Was technological change in the early Industrial Revolution Schumpeterian? Evidence of cotton textile profitability

Explorations in Economic History 49 (2012) 516–527

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Was technological change in the early Industrial Revolution Schumpeterian? Evidence of cotton textile profitability C. Knick Harley St. Antony's College, University of Oxford, Oxford OX2 6JF, UK

a r t i c l e

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Article history: Received 22 April 2010 Available online 28 June 2012 Keywords: Industrial Revolution Schumpeterian growth Cotton textiles Prices Profits

a b s t r a c t Price and profit data between the 1770s and the 1820s from accounting records of three Lancashire cotton firms help to illumine the nature of the economic processes at work in early industrialization. Many historians have seen the Industrial Revolution as a Schumpeterian process in which discontinuous technological change led by the mechanized factories of the cotton industry created large profits for innovators that persisted in succeeding decades while technology slowly diffused. In this view imperfect capital markets limited the use of the new technology, keeping profits high. Reinvestment of these profits gradually financed expansion of innovating firms. The new technology dominated only after a long diffusion process. The evidence here, however, supports a more equilibrium view in which the industry expanded rapidly and prices fell in response to technological change. Expansion of the industry led to dramatic declines in the prices of cotton goods as early as the 1780s. There is no evidence of super-normal profits thereafter. Prices continued to fall and output expand thereafter as cost-reducing technological change continued. © 2012 Elsevier Inc. All rights reserved.

1 . Introduction The British Industrial Revolution in the last quarter of the eighteenth century was a key event in the emergence of modern economic growth. Years ago, Eric Hobsbawm noted (1968, 34) “Whoever says Industrial Revolution says cotton.” Technological and organizational changes in the cotton industry have been widely studied in attempts to understand the nature of economic change. This extensive literature notwithstanding, questions remain unanswered. In particular, it is of interest to know the way in which the fruits of technological advance were shared between rising profits, rising wages and falling prices. Although the existing literature frequently makes assumptions on this issue, there is little evidence based firmly on primary sources. This paper attempts to fill this gap by examining cotton textile prices, costs, profits and capital mobilization between the 1760s to the early nineteenth century using surviving account books, although, unfortunately, of a very limited number of firms. Most of the new data have been compiled from the accounts of three cotton textile firms that are preserved in archives in Greater Manchester. One was a weaving firm, Richard Cardwell and Richard Birley and partners, that put yarn (and initially unspun cotton) out to domestically-based handloom weavers. The other two were spinners who were early adopters of the new mechanized spinning techniques: Samuel Greg and partners, and William Grey and partners. This is, of course, a very much narrower coverage of the industry than one would hope for and general conclusions cannot be definitively drawn. The data do, nonetheless, add important detail to what we know about cotton textiles in the Industrial Revolution. The data presented here are, of course, useful in their own right. Additionally, they can help us to understand the process of economic change in the leading industry in late eighteenth and early nineteenth century Britain, and by extension, about the Industrial Revolution generally. The question of how great a role the mechanical inventions and the associated development of the factory system in British cotton textiles at the end of the eighteenth century played in the emergence of modern economic growth and

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the subsequent ‘great divergence’ remains a persistent debate in economic history. From the late nineteenth century onwards most economic histories have taken a Schumpeterian view that emphasized that innovations in economic organization, social relationships and technology in the cotton factories in the late seventeenth century were the key transformation. Some dissenters, most notable Sir John Clapham (1926), pointed out despite its growth cotton constituted a small part of the economy and emphasized continuity. Nonetheless, the view of a decisive change — the Industrial Revolution — dominates. The pioneering quantitative estimate of British economic growth by Hoffmann (1955) and Deane and Cole (1962) showed accelerating growth during the Industrial Revolution and reinforced the view of the decisiveness of the cotton innovations. The revisions of national income estimates in the 1980s (Crafts, 1985; Harley, 1999; Crafts and Harley, 1992) showed little, if any, acceleration of aggregate growth between 1760 and 1830, suggesting a more gradualist view in which changes in the cotton industry were less central to the emergence of modern economic growth. A perception of slower aggregate change, however, does not necessarily contradict a central position for the cotton innovations. Joel Mokyr, one of the leading scholars of the Industrial Revolution, has argued for what he calls a ‘growing-up model’ (Mokyr, 1976, 1999, 82–89; 98–103). This is a Schumpeterian view in which technology created profit opportunities but innovation only slowly diffused throughout the economy. The essence of the model can be seen in the following quotation (Mokyr, 1999, 83): The growing-up model…is a disequilibrium model. Its dynamics depend on the coexistence and interaction of the “old” and “new” technologies…. The traditional sector, which produces the same good (or a close substitute) as the factories, can continue its existence for a long time after the process has started, because the modern sector is still too small to supplant it altogether. As long as the two sectors coexist, the modern sector earns a “quasi-rent,” a disequilibrium payment that will eventually disappear when the manual industries have disappeared. Through continual reinvestment, this rent in its turn provides the fuel for further growth of the modern sector. Mokyr envisages a long disequilibrium phase; his discussion of wage trends (Mokyr, 1991, 190) suggests that he feels it persisted until 1840 or 1850. Imperfect capital markets underlie the long disequilibrium. New firms are unable to enter the industry in response to high profits and expansion of innovating firms depends on retained earnings and so the growth of firms with the new technology is limited (Mokyr, 1999, 99). In contrast to Mokyr's perception of a long disequilibrium diffusion of new Industrial Revolution technology, Crafts and Harley have attempted to analyze the Industrial Revolution using comparative static general equilibrium analysis (Harley and Crafts, 2000; Crafts and Harley, 2004). This analysis rests on assumptions of product and factor markets finding equilibrium fairly rapidly. Profit opportunities created by technological change provided incentives that induced output growth and falling prices. Mokyr's perspective owes much to Schumpeter's insights on the central role of entrepreneurship and industrial finance in economic development and also draws on Arthur Lewis's (1954) model of development with unlimited labor. This view sees the Industrial Revolution as a discontinuous technological change affecting the whole economy. Cotton technology and factory organization acted, in Harberger's (1998) term, like a “yeast”, leavening the economic process generally, but involving protracted diffusion. The leavening process of shift to modern conditions was constrained by limited enterprise, secrecy in technological knowledge and pre-industrial constrains on the mobilization of capital to new profitable industries. The Schumpeterian view characterizes the textile (and steam power) innovations in mechanical production and factory organization as introducing a major discrete general-purpose technology in the late 1760s. Innovators experienced a significant fall in costs but initially their output was small relative to the economy so product prices did not fall. Instead innovators reaped large returns on their investments. In this view, the following several decades were characterized by profits for innovators, reinvestment of these profits and slow diffusion of the superior technology. In contrast, an alternative, more neo-classical, view, recognizes the important initial technological breakthrough, but sees them more like mushrooms popping up here and there in specific technologies in specific industries. The effects of the breakthrough, although initially creating profits to some innovators, principally resulted in lower prices of the products of particular industries in which technology improved. In this view the decades after 1790 when cotton textile prices continued to fall and output continued to expand arose from refinements of technology, introduced more or less continuously into textile production for a half a century or more after Arkwright and Crompton's conceptual breakthroughs, rather than by a diffusion process. The technology was specific to textile production; not a general-purpose technology applicable to the manufacturing generally but mushroom-like appearing here and there apparently at random. Historians of particular regions or industries tend toward the “mushroom” view and stress diversity among regions and industries in the late eighteenth and early nineteenth century (e.g. Clapham, 1926; Berg and Hudson, 1992). The histories of the cotton industry (Fitton and Wadsworth, 1958; Fitton, 1989; Chapman, 1967, 1972; Wadsworth and Mann, 1931; Edwards, 1967), implicitly at least, take the “mushroom” view and stress cotton industry specific changes. The competing views have contrasting predictions about the movement of observable economic variables. Prices movements are the most easily observable implication. A Schumpeterian view, such as Mokyr's Lewis-type model, predicts and, in fact depends on, a delay in the fall of the price of goods after the technological breakthrough and a protracted period of exceptionally high profits for the innovating firms. The gradualists, or neo-classicists, emphasize the diversity of manufactured products, the product-specific nature of technological change, and the rapid exploitation of technological change. In this view the prices of cotton textiles — the specific goods in which technological breakthroughs occurred — fall rapidly relative to the prices of other goods, both manufactured and agricultural, as cotton output expands. The relationship between technologically advanced industries and the capital market provides another contrast. Capital market failure is central to delayed diffusion of technology in Schumpeterian diffusion models. New firms were unable to challenge

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innovating firms and innovating firms were unable to expand rapidly in response to high profits. As a result, super-profits prevailed for a long period. The expansion of the use of new technology was delayed by the limits of financing from innovators' profits. The gradualist neo-classical view rejects prolonged capital market failure. In this view, persistent profit opportunities attracted capital from elsewhere in the economy. Product prices fell and eliminate super-profits. The different views of capital markets invite investigation of the availability of capital for expansion of the new industries and the implications for profit rates provide an avenue for discriminating between the views. Interest in profit levels enters the Industrial Revolution literature in other ways as well. Recent work by Robert Allen (2009) compares estimates of national income and of real wages and concludes that from the 1760s to the mid-nineteenth century the rate of profits and capitalists' share of income doubled. He models the period as characterized by biased technical change that increased the relative demand for capital and thus its price. Furthermore, his simulations suggest that high profits were important to growth. New technology required increased investment and higher capitalists' incomes financed the investment that successful implementation of the new technology required. Not all recent aggregate views, however, see high profits as central. In particular, Greg Clark has recently estimated national income in Britain over the very long run (Clark, 2009). He uses a method that assumes largely unchanged rates of return to capital over the late eighteenth and early nineteenth centuries. It is appropriate to examine the profit rates various authors have in mind in order to place data from the cotton firms into context. Allen is the most explicit. He calculates that the rate of return to capital rose from near 10% in the late 18th century to 15% in the early 19th and surpassed 20% in the middle of the century (Allen, 2009, 241). In contrast Clark's income estimates extrapolate mid-nineteenth century profits into the seventeenth century using output measures. He presents a number of estimates for the rate of return on capital in low risk activities. He indicates that the rate of return on farm land and rent charges was about 4% (consol yields were between 4 and 6% during the early years of the nineteenth century). He considers this to be a risk-free rate. He figures that the average rate of return for farmers' capital at the risk-free rate and cites a figure of 9% for shipping (Clark, 2009, 23). Published histories of the cotton industry during the early Industrial Revolution contain surprisingly limited systematic information on the industry's prices and profits. Arkwright's water-frame, patented in 1769, and a decade later, Crompton's mule were major technological breakthroughs in spinning technology. Arkwright and his partners were Schumpeterian innovators and certainly reaped large profits for a decade or more under patent protection. Soon, however, competitors challenged the patent monopoly and unauthorized use of the technology by new firms eroded cotton prices and profits even before the patent lapsed in the 1780s. With the end of patent protection, competition increased output rapidly and yarn prices quickly fell. In 1787 the Lancashire cotton spinners unsuccessfully approached the Board of Trade for protection from Indian imports. This can be taken as signaling the end of the era of super-profits. Expansion of English production had depressed prices and a period of restricted supply from India had ended. British producers' petition for assistance stated1: Such is the state of the British Cotton Manufacture at present — with establishments and mechanical powers capable of bringing forward immense quantities of goods into consumption. This Manufacture is checked as it were in a moment by a great and sudden reduction of the prices of East India goods of some species which have recently sold 20%. on average, under the lowest prices at which British Manufacturers can afford to sell without loss. The consequence of which has been that a universal stagnation has taken place; the stock of hand daily accumulate — the poor Spinners who work upon hand-mills are in greatest distress and a great and valuable system is in danger of being broken down in a moment, if some remedy cannot be applied; for unless the British Market can be opened for the home Manufacturer, it is impossible to go on — Men and women trained to the business, at great expense, will be set adrift and numerous children sent back to the hospitals and parishes from whence they came. Improved technology apparently no longer created substantial profits, but rather provided consumers with textiles at lower prices. Thereafter the industry grew as a result of continued technological progress and demand expansion not from the reinvestment of entrepreneurial super profits. The end of super normal profits is confirmed by the archival evidence presented here that shows profits fluctuated sharply thereafter but not, on average, exceed a competitive rate of return commensurate with the risks involved.

2. Entry into early cotton spinning The Schumpeterian process of super profits and slow diffusion incorporates the view that innovating entrepreneurs successfully retained market power because entry of outsiders was difficult and slow. The expansion of the use of innovative techniques is seen as profit-financed expansion by innovating firms. Evidence of the number of firms in the industry provides insights into the presence or absence of a Schumpeterian process. Systematic evidence of the number of cotton spinning firms or mills (more than one firm often shared a single mill and some firms operated multiple mills) is not regularly available until the reports of the Factory Inspectors began to appear in the 1830s. The first Inspectors' enumeration of textile mills using power in 1835 (British PP 1836 XLV p.51) listed 990 working cotton mills in the 1 In 1787 the new cotton industry underwent its first major crisis and petitioned the government for relief. Patrick Colquhoun from Glasgow led the delegation that went to London seeking government assistance. The notebook he prepared on that occasion has survived and provides an invaluable glimpse at the industry in the early days of its growth (Colquhoun Ms. Baker Lib. Harvard Business School. Mss. 442 1771–1789 c722). Also see related information in the Public Records Office (BT 6–112; 140; 180) and in the Liverpool Papers in the British Library (Add Mss. 38223 (2); 38391 (26; 35; 56)). The quotation below is from British Library, Add Mss 38223, F, 5, p.2.

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Table 1 Estimates of number of mills in cotton industry 1787–1825. 1787–1812: Chapman (1972) Table 3, p. 30. 1825: Lyons (1985 ) Table 1, p. 420. Date

Origin of estimate

Arkwright mills

Mule factories and workshops

1787 1795

Colquhoun Chapman

143 c. 300

n.d. n.d.

1797 1812

Watts Crompton

n.d.

1825

Lyons

|{z} 900

|{z}

673

799

Lancashire, Cheshire, Derbyshire and West Riding heartland of the industry, plus 8 under construction and 46 unoccupied. In Scotland there were an additional 159 mills (of these 49 wove but did not spin). Elsewhere another 100 mills were enumerated. Here, certainly, there was little market power for firms. Estimates of the number of mills at earlier dates from various sources are listed in Table 1. The Colquhoun estimate comes from the 1785 representation to the Board of Trade referred to above. Chapman's estimate for 1795 and the Watts estimate for 1797, reported by Chapman, are based on fire insurance records. The 1812 estimate arose from Samuel Crompton's effort to obtain a Parliamentary grant in recognition of his invention. John Lyons estimated the number of mill in 1825 by tabulating entries in a major contemporary commercial directory. The numbers in Table 1 clearly illustrate the rapid entry of firms into cotton spinning after (and even before) Arkwright's patents were set aside in 1885. By the late 1780s it is unlikely that restrictions on entry into the industry were sustaining super profits. 3. Cotton textile prices, 1760s to 1830 The movement of cotton textile prices is the most easily observed indicator of the nature of the diffusion of the cotton technology. Falling prices of cotton goods caused by new technology, first in spinning and then from the second quarter of the nineteenth century in power weaving, have been well-known generally but only recently has archival research in company accounts books traced the price movements with greater precision (Harley, 1998). Initially innovation was confined to spinning and had much greater impact on fine yarns and on warps than on coarse wefts. Nonetheless all yarn prices declined dramatically from the mid 1780s or before (see Table 2), eroding initial profits. The price of even the coarsest weft yarns fell relative to the price of other goods to only a third of their early 1780s level by 1815 and prices of other yarns fell by much more. Cotton cloth prices fell much more slowly in the first generation of the Industrial Revolution. This slower price decline occurred, however, not because of a delayed diffusion of new technology but because economically meaningful technological advance had not occurred in weaving. Even so, as Table 3 shows, cloth prices fell impressively in real terms before the end of the Napoleonic Wars because the price of yarn had fallen so much. Cloth prices continued to fall thereafter as technology improved in weaving and finishing. The particular nature of technological advance changed relative prices of cotton goods at relative stages of production as a process of competitive entry would predict. Since the industry was vertical disintegrated, market prices of semi-finished goods at various stages are available. Weaving firms bought yarn and sold gray cloth. Table 3 shows the movement of prices of various components of a standard gray calico suitable for printing between the early 1780s and the 1830s.2 It is useful to trace the ‘margin’ between the price of a piece of cloth and the costs of yarn and raw cotton used in its construction 3 (Table 3, col. 4 and 5). There was no relevant technological improvement in weaving until the 1820s so the weaving margin provides an indication of the shorter term fortunes of the industry. The margin provides an indication of profitability but also contain returns to labor. The ‘normal’ weaving margin appears to have been between 6 and 7 shillings per cloth both in the 1780s and in the early 1820s. Levels above that rate reflected prosperity and expansion and below, distress. From the 1780s to the end of the century, yarn prices and the margin between raw cotton and yarn prices fell, but the value added from weaving yarn into gray cloth did not. Indeed, weaving margin increased by about fifty percent as the industry expanded enormously to take advantage of cheap yarn. During these years weavers and weaving entrepreneurs shared exceptional gains. Weaving wages rose dramatically. Almost all commentators since Baines (1835, 337) have included the following quotation from William Radcliffe's, 1828 memoirs (1828, 59; 66): In the year 1770,…the father of a family would earn from eight shillings to half a guinea at his loom, and his sons, if he had one, or two, or three along side of him, six or eight shillings each per week.... From the year 1770 to 1788 a complete change had gradually been effected in the spinning of yarns....[O]ur family and some others in the neighborhood during the latter half of the time, earned from three to four fold wages [in weaving] to what the same family had heretofore done.... The next fifteen years, viz. from 1788 to 1803, which fifteen years I will call the golden age of this great trade, which has been ever since in a gradual decline....the price of labor only rose to five times the amount ever before experienced in this sub division, every family bringing home weekly 40, 60, 80, 100 or even 120 shillings per week!!! 2 3

The cloth is that discussed by Neild (1861). See Appendix 1 in Harley (2010) for a detailed discussion of the components of the cost of a standard cotton cloth.

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Table 2 Yarn prices, nominal and deflated, 5 year averages 1769–1827 (pence per lb). Harley, 1998. Deflation uses Feinstein's (1995) cost of living index. Current prices Deflated prices

1769 1778 1780/1784 1785/1789 1790/1794 1795/1799 1800/1804 1805/1809 1810/1804 1815/1809 1820/1804 1825/1807

18 weft

40 warp

100 twist

18 weft

40 warp

100 twist

33 34 33 33 27 33 31 22 21 18 11 10

122 99 74 71 62 46 42 35 22 21

532 240 104 92 78 69 72 51 53

47 47 36 36 27 19 15 15 11 10

168 142 97 77 55 39 30 30 22 20

761 318 112 80 66 50 62 51 52

Table 3 Cost components (deflated), printing cloth (shillings per cloth). Harley (1998). Cloth

1782/1785 1786/1790 1791/1795 1796/1800 1801/1805 1806/1810 1811/1815 1816/1820 1821/1825 1826/1830

Yarn

Cotton

Margin between: Cloth and yarn

Yarn and cotton

(1)

(2)

(3)

(4)

(5)

49.0 40.4 34.6 30.9 23.6 15.8 19.5 16.7 14.1 9.8

42.9 33.6 25.7 20.0 15.0 10.8 9.4 8.8 7.3 5.2

11.4 10.3 10.6 11.8 7.8 7.3 6.7 5.9 3.9 2.8

6.1 6.8 9.0 10.9 8.6 5.0 10.1 7.9 6.8 4.5

31.5 23.3 15.1 8.2 7.1 3.5 2.7 2.9 3.4 2.5

Weaving margins and weavers' wages began to decline after the turn of the century as an abundant pool of labor within traditional sectors of the economy moved into weaving in response to the (temporarily) high wages. Added to the effect on the margins of the fall in weavers' wages were real difficulties in the industry arising from the Napoleonic Wars. Napoleon's Continental System and the British Orders in Council sharply cut into the export trade and in the highly competitive industry excess capacity led to sharp declines in prices. 4 Table 3 reveals the second half of the first decade of the century as very difficult for the industry (as the profit calculation below confirm). Napoleon's defeat temporarily reversed the situation. The industry enjoyed exceptional prosperity as Continental markets reopened after the failure of Napoleon's Russian campaign in 1812 and the boom continued until after Waterloo. The boom was short-lived; exceptional condition passed and the deflationary years that accompanied the return to gold created further difficulties. By the mid 1820s technical improvement in power weaving started to reduce the margin between yarn costs and cloth prices. In this environment the earnings of hand-loom weavers continued to deteriorate even in normal years for the industry.

4 The authoritative source remains Crouzet (1958). This work draws heavily on the letter books of the Manchester fine spinning firm of McConnel and Kennedy (in the Rylands Library in Manchester). His description of the industry's fortunes between 1803 and 1812 contain the following summary statements: Aussi, à la crise de 1803 succéda, en 1804, une sorte de marasme prolongé, que provoqua de plaints de la part des milieu cottoniers. En 1805, la situation fut meilleurs (c'est ainsi que les salaries de tesserands augmentèra légèrement). Mais la correspondence de Mac Connel et Kennedy révèle que les filatueurs conurent ceraines difficultés (p. 192). Au total, it apparâit que l'industrie du coton connut pendant l'année 1806 des fluctuations assez fortes; cependant, l'été fut une période d'activité intense, et la production totale fut certainement supérieure à celle des années precedentes. Mais on peut penser que les profits de entrepises de filature ne furent pas très considérables (p. 195). Au total, l'année 1812 fut assez mauvaise pour l'industie du coton. Certes, elle ne connut pas un marasme aussi complet et persistant qu'en 1811, mais la depression regna pendant la plus grande partie de l'année, et la situation ne s'améliora nettement qu'à l'extrême fin de celle-ci (p. 728). Also see Edwards (1967, Ch. 4).

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4. Profit rates Profit data are much more difficult to obtain than evidence of firm entry or product prices since private partnerships have no interest in publicizing them. Furthermore, while a competitive market generally equalizes product prices among firms (with due allowance for quality differences), profit levels will vary with management ability and luck. The general histories of the cotton industry offer conflicting evidence. Certainly Arkwright, and Jedediah Strutt, his already rich initial partner and financer, became very rich (Fitton and Wadsworth, 1958). We also know, however, that Samuel Oldknow who invested in spinning in the 1780s in close connection with the Arkwrights was kept afloat in his lifetime only by the help of the younger Richard Arkwright who assumed his assets on his death (Fitton, 1989). It is also well known that Samuel Crompton never reaped financial fortune from the mule that he invented. In the cotton finishing business, the Peels became very rich (in large part from early connection with Arkwright) but their late eighteenth century rivals, Hargreaves and Liversey, succumbed to spectacular bankruptcy in 1788. The qualitative evidence suggests that there was a broad range of profit experience but provides no precise indication of profits relative to capital employed. Unfortunately, this also suggests that a small sample of carefully examined firm-level profit data cannot confidently reveal average industry trend. Nonetheless, it is useful to examine the profit performance from surviving company records in detail. Eighteenth century accounting procedures make computing profit rate difficult since it was common to compute and pay ‘interest’ on partners capital to a separate account before calculating profits. In addition, accounting for fixed capital was not systematic. Sufficiently detailed records survive to examine profits and capital stock for protracted periods around the turn of the nineteenth century for three companies — Richard Cardwell and his partners; Samuel Greg and his partners; and William Grey and his partners. The first firm — through most of the period a partnership between Richard Cardwell and Richard Birley although the records cover several partnerships with some variation in makeup — was an extensive putting-out weaving firm that purchased cotton and yarn that it provided to country hand-loom weavers who wove the cloth the firm sold. Profits can be calculated from account books from the late 1770s to late 1810s. The second firm, the Quarry Bank Mill whose principal owner was Samuel Greg, was a rural water frame spinner. The accounts from which I have calculate profits and capital stock span from 1796 to 1811. The third firm, William Gray and Sons, was a Bolton mule spinning firm. Profitability can be estimated — rather less comprehensively than for the two firms above — from accounts of this firm that run from 1801 to 1810. Three firms are, of course, a very small sample and their profit figures may well not be representative of the industry. The problem of survivor bias is pervasive in historical work generally and particularly in economic history based on surviving business records. Survivors are almost guaranteed to be more successful than the average firm. There were large numbers of unsuccessful firms that left no records. All three firms here were eventually notably successful. Greg and Richard Hornby, and their descendants were major figures in the industry of the first half of the nineteenth century. The Grays' firm continued to prosper until at least the 1850s. By the second quarter of the century the Grays, Cardwells, Hornbys and Gregs had entered urban elites and bought into landed society (Howe, 1984, 63, 113). Data from these firms almost certainly exaggerate the overall industry profit rate, but on this we have no direct evidence. Assessing profit rates for eighteenth century firms requires care in identifying both the returns appropriately allocated to capital and the firm's capital stock. Accounts from these cotton firms of the late eighteenth and early nineteenth centuries contains information to construct capital stock values and returns but doing so requires careful attention to accounting practices. All three firms followed a general practice of estimated profits by comparing balance sheet totals — of work in progress, finished goods and financial assets and liabilities — in sequential periods. However, considerable payments to capital are missed in these profit calculations. 5 In particular, firms usually paid interest on partners' initial capital and any accumulated interest and distributed profits that had previously been left in the firm before constructing profit estimates. Such payments to partners usually appear in Private Ledgers of the partners. These payments to capital need to be included in measures of returns to firm capital in addition to the profits from the profit and loss accounts. In addition, calculation of the firm's capital stock requires the consultation of various Private Ledgers in addition to the main profit and loss accounts. Finally attention should be drawn to two additional problems for calculating meaningful profits. First, the partnership accounts make it possible to identify payments to the partners but do not distinguish payments to capital from payments for management. Second, general price level changes distorted profits during the inflationary era of the Revolutionary and Napoleonic Wars and the deflationary post-war period. In the accounting practices used, a rising price level will lead to a higher valuation of the inventories and accounts receivable that constituted the bulk of the firm's assets than would have been the case if prices had remained stable. Consider a firm that ended the year with exactly the same assets, in terms of physical inventory and accounts receivable relative to sales, that it started the year with. In physical or real terms, its assets had not increased in value but the balance sheet would reveal an increase in assets. This increase would be reported as profits, thus exaggerating the rate of return of capital. This problem is particularly important in the early years of the war when prices rose rapidly. Of course, a similar but exactly opposite distortion occurred during the post-war deflation where real profits are understated.

4.1. Cardwell and Birley Cardwell and Birley's weaving business primarily involved circulating capital in the form of goods in process of production and shipped but not yet paid for and only small amounts of fixed capital, consequently return to capital is relatively easy to calculate. The 5

Profits from these accounts have been reported in the literature. See, for example, Howe (1984, 27).

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firm's accounting centered on annual inventories of stocks of raw materials, work in progress and finished goods, debts and credits and a private ledger that recorded the partners' financial interests in the firm.6 The annual inventories contain information about the stocks of inputs, initially raw cotton and linen warps and then increasingly cotton yarn, held in the firm's warehouses and the large amount of warps and cotton or yarn in the hands of weavers. The firm employed some 250 weavers in the late 1770 and the number increased to the end of the century when the firm had well over a thousand warps in the hands of weavers (typically one warp per weaver). The inventories also recorded debts owed by and owed to the firm. A considerable amount of the debt was trade credit, but a not insubstantial amount was clearly capital provided by long-term lenders who received interest at 5%. The firm calculated its profits from changes in the value of the annual inventory of goods and financial assets and liabilities. That calculation is a misleading indication of the return to capital, however, because before the partners calculated the firm's worth, they made book transfers to themselves. These transfers consisted of two parts. First, a payment of 6% of the partnerships original capital (£12,000 in the initial partnership) was moved to the private ledgers (£720 per year).7 In fact relatively little of the money credited to the partners in the private ledgers either as interest or as shares of calculated profits was actually removed from the firm. These balances left in the firm were counted as loans by the partners to the firm and received interest at 5% before the inventory balance was calculated. These “loans” were quite large. For example, during the partnership of Richard Cardwell and Richard Birley initiated in 1772 with an initial capital (and stock in trade) of £12,000 the partners' “loans” peaked at £4957 in 1783. Correctly accounting payments to capital requires the inclusion of not only the surplus calculated in the profit and loss accounts but also the interest payments on partners' capital and retained earnings. The capital to relate to these payments is the partners' capital invested (original capital plus retained earnings). Calculating this involves combining information from the private ledgers with the profit and loss inventories. Annual profit rates calculated in this manner are plotted as the dark bars in the top panel of Fig. 1. Over the entire range from 1777 to 1809 profits average 12.5% and range from a high of 45% in 1795 to 10% loss in 1793. The profits calculated above, however, represent not only payment to the firm's employed capital but also to management. The account of the late 1790 indicated that Richard Cardwell's son (also Richard) who had been entered the firm as an apprentice in the early 1790 and became a partner with his father when the partnership between Cardwell and Birley ended in 1799 was being paid £200 per year. If that amount is deducted (presumably conservatively) for each partner before calculating profits, the profit rates are indicated by the clear bars in the top panel of Fig. 1. The average rate of return over from 1777 to 1809 was 11.4%. If we double the estimated management payment the return is reduced by about another percent. 4.2. Samuel Greg at Quarry Bank 8 The surviving records from the Samuel Greg's Quarry Bank Mill trace the profits of a rural water-powered Arkwright spinning mill in the very last years of the eighteenth and first years of the nineteenth century. The structure of the firm, both in its operation and in its accounts, was more complex than was that of Cardwell and Birley because the spinning firm, unlike the putting-out weaving firm, had substantial fixed capital. The general structure of the accounts, however, was quite similar. The firm calculated its profits semi-annually as the change in the value of an inventory of its stock in trade and financial holdings.9 As in the case of the weaving firm, amounts were transferred to private accounts of the partners to cover interest before profit or loss was calculated. In addition at the same time a payment for the cost of fixed capital was transferred to the relevant private account. The accounts used here begin with the establishment of a partnership between Samuel Greg and Peter Ewart on 1 Sept. 1796.10 Ewart brought no capital to the initial partnership but was given a quarter share in the partnership. Greg, on the other hand, brought considerable capital. He owned the mill and its machinery which was valued at £12,000 — calculated on the basis of 95 shillings per spindle ‘including tools and implements of every kind’. The partnership paid Greg rent of 10% annually on the value of the mill (and subsequent additions) into an account (titled F/O) before calculating profit and loss for distribution. Greg also brought into the partnership stock in hand worth £5002 plus £8973 in cash that was to receive annual interest at 5% that was transferred to his private account before calculation were made of partnership profits and loss.11 Again, most the funds transferred to private accounts as rent, interest and distributed profits were retained in the business. Subsequently, the partners received 5% interest on this retained earnings prior to profit calculations.12 Payments from Greg's private account financed additions and improvements to the mill and equipment. These were recorded separately, added to the mill valuation in the F/O accounts and received the same 10% rent as the rest of the mill and equipment.13 One feature of the Quarry Bank accounts was a striking accumulation of cash balances. This was certainly not a financially constrained firm whose expansion was limited by profits available to plow back into fixed capital. In the first valuation, at the end of 1798, the firm had a debt balance of £3822 in its bank accounts. This quickly became a positive balance. By the end of March 1801, it 6

Rylands Library English MS 1199/1. The following note (from the end of the inventory for 31 Dec. 1782 (Rylands Eng MS 1199/1 p. 108)) appears regularly: “Having first deducted 6pCt on £12000 agreed to be taken out yearly by C&B being their original Stock in Trade & entered to their Credit in each of their private accounts in the Ledger amounting together to £720.” 8 The history of the Greg and Quarry Bank has been covered at length in Rose (1986). Chapters 1 and 2 deal with the period discussed here but Rose does not explore the account books in detail. 9 Manchester Reference Library, Ms C5/1/2/2 F/N (Factory/New) accounts. 10 For the initial sources of Greg's capital see Rose (1986, Ch. 2. 11 Manchester Reference Library, Ms C5/1/2/2 F/O (Factory/Old) accounts. 12 Manchester Reference Library, Ms C5/1/2/2 SG (Samuel Greg) and PE (Peter Ewart) accounts. 13 Manchester Reference Library, Ms C5/1/2/2 SG his a/c with Stock. 7

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523

Cotton Firm Profits 1977-1830 50

%

40

Cardwell and Birley

30 20 10 0 -10 1775

1780

1785

1790

1795

1800

1805

1810

1815

1820

1825

1830

1800

1805

1810

1815

1820

1825

1830

40

%

30

Greg

20 10 0 -10

1775

1780

1785

1790

1795

£

2000

Gray

1000 0 -1000 1775

1780

40

1785

1790

1795

1800

1805

1810

1815

1820

1825

1830

1795

1800

1805

1810

1815

1820

1825

1830

Arkwright

£ '000

20 0 -10 1775

1780

1785

1790

-20 -30 -40 Fig. 1. Cotton firm profits, 1775–1830.

had been transformed into a credit balance of £16,342. The balance grew fairly steadily to £69,047 in September 1810. At this point these balances constituted sixty six percent of the firm's total assets of £104,354. At that time the partners withdrew £43,650 from both the firm's cash account and from their private ledgers with the partnership. The cash account remained substantial, growing to £44,127 in September 1814 before declining slightly. Calculating economically meaningful profit rates to represent returns to capital in cotton spinning from these accounts requires several adjustments. First, of course, the payments to the F/O account for rent of fixed capital and to partners private ledgers for interest on retained earnings invested in the firm need to be added back to the profits calculated for partnership distribution to arrive at the return to capital. Second, depreciation of the fixed capital needs to be considered. It is clear from the fact that the valuation of the fixed capital enumerated in the F/O accounts declined about 5% in most years that the partnership was calculating depreciation. The reported depreciated value of capital should appropriately be included in the denominator of profit rate calculation. In addition, depreciation should be deducted from profits as a cost rather than being considered a part of the return to capital. I have calculated two profit rates one with a 5% depreciation rate and second with a 10% depreciation rate (even though Greg seems to have used a rather less systematic procedure). Mary Rose's history of the firm notes that there was a later (1831) dispute between Samuel Greg and his sons regarding the valuation of the capital. An outside mediation concluded that the fixed capital was worth only 52% of the value it was being carried on the books (Rose, 1986, 52). Third, the firm's large bankers' balances are problematic. These balances did not make up a part of the economically relevant capital stock of the cotton spinning firm. In addition they presumably received interest from the bankers that entered the bank accounts that appeared in the balances that underlie the firms profit calculations. In the absence of direct evidence, I have assumed that the bankers' balances received 5% interest and removed that amount from the calculated profits and also removed the balances from the capital stock. It is worth noting that this increases the calculated profit rate since the rate I calculate considerably exceeds 5%.

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In calculating profit rates, I have focused on the Greg's capital and his returns since Ewart initially brought no capital to the firm. Just as in the case of Cardwell and Birley there remains the question what part of Greg's income should be considered managerial remuneration. Ewart's share of the profits amounted to approximately £800 per year and I have deducted this from Greg's income to calculate a pure return to capital that is presented in the second panel of Fig. 1. The light bars on the left are gross of depreciation and management salary. The other two deduct management and depreciation at 5% and 10%. Greg's average rate of return gross of management salary and depreciation from 1797 to 1815 amounted to 16.9%. If management salary and depreciation is deducted the rate of return falls to 11.1 or 8.4% depending on the rate of depreciation. These rates are considerable below the average of 18% the Rose reports from the accounts for 1802 to 1811 (Rose, 1986, 24–25). Again these are hardly spectacular rates of profit. As was the case with Cardwell and Birley returns fluctuated quite widely between a maximum (deducting ten percent depreciation and management cost) of 29% in 1800 and a small loss in 1798. 4.3. William Gray and Sons The third set of accounts from which I have been able to examine profitability over a substantial period are those of a firm that became William Gray and Sons. 14 This was a mule spinning partnership in Bolton that subsequently expanded into a major business in the region during the early nineteenth century. The detailed surviving accounts run from 1801 to 1810 and relate to a partnership of three brothers, John, Henry and William Gray. The firm survived and eventually prospered, but the period covered by these accounts was difficult. When the surviving accounts begin in 1801, it appears that the sons had recently taken over the firm from their father who had provided most of the capital employed. The liability side of the 31 December 1801 balance sheet 15 was as follows: To:

Sundry Persons My Father on Bond Ballance (sic)

£968 £3300 £3953

The firm's assets were divided among trade credit due, plant and equipment and work in progress in the following manner. Due from Sundry Persons Inventories of raw material and work in progress Machinery Factory, Weir etc. Total

£2242 £3863 £3066 £5500 £13,721

When the trade liabilities (£968) are netted out the firm's capital amounted to £12,753. The mill was not included among the firm's assets in the balances until the end of 1805. 16 It is likely that the father retained ownership but it is possible that the mill was left out of the balance sheets that were used to calculate profit and loss because its valuation did not change over time. Much of the capital — the majority if the mill remained in old man's hands — was in the hand of the father. I have not been able to ascertain the payments credited to the elder Gray and the partners prior to the striking of the annual balance. Given contemporary practice, however, it is almost certain that an interest was paid on the bond listed above. It is likely that rent was also paid on the mill and that any balance partners left in the firm also received interest. Lacking details on these payments make calculations of profit rates problematic. The Grays periodically, but not systematically, reduced valuation of the machinery for depreciation in calculating balances. The 1809 account, for example, contains the following17: The machinery is the same as last year From which deduct on sixth

£1700.6.0 £283.7.8

Thus, although depreciation accounting was not systematic calculated profit and loss are net of some depreciation. Since our concern is primarily to investigate whether cotton textile firms generally gained super profits during the first generation of expansion these problems need not trouble us excessively because the few years that began in 1805 were nearly fatal for the Gray firm. The partners clearly knew that they were in financial trouble since the accounts contain quarterly calculations of the (declining) balance of equity in the firm rather than the customary annual calculation. As conditions deteriorated further from 1806 until 1808, only partial calculations were made that did not contain final balances. When a balance was struck at the end of 1808 it showed a negative net worth for the firm. 18 The ‘profits’ calculated from the balances from 1801 to 1810 are shown in the third panel of Fig. 1. Over these years the balance averaged a loss of £360 per year. Not a large percentage loss on a capital over £10,000 but certainly not super profits. It is fairly certain that some capital charges were either paid or transferred to other accounts prior to striking of annual balances. Those 14 15 16 17 18

Bolton Archive and Local Study Service MS ZGR. ZGR 6 f. 16. f. 134. ZGR 6 f. 169. f. 165.

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Table 4 Average profits: 3 cotton textile firms, late eighteenth and early nineteenth century. Cardwell and Birley, 1777–1809 Greg, 1797–1815

Gray, 1801–1810

Gross rate of return on capital Net of management Gross rate of return on capital Net of management and 5% depreciation Net of management and 10% depreciation Balance on profit accounting

12.5% 11.4% 16.9% 11.1% 8.4% −£360

Source: See text.

payments should be included in the return to capital so the firm's cash flow and actual return to capital was almost certainly not negative. Interest was certainly paid, at least in reasonably good years, on the debts to John Gray, Sr. The interest rate on these debts, however, was low. An “account John Gray, esq” indicates “To my Bond for the Balancing with Int at 3 per C ..£350” in 1796. An entry for 1797 reads; “To my Bond fro Ballancing with Int st at 4 perC from the 6th March 1797…£500” and “To my Note with Interest at 5 perCt from 6th March 1797..£150.”19 With these varying interest rates it is impossible to present an accurate estimate of the return to capital. It was, however, clearly below the opportunity cost of capital and well below any reasonable risk adjusted competitive return. This, of course, would be even more clearly so if management income for the partners were accounted for in the calculations (Table 4). 4.4. Arkwright The spinners we have considered were not earning excess profits by 1800 or so. The impression that super profits had disappeared by the late years of the eighteenth century is reinforced by the experience of the pioneering firm in the industry. R. S. Fitton reports annual profits in money terms for Richard Arkwright Jr.'s (Fitton, 1989, 225–228). These are summarized in bottom panel of Fig. 1. Unfortunately, there is no information about how were these profits were calculated or the capital base to which they relate. Nonetheless they confirm both that profits fluctuated and their declining trend. The difficult war years after 1802 that show up in the other three firms are evident here as is the boom that accompanied reopening of trade with the Continent in 1812. The unprofitable state of the industry after the return to peace also stands out (although here the price deflation led to accounting profits falling below real profits). 5. The firms and the capital market The relationship between expanding industries and the capital market provide another contrast between a Schumpeterian view and a moving equilibrium view. In the “growing-up” model, capital market failure is central to delayed diffusion. Outside capital was unable to enter the industry in response to profits and consequently super-profits or quasi-rents persist. Expansion of the new technology was only financed out of these profits. In the neo-classical view, profit opportunities are rapidly exploited, attracting capital from elsewhere in the economy if necessary. Product prices fell and eliminated super-profits. A sample of three firms is, of course, too small to draw confident conclusions. In these firms profits fluctuated widely, but they do not appear obviously above the opportunity cost of capital in the economy when risk and management responsibilities are considered. The firms' records show engagement with capital markets that is consistent with the existing literature of financing of firms during the Industrial Revolution. Both Cardwell and Birley and Greg at Quarry Bank plowed back large amount retained earnings into the business. Availability of retained earnings did not, however, seem to constrain the firms' expansion. This is certainly the case with Samuel Greg's Quarry Bank mill that carried large cash reserves which came to exceed the total non-financial assets of the firm. Cardwell and Birley accounts demonstrate the availability of outside funds, apparently based on personal contacts to be sure, particularly in the start up phase of the business. The inventories recorded debts owed by and owed to the firm. Much of the debt was trade credit, but much was clearly capital provided by long-term lenders who received interest at 5%. By my possibly incomplete calculation, these investment in the firm in 1778 amounted to more than £5000, a substantial amount relative to the £12,000 initial capital of the partnership.20 The lenders seem to have had personal connections with the partners in the firm. Over £861 comes from Hugh Hornby & Wm Clayton and £228 from Elizabeth Cardwell. The largest deposit was £1747 by the Executors of the late Mr Holme. Most intriguing are three deposits by the “Trustees of the Charity School” amounting to £408 (Harley, 2010). Trade credit also could swing considerable. Cardwell and Birley's accounts always showed substantially more due to them than they owed. The Grays, however, went from a situation in 1801 and 1802 when their receivables exceed their payables by more than a £1000 to having net debts of over £5000 in 1809 (a a swing equal to about half of the 1801 value of the firm of £12,753). The diffusion model receives support from the widespread observation that reinvested profits financed most of the expansion of the Industrial Revolution's firms and the accounts reviewed here also reveal the dominant role of retained earnings. Such observations, however, are weak indications of capital market failure. Certainly reinvested profits were a major source of investment funds but this remains true for firms today and is a poor indicator of capital market weakness. Most detailed studies of the late eighteenth century textile industry reject the view that firms were isolated from capital markets and suggest several reasons for 19 20

ZGR 2 p. 34–35. Rylands Eng MS 1199/1 p.55.

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doubting the existence of a serious capital constraint. Even with the mills and machinery of Arkwright-type yarn production, fixed capital played a relatively modest role in the costs of new firms. Furthermore, the new technology attracted capital from pre-existing putting out and mercantile sources. New firms using the new technology were also able to fit into the sophisticated “web of credit” that existed in Britain by the late eighteenth century (Crouzet, 1962, 1972; Pollard, 1964; Chapman, 1967, 1970; Cottrell, 1980; Hudson, 1986, 1989). The credit system involved book credit among customers, bills of exchange and the emerging country banking system. Crouzet (1972, 45) citing Pollard (1964)) concludes that ‘this web of credit should be placed near the centre of the exposition of the accumulation of capital.’ Merchant firms, which supplied industry with a large part of the circulating capital, thus played a dominant and decisive part in the Industrial Revolution, and the financing of stocks by mercantile capital was much more important than industry's self‐finance, at least up to 1815. Crouzet ends his discussion of the financing of firms (1972, 53) concluding that the emphasis which recent writing has placed upon trade credit, a closer relationship between banks and industry, and the early capital market, has tended to show that in eighteenth century and early nineteenth century Britain, with its sophisticated and innovating financial system, capital supply was not a serious problem. That eighteenth century businesses drew heavily on internal funds and external funds from individuals with personal or business contacts with the firm's owners should not cause surprise. Investment always involves the surrender of command over current resources for expectations of future return. Future returns depend in large measure on the ability, diligence and honesty of those running the firm that is using the investment. When outsiders lend they must be compensated for the risks they bear from depending on the performance of others in managing the firm. This risk of uncertain agent behavior does not arise when partners in the firm invest their own funds. Consequently internally generated funds are cheapest to the firm and will be used in preference to other funds if they are available. The next cheapest funds come from those who are able independently to judge the character of the firm's partners. Only when the economies of scale in the technology are so great as to necessitate very large firms for efficient production does it become appropriate to invest in managerial and accounting techniques that can provide investors who do not personally know the managers of the firm the reassurance they need to be willing to part with their funds. 21 The predominance of internally generated funds in the expansion of firms cannot, by itself, tell us whether the capital market operated efficiently during the Industrial Revolution or not. Perhaps firms needed no additional funds to exploit the opportunities the technology presented. In the accounts examined, this was clearly the case at Quarry Bank where the partnership carried large cash balances through the period investigate. The rate of return that capital earned in the industry relative to earnings in other uses with comparable risk provides a proper test of the availability of capital and the calculated rates of return do not suggest opportunities to invest were missed.

6. Implications of entry, price and profit data for views of the Industrial Revolution Schumpeterian and gradualist neo-classical views of the Industrial Revolution predict different price and profit developments following the famous cotton innovations of the 1760s and 1770s. Firm entry and prices movements are the most easily observable implication. A Schumpeterian view, such as Mokyr's, predicts, and in fact depends on, a delay in the fall of the price of manufactured goods after the technological breakthrough and a protracted period of exceptionally high profits. The neo-classical view emphasizes the diversity of manufactured products and the product specific, and thus limited, nature of technological change and its rapid exploitation. The expectation of this view is for the prices of cotton textiles — the specific goods in which technological breakthroughs occurred — to fall relative to the prices of other goods, both manufactured and agricultural, as cotton output expanded. Data on numbers of firm in the industry challenges a view that entry was restricted. Price data show a rapid fall in cotton textile prices and a pattern of price changes between yarn and cloth that reflects the timing of technological change. Examination of the profits earned by a small sample of cotton textile firms suggests that technological change that lowered costs of production quickly attracted enough investment to increase output and drive down price to the reduced cost level. Limited data on profits are far from conclusive, too be sure, but they indicate that sufficient capital was attracted to the industry to expand output and drive profits down to something that resembles the equilibrium of the economists' model of a perfectly competitive market. The data examined here do not support the contention that the process originated by improved cotton technology is usefully analyzed by a disequilibrium “growing-up” model that emphasizes the difficulty that outsiders had in gaining knowledge of the technology and the imperfections in the capital market. It suggests, instead, that a more equilibrium modeling that recognized that the impact of technological change was specific to particular industrial processes and focuses on distinctions among industries and changing relative prices probably has more to offer in understanding the beginnings of modern economic growth in Britain. This in turn suggests that although the history of the cotton textile industry deserves the attention it receives, it is far from providing the key to understanding of the modern growth process.

21

See Neal (1994, 151–157) for a discussion of this issue; also Mokyr (1999, 99–102).

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(Eds.), Labour's Reward: Real Wages and Economic Change in Nineteenth- and Twentieth-century Europe. Aldershot. Fitton, R.S., 1989. The Arkwrights: Spinners of Fortune. Manchester University Press, Manchester. Fitton, R.S., Wadsworth, A.P., 1958. The Strutts and the Arkwrights: 1758–1830. Manchester University Press, Manchester. Harberger, Arnold C., 1998. A vision of the growth process. American Economic Review 88, 1–32. Harley, C. Knick, 1998. Cotton textile prices and the industrial revolution. The Economic History Review 51, 49–83. Harley, C. Knick, 1999. Reassessing the Industrial Revolution: a macro view, In: Mokyr (Ed.), The British Industrial Revolution: An Economic Perspective, 2nd edition. Westview Press, Boulder, pp. 160–205. Harley, C. Knick, 2010. Prices and profits in cotton textiles during the Industrial Revolution. Oxford University Discussion Papers in Economic and Social History, p. 81. Harley, C. Knick, Crafts, N.F.R., 2000. 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REFERENCES Primary sources Cotton and woolen factories. Returns of persons employed in cotton, woolen, worsted, flax and silk factories of the United Kingdom, PP 1836 XLV. Colquhoun Ms: Baker Library, Harvard Business School in bound volume entitled “Manuscript Memorandum of Cotton Manufacture in Great Britain” HB 44LT E. MSS: 442 1771–1789 C722. Liverpool Papers, British Library Add Mss. 38223 (2); 38391 (26; 35; 56). Public Records Office BT 6–112; 140; 180. The records of Cardwell, Birley and Hornby (after 1798, Birley and Hornby). The John Rylands Library, Manchester. English Ms. 1199. The records of W Gregg and Partners. The Manchester Reference Library, Local History Unit. Quarry Bank Mss. Ms C5/. The records of William Grey and Sons. The Bolton Archive and Local History Service. Ms. B259.