History of the Western Economy


Economics is the study of the production and distribution of goods and services. Put another way, economics is the study of how we use the world's limited resources to satisfy our needs and wants. No human endeavour is possible without an economic foundation to support it.


The production of goods and services is known as industry, which can be divided into three types: primary, secondary, and tertiary.

Primary industry, which generates raw materials, includes agriculture, forestry, fishing, and mineral extraction. Secondary industry, also known as manufacturing, processes raw materials into products. Tertiary industry is the provision of services, including food, transportation, education, and financial services.6 The most basic tertiary industry is commerce (trade in goods), which encompasses everything from local shops to international shipping companies.

Throughout most of history, economies were based mainly on agriculture, manufacturing (by hand), and commerce. Though the latter two thrived as important sectors of many pre-modern states, neither came to dominate a national economy until the Industrial Revolution, when manufacturing by hand was largely superseded by machines (allowing manufacturing to become the dominant sector of industrialized states). Eventually, manufacturing was in turn succeeded by tertiary industry as the largest component of the world's most advanced economies.

Medieval/Early Modern Age

ca. 500-1800
prevailing Western economic system
Middle Ages
ca. 500-1500
Early Modern age
ca. 1500-1800
mercantilism (formative age of capitalism)
modern age
ca. 1800-present
mature capitalism

The violence and deurbanization of the Middle Ages compelled the development of feudalism, an agricultural economy in which serfs (property-bound agricultural workers) supported a hierarchy of nobility (see Feudalism and Serfdom). During the later Middle Ages, manufacturing and commerce made a gradual recovery. This allowed feudalism to be replaced by mercantilism in the Early Modern age.

Mercantilism is the national policy of maximizing holdings of precious metals (i.e. money, since precious metals served as currency). Consequently, mercantilism is synonymous with the aggressive exportation of manufactured goods (which are relatively expensive) and importation of raw materials (which are relatively cheap), to the end of maximizing incoming flows of gold and silver from other nations. Mercantilism views economics as a zero-sum game: with a limited amount of gold and silver in the world, one nation's gain is another's loss. Colonies were particularly beneficial for this strategy, as they provided cheap raw materials and served as markets for exports.15,28

Mercantilism calls for major government intervention in the economy, especially in the form of protectionism: the imposition of tariffs on imported goods.28 Tariffs discourage a national population from buying foreign goods, thus diverting their money to domestic producers. The opposite of protectionism is free trade, in which goods flow between nations without being taxed.

The span of the Early Modern age (ca. 1500-1800) is also known as the Commercial Revolution, since this period witnessed the rise of global trade, the establishment of chartered companies, and the development of modern banking, insurance, and financial markets (e.g. credit and stock markets). (A chartered company is a registered business which has certain legal rights and obligations; the modern equivalent is the corporation.) While the roots of these financial innovations lie in medieval Italy, they truly flowered in the Netherlands and England during the Early Modern age, with Amsterdam and London thriving as the world's busiest financial hubs.K276-77,36,37

The Early Modern age also witnessed the rise of the middle class as a major force in Western societies. As capitalism increasingly became a path to great wealth, the power of nobility and clergy (whose wealth depended on taxation of the peasantry) declined. Yet capitalism could only flourish in regions where individuals enjoyed freedom of economic activity (as opposed to economic activity being state-controlled), which was strongest in England and the Netherlands.

Mercantilism ended in the modern period, when it finally became apparent that a nation's economic performance does not depend upon the sheer accumulation of precious metals. Moreover, economic theory provided convincing arguments for the benefits of free trade, leading to the gradual abandonment of protectionism throughout the modern age. The chief exception to this trend was the interwar period, which witnessed a temporary resurgence of tariffs in response to the Depression.15

Modern Age

ca. 1800-present

The prevailing economic system of the modern age is capitalism, which has been defined in various ways. (Capital is anything used to produce goods or services, from an car-maker's factory to a carpenter's hammer.) It is often defined simply as "an economic system in which capital is privately owned". This addresses the contrast between capitalism and socialism (in which capital is owned by the state).

Another definition states that in a capitalist economy, profits are largely spent on the expansion of capital, such that one's productive capacity steadily increases; for instance, a factory owner might take a year's profits and buy ten new machines, thereby expanding the amount of production in the following year. Consequently, a capitalist economy as a whole tends to grow constantly. In ancient and medieval economies, the bulk of profits tended to be spent on luxurious non-productive goods (e.g. vast architectural projects), thereby stifling economic growth.39

The Early Modern period served as the formative age of capitalism. The dawn of mature capitalism coincides with the Industrial Revolution (ca. 1750-1850), during which machine-based manufacturing became the dominant sector of Britain's economy. Belgium and France industrialized toward the end of this period, followed by the United States, Germany, and Japan in the late nineteenth century.11,36

The modern age has featured constant debate over the degree to which national economies should be free market (laissez-faire) or command (socialist). In a strictly free market economy, all goods and services are produced by private firms; the government does not interfere. In a strictly command economy, production and distribution is carried out entirely by the government. Between these extremes lie mixed economies (e.g. government ownership of utilities). Generally speaking, history has shown that strongly free market economies tend to have problems with stability and equitable distribution, while strongly command economies are susceptible to inefficiency.3 (Note that the term "socialist" sometimes only denotes a measure of government intervention, rather than outright control.)

Three particularly important present-day global economic organizations may be noted. The World Trade Organization oversees international commerce, discouraging protectionism and fostering free trade.8 The World Bank is the world's largest funder of international development programs; its first projects were the massive postwar reconstruction efforts.9 The World Bank therefore has a long-term focus (development), whereas the International Monetary Fund has a short-term focus (stability), ensuring that exchange rates remain stable and providing short-term loans to nations experiencing debt-servicing difficulties.14

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29 - "Mercantilism", Encarta 2004.
32 - "Building Construction: The history of building construction » The second industrial age", Encyclopedia Britannica. Accessed March 2010.
36 - "Commercial Revolution", Columbia Encyclopedia. Accessed February 2010.
39 - "Capitalism", Encyclopedia Britannica. Accessed February 2010.
40 - "Economics A-Z", Economist.com. Accessed June 2010.
41 - "Neoclassical economics", The Concise Oxford Dictionary of Politics. Accessed June 2010.