The Evolution of Markets and the Revolution of Industry

Why did the Industrial Revolution start sometime in the 18th century in England and not earlier and in some other country? This paper argues that the key to the start of the Industrial Revolution was the expansion and integration of markets that preceded it. Due to less regulation, increasing population, and declining trade costs, markets in England came to support an increasing variety of goods. As such, the demand became more elastic and competition intensified. This increased the benefits to process innovation. Sometime in the 18th century, these benefits became sufficiently large for firms to cover the fixed costs of innovation, giving rise to the Industrial Revolution. We illustrate this mechanism in a model with endogenous innovation and population and show that it generates a transition from a Malthusian era to a Modern Economic Growth era as well as a demographic transition and a structural transformation. We provide empirical support for our theory by documenting the evolution in markets in England prior to the Industrial Revolution and by documenting that markets at the start of the 18th century were more developed in England than in the rest of the world.