricalresearch.Partof the
reason for so much renewed interest in whetherthe deflationof the 1930s was
anticipatedor not is relatedto Bernanke'swork. When debts are denominatedin
currentdollars,an unexpecteddeflationcauses widespreaddefaultsand weakens
the financialsystem.Thus, IrvingFisher'snotion of the importanceof debt deflation is closely relatedto Bernanke'semphasison the cost of creditintermediation.
Calomirisand Hubbard(1989) make this link explicit. Using a structuralvector
autoregression,they findthatdeflationsin the late 1800s andearly 1900s typically
caused financialdistressand led to declines in output.
A host of other new books and articles about the Great Depression have appearedin recentyears.I like to thinkthatmy 1992 article,"WhatEndedthe Great
Depression?",tells an importantstory about the recovery of the United States
from the GreatDepression.I arguethata huge gold inflow,causedpartlyby devaluation and partlyby political tensions in Europe,caused the U.S. money supply
to increase dramaticallystartingin 1933. I find that this increase in the money
supply,ratherthanfiscal policy or self-correction,explainswhy the U.S. economy
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53

recoveredas much as it did in the mid- and late-1930s. In anotherstudy of the

recoveryfrom the GreatDepression,Margo(1988) analyzesthe behaviorof labor
marketsusing microeconomicdatafrom the 1940 census. One of his most interesting findingsis thatmany workerson public worksjobs in the 1930s held these
jobs for a numberof years. Furthermore,the low wages paid by such jobs may
have been quite high relativeto the alternativesavailableto the unskilledworkers
who got them, especially when the steadinessof public employmentis takeninto
account.These findingsmay suggestthatDarby's(1976) seeminglyhereticalview
thatworkerson public worksjobs should be viewed as employedratherthanunemployedmay be at least partiallycorrectafterall.
THE EVOLUTION OF LABOR MARKETS
Anotherareain which economics has fused with the rest of economics is labor
history. Both labor economists and economic historians have made important
strides in the last decade in understandingthe evolutionof labor marketsin the
United States.As with the studyof the GreatDepression,the combinationof field
specialists and history specialists has led to work that is both theoreticallyand
statisticallyrigorousand historicallysensible and careful.
One topic thathas received a greatdeal of attentionis the rise of internallabor
markets.In his excellent book, Jacoby (1985) analyzes the change in American
labor marketsfrom the spot market,in which the foremanof the factory hired,
fired,paid, and harassedworkersat will, to the internallabormarket,where most
aspects of labor relations are governed by accepted rules and proceduresand
where hiring,firing,and pay are conductedby formalpersonneldepartments.Jacoby argues that, although internal labor markets expanded somewhat during
WorldWarI, it really was not until the GreatDepressionand WorldWarII that
therewas a substantialrise in the prevalenceof personneldepartments,which he
takes as a prime indicatorof the bureaucratization
of employment.He attributes
the rise of internallabormarketsto the laborlaws passedduringthe GreatDepression and to the governmentemploymentpracticesthat were mandatedfor firms
supplyinggoods duringWorldWarII.
Jacoby'swork has stimulateda great deal of subsequentresearch,much of it
critical of his view that internallabor marketsemerged ratherlate in the United
States. Carterand Savoca (1990), for example, analyze a variety of survey evidence on job durationin the late 19thcenturyand findthatmale workerstypically
stayedin a given job for an extendedperiod.To cite an extremecase, in a survey
of workersconductedby the CaliforniaBureauof LaborStatistics in San Francisco in 1892, nonunionmale workerstypicallystayedwith theircurrentemployer
for almost 13 years.They arguethatthis substantialjob attachmentis inconsistent
with Jacoby'sview that the U.S. labormarketwas essentially a spot marketuntil
WorldWarI.
Sundstrom(1990) also challenges Jacoby'sview that a golden age of flexible
wages existed before WorldWarI. Using an annualsurveyof manufacturingestablishmentsconductedby the Ohio StateBureauof LaborStatisticsin the 1800s
and early 1900s, Sundstromfinds that duringthe severe recessions of 1893 and
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1908 only a small minority of Ohio workers actually had their wage rates cut.
Average earnings did fall, however,because of job sharing and changes in the
occupationalcomposition of those employed. Sundstromsuggests that the fact
that firms in the late 19th centurychose to layoff workersor reassignjobs rather
thancut wage rates may indicatethat internallabormarketsemergedearlierthan
Jacobybelieves.
Both the Carterand Savocaand the Sundstromstudiesuse detailedsurveydata
from particularstates for certainyears to analyze the natureof labor marketsin
the late 19th and early 20th centuries.Although one must be very careful about
generalizingfrom such limited surveys,theiruse is an importantrecent development in economic history.The drive to find more hard,microeconomicdata on
labor marketsaroundthe turnof the centuryholds greatpromisefor finally pinning down the natureof work and pay in Americabefore WorldWarII.
Discoveringwhen employmentpracticesbecame more structuredand formalized is a topic of greatinterestto macroeconomistsprecisely because of the issue
of wage rigidity addressedby Sundstrom.Wage rigidity is a crucial component
of manyof the KeynesianandNew Keynesiantheoriesof the cause of recessions.
If the rise of internallabormarketscaused a change in wage flexibility,then this
could have led to changes in the natureand severityof business cycles over time.
Variousstudiesin recentyearshaveattemptedto test whetherwages became more
rigid at some point in the 20th century.Most recently, Allen (1992) examines
whetherthe cyclical sensitivity of wages was differentbefore WorldWarII and
after.He discovers no large change in wage flexibility between 1890 and today.
He finds that much of the conventionalwisdom thatwages used to be more flexible may be an artifactof the crude aggregatewage indexes typicallyused for the
prewarera. If Allen is right,his resultscould suggest eitherthatthe rise of internal
labor markets does not affect wage flexibility, or that internal labor markets
emerged much earlierthanJacobybelieves.
Anotherhistoricaltopic on which muchhas been accomplishedis the changing
role of women in the work force. Goldin (1990) presents a comprehensiveand
compelling portraitof changes in the labor marketexperience of women, especially marriedwomen, between the end of the 19th centuryand today.She deals
with a wide range of topics, including discriminationin women'spay and the
decline of bans againstthe employmentof marriedwomen in the 1950s. One of
Goldin'svery interestingfindings, and one useful for teachingeven introductory
students,concerns the relative importanceof supply and demandfactors in explainingthe increasein the laborforce participationrate of marriedwomen over
the last century.Using existing postwarestimates of the determinantsof labor
force participation,she calculatesthatpriorto 1940, most of the increasesin the
laborforce participationof women were due to supply factors such as increasing
educationand decreasingfertility.For the period 1940 to 1960, Goldin finds, not
surprisingly,that demandforces, such as WorldWarII and the baby boom that
increased the demand for school teachers, are the main explanationfor the increasinglaborforce participationof women. Finally,for the period 1960 to 1980,
Goldin shows that both demand forces, such as the explosion in clerical work,
and supplyforces, such as the women'sliberationmovement,contributedroughly
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55

equally to the continuingincreasein the fractionof marriedwomen enteringthe

laborforce.
Anotherof the many excellent studies in the field of labor history is the work
by Raff (1988) on HenryFord and the $5 day.When HenryFordin 1914 decided
to pay his factory workers$5 a day, his competitorsthought he was crazy, and
indeed he might have been. Raff, however,tries to see if Ford'sbehaviorcan be
explainedusing some of the modernideas of labor economics. Most important,
Raff asks if Ford paid high wages in orderto reduce turnoverand improvethe
productivityof his workers;that is, did he pay efficiency wages? This is an importanttopic becauseefficiency wage theoryhas been one of the leadingcontenders for explainingwhy firmstodayseem to pay workersmorethanthe equilibrium
wage and why wages do not fall in responseto unemployment.If HenryFordwas
indeed acting in accordancewith this theory, it would make it at least a more
plausibleexplanationfor modem experience.
Raff, however,does not find thatefficiency was the main motivationfor Ford's
unorthodoxpolicies. Turnoverwas not a large problemfor Fordbecause workers
could be trainedfor auto assembly jobs in just a few days. Monitoringworker
productivitywas also not a problembecause, on the assemblyline, it was obvious
when a workerwas not doing his job well or was not keeping up with the pace.
Raff concludes that the main reason that Ford paid his workersso much was to
preventunionizationand the related threat of sit-down strikes. Because Ford's
profits hinged crucially on the efficiency with which his specialized machines
were used, workerunrestthatpreventedthe plantfrom operatingwould have imposed a huge burdenon the firm. Therefore,high wages, which sharedthe rents
from producingFord'svery profitableModel T with workers,turnedout to be the
profit-maximizingcourse of action underthe tense laborconditionsprevalentin
the early 1900s.
THE SOURCES OF ECONOMIC GROWTH
A thirdareawhere importantdevelopmentsin economic historyhave occurred
in the last decade concerns the sources of economic growth. Perhapsmore than
in any other area, the melding of economic history with the other subfields of
economics has benefittedall of the participantsinvolvedin this researchprogram.
Economictheoristshavelearnedthe facts thatneed to be explainedandeconomic
historianshave learned the theories that can motivate new empirical tests and
explain perplexingfindings.
The theoreticaladvancethat is relevanthere is the endogenousgrowththeory
pioneered by Paul Romer (1986, 1987). Romer'sinsight, which sounds almost
ridiculously simple in its crudest form, is that there may be externalitiesfrom
capitalformation.When a society investsin capital,outputmay increaseby more
than the directresultof havingmore machines.It may rise because technological
change is more rapidwhen there are a lot of machinesaroundand workersthink
of ways to improvethem. It may also rise because there is learningby doing or
knowledgespilloversfrom one industryto another.WhatRomershows is thatthis
simple insight has enormousimplicationsfor how one thinks about the process
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of economic growth.For example, in his model, an increasein capitalformation

can explaina permanentincreasein the rateof growthof output,notjust a temporaryaccelerationin the traversebetween steady states.
Anothertheoreticaladvanceclosely relatedto that of Romer is work by Murphy, Shleifer, and Vishny (1989) on the role of income distributionin economic
growth. They show in a simple model that the presence of a large middle class
may foster industrializationand growth by generatingdemandfor the kinds of
goods amenableto mass productionand for which spilloversmay be substantial.
The idea that learning by doing could be importantand that there could be
externalitiesfrom capital formationis very appealing,and I might add, not very
surprising,to economic historians. Indeed, as a justification for his models,
Romer cites the work of Schmookler(1966) on the positive correlationbetween
patentingactivity and investment.He also could have cited the classic study by
David (1970) on learningby doing in the Americancotton textile industry.The
idea that income distributioncould also matteris derived very closely from the
work of Rosenberg(1972), who shows thatthe presenceof a large groupof yeoman farmersin the United States increasedthe demandfor goods such as basic
guns, and thus stimulateda high growth,high productivitysectorof early American industry.
In recent years, work by economic historianshas tended to confirmand flesh
out the new growth theory. One of the most importantcontributionsis a short
articleby De Long (1988) that challenges Baumol's(1986) findingthat the level
of per capitaincome of variouscountrieshas convergedovertime. De Long shows
that Baumol's results are almost entirely due to sample selection problems:by
looking only at countriesthatwere rich in 1979, Baumolbiased his resultstoward
finding convergence.De Long shows that if one looks instead at countriesthat
were rich in 1870, one finds that levels of per capita income have not converged
over time. Countriessuch as Argentinaand Spain that looked poised for success
in 1870 have not done as well as other countries,such as the United States and
Germany,thatwere also prosperousin 1870.
De Long'sresultsarerelevantto Romer'stheorybecause they mayrevealsomething about the natureof technological change. If technological progress were
exogenous in the way the Solow model seems to imply,then it shouldbe the case
that as knowledge spreadsfrom countryto country,per capitaincomes converge.
On the other hand, if technological progress is mainly endogenous, one might
expect the richto get richer;countriesthatinvestmoreget morelearningby doing
and grow even faster. Because De Long finds no evidence of convergence,his
results are at least partialcorroborationof Romer'sconjectures.
Wright's(1986) excellent book, Old South,New South, is also relevantto the
debateaboutthe process of economic growth.AlthoughWrightcoversmanytopics in this wide-rangingbook, one of the most interestingis the questionof why
the American South was slow to industrializeduringthe 19th century.Wright's
case studies of particularindustriessuggest thatthe late startto southernindustrializationwas a majorfactorinhibitingfastergrowthanddevelopment.By starting
late, the South lost out on developinga trainedindustriallaborforce. As a result,
when industrializationbegan afterthe Civil War,laborproductivitywas low and
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the incentive to set up factories was less than in the North. Wrightalso shows
thatthe lack of an indigenoustechnologicalcommunitymeantthatthe innovation
necessaryto adaptnortherntechnologies to the particularconditions and natural
resourcesof the South were missing. Both of these stories are very much in the
spirit of Romer'sanalysis that there are externalitiesfrom capital formation,or
conversely,that the absence of capital formationhas very large adverse consequences.
Althoughthe worksof De Long and Wrighthavebeen supportiveof the Romer
view of endogenousgrowth, clearly much more work is needed in this area. Indeed, if I were the social planner,I would directmuch morehistoricalresearchto
understandingthe process of economic growthand technologicalchange. I think
much could be gained by looking more at differentialsin growthacross regions
or countriesand at the spilloversfrom concentratingproductionin certainplaces
or at certaintimes.
One piece of careful and interestingresearch that does exactly this kind of
analysisis an articleby Clark(1987) who tries to understandwhy textile workers
in countriessuch as Indiaand Chinain the late 19thand early 20th centurieswere
so much less efficient than textile workersin the United Kingdomor the United
States. Clark'sconclusion is that none of the conventionalexplanationscan explain the productivitydifferential.He argues that the capital was the same, the
managerswere the same, the raw materialswere the same, the workertraining
was the same;everythingidentifiablewas too similarbetween,say,IndiaandEngland to explain a nearly six-fold difference in productivity.He, therefore,concludes thatwhat mattersis local culture;in some areas,workersworkharderthan
in others.One piece of evidence in favorof this unconventionalview is thatworkers who migratedfromless-productivecountriesto more-productivecountriesbecame as productiveas nativeworkers.
If Clarkis right, and his work has generateda heated-enoughdebatethat it is
questionable,he maypresentan importantchallengeto Romer.Maybetechnological change and growth are not the endogenous result of capital formation.Instead, perhaps local attitudes,religion, and inexplicable culturalfactors are the
real determinantsof productivityand progress.Only extensive researchof other
countriesand otherindustrieswill ever resolve this importantdebate.
THE ROLE OF FINANCIAL INSTITUTIONS
A fourthareaof researchin economic historyin which substantialprogresshas
been made in the last decade concernsthe role of financialinstitutions.This is a
topic that is obviously closely related to the sources of economic growthjust
mentioned:if capitalformationis very importantto economic development,then
financial institutionsthat affect capital formationare also very important.This
is again a topic on which economic historians,macroeconomists,and financial
economists have all contributedgreatlyto the literature.
One of the most interestingarticles in this area is a study of New England
banks in the early 1800s. Lamoreaux(1986) shows that New Englandbanks in
the early nationalperiod were very peculiar institutions.For the most part,they
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were extensionsof the kinshipgroupsthathad dominatedthe New Englandshipping industryin the colonial period. As capital requirementsincreasedwith the
rise of industry,the kinshipgroupsopened banksand solicited deposits from outsiders. However,most of the loans were then plowed back into the family business. Lamoreauxpoints out that despite their idiosyncracies,the New England
banks functioned fairly well. The banks were highly capitalized; indeed, they
were almost more like investmentpools thangenuinebanks.The high capitalization meant that deposits were very safe and this presumablyencouragedsavings
throughintermediaries.The banks also appearto have made more loans to businesses thanwas previouslythought.By going throughthe loan recordsof various
banks, Lamoreauxis able to show that what appear to be short-termloans to
individuals,were often loans to the owners of firms that were rolled over many
times.
Lamoreaux'sportraitof early New Englandbanksin some ways challengesthe
conventionalview that advancedfinancialinstitutionsare crucial for investment.
Or, at least, it challenges the conventionalview of what constitutesadvancedfinancialinstitutions.The fact thatthese seemingly peculiar,nepotistic,investment
pools mobilized the funds necessaryto fund the early industryof New England
suggests thateconomies mayfindwaysto adaptwhen ideal institutionsareabsent.
An articleby De Long (1991) makes a similarpoint in a differentcontext. De
Long, like Lamoreaux,asks whethera peculiar,imperfectfinancialinstitutionhad
a positive benefit for the firms associatedwith it. Morganand Companywas the
first large investmentbank in the United States. During the early decades of the
20th century,many reformersthoughtthat Morganand Company,which held a
virtualmonopoly on certifying stock issues and arrangingmergers,imposed an
unfairand destructivetax on firmsby charginghigh fees for its services. Others
fearedthatMorgancould swindle investorsby falsely certifyingweak firms.
De Long constructsa uniquedataset thatincludesstock prices,dividends,capital stock, and other variablesfor the firms closely associated with Morganand
Companyand for a controlgroupthathad nothingto do with the investmentsyndicate. The controlgroup is chosen to matchthe size and industrialcomposition
of the Morganfirms.De Long then examines, amongotherthings, whetherstock
prices were higher relativeto dividends for Morganfirms than for non-Morgan
firms.He finds thatJ. P. Morgan'smen did indeed add value; that is, stock prices
for firmsthat had a J. P. Morganpartneron their boardof directorswere consistently higherrelativeto measuredfundamentalsthanthose of firmswith no relation to Morgan.De Long then tries to figureoutjust whatthe Morganconnection
actuallyprovided.He concludes that the Morganrelationshipdid not just enable
firmsto gain monopolypower,but ratherprovidedvaluableguidancein the choice
of top-level management.
Ramierez(1992) providesanotherinterpretationof De Long's findings.Using
additionalinformationon liquid assets for the same sample of firms, he argues
that what the J. P. Morgan connection provided was cash flow. He finds that
Morgan-associatedfirmswere able to investwhen conditionswere right,whereas
the investmentexpendituresof non-Morganfirms were very sensitive to current
cash flow. WhetherRamierezor De Long is right about what Morganprovided,
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59

both suggest thatwhat was conventionallythoughtto be a noncompetitive,highly

questionablefinancialinstitutionactuallyprovideda very useful service to early
industrialists.In this way,they echo Lamoreaux'sview thateven financialinstitutions that are not advancedor perfect in the conventionaleconomic sense, may
foster development.
Two papersby Barskyand De Long (1990, 1992) sound a relatedtheme about
the Americanstock marketin the 20th century.Ever since Shiller's(1981) article
on the excess volatilityof stock prices, economists have been puzzled by the fact
that stock prices seem to move much more than would be justifiedby changes in
dividendsor otherfundamentals.This fact has naturallyled to conclusionsabout
the inefficiency or the imperfectionof the U.S. stock market,with all of the related implicationsfor distortionsin the cost of externalfinance.
Barskyand De Long, however,show thatmuch of the seeming excess volatility
of stock prices between 1900 and today can be explained by understandable
swings in expectations.As an empiricalmatter,Barskyand De Long arguethatif
the futuregrowthrates of dividends are highly uncertain,investorsare likely to
put more weight on recent dividendperformancethan on dividendgrowthin the
distant past. They show that for plausible specifications, such rules of thumb
could give rise to the long swings in stock prices observedin U.S. data.The authors then go on to look at qualitativeevidence of investors'expectations.They
find that professionalstock analystsseemed to interpretfundamentalsin exactly
the way predictedby theirrule-of-thumbequations.Thus,the long swings in stock
prices that seem to be unjustifiedby actualperformance,can neverthelessbe explained by long swings in expectations.The obvious implicationof this finding
is that the U.S. stock marketwas not a highly imperfectfinancialinstitution,but
rathera well-functioningmarketthatreflectedthe expectationsof the participants.
Althoughthe Lamoreaux,De Long, and Barskyand De Long articles contribute muchto ourunderstandingof particularinstitutions,the role of financialinstitutions in economic developmentis one that I think still requiresmuch more research. What these authorshave shown is that particularAmerican institutions
thatwere conventionallythoughtto havehamperedinvestmentreally were not so
bad. We still do not know how much morecapitalformationwould have occurred
if more such institutionsor betterinstitutionswere availablehere or in othercountries. We also do not know if more advancedfinancial institutionswould have
caused the patternof industrializationto be differentthan it actually was. For
example, one of the most intriguingquestions that has not yet been adequately
resolved is thatraisedby Davis (1966) on whetherthe difficultiesin raisingfunds
in the late 19th centuryin the United States was an importantsource of the increasingconcentrationof Americanbusiness.AlthoughDavis presentssome very
interestingcase studies, broad empirical analysis of this relationshiphas yet to
be done.
One articlethat stressesthe failuresof Americanfinancialmarketsratherthan
the strengthsis Calomirisand Hubbard(1992) on the UndistributedProfitsTax
of 1936-1937. Calomiris and Hubbardpoint out that the UndistributedProfits
Tax, which imposed an extra tax on firms that held extensive retainedearnings,
providesan excellent experimentfor comparingthe costs of internaland external
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financein the interwarperiodin the United States.Firmsthatwould chose to hold

on to retainedearningsandpay the substantialadditionaltax ratherthandistribute
the earningsas dividends, must feel that the cost of obtaininginvestmentfunds
throughissuing stocks or borrowingfrom banks was even higher than the tax on
retainedearnings.One would expect that the investmentdecisions of firms with
such high costs of externalfinancewould be very sensitiveto cash flow.
Calomiris and Hubbard'sfinding is that a substantialnumber of firms did
choose to pay the UndistributedProfitsTax, indicatingthateven a fair numberof
large, publicly tradedfirmsfaced a very big wedge between the costs of internal
and externalfinance.Moreover,the investmentexpendituresof these firmswith a
high wedge between internaland externalfinancingcosts were muchmore sensitive to cash flow than those of firms facing less of a differential.In additionto
showing that Americancapital formationin the prewarera in general may have
been inhibitedby imperfectionsin the financialsystem, the Calomirisand Hubbard story may provideinformationon why the recoveryfrom the GreatDepression was not faster.If liquid assets were an importantdeterminantof investment,
then a prolongeddepressionthat wiped out liquid assets would sow the seeds of
its own slow recovery.
THE STABILIZATION OF THE POSTWAR ECONOMY
A fifth areaof economic historythathas experienceda flurryof recentactivity
involves possible changes in the natureand severityof business cycles over time.
This is anotherexample that fits well my theme of the blurringof the lines between economic historyand the rest of economics. The questionof whetherbusiness cycles have gotten shorteror less severe over time is one thathas been analyzed by both macroeconomistsand economic historiansand one whose answer
is importantfor furtherstudy in both areas.
The pioneeringwork on changes in business cycles over time was conducted
by Wesley Mitchell (1927; and Burns and Mitchell 1946). Mitchell illustrates
beautifullythe view that economic history was once not seen as a separatesubfield of economics, but ratheran integralpartof all subfields.Mitchell probably
would have defined himself as a business cycle economist. Yet, his work was
explicitly historical.To define what a business cycle was, he used the patternof
cyclical behaviorshown in the second half of the 1800s and the early partof the
1900s. To constructa theory of the cause of cycles, he looked at historicalevidence on what caused previousrecessions. To predictwhat would happenin the
future,he looked at what had happenedin the past. History,theory,and statistics
all blurredtogetherin Mitchell'swork.
In more recent decades, changes in cyclical behaviorhave typically been the
purview of macroeconomists.Several studies point out that almost all indicators
of real and nominal economic activity are dramaticallymore stable after World
WarII thanin the late 1800s andearly 1900s. The authorsof these studiesexplain
the phenomenonof the stabilizationof the postwareconomy in a varietyof ways.
Tobin(1980) drawsthe obvious conclusionthatsince stabilizationpolicy and stabilization occurredat roughly the same time, Keynesianpolicy should be given
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61

at least some of the credit. Baily (1978)offers a more subtle argument:the sheer
availabilityof stabilizationpolicy caused firms to react less to shocks, and thus
policy stabilizedthe economy without havingto be used. De Long and Summers
(1986) offer the novel hypothesisthat the greaterprice flexibilityof the prewar
era was destabilizingbecause it led to extremeswingsin real interestrates. Thus,
the real stabilizationwas a consequence of the nominal stabilization.
In a series of articles(1986a, 1986b, 1989), I used the historian'shealthyskepticism for acceptedfacts and questionabledatato challenge not just the interpretations of the stabilizationof the postwareconomy,but the occurrenceof the phenomenon itself. I show that the apparentstabilizationof the Americaneconomy
after WorldWarII is to a large degree an artifactof changes in data collection
procedures.The startingpoint of this workwas the realizationthata series pulled
out of HistoricalStatisticsis often not one consistentseries measuredin the same
way over time, but, rather,different series spliced on to one another.Indeed, in
the case of most aggregatemacroeconomicseries, such as gross nationalproduct
(GNP), the unemploymentrate, and industrialproduction,major changes occurredin the data collection proceduresaroundWorldWarII. The series as we
think of them today only startedbeing collected using sophisticatedprocedures
in the 1940s. The estimatesfor the decades before 1940 were all constructedlong
afterthe fact using whateverbits andpieces of datawere found in census records,
firm archives,and special studies.
My reading of the methods used to convertsuch bits and pieces of data into
aggregateestimates led me to wonder if these changes in procedurescould account for the apparentstabilizationof the postwareconomy.For example,to estimate unemploymentbefore 1930, Lebergott(1964) firstestimatedthe laborforce
and then subtractedan estimateof employment.To estimateemploymentin certain key industries,he assumedthatemploymentmovedone-for-onewith output.
However,for the postwarperiod, we know that the laborproductivityis strongly
procyclical:ratherthan moving one-for-one with output,employmentfalls less
than output in recessions and rises less than output in booms. If the same were
true in the prewarera, Lebergott'smeasures,which do not take this into account,
would show employmentfalling more than was probablytrue in recessions and
rising more thanwas probablytruein booms. This wouldmakeprewarunemployment, which is measuredas a residual,excessively volatile. The methodsused to
constructtwo other series, real GNP and industrialproduction,also led me to
wonderif they might be excessively volatile in the prewarera as well.
To see if such changes in datacollection and constructiontechniquesreally are
large enough to accountfor the apparentstabilizationof the postwareconomy,I
conductthe following exercise. I startby admittingdefeat;thereis simply no way
to go back and conduct the same kind of surveysthat are used todayto measure
unemploymentor GNP.WhatI can do is throwawaythe modem dataandmeasure
modem unemploymentor other series using the same bits and pieces of dataand
the same assumptionsthatwere used to constructthe historicalseries. The result
of this exercise is the creationof series that are consistentover time; consistently
bad, but consistentnonetheless.
These consistent series for the unemploymentrate, real GNP, and industrial
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productionshow much less change in the severity of cycles over time. Indeed,
recessions in the periodbefore WorldWarI or before 1929 look remarkablysimilar to recessions after 1947. The GreatDepression,however,most definitelydoes
not disappear.In some ways it stands out even more than in the conventional
macroeconomicindicators.Ratherthanjust being the worst of many bad prewar
recessions, it looks like the anomalouscollapse of an economy thatis very similar
in the 40 yearsbefore and after.
The fact that the prewarextensions of three majormacroeconomicindicators
were all constructedin a way that accentuatedtheir volatilityis not as surprising
as it may seem. At the time thatall of these series werebeing created,the accepted
techniquewas to take whateverbits of informationwere availableandassumethat
the aggregatethatone was tryingto measuremovedone-for-onewith the pieces of
availabledata.Because a certainamountof cancellingout of fluctuationstypically
occurs when manyseries are addedtogether,interpolatingby a limitednumberof
series will tend to accentuatevolatility.More important,the bits of information
availablefor the prewarera often tendedto be particularlyvolatile ones. In which
states is unemploymentmost likely to be measured?Those that have an unemploymentproblem.What commoditiesare likely to be measured?Those that are
easy to count such as pig iron and raw cotton. Such industrialmaterialsare also
goods that tend to be quite volatile because of inventoryfluctuations.Because
these limitationsin techniqueand the type of data availableare likely to apply to
most macroeconomicindicators,it is not surprisingthat the series I examine all
show similar inconsistenciesover time. Nor would it be surprisingif series that
have not yet been tested also have similar problems;indeed, it would be more
surprisingif they did not.
Those who are familiarwith this literaturewill know that my resultshave not
gone unchallenged.Balke and Gordon (1989), for example, create a new GNP
series for the pre-1929 era thatis just as volatile as the Kuznetsseries (published
and analyzed in Kendrick1963) it replaces.Weir (1986) suggests that my technique of carryingthe old methodsforwardin time may overstatethe similarityof
the size of prewarand postwarrecessionsbecause of structuralchanges.It is possible thatthe assumptionsused to createthe old series were correctfor theirtime
period, but are not correctfor today.
However, my work has also been confirmedby other studies. For example,
Shapiro(1988) examines changes in the volatility of stock prices over time and
argues that a relationshipshould exist between the real economy and the stock
market.Because he findsthatstock prices havenot become more stableover time,
he concludes thatmy findingson the absence of stabilizationof the real economy
are plausible. Sheffrin(1988) looks at the data for manyEuropeancountriesthat
startedto keep official output statistics long before the United States. He finds
that no countryexcept Sweden has become noticeably more stable between the
pre-WorldWarI and the post-WorldWarII eras. If one believes that the experience of majorindustrialcountriesshould have been similarover time, then Sheffrin'sresultsalso lend credenceto my findings.
Howeverthe debate aboutthe stabilizationof the postwareconomy is eventually resolved (and I naturallyhope that I am eventuallyjudged to have been at
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63

least partlyright),I thinkmanypositiveresultshavealreadyemerged.Most obviously, researchershave become much more cautious abouttheirdata. Macroeconomists seem much less likely to include prewarseries in theirregressionswithout firstchecking how the series were constructed.Even more encouragingis the
fact that many new data-collectionprojectsseem to be underway. Susan Carter,
Roger Ransom, and RichardSutch, for example, are attemptingto create new
estimates of unemploymentusing the survey data availablefor various states in
the late 1800s and early 1900s. JeffreyMironhas been overseeinga projectat the
NationalBureauof Economic Researchto make availablethe manydisaggregate
series that underlie the work of Simon Kuznets, Solomon Fabricant,and other
creatorsof early macroeconomicindicators.Such projectshold greatpromisefor
increasingour factual knowledge about the prewarmacroeconomy.Finally, the
debate about stabilizationmay have stimulatedeconomists to questionjust what
factors are likely to have affected the cycle over time. Once the facts come into
doubt,theoriesaboutwhat shouldhavehappened,and aboutthe role of such factors as monetarypolicy, supply shocks, and credit marketimperfectionsseem to
have multiplied.
Perhapsmore thanany particularfindingor directimplication,the fact thatthe
debateaboutstabilizationand the new datacollection effortsarebeing carriedout
by a mixtureof economic historiansand macroeconomistsis the most desirable
developmentof all. As with all of the other recent developmentsin economic
history that have been discussed here, the bringingtogetherof researcherswith
differentperspectiveshas not only stimulatedexcitingresearch,it has also meant
that the lessons of history have been incorporatedinto other fields. In this way,
the end of economic history has really been just the beginning of better and
richereconomics.

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CALLFOR PAPERS

New Research in EconomicEducation

he NationalCouncilon EconomicEducationand the NationalAssocia-

tion of Economic Educators will conduct two sessions on new researchin

economic education at the undergraduateand precollege levels during the January 1995 meetings of the American Economic Association. Individuals interested in serving as presenters should prepare an abstract for the paper for review by the screening committee. Send abstracts as soon as possible, but no
later than June 15, 1994, to Robert Highsmith, Vice President for Program
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