Theology and Economics: Capital Markets (Part 3)

Renaissance to Enlightenment

Most of Europe was a collection of feudal agrarian societies before the Renaissance. Serfs paid rent to a lord for the use of land. That lord paid rent to a higher lord, who paid rent to a King. Lack of a clear title for land ownership made exchanges in real estate very difficult. Furthermore, tenants were unlikely to make more than minimal improvements to property because their hold on property was so tenuous. It was enough to survive.

This "rent seeking" practice was ingrained in most of the monarchies of continental Europe. As the economies grew, rent seeking expanded into every aspect of life. Permission was needed from the government to engage in most economic activities. Permission was granted upon payment of fees to government officials. The King's nobles, exempt from taxes themselves (along with clergy), were the ones who collected the fees. One could purchase a position of nobility by paying a large fee to the King. In return, the King would grant the noble a monopoly on collecting certain fees in certain areas. These nobles might, in turn, sell rent-collecting positions to others under them.

This behavior resulted in creating a highly corrupt government system that was utterly indifferent to economic productivity. It created an economy where prosperity was achieved by securing government favor and living a life of leisure off of the revenue exacted from productive workers. In France, this rent-seeking system eventually forced farmers to sell their lands and become indentured servants to the nobility. It also brought on the French Revolution at the end of the eighteenth century.

However, not all of Europe was dominated by despotic monarchies. The city-states of Northern Italy were an important exception, Venice in particular. Venice's inhabitants were the descendants of wealthy refugees who fled from the mainland of Italy when the Lombards attacked in the years following the collapse of the Roman Empire. Its geography made it an excellent defensive position and an ideal location for shipping traffic. Initially, Venice aligned itself with the Byzantine Empire, and its leading residents were considered nobility. However, they were nobles without landed estates and located at the empire's far edge. From the start, their economy was tied to trade between the East and Europe.

The absence of dominant feudal systems and the focus on trade made cities like Venice, Florence, Pisa, Genoa, and Milan the most economically innovative centers in Europe. By the thirteenth century, these cities produced banking families with outlets as far away as present-day Germany, England, and Portugal. They used and perfected the letters of credit method used by the Templar Knights and the monasteries. (In fact, the Knights may have learned their financing techniques from the city-states.) The abacus, Arabic numerals, and the concept of zero were made widely accessible in Europe in 1202. Schools sprang up to teach these skills and concepts in Northern Italy. Double-entry bookkeeping was invented. By the fourteenth century, these firms had created corporations complete with by-laws, corporate seals, charts of accounts, and, in some cases, the corporation's share ownership concept. Family companies like Riccardi, Medici, and Peruzzi dominated lending and finance all across Europe by the fifteenth century.

It is important to note that these were indeed family businesses. During the Roman Empire, business failure and loan defaults could result in the complete confiscation of property and servitude for the defaulting party. This tradition carried over into Europe, including the Italian city-states. For this reason, all European branches were run by family members partly because no family member would exact such draconian penalties on other family members. For this reason, almost all commerce conducted up to this time, and for a few more centuries beyond used debt financing. Partnership or share ownership with others meant that if the business went under, everyone connected stood to lose everything they had, including their freedom. Lending meant only the capital lent was at risk.

The Northern Italian model of city-state commerce quickly spread north to cities that had escaped dominance by the rising nation-states of continental Europe. Other cities and regions managed to gain some autonomy, but the rural areas of continental Europe remained trapped in feudalistic relationships. The Northern Italian cities quickly declined as Spain expanded its despotic control over the area in the early decades of the sixteenth century. The center of commerce shifted to the great cities of present-day Netherlands and England.

The story of Dutch commerce is of great importance to economic history. It played out primarily in the sixteenth through eighteenth centuries when France brought about its demise. For our purposes here, we will simply note the Dutch, along with Spain, France, and England, began the world colonization process that eventually created the global economy (although initially with a highly destructive mercantilist mentality.) This expansion of trade and commerce led to continual refinements in market practices at home and internationally. The Dutch were leaders in developing joint-stock companies, the forerunner of the modern corporation. We have more to say about this in the next post. The next major leap forward in capital markets would come from England and the United States during the Eighteenth Century to the present.

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Comments

[Dana Ames]

Hmmm....the "rent seeking" activity you describe could characterize lots of places in Africa and South America today. Not a pretty picture- how to get the hamster off the wheel?

I am glad to know that the northern Italians, from whom I am descended, were so innovative :)
Dana

[Michael Kruse]

"..."rent seeking" activity you describe could characterize lots of places in Africa and South America today."

I will write more about this next week but you are right on. Who colonized Central and South America as well as large portions of Africa? Spain, France and Portugal. The big three "rent seeking" cultures of Europe. It is deeply ingrained. How to get the hampster off the wheel indeed!