How the Industrial Revolution created modern debt
This is an excerpt from Paper Promises: Debt, Money and the New World Order, published this week by PublicAffairs.
Consumers have always borrowed money from friends, neighbors and relatives. Merchants would not exist without credit; the habit of making debts on a “slate” in the local butcher or greengrocer was still common in the middle of the twentieth century. But the local merchant would normally offer credit only to a known, local customer; serial defaulters, or those deemed to be untrustworthy, would be refused business. In David Copperfield, Mr. Micawber’s failure to repay merchants required him to cadge off his friends.
But the modern idea of widespread consumer credit (in the form of national lenders, credit cards, etc.) really dates to the Industrial Age. A peasant’s income is unlikely to grow over the long term; at best, it will be highly variable, with bumper harvests in good years giving the peasant sufficient income to pay off debt incurred in bad years. But two or three bad harvests in a row could be ruinous.
This point illustrates a wider truth. The granting of a loan requires both the creditor and the debtor to be confident that the latter’s income will grow sufficiently to repay the debt. Think of a retailer that sells a washing machine, or television, in installments. Clearly the customer does not have the money now; otherwise he or she would pay upfront. Moreover, the overall bill, including interest, will be greater than the cash price. So the debtor must be confident that he will stay in employment to pay the larger sum. In addition, he or she will probably be confident that their future income will rise so as to offset the additional interest. A growing economy makes that calculation all the more likely. The Industrial Revolution changed the pattern of human civilization. It allowed economic growth to expand at a much faster rate than ever seen before. This was probably down to the use of carbon-based fuels (wood, coal and, eventually, oil) to power technologies to replace human and animal labor. This resulted in a substantial increase in productivity.
Think of an economy as a business with inputs and outputs. An agrarian economy is often dubbed a subsistence economy; it takes all the energy of the workers (and their livestock) to produce the food necessary to live. A bull may plow a field, and reduce the effort of the farmer, but it takes a lot of land to feed the bull. The economy (business) does not produce a profit. Carbon-fuelled machines transform the situation. Initially, man naturally exploited those fuels that were easiest to reach; chopping down trees, getting coal nearest the surface and so on. So the output, in terms of goods and energy produced, was much greater than the effort put in.
The movement of people from the land to the new industrial cities also required an agrarian revolution. Those remaining on the land had now to produce a surplus, enough to feed the industrial workers as well as themselves. Fortunately, this happened, thanks to the consolidation of smallholdings, new farm machinery, crop rotation and a host of other small reforms. In turn, these improvements allowed the population to grow.
So we now had economic growth and population growth. The next stage emerged as workers gathered in factories. Initially, the conditions were terrible – long hours, low pay (albeit better than a farm laborer’s income) and non-existent safety standards. In the crowded towns, sanitation was poor, disease spread quickly and life expectancy was severely restricted. But factories made a big difference in that they grouped workers together and made it easier for them to organize in their own interest. That was very difficult for geographically dispersed agricultural workers. Steadily over the nineteenth century, trade unions grew in membership and workers flexed their muscles through strikes. Governments started to recognize their power and buy them off. Bismarck, a hard-headed pragmatist, introduced old-age pensions in Germany as a way of recruiting worker support for the Hohenzollern monarchy.
As with all systemic problems, when local banks got big enough to go national and then international greed and profit became more important than helping “store” local successes and make more by lending a portion to others.
Morals and intergrity were used to compare banks not profit, hence decay in the banking industry. Which gave rise to investment schemes with effective lobbying of government ruling bodies.