Read an Excerpt
CHAPTER 1
The East Indian Monopoly and the Transition from Limited Access in England, 1600–1813
Dan Bogart
History shows that many important markets are limited by laws and customs enforced by political and religious authorities. Examples are bans on trade, prohibitions on migration, and grants of monopoly. The result in all cases is that favored individuals and firms earn "rents," or an excess payment over and above the amount expected in open markets. Introductory economics suggests that limiting markets generally reduces social welfare and hampers development by lowering incentives for innovation.
The importance of limited markets has led to much theorizing and analysis. North, Wallis, and Weingast (2009) is an important recent work tackling this issue. They argue that most societies in human history can be described as "limited-access orders," where the ruling coalition limits entry to markets and the political system. The resulting rents give elites in the ruling coalition an economic incentive to support the regime rather than undermine it through violence or other means. Some limited-access orders can be fragile, such that commitments to elites are fluid and unstable. Shocks can easily lead to violence and the creation of a new coalition. There are alternative systems called "open-access orders." In these societies, governing coalitions do not limit entry to markets and the political system. Instead, social stability is sustained through political and economic competition. Open-access orders are also capable of sustained development above and beyond what is possible in limited access. The interesting question then is why don't all societies transition from limited- to open-access orders?
Providing a satisfactory answer to this question is extremely difficult. The approach taken by North, Wallis, and Weingast (2009) is to use history to illuminate the transition. They propose three doorstep conditions in the transition from limited to open access: the rule of law for elites (doorstep 1), the existence of perpetually lived organizations (doorstep 2), and consolidated political control of the military (doorstep 3). Rule of law for elites is achieved when law is applied equally to all elites and is enforced without bias. In such settings, elite-owned assets and organizations are protected from predation even when the ruling coalition changes. Perpetually lived organizations are those whose existence does not require the sanction of the governing coalition. Companies formed under general incorporation law are good examples of perpetually lived organizations, but there are many other examples in the public and religious spheres.
This chapter studies the English East India Company, with the aim of understanding how the doorstep conditions were met in England. The English Company is notable in the broader literature because it paved the way for Britain's colonization of India starting in the mid-eighteenth century. But for more than a century prior, it was a privileged company with a monopoly over all trade between England and Asia. The East India monopoly is an excellent example of limited access. The Company gave the monarch added tax revenues through special customs duties and a share of the prizes from captured ships. It also provided defense against other European nations in Asia. In return, the Company got the right to earn profits from its monopoly privileges. This partnership was made explicit by the original charter in 1600 and those that followed.
The English Company's monopoly lasted several centuries, but it was far from secure, especially before the early eighteenth century. The government (at first the monarchy and then parliament) authorized groups known as interlopers to trade in East Indian markets, which violated the terms and spirit of the Company's monopoly. The government also forced the Company to lend money and demanded extra payments. As I argue below, political instability and fiscal incapacity were the root causes of the insecurity. The Company usually had political connections to the government to strengthen its privileges, but these were less effective or counterproductive when politics became unstable, as often happened in the seventeenth century. The government was also desperate for loans and taxes, usually in times of war, and thus it could not commit to allow the Company to earn profits in accordance with its charter and agreement.
Remarkably, the East Indian monopoly became more secure by the mid-eighteenth century. Previously, the Company's trading privileges were renegotiated according to the dictates of politics and finance. But after 1744, the monopoly was renegotiated only when the terms of the previous charter expired. Thus an important step was taken toward the rule of law for elites. The achievement of political stability under the early Hanoverian monarchs (1715–1760) and the greater capability of Britain's fiscal system were some of the key factors behind this step.
Despite these developments Britain had not yet reached the second doorstep condition, in which most organizations operate without sanction from the governing coalition. From 1781 to 1813, the monarch and parliament continued to renew the Company's trading privileges for terms of ten or twenty years despite pressures to end them. Key reasons were the Company's strong political connections and its value in defending India against the French. British governments were also keen to preserve the monopoly because the Company earned vast new revenues following the Battle of Plassey and its takeover of tax collection rights in Bengal in the 1760s.
A huge step toward open access was taken in the 1813 charter act. In this act, the Company lost its monopoly over trade with India. From that point forward, private traders could enter the Indian market with few restrictions. The opening of Indian market access was due to several factors. First, manufacturers in the north of England, whose economic interests went against the Company's monopoly, became more influential by 1813. Lord Liverpool's "Liberal Tory" government believed it was necessary to accommodate the growing manufacturing interest and end the monopoly. Second, a random event played a related role. In May of 1812 the Prime Minister Perceval was assassinated. In the election that followed the Company's connections to the governing party in the Commons were much weaker than in previous years, and it could not defend itself against opponents. The timing was bad for the Company because its charter was up for renegotiation in the winter of 1813. Third, the fiscal value of the Indian monopoly diminished as the customs revenues from Indian trade fell in the early 1800s. Notably customs revenues in the lucrative Chinese tea trade rose sharply in the early 1800s, and partly for this reason the Chinese monopoly was kept intact until 1833.
This chapter contributes to a broader understanding of the transition from limited to open-access orders. It also contributes to the literature on the evolution of markets and British institutions. The history of the Company suggests there was no moment when the rule of law for elites and open markets emerged in Britain. In particular there was no dramatic shift to open access following constitutional reforms, like the Glorious Revolution. The gradual building of political stability and fiscal capacity by the mid-eighteenth century were the key processes leading to the rule of law. The growth of northern manufacturing interests in the late eighteenth century was also significant in bringing the monopoly to the end. The last finding raises more general questions about the relationship between the transition to open access and economic growth. It is not clear which caused the other. The conclusion returns to these broader themes.
1.1 The Origins of Monopoly in the East Indian Trade
The East India Company was founded in 1600 through a charter granted by Queen Elizabeth. Management was in the hands of a governor and a board of directors. Shareholders with a minimum number of shares elected the governor and directors. The Company was given a monopoly over all trade and traffic from the Cape of Good Hope to the Straits of Magellan — an area encompassing much of the world's population (Scott 1912, 92).
The East Indian trade was not unique in being organized around monopoly. Jha (2005) identifies twenty-eight chartered companies in foreign trade from 1555 to 1640. Most of these companies were granted a monopoly over trade with a particular region, like the East Indies. Monopoly was common because it offered the monarchy added tax revenues, a source of loans in times of emergency, and assistance in governing at home and abroad. In the East Indian context, there is an argument that monopoly was also selected because of the efficiency benefits to directors and employees due to the violent trading environment in Asia, and the challenges of corporate governance in an age with poor communication. The social welfare implications of the monopoly are not obvious, but for our purposes this is not the main issue. The monopoly was mainly selected because it suited the needs of the monarch.
It is important to note that the legal foundation for the East Indian monopoly was weak. The original charter from Queen Elizabeth allowed any privileges to be voided by the monarch with two years notice and with little justification (Scott 1912, 92). Therefore, is not surprising that the Company's first directors tended to be closely connected to the monarch, and were part of the governing coalition. The Company's first governor, Thomas Smythe, was connected to Queen Elizabeth because his father had improved Elizabethan customs collection. Smythe strengthened his connections to the Queen in his early life. He was appointed as a trade commissioner to negotiate with the Dutch in 1596 and 1598. In the 1590s he became purveyor for the troops in Ireland. Smythe remained the Company's governor over the next two decades. He retained connections to the monarchy after James I came to the throne. Smythe was made joint receiver of the Duchy of Cornwall in 1604 and receiver for Dorset and Somerset. In that same year he was appointed special ambassador to the Tsar of Russia. See North, Wallis, Weingast (2009) for a discussion of the natural state.
1.2 The East Indian Monopoly under the Stuarts
At the start of the King James I reign in 1603, the Company's monopoly appeared secure. But it quickly became apparent that the Stuart monarchs would not honor the terms of the charter. King James I, and later King Charles I, regularly authorized "interloper" traders to enter the East Indian market. This section details these events and argues that the Stuart's actions were linked with their need for revenues and to reallocate rents to an evolving coalition of supporters.
The first group of interloper traders was headed by Sir Edward Michelborne. In 1604, Michelborne obtained a license from King James I "to discover the countries of Cathay, China, Japan, Corea [Korea], and Cambaya [Cambodia], and to trade there." The license claimed to supersede all previous grants and allowed Michelborne to trade in the East India Company's territory. Michelborne had strong political connections to King James I through the patronage of Thomas Sackville, the first Baron of Buckhurst. Sackville was one of James I's closest advisors, serving as Lord Treasurer beginning in 1603, just one year before Michelborne was granted the license to trade in Asia. After receiving the license Michelborne sailed two ships to Asia, but he was ultimately not successful and returned to England in 1606.
The next interlopers were headed by Richard Penkevell. In 1607, they were given a grant to discover the northern passage to China, Cathay, and other parts of the East Indies (Scott 1912, 100). Less is known about Penkevell except that he was a member of Parliament in the late sixteenth century. After Penkevell, the Company reaffirmed its legal position by getting a new charter from King James I in 1609. In the charter, James I stated that the whole trade in Asia was conferred upon the Company forever, except if the king or his heirs deemed that the Company was not profitable to the monarchy or to the realm.
James I honored the letter of the charter, but not the spirit. In 1617 the king granted a charter to a new interloper group under the name of the Scottish East India Company (Scott 1912, 104). The Scottish Company was headed by Sir James Cunningham, a member of the Scottish Privy Council. The Scottish Company was authorized to trade in the East Indies, the Levant, Greenland, and Muscovy. It appears that James I exploited that he was also the King of Scotland and chose to charter the rival company under the Scottish royal seal, not the English seal. The Scottish East India Company posed a significant threat to the East India Company and the Levant Company, another chartered company operating at the time. The two bought the license from the Scottish East India Company and paid a "valuable consideration" to its leaders and promoters (Bruce 1810, 193–94).
The 1620s marked the beginning of a prolonged period in which the monarchy tried to extract revenues from the East India Company. Scott's (1912, 125–26) analysis of the Company's early dividends shows that the trade had proven profitable. At the same time, tax revenues were stagnating, making the Company an attractive target for royal extraction. In 1620 James I ordered the Company to pay £20,000 to himself and the Duke of Buckingham for captured prizes from Portuguese ships (Chaudhuri 1965, 31). A few years later, in 1624, James I offered to become an adventurer and to send out ships under the royal standard. The Company refused the offer on the grounds that "the whole undertaking would revert to the Crown, since there could be no partnership with the King." In 1628 there was another scheme to admit King Charles I as an adventurer for one-fifth of the stock and profits in return for taking the Company under royal protection. The Company refused once again (Scott 1912, 108–12).
Charles I's failed attempt to gain ownership in the Company provided an opportunity for the interlopers. In 1635 a new syndicate obtained a license from Charles I for a trading voyage to Goa, Malabar, China, and Japan, an activity considered to be within the bounds of the Company's monopoly (Scott 1912, 112). One of the main promoters of the syndicate, Endymion Porter, had been in the service of Edward Villiers, the royal favorite of King James I in the 1620s. Porter's connections to the monarchy continued under Charles I, serving as the "Groom of the King's Bedchamber." Another promoter, William Courteen was a wealthy merchant who made loans to Charles I through Villiers. Charles I eventually became an adventurer in what became known as the Courteen Association. The king was credited with stock worth £10,000, and his secretary of state, Windebank, was also credited with £1,000. The East India Company protested that the license to the Courteen Association violated their charter. Charles I responded that no hindrance or damage was intended to the Company's trade as the ships being prepared by Courteen were for a voyage of discovery. The king also stated that the East India Company neglected to make discoveries and plantations in the East, and thus had no legal basis to protest. The Courteen Association received further support from Charles I in 1637 when the king authorized the partners to send out ships and goods to the East for five years "without impeachment or denial of the East India Company or others" (Scott 1912, 113–14). The Courteen Association was generally unsuccessful in its trading ventures, but in the process the Association caused much financial damage to the Company.
The Company experienced further extractions in 1636 and 1641. In 1636, Charles I increased the customs duties on pepper by 70 percent. The result was that the customs duties derived from the Company's trade were yielding around £30,000 per year by the early 1640s (Foster 1904, 1929, xxviii). At this same time, the political conflicts between Charles I and Parliament were increasing. This made the king's fiscal situation dire. In this context, the king forced the Company to hand over its stock of pepper, which was valued at £63,283. The so-called pepper loan of 1641 was to be repaid in four installments and was secured by the farmers of the customs. The Company had recovered around £21,000 by the late 1640s, but at this point Charles I was executed and the monarchy was abolished. The remainder of the pepper loan was lost for the moment, and was only partly recovered in the 1660s.
(Continues…)
Excerpted from "Organizations, Civil Society, and the Roots of Development"
by .
Copyright © 2017 National Bureau of Economic Research.
Excerpted by permission of The University of Chicago Press.
All rights reserved. No part of this excerpt may be reproduced or reprinted without permission in writing from the publisher.
Excerpts are provided by Dial-A-Book Inc. solely for the personal use of visitors to this web site.
