The Third Pillar - Raghuram Rajan

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the advances it had made the king, so it did not have to stand in line outside the treasury for an uncertain repayment, unlike ordinary creditors. Finally, because the privileges came directly from the king for the most part (only some were authorized by Parliament), the guilds and monopolist companies became his loyal supporters, if nothing else because their continued fortunes depended on his survival. Every side benefited except the consumer who paid the higher cartelized prices!

      The monopoly charter was not a secure form of property right. It was an easily transferred right, not fortified by the competence of the holder—indeed, the longer the monopoly was held, the more inefficient the holder would get, and the easier it would be to expropriate, as was the case with the monastery land. What kept the monarch from large-scale taking-back-and-reselling of monopolies was probably concerns about the risk of angering a large group of merchants or craftsmen in the guilds or companies, as well as the loss of reputation and the damage it would do to the sale price of future monopolies. These were fragile supports on which to build large-scale investments, and typically such businesses invested little.

      . . . AND MERCANTILISM

      The alliance of town and Crown was not without other vulnerabilities. Foreign producers could compete with domestic ones and push prices down. Monarchs, however, had a very short-term view of economic might, perhaps influenced by the multiple reign-ending military threats they faced. They essentially believed that economic prowess depended on what was produced in the country in the short run, and thus sought to discourage imports and encourage exports—a practice which was called mercantilism. It was thought this would create more domestic jobs and income, exactly the argument that today’s populist politicians put forward. A collateral benefit would be that as a country sold more abroad than it imported, it would accumulate gold and silver, allowing it to reduce its dependence on foreign loans. So over and above the domestic restraints on competition, nations imposed tariffs on imports, and encouraged exports by offering subsidies. Not only did all this subject domestic consumers to yet higher prices, it gave domestic producers yet another layer of protection from the need to compete and innovate. Indeed, that was the purpose of mercantilism—to favor domestic producers over consumers.

      Mercantilism, as we have seen with the recent export-led growth of Asian economies, can be helpful in the initial stage of a country’s growth, provided other countries do not join in. If, however, other countries practice a tit-for-tat mercantilism, it impoverishes everyone. Moreover, as economic philosopher David Hume argued, if a country did prove successful in exporting more than it imported through mercantilist policies, the resulting inflow of gold and silver would eventually raise domestic wages, rendering its producers uncompetitive.22 Furthermore, mercantilism, appealing as it was to producer interests in the short run, created distortions over the long run. It led to inefficient production methods and investment in the wrong industries. It raised prices of goods domestically, and hurt consumers who consequently had to consume less. Finally, it made producers yet more dependent on the sovereign for protection, preventing them from emerging as an independent power.

      Clever monarchs repeatedly emphasized national identity as an alternative to religious, regional, feudal, or community loyalties. This made mercantilism easier for the public to swallow. Nationalism helped justify higher prices, for they were the cost of keeping jobs at home, thus making the nation stronger. For example, the preamble to the Book of Rates in 1610 (which set trade tariffs in England) appealed to this sentiment, stating that importing unfinished raw materials from other countries was better for “the people of our kingdom might thereby be set on work.” Other finished goods imports were frivolous and not “for the necessary use of our subjects or any ways for enriching our kingdom.” If it was desirable to prefer “our own people to strangers,” it was better to set tariffs on such imports “than that the people of our own kingdom should not be set on work or the country impoverished by the importation of unprofitable or unnecessary merchandises.”23 There is probably no pithier statement of mercantilist nationalism—import less, consume less, produce more!

      Nationalism attempted to bring the country together under one monarch. The advantage, then as now, is that it provided a potent force to motivate citizens to support a national program, usually war, as the power of religion to motivate waned. It also allowed the monarch to break down internal barriers—instead of town-based guilds with small local markets, the monarch encouraged nationwide guilds and a national market. The state gained power at the expense of the community. The disadvantage, then as now, is that it could be misused to persuade people to support unnecessary wars or policies like mercantilism that served narrow interests, and were against the collective good.

      It was hard to suppress competition and the market indefinitely. As with the feudal manor, market forces started eroding some of these cozy restrictive arrangements.24 Skilled craftsmen who were unwilling to put up with the guild’s anticompetitive rules moved to suburban and rural areas, outside the guild’s reach.25 Adam Smith wrote, “If you would have your work tolerably executed, it must be done in the suburbs where the workmen, having no exclusive privileges, have nothing but their character to depend upon, and you must then smuggle it into the town as well as you can.”26

      Competition from foreign producers was also a constraint on how restrictive local guilds or monopoly companies could be. In countries with long coastlines close to major towns such as England or the Netherlands, ships could bring goods quickly in bulk. If there was a sufficient gap between foreign and domestic prices, either because the guild set prices high or because it produced too little given unexpected demand, imports would flood in. The guild could collude with the mercantilist government to impose high tariffs, but with governments having limited resources with which to police borders, smuggling went on all the time to thwart such intent.27 Most entities therefore had to be somewhat competitive, and could not become overly dependent on the state for protection and profits. Along with its independent gentry, therefore, England had a number of independent merchants and craft-masters, even amidst the monarchy-sanctioned monopolies.

      In the next section, we will see how the monarchy became constitutionally limited and more able to borrow directly from citizens, but once it achieved this, it had no real need to continue to privilege certain businesses, especially as it also built out a reliable revenue service to collect its taxes. Conversely, with the government more predictable and solvent, business did not need the extra protection of organizations like guilds or merchant companies. Guilds became largely toothless in the two most constitutionally limited and market-oriented European states, England and Holland, by the end of the seventeenth century. They morphed into brotherhoods and friendship societies, characterized by annual dinners full of pomp and show and plenty of alcohol, but with little actual business.28

      SUSTAINABLE STATE FINANCE

      Let us return to the problem of state revenues. Ideally, the state’s freedom to act would be limited to legitimate actions, not arbitrary or despotic ones, but it should have the capability to act firmly and quickly to deal with the nation’s domestic or external problems when needed. Herein lay the catch. If the king had a powerful standing army and a professional revenue service that collected substantial taxes, that is he had the capability to act, he also typically obtained the freedom to commit any act—hence the absolute monarchy of Louis XIV in France, for example. An alternative was to have a king with very modest government capability, for example one with a small army and no revenue service, as in England under the Stuarts. However, even though the weak monarchy’s capabilities were constrained by the need to raise money to fund any new action, it had not given up its freedom to act. As a result, it tussled constantly with Parliament. England needed firm prespecified boundaries on what the monarch could do so that he could be freed to roam within them.

      The gentry and the increasingly independent merchants and moneylenders were a potential bulwark against the king, a force that could place these boundaries. The king had to unite the forces against him, though, for them to have enough influence. This the Stuarts unwittingly managed to do.

      The Stuarts’ Errors

      The Stuarts’ need for funds led them to antagonize the propertied, both landowners as well as businessmen. James I started selling knighthoods, a practice continued by his son, Charles I. When the going rate for a title declined because so many were sold, they sold higher titles and even peerages. Not

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