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In the quest to explain economic development, institutional competition has been almost systematically ignored by many economists and historians alike who have fallen under the spell of the interpretation of nineteenth-century German historicists. The members of the German historical school, and especially Schmoller and Bücher, saw the state as the institution that was responsible for the creation of both the market and modern capitalism. Modern institutionalists, although they differ from historicists in many ways, have accepted this narrative, arguing that political centralization is a prerequisite to economic development. One book showing this tendency to accept the historicist narrative can be found, for instance, in Acemoglu and Robinson’s Why Nations Fail (2012). Distinguishing between extractive and inclusive institutions, Acemoglu argues that centralization is a necessary step to building inclusive institutions favorable to economic development. Although Why Nations Fail is a compelling book, its authors fail to explain why centralization is a feature of inclusive institutions. It is, on the contrary, institutional competition that can explain the rise of inclusive institutions in Europe rather than elsewhere — inclusive institutions that ultimately resulted in the most durable and incredible development of standards of living in human history.

Commercial institutional competition was a key factor in the development of the institutional framework that led to modern capitalism. To this extent, the history of Europe is unique. Contrary to other regions, there was no single uniform authority in Europe that could halt commercial development, no universal plundering of the entrepreneurs and workers by the state. As the historian Paul Kennedy notices in The Rise and Fall of the Great Powers, “there were always some princes and local lords willing to tolerate merchants and their ways even when others plundered and expelled them.”

The fall of the Roman Empire gave way to a period of political anarchy and radical decentralization where cities, aristocrats, kings, and the church all competed with each other. Over the centuries, a long evolution of the institutions gave birth to individual liberty. Although the European aristocracies and states were restricting freedom, they were forced to grant more autonomy to their subjects, for, if they did not, people were opting out by migrating or using black markets. As Leonard Liggio puts it, after 1000 A.D.:

While bound by the chains of the Peace and Truce of God from looting the people, the uncountable manors and baronies meant uncounted competing jurisdictions in close proximity. ... This polycentric system created a check on politicians; the artisan or merchant could move down the road to another jurisdiction if taxes or regulation were imposed.

Europe was where the road to freedom began. It was in Europe that the values of individualism, liberalism, and autonomy rose from history and gave humanity a sense of progress that no civilization had ever experienced to such an extent before.

Far from being linked to political centralization, the commercial revolution of the Middle Ages took place in the local and non-centralized cities of northern Italy, the Hanseatic League, and the fairs of Champagne. Commercial cities such as Venice, which could prosper because its lagoons protected its autonomy from invaders, soon competed with Genoa, Pisa and other free cities for commercial superiority, thus improving the institutions necessary for the development of commerce. The guild system disappeared first in non-centralized regions such as the Netherlands and Italy. Freedom of labor was instituted in Milano already in 1502 and the Hanseatic cities took the habit of creating free masters during the sixteenth century, thus increasing both competition and production. Later, in the sixteenth and seventeenth centuries, it is free, localized Antwerp and Holland that became the economic powerhouses of Europe while retaining medieval local autonomy and eschewing state-building. Instances of success by the relatively small states in the Middle Ages could be multiplied and directly contradict the historicist narrative.

Conversely, centralization caused much economic backwardness. The fairs of Champagne, for instance, were destroyed by royal taxation. Similarly, the guild system became highly monopolistic only when centralized states started to extend their power to cities and distribute patents. In France and England, where centralization and state-building was comparatively early, cities progressively lost their autonomy and freedoms during the thirteenth and fourteenth centuries. With this loss of autonomy came a lower level of institutional competition and, therefore, a recrudescence of anti-market practices. Before the sixteenth century, for instance, most craftsmen were not members of formal guilds in France. It is only with the support of the crown that the free crafts were adopting ever stricter regulations so that it became impossible to distinguish crafts from guilds. It is only with the 1581 and 1597 royal edicts that every producer was forced to join a guild whose privileges had to be enforced nationally, thus reducing economic competition.

In the eighteenth century, one of the main arguments advanced by the first political economists was that if the king does not free commerce, other princes will do so and attract the most talented workers. Vincent de Gournay, to whom the phrase laissez-faire, laissez passer is attributed, was constantly worrying that French workers were moving to economically freer countries such as Holland or England. Economic competition between states was still vivid during the times of Gournay and worked constantly to relax the anti-economic barriers created and maintained by the increasingly centralized states.

Europe’s high level of decentralization can account for what is sometimes called “the European miracle.” The best institutions prospered over the centuries whereas anti-economic institutions progressively declined or disappeared. As Bradford DeLong and Andrei Shleifer show in their paper Princes and Merchants (1999), limited government allowed for faster city growth during the 800 years before the Industrial Revolution. In other words: free cities, prosperous cities; prosperous cities, powerful princes.

India, China or the Arabic world never got the communal movements of the eleventh and twelfth centuries. Nor did they benefit from the institutional competition brought about by the free cities of the Middle Ages. In L'Esprit des Lois, Montesquieu, while comparing the European with the Asian political system, notes:

In Asia one has always seen great empires; in Europe they were never able to continue to exist. ... Therefore, power should always be despotic in Asia. For if the servitude there were not extreme, there would immediately be a division that the nature of the country cannot endure. In Europe, the natural divisions form many medium-sized states in which the government of laws is not incompatible with the maintenance of the state; on the other hand, they are so favorable to this that without laws this state falls into decadence and becomes inferior to all the others. This is what has formed a genius for liberty, which makes it very difficult to subjugate each part and to put it under a foreign force other than by laws and by what is useful to its commerce.

“Decentrism” is, as Röpke writes in A Humane Economy, “the essence of the spirit of Europe.” It is what gave room for inclusive institutions to develop, for the merchant to trade and for the ingenuous worker to innovate while keeping the fruit of his labor. Institutional competition formed the cracks through which the productive members of society could finally serve their fellowmen for a profit and participate to a flourishing economy. It was, in other words, the driving force of the European miracle.