Title: Going the Distance: Eurasian Trade and the Rise of the Business Corporation, 1400-1700
Author: Ron Harris
Scope: 3 stars
Readability: 3 stars
My personal rating: 5 stars
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Topic of Book
Harris seeks to understand differing institutions for trade in Eurasia. In particular, he seeks to understand why Europeans invented the business corporation.
- The business corporation was one of the greatest organizational innovations of the modern world.
- The idea of a corporation first started with the Catholic Church during Medieval times. Its purpose was to create an entity separate from both the individual and the state that could live beyond the life-span of a generation.
- The concept was then applied to universities, guilds and cities in Medieval Europe. Finally, it was expanded into business.
- European and Asian societies tried to adapt many different organizational models in responsive to the risks of Eurasian trade:
- Individual peddlers
- Family firms
- Ethnic-based merchant networks
- State-owned enterprises
- All of the failed to compete against European business corporations.
- The English East India Company (EIC) and the Dutch East India Company (VOC) were the first two business corporations. They were founded to reduce the enormous risks involved in Eurasian maritime trade.
- Business corporations could only be formed in societies where the government could credibly promise not to expropriate their money. This was only possible in England and Netherlands.
- The new organizational form enabled the English and Dutch to deploy more capital, more ships, more voyages, and more agents than other organizational forms.
- The EIC and VOC remained the largest business corporations in Europe for the next two centuries and served as the basis for the formation of the British and Dutch Empires.
- The EIC and VOC became models for all future business corporations, but the model stayed restricted to Britain and the Netherlands until the invention of the railroad. This gave those two nations a great competitive advantage.
- The failure of all Asian and most European nations to copy business corporations seriously undermined their levels of economic development.
Important Quotes from Book
Around the year 1400, long-distance oceanic and overland trade along the Eurasian landmass was still mostly conducted over short trajectories.
Business was generally conducted by sole traders or organized around small-scale enterprises: stationary and itinerant agents, family firms, small partnerships, and ethnic networks. But by 1700 the scene had changed completely. Goods were making their way directly from China, Japan, and the Indonesian archipelago to northwestern Europe. They were transported mostly by sea, across the Indian Ocean and around the Cape of Good Hope into the Atlantic. Trade was controlled by English and Dutch merchants, organized on a much larger scale and in an impersonal, organizational form: the joint-stock business corporation. Two such corporations, the English East India Company (EIC) and the Dutch East India Company (VOC), dominated the growing oceanic Eurasian trade.
From another perspective, that of organizing business more generally, until around 1500 business enterprises throughout Eurasia were organized quite similarly in family firms, partnerships, and ethnic networks. Thereafter, Western Europe diverged. Its larger businesses—first in trade, then in finance, later in infrastructure and transportation, and later still in manufacturing—were organized in the form of business corporations, many of them with joint-stock capital. This new organizational form remained exclusively European for three hundred years before it slowly migrated to other parts of Eurasia and the globe.
Another, more abstract perspective identifies the shift from personal to impersonal exchange as a key developmental stage that was essential to the economic rise of Europe. Personal exchange, or cooperation, was based on family, locality, or ethnic kinship ties. Impersonal exchange between strangers was traditionally confined to simple and instantaneous bartering or cash transactions. The shift in Western Europe from family firms and closed partnerships to the joint-stock corporation constituted more than just a switch from one organizational form to another. It was a shift from personal cooperation to impersonal cooperation. This shift amounts to what can be termed an organizational revolution.
Why did the joint-stock business corporation emerge exclusively in Western Europe? This question can be separated into three subquestions: Why did this shift occur around 1600? Why in the context of long-distance trade? Why in England and the Dutch Republic and no other Western European countries? The last chapter of the book deals with two comparative questions: Why wasn’t the European business corporation, if so effective in organizing long-distance trade, mimicked by other Eurasian regions for another three hundred years?
The first-level argument is that the organizational design of the EIC and VOC, the first long-lasting joint-stock corporations, enabled for the first time in human history the formation of large-scale, multilateral, impersonal cooperation. More concretely, it enabled a huge amount of capital to be raised voluntarily from thousands of passive investors. In order for such large-scale, impersonal cooperation to be possible, credible commitment had to be conveyed on two levels of relationships. The first commitment needed was that of the ruler not to expropriate the newly pooled, tangible capital. Such a commitment could be credibly conveyed around 1600 only in England and the Dutch Republic due to the restrained characteristics of their governments, which we take here as exogenous. The second commitment needed was that of the entrepreneurs not to cheat or shirk the outside passive investors. The commitment devices designed for the VOC and EIC governance provided outsiders with a reasonable mix of participation in decision making, exit through the selling of shares, access to information, and share in the profits. Without such institutionalized and credible commitments, the outsiders would have refrained from investing with the new, strange, and impersonal institution known as the business corporation. The ability to convey credible commitment to strangers through the corporate form was a breakthrough on the way to impersonal investment and, ultimately, the modern economy.
The organizational revolution brought about around 1600 by the EIC and VOC in the context of long-distance trade was a turning point in the history of business organization. It formed the basis for the future use of the joint-stock business corporation in the financial, transportation, colonial, and even industrial revolutions.
The new organizational form enabled the English and Dutch to deploy more capital, more ships, more voyages, and more agents than other organizational forms.
Long-distance oceanic trade was the most challenging business activity to be organized in the pre-modern world. Merchants had to deal with risks associated with transportation, navigating their way through unfamiliar routes in the Indian Ocean and along the Silk Route. At sea, they had to confront risks such as storms, monsoons, reefs, and sandbars, and overland they contended with sandstorms, winter storms, and a lack of water and food supplies. They had to bear political and military risks such as those posed by pirates, land bandits, and hostile or unreliable foreign rulers, both en route and in the trade destinations, that could result in expropriation and even death. They had to assume market risks such as price fluctuations and lack of demand for exported goods. If they aimed at anything more than basic spot-barter transactions, they also had to identify common means of exchange and deal with credit risks and contract-enforcement risks.
Long-distance trade organizations were at the organizational cutting edge of the period 1400–1700. The particular challenges they faced were comparable in scale and ambition to those of organizing the Roman Catholic Church and independent cities in earlier centuries; canals in the eighteenth century; railways in the nineteenth century; the financial sector today.
the following is now known: to begin with, Europeans did not enjoy any advantages in shipping or navigation technology over Asians; Asians had better-adapted ships and better knowledge of the Indian Ocean environment; and maritime technology traveled relatively easily because it was not deeply embedded in culture or civilization, so any technological advantage in this realm could be offset by a short technology-adoption timespan.
What is a “business corporation”? The following seven characteristics are in my view the core characteristics of the business corporation: (1) a separate legal personality, which provides longevity and corporate ownership of property; (2) a collective decision-making mechanism which includes delegated centralized management; (3) joint-stock equity finance; (4) lock-in of the investment; (5) transferability of the interest (decision-making and profits) in the corporation; (6) protection from expropriation by the ruler/state; and (7) asset partitioning, which includes two elements—protection of private assets of shareholders from creditors of the corporation and protection of corporate assets from the creditors of shareholders.
The first two attributes could be found centuries before 1600 in religious and municipal corporations. Attributes three through six were attached to the corporate form for the first time around the year 1600 as part of the design and early evolution of the first two joint-stock business corporations, the EIC and the VOC. Attribute seven, which is now considered as one of the cornerstones of the business corporation, was developed only after our period and outside the context of trade.
My argument is that one cannot understand the innovation and leap forward of 1600 without understanding the earlier history of the organization of Eurasian trade. Earlier developments in the organization of trade are important in three respects. First, some of the attributes that were attached to the corporate entity around 1600, notably joint-stock finance and transferable shares, had earlier history in other organizational forms. The cliche that all Western European commercial practices had Italian origins is valid in this case as well, but with qualifications. Second, the shortfalls of organizing long-distance trade in ruler-owned enterprises, family firms, and merchant networks convinced the English and Dutch that it was necessary to innovate in order to make up for being latecomers entering the scene from the very far end of Eurasia. Third, on the more conceptual level, the earlier experience called their attention to the issues that had to be dealt with by the new and innovative organizational form—namely, agency problems, risk mitigation, and information flows.
My argument is that the years around 1600 constitute an organizational revolution. This revolution was constituted by identifying the organizational challenges of Eurasian trade, recognizing the pitfalls of earlier organizational forms, by making use of a uniquely European public-law organization—the corporation, with its legal personality and governance structure, attaching to it financial and business attributes that were developed in the context of trade—joint-stock equity investment and transferable shares, and creating by this intermingling two additional features—lock-in of capital and a sufficient level of protection from expropriation.
What is important for our purposes is that the corporate features were developed within these controversies in order to resolve organizational difficulties within the Roman Catholic Church.
Once corporate practices, such as corporate ownership of property, collective decision-making, and group litigation started to take place in the context of the Church, they were gradually legalized and formalized in canon law.
Why did the Roman Catholic Church, out of all the organized religions, need such a legal–constitutional conceptual framework? Two factors played an important role. While several major religions were an integral part of the apparatus of states, a prime example being Confucianism and the early Eastern Orthodox Church, the Catholic Church aspired to separate itself from the emperor and other secular rulers. Although several major religions were decentralized, notably Hinduism, Buddhism, Judaism, and in many respects also Islam, the Roman Catholic Church was fully centralized and hierarchical. The combination of these two factors made it quite singular.
Roman law and the Roman Catholic Church were the breeding ground of the corporation and created the preconditions for its transformation into the business corporation.
By the fifteenth and early sixteenth centuries, the corporation was already well established as an important organizational and constitutional platform in Europe well beyond the Church. It was uniquely European, having been employed for several centuries to ecclesiastical ends. However, the use of the corporate form had already expanded from spiritual to secular functions. It was increasingly used in the municipal context. Cities in some regions of Europe assumed a level of independence and autonomy from popes and emperors and from the rural feudal system. They found the corporation to provide a good platform for organizing municipal governance and city-based economic activities such as craft guilds, merchant guilds, livery companies, regulated companies, and educational endeavors such as universities and colleges. Guilds—the most significant, late-medieval economically active corporations—had considerable social, fraternal, ritual, and even religious elements.
The first five centuries in the history of the European corporation can be divided into three periods. As with most periodization, this one isn’t neat. Yet the rough scheme is of a first period in which the corporation was conceptualized and used for legitimizing and organizing various elements within the Roman Catholic Church and was used for the constitutional and practical purposes of the Church. In the second period the corporate concept spilled from religious to secular contexts and was used by municipalities and other urban organizations, such as guilds and universities, in order to address their governance needs and consolidate their autonomy vis-a`-vis popes and emperors. England, with its more centralized monarchy, was the first to enter the third period. In that period the Crown monopolized to itself the privilege of creating corporations and used the corporate form as one of its tools for policy promotion, income generation, and control. Entities that viewed themselves as corporations formed in the second period were reincorporated by charters in the third period in order to assert and demonstrate the Crown’s monopoly on incorporation.
Toward the end of the sixteenth century, English long-distance trade to the eastern edges of Europe, Russia, and the Levant was redesigned in a new and experimental organizational form: the joint-stock corporation. Unlike the regulated corporation, the joint-stock corporation traded in only one joint account. This meant that members shared not only overhead but all business outcomes of the corporation—that is, all profits and losses. Unlike joint ventures, these companies had a continued existence beyond a single voyage, often because of the need to make more permanent investments in Russia and the Levant. This existence was anchored on the corporation.
The EIC and the VOC were incorporated by state charter in 1600 and 1602, respectively. They were involved in similar business activities, namely, oceanic trade in high-value goods between Europe and Asia, via the Cape Route. Both were organized as joint-stock corporations, with huge capital and hundreds of shareholders. The formation of the companies occurred at a crucial juncture in the history of business organizations and stock markets. The two entities were significantly larger, in terms of capital and number of shareholders, than any earlier merchant company in England or the Dutch Republic. They were larger than any other Eurasian trade enterprise in history, with the exception of the Portuguese king’s Estado da India and the Chinese state-operated, commercial-cum-political enterprise headed by Zheng He. They remained the largest business corporations in Europe for the next two centuries and served as the basis for the formation of the British and Dutch Empires.
The English and Dutch adventurers had to break through the frontiers of well-established Eurasian organizational forms. The challenges could only be met by designing a multilateral institution that would pool together capital from a larger group of equity investors, based on impersonal cooperation. As the investment was mainly in working capital, ships, crews, and goods in remote seas, no significant collateral could be offered to creditors. The extreme business environment made it more difficult to align the interests of entrepreneurial equity holders and passive debt investors. What they needed was a multilateral institution that could provide a good platform for equity investment, longevity, and capital lock-in. The business corporation was invented to meet this need. It was invented by adding four features—joint-stock, lock-in, transferability of shares, and protection from expropriation—to the corporate platform, turning it into a joint-stock corporation.
To summarize, in the Dutch Republic the federal structure of the state, the overlap between political power and economic power, and the political will to expand trade all helped ensure that the VOC’s assets would not be expropriated by the state and that its charter would not be repealed unilaterally. These factors—not the rule of law, as was the case in England—made the VOC charter a credible commitment device.
The VOC and the EIC were totally different from any other entity that predated them in human history, but they did have much in common with each other—not least, in my view, three very important underlying characteristics. First, they endeavored to undertake the most challenging, risky, and complicated business activity contemporaries could imagine: the longest-distance trade possible on the globe, carrying American silver through Europe around Africa to southern and eastern Africa, and bringing back Asian goods in return. In this respect, the English and Dutch were challenged a little more than the Portuguese and far more than any other enterprise or ruler. Second, they pooled together resources on a level beyond the means of any individual or family and beyond the reach of any social network. The VOC and EIC were both based on outside investment, and brought about the transformation from personal to impersonal cooperation. Third, they were separate from the ruler and from the state apparatus. They were formed in an intermediate space between the state and the family, in which associations of individuals and families could freely exist. England and the Dutch Republic were singular in providing the preconditions for the creation of such a protected space that would, to some degree or other, be resilient to state expropriation of the property and capital accumulated by such associations.
The two companies were by far the largest business enterprises of their time in Europe. They were able to raise joint-stock capital on an immense scale, unparalleled by earlier enterprises—with the exception of the Fugger family firm, the richest firm in Europe of the previous century and the bankers of choice for European rulers.
Within a short span of years, ships operated by companies dominated the Cape Route. In the second decade of the seventeenth century, the VOC and EIC together sent 194 ships past the Cape to Asia, while Portugal sent only sixty-six ships. In the third decade of the century, they sent 199 ships compared to sixty, respectively, and the rising trend in both the number and size of VOC and EIC Cape Route ships (and decline in Portuguese ship numbers) continued throughout the seventeenth century.
Portuguese ships dominated the Cape Route until 1581, while the VOC and EIC dominated the Cape Route from 1610.
What can explain the Portuguese failure?… My hypothesis is that the Portuguese Crown could not credibly commit not to expropriate outside investors.
To the extent that we refer only to well-functioning business corporations, then, even in Europe, the business corporation was confined for a long time to England and the Dutch Republic.
Rather, the relevant difference was in the political structure. In England and the Dutch Republic, the ruler (or state) was constrained and therefore could not do as it wished.
In Portugal and France, the ruler could expropriate the pool of assets created by the investment of private individuals in joint-stock companies. In England, a nascent rule of law allowed the Crown to credibly commit not to expropriate. In the Dutch Republic, a combination of federal political structure and the central role of merchants in the political elite made expropriation impossible.
We now have most of the pieces of these puzzles. Corporations developed in Europe because of the unique needs of the Roman Catholic Church, which sought to separate itself from secular territorial rulers and maintain a hierarchical structure. They were used for organizing joint-stock, for-profit enterprises when Western Europeans aspired to enter long-distance trade with Asia and particularly when European merchants entered Cape Route oceanic trade with Asia, without reliance on platforms provided by rulers and states. They could best thrive in England and the Dutch Republic because, in these countries, a space was created between the state and individuals in which corporate entities could fully develop and flourish. In both of these countries, the state could credibly commit not to unilaterally revoke the charter of incorporation and not to expropriate the merchants and investors.
The corporations, and in particular the EIC and VOC, became dominant in the Cape Route trade because they could raise more capital from more people than any other organizational form but the ruler himself. Unlike the ruler, joint-stock corporations were rational in the sense of accounting for business activities separately from other activities such as waging European wars. They were more focused on making the highest possible profits for their equity investors (or at least some of them). They could not raise the required capital through taxation, as could the Portuguese or the Chinese. Their size and span afforded them huge informational advantage over family firms and partnerships.
The major obstacles to the migrations of organizational forms were not the lack of contacts, knowledge, or opportunities. They were antagonism and resistance. The corporation was an embedded organizational form not simply because it was unknown or underappreciated in China, India, or the Ottoman Empire, but because it did not fit well with the religion and polity of these regions. Moreover, the corporation was not effective without complementary institutions. It could thrive only alongside a state that could credibly commit not to expropriate its asset pools and revenues, as was uniquely the case in England and the Dutch Republic. It could attract outside investors only because these investors were offered an outlet, an exit option, through a stock market. A business corporation unaccompanied by a preexisting bond market, as was the case in the Dutch Republic, or an emerging share market, as was the case in England, was a different and less attractive form of organization.
Before 1600, business organizations relied on personal familiarity between their members, either based on family ties, shared locality, or common ethnicity. Family firms were involved in substantial and quite sophisticated long-distance trade. Using either the lineage or the partnership as an organizing core, such firms conducted large-scale, long-distance trade from bases in Florence, Augsburg, Cairo, Surat, and Quanzhou, among other cities. They relied on family members and used marriage as a tool for extending outward and forming strategic partnerships. They employed agents, sometimes as partners, to further extend their reach. But family-based enterprises had their limits. They could hardly go beyond the family.
Merchant networks, another important pre-corporate organizational form, were usually structured with a hub and spokes. Typically, older and wealthier individual merchants, and the wives and children of younger traveling merchants, resided in the hub. The younger members of the core families and more distant relatives from the same ethnic or religious group served as itinerant agents traveling back and forth between the hub and the spokes, or were employed as stationed agents in spokes. The hub was where funding for the trade came from, a place for information exchange, for hiring agents and for dispute resolution. The networks were not as cohesive as the family firm. Networks were ruled and disciplined by merchant norms and enforcing tribunals. The boundaries of the networks were fixed by the size and scattering of the ethnic group. Networks as such were not able to be involved in cross-cultural trade.
By contrast, ruler-owned enterprises could go beyond the confines of the family and ethnic group and achieve a Eurasian span. Rulers could finance their trade using their sovereign powers of taxation, and could use personnel of the state apparatus, such as admirals, viceroys, ambassadors, administrators, and eunuchs, to manage and control such enterprises. They could use conscripts as employees and soldiers. They did not account for business expenses and profits separately from military and political ones. State-owned enterprises often mingled business and political aims and did not necessarily aim at maximizing monetary profits. They were in a sense impersonal, but unlike the business corporation, they were not voluntary, rational, profit-maximizing entities but rather impersonal entities that were coercive, irrational and redistributive. This was their downside. State-based trade enterprises were seen in fifteenth-century Ming China and sixteenth-century Portugal. However, neither enterprise lasted very long, and by the seventeenth century they no longer played a significant role in long-distance Eurasian trade.
The shift to impersonal, voluntary cooperation was achieved by using the corporation as a platform for advancing business purposes. The European corporation developed neither in the environment of the family nor in the environment of states and rulers. It developed in a religious environment. The exceptional circumstances that existed in the Roman Catholic Church served as the incubator for the corporation. As a religion, Roman Catholicism was hierarchical, on the one hand, and detached from any lay political ruler or state apparatus, on the other. The Church developed the corporation as the core of its constitution to organize decision-making and property ownership within the Church, from the level of abbot and monastery to that of pope and council. A nonhierarchical religion did not need a formal constitutional organizational form. A religion that, theologically and organizationally, was not separate from the state did not need a constitutional structure separate from that of the state. Neither would it serve as a good incubator for the corporation.
After the corporation was developed within the Catholic Church in the eleventh through thirteenth centuries, it was later used for other purposes as well, including the organization of colleges and universities, schools and hospitals, guilds, and cities. It was available “off the shelf ” by the time the English and Dutch were looking for platforms for organizing their Cape Route trade, around the year 1600. The corporate charter provided longevity, a property-owning entity, and a governance structure. The corporate form was useful once the entrepreneurs realized that the family or the ruler could not provide the full solution and that a space was available between the family and the ruler in which corporations could function without concern over imminent expropriation or revocation. Such a space became available only when rulers could credibly commit to avoid expropriation and revocation. In the seventeenth century, among all European rulers, only the rulers of England and the Dutch Republic could credibly make this commitment.
The corporate entity was coupled by English and Dutch entrepreneurs with the financial scheme of joint-stock equity investment. The Dutch built upon experience with commenda and ship shares, while the English built on experience with joint ventures. The two together, when designed appropriately and used in a supportive environment, allowed the matching of outside passive investors with insiders, merchants, and managers and the pooling-together of immense working capital. The outsiders received a voice, an exit option, and information that assured them reasonable protection and a fair share in the profits.
The combination for the first time of the features of joint-stock equity finance, lock-in of investment, transferability of interest, and protection from expropriation by ruler with the older corporate features of separate legal personality, longevity, and concentrated governance amounted to an organizational revolution. The first business corporations, the EIC and VOC, achieved longevity of existence, concentration of management powers, employment of multiple agents and employees, legal standing in transactions and in court litigation, and tradeable equity investment by thousands of passive investors (though not limitation of shareholder liability in the modern sense).
The benefits of having such giant corporations, rather than smaller firms organized as commenda, partnerships, or family firms, lay not only, or primarily, in capturing monopoly rent, as many historians believe. The main advantage in having a single business corporation with ships, factories, and agents all over Eurasia was informational. The headquarters of the EIC and VOC had access to better information about markets in Asia and Europe, prices, goods, routes (and the risks involved in them), agents (and their loyalty and performance), and competitors (anywhere from Japan and China to Europe) than any earlier long-distance trade enterprise before them. They used this information to make better informed business decisions. They used the information to better monitor agents throughout Eurasia. Finally, they shared the information with outside investors in their home countries to ensure the latter’s willingness to invest and to lock-in their investment.
In Europe, long-distance trade was the first sector, but definitely not the last, to shift to impersonal cooperation. It was followed by the late seventeenth century by water supply, banks, and insurance corporations, in the eighteenth century by river navigation, roads, and canal construction, and in the nineteenth century by railway, gas lighting, and industrial corporations.
If you would like to learn more about the role that organizations play in creating progress, read my book From Poverty to Progress.