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The Great Default and the Great Divergence

Economics / US Economy Oct 05, 2011 - 01:40 PM GMT

By: Gary_North


Diamond Rated - Best Financial Markets Analysis ArticleThe #1 Historical Question Is Unanswered
I do not refer here to a historical question raised by a book said to be revealed by God. I refer to a question that historians have struggled with for a century without any agreed-upon solution. It is this:

What happened between 1780 and 1820 that produced compound per capita economic growth in Britain and the United States of approximately 2% per year?

If you think this is a matter of no concern to you, consider this question:

Will my grandchildren live in a more prosperous, more productive world in 50 years?

For almost two centuries, Americans have assumed that the answer to this question is "yes."

From the beginning of recorded history until about 1820, the answer was "probably not." This answer applied to those grandchildren who were born to parents who survived diseases, famines, and childhood accidents. Most did not.

This changed after 1820. Why?

For a good summary of the most recent findings on the extent of this growth, click here.

World population was a billion in 1800. Today, it is 6.7 billion. Yet most people in the urban world have far more wealth than anyone had in 1800.

South Korea was not much richer than sub-Sahara Africa in 1950. Today, it is very rich. North Korea is not.

China is experiencing the fastest economic growth in history for a large nation. Yet it did not begin to grow until Deng Xiaoping freed up agriculture from socialist controls in 1978.


There have been lots of reasons offered by economic historians for this transformation, but these have all been called into question by economic historian Dierdre McCloskey, who began working on this issue as Donald McCloskey three decades ago. In a proposed six-volume set, The Bourgeois Era, McCloskey is exploring this question in detail. Two volumes are available. They have presented the problem. In volume 2, Bourgeois Dignity. McCloskey refutes the prevailing explanations one by one.

Then what did it? McCloskey's theory, not yet proven: a change in attitude toward the legitimacy of wealth. This began in the 17th century in the Netherlands. (McCloskey speaks Dutch.) This spread to Scotland and England.

I am partial to the thesis. I have believed it for at least 25 years. But there is a problem. What motivated people to change their views after – basically – the history of mankind? These were Calvinist societies in the 17th century. What changed in Calvinist theology in the century after Calvin? The 17th-century creeds did not change the theology. The Synod of Dort (1619) and the Westminster Assembly (1643-47) did not alter the old Calvinism. So, what was the crucial factor?

I have a suggestion: their concept of the nature of God's kingdom on earth. The shift was to what is today called postmillennialism: the belief that the final judgment only comes after Christ's kingdom has filled the earth. This transformation involves compound blessings (Deut. 28:1-15) including economics. This was not held by Lutherans and 16th-century Calvinists.

In both the Netherlands and Scotland, there were postmillennial theologians. But McCloskey's research challenge will be to see if the supposed shift in attitude toward business wealth was associated with this shift in eschatology. If there was no connection, then what was the source?

Adam Smith's Wealth of Nations (1776) favored economic wealth. He was a Scot. He was a liberal Presbyterian. But McCloskey thinks the change in attitude preceded Smith by 150 years.

Proof is scheduled for Volume 3. I await it with great anticipation.

McCloskey became co-editor of the American academic journal, The Journal of Economic History, in the spring of 1982. Beginning 15 years earlier, the editor had been my professor, Hugh Aitken. I recall the evening in a graduate seminar, probably in 1966, when Aitken had posed the #1 question. How did the transformation happen? He said the scholars did not know.

As far as I can see, they still do not know.


Harvard historian Niall Ferguson has called the great transformation of the West the great divergence. Asian nations had about the same wealth per capita as Western nations in 1800. By 1900, the two societies diverged greatly. This continued until 1970, he argues.

In a TED video, Ferguson attributes this to six factors:

  1. Competition (both political and economic)
  2. The scientific revolution
  3. Property rights (not democracy)
  4. Modern medicine
  5. The consumer society
  6. The West's work ethic

I don't believe any of this. That is because I have read McCloskey's two volumes (twice). McCloskey refutes them all, plus a dozen more.

The late medieval world had political competition. It was highly decentralized. It also had competing markets. It had carefully defined property rights.

The scientific revolution had almost no effect on the West until 1900. The changes came before 1900 from technology, which was not governed by the scientific method. The first major use of the scientific method in economic production was in the German chemical industry in the late 19th century. The growth of technology before this was the product of independent tinkerers and inventors who had creative ideas and who (somehow) got access to the minimal suppliers of capital available for investing. The secret of success here was retained earnings, not great infusions of capital, as McCloskey shows.

Modern medicine had no impact on Western populations until the late 19th century. Until then, the big two factors were (1) separation of latrines from water wells, known for millennia; (2) the wire mesh screen, which came after 1860. The smallpox vaccination had been brought to England from Turkey and Persia in the early 1700s. It had been used there since the late 1600s.

There is no evidence that I am aware of that the Protestant West worked longer hours that rice-paddy families in China.

As for the consumer society, what changed in the West in 1800? There had been production for markets for 400 years.

In other words, Ferguson doesn't know, yet he is a superior historian. He has looked at this issue for a long time. He is still wandering in the dark. So are his peers.

We do not know how the West first achieved compound economic growth two centuries ago. We know that there were preconditions for this growth. Property rights were one factor. Reliable courts were another. So was widespread literacy. Then there was preaching against envy – a factor that sociologist Helmut Schoeck pointed out 45 years ago. There was optimism regarding the future. But the two questions remain:

Why did it take place in the West?
Why didn't it take place centuries earlier?
I think it had more to do with the steam engine than anything else. But that was not sufficient to explain the transformation. Some previously ignored combination of factors is missing from our analysis.


We search for cause and effect in history, as in every other field. We do not know what was the cause of the incomparable effect that became visible after 1820.

The East has surely picked up Western techniques over the last half century. Japan adopted Western technology after the Meiji Restoration in 1868. Hong Kong followed suit after 1945, Korea after 1950. China's reform in 1978 launched the so-called miracle. India was still a low- growth nation until after the free market reforms of 1991. Then, almost overnight, the nation began to grow rapidly.

The speed with which Asian nations have been able to adopt Western capitalism has been unprecedented. The result has been rapid economic growth. There have been holdouts. Malaysia has discriminated against the Chinese natives, with predictable results: slow growth. But Singapore is growing rapidly.

The markets are now international. The consumer society is becoming universal. The means of accessing this market is price competition. Innovation seeks to create demand in mass markets.

The entry into the middle class of 100 million Chinese and 50 million Indians has opened up the possibility of more rapid economic growth worldwide. The crucial economic resource is human creativity. The free market offers opportunities for innovators. The entrepreneur serves anyone who can afford to buy the output of his creativity. This offers tremendous benefits to anyone, anywhere who can afford to buy this output. The fact that someone lives in India or China has no relevance for the value of his invention for others living outside his nation's borders.

The free market rewards creativity that makes life better for customers. By opening up Asian markets, the importation of capitalist institutions has opened up a two-way flow of creativity. Specialization of production will increase. Production costs will decrease. This is the lesson of capitalism for two centuries.


Will the pace of change continue? Yes. This we have learned: this process has been sustained for two centuries, despite war, inflation, and depression. It has been maintained in the face of a vast expansion of centralized political power after 1914. That centralization is now reversing. The financial panic that surely lies ahead will decimate government budgets.

A great international default is coming. It will come in the West. The welfare promises of national governments will be reneged on by a new generation of politicians. The present deficits cannot be sustained for a decade or more.

Martin van Creveld, Israel's military historian, a dozen years ago wrote a book, The Rise and Decline of the State. He meant the nation-state. In the final chapter, he made a forecast.

People or organizations who used to rest peacefully in the bosom of the state will have to do, indeed are already doing, more to defend themselves, for example, by purchasing all kinds of specialized equipment; fortifying the premises in which they live and operate; mounting their own guards, whether in or out of uniform; and possibly even setting up their own armed forces under suitable commanders. . . (p. 419).

In other words, as the state begins to disintegrate, localism will replace nationalism. "Compared to what we have witnessed in 1914-45, most of the violence in question will almost certainly be local, sporadic, and on a rather small scale." He thinks Bosnia and Sri Lanka are heralds of the future.

For groups as diverse as government employees and the recipients of social security (particularly those who hope to receive benefits in the future), the writing is on the wall. Either they start looking elsewhere for their economic status and, in some cases, even their physical protection; or else there is probably no future for them. As was also the case during previous periods when empires fell apart and feudal structures emerged, often looking elsewhere will mean losing their freedom by becoming the clients of the strong and the rich, whether in the form of individuals or, which is perhaps more likely for the majority, of corporations of various sorts (p. 419).

Your grandchildren will do just fine.

You, on the other hand, will have major problems.


We are coming to another turning point. This one will be comparable to the one the West experienced around 1800. Economic growth began to compound. So did population – in Asia, where there was no industrial revolution, as well as in the West. The world of today does not resemble the world of 1800.

Now we are nearing the great default. The nation-state will find itself on the defensive in the West. The state seeks to regulate everything, but the digital revolution has put tools of innovation and change into the hands of hundreds of millions of people. Soon, this will be billions.

There will be short-term setbacks in compound economic growth, just as were in the 1930s and World War II. But the West's exponential growth curve returned and extended into Asia. This is the free market's way. Good ideas are copied. Price competition extends the new products into new audiences.

There will be times of trouble for those who are dependent on the welfare state. There will be huge losses sustained by those investors who have assumed that government promises will be met. Wealth will move from oldsters who trusted the welfare state to younger voters who have their elected representatives pull the plug.

Medicare is a Ponzi scheme. So is Social Security. Both will default. But that will be liberation for the market, which serves productive workers, not the beneficiaries of unfunded political promises.

Our grandchildren will live in a world in which they have more choices than we do, just as we have more choices than our parents did. The question is: How many choices will you have during the transition?

Gary North [send him mail ] is the author of Mises on Money . Visit . He is also the author of a free 20-volume series, An Economic Commentary on the Bible .

© 2011 Copyright Gary North / - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

© 2005-2019 - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Ernie Messerschmidt
06 Oct 11, 12:31
get real

"the market, which serves productive workers, not the beneficiaries of unfunded political promises."

No, the market serves non-workers above all: parasitic predatory capitalists who have captured government. The main beneficiaries of political promises are the big corps and banks that live off of government welfare and bailouts. The promises to them are fulfilled because their political bribes keep politicians in office. Social Security has already been paid for by workers' taxes. Who stole that money?

"Our grandchildren will live in a world in which they have more choices than we do, just as we have more choices than our parents did." What world are you living in, North? Young people nowadays have no jobs to pay for their huge college debts to banks. Very few choices indeed. Such is the legacy of the radical neoliberal agenda that you push. It just doesn't work. See Ha Joon Chang's Bad Samaritans for an account of how it hasn't worked around the world, including an account of how the amazing Korean economic miracle was NOT due to the free market at all, but to state planning, public banking, careful protection of industries rather than suicidal "free trade", etc. Ditto China. Get real. Why not cite the stupendous growth of the USSR in it's heyday? You are biased indeed.

20 Jun 12, 20:28
The Great Default - United States

I don't care about the past, cause the present is where we are. The American Deficit produced by the Federal Government to now, 15 trillion dollars is unrepayable by any means! That is the 600 pound gorilla in Washington! Everyone there is busy ignoring it! Money comes in from taxes, money goes out on programs. Not enough coming in so what does Washington do, ask others for money withthe PROMISE OF repayment plus interest. Come on, wake up! The Great Default is going to happen. Unless some miracle produces the hard currency needed to pay the ever climbing interest on the debt and the balance due. One day, those lenders will say, NO MORE! Then the chickens will come to roost. Economic DISASTER is the result of the in denial Washington politicians.

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