9. The golden winds of trade
If you have a simple model in your head of how the economy has developed over time, it probably goes like this: we started out living off the land (the primary sector), then moved in to factories and manufacturing (the secondary sector) before switching to a service economy (the tertiary sector). This model isn’t bad as one-sentence summaries go, but it can leave you with a lot of misconceptions. One of those misconceptions is that, by dividing the economy up between production and services, we tend to underestimate the role of trade in the economy.
It is true that the UK economy today is dominated by services. It is certainly not true that we don’t make anything any more. Our manufacturing industry produces far more today than it did in the Victorian era. Manufactured goods still make up about 35% of what we consume, despite manufacturing employing only around 8% of the workforce. Yes, we import a lot of the manufactured goods we consume, but we still make more than we import*. No person can live on services alone, and very few countries can either.
It is also true that the Victorian economy was driven by manufacturing, and the shift from agricultural jobs in the countryside to industrial jobs in towns and cities. But factories have never employed more than half of the British workforce. In fact, by the early 1900s, at the height of Britain’s industrial prowess, more people worked in services than in manufacturing. A growing economy can’t live without services either.
The idea that agriculture, industry and services compete with each other is wrong. In fact, they play a crucial role in supporting each other. Agriculture and manufacturing have never gone away — we eat more food and buy more manufactured goods now than ever before. Rather, as they’ve got more productive over time, they’ve supported a service sector that has grown much faster and made us richer.
It is trade that links together the different parts of the economy. Trading in things is often a profitable business. It also tends to be labour-intensive, which means it creates a lot of jobs. As the economy produces an ever-wider range of goods and services, there are ever more opportunities for trade, because there is more work to do to match buyers to the products that suits them best. Trade helps to oil the wheels of the economy, but it has also become a big chunk of the economy in its own right. When we think about the economy, we generally need to think more about trade. This blog aims to explain why.
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Trade is one of the few areas of economics which enjoys almost complete consensus. Almost all economists agree that trade is good — whether that’s trade between individual people, or between countries. There’s a very simple logic behind this: people only agree to a trade when it makes them better off. So the more trade there is, the better off everyone should be, because it helps everyone get more of the things they want**.
Trade can be extremely profitable for those involved in it, because there are often big differences in the price people are willing to pay for the same product. In the early modern economy, for example, spices were cheap and abundant in South East Asia, but scarce and expensive in Europe. Merchants who could transport spices between the two — navigating the trade winds between Asia and Europe — could make huge profits, buying cheap and selling high. The same effect applies today to shops that sell umbrellas during unexpected rainstorms, or refreshments when people get stranded. Wherever there are price differences between different markets, there is money to be made for traders. Economists call this arbitrage, as it eventually evens out the price differences. Many world markets today, such as for commodities and currencies, have single price across the whole world — that is because they are traded so efficiently and extensively that price differentials have largely disappeared.
Trade works for individual people and for countries. If you were a medieval sheep farmer, you’d be able to sell your wool at your local market town and use the proceeds to buy tools, building materials, perhaps luxury goods made by other people; whatever you could afford. If you were a country that specialised in producing textiles (you know, like Britain before and after the industrial revolution), you could sell them to other countries in return for wines, spices, tobacco; whatever goods you sought from around the world. Economists generally agree that countries should follow the principle of comparative advantage in their global trade — that is, each country should focus on producing the things they are good at relative to other countries, and use the proceeds from exporting them to buy the things they find relatively harder to make. This approach should enable countries to specialise in developing their economic strengths, and also to enjoy a better standard of living than if they tried to make everything domestically.
But trade is not just a tool to make economies more efficient and productive. It is also a big part of the economy in its own right. Partly because it can be so profitable, and partly because it is hard work.
Trade often involves moving things around to the places they need to be — transport, as we normally call it. Whether you transport things by horse and cart, by canal or railway, by ship, aircraft or lorry, you need people, equipment and infrastructure to do it. And those things create work and opportunities for businesses to make money; in fact, they are industries in their own right. The travel and logistics industries are just like the manufacturing industries, even if they don’t make anything.
Trade can also involves the sharing of information, helping people to buy the things they really need (or perhaps persuading them to buy things they don’t really need). Estate agents, for instance, help you buy or sell your home, not by moving the home but by matching homes to buyers. Online shopping sites perform a similar role, whether for clothes or holidays. The advertising industry also, in a way, helps to feed us information about what we should buy. All of these parts of the economy, and others besides, exist to make trade happen.
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The industrial revolution was partly inspired by the steady rise of global trade from the 1500s onwards, and it turned that steady rise into an explosion. Industrialisation gave the world far more things to trade with. In a world of mainly land-based or hand-made goods, there were always natural limits on how fast trade could expand. You can only trade what you can make after all. By increasing the production of some goods exponentially, the new industrial economy greatly increased the flows of global trade. The chart below shows just how explosive the growth in Britain’s exports was: it plots Britain’s exports against the growth of real GDP, the size of the economy. Even when you allow for the economic growth we associate with the industrial revolution, this rise in exports is extraordinary: Britain’s exports grew by 20 times in the century after the industrial revolution began, while the overall economy expanded by 5 times.
The industrial revolution also spawned many of the technologies that enabled more trade to be carried out. The rise of coal, steam power and industrial metal working led to the railways, which massively expanded trade within Britain (and soon many other countries). It also enabled shipping capacity to increase dramatically, replacing sail with steam and wood with steel in the process. Note how, in the chart above, the fastest expansion in trade happens after the development of the railways from the 1830s onwards. In many ways, you can’t really separate the rise in trade from the rise in production, as we try to by distinguishing manufacturing from services. Trade and production were two sides of the same coin after the industrial revolution, and they aren’t so easy to separate now either.
You can see the economic impact of this explosion in trade by looking at how Britain’s service sector grew during the 1800s. The chart below shows how the share of people employed in some parts of the service sector grew from 1861 to 1921. Specifically, it shows how transport and retail, the two main service sectors involved in trade, grew to contribute a quarter of all jobs in Britain between them by 1921. This is a huge jump in employment shares during an era of rapid growth in overall employment. Transport went from around 500,000 workers to 2.2 million workers in those 60 years, retail from 800,000 to 2.7 million. That is prodigious growth, even by the standards of the Victorian economy, and it was driven primarily by trade.
What were all these people doing? They were working on the railways, and in the docks of London, Liverpool, Bristol and so on, or sailing ships around the world. And they were working in shops, moving goods from depots to where people lived, and making goods from around the world easily accessible to people across Britain.
To help put this growth in the trading services into context, the chart below shows how the overall breakdown of employment between agriculture, production and services changed from the medieval period through the to early 1900s (note the very big time gaps). From 1760 to 1861, you see a big jump in the share of manufacturing employment, as the industrial revolution took hold; services retains a roughly steady share of employment during this period. But from 1861 to 1921, it is services (and primarily those trading services) that see the biggest employment growth, with agriculture seeing a big drop in its share of employment. Transport and retail services were, in effect, the biggest growth sectors of the economy from 1861 to 1921.
As you probably know, the service sector’s share of employment has continued to grow ever since the 1860s. Today, almost 85% of jobs are in the service sector, with just 2% in agriculture and 8% in manufacturing. Trading services are still a big part of that service sector, even though some areas — particularly transport — have seen falls in employment since their Victorian heyday, mainly due to productivity increases***. Today, the retail sector employs some 4.6 million people, some 15% of all employment (though that figure may fall in the wake of the Covid-19 pandemic). Transport employs 1.5 million people (more lorry drivers and air stewards than rail and dock workers). There are 600,000 estate agents, 100,000 travel agents, and 160,000 people working in advertising. By my rough sums, over 7 million people, or 23% of the workforce, are directly involved in enabling trade in today’s economy. That’s about seven times as many people as work in financial services, about four times more than work in construction.
Trade is not, then, something you can take or leave when thinking about an economy. The French revolutionary who described Britain as a “nation of shopkeepers” clearly underestimated how important trade is, and I suspect it remains a common mistake. Trade is not just a spin-off from more tangible economic activities; it is one of the most important sources of prosperity and work that humans have ever developed.
Technical notes
* According to the 2018 ONS Supply and Use tables (my favourite dataset on today’s economy), UK domestic output of manufactured goods and services is £512 billion, while manufacturing imports total £454 billion.
** There is an important concept in economics called “Pareto efficiency” which relates closely to this trade-is-always-good idea. Pareto efficiency is a situation where you cannot make anyone better off without making someone else worse off — in other words, where there is no more scope for trade, because all of the mutually beneficial swaps have been done. In a Pareto inefficient situation, it should make sense for people to trade until everyone is as well off as they can be.
*** For example, the modern, containerised docks in deeper waters near London, Bristol and Liverpool are among the most highly automated and least labour-intensive systems in the country.
