Economics of the American Revolution

Economics of the American Revolution

Was Revolutionary War motivated by economics?

• Not much popular sentiment for independence– Best estimate is 1/3 population pro Brisith, 1/3 for

independence and 1/3 indifferent.– Colonial elite were in favor of independence,

probably not common man.

• All evidence suggest colonial economy grew both in overall size and per capita.

Popular View

• Revolutionary War was a response to policies of the British government towards its empire, specifically tax– Taxes were high– Taxation without representation

• Is this view true?

British Empire, Colonists point of view

• Both costs and benefits of membership in the British Empire

• Consider the Navigation Acts– Passed in 1630s– All trade must be carried in ships built in Britain or colonies.

Crew had to ¾ British or Colonial• Benefitted New England ship building industry

– All foreign trade came through Britain• Increased price of imported goods in colonies• Reduced price of exported goods

– Enumeration- certain goods could only be exported to England• Originally tobacco, sugar, cotton, indigo but was expanded latter.• Reduced price that colonial producers received

– Subsidized production of some goods

Benefits of membership in Empire

• Military protection – Reduction of piracy. Cost to British was about

400,000 pounds (British National income was about 130 million pounds in 1770.)

• Protected markets for some goods like colonial shipping

• Subsidies for some goods like indigo

Costs of membership in British Empire

• Taxes • The level of taxation in Britain was high

relative to the rest of the world and its colonies.

• Great Britain 100

Ireland 26

MA, PA, Maryland 4

NY 3

CN, VA 2

Other costs

• Enumeration increased the cost of some imports and reduced the price received for some exports

• prohibition of manufacturing• How burdensome were these?

Counterfactual Analysis

• What would have happened to the American economy in the absence of the Navigation Acts?

• Thomas (1965) • Enumeration like an excise tax

Enumeration Costs

• Thomas estimates of costs and benefits. Overall he finds the burden less than 1 % of GDP. Highest estimate is about 3% of GDP.

• However, burden is not shared equally.– Price in VA for tobacco would have been 33%

higher without enumeration.

Events that change expectations• French and Indian War in 1763 • Expensive for British (Colonial taxes do not cover the costs)

– Increase in taxes – sugar act 1764, stamp act, 1765, Townshend duties 1767, tea act,

1773• Colonist boycott and protest and taxes were reduced or repealed.• On the same day it repealed the Stamp Act, Parliament passed the

Declaratory Act stating the British government had the full power and authority to make laws governing the colonies in all cases whatsoever including taxation.

– Policies not principles had been overturned.– Concern after Townshend duties that taxes would be collected, but it

is repealed in 1770– Tea Act tips the scale over to war

Events that change expectations

• Land policy after French and Indian War– British acquire territory between the Allegheny

Mountains and the Mississippi River – The Proclamation of 1763 and the Quebec Act of

1774 forbid colonists to settle there or trade with the Indians without the permission of the British government.

• maintain British control of the fur trade in the West • Reduce conflict with native Americans and reduce

British defense expenditures

Causes of Revolution

• Restrictions on settlement• Concern for future taxes• Colonial elites especially in the southern

colonies are harder hit by trade restrictions• War breaks out in 1775. Ends in 1782

Economic Impact of Revolutionary War

• Disruption of Trade• British emphasize war at sea. Try to Blockade

ports.– Does not effect small farmers producing for

themselves or local market. Some benefit as price increases from demand from both sides.

– Not as large an effect on South as might expect they are able to evade British blockade.

•

• Americans are able to counter even though Continental Congress has limited ability to tax.

• Naval war is fought through privateers.– They get to keep a percentage of what they

capture. (incentives matter)• Quite effective- British lost 18 billion pounds

in shipping.•

Financing of Revolutionary War

• Continental Congress does not have a lot of power. Limited ability to tax.

• Price controls. Set maximum price farmers could charge Continental army. – Largely responsible for Washington’s disastrous

winter at Valley Forge. – Quickly realize that this does not work.– Why doesn’t it work?

Supply and demand analysis

D

P

Q

The demand curve shows how much consumers want to buy at a given price.

If the price is $3, then consumers want to buy 5 units.

Demand curve is downward sloping

$3

5

Supply and demand analysis

SP

Q

The supply curve shows how much producers want to produce at a given price.

If the price is $3, then producers want to sell 15 units.

Supply curve is upward sloping

$3

15

Supply and Demand Analysis

P

Q

S

D

$5

10

The equilibrium price is $5. At that price the Qd is equal to the Qs, 10. There is not pressure on the price to change. What happens if the price is higher than $5.

Supply and Demand Analysis

P

Q

S

D

10 155

$5

$7If the price is $7, quantity firms want to produce is 15, but consumers only will purchase 5. Inventories will build up and firms will reduce price to sell goods.

Supply and Demand Analysis

P

Q

S

D

$5

10 15 5

If price is set at $3, quantity demanded is 15, but the quantity produced is only 5. There is a shortage. Continental Congress passes a price control law that sets the price of food and supplies at a level below equilibrium price. Farmers and merchants will not sell to Continental army at that price.

Financing of Revolutionary War on land

• Printed Money– Lots of Money. About ¼ of billion dollars.– States also printed money– Initially planed to redeemed with specie, but

could not without power to tax– Value of continental $ driven to 0 by end of war.

Economic Costs

• War ends in 1782. Goldin estimates that per capita income growth declined .34% annually between 1774-1793.

• Some winners-– tobacco price increases

• Some losers– New England shipping industry– Indigo farmers in South– No British protection for shipping– US manufactured goods cannot compete with British

Institutional Change in Early National Period

• Question is how strong should the federal government be compare to state government?

• Articles of Confederation replace Continental Congress in 1781.

• Fed gov does not have power to tax. It depends on revenue sharing with states.

• In 1785 billed the states 3 million $ by 1787 received less than 4%

• To impose tariff needed approval of all 13 states• Could not police frontier or resolve international trade

issues

Why does the state exist?What determines the policies of the state?

• Economist answer is the state exists to provide public goods– MC of one more person using the good is zero– Cost of excluding users is high– Government can tax and force all to pay– Many are necessary for the market to function

• National defense, property rights etc– What determines what kind of goods are provided?

Clearly some states provide public goods that encourage economic growth and some do not.

American case

• Federal government’s inability to collect taxes makes it unable to provide public goods

• Leads to Constitutional Convention of 1787– Delegates were appointed by state governments

who were elected by voters– General consensus in America that rivalry would

take place through democratic process

Issues at Constitutional Convention

• Agreement that national government needed the power to tax in order to pay government debt, provide for national defense, judiciary and to in some way regulate interstate and international commerce

Issues at Constitutional Convention

• Two systems proposed:– Federal system with a stronger national gov but

preserving states rights – National system with strong federal government

and limited state rights

Strong Government Supporters

• Creditors (bond holders) wanted gov to control inflation, pay debt– Needed Fed gov to control note issue

• Merchants wanted Fed gov with control of interstate commerce

• Western land speculators wanted Fed gov to be able to defend frontiers and expand them

•

Weak Government supporters

• Debtors - inflation is in their interest, avoid taxes– Landowners may also want to avoid tax

• Slave Owners- afraid fed gov dominated by Northerners would end slavery

• National system adopted but does not resolve all the tension between states rights and rights of federal government

What was the effect of constitution on economic growth? What does it tell us about

strong vs weak gov? • Growth increased during early national period

but there are other factors responsible as well as change in government

• Tax and payment of debts are key to gov ability to provide public goods which are necessary to economic growth

Constitution allows government to:

• provide for common defense• regulate foreign and interstate commerce

– fed gov can impose tariffs and quotas not states

• postal service • weights and measure• dispose of western land• control money supply- states cannot issue notes•

Most important part of the Constitution is in section 10

• Clause prohibits states from enacting any law impairing the obligation of contract

• Sets the stage for modern contract law under which individual parties who agree to a contract are essential law makers– Available to anyone, not just a select few. – Allows for institutional change when change will

increase efficiency

Economic interests of individuals vs the economy as a whole?

• 3 branches of gov, executive, legislative and judicial– Placed constraints on behavior of both elected

and appointed officials• Checks and balances written into the

constitution make it more difficult for groups to set up a system of property rights that promote their interests over the economy as whole

• Growth did occur during colonial period but Britain was provided national defense

• Some government is necessary to growth