Monday, February 13, 2012

The Long Divergence (2)

This is the second part of my review of Timur Kuran’s excellent economic history The Long Divergence: How Islamic Law Held Back the Middle East. The first part was in my previous post. The concluding part is in my next post.

Having set the analytical framing, Kuran them moves on to “Part II: Organizational Stagnation”. His entry point is the question he posed at the end of Part I:
What was the cutting edge of commerce in the seventh century, and in what ways did Islam matter (p.41).
The chapter headings outline the path of his analysis: Commercial Life Under Islamic Rule, The Persistent Simplicity of Islamic Partnerships, Drawbacks of the Islamic Inheritance System, The Absence of the Corporation in Islamic Law, Barriers to the Emergence of a Middle Eastern Corporation, Credit Markets without Banks.

Early Islam
Kuran starts by taking the reader through how early Islam promoted economic activity. The Qur’an is profit-positive, characterising profit as Allah’s bounty to humanity. The Haj, the annual pilgrimage to Mecca, was also a great economic event: pilgrimages were often funded by trade and the Qur’an endorses the Haj having an economic role. The scale of the Haj provided a stimulus to economic activity, but also likely discouraged the development of secular fairs (which were important in economic development in medieval Europe) (Pp45-8).

One of the key factors in economic development is promoting cooperation among non-kin. Islamic law tended to be commerce positive not least because a large majority of Islamic jurists (up to 75%, according to one study) primarily made their living from commerce. The development of Islamic partnership law promoted non-kin cooperation (even across confessional boundaries); more than Talmudic partnership law, as it allowed wider latitude in arrangements. Sharia promoted wide-ranging, long-distance trading that linked across three continents under a common legal system (Pp48ff).

Islamic partnerships lacked legal personhood: all legal interactions were between individuals. Most variations also required a partner’s principal to consist of currency: they could not invest in merchandise directly. A merchant’s mission was also incomplete until he had sold all the merchandise bought with the currency. This could lead to sub-optimal exchanges and, while legal ruses existed to get around such problems, they added to the transaction costs involved (Pp59ff).

While Islam had been commercially dominant in its early centuries, its share of global trade began to shrink substantially. Kuran quotes Angus Maddison’s figures that the Middle East’s share of world GDP was 10% in 1000 but had plummeted to 4% by 1600 and 2% by 1700. By contrast, the west European share surged from 9% in 1000 to 22% in 1700. Islam’s institutional advantage had clearly vanished (Pp61-2).

Fragmenting wealth
Kuran examines the limitations of Islamic partnership law—what he calls its “persistent simplicity”—assembling considerable illustrative data (Pp63ff). Then it is on to the limitations of the Islamic inheritance system: subject to the most detailed set of economic rules in the Qur’an. While the rules:
clearly subordinated personal preferences to the extended family’s need for financial security and predictability (p.78)
and may have strengthened female inheritance rights, they also:
made it difficult to keep property intact across generations (p.79).
This inhibited the creation of commercial or landowning elites able to restrain rulers while also dispersing productive assets. To keep land in viable productive units, it was generally classed as state land, thus not covered by Islamic inheritance law, with tenants paying land tax. They could not sell, grant or partition their plots without official permission (Pp79-80).

As an aside, this system also embedded a permit raj into operation of the most important asset, land—a pattern that continues to bedevil the Middle East (pdf).

Various techniques were developed to circumvent the Qur’an’s inheritance rules, but they were patchy in operation (p.80). One of the most common was use of a waqf or trust: an institution whose benefits and limitations later becomes a key focus of Kuran’s analysis.

Kuran compares this to the situation in Western Europe, where there was considerable variety but one key feature—inheritance rules were not based in religious law, so far more easily open to change. The spread of primogeniture provided Western Europe for a simple mechanism to keep wealth intact across generations: far more so than in the Islamic Middle East (Pp81-2). Kuran notes that the Qur’an’s rules clearly made more sense for a pastoralist society, where herds could be “bred up”, than an agrarian one, where concern to discourage fragmentation of land made more sense. As the Industrial Revolution advanced and more divisible forms of wealth became more important, inheritance rules evolved in a more egalitarian direction. Kuran also cites control over irrigation system as a key feature of state power in the Middle East—he argues this would also encourage more egalitarian inheritance rules, to discourage concentrations of land that might threat state control of water supply; a pattern that operates far back in Middle Eastern antiquity (Pp82-3).

Islam also permitted polygyny, though it was largely the preserves of the rich and powerful, so a sign of status. Polygyny allowed the forming of wider kin connections (so helped networking) but increased the dispersion of assets (since the Qur’an mandated equal treatment of wives and their children). It also encouraged an egalitarian inheritance system, otherwise families would be reluctant to offer their daughters: so polygyny and egalitarian inheritance were mutually supporting institutions, while primogeniture was much easier where only one spouse was legally recognised (Pp84-5).

The European inheritance system made enduring partnerships much more likely than in the Middle East with much more capacity for experimentation, and so a need for innovation, leading, over time, to a wider range of organisational forms and commercial techniques. Europe was set off on a path of expanding innovation while the Middle East stagnated, one sign of which is the paucity of private records as historical sources. That, until the C19th, Middle Eastern trade was predominantly with regions where Islamic institutions were competitive or advantaged undermined any incentive to break out of the mutually supporting nature of Islamic inheritance and partnership arrangements (Pp85ff).

Critiquing various existing explanations for Middle Eastern economic stagnation, Kuran points out the above pattern is an example of unintended secondary consequences. Islamic institutions worked quite well in context but their mutually supporting nature blocked further institutional development (Pp93ff).

Natural persons only
The corporation—a critical characteristic of which is legal personhood—did not reach the Middle East until 1851 and did not “take off” until the Ottoman Parliament passed a corporation law in 1908. Kuran traces the Roman origins of corporate entities, the rise of “self-declared” corporate entities during the period of weak European states (notably the Church, subsections thereof, and cities) and its expansion into granted corporate status (through charters). That Christianity grew up under a strong state (the Roman Empire) encouraged Church focus on faith, morality and community: not political and economic organisation. This led to acceptance of parallel legal systems and a secularised legal domain (Pp97ff).

Eastern Roman law was much more centrally controlled than what developed further West. Still, both it and Zoroastrian law (where temples could own property and make loans) had the legal building blocs of corporation: yet it is absent from Islamic law. Kuran puts the failure down to the tribal milieu of pagan Arabia, with its continuing feuds:
Because of this resulting insecurity, people stood to gain from an ideology capable of unifying peoples through all-inclusive bonds of solidarity.
…[Islam] fostered an ideology conducive to weakening kinship ties, reducing intertribal violence, and enhancing material security. It also facilitated collective action against outsiders, as evidenced in the early conquests (p.105).
There is a conspicuous absence in this Quranic community building:
No collective economic actor appears in the Quran, let alone a collectivity considered a legal person (p.106).
So, no basis from which to develop legal personhood:
At the point when the Quran becomes a closed book, tribal bonds remained strong … Over the next few centuries, as the medieval Church weakened tribal bonds among Christians through the prohibition of marriage within kin groups, tribalism remained a potent force among Muslims (p.106).
Moreover, the all-encompassing nature of Islam was a further barrier:
Like the commitment to a union of tribes in one great family, the lack of a formal separation between the religious and secular thus conflicted with the concept of incorporation, and all the more so with the ideal of incorporation at will (p.107).
The development of Islamic jurisprudence was highly individualist, muftis and kadis acted as individuals, not members of some corporate entity:
In keeping religious interpretation decentralized, Islam thus denied the Muslim community a corporate prototype (Pp107-8).
Since the learned class was paid for giving its opinions and judgements, it had no interest in encouraging self-governing bodies which might reduce the demand for their monopoly of adjudication services. Islamic political theory also did not recognise intermediate groupings of Muslims—all Muslims were members of an Islamic community conceived as unitary: an outlook the carried over into courts, the levying of tariffs, and so on. This also discouraged recognition of sources of intermediate loyalty that might promote factionalism (Pp107-9).

In trusts we trust
Islam did develop an organisation capable of indefinite existence: this was the waqf or trust. Trusts existed in Roman and pre-Islamic Law. At one level, the waqf was a stunningly successful institutional form, financing an enormous array of services. It was not, however, a corporation: it had a single founder, its rules and purpose could not be changed, it had no self-governance beyond carrying out the original instructions. This accorded with the Islamic concept of communal unity and anti-factionalism in a way a self-governing organised group did not (Pp110-2).

Founding a waqf provided status and prestige; it also protected property against expropriation. This was particularly useful given a founder could appoint himself caretaker (mutawalli), appoint relatives to positions and nominate his own successor (so getting around Islamic inheritance laws). Commitment to providing designated social services was something of a quid pro quo with rulers for foregoing expropriation opportunities. The capacity for change was extremely limited, abandonment of the activity would lead its assets to be distributed to the poor and combining waqfs, or pooling their capital, was forbidden. This profoundly blocked innovation in the use of capital. An example Kuran uses is contrasting medieval European universities—which rapidly became self-governing institutions, able to change their curricula and subjects offered—to waqf funded madrasas of the Middle East, whose far more stagnant curricula and subject offerings helped turned the Middle East into an intellectual backwater (Pp112-5).

Europe booms
While medieval Europe had corporations, they did not really take off as a commercial form until the C16th, though proto-business corporations (such as the Genoese Bank of San Giorgio, founded 1407) had emerged earlier. They were a means of raising fixed and working capital, and handling risk. As merchants experimented with arrangements, new needs triggered new innovations. Economic activity expanded; 770 European ships sailed to Asia in the C16th: 6,661 did in the C18th, with English and Dutch corporations accounting for three-quarters of the total. Both partnerships and corporations involve various trade-offs (hence their prevalence varies by sector) but the larger the activity, the more likely the corporate form is to be employed (Pp115ff).

Kuran considers the ways in which importing of European commercial and legal forms could have taken place, including through trade, observing resident European merchants, and the operation of the “capitulations” which allowed European merchants to operate under their own law, via local consuls, thus avoiding the problems of Muslim inheritance law in particular. Islamic law was never completely frozen, it showed capacity to adapt over time (particularly in matters of rulership). Kuran argues that, if some major constituency had pressured the courts to go down the corporation path, likely ways would have been found (Pp121ff).

The Middle East doesn’t
The small and short-lived partnerships generated by Islamic inheritance law blocked demand for a range of innovations which, in Europe, led to the development of the corporation. For example, lack of standardised bookkeeping blocks measurement of net worth in investor-accessible ways and makes bankruptcy fraught. The tendency of successful merchants to turn their wealth into real estate to support a waqf, in response to the weakness of private property rights, also blocked innovation. Especially as capital, skill, networks and motivations thus constantly flowed out of the profit-oriented private sector to the non-profit sector (Pp126-8).

Nor was the waqf a source of innovation. Minimising risk (and thus managerial discretion) was early established as a central principle. To the extent it was permitted, changing waqf was expensive. Kadis had little incentive to agree to move a waqf in a self-governing direction—there was no collective entity able to negotiate on the behalf of kadis, their tenures were often brief and insecure (encouraging get-as-much-as-you-can attitude) and they derived income from enforcing waqf rules and disputes about a caretaker’s actions. The lack of legal personhood elsewhere—even officers of the state had personal liability—compounded the block to developing corporate forms (Pp129-31).

Guilds did develop, but they lacked common assets and internal dispute resolution procedures while their heads were state-appointed. The unification of most of the Middle East under Ottoman rule meant a strong, unitary state with little incentive to permit any autonomy beyond that useful for itself. Tax farming developed some of the elements of corporations, such as trading in tax farming shares. However, in the early C19th, the Ottoman state became concerned about its increasing difficulty in keeping track of who owned what and systematically confiscated tax farms from 1812 to 1842 (Pp132ff). The Middle East’s lack of stable competing jurisdictions worked against development of formal autonomous social forms.

There were some exceptions in the dispersal of assets through inheritance—the Armenian merchants of New Julfa, Iran and the Karimi merchants of Mamluk Egypt. But their very oddity (which likely comes from very specific features) demonstrates how strong the barriers were. The persistent simplicity of partnerships, a function of the Islamic inheritance system; the supply of social services through the waqf; the operation of state policies. These all blocked the development of the commercial corporation. Kuran points out that institutional forms (such as corporations and legal personhood) were imported from the West from the mid C19th onwards and now operate with little complaint from even the most ardent Islamic purists. It is not some feature(s) essential to Islam that were the issue, but interlocking incentives (Pp136ff).

Fumbling finance
Then it is on to Credit Markets Without Banks. Kuran is deeply sceptical that the ban on interest (or, more specifically, the explicit banning of riba, an age-old arrangement where failure to pay a loan on time doubled the liability, often leading to penury and debt enslavement) explains much. Credit markets continued to exist in the Middle East and Europe also had bans on levying interest (Pp143-5).

From the Quranic ban on riba, Islamic jurisprudence (arising in societies long used to financial restrictions) argued that all interest was illegal, on the grounds that it enriched the lender without compensating benefit to the borrower. Debt enslavement from borrowing for consumption was a recognised social evil:
In the overwhelmingly agrarian economies of antiquity, loans for production or commerce were uncommon and governments rarely borrowed. The main purpose for borrowing was to meet personal subsistence needs (p.146).
Harvests being variable and unpredictable, such borrowings could go horribly wrong, leading to the:
the ubiquitous and socially destablizing danger of enslavement for unpaid debt. Throughout the ancient world … defaulters were routinely sold into slavery and often shipped to foreign lands. Such horrible consequences tainted all interest earnings, making profit-reaping lenders appear as greedy exploiters (p.146).
… the Islamic view that interest produces unjustified enrichment simply re-expresses an ancient prejudice common to the eastern Mediterranean (p.146).
Something we can see, for example, in Aristotle’s denunciation of interest.

Despite the ban, no Islamic economy was entirely interest free: an inevitable result of exchanges between agents with different risk tolerances. (Though the ban on debt enslavement was apparently enforced.) Compartmentalisation and casuistry was used to evade the ban on interest. Both techniques being recognised and enforced by Islamic courts (though which techniques were recognised by which school of law varied). But these techniques still raised costs, entailed extra risks and blocked open and honest discussion of interest and credit, including the time value of money (Pp147ff).

Christian Europe had many of the same qualms (and bans on) the levying of interest as the Islamic Middle East. However, beginning in the C13th, debates began to shift attitudes so that, by the C15th, most theologians thought interest could be legitimate. A process that accelerated until, by the C19th, the morality of interest was not much questioned. The more stable partnerships of Europe developed into active and inactive partners that developed into share trading. The ability to accumulate wealth across generations led to much wealthier private lenders. The corporate form was adopted by banking. Interest rates fell: those on long-term borrowing in England fell from 14% in 1693 to 3% in 1739 (Pp153ff).

In Anatolia and the Balkans, the cash waqf developed. While purists denounced it as illegal, pragmatism eventually won out. However, the cash waqf retained the limitations of the institutional form: single founder and caretaker, set rules (often including a set interest rate), inability to pool capital, inability to benefit from changing circumstances (indeed, they rarely lasted beyond a century). Most parts of the Middle East did not even develop it at all (Pp158ff).

In the C19th, European banking spread to the Middle East, though significant locally-owned banks did not develop until the late C19th and predominantly Muslim owned ones until the early C20th. The aim was to evade the difficulties of traditional moneylenders:
In the second half of the nineteenth century, and in many places even later, peasants without access to banks paid interest rates varying between 20 percent and 100 percent, with their crops serving as collateral. By contrast, European agricultural interest rates had fallen to around 4 percent. Commercial interests, too, were high in traditional markets. In those of Lebanon and Syria they stood at 24 per cent in the mid-nineteenth century. Meanwhile the silk guilds over Istanbul were paying 18 percent, as compared with the 5 percent paid by their counterparts in Lyon, France (Pp162-3).
Which puts the above concerns about interest and money-lending in agrarian societies in context, as well as the scale of European advantage. European institutions, such as the consular courts, operated to spread modern banking to the Middle East (Pp161ff).

The now familiar barriers to institutional (and thus economic) development—the Islamic law of partnerships and inheritance system, the waqf, the individualism of Islamic law—also operated to block financial innovation. This had to be (eventually) introduced from outside, from Europe. Kuran dismisses both the Islamist view of such as destructive westernisation or the dependency theory notion of them as imperialist instruments of dependence. On the contrary, he seems them as vehicles of institutional development rationally welcomed (and adopted) by local agents (Pp164ff).

The third and final part of this review is in my next post.

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