Download The livelihood model

LIVELIHOOD MODEL
An explanation of the motivation for settlement and of the rate of development of a new region.
Assumptions:
1.
A perfectly elastic supply of labour at an international real wage.
2.
A perfectly elastic supply of capital at an international profit rate. But market imperfections
such as imperfect knowledge regarding risk made accessibility to capital uneven throughout
the economy.
3.
A finite supply of natural resources on which diminishing marginal product eventually
occurs.
I. Extent of settlement:
A.
Settlement occurred in a region as long as the marginal physical product of another unit of
labour (and capital) was greater than the international wage (and profit) rate. That is, farm
families with ploughs, fishers with fishing boats, fur traders with trade goods, or tobacco
planters with ploughs and slaves, settled as long as they obtained more output from the
application of their labour and capital to the land than in their next best opportunity.
The present value of future streams of income should be compared. Income was often very
low on first settling especially when land clearing required a lengthy investment of time and
labour before agriculture became productive. The higher future income had to be compared
to the income in the old country. The future income also had to offset the cost of travelling
to the new world, including the risk that you or your children would not survive the voyage.
These costs were quite high in the 18th century and fell substantially as time passed.
The decision to migrate was made on the basis of expected future income. Securing
information about conditions in the new world, evaluating the quality of the information,
and assessing the risks were themselves costly. Migrants often relied on information from
friends and relatives who had preceded them. Official government information and
information from various other promoters was very likely less reliable.
LIVELIHOOD MODEL
CHANGE IN OUTPUT PER INPUT TIMES
PRICE
60
50
40
rich land
30
opp. Cost
20
10
0
0
5
10 15 20 25 30 35 40 45 50 55 60
SETTLERS WITH CAPITAL
Income is the quantity of output times the price of output. The equilibrium number of
settlers is at 6.5, where the present value of future flows of income in the two places are just
equal. The total income in the new land is the area under the curve from zero settlers to 6.5
settlers. That is, the income of each settler is added together, from the high incomes of the
first settlers on the best land added to the incomes just equal to those of the last settlers.
This total income creates the extent of the domestic demand in the local economy.
B.
The initial rate of settlement, economic development and diversification of a region
depended on the productivity of the natural resources of the region.
The more productive the natural resource, the larger the number of settlers attracted, and the
higher total income.
LIVELIHOOD MODEL
CHANGE IN OUTPUT PER INPUT TIMES
PRICE
60
50
40
poor land
30
rich land
opp. Cost
20
10
0
0
5
10 15 20 25 30 35 40 45 50 55 60
SETTLERS WITH CAPITAL
High productivity in any economically viable natural resource could produce high incomes.
However, the danger was that the demand created from the natural resource production
could merely stimulate imports rather than result in domestic production.
II. Tendency to trade
A. Trade in particular commodities is determined by the cost of production (supply), the
domestic demand and the price at which that good can be imported or exported, net of
transportation costs.
EXPORTED COMMODITY
16
14
PRICE
12
10
Demand
8
Supply
6
Pext - T
4
2
0
0
2
4
6
QUANTITY
8
10
12
In the 17th and 18th century transportation costs were very high. Products such as fish and furs, sugar
and tobacco could be exported from the new world to the old world. The cost of production in the
new world was low compared to the old world. The demand in the new world was relatively low.
The external price was quite high. Even after paying transportation costs, the price of these goods
was higher than the price in the new world. As a result, they became staple exports.
Other products were more expensive to produce in the new world than the old world. Manufactured
goods were particularly likely to be expensive to produce locally because capital and labour are
heavily used in manufacturing and are scarcer in the new world than in the old. However,
transportation costs had to be paid on imported goods, so the costs of production in the old world
had to be sufficiently lower than the costs in the new to cover transportation costs.
The extent of demand for imports depended on total income earned from other productive
activities, such as staple production. The higher the price of staples, and the more productive the
staple sector, the larger the demand for imports.
Demand was created not just by the desire for consumption goods, but also by the need for capital
as a factor of production. Thus fishing created a demand for ships which could be met either locally
or through imports. Fur created a demand for trade goods which could be met either locally or
through imports.
IMPORTED COMMODITY
16
14
PRICE
12
10
Demand
8
Supply
6
Pext +T
4
2
0
0
2
4
6
8
10
12
QUANTITY
Many goods could not be economically traded because transportation costs were too high. In the
17th and 18th centuries, foodstuffs, boots, blankets fell into these categories. Food may have been
more cheaply produced in the new world than in the old, but transportation costs lowered the price
too much to make them a viable export. Blankets may have been more cheaply produced in the old
world, but transportation costs raised the price too high to make them a viable import
NO TRADE
16
14
PRICE
12
Demand
10
Supply
8
Pext + T
6
Pext - T
4
2
0
0
2
4
6
8
10
12
QUANTITY
Regions of new settlement were likely to have a good with a sufficiently low opportunity
cost relative to imports that transportation and other transaction costs could be overcome,
allowing trade. Thus even the relatively self-sufficient Acadians exported livestock and
other agricultural products to Louisburg and New England to obtain, manufactured goods
and other imports.
In some regions, a product was available at very low opportunity cost which was valued
highly in Europe or other external markets. These became the staples of the region. The
larger the difference between the cost of production and the value in Europe the more likely
the good was to dominate production in the region.
Newfoundland's fish, New France's fur and New Brunswick's timber are all examples. In
these cases the high marginal physical product which drives settlement stemmed to a large
extent from the production of these staple exports.
In other regions, no one product may have a disproportionately low opportunity cost so that
it dominates exports. In these areas, a variety of goods may be traded with neighbouring
markets. European goods can then be obtained by trading with regions which do have an
export to Europe. Thus exports of general agricultural goods from the mid-Atlantic states
and from New England to the West Indies paid for their imports of goods from Europe.
The general principles regarding trade apply here, as always. Each ‘nation’ exports the
product in which it has the lowest opportunity costs. So long as costs differ by more than
transportation costs, trade in some commodities will be profitable.
III.
Diversification into manufacturing
The ability to produce generated income which created local demand. Whether this local
demand led to a diversified economy depended on the ability to produce domestically. If a wide
range of goods could be produced locally more cheaply then they could be imported, after
transportation costs, then domestic diversification would have been encouraged. If goods could
be imported more cheaply than they could be produced locally the economy would fail to
diversify and would remain dependent on staple production.
A new settlement’s comparative advantage was likely to be the export of primary products and
the import of everything else, because natural resources were abundant while capital and labour
were relatively scarce. Capital and labour had to be attracted to the region of new settlement,
but higher returns had to be paid to draw them in. As a result interest rates on capital and wages
of workers were higher in the new world. However, transportation costs were very high, so that
if raw materials and cheap sources of energy were available locally, it might be economic to
process the raw materials locally rather than to pay the transportation costs of importing
finished products.
High productivity in temperate mixed agriculture was particularly beneficial because that form
of agriculture produced a wide range of raw materials well suited to meeting the needs of
European settlers. Not only food and drink but also the raw materials essential to the
production of clothing (wool and linen), footwear (hides for leather), and the inputs required for
transportation (horses, oxen, oats, hay and leather for harness) were produced by temperate
mixed agriculture. The lumber available through clearing farm land, on wood lots common on
northern farms, and from nearby waste land also provided building materials for construction,
furniture and transportation equipment.
Rich agricultural lands provided the basis for manufacturing diversification into flour milling,
saw milling, clothing production, tanneries and leather manufacturing, brewing and distilling.
Demand was created for black smithing and foundries, although agriculture did not provide the
required raw materials for these industries. If transportation costs were not too high, iron was
imported and worked up into difficult to transport goods such as stoves locally. Where
transportation costs were too high, local supplies of iron or and charcoal were used to smelt
iron. Eventually, machine industries developed to serve these various manufacturing interests.
Note that the real cost of labour would have been lower in regions with local supplies of
foodstuffs and agricultural produce. For example, Newfoundland had to pay the cost of flour,
salt pork and butter in Boston plus the cost of transporting them to St. John’s. Wages had to be
higher to compensate for the higher cost of food and provide a similar standard of living.
Otherwise workers could move to Boston, where immigrants were welcome. Wages could be
lower in Boston while providing the same real cost of living. As a result, manufacturing could
take place with lower wage costs where basic consumption goods were cheaper.
Agricultural has resulted in more income per square mile than other types of primary
production. (Today Prince Edward Island has the highest population density of any province in
Canada.) Mining results in cities, but they are isolated in areas of low population, unless they
are surrounded by other types of economic activity. Other primary production all tend to scatter
the population across the land more thinly than agriculture.
Higher population density results in larger markets within a given radius of any manufacturing
centre. As a result, agriculture resulted in the ability to produce raw materials for further
processing, but also resulted in a dense enough population to provide a good market for a given
manufacturing plant.
Manufacturing growth tends to be cumulative, at least up to some point. As more activity
locates in a region, the better the market is for additional activity. As the local market grows
manufacturers can gain economies of scale. These reduce the costs of production and increase
the returns to capital and labour, so that more commodities can be produced locally in
competition with imports.
IV.
Comparison with the staples thesis
Similarities
1. Refers to a new country only: labour and capital must be attracted to a new land.
2. Settlement is limited by diminishing returns.
3. Settlement creates a domestic demand for other goods and services.
Differences:
1. The livelihood model emphasizes the ability to produce. Differences in the nature of the
linkages of each staple – that is the demand for other goods created by staple production –
were less important than differences in each region’s productive capacity. Staples might
create demand, but that demand was of no significance if a region lacked the productive
capacity to respond to that demand.
2. Staples were not essential to a region’s development.
Temperate mixed agriculture could yield sufficient income to attract settlers. Some good
could be found to export according to each region’s comparative advantage.
3. Staples might have hindered diversification by financing imports and discouraging local
production. Production of a staple such as sugar raised the opportunity costs of more
diversified agriculture. Staple production probably yielded higher incomes than alternatives,
but the high degree of specialization may have had negative long-term consequences.
Open Issue: Could a region have been settled based solely on agriculture with no ability to import
from Europe either as a result of direct export to Europe of a staple or by trade with a region with
the ability to export to Europe?