English Institutional Evolution 807 Consider a loan to a sovereign in which the ruler promises to return the principal along with interest at a specified date.What prevents the sovereign from simply ignoring the agreement and keeping the money? Reputation has long been noted as an important factor in limiting a sovereign's incentive to renege,and this approach has recently been formalized in the elegant models of modern game theory.The"'long arm of the future''provides incentives to honor the loan agreement today so as to retain the opportunity for funds tomorrow.In many of the simple repeated games studied in the literature,this incentive alone is sufficient to prevent reneging. Yet it is also well known that there are circumstances where this mechanism alone fails to prevent reneging.3 In the context of current Third World debt,Jeremy Bullow and Kenneth Rogoff show that repeat play alone is insufficient to police reneging,and that more complex institutional arrangements are necessary.Similarly,in the medieval context,John Veitch has recently shown that medieval states had strong but not unambiguous incentives to develop reputations for honoring debt commitments,and that by and large they did so.Nonetheless,a series of major repudiations occurred when a second and typically more plentiful source of funds emerged.Edward I confiscated the wealth of the Jews in the late thirteenth century once the Italian merchants began operating on a larger scale;Phillip IV confiscated the wealth of the Templars under similar circumstances. One important context in which repeat play alone is insufficient to police repudiation concerns variations in the sovereign's time prefer- ence or discount rate.States in early modern Europe were frequently at war.Since wars became increasingly expensive over the period,putting increasingly larger fiscal demands on the sovereign,the survival of the sovereign and regime was placed at risk.When survival was at stake, the sovereign would heavily discount the future,making the one-time gain of reneging more attractive relative to the future opportunities forgone.Indeed,there is a long history of reneging under the fiscal strain accompanying major wars.6 The insufficiency of repeat play and reputation to prevent reneging "The New Economics of Organization,"American Journal of Political Science,28 (Aug.1984), pp.73977. 3 Paul R.Milgrom,Douglass C.North,and Barry R.Weingast,"The Role of Institutions in the Revival of Trade,Part I:The Medieval Law Merchant,"Mimeo.,Hoover Institution,Stanford University,1989.Jeremy Bullow and Kenneth Rogoff,"'A Constant Recontracting Model of Sovereign Debt,"Journal of Political Economy,97 (Feb.1989),pp.155-78;John M.Veitch, "Repudiations and Confiscations by the Medieval State'this JoURNAL,46(Mar.1986),pp.31-36. 6 Joseph Schumpeter,Fiscal Crises and the Tax State,"in Richard A.Musgrave and Alan T. Peacock,eds.,Classics in the Theory of Public Finance (London,1962).John Hicks,A Theory of Economic History (Oxford,1969).North,Structure and Change,and Veitch,"Repudiations and Confiscations."This is not to say that the sovereign will never honor commitments,only that he will not always do so
English Institutional Evolution Consider a loan to a sovereign in which the ruler promises to return the principal along with interest at a specified date. What prevents the sovereign from simply ignoring the agreement and keeping the money? Reputation has long been noted as an important factor in limiting a sovereign's incentive to renege, and this approach has recently been formalized in the elegant models of modern game theory. The "long arm of the future" provides incentives to honor the loan agreement today so as to retain the opportunity for funds tomorrow. In many of the simple repeated games studied in the literature, this incentive alone is sufficient to prevent reneging. Yet it is also well known that there are circumstances where this mechanism alone fails to prevent reneging5 In the context of current Third World debt, Jeremy Bullow and Kenneth Rogoff show that repeat play alone is insufficient to police reneging, and that more complex institutional arrangements are necessary. Similarly, in the medieval context, John Veitch has recently shown that medieval states had strong but not unambiguous incentives to develop reputations for honoring debt commitments, and that by and large they did so. Nonetheless, a series of major repudiations occurred when a second and typically more plentiful source of funds emerged. Edward I confiscated the wealth of the Jews in the late thirteenth century once the Italian merchants began operating on a larger scale; Phillip IV confiscated the wealth of the Templars under similar circumstances. One important context in which repeat play alone is insufficient to police repudiation concerns variations in the sovereign's time preference or discount rate. States in early modern Europe were frequently at war. Since wars became increasingly expensive over the period, putting increasingly larger fiscal demands on the sovereign, the survival of the sovereign and regime was placed at risk. When survival was at stake, the sovereign would heavily discount the future, making the one-time gain of reneging more attractive relative to the future opportunities forgone. Indeed, there is a long history of reneging under the fiscal strain accompanying major wars.6 The insufficiency of repeat play and reputation to prevent reneging "The New Economics of Organization," American Journal of Political Science, 28 (Aug. 1984), pp. 739-77. Paul R. Milgrom, Douglass C. North, and Barry R. Weingast, "The Role of Institutions in the Revival of Trade, Part I: The Medieval Law Merchant," Mimeo., Hoover Institution, Stanford University, 1989. Jeremy Bullow and Kenneth Rogoff, "A Constant Recontracting Model of Sovereign Debt," Journal of Political Economy, 97 (Feb. 1989), pp. 155-78; John M. Veitch, "Repudiations and Confiscations by the Medieval State" this JOURNAL, 46 (Mar. 1986), pp. 31-36. Joseph Schumpeter, "Fiscal Crises and the Tax State," in Richard A. Musgrave and Alan T. Peacock, eds., Classics in the Theory of Public Finance (London, 1962). John Hicks, A Theory of Economic History (Oxford, 1969). North, Structure and Change, and Veitch, "Repudiations and Confiscations." This is not to say that the sovereign will never honor commitments, only that he will not always do so
808 North and Weingast provides for the role of political institutions.If the problem of variable discount rates is sufficiently important,individuals have an incentive to devise institutions to protect against reneging.It is important to observe that these institutions do not substitute for reputation-building and associated punishment strategies,but complement them.?Appropri- ately chosen institutions can improve the efficacy of the reputation mechanism by acting as a constraint in precisely those circumstances where reputation alone is insufficient to prevent reneging.The literature on the theory of the firm is replete with illustrations of how specific institutional features of the firm are necessary to mitigate an incentive problem that is insufficiently policed by reputation.8 This view provides an endogenous role for political institutions. Restrictions on the ex post behavior of the state improve the state's ability to maintain its part of bargains with constituents,for example, not to expropriate their wealth.As we show below,this logic can be used to interpret the institutional changes at the time of the Glorious Revolution. Our view also implies that the development of free markets must be accompanied by some credible restrictions on the state's ability to manipulate economic rules to the advantage of itself and its constitu- ents.Successful economic performance,therefore,must be accompa- nied by institutions that limit economic intervention and allow private rights and markets to prevail in large segments of the economy.Put another way,because constitutional restrictions must be self-enforcing, they must serve to establish a credible commitment by the state to abide by them.Absolutist states which faced no such constraint,such as early modern Spain,created economic conditions that retarded long-run economic growth. The ability of a government to commit to private rights and exchange is thus an essential condition for growth.It is also,as we shall see,a central issue in the constitutional debate in seventeenth-century Eng- land. II.ENGLAND UNDER THE STUARTS:LIMITED CREDIBLE COMMITMENT TO RIGHTS After the Crown passed from the Tudors to the Stuarts in 1603, revenue problems and their consequences become increasingly impor- 7 Weingast and Marshall,"Industrial Organization of Congress";Milgrom,North,and Wein- gast,"The Role of Institutions." 8 Vertical integration is the standard example:because of potential transactions problems due to "asset specificity"or"appropriable quasi-rents,"firms that internalize the problem via vertical integration outperform those which do not.See Williamson,Economic Institutions. 9 In this sense our argument parallels that of James Buchanan and Geoffrey Brennan,who argue that the "recognition of the temporal dimensionality of choice provides one 'reason for rules'- rules that will impose binding constraints on choice options after the rules themselves have been established."James Buchanan and Geoffrey Brennan,Reason of Rules(Cambridge,1981),p.67
808 North and Weingast provides for the role of political institutions. If the problem of variable discount rates is sufficiently important, individuals have an incentive to devise institutions to protect against reneging. It is important to observe that these institutions do not substitute for reputation-building and associated punishment strategies, but complement them.7 Appropriately chosen institutions can improve the efficacy of the reputation mechanism by acting as a constraint in precisely those circumstances where reputation alone is insufficient to prevent reneging. The literature on the theory of the firm is replete with illustrations of how specific institutional features of the firm are necessary to mitigate an incentive problem that is insufficiently policed by reputation.* This view provides an endogenous role for political institutions. Restrictions on the ex post behavior of the state improve the state's ability to maintain its part of bargains with constituents, for example, not to expropriate their ~ealth.~ As we show below, this logic can be used to interpret the institutional changes at the time of the Glorious Revolution. Our view also implies that the development of free markets must be accompanied by some credible restrictions on the state's ability to manipulate economic rules to the advantage of itself and its constituents. Successful economic performance, therefore, must be accompanied by institutions that limit economic intervention and allow private rights and markets to prevail in large segments of the economy. Put another way, because constitutional restrictions must be self-enforcing, they must serve to establish a credible commitment by the state to abide by them. Absolutist states which faced no such constraint, such as early modern Spain, created economic conditions that retarded long-run economic growth. The ability of a government to commit to private rights and exchange is thus an essential condition for growth. It is also, as we shall see, a central issue in the constitutional debate in seventeenth-century England. 11. ENGLAND UNDER THE STUARTS: LIMITED CREDIBLE COMMITMENT TO RIGHTS After the Crown passed from the Tudors to the Stuarts in 1603, revenue problems and their consequences become increasingly impor- 'Weingast and Marshall, "Industrial Organization of Congress"; Milgrom, North, and Weingast, "The Role of Institutions." Vertical integration is the standard example: because of potential transactions problems due to "asset specificity" or "appropriable quasi-rents," firms that internalize the problem via vertical integration outperform those which do not. See Williamson, Economic Institutions. In this sense our argument parallels that of James Buchanan and Geoffrey Brennan, who argue that the "recognition of the temporal dimensionality of choice provides one 'reason for rules'- rules that will impose binding constraints on choice options after the rules themselves have been established." James Buchanan and Geoffrey Brennan, Reason of Rules (Cambridge, 1981), p. 67
English Institutional Evolution 809 TABLE 1 REVENUE SOURCES AND EXPENDITURE LEVELS,1617 Amount Revenue Source (f/year) Crown Lands ￡80,000 Customs and"new impositions" 190,000 Wards,and so forth(besides purveyance) 180,000 Total Revenue 450,000 Total Expenditures 486,000 Deficit 36,000 Source:David Hume,The History of England (Indianapolis,1983),appendix to "The Reign of James I.' tant.At this time the king was expected to"live on his own,''that is,to fund the government in the manner of an extended household.The execution of public laws and expenditures was not subject to a public budgetary process,and Parliament played only a small role in the decisions over expenditure and investment.The Crown therefore had considerable discretionary power over how and on what the money was spent.Parliament's main source of influence over policy resulted from its power to provide the Crown with tax revenue,typically for extraor- dinary purposes such as various wars.Parliament was also responsible for granting the Crown its revenue from other sources,such as customs, but in practice,the Stuarts,particularly Charles I,continued to collect the revenue without parliamentary consent. Throughout the Stuart period revenue from traditional sources did not match expenditures.While figures for government expenditures during the Stuart period have not been collected as systematically as for the period following the Glorious Revolution,the following picture emerges. At the beginning of the Stuarts'reign,Crown lands produced roughly half the annual revenue.To make up annual shortfalls,the Crown regularly resorted to sale of these lands.0 Following the war with Spain in 1588,Elizabeth had sold 25 percent of the lands,raising f750,000. Still,James I inherited sizable debts from Elizabeth's war.Over his reign(1603-1624),another 25 percent of Crown lands were sold,and the remainder went during the reign of his son,Charles I(1625-1641).Sale of a major portion of a revenue-producing asset for annual expenses indicates the revenue problem was endemic.It also implies that over time the revenue problem had to get worse,for with every sale the expected future revenue declined.And,indeed,as Table 1 shows,for 10 See,for example,Derek Hirst,Authority and Confict:England,1603-1658(Cambridge,MA, 1986),chap.4,and Lawrence Stone,The Crisis of the Aristocracy,1558-1641 (Oxford,1965)
English Institutional Evolution REVENUE SOURCES A TABLE 1 ND EXPENDITURE LEVELS, 1617 Revenue Source Amount (flyear) Crown Lands Customs and "new impositions" Wards, and so forth (besides purveyance) Total Revenue Total Expenditures Deficit Source: David Hume, The History of England (Indianapolis, 1983), appendix to "The Reign of James I." tant. At this time the king was expected to "live on his own," that is, to fund the government in the manner of an extended household. The execution of public laws and expenditures was not subject to a public budgetary process, and Parliament played only a small role in the decisions over expenditure and investment. The Crown therefore had considerable discretionary power over how and on what the money was spent. Parliament's main source of influence over policy resulted from its power to provide the Crown with tax revenue, typically for extraordinary purposes such as various wars. Parliament was also responsible for granting the Crown its revenue from other sources, such as customs, but in practice, the Stuarts, particularly Charles I, continued to collect the revenue without parliamentary consent. Throughout the Stuart period revenue from traditional sources did not match expenditures. While figures for government expenditures during the Stuart period have not been collected as systematically as for the period following the Glorious Revolution, the following picture emerges. At the beginning of the Stuarts' reign, Crown lands produced roughly half the annual revenue. To make up annual shortfalls, the Crown regularly resorted to sale of these lands." Following the war with Spain in 1588, Elizabeth had sold 25 percent of the lands, raising £750,000. Still, James I inherited sizable debts from Elizabeth's war. Over his reign (1603-1624), another 25 percent of Crown lands were sold, and the remainder went during the reign of his son, Charles I (1625-1641). Sale of a major portion of a revenue-producing asset for annual expenses indicates the revenue problem was endemic. It also implies that over time the revenue problem had to get worse, for with every sale the expected future revenue declined. And, indeed, as Table 1 shows, for 'O See, for example, Derek Hirst, Authority and ConJlict: England, 1603-1658 (Cambridge, MA, 19861, chap. 4, and Lawrence Stone, The Crisis of the Aristocracy, 1558-1641 (Oxford, 1965)
810 North and Weingast the year 1617 total revenue did not match expenditures,leaving a deficit of f36,000 or of just under 10 percent of expenditures Under the Stuarts,therefore,the search for new sources of revenue became a major priority.An important new source which produced conflict between the Crown and Parliament was the raising of customs revenues through new "impositions.''Indeed,in the 1630s such in- creases almost brought financial solvency,and with it the ability of the Crown to survive without calling Parliament. Another method used by the Crown to raise revenue was to demand loans.The Crown did not,however,develop a systematic,regular relationship with moneyed interests,negotiating a series of loans in which it honored today's agreements because it wanted to avail itself of future loan opportunities.Indeed,just the opposite occurred.The Stuarts secured most of their loans under threat;hence they are known as "forced loans,''of which more later.Repayment was highly unpre- dictable and never on the terms of the original agreement.In the forced loan of 1604/5 the Crown borrowed fl11,891,nominally for one year; "although ..ultimately repaid,f20,363...was still due as late as December 1609.'11 The forced loan of 1617 (just under f100,000)was not repaid until 1628.The Crown behaved similarly on loans from 1611 and 1625.As time went on,such loans came to look more and more like taxes,but because these were nominally loans the Crown did not need parliamentary assent.12 The Crown's inability to honor its contractual agreements for bor- rowed funds is a visible indicator of its readiness to alter the rights of private parties in its own favor.Despite the significant incentive provided by the desire to raise funds in the future,the Crown followed its short-run interests,reneging on the terms to which it had agreed.As noted above,this type of behavior was not unique to England. A second revenue-raising method was the sale of monopolies.While not the most important source of new revenue,it is particularly instructive because of its economic consequences.13 In order to raise revenue in this manner,the Crown used patents in a new way. Originally designed to protect and promote the invention of new processes,patents came to be used to "reduce settled industries to monopolies under cover of technical improvements."14 From a revenue standpoint,the best sources of new monopoly rights involved an 11 Robert Ashton,The Crown and the Money Market,1603-1640(Oxford,1960),p.35. 12 Ashton,Crown and the Money Market,p.36.Richard Cust,in his recent study of the 1626 forced loan,provides several instances of sanctions imposed on individuals refusing to provide funds:leading refusers were "either committed to prison or pressed in readiness for service abroad."Richard Cust,The Forced Loans and English Politics (Oxford,1987),p.3. 13 Robert B.Ekelund,and Robert D.Tollison,Mercantilism as a Rent-Seeking Society (College Station,1981). 14 W.Price,English Patents of Monopoly(Boston,1906).Examples include soap,tobacco,and starch
810 North and Weingast the year 1617 total revenue did not match expenditures, leaving a deficit of £36,000 or of just under 10 percent of expenditures. Under the Stuarts, therefore, the search for new sources of revenue became a major priority. An important new source which produced conflict between the Crown and Parliament was the raising of customs revenues through new "impositions." Indeed, in the 1630s such increases almost brought financial solvency, and with it the ability of the Crown to survive without calling Parliament. Another method used by the Crown to raise revenue was to demand loans. The Crown did not, however, develop a systematic, regular relationship with moneyed interests, negotiating a series of loans in which it honored today's agreements because it wanted to avail itself of future loan opportunities. Indeed, just the opposite occurred. The Stuarts secured most of their loans under threat; hence they are known as "forced loans," of which more later. Repayment was highly unpredictable and never on the terms of the original agreement. In the forced loan of 160415 the Crown borrowed £ 11 1,891, nominally for one year; "although . . . ultimately repaid, f20,363 . . . was still due as late as December 1609. "l The forced loan of 1617 Gust under f 100,000) was not repaid until 1628. The Crown behaved similarly on loans from 161 1 and 1625. As time went on, such loans came to look more and more like taxes, but because these were nominally loans the Crown did not need parliamentary assent. l2 The Crown's inability to honor its contractual agreements for borrowed funds is a visible indicator of its readiness to alter the rights of private parties in its own favor. Despite the significant incentive provided by the desire to raise funds in the future, the Crown followed its short-run interests, reneging on the terms to which it had agreed. As noted above, this type of behavior was not unique to England. A second revenue-raising method was the sale of monopolies. While not the most important source of new revenue, it is particularly instructive because of its economic consequence^.'^ In order to raise revenue in this manner, the Crown used patents in a new way. Originally designed to protect and promote the invention of new processes, patents came to be used to "reduce settled industries to monopolies under cover of technical improvements." l4 From a revenue standpoint, the best sources of new monopoly rights involved an " Robert Ashton, The Crown and the Money Market, 1603-1640 (Oxford, 1960), p. 35. l2 Ashton, Crown and rhe Money Marker, p. 36. Richard Cust, in his recent study of the 1626 forced loan, provides several instances of sanctions imposed on individuals refusing to provide funds: leading refusers were "either committed to prison or pressed in readiness for service abroad." Richard Cust, The Forced Loans and English Politics (Oxford, 1987), p. 3. I' Robert B. Ekelund, and Robert D. Tollison, Mercantilism as a Rent-Seeking Society (College Station, 1981). l4 W. Price, English Parents of Monopoly (Boston, 1906). Examples include soap, tobacco, and starch
English Institutional Evolution 811 economic activity that was profitable and whose participants were not part of the king's constituency.This led to a systematic search for and expropriation of quasi-rents in the economy.Moreover,as we will see in the next section,the Crown utilized a different system for enforcing these grants than that used for the older mercantilist controls,and one that was considerably more responsive to the Crown's interests.The system involved circumventing existing rights and the institutions designed to protect these rights. Grants of monopoly clearly disrupted both existing economic inter- ests in the targeted activity and those who depended on it(for example, suppliers and consumers).Monopoly grants thus acted as a tax that, since it expropriated the value of existing investment as well as future profits,was considerably greater at the margin than a 100 percent tax on profits.This risk lowered the rewards from all such new investments and hence discouraged their undertaking. Beyond grants of monopoly,James,and especially Charles,used a variety of other,more subtle forms of expropriation of wealth.Because so many dimensions of public policy were involved,the political risk to citizens increased substantially over previous times.One important example was expansion of the peerage by the Crown,again in exchange for revenue.5 While this expansion had broad social,cultural,and ideological implications,it also had significantly negative effects on existing peers.Expansion of the size of the House of Lords altered the value of an existing seat since it limited the ability of existing lords to protect themselves against the Crown.16 Between the coronation of James I and the outbreak of the Civil War,the Stuarts'sale of peerages doubled the number of lay peers. Governmental power was used in other ways to raise revenue. Employing the ancient power of purveyance,agents of the Crown seized various goods for"public purposes,"paying prices well below market.Purveyance brought in an annual "'unvoted''tax of f40,000 in the 1620s.17 James also put hereditary titles up for sale:for example, offering to sell the title of baronet for f1,095 and promising that only a fixed number would be sold.This brought in f90,000 by 1614.But James soon reneged on this,lowering the price and selling more than the promised number.By 1622 the price had fallen to f220.18 Through the 15 F.W.Maitland,Constitutional History ofEngland(Cambridge,1908):Wallace Notestein,The Winning of the Initiative by the House of Commons (London,1924);and Stone,Crisis of the Aristocracy. 16 There were two separate reasons for this:the total number of voters was increasing,and the expansion added new members whose views systematically differed from those of existing nobles. The exchange that brought new nobles to the Lords undoubtedly entailed a commitment of support for the king. 17 Hirst,Authority and Conflict,p.103;and C.Hill,Century of Revolution,1603-1714 (2nd edn., New York,1980),chap 4.See also John Kenyon,Stuart England(2nd edn.,New York,1985). 18 Hirst,Authority and Confict,pp.113-14
English Institutional Evolution 811 economic activity that was profitable and whose participants were not part of the king's constituency. This led to a systematic search for and expropriation of quasi-rents in the economy. Moreover, as we will see in the next section, the Crown utilized a different system for enforcing these grants than that used for the older mercantilist controls, and one that was considerably more responsive to the Crown's interests. The system involved circumventing existing rights and the institutions designed to protect these rights. Grants of monopoly clearly disrupted both existing economic interests in the targeted activity and those who depended on it (for example, suppliers and consumers). Monopoly grants thus acted as a tax that, since it expropriated the value of existing investment as well as future profits, was considerably greater at the margin than a 100 percent tax on profits. This risk lowered the rewards from all such new investments and hence discouraged their undertaking. Beyond grants of monopoly, James, and especially Charles, used a variety of other, more subtle forms of expropriation of wealth. Because so many dimensions of public policy were involved, the political risk to citizens increased substantially over previous times. One important example was expansion of the peerage by the Crown, again in exchange for revenue.15 While this expansion had broad social, cultural, and ideological implications, it also had significantly negative effects on existing peers. Expansion of the size of the House of Lords altered the value of an existing seat since it limited the ability of existing lords to protect themselves against the Crown.16 Between the coronation of James I and the outbreak of the Civil War, the Stuarts' sale of peerages doubled the number of lay peers. Governmental power was used in other ways to raise revenue. Employing the ancient power of purveyance, agents of the Crown seized various goods for "public purposes," paying prices well below market. Purveyance brought in an annual "unvoted" tax of £40,000 in the 1620s.17 James also put hereditary titles up for sale: for example, offering to sell the title of baronet for £1,095 and promising that only a fixed number would be sold. This brought in 290,000 by 1614. But James soon reneged on this, lowering the price and selling more than the promised number. By 1622 the price had fallen to 2220. l8 Through the l5 F. W. Maitland, Constitutional History of England (Cambridge, 1908); Wallace Notestein, The Winning of the Initiative by the House of Commons (London, 1924); and Stone, Crisis of the Aristocracy. l6 There were two separate reasons for this: the total number of voters was increasing, and the expansion added new members whose views systematically differed from those of existing nobles. The exchange that brought new nobles to the Lords undoubtedly entailed a commitment of support for the king. I' Hirst, Authority and Conflict, p. 103; and C. Hill, Century ofRevolution, 1603-1714 (2nd edn., New York, 1980), chap 4. See also John Kenyon, Stuart England (2nd edn., New York, 1985). l8 Hirst, Authority and Conflict, pp. 113-14