Industrial Finance, 1830-1914

The Finance and Organization of English Manufacturing Industry

P.L. Cottrell

• Publisher: Taylor & Francis
• Year: 2013
• eBook ISBN: 9781136597428
• Edition: 1
• Topic: Business
• Subtopic: Business generale
• Index: Business

The nineteenth century was a time of rapid change in forms of organization of economic activity. A central feature of such change was, inevitably, the development of new types of finance adapted to the radically new environment.

An appreciation of the history of these developments makes a substantial contribution to the understanding of the growth and development of the British economy in one of its most dramatic phases.

Philip Cottrell has written an impressively documented full-scale survey of this crucial period, discussing finance in the context of sweeping reforms of company law, unprecedented technological change and economic expansion, and the institutional effects of all of these. He is primarily concerned with English manufacturing industry but frequently refers, by way of comparison, to extractive industry, Scottish and Welsh developments and the economies of other West European countries. As well as providing a comprehensive overview, the book pays particular attention to coal, iron and textiles amongst the industries and, at the level of organization, to the emergence of the joint stock limited liability company and its gradual adoption by industrialists. The relationship between commercial banks and manufacturing receives detailed consideration and the role of internally accumulated funds and trade credit is discussed. this classic book was first published in 1980.

1 Financing the industrial revolution
I – institutional change

In the examination of the process of economic growth, the role of capital has received what can only be called a ‘mixed press’. During the 1950s, largely as a result of the impact and development of Keynesian theory, primacy was given to investment as the key variable. This interpretation led to changes in the ratio of investment to income accepted as the indicator of industrialization. Analyses with this premise stimulated a search for empirical evidence with which to test the hypotheses on which they were based. Initially it seemed that too much emphasis had indeed been given to the relationship between the growth of investment, its consequent increased absorption of income, and structural change. It appeared that instead of the investment ratio rising from about 5% to 12–15% within the space of 30 to 50 years, the accumulation of capital assets during industrialization was far slower and less dramatic. Deane and Cole’s work on British economic growth indicated that the needs of investment took up about 5% of national income in the decades before the 1780s, increased to only 7% by the 1800s, and only reached the level of 9–10% with the railway construction booms of the 1830s and 1840s. Although research by Hoffmann and others on the German economy found an appreciable rise in the ratio of net capital formation to national income from about 8.5% in the 1850s to 13.5% in the early 1870s, this was partly due to the abnormal amplitude of the upswing of the trade cycle in the latter decade. In the 1880s the ratio was still below 14%. Testing of what may be termed the Rostow–Lewis thesis of the explanation of industrialization appeared to find it wanting. The role of capital was also apparently diminished by findings from sources of growth analyses in which the growth of output was accounted for by the growth of factor inputs. Results, which initially met with some surprise, showed that generally at least a third of the growth of real output was attributable to a residual, not being explained by increases in the volume of land, labour, and capital employed.

The pendulum of interpretation may now be swinging back somewhat in favour of capital. Further estimates of capital formation have been laboriously assembled and those recently published by Feinstein for Britain are not in accordance with the Deane and Cole interpretation which had received growing acceptance during the 1960s. Feinstein’s data, which will be discussed later, point to the investment ratio rising sharply during the eighteenth century from about 8% in the 1760s to 14% in the 1790s, almost doubling in a Rostow–Lewis manner. However, thereafter, with the exception of a dip during the Napoleonic Wars, investment’s absorption of income in proportionate terms did not change and was not lifted to a new higher level by the coming of the railway. Recent estimates constructed by Lévy-Leboyer show a somewhat similar picture with the share of French national product invested increasing from about 7% in the 1810s to 12% by the 1850s and then remaining at this level for the next four or five decades. However although the Rostow–Lewis view may now be finding new foundations, the stress placed on the investment ratio has to be viewed in terms of a wider perspective. One reason for the appreciable rise in the ratio during the onset of industrialization is that at this stage in an economy’s modernization, capital goods are relatively expensive compared with consumption goods. Initially there is no machine-producing industry and once producer goods have evolved beyond the point of being cheap, crude and self built, there may occur a period, albeit brief, when they are relatively costly. Subsequently the growing demand for capital goods will lead to the emergence of specialist builders. In addition to the play of specific factors, it may be important to turn to the movement of the consumption ratio. A rapid doubling or tripling of the investment ratio, partly caused by supply inelasticies, appears dramatic, an event consistent with a revolutionary interpretation of industrialization. Even though it may occur, it is accommodated by a small decline in the share of consumption, of the order of not much more than 10% during a period when income is continuously rising in the medium term relatively to population growth. Perhaps what is more important is not the comparison of the investment ratio at the beginning and end of the stage of the onset of industrialization but rather changes in its very long term behaviour. The investment ratio in a pre-modern society is generally thought to be very low, of the order of 3% of income, although in England’s case at least it could rise to about 6% for limited periods, as after the plague and the Great Fire of London. These short term movements may have of course been due to dishoarding, hoards having been accumulated precisely for such ‘rainy day’ periods, or to a reduction in conspicuous consumption. However during industrialization the investment ratio rises secularly, probably as a result of a changed view of what the future holds, and then remains stubbornly at a new higher level. The magnitude of the shift in the ratio is substantial but it has to be considered with the movement of other variables. Europe’s industrialization took place against a background of rapid population growth and in Britain’s case at least capital per head was only barely maintained, according to Feinstein’s data, between 1760 and 1830, but over this period output per head almost doubled. Investment was required simply to maintain the existing capital: population ratio but changes in the nature and quality of the factors of production lead to increases in productivity which increased income and accommodated the need for investment. This raises questions not simply about the growth of the volume of the input of capital and its consequent absorption of income but rather about the nature, quality, and character of the new capital employed during industrialization.

Unfortunately sources-of-growth calculations provide little assistance in this area. Capital is assumed to be homogeneous, a premise which may be of some validity in the short term, but crumbles over longer periods, especially when they span marked discontinuities in an economy’s development. Feinstein’s data indicate that capital inputs were responsible for about 25% of the 2% per annum increase in British real output during the century after 1760, whereas the ‘residual’ accounted for about 35%. Such quantitative pointers to the sources of growth during industrialization should not cause alarm, despondency, or even surprise. At the outset before considering the implications, it should be realized that there are major problems in measuring the growth of the real capital stock. In particular the necessary price indices required for deflation are rare and unreliable and consequently any resultant series, and this is not to deny their worth, will not adequately reflect improvements in the quality of capital. These ‘measurement’ problems alone will produce a downward bias with regard to the role of capital. However a positive residual does not simply arise because of the pardonable failure of the input series to take into account changes in the quality of the factor employed. It is also a product of productivity growth, mainly arising from increasing returns to scale, the redistribution of factors of production, and technological change. All these factors can be assumed to have played a major role in growth during a period of structural transformation of an economy brought about by industrialization. Scale effects will arise as both production units develop and an economy becomes more fully integrated. The greater spread of market forces will lead to the migration of labour and capital to areas within the economy where they can obtain the highest return. This shift from low to high productivity employments will produce a rise in output not accounted for by increased inputs. Lastly there is technological change, moulded by the relative costs of factors of production, but usually embodied in capital and so the residual partly measures another side of the contribution of capital to growth.

As the capital stock grows during industrialization, its composition changes. Generally in the early stages of growth the biggest demands for capital arise from urbanization and the development of transport systems. The demand of manufacturing industry is normally small and a high proportion of its share of investment consists of inventories. The need for stocks declines with the integration of the economy brought about by improved transport but at the same time the volume of producer’s equipment substantially increases. Consequently with the tailing off of construction expenditure, industry’s share rises. It would seem that in Britain’s case fixed industrial and commercial capital rose from 5% to 25% of domestic reproducible capital between 1760 and 1860. Business investment in Germany increased from a seventh to nearly half of total net investment between the early 1850s and the opening years of the twentieth century. These changes in the type of investment undertaken will produce mirror reflections in the mobilization of savings–in the demands placed upon the markets for credit and capital–which in turn will shape the pattern of institutional development that takes place to accommodate them.

A consideration of the methods used by manufacturers to raise capital and credit during the industrial revolution is important, not only in itself but also because the techniques adopted tended to mould financial behaviour throughout the nineteenth century. The greater development of financial practices was a consequence of the amount of resources absorbed by the growing industrial sector and especially of the type of assets involved. Attempts have been made to construct series displaying the growth of investment for both specific industries and the economy. All are exploratory exercises,¹ difficult forays to mount, into an era bereft of any reliable and continuous quantitative source material, and consequently their foundations, especially at the level of the economy, are very fragile. It is therefore not surprising that there is little agreement between them, though it is unfortunate for present purposes that the largest differences arise in the areas of industry and trade. The most recent estimates by Feinstein² are in conflict with earlier constructed series, their author considers them to be the product of conjecture, but they are the most comprehensive. They indicate that gross domestic fixed capital formation in the case of industrial and commercial fixed assets rose from £0.77m. per annum at current prices in the 1760s to £5m. per annum by the 1810s and reached the level of £13.29m. by the 1840s. Consequently the share of fixed investment absorbed by the industrial and commercial sector increased from about 20% in the decades around the 1770s to over a third by the middle decades of the nineteenth century. Fixed industrial investment appears to have grown at about 3% per annum in real terms for the first century of industrialization, and this secular increase from the 1790s was due primarily to investment in machinery rather than in buildings to house it. The key characteristic of this investment, which distinguished it from previous outlays, was its growingly specific nature. Chapman has found that fixed capital assets held by textile manufacturers in the middle decades of the eighteenth century had general rather than specific uses, this being an insurance against the vagaries of trade and the erratic course of economic change.³ Such hedging also took place through involvement in other activities such as farming, malting and the ownership of inns.

Although there is considerable disagreement over the amount of demand for financial resources generated by the transformation of English manufacturing industry, it is generally accepted that savings within the economy were not inadequate to support industrialization.⁴ This is not to imply that individual entrepreneurs in the eighteenth and nineteenth centuries did not face considerable difficulties in raising funds for either commencing or expanding production. However, generally the problem was the personal one of obtaining finance, rather than resources being either totally unobtainable or insufficient for envisaged needs. There were geographical and institutional barriers which impaired the mobilization of savings but during the eighteenth century financial markets began to emerge which brought savers and borrowers into contact. This chapter will review these general developments. The next will look at the growth of a number of major industries as it is evident that each industry and each industrial district had specific financing methods.⁵

*

The first step towards the creation of a formal capital market was the development of long-term borrowing by the state in order to finance war expenditure, a process begun by the Tontine of 1693. This market became fully developed during the first half of the eighteenth century and by the 1750s the London bourgeoisie, institutions and trustees were placing substantial sums in government securities.⁶ The acquisition of government securities throughout the eighteenth century seems to have been predominantly a metropolitan habit. In the provinces the mortgage market was more important. Here the key figure was the attorney and although most of the transactions he arranged were for financing consumption or real-estate development, there are some recorded cases of savings being directed into the coal and glass industries.⁷ Yorkshire land law was actually modified in the 1710s specifically in order that tradesmen in the cloth trade could provide acceptable security for loans to provide working capital for their businesses.⁸ While nearly all of these changes, especially those in the metropolis, were remote from the needs of the industrialist, they do mark the beginnings of regional capital markets which in turn allowed the establishment of other financial institutions.

Similarly another important step forward was the absorption of the ‘law merchant’ into the formal legal system at the beginning of the eighteenth century. The Payment of Bills Act, 1698 and the Promissory Notes Act, 1704 put foreign and inland bills on the same statutory footing. During the next decade the foundations of modern commercial law regarding bills of exchange were laid. The doctrine of negotiability was recognized and the rights and liabilities of the parties to a bill were established legally in considerable detail. The finishing touches were added by Chief Justice Mansfield during the middle decades of the eighteenth century through establishing practice where it was still uncertain with the aid of special juries of merchants. This was a major advance over the situation in the 1690s when Sir Josiah Child commented: ‘it is well if, after great expenses of time and money, we can make our own Counsel understand one-half of our case, we being amongst them as in a foreign country.’⁹ These legal developments placed England in a unique position. The bill of exchange became the engine of commercial and industrial credit as a result of the flexibility of the legal code which acknowledged mercantile custom and practice to be the guiding rule. As a result in England it was not necessary to express on a bill that value had been given, a bill could be drawn and made payable in the same place, and from 1765 could be drawn payable to bearer. However in France the position of the bill remained fixed, the mere transfer of a trade debt, as a consequence of legal conservatism.¹⁰

The development of state funded and floating debt, the integration of the mortgage market through intermediaries such as attorneys, and the increased flexibility of commercial bills were important stages in the establishment of the conditions allowing the emergence of fully-fledged financial institutions. During the first half of the eighteenth century this occurred mainly in London through growth of state borrowing. There existed in the metropolis by 1720 an embryonic market for credit and capital in which the principal intermediaries were the Bank of England, a number of private bankers, and the stock exchange which provided a secondary market in government debt.¹¹ There were no similar developments in the provinces but the absence of people calling themselves bankers should not be taken literally. Although the great growth of country banking did not occur until half a century later, there were even in the 1720s many people in provincial towns and cities who would discount bills, remit funds and arrange loans.

One possible consequence of these financial developments of the first half of the eighteenth century was a fall in the rate of interest. The secular trend of the yield on government stocks was gently downwards from the 1690s until the 1750s and the rate on short-term securities followed a similar course, as did private rates. At the same time the differentials between long- and short-term rates, and between government and private rates narrowed. Interest rates rose from the 1750s but were at low levels from the mid-1770s and even fell between the mid-1780s and the mid-1790s.¹² It is difficult to establish the mechanism causing the fall in the rate of interest. Most probably it was due to special market conditions arising out of a conjunction of an increase in the volume of savings seeking a relatively secure placement with a decline in the amount of government bonds available for purchase. The markets in state and private debt were linked through the London banks and insurance companies which both invested in the funds and provided agricultural mortgages.¹³

The fall in the rate of interest appears to have had an important positive effect upon the volume of land sales, enclosures and transport and urban improvements. Pressnell has drawn a convincing picture of sympathy between low interest rates and high investment in these areas, at least at the major turning points. However, it is doubtful whether the secular decline of the first half of the eighteenth century had any major stimulative effect upon industrial investment as was once suggested. Industrialists in general appear to have raised very little capital externally other than through personal and filial connections. Such a pattern of behaviour diminished considerably their sensitivity to movements in the rate of interest. It is also probable that the rate of interest was not a crucial variable in their calculations, because normally industrial investment yielded a much higher rate of return and had a shorter ‘life’ than capital outlays in agriculture and public utilities. Probably what counted most in the pace and timing of manufacturing investment on the supply side was the sheer availability of funds rather than their price, given the restricted personal pools of savings on which entrepreneurs could draw.¹⁴

Commercial transactions, unlike government borrowing, were subject to the Usury laws. These restricted the extent of interest rate sensitivity of private business because when the yield on government securities rose above the legal maximum, funds did switch from private to government paper in sufficient volume to cause liquidity prob...

Table of contents

• Cover
• Title Page
• Copyright Page
• Original Title Page
• Original Copyright Page
• Dedication
• Contents
• Preface
• 1 Financing the industrial revolution I – institutional change
• 2 Financing the industrial revolution II – textiles, coal and iron
• 3 The development of company law 1825–1914
• 4 Shares and shareholders of early limited companies
• 5 Cotton and iron: the provinces and the metropolis 1855–85
• 6 Private companies and public combines 1885–1914
• 7 Banks and the finance of industry
• 8 Internal and private sources of funds
• Bibliography
• Index to authors
• Index to banks and firms
• Subject index