The Third Pillar: How Markets and the State are Leaving Communities Behind. Raghuram Rajan

in long parallel lines, with the first line firing then stepping behind the second to reload, and so on, so that near-continuous volleys of fire could be directed at the enemy. To be effective, the army needed many more recruits with substantial drilling and discipline, which meant a large standing army.27 The size of armies of some states increased tenfold between 1500 and 1700.28

      To afford both cannonry and an army, any political entity required a larger catchment area, both to find peasant recruits and to find taxes to pay their bills. Little political entities no longer had the population nor could afford the minimum necessary expenditure. The average size of the state increased as entrepreneurial rulers started integrating smaller entities in the fifteenth century, and by the end of the century, the number of entities had halved to around five hundred. By 1900, these were down to twenty-five or so.29

      The expansion in the size of the political state also meant an expansion in the size of its domestic market. Monarchs increasingly obtained monopoly control over violence within their country by controlling the powerful landed magnates, a subject we will explore in greater detail in the next chapter. They also suppressed the entrepreneurial robber barons and pirates, making trade routes safe.

      This meant that producers could sell in the entire national market. Moreover, in the thirteenth and fourteenth centuries, aids to navigation like the dry compass and the astrolabe, coupled with new technologies in ships such as multiple masts with lateen sails and the sternpost-mounted rudder, which improved ship maneuverability and stability, meant ships no longer had to hug the coast, and could venture much farther out at lower risk. This expanded trade, and thus added to the size of the accessible market. With larger available markets, producers could specialise, as well as raise the scale of their production, thus reducing unit costs of production. As the prices at which they were willing to sell fell, demand for goods increased.

      In sum, political consolidation led to economic integration. When combined with maritime technological innovation that allowed trade with more distant land, producers could now exploit economies of scale. European production of crafts and manufactured goods, centered in towns and cities, expanded. And as markets delivered all manner of goods, the manor too specialised, with some focusing on cash crops like grapes, transformed into wine, instead of the earlier emphasis on necessities like cereals – for cereals could now be bought with the money obtained from selling wine.30

      The increase in production and trade played an important role in weakening the case against usury. A master craftsman or merchant wanting to borrow to finance an expansion in his business or trade was not in the sympathetic position of an illiterate peasant living at the margin of starvation. As the community turned from consumption loans to small production or trade loans, public attitudes toward usury became more favourable. After all, it seemed only fair that those who sought commercial loans to make profits should pay a share of their profit out as interest.

      THE POWERFUL INTERESTS

      Moreover, the monarch was now an interested party. With the increase in the expense of fighting wars, he needed additional sources of revenue. The merchants, artisans, and moneylenders in the growing towns could be taxed, but yet more tax revenue could be obtained if they were freed somewhat from Church regulations concerning the just price at which transactions could be done or the interest that could be charged, and allowed to make larger taxable profits.

      Furthermore, when rulers still needed funds after squeezing all they could out of the taxpayer, debasing the currency, and seizing the estates of weak lords, they had to make their way to the moneylender. There was always a danger that the king could turn on his lenders, labeling them usurers and refusing to repay. The few who did lend did so at high rates. They kept the impecunious monarch on a tight leash so that if he defaulted, he risked shutting off further recourse to loans, which might especially weaken his ability to fight off his enemies. So monarchs repaid enough to keep the loan spigot open, and were inclined to look for ways to permit such lending.

      There was also a mighty potential lender: the Church itself. It had become rich, in part because of the way it had shaped rules governing usury and inheritance. Church treasuries were full of reliquaries, candlesticks, and vessels made of precious metals, which not only increased the grandeur of Church services, but also could easily be melted down, coined, and loaned. The French historian Henri Pirenne asserts that ‘the Church was the indispensable moneylender of the period.’31

      With both monarchs and the Church administration inclined to allow some borrowing and lending, ways had to be found. Many in the Church were not comfortable with violating what they believed was a Scriptural ban. Financial innovation helped satisfy those in the Church looking for a fig leaf that the letter of the interest prohibition was not breached. For example, bills of exchange allowed a borrower to pay interest to a lender provided the borrowing was done in one currency and repayment in the other. The interest payment was hidden in the rate at which one currency was exchanged for the other, but could also be justified as a compensation for the exchange rate risk the lender bore.32

      Similarly, the Church, following Roman law, allowed a penalty imposed for late payment, poena detentori. It was then a simple matter to lend with a fixed date for repayment and an implicit agreement that the borrower would not repay by that day. When he paid a few days later, a penalty was tacked on, which surprisingly approximated the market interest that ordinarily would have been charged by less conscientious lenders! When there is a will, the market finds a way around impediments; financial innovation helped finesse the Scriptures, much as it helps aggressive financiers avoid regulations today.

      THE STATE MOVES AGAINST THE CHURCH

      Not only was the Catholic Church inclined to turn a blind eye to some types of lending, it was becoming weaker politically once again. Its pronouncements, including on usury, began to carry less weight. The Church’s wealth made it an attractive target for monarchs. They preferred their subjects’ wealth to stay within their control rather than be transferred into the hands of a distant, and possibly antagonistic, Rome.33

      Much as social media today has allowed politicians to reach people directly, bypassing the filters of the mainstream press, Gutenberg’s movable-type printing press allowed critics of the Church, abetted by the local prince, to gain direct access to the masses. The reduced cost of printing pamphlets, as well as the spread of literacy, especially among the growing business community, ensured that the Church could be challenged and the arguments would reach many more people than in the past. Indeed, conservatives at that time warned that ‘printed books and broadsheets would undermine religious authority, demean the work of scholars and scribes, and spread sedition and debauchery.’34 They were right! For instance, over three hundred thousand copies of Martin Luther’s theses against the Catholic Church were circulated between 1517 and 1520, something that would not have been possible without the press.35

      Additional pressure for reform came from secular law and secular courts that increasingly competed with the Church to try usury cases. Over time, though, as commercial and state activity necessitated the charging of interest, secular courts became willing to enforce loan contracts, especially when interest rates were moderate. French and English monarchs adopted the legal fiction that their moneylenders, both lay and clergy, were to be considered Jews for legal purposes, and came under secular law courts.36 Judges, however, needed more than workarounds. Scholarly arguments were made to support the practical judgments of secular courts. As monarchs grew more powerful and independent of the Church, this meant more protection to usury.

      As selective violations of usury prohibitions, such as royal or commercial borrowing as well as Church lending, increased, usury prohibitions became ever more difficult to justify as a purely religious matter. As the historian Richard Tawney has argued, the religious arguments for the prohibition