Subject Business Economics

Paper No and Title 6, Industrial Economics

Module No and Title 2,Industrial Revolution and Structural Shifts in GDP

Module Tag BSE_P6_M2

BUSINESS PAPER NO.: 6,INDUSTRIAL ECONOMICS

ECONOMICS MODULE NO.: 2, INDUSTRIAL REVOLUTION AND STRUCTURAL
SHIFTS IN GDP
 TABLE OF CONTENTS
1. Learning Outcomes
2. Introduction
3. Industrial Revolution
3.1 Historical Back ground
3.2 Industrial Revolution – Economic perspective
3.2.1 Technological Inventions
3.2.2 Organizing production
3.2.3 High wage cheap energy
3.3 Industrial Revolution – Consequences
4. Structural shift in GDP
4.1 Industrialization and Structural Change
4.2 Structural Shifts in Developing Countries – Consequences
andImplications
5. Summary

BUSINESS PAPER NO.: 6,INDUSTRIAL ECONOMICS

ECONOMICS MODULE NO.: 2, INDUSTRIAL REVOLUTION AND STRUCTURAL
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 1. Learning Outcomes
After studying this module, you shall be able to -

 Know the historical background and the causes that led to ‘Industrial Revolution’
 Understand the economic perspective of the ‘Industrial Revolution’
 Have an idea of the essential conditions necessary for such revolution and its
consequences on the society and economy.
 Understand the role of industrialization in the structural shift of GDP
 Analyzethe consequences of structural shift in GDP in developing and developed world.

2. Introduction
Middle of the 18th century saw the beginning of the fundamental change from a typically agrarian
society to an industrialized one in England. The period there after was characterized by
technological inventions which revolutionized the society and the economy in several ways. This
period of change was known as ‘Industrial Revolution’. The process of change spread to the other
parts of the world as well. Over the last half century similar shift or industrialization has been
observed in many developing countries contributing significantly to the economic development of
the country. This module aims at developing a clear understanding of the conditions that led to
industrial revolution and its consequences. Further it explores the importance of industries in the
structural shift in GDP of an economy.

3. Industrial Revolution

3.1 Historical Back ground

The period – 1760 to 1850 was marked with fundamental changes in England. The country
witnessed a gradual, though not abrupt, transformation in agriculture, textile and metal
manufacture, transportation, economic policies and the social structure. The era saw the change of
a typical agrarian and handicraft based economy to an economy which was predominantly based
on industries and machine manufactured products. This process of change has been termed as the
‘industrial revolution’. The term ‘industrial revolution’ was first used to describe England’s
economic development from 1760 to 1840 by English economic historian Arnold Toynbee. The
process of change or the ‘revolution’ that began in England in the 18th century soon spread across
Europe and North America. Though the year 1760, represents the beginning of the industrial
revolution, it is often considered that it actually started way back in 16th century with major
scientific discoveries and ideas, benefits of which was being materialized in post 1760 period.

The main features of the industrial revolution were the technological, socio-economic, and
cultural changes. The technological changes were the key to the entire revolution. This included
use of new metals like iron and steel and most importantly the use of coal based steam engines,
internal combustion engines and electricity. Invention of spinning jenny and power looms

BUSINESS PAPER NO.: 6,INDUSTRIAL ECONOMICS

ECONOMICS MODULE NO.: 2, INDUSTRIAL REVOLUTION AND STRUCTURAL
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 resulted in increased production with minimal expenditure of human energy. Concept of factory
system having distinct division of labour and specialized role of the workers came into being.
Development of means of transportation and communication enabled trade and expansion of the
market for the finished products. Technological advancement tremendously increased the
efficient use of natural resources and allowed for mass production of the goods. During this
period industry grew 4 times faster. The Industrial Revolution brought about changes that
completely revolutionized families and lifestyles. Factory system attracted workers to an extent
that they moved out of their rural family economy to urban areas. This led to rapid urbanization
inEngland and cities grew at a tremendous rate. By 1900, Great Britain alone had more cities with
population of 100, 000 or more than the entire Europe had in 1800.

3.2 Industrial Revolution – Economic perspective

Several views have been put forward in the past explaining the ‘industrial revolution’. Most of
these were restricted to identifying the causes. Apart from technologies there were other factors
that favoured industrial revolution in England. This included religious freedom, confidence of no
invasion and trade potential due to long coastlines of this island nation, unification of the states
into single economic unit and presence of huge coal reserves. However there has been, to a great
extent, agreement on the role of political system, property rights and flexibility of legal system as
the cause that led to the industrial revolution. These views attribute the changes which took place
in the late eighteenth century to the Glorious Revolution of 1688 that reinstated the supremacy of
the parliamentary system, minimal government, and secure property rights. Presumably these
changes in the legal system created conducive environment for investment which led to the
‘industrial revolution’. But evidences do not support these views as no structural changes could
be detected after 1668 in any of the financial data like interest rates while property rights were as
secure as in other European countries. Table 1 shows the per capita level of industrialization from
1750 – 1913 of different countries. Great Britain clearly outnumbers rest of the countries
throughout the period.

Table 1 Per capita levels of industrialization: 1750-1913

1750 1800 1830 1860 1880 1900 1913

Great Britain 10 16 25 65 87 100 115
Belgium 9 10 14 28 43 56 88
United States 4 9 14 21 38 69 126
France 9 9 12 20 28 39 59
Germany 8 8 9 15 25 52 85
Austria-Hungary 7 7 8 11 15 23 32
Italy 8 8 8 10 12 17 26
Russia 6 6 7 8 10 15 20
China 8 6 6 4 4 3 3
India 7 6 6 3 2 1 2
Note: All entries are based on the index value of 100, equal to per capita industrialization in Great Britain
in 1900. Data for Great Britain includes Ireland with England, Wales and Scotland, collectively known as
United Kingdom (UK).
Source: Bairoch, P (1982) “International Industrialization Levels from 1750-1980” Journal of European
Economic History. 11: 294.

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ECONOMICS MODULE NO.: 2, INDUSTRIAL REVOLUTION AND STRUCTURAL
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 3.2.1 Technological Inventions

Industrial revolution was mainly a technological revolution brought about by the major inventions
during that period. The underlying reasons that could explain the industrial revolution requires
focusing on the sources of these inventions. These inventions turned out to be the major factor
that differentiates Britain from other countries. The focus therefore shifts on the economic
incentives for the inventors, which acted as a driving force for inventions leading to the
industrial revolution. It becomes evident that the industrial revolution in Britain was the outcome
of Britain’s success in the international economy which offered Britain’s inventors with unique
and highly remunerative possibilities as opposed the common belief that it happened due to luck
or genius minds, British culture and scientific advancement. However, role of greater literacy and
numeracy cannot be ruled out which downplayed the major technological achievements through
innovation in the eighteenth century. The technological achievement of the industrial revolution was
consequences of the economic development that preceded the industrial revolution which
produced the high wage, cheap energy economy.

Allen (2006) argues that the main motive of invention of technology was to make money. The
major implications of this concept were –
(i) Technological inventions were considered as investment which would yield returns in future,
high enough to offset the current cost.
(ii) The inventions were done mainly to come up with new product or reduce the making cost of
existing product. Expensive labour and cheap energy led to the invention of machines that
substituted energy and capital for labour.
(iii) Market size is very crucial for the profits to offset the cost of inventions for example scale of
mining industry was much greater than any other country, so returns on inventions in mining
machinery were highest.
(iv) Inventions were also encouraged by patents which gave the inventors right to all the gains
from the inventions. Better property rights for the knowledge were the main reason that led
to the inventions of the industrial revolution (North and Thomas 1973). Though, English
patent law was enacted in 1624, it failed to draw much interest during seventeenth century
having minimal role in inventions compared to the other incentives to invent
(v)In the absence of patent, incentives for private invention were small compared to group or
collective inventions which enabled them to divide the cost and pool

3.2.2 Organizing production

During the Industrial Revolutionfamilies produced most of the food, clothing, and other articles
they used in the rural areas. In cities, manufacturing was strictly regulated by the guilds and the
government. Goods thus manufactured were of high quality but limited and costly. Merchants
needed cheaper items, as well as in large quantities for their trade to grow.This led to the major
shift in the organization of production, from the cottage industry to factory. Merchants started
controlling the manufacturing process from start to finish. For example cloth merchant would buy
raw wool from the sheep owners, have it spun into yarn by farmers' wives, and take it to country
weavers to be made into textiles. The country weavers manufactured the cloth at a much lower
cost. Similar methods of organizing and controlling the process of manufacture also started in
other industries, such as the nail, cutlery, and leather goods. These small household workshops
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 were termed as the cottage industry. The advantage of such system was that the merchants had a
large supply of manufactured goods at fairly low prices. It provided job opportunities to all the
members of a crafts workers family and gave jobs to the skilled worker who otherwise did not
have capital to start their own set ups. A few merchants who had enough capital had brought
workers together under one roof and supplied them with the machineries like spinning wheels
and looms and started manufacturing in large scale. These establishments were known as
factories

3.2.3 High wage cheap energy

Inventions being economic activity were favored by business profitability including the low input
prices. Britain had a unique wage rate and energy price one of the key factors leading to the
industrial revolution. Comparisons of the wage rate and energy price of the major economies
reveal that Britain was high wage and cheap energy economy. Britain was high wage economy in
terms of exchange rate, high silver wages resulting in high living standards, high wages relative
to capital prices and exceptionally high wage compared to energy prices. Figure 1 compares the
nominal wage of building labourers in major cities of the world. Databases of wages and prices
assembled from price histories1 written since the middle of the nineteenth century have been used
to construct these figures for comparison (Allen 2006). The different units of wages were
converted in terms of grams of silver as silver coins were principal medium of exchange.

Figure 1 Labour wages in major cities of the world

Source: Allen (2006)

As indicated in Figure 1, starting from the late seventeenth century, London wages were the
highest recorded. By the end of the eighteenth century all parts of England had exceptionally high
silver wages (Allen 2001, 2003). In comparison, labourers in the Asian cities earned just 1 or 2
grams of silver per day. The high wage rate in England resulted in high living standard as well.
This has been confirmed using the welfare ratio, calculated by dividing the annual earning by the
cost of basket of consumer goods sufficient to keep a family at minimal subsistence. Figure 2
show the welfare ratio in the major cities of the world. In the period before the start of industrial
revolution welfare ratios of these cities were almost trendless and the workers earned 3 – 5 times
the subsistence cost. However in the mid eighteenth century welfare ratio of most of the cities
touched the level of about 1 except London which showed an upward trend, reaching almost 6
times than required for bare bone subsistence, indicating high living standards. This increased the

1
For details of the data generation process for figure 1- 4 see ‘know more’ section.
BUSINESS PAPER NO.: 6,INDUSTRIAL ECONOMICS
ECONOMICS MODULE NO.: 2, INDUSTRIAL REVOLUTION AND STRUCTURAL
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 demand for food and non-food consumer goods as a result mass market for consumers was much
larger in Britain compared to the other cities in Europe and Asia.

Figure 2 Subsistence Ratio for Labourer in major cities of the world

Source: Allen (2006)

Evidence of the high wage economy is also established in terms of the wage rate relative to the
price of the capital. Comparison of the building labour daily wage relative to the index of the
rental price of the capital in the three European cities is presented in Figure 3. The average of
price indices for iron, nonferrous metals, wood, and brick multiplied by an interest rate plus a
depreciation rate gives the rental price of capital.

Figure 3 Wage Relative to Price of the Capital in three cities of Europe

Source: Allen (2006)

The series for the wage rate relative to price of the capital diverged from1650 onwards in England
indicting inflation of the nominal British wages. This created incentives for the industries to
mechanize leading to the industrial revolution. Consistent rise in the cost of the labour provided
increasingly greater incentive to invent technologies to substitute capital for labour in production.
The final evidence for high wage rate and cheap energy is provided by the comparison of wage to
price of energy. In Figure 4 each bar represents the ratio of labour wage rate and price of energy
in the early eighteenth century. Newcastle turns out to be city with the highest ratio. This is

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 mainly due to high labour costs and very low cost of coal. This extensively high cost of labour in
England created greater incentives to replace labour with capital which required inventive
measures leading to industrial revolution.

Figure 4 Price of Labour Relative to Energy in early 1700’s,

Source: Allen (2006)

Industrial revolution originated in England and spread to United States and rest of Europe. The
essential conditions required for such revolution remained almost same and included -
 Availability of natural resource like coal, minerals like iron-ore etc.
 A surplus of money to invest
 A political and institutional framework facilitating innovation.
 Availability and sufficient size of domestic and foreign market.
 Access and control of raw materials
 Sufficiently large pool of skilled manpower and cheap labor
 Infrastructure like transportation system – road, railways and shipping.

3.3 Industrial Revolution – Consequences

Industrial revolution had several benefits and negative consequences. It has been debated since
19th century whether the Industrial Revolution was a blessing or a curse. Industrialization resulted
in severe problems and hardship for the people in its early phase. However with time it had
number of positive effects outweighing the negative consequences. It created jobs for workers
and also made a significant contribution to the wealth of the nation. The period was characterized
by immense progress and inventions. It greatly increased the mass production of goods in
response to the increased demand, which led to opening of new factories. This created more job
opportunities. Rise in wages left the workers with surplus to spend on activities other than paying
rent or buying food like buying a newspaper or visiting a music hall. Cheaper transportation,
railways in particular, brought distant relative closer as travelling became affordable. It raised the
overall standard of living which included healthier diets, better housing, and cheaper, mass-
produced clothing. Prosperity of the middle and upper classes came as an immediate effect of
industrial revolution. While the reforms for the labourers eventually came only after they joined
together to form labor unions which fought and won the rights to higher wages, shorter working
hours, and better working conditions. The negative consequences included migration of job
seekers to cities which resulted in growth in size of the urban areas along with the suburbs as

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 people started fleeing over-crowded cities. The overcrowded cities lacked sanitary codes or
building controls and other basic amenities like housing, water, and social services etc.

4. Structural Shift in GDP

4.1 Industrialization and Structural Change

Industrialization began in the 18th century in the United Kingdom with steady development in
manufacturing. This was followed by Belgium, France, Switzerland and the United States in the
19th century, while the developing world was still moving on with their traditional primary
production (Maddison 2007). This process of industrialization continued for decades.
Manufacturing jobs in the factories increased from 22% to more than 35% between 1841 and
1960 in UK and in US it increased from 16% to 36% of the total employment during the same
period. Beginning of the 20th century saw the distinct division of world economy into industrial
rich economies and agricultural poor economies. Industrialization had become synonymous with
wealth, economic development, technological leadership, political power and international

dominance (Szirmaiet al. 2013). Post World War II more countries began to take up
industrialization, enabled by technology transfer policies of “developmental states”. Those that
failed to keep up the pace of development of manufacturing sector had to suffer greater welfare
losses (Bertola and Ocampo 2013).

Manufacturing industry served as catalyst in transformation of the economic structure of agrarian

economies. The concept of structural change has direct relation with the relative importance of
sectors in the economy or to changes in the location of economic activity (Syrquin 2010).
Structural change has been typically defined ‘as the ability of an economy to constantly generate
new dynamic activities characterized by higher productivity and increasing returns to scale
(Ocampo 2005; Ocampo and Vos 2008; UNDESA 2006a; UNIDO 2013). The structural change
has emerged as the key component on which the development of an economy depends. It plays a
deterministic role in determining the rate and pattern of growth. Failure to achieve structural
change has been found to be the common cause for countries to remain poor. They have, in fact
failed to shift from the agriculture and the production of traditional goods to manufacturing and
services (Syrquin 2010, Lin 2012).

In the developing countries, contribution of agriculture and manufacturing was 40% and 12%
respectively in 1950. After more than a half century, share of agriculture fell to just 16% and the
share of manufacturing peaked at around 17% in the early 1980’ followed by a decline thereafter.
While services exhibited a consistent growth of more than 10 percentage point. In 1950 the
developed countries were already industrialized with manufacturing contributing 30% of the GDP
while agriculture accounted for a minor share of 16%. However by 2005, these developed
economies showed greater preference for the service industries and neglected the manufacturing
sector. In these economies manufacturing declined to an extent to be almost at par with the share
of manufacturing in developing countries.

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 The major structural shift in the GDP has been observed in case of developing economies. In the
period between the middle of the last century and 2005, contribution of agriculture in the
country’s GDP decreased from 40% to 3-13% while share of manufacturing increased from 14%
to 25% in China, Indonesia, the Republic of Korea, Malaysia and Thailand. This indicated the
huge shift from agriculture to manufacturing. Among the developing countries, the structural shift
was not similar for all as some opted for a different kind of shift. In the Latin America, largest
economy like - Argentina, Brazil and Mexico took to a major shift from agriculture to services
and to lesser extent to non-manufacturing industries. Share of agriculture declined but
manufacturing remained mostly unchanged. A similar trend can be observed in case of India as
well. Figure 5 shows the share of agriculture, industries and services in GDP for the year 1951-
2011. Structural changes become evident as there has been a major decline in the share of
agriculture which decreased from 52% to 18% during 1951-2011. Share of industries remained
almost unchanged with slight increase from 11% to 18% during the same period, while share of
services increases from 34% to 63%. Thus it can be concluded that in India there has been a
major shift in the structure of the GDP from agriculture to services.

Figure 5 Percentage share of Agriculture, Industries and Services in GDP of India: 1951-2011
Source: Based on the data from CSO.

4.2 Structural Shift in Developing Countries – Consequences and Implications

Developing countries have been the centre of the structural changes. These changes mainly
started in 1950’s and the effects became profound in the first decade of the present century. This
section presents the case of structural shifts in two different developing countries - Republic of
Korea and Ghana. Both, Republic of Korea and Ghana almost had similar share of agriculture and
manufacturing in the GDP in 1960. The GDP per capita was same for the two economies in 1960.
However 45 years later in 2005 there has been a radical change in the structure. Figure 6 shows
the share of agriculture, industries (manufacturing and non-manufacturing) and services in the
GDP for the two countries.

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 Figure 6 Percentage share of Agriculture, Industries and Services in Ghana and The Republic of Korea:
1960-2005
Source: UNIDO (2013)

Though the two economies started almost at the same level, the Republic of Korea brought about
drastic changes in its structure by reducing agriculture’s share and increasing share of
manufacturing, but in Ghana agriculture remained the largest sector. This had direct impact on the
economic performance of the two countries. In 2005, GDP per capita of Ghana was just one tenth
of that of the Republic of Korea giving a strong indication that the countries with structural shift
performed much better with stronger GDP per capita growth than the one that did not opt for the
structural shift.

The structural change when viewed at different incomes instead of different moments in time
provides a better picture of structural change as it takes into account the important differences in
structure that arise from different incomes and two country-specific characteristics (natural
resources and population) which otherwise gets masked due to averaging. This facilitates better
understanding of the structural change as it avoids comparison of the economy based on any prior
definition of development (such as advanced versus developing). Structural change can then be
seen as the set of transformations that takes place as countries become richer irrespective of the
time and speed with which it occurred.

When the country has low income, share of agriculture is higher than the industries, typically
larger than manufacturing and non-manufacturing industries together. As the income grows
situation is reversed and manufacturing starts gaining ground and reaches a peak of about 20
percent of GDP. Thus the economic development takes place with the increase in share of
manufacturing in the economy largely at the expense of agriculture, whose share shrinks
dramatically. Share of manufacturing starts declining after reaching the peak exhibiting an
inverted U shape. At very high incomes it is comparable to earlier stages of development. Share
of services keeps growing as incomes rises, only the agriculture declines. At very low incomes,
non-manufacturing industries show a sharp increase which maintains a stable share even after
peaking. However such trends are not seen in case of higher incomes or for high-income
countries.

BUSINESS PAPER NO.: 6,INDUSTRIAL ECONOMICS

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 Natural resource endowments and population size are the two characteristics specific to the
countries known to have an important impact on the pattern of structural change. Studies have
found that both these characteristics have significant impact on the structural transformation as
the country becomes richer. However in case of natural resource–rich countries, the
manufacturing is less important at any level of income than in the aggregate picture. Its share
starts declining at a much lower income, while non-manufacturing industries are much more
important reaching its maximum only at very high income. In the presence of rich natural
resource base, economy’s incentives is mostly biased towards nonmanufacturing industries (or
agriculture), leading to a “natural resource curse” or “Dutch disease” (Palma 2005). Where as in
the large economies manufacturing accounts for a much higher share of GDP at all incomes and
the turning point is reached only at a very high income when manufacturing accounts for almost
25 percent of GDP. Services have lower share at all incomes. Manufacturing in large economies
are of great importance due to presence of large domestic markets enabling them to exploit
economies of scale even at low levels of development.

5. Summary
 1760 to 1850 was the era in England which witnessed the change of a typical agrarian
and handicraft based economy to an industries and machine manufactured products based
economy – this change has been termed as ‘Industrial Revolution’
 The technological changes were the key to the entire revolution.
 During this period industry grew 4 times faster and job opportunities led to rapid
urbanization.
 Industrial revolution was mainly a technological revolution realized through inventions
 Economic incentives for the inventors acted as a driving force for inventions leading to
the industrial revolution.
 Inventions were favoured by higher wage rate, subsistence ratio, wage rate relative to
price of capital and price of labour relative to energy.
 Number of positive effects emerging from industrial revolution outweighed the negative
consequences
 Manufacturing industry was instrumental in transformation of the economic structure of
agrarian economies.
 The shift in the structure of the economy is intrinsically linked to economic development
 Countries with structural shift (mainly from agriculture to industry) performed much
better with stronger GDP per capita growth than the one that did not opt for the structural
shift.

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ECONOMICS MODULE NO.: 2, INDUSTRIAL REVOLUTION AND STRUCTURAL
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