1    India, the Great Depression and Britain’s demise as world capitalist leader

Utsa Patnaik

Introduction

One of the most interesting periods in the history of modern capitalism is the inter-war Great Depression. Apart from plunging the capitalist world into a deflationary spiral of falling output, employment and trade, this period also saw the demise of Britain as the world capitalist leader and the passing of this mantle to a reluctant and unprepared United States of America. The impact of the Depression is widely recognized to have been more severe and prolonged in the USA than in Britain, so the fact of being caught up in the Depression could not be the main reason for Britain’s inability to maintain its long and undisputed position as the world capitalist leader. True, the difficulties of maintaining the smooth operation of the international gold standard had started even before the Depression as an outcome of the economic dislocation and imbalances caused by the First World War, well described by W.A. Lewis in his Economic Survey 1919–1939. But by the mid-1920s, Britain appeared to have returned to its earlier position as undisputed leader of the capitalist world.

According to Kindleberger (1987), the world capitalist leader has to either keep its economy open to free imports to shore up the level of activity elsewhere, especially in periods of global recession, or it has to export capital to developing economies and so keep up demand in the global economy. Britain performed not one but, simultaneously, both of these functions up to the mid-1920s: not only did it continue to be the largest exporter of capital to Europe and to developing regions of white settlement, but it also kept its markets open to imports, running large trade and current-account deficits with these regions and so fulfilling the task of shoring up demand in the world economy. In this very act of performing both functions at the same time lay a contradiction, as running large current-account deficits is not normally compatible with being a net exporter of capital; today the country with the largest current-account deficit, the USA, is the world’s largest debtor. To understand how Britain was able both to run very large current-account deficits with its major trading partners and at the same time export capital to them is also to understand why, from the mid-1920s onwards, it was no longer able to do so, and went into a terminal decline.

In the mid-1920s, nobody could have predicted that within less than a decade Britain would have great difficulty in balancing its external accounts, that it would be forced to abandon the gold standard in 1931, and that it would soon sink into the status of a second-rank power. In the extant literature, economists’ analysis of why this happened is merely descriptive, pointing to the well-known fact that Britain’s invisible earnings registered a sharp decline; however, the unique composition of these invisible ‘earnings’ – namely that a substantial part was not ‘earned’ by Britain at all – is little understood, because a crucial element of Britain’s long and successful time as world capitalist leader is never analytically taken into account. This is the role that its colonies – in particular its largest colony, the Indian sub-continent, and later also Malaya – were made to play in providing the foreign exchange earnings which ensured the functioning of the international payments system centred on Britain.

This chapter argues that there was a close causal connection between Britain’s exploitation of its colonies and its successful innings as world capitalist leader, and that the agricultural depression from the mid-1920s onwards, which disrupted the colonies’ ability to support Britain’s balance of payments, was a major cause of its collapse. As the exchange earnings from its colonies registered a sharp decline, it became impossible for Britain to continue to export capital, at precisely the time at which the global depression required such countercyclical lending to distressed nations from its leading power. Borrowing short from Europe to lend long was briefly resorted to, but this was not sustainable and fatally undermined confidence in the pound sterling, which was eventually forced off the gold standard, just as dozens of other countries had previously been after futile and self-defeating attempts to solve the problem by deflating their economies.

An early study of the pattern of merchandise trade between countries and regions of the world relating to 1928 was made under the auspices of the League of Nations.¹ Subsequently, data on the matrix of world trade by provenance and destination has been made available by the United Nations for selected seven-year periods from 1900 to 1958.² This chapter seeks to support its proposition at the theoretical level by analysing the data on this matrix of world trade to show the quantitative relation between the total deficits which Britain incurred with the world and the export surplus earnings of the Indian sub-continent.

The dependence of the international payments pattern on colonial and, in particular, on India’s export earnings

The period spanning the last quarter of the nineteenth century up to the First World War – the period of high imperialism – saw the fullest development of the multilateral payments pattern centred on the world capitalist leader, Britain. A major and indeed decisive part was played by that country’s appropriation of the colonies’ exchange earnings not only to cover its current-account deficits with Europe and the developing regions of new European settlement on three continents, but also to export capital precisely to these regions on a large scale. Britain invested not in its tropical colonies but mainly those on the European continent, in the USA and in recent settlement regions (Ragnar Nurkse 1954) where it found it was profitable to do so, and since it already ran current-account deficits with these regions, investing thereby ran up large and increasing balance-of-payments deficits (Saul 1960). It could do so with impunity, however, and faced virtually no strains in operating within the system of fixed exchange rates, the gold standard, because it could appropriate entirely the large and increasing exchange earnings of its tropical colonies to offset its balance-of-payments deficits with the European continent, the USA and regions of recent settlement, thus achieving overall external balance. What was recorded as Britain’s increasing invisible income from its colonies was only in minor part from legitimate returns on investment of its resources: the bulk represented the exchange surplus earnings of its colonies in the rest of the world, which reached very large magnitudes in the period from 1900 to 1928, as Tables 1.1 and 1.2 show. These exchange earnings were not permitted to flow back but were instead appropriated, simply by imposing politically determined invisible charges to an equivalent amount not only under the usual headings (of so-called Home Charges, remittances and so on) but many additional ones whenever required – including ‘gifts’ from India to Britain, which no Indian knew anything about.

Needless to say the large amount of exports from the colonies to the rest of the world were deliberately promoted as a matter of policy, leading in most cases to a decline in food output per head for local populations, as more and more land and resources were devoted to export crops’ production whilst too little was done to raise yields. Export of simple manufacture from the colonies – yarn and textiles – was also promoted, sometimes against the representations of metropolitan industry, because the requirement of earning foreign exchange to balance Britain’s payments was generally accorded priority over sectional interests. Direct political control over its colonies meant that, for accounting purposes, very large invisible charges could be made, which were adjusted to the magnitude of their fluctuating export surplus earnings in order to transfer all these earnings for Britain’s benefit. Throughout, the fiction could be maintained that Britain was balancing its global trade and exporting capital entirely out of its own resources; this fiction is uncritically reiterated in modern analyses of the period, which do not recognize the special nature of the macroeconomic relation between colonies and metropolis.

The standard expression of macroeconomic balance in open economies, as explicated in the textbooks, does not conceptually recognize the question of colonial transfers at all; so in the next section there is a brief exposition of how these relations are modified once transfers are taken into account. In this section we discuss the reasons for regarding trade between Britain and its colonies not as the normal trade depicted in textbooks, but as managed trade involving a very substantial order of transfers from the colonies to the metropolis. Transfer can be measured in a number of ways. From the budgetary side it is that part of government revenues not spent domestically under the normal headings but rather set aside as the local currency provision for expenditures incurred abroad,³ which were financed by foreign exchange earnings from export surplus. From the trade side it can be measured as the colony’s merchandise export surplus earnings from the world: this is the measure which has traditionally been used.

The reason for treating the export surplus of colonial goods to the world (after adjusting for net payments on account of normal invisibles) as transfer to the metropole, and not as normal export surplus, lies in the tax-financed or rent-financed nature of all net exports from the colony. This meant, first, that there was no external liability the metropolis had to face on account of its own direct-import surplus from the colony, as was the case with its import surplus from any sovereign trading partner. In the case of normal trade with a sovereign and equal trading partner, Britain’s import surplus had to be settled either through specie outflow or by allowing claims to be held against it (viz. by borrowing). But in the case of its import surplus, say, with colonized India, no such payment was required. If an average Indian farmer-cum-artisan paid Rupees 100 in taxes to the colonial government, and then got back Rupees 30 out of that as ‘payment’ for the cotton cloth/opium/jute/cotton for export that he sold to the world, this would be the same as his giving the total tax of Rupees 100, divided into two parts: Rupees 70 cash tax handed over from sale of domestically traded goods, and Rupees 30-worth of exportable goods handed over gratis as tax. Suppose that of the total of Rupees 30-worth of export goods, one-third went directly to Britain: the Rupees 10 worth of imported cloth/opium/jute/cotton (in excess of any goods exported from it to the colony) becomes completely costless to Britain, for it is the commodity equivalent of taxes that the Indian has paid. This import surplus creates no external liability, does not have to be paid for to Indians in specie and does not lead to any claim on Britain by Indians. Therefore the import surplus is not an ‘import surplus’, as in normal trade, but a transfer. There is a substantial Indian literature dealing directly or tangentially with such transfer.⁴

Sometimes the argument is put forward that nationals in the metropolis paid fully for the tropical goods they purchased – and, indeed, paid high prices because of monopoly trade and high transport costs – so the only people who benefited were the traders. Writers from ex-colonized countries themselves fall into the trap of trying to estimate transfer by estimating trading profits. But this argument is not germane to the issue of transfer: it merely confuses individual economic agents with the macro-economy. Consumers of imported goods in any country, including developing countries today, always necessarily pay the full price in local currency for the imported goods they consume, and evidently consider it to be worth doing so no matter how high the price, otherwise the imports would not be undertaken in the first place. The point about traders’ margins and high prices is irrelevant. The relevant point is: in any trade between two countries, if – owing to its high propensity to consume imported goods – the home economy’s import value exceeded the value of its exports to the other country (namely, there is a deficit on the current account), under normal conditions this would necessarily create an external liability for that economy; this liability would have to be settled by outflow of specie in payment (outflow of monetary silver and gold), by borrowing from the trading partner or by a combination of the two. The import surplus from the colony into the metropolis, however, created no external liability for the latter and was therefore a transfer. Lowering of transport costs and traders’ margins over time was historically associated with larger, not smaller transfers, as demand for tropical goods in temperate land markets was both price and income-elastic. The cheapening of tropical imports led to even greater demand and larger tax-financed net exports, or larger transfer.

Second, apart from direct export surplus to the metropolis, the colony had substantial export surplus to the rest of the world, hence rising foreign exchange earnings. Local producers of goods exported to the rest of the world were ‘paid’ in local currency from budgetary revenues to which they contributed taxes, just as exporters directly to Britain were ‘paid’. None of these exchange earnings from export surplus with the rest of the world flowed back to the colony; rather, they were appropriated and used by the metropolis to settle its own large trade deficits with other sovereign countries, arising from its high propensity to import from elsewhere in the world. It was simplicity itself for the colonial government to devise a payments system to appropriate the exchange earnings. For as long as the East India Company had the trade monopoly, it directly re-exported Asian and West Indies cotton textiles and tropical goods – four-fifths of re-exports went to Europe – and foreign currency earnings were thereby directly available to Britain for use in purchasing its requirements from these lands, in excess of what its domestic exports could purchase. Re-export of the mainly tropical goods obtained from colonies was very important indeed: over the period from 1765 to 1804, re-exports boosted the purchasing power of Britain’s domestic exports by 53.5 per cent (calculations from basic time series data, in Patnaik 2006). Britain’s re-exports were always positive and experienced a surge more than a hundred years later in the years up to 1913, when £110 million worth of goods were re-exported (Saul 1960: 59, fn. 1).

Britain’s best-known economic historians have in the past systematically excluded re-exports from their calculation of what they called ‘the volume of British trade’ without discussing why they did this (Deane and Cole 1969). They defined ‘the volume of trade’ as the sum of imports retained within Britain and exports of domestically produced goods. But this is not the generally accepted definition of trade; no textbook of macroeconomics and no international body (such as the World Bank, IMF or United Nations) uses this definition, which is called ‘special trade’. The definition of trade always used in these circles is general trade, which includes all imports, whether retained or re-exported, and all exports, whether domestically produced or re-exports of imported goods. The exclusive use of the special trade definition has led to a great underestimation of Britain’s actual trade and level of integration with the world economy. By the triennium centred on 1800 the sum of Britain’s imports and exports was £82 million; Deane and Cole (1969), using the special trade concept which excluded re-exports, place it at a mere £51 million. In short, the correct trade estimate is 60 per cent higher than the estimates provided in the standard literature. By 1800, the actual trade-to-GDP ratio in Britain by 1800 was 56 per cent, rather than the 34 per cent estimated by Deane and Cole (1969). (For a detailed re-estimation of Britain’s trade series using the primary data for the entire eighteenth century presented in Mitchell and Deane 1962, see Patnaik 2000). These underestimates have crept into all subsequent writings (Kuznets 1967; Crafts 1985) and have seriously misled development economists. A detailed critique of the Kuznets’ estimates for Britain – which are even lower than those found by Deane and Cole (1969) using their special trade concept – is available in Patnaik 2011).

By 1833, after the Company’s trade monopoly had ended, a number of different financial mechanisms were in use which continued to make payment to colonized producers for the goods they exported to different regions of the world through the use of rupee bills of exchange by private traders. By 1861 this had been formalized into one system, where payments by foreign importers of Indian goods were made through exchange banks to the Secretary of State for India in Council, in London. The foreign importers purchased bills (termed ‘council bills’) issued by the Secretary of State by paying in sterling and other currencies up to the value of their imports. The crucial characteristic of the bills was that they were encashable only in rupees – this was the feature designed to deny exchange earnings to the colonized producers. The sterling, US dollars, francs and other currencies given as payment by the rest of the world for India’s net exports thus piled up in London, and the rupee bills issued against these sums were sent by the foreign importers to the Indian exporters (by post or by telegraph) for encashing through local exchange banks; these rupees in turn came out of the sums earmarked in the Indian budget for that purpose, under the general head of expenditures incurred abroad. This system also helped the colonial government to stabilize the exchange value of the rupee (a consideration which became all the more important following the prolonged fall in silver prices and hence rupee depreciation from 1873, which sharply raised the rupee equivalent of the downwardly inflexible sterling tribute and led to increased tax extraction from the Indian people – with the result of an unusually high incidence of famine in the 1890s). As much as 25–27 per cent of rupee budgetary revenues were being so earmarked and transferred even in the Great Depression years of the early 1930s, when export prices were falling.⁵

On the Indian side of the balance of payments, the accounting mechanism through which such wholesale appropriation of the colony’s exchange earnings was rationalized by the colonial government is quite simple once it is comprehended. The imposition of an annual politically determined tribute in the form of administered invisible charges denominated in pounds sterling (and, converted to equivalent rupees, shown in the budget as expenditures incurred abroad) was the accounting means through which the colony’s earnings from export surplus to the world on merchandise account adjusted for normal items of invisibles payments, hence its normal current-account surplus, was entirely siphoned off by the metropolis for its own benefit. These special invisible charges were administered and hence autonomous, in the sense that they were determined by government and were not the outcome of the decisions of any individual or corporate economic agents. Being tribute and politically determined by the colonial government, the charges could be easily manipulated – and were so manipulated to be at least as high as foreign exchange earnings from the colonies’ export surplus to the world, in order to siphon off these earnings.⁶

This politically imposed tribute was adjusted to trade-surplus trends, in an asymmetric manner. Thus if earnings from the colony’s merchandise export surplus in a particular period rose to an unusual extent (as was the case during the Second World War), the administered part of invisible liabilities – the tribute – was promptly jacked up with additional headings of special charges in order to siphon off as much of the extra earnings as possible. India saw a massive export surge from 1911 to 1919, taking its average annual export surplus to Rupees 742.8 million (nearly £50 million, or 240 million USD). Over and above the normal transfer, an additional £100 million of India’s wartime exchange earnings were appropriated as a ‘gift’ by Britain from British India, a gift that no Indian knew about until it was unearthed by Professor A.K. Bagchi’s research eight decades later. It represented ‘more than four years’ worth of pre-War Home Charges or tribute remitted by India to Britain’ (Bagchi 1997: 522). However, the converse proposition was not true. If the colony’s exports happened to falter in a particular period – owing, say, to world recessionary conditions – the tribute was not lowered, and the gap between tribute and exchange earnings had to be covered through enforced borrowing by the colony.⁷ The major part of the gold reserves, as backing for the colony’s currency system, were mandatorily held in London despite having been acquired from the colony’s resources, and were freely used for the metropole’s own accommodation when required.

Modifying the relation between budgetary, trade and savings–investment balances to take account of transfers from colonies to the metropolis

Let us recapitulate the relation between the budgetary balance, trade balance and savings-investment balance which hold for a sovereign economy and how they are modified for a colony. We have the following identities, where YD is disposable income, T is taxes, C, S and I refer to private consumption, savings and investment and NX refers to net exports.

YD = Y−T

YD = C + S, hence C = Y −T−S

Now, in a sovereign economy, Y = C + I + G + NX

or Y = (Y − T −S) + I + G + NX

Transposing terms, we obtain the well-known relation between the budget deficit and trade surplus, for a sovereign open economy (the only type discussed in the textbooks):

where S and I refer to private savings and private investment, (G − T) to the excess of government spending on goods and services G over its tax revenue T – or the budget deficit – and NX refers to net exports, the brief form of (X − M), namely the excess of exports of goods and services over the imports of the same. In a sovereign economy, if private savings and investment are equal, a given level of the budget deficit/surplus is reflected in an equal level of current-account deficit/surplus. If the government’s budget is balanced, an excess of S over I is reflected in an equal level of current-account surplus, whilst a deficit of S relative to I is reflected in an equal level of current-account deficit.⁸

The matter is quite otherwise in a colonized economy where there is never a budget deficit, but rather a budget surplus considering normal items of government expenditure – where this budget surplus represents politically determined tribute, transferred via a trade surplus which is always offset or more than offset by administered liabilities, leaving the current account balanced or in deficit. Colonial expenditure – which, for simplicity, is assumed to be met solely with taxes – is distributed over two headings: GD, defined as government’s expenditure on domestic goods and services under headings which are also found in any other economy, and GA, which stands for expenditure of Government abroad, a heading which is specific to the colony. The budget is always kept in surplus considering GD alone, and is kept balanced as a matter of policy through incurring GA.

Thus:

This excess of T over GD in the colony is referred to by a special term, ‘expenditures incurred abroad’, and these sums of GA in local currency are used to pay local producers for their net exports to the rest of the world, NX1. The current account comprising net exports of goods and services, NX, is also divisible into two distinct parts in a colonial economy:

The first part, NX1, refers to the export surplus on account of goods and services to the world including the metropolis, and is always kept positive and large for a colonial economy through policy measures to increase merchandise exports, since this is how the budgetary surplus is transferred. The export drive becomes particularly intense when the colony also becomes an important absorber of imports from the metropolis, and hence its merchandise export surplus tends to get reduced. Since the excess of colonial tax revenues, T over GD, is embodied in this export surplus, we have:

The above states the direct link between the budget and trade, which is absent in the case of the sovereign economy. This means that we can take either (T− GD) or NX1 as the measure of transfer.

The second part of the current account, NX2, represents the administered invisible charges. These always constitute a large negative figure, which is rationalized by the colonial government as payment for the service of alleged ‘good governance’. Since local governance existed before colonial conquest, and the colonized population is not consulted regarding their willingness to meet the charges, this part is nothing but a politically determined tribute imposed on a subject people. These administered liabilities are deliberately pitched sufficiently high by colonial government, guided from the metropolis, to siphon off all exchange earnings from NX1 to the rest of the world, and are sometimes pitched even higher than NX1, obliging the colony to borrow to discharge its liabilities.

On the other side, for the metropolis receiving transfers, we need to distinguish between the two types of trade it carries out – trade with sovereign areas and trade with colonized regions – and accordingly divide the NX term for the metropolis into two parts: NX = (NX sov. + NX col.), always bearing in mind that NX col. in turn is divisible into two parts:

NX col. = (NX1 + NX2), so NX = (NXsov.) + (NX1 + NX2)

where the signs of NX1 and NX2 are reversed compared to our discussion of the case of the colony. Thus NX1 for the metropolis is either zero or negative – taking all its colonized regions together, it either has zero net imports or a deficit (positive net imports) considering all normal transactions, including normal invisible payments like freight, and dividends on capital. Zero net imports might be achieved when sufficiently large manufacture exports are made by the metropolis to the captive and compulsorily open colonial markets on private and government account, to offset the value of its direct imports from colonies. But even a deficit – an import surplus; that is, a negative NX1 – does not matter and creates no liability for it, because political control over the budget and exchange earnings of its colonies enables it to so administer NX2 that it is positive to a very much larger extent than any negative, direct-import surplus NX1. It is important to remember what it is that NX2 represents: it is the autonomous element in the balance of payments, the politically determined tribute deliberately pitched by the metropolis to a level equal to or a little greater than the colonized regions’ foreign exchange earnings from the entire rest of the world, in order to siphon off these earnings completely. The overall current-account balance with the colonized regions, NX col., is thereby always kept at a large positive figure – a large credit for the metropole for at least offsetting its deficits on account of NX sov., its current-account balance with sovereign regions.

As regards trade with sovereign regions, the metropolis typically run a current-account deficit with the main regions (in Britain’s case these were the Continent and the USA), less than offset by any positive balances with smaller sovereign areas so that there is an overall current-account deficit, rendering NX sov. negative. But since it also exports capital to these sovereign regions, it follows that a given level of current-account deficit with sovereign regions becomes an even larger balance-of-payments deficit, which has to be offset by overall current-account surplus NX col. to the required extent with colonized regions – the latter surplus being achieved only through the imposition of the administered liabilities NX2 to the required extent. Take a numerical example. If the current account surplus NX col. is 200, after factoring in the political charges or tribute on the colonies, this can finance either a current-account deficit of 200 with sovereign regions with no capital exports to them, or if there are capital exports of 100 to these regions, it can finance this capital export in addition to a current-account deficit of 100 with the same regions.

Therefore,

while

NX = NXsov. + NXcol. > 0 or = 0

The above expresses the fact that the metropolis’ administered liabilities on colonies, NXcol.– which is a positive item for it – is so pitched as to offset or more than offset the deficit on the trade with sovereign countries, combined with the deficit – if any – on the trade with colonies.

Just as the heading of ‘expenditures incurred abroad’ in the colony meant a siphoning off of tax revenues, the converse for the metropolis has to hold: domestic tax resources are augmented by transfers from abroad. Government’s total expenditure (assuming it is matched by revenue) can be divided in to two parts: GDT, met out of domestic revenues DT and GTR, met out of transfers TR.

Thus G = GDT + GTR, implying that government’s expenditure is not constrained by domestic revenues but can exceed it by a (maximum) amount given by the transfer. Redefining T to stand for Total budgetary resources, T = DT + TR, the expression for the budget deficit (G – T) becomes (GDT + GTR) – (DT + TR). Namely, considering domestic revenues, DT, the budget is always in deficit, exercising an expansionary effect on the economy, and is balanced when transfers are factored in on the resources side. Let us see what this implies in terms of the savings–investment balance:

S − I = {(GDT + GTR) − (DT + TR)} + NX

Taking a numerical example, let income Y = 500, DT = 50, so disposable income is 450, made up of, say, 410 private Consumption and 40 private Savings. G = GDT + GTR = 50 + 30 = 80.

T = DT + TR = 50 + 30 = 80.

Assume to begin with that NX = NX sov. + NX1 + NX2 = −30 +0 +30 = 0. If private savings and investment are equal so that S − I = 0, the overall current account NX = 0 is matched by a budgetary balance:

40 − 40 = 0 = (50 + 30) − (50 + 30) = 0

This budgetary balance at the high level of G = 80 is only made possible because domestic resources, DT = 50, are augmented by transfer. If however the budget expenditure is limited to the amount of domestic tax resources alone, the resulting surplus (GDT − DT − TR) or (50 − 80) = −30, will be reflected in a matching excess of private investment over saving, S − I = −30. Various combinations of G greater than DT and I greater than S are also possible – thus if (G − T) is (70 − 80) then (S − I) will be (40 − 50). What the transfer permits is raising private investment above private savings, raising government spending above its domestic tax revenues or some combination of the two.

Dropping the assumption of external balance, suppose that NX = 20 because, say,

NX sov. + NX1 +NX2 = −20 + 10 + 30 = NX.

If S = I then the current account surplus of 20 must be reflected in an equal budgetary surplus, thus

S − I = (G − T) + NX, or, 0 = (60 − 80) + 20

However, the important point to note that the ‘budgetary surplus’ is actually a deficit if domestic revenues alone are considered, and turns into a surplus only owing to the transfer. In a normal economy, a current-account surplus must be accompanied by a surplus of domestic taxes over expenditure or an excess of private savings over investment. But in a metropolis with colonies, the converse is the case: a current-account surplus, being financed through politically administered liabilities on colonies, can accompany domestic investment in excess of domestic savings or government expenditure in excess of domestic taxes. Provided we assume that demand was not a constraint – and this is a realistic assumption, given the drive to acquire and exploit the purchasing capacity of populations in old territories and the overseas settlements of Europeans – the expansionary effects of the transfer, by providing substantial extra resources, are obvious.

The mechanism of transfer analysed here was not limited to India alone; it was the typical mechanism, with specific modifications, in all other colonies where producers were not slaves but were nominally free peasants and artisans who were taxed (as in Java under the Netherlands, Korea under Japan and Ceylon, Burma and Malaya under Britain). The colonized country was typically made to build up a rising merchandise export surplus (which was sustained for 180 years in the Indian case) and a slightly smaller order of current-account surplus after factoring in net normal invisibles payments; but the imposition of the administered component of political charges ensured that it never had a final current-account surplus. No matter what heights the trade surplus might reach (in 1911–13 India had the second largest annual trade-surplus earnings in the world, at 175 million USD, second only to the USA – it maintained this position up to the mid-1920s. See Figure 1.1), sufficiently larger invisible political charges were imposed to mop up, and more than mop up, the increased export surplus earnings and produce a small deficit on the current account.⁹ Borrowing from Britain then became necessary in order to balance overall payments, which added to future interest burdens.

International trade and investment in this period was thus a looking-glass world, where the trade-surplus colonized countries were obliged to borrow capital and the trade-deficit metropolitan countries became capital exporters. A country with a large and growing merchandise export surplus (such as India, and later Burma and Malaya as well) had more than its earnings siphoned off through politically imposed invisible burdens and had to borrow, whilst a country with large and growing trade deficits (Britain) was able, through politically imposed and manipulated charges, to appropriate the exchange earnings of its colonies to more than offset its current-account deficits with sovereign regions, so that it exported capital to these regions; it did this on an increasing scale.

For the period of high imperialism, we still have to rely on the only study in existence – a most valuable one – which tries to trace regional trade and current account balances: S.B. Saul’s Studies in British Overseas Trade (1960). Whilst this does not give us continuous time series which can be further worked on, it does give us snapshot pictures for certain periods and dates. Britain used the exchange earnings of all its colonies, but quantitatively by far the most lucrative and important was India: Britain’s deficit on current account plus gold with USA and the European continent was in excess of £70 million in 1880 (amounting to more than 5 per cent of its current-value GDP), and it had £25 million of credit with India alone, mainly on account of siphoning off India’s exchange earnings through imposing invisible burdens: ‘The position was that Britain settled more than one-third of her deficits with Europe and the United States through India’ (Saul 1960: 56), whilst smaller sums were contributed by a number of other colonies’ earnings. By 1910 Britain’s balance-of-payments deficit with Europe, the USA and Canada combined had increased to £120 million; when this was added to smaller deficits with other developing regions of European settlement, this gave a total deficit of £145 million. Earnings from India’s export surplus alone were a massive £60 million pounds at that date – this was made to appear entirely as Britain’s credit vis-a-vis India (Saul 1960: 58, Table XX).

As Saul puts it, ‘[t]he key to Britain’s whole payments pattern lay in India, financing as she probably did more than two-fifths of Britain’s total deficits’. Further, ‘[t]he importance of India’s trade to the pattern of world trade balances can hardly be exaggerated’ (Saul 1960: 62, 203). As Britain’s largest, most lucrative colony, India was earning £71 million from its global exports by 1913–14 (Saul 1960: 197) – the second largest export earnings in the world, after the USA. These earnings were siphoned off by Britain to pay for its own deficits via a managed¹⁰ direct trade surplus with India, plus much larger political charges. Further, at that date there were re-exports from Britain of Indian and Straits Settlements to the tune of £25.8 million, accounting for nearly a quarter of all Britain’s re-exports.

The transfer in fact greatly exceeded the amounts required for meeting Britain’s current-account deficits with other regions alone: ‘But this was by no means all, for it was mainly through India that the British balance of payments found the flexibility essential to a great capital exporting country’ (Saul 1960: 62). The same point can be put a little differently. Britain shored up demand in the world outside its colonies by continuously running current-account deficits with the European continent and the USA, and later with the other regions of European settlement – Argentina, Australia and Canada. It would have been impossible for Britain to have exported capital to these regions at the same time – as it did – thereby developing them rapidly and also incurring even larger and rising balance-of-payments deficits with them, without access to the enormous exchange earnings of colonized lands which were transferred to Britain to offset deficits and substantially finance its capital exports. In the absence of the transfers, the attempt to export capital to develop Europe, North America and regions of recent European settlement, given the negative current-account balance with these regions, would have put intense pressure on Britain’s balance of payments, would have forced loss of gold, departure from the gold standard and the collapse of the global capitalist system many decades before 1931.¹¹

In the past twenty-five years the US has been running large, continuous current-account deficits with the world – but without access to transfers in the old form, it is not an exporter of capital but is instead the world’s largest debtor. The US, as world capitalist leader, finds itself in a more vulnerable position today. Whilst direct colonial control meant that Britain could maintain the fiction that it was settling its deficits and exporting capital entirely out of its own resources, no such veil is available for the USA. As has always been the case, the poorest countries in the world – not only the advanced surplus countries, but China to a substantial extent and India to a lesser extent – lend to the US to fill its yawning current-account deficits, allowing it to live beyond its means and still maintain the capitalists’ confidence that its currency is as good as gold.

The sharply declining magnitude of export earnings of the Indian sub-continent owing to agricultural depression

The country trade data from United Nations statistics relating to India for the periods from 1900 to 1913 and from 1921 to 1938 are summarized as three-year annual averages in Tables 1.1 and 1.3. Data for the years 1914 to 1920 were not available from the source. We see that India’s annual export surplus earnings reached nearly $100 million during the period between 1900 and 1906 and increased to nearly $140 million over the next seven years. Whilst the UN source is incomplete and does not cover the period from 1914 to 1920, we know from Indian sources that the First World War period saw an export surge, largely owing to the belligerent European countries’ demand for jute for sandbags and other uses. Between 1911 and 1919 the export surplus of British India (which included Burma up to 1935, apart from the territories of present-day Bangladesh and Pakistan) was on average 240 million USD, or about £50 million, applying the pre-War exchange rate. The UN data from 1921 to 1928 in Table 1.3 show that after the post-war deflation, the export surplus averaged 200 million USD. As late as 1928, a peak level of exports – 1229 million USD – was achieved, mainly because export quantum or volume increased as prices started to decline from 1925. Over the triennium 1924–6, India’s export surplus reached an all-time high of 329 million USD, with a steep plunge thereafter. The effects of continuing global primary price deflation on exchange earnings could not be staved off indefinitely, particularly since the colonial government implemented sharp fiscal compression in India as regards domestic spending on irrigation, railways and so on (namely, it reduced GD, releasing more revenues for financing the transfer of GA), which affected agricultural output.

Kindleberger (1987) observes that the world agricultural depression preceded the industrial depression, and provides a lengthy analysis of the impact: from the end of 1925, primary product prices went into a prolonged decline, and this directly led to external imbalances for the mainly primary product-exporting countries. At that time both the USA and Germany were substantial exporters of primary products, which made up the bulk of the export basket from the regions of recent settlement in Latin America, South Africa and Australia–New Zealand. The fiscal compression – aiming at balanced budgets – misguidedly advised for these countries by the British government merely made matters worse since, being universally applied, it led to a general reduction in demand for each other’s exports on the part of the deflating countries and sent their external accounts even further into the red. The Latin American countries and British dominions suffered the earliest and largest loss of gold in the attempt to maintain the fixed exchange value of their currencies, and were soon forced to go off gold and devalue (Kindleberger 1987).

India did not face a severe loss of export earnings until after 1926, but the plunge was very sharp thereafter. The Indian sub-continent’s export surplus earnings from the rest of the world excluding Britain declined from a peak of nearly 500 million USD in 1928 to a mere 96 million USD by 1935 (see Table 1.4, constructed from the matrix of world trade, and Figure 1.2. See also Table 1.5) – a decline of 80 per cent. According to Triantis (1967), whose data ranked countries by the severity of their decline in exchange earnings, we find that only six other countries in the world suffered a larger proportional range of decline in earnings than India.

Since these exchange earnings by its colonies from the rest of the world had been the mainstay of Britain’s global payments network, it is not surprising that such a precipitous decline should cause a severe crisis, given that Britain had little possibility of significantly reducing its trade deficits with the rest of the world. By 1928, Britain’s total trade deficits, excluding the Indian sub-continent, had reached a peak of over £400 million, or nearly two billion USD.

That the basic cause of Britain’s payments crisis after 1925 was the sharp decline of its colonies’ exchange earnings, which it had used to pay for its deficits for decades on end, to this day finds no mention at all in the literature. S.B. Saul’s excellent work, now half a century old, has not been followed up by scholars in the developing world to construct time series of regional balances; the economics profession continues to ignore the fact that ‘the importance of India’s trade to the pattern of world trade balances can hardly be exaggerated’ (Saul 1960: 203). Overvaluation of the pound when Britain returned to gold in 1925 after the wartime dislocation is often mentioned in the literature, but the weakness of this argument, if it is an argument, is patent. Britain had for decades run such a large trade deficit with the world, always settled by invisible income inflow, that no implicit argument about reduced competitiveness could be the answer to its payment difficulties.

Only the colonies, including the Indian sub-continent, were compulsorily kept open to imports from Britain, and the colonial stores purchase policy meant that everything, including the famous red tape for binding official papers, had to be purchased from the metropolis. The Indian sub-continent was therefore made to run a trade deficit with Britain which, as Table 1.2b shows, became large as – facing competition from European industrializing powers – Britain turned ever more to its captive colonial markets, and above all the Indian sub-continent. The latter ran trade surpluses with every other part of the world, earning 300–500 million USD. With the 1931 Smoot–Hawley tariff in USA and a wave of protectionism by other countries, Britain resorted to Imperial Preference, which erected tariff barriers with non-Empire countries; however, it found it impossible to continue to lend capital to distress-hit recently settled nations. As previously mentioned, for a time, Britain tried borrowing short from European banks to lend long to its traditional destinations, but this proved unsustainable.

The precipitous decline of India’s export earnings can be seen in Table 1.3 and Figure 1.2. The regions with which the Indian sub-continent traded most were not necessarily the regions from which it earned the most. Britain accounted for the largest share of India’s trade, but was the only country with which it had a trade deficit. The largest export surplus earnings for the Indian sub-continent were with continental Europe, including the Soviet Union – this figure reached 199 million USD by 1928, whilst trade with the USA and Canada earned 114 million net USD. Combined total earnings of 313 million USD had declined to only 83 million USD by 1935 (see Tables 1.2a and 1.2b). India also had substantial net earnings from Japan, Latin America, West Asia, China and South East Asia, totalling nearly 150 million USD in 1928; this had collapsed into negative figures by 1935.

The Indian sub-continent’s total export surplus earnings from the world, excluding the UK, amounted to 35.3 per cent of the total of the UK’s trade deficits with the world, excluding the Indian sub-continent, in 1913. By 1928, this share had declined to 25.1 per cent; it fell sharply again to only 7.3 per cent by 1935. If we had the time series data we could add the export surplus of other colonized regions, such as Malaya, which was supplying 92 million USD to Britain by the mid-1920s and whose earnings fell even more sharply than India’s. In effect, the foundation of the entire structure of Britain’s long imperium was destroyed with the decline in its colonies’ export earnings. This did not mean that colonial exploitation ended with the inter-war years of depression; on the contrary, Britain extracted another £1200 million from India over the six-year period between 1941 and 1946, by placing most of the burden of the Allies’ war expenditure in Asia on Indian revenues. What the inter-war depression of primary product prices did, however, was contribute decisively to Britain’s demise as the world capitalist leader.

Notes

1  League of Nations 1942, The World Trade Network, mainly authored by Folke Hildgerdt.

2  United Nations 1962, International Trade Statistics 1900–1960, available at www.unstats.un.org/unsd/trade/imts/Historicaldata1900-1960.pdf. The data are stated to be provisional.

3  For an exposition of the mechanism of tribute transfer in diagrammatic form see Patnaik 1984.

4  The relevant literature includes among others, Dadabhai Naoroji 1962, R.C. Dutt 1970, T. Morison 1911 (whose book was reviewed by J.M. Keynes 1911); Y.S. Pandit 1937, B.N. Ganguli 1965, S. Habib 1975, A.K. Bagchi 1976, 1989, A.K. Banerji 1982, I. Habib 1995, K.N. Chaudhuri 1985, S. Sen 1992 and D. Banerjee 1999.

5  Across a period of 130 years, India showed consistent export surplus, with one exception. Reverse Council Bills (payment by Indian importers in rupees to foreign exporters, which were encashable in sterling) came into operation owing to Indian import surplus in only one brief three-year period immediately after the First World War since, owing to the wartime shortage of shipping, there had been a sharp decline in imports into India and a compensating import surge once the War ended.

6  Colonial administrators were clear regarding the working of the mechanism of tribute transfer, even while, as direct beneficiaries, they complacently rationalised it. Bagchi (1989: 71) quotes L Mallet, permanent under-secretary of state for India, from his 1876 memorandum: ‘India sends to England every year about 20,000,000l.sterling worth of produce, with no commercial equivalent… In other words, India incurs an annual commercial loss of 20,000,000l. on her foreign trade, in return for the advantages (sic) of British rule… And it will accordingly be found that in a series of years the excess value of Indian exports over Indian imports in round numbers corresponds with this amount of so-called tribute, which is composed partly of the “Home Charges”, and partly of private remittances…’.

7  T. Morison 1911 and Y.S. Pandit 1937 both estimated the extent of capital imports into India.

8  Any standard elementary macroeconomics textbook gives an exposition of the identities for a sovereign open economy. See Dornbusch and Fischer 1990, Krugman and Obstfeld 1994.

9  The strong export surge just before the First World War defeated the ingenuity of India’s rulers in thinking up new heads of appropriation and for two years only – 1910 and 1911 – Britain appears to have imported capital from India, according to Saul.

10  ‘Had not British exports, and particularly British cottons, found a wide-open market in India during the last few years before the outbreak of the war, it would have been impossible for her to have indulged so heavily in investment on the American continent and elsewhere’ (Saul 1960: 88).

11  In short, capital movements were completely divorced from constraints of the current account balance as regards Britain’s trade and payments with developing temperate regions. Britain invested heavily in these regions owing to profitability, quite undeterred that thereby it rapidly increased its balance of payments deficit with these regions. Nor were there any offsetting balance of payments surpluses of Britain to the required extent with its tropical colonies as long as the normal items of trade and payments are considered: it is only the politically determined, administered item of invisible tribute which allowed it to siphon off the colonies’ exchange earnings.

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