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

risk subjugation.

      It was not just enough to produce more – the monarch had to be able to collect his share in taxes. The more he threatened to take in taxes, and the more unpredictable his behaviour in doing so, the less his people would want to invest in, or put effort into, income-generating economic activity. Instead, they would focus on hiding their income and wealth. The monarch needed a mechanism to signal that he would tax reasonably, even in times of war when he might be tempted to levy huge taxes or expropriate property in order to preserve his reign. So the king had to create institutions that would limit his own ability to be arbitrary, thus convincing people that their taxes would not be used to extort yet more from them. The Church was one such institution, but as discussed in the last chapter, its power was fading. In most European countries, monarchs therefore committed to levy new taxes or raise old ones only if approved by the representatives of the rich and propertied who, in England for instance, were seated in Parliament (and the Estates General in France and the Riksdag in Sweden). Given the difficulty of getting anyone to approve higher taxes on themselves, monarchs tried to find ways to not put the question to the representative bodies if they could find other ways of gathering revenues.

      The obvious alternative was to do cozy deals with the businessmen in the towns, which the emerging absolute monarchs of sixteenth- and seventeenth-century Europe proceeded to do. Europe’s first stab at a regime more tolerant of business resulted in a pro-business but not pro-enterprise economy. Government and business formed a closed community – or what would be called crony capitalism today. The towns were certainly not free markets.

      Taxing Towns

      As agriculture became more commercialised and prosperous, it could provide more taxable income. There were limits, though, on how much the powerful landed could be taxed – in France they were not, and in England, landowners colluded to pass laws in Parliament to avoid taxes.16 Moreover, the king needed every last bit of revenue for the new forms of mass warfare because, as Louis XIV declared, ‘after all it is the last Louis d’or which must win.’17 So the king looked to the towns and ports, where excise duties could be levied on goods like beer and bricks and customs duties could be charged on imports. In England, for instance, over two-thirds of government revenue from taxation came from Customs and Excise in the early eighteenth century.18

      In order to tax urban production, the monarch had to deal with town bodies like the guilds that had formed for different trades and crafts, as well as the emerging monopoly merchant companies. In the same way as the manor-ial community protected the peasant against the uncertainties of life lived at the economic margin, the guild in a town protected its members from competition, both from others within the guild and from outsiders. It fixed membership fees; hours of work; the prices the master craftsmen could charge, and the wages they could offer; the terms, number, and fees for apprenticeships; and it negotiated on behalf of its members with the monarch or with town leaders for restrictions to be placed on outside competitors. If the response from the authorities was inadequate, the guild was not above taking the law into its own hands. Some organised armed expeditions of their members to search out and destroy any competitor that tried to do business in the territory they had earmarked for themselves.

      The guild was effectively a cartel trying to ensure all its members got a decent living in an environment of weak economic growth, but also seeing to it that none was so energetic or entrepreneurial so as to put the others at a disadvantage. Like the manor, it aggregated the power of its members, a necessity in times when the law was weak, and might often right. It was also a social organisation like the medieval manor, providing economic support to those in need and encouraging interactions between its members. A somewhat disapproving description of members of the merchant guild of the Dutch city of Tiel dating from 1024 comments that members ‘begin their drinking bouts at the crack of dawn, and the one who tells dirty jokes with the loudest voice, and raises laughter and induces the vulgar folk to drink, gains high praise among them’.19 Like the manor, it ensured stability and comradery, at the cost of innovation and efficiency.

      The Alliance of Town and Crown

      The interests of the towns were initially opposed to those of the landed nobility. For the peasant working in the lord’s fields, the town represented new opportunities. The efforts of towns to attract additional labour set them in opposition to the lords, who resented the attractive pull of the town on their field workers. Furthermore, while towns wanted cheap food for themselves and their workers, and thus preferred low tariffs on food imports (and high tariffs on manufactured goods), the landed nobility who produced food and consumed manufactured goods preferred the opposite. Also, the increasingly wealthy merchants and financiers were a challenge to the social status of the landed nobility.

      The alliance of the town and Crown was more than just a matter of befriending the enemy of the enemy. Each offered something important to the other. For the merchant or the craftsman, the king offered protection, not just from physical attack or intrusion from manorial or canon law, but also from competition – he endorsed the anticompetitive guild and its practices through a royal charter. The resulting monopoly profits were the rents that are so necessary to sustain relationships. It kept the guild members united, creating a tight-knit association that was a powerful defense against other predatory powers of the time. The guild shared some of those profits with the king through periodic fees or loans, thus fulfilling its side of the Faustian bargain.20

      Why Monopolies?

      Why could the king not tax his people directly, instead of leaving them to the tender mercies of the monopolist guilds? As we have seen, taxation required authorisation by Parliament. Instead, the king could offer royal charters directly, thus bypassing Parliament. Royally licensed monopolies were less clearly offensive to the people, since high monopoly prices were an implicit concealed tax. So long as they were on a relatively few items, they would be borne with only a little grumbling.

      Equally important, the nation-states in their early incarnations had weak bureaucracies and therefore limited abilities to collect taxes, tolls, or custom duties. The king benefited far more by investing scarce revenue in an army of soldiers than in an army of tax collectors. Therefore, the guilds and the merchant companies essentially served as the king’s tax collectors, estimating and collecting what was owed from their members. They often paid directly to the treasury upfront for the monopoly privilege, which reduced the king’s need to borrow or rely on a costly corrupt bureaucracy to collect taxes.21 Moreover, monopoly profits came into the guild’s coffers as repayment for the advances it had made the king, so it did not have to stand in line outside the treasury for an uncertain repayment, unlike ordinary creditors. Finally, because the privileges came directly from the king for the most part (only some were authorised by Parliament), the guilds and monopolist companies became his loyal supporters, if nothing else because their continued fortunes depended on his survival. Every side benefited except the consumer who paid the higher cartelised prices!

      The monopoly charter was not a secure form of property right. It was an easily transferred charter, not fortified by the competence of the holder – indeed, the longer the monopoly was held, the more inefficient the holder would get, and the easier it would be to expropriate, as was the case with the monastery land. What kept the monarch from large-scale taking-back-and-reselling of monopolies was probably concerns about the risk of angering a large group of merchants or craftsmen in the guilds or companies, as well as the loss of reputation and the damage it would do to the sale price of future monopolies. These were fragile supports on which to build large-scale investments, and typically such businesses invested little.

      … AND MERCANTILISM

      The alliance of town and Crown was not without other vulnerabilities. Foreign producers could compete with domestic ones and push prices down. Monarchs, however, had a very short-term view of economic might, perhaps influenced by the multiple reign-ending military threats they faced. They essentially believed that economic prowess depended on what was produced in the country in the short run, and thus