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

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TOLERATING AVARICE

In this chapter, we will see how the markets and the state separated from the medieval manor community and became powerful pillars in their own right. We will follow these developments through the use of the quintessential market contract: debt. The Catholic Church will play a cameo role in this story, initially filling the vacuum left by the absence of a strong state, then competing with the state to both protect and exploit people. Crucially, though, for our narrative, the Church managed to stand up to the state, armed only with the power of religion. It established the idea that there was a higher legitimacy that constrained state actions, over and above temporal power. As we will see, this was an important step toward a constitutionally limited state, which in turn was necessary for markets to have full play.

THE DEBT CONTRACT

Unlike the favours we have been discussing between members of a community, a loan contract is an explicit commitment by a borrower to repay the loaned amount with interest at a prespecified time, failing which the lender will be able to use the force of the law to recover the value lent. Typically, she will do so by seizing pledged collateral. If the security offered by the borrower is valuable – such as a farmer borrowing against his land – the lender need not know very much about the borrower or monitor his activity closely. By making terms explicit, the debt contract frees the lender from dependence on the whims or fortunes of the borrower. No longer is it the borrower’s choice whether to repay and when to do so – he must pay on the contract’s maturity or face the stipulated penalties, which in some societies were as harsh as slavery or death. Since the debt contract is written down, it is not dependent on the frailty of human or community memory. Favours can be forgotten – debt cannot.

Debt is thus an arm’s-length exchange of money for interest, untrammelled by the need to maintain social ties. This can draw in lenders from outside the community. In fact, such lenders may be the best at getting repaid because they will not sympathise with a borrower who has fallen on hard times, unlike a lender from within the community. Shylock, who hated Antonio, Shakespeare’s merchant of Venice, was, in a sense, the ideal lender, since he was perfectly willing to take his pound of Antonio’s flesh if Antonio did not repay the debt. Because Antonio then had every incentive to repay, Shylock was willing to lend.

These attributes of debt – that it is explicit, often secured by collateral, and impersonal – seem to favour the lender. They also make it much easier, though, for a potential borrower to get a loan at a low interest rate in competitive environments – somewhat paradoxically, the harsher the debt contract and the more it seems weighted in favour of the lender, the greater and broader the borrower’s access to finance. If, in contrast, sympathetic courts were to suspend the lender’s power to recover whenever the borrower was in difficulty, lenders would not be eager to lend to anyone who was even moderately risky, and lending would dry up. The few loans that would still be made to risky borrowers would be at sky-high interest rates. So it is from the very harshness of the debt contract, and the lender’s ability and willingness to enforce it, that the borrower gets easy access to funds. None of this is to say that borrowing is appropriate for everyone who wants money, or that debt forgiveness is bad, only that the debt contract is fit for its purpose.

In the relationships we have discussed so far, one member of the community does a favour to another without the expectation she will be repaid in full measure. In the typical debt contract, the terms including the interest rate are calculated so that both sides are satisfied if the contract is adhered to, even if they never see each other again. A relationship leaves possibilities open-ended; the debt contract calculates them to closure. A relationship requires parties to have some empathy for each other or some sense they are part of a larger, longer-term whole; the debt contract is entirely self-contained. It is in these senses that the debt contract represents the quintessential individualistic arm’s-length market transaction.

Despite the usefulness of debt, lending for interest, otherwise known as usury, has been proscribed by many religions and cultures. Usury laws capping interest rates prevent the equalisation of benefits to both borrower and lender. The lender gets less than what he might obtain in a free market. Why did such laws emerge?

THE PROHIBITION ON USURY

Societies have often prohibited lending at more than a specified moderate rate of interest. The Arthashastra, attributed to Indian Emperor Chandragupta Maurya’s adviser, Kautilya, and written around 300 BCE, has detailed prescriptions on the maximum rate of interest that can be charged for different kinds of loans. The ceiling was 1 1/4 per cent per month or 15 per cent per year for ordinary loans to people, intended to finance consumption or emergency needs.1 It went up to 5 per cent per month for ordinary commercial loans, 10 per cent per month for riskier commercial transactions that involved travel through forests, and 20 per cent per month for trade by sea. The only exception to these limits was in regions where the king was unable to guarantee security, where judges were asked to take into account customary practices among debtors and creditors. Thus, ancient India recognised a distinction between consumption loans and loans taken to fund profitable commerce, with lower ceilings on interest charged on the former. It also saw the need for the lender to receive a higher interest rate when the commercial enterprise was riskier.

The Old Testament was much less tolerant of usury. For instance, according to Exodus 22:25, ‘If thou lend money to any of my people that is poor that dwelleth with thee: thou shalt not be hard upon them as an extortioner, nor oppress them with usuries.’ Elsewhere in the Old Testament, though, there is an exception – strangers. In Deuteronomy 23:19–20: ‘Thou shalt not lend upon usury to thy brother; usury of money, usury of victuals, usury of anything that is lent upon usury. Unto a stranger thou mayest lend upon usury; but unto thy brother thou shalt not lend upon usury.’

Is the payment of interest unjustified compensation? After all, the lender has to postpone her own use of the money – think of all those middle-aged people investing money in a debt mutual fund for their old age, which the fund then lends to firms. Postponed gratification, as well as the loss of convenience in not having the money at hand for emergencies, requires some compensation. So too does any cost of preparing the loan document, checking the borrower’s credentials, and administering the loan. The lender also takes the risk the borrower may not repay, or may repay only partially, despite all the safeguards built into debt. So she also needs compensation for the risk of default. Finally, the lender’s use for money, as well as her ability to buy goods with it when she gets repaid, may be very different from today. This is another risk she bears.

The economically defensible interest rate therefore includes the time value for money plus transactions costs for making the loan plus the compensation to the lender for the risks she takes. The final piece that is tacked on is the lender’s profit, based on how pressing the borrower’s need is and what the alternative sources of loans are. So why would the ancient Hebrews prevent lenders from getting what modern economists think is their legitimate due? The answer relates to three factors: the size of the community, the condition of the borrower, and the extent of competition between potential lenders.

THE RATIONALE FOR PROSCRIBING USURY

In biblical times in Palestine, tribes were small, people poor, and the occasional borrower needed money typically to buy food or shelter for survival. The prohibition on usury within the community essentially meant the members of the community insured one another against adversity. If one tribesman’s goats died accidentally, he could go to others who were not similarly afflicted for help while he rebuilt his herd, promising to repay the favour when his luck improved.

A prohibition on taking interest would have a number of beneficial effects here. When people are living close to the edge, they are willing to promise anything for their family’s survival. If the community is poor and only a few have resources to spare at any given time, those few would then have tremendous bargaining power over the needy. If there were no prohibition on charging exorbitant interest, a temporary setback to some members of the tribe could lead them to become permanently indebted and thus enslaved to other luckier members. Over time, the enslaved would have little reason to work, the tribe would become even more impoverished, and conflict would increase.

In contrast, though, if the charging of interest were limited or even prohibited, the better-off members would have little profitable use for surplus resources. They would be forced to help out proximate neighbours or kin with interest-free loans, thus accumulating favours they could draw on when they themselves were hit with adversity. Those on the verge of starvation would have much more use for the shekel saved in interest than the well-fed lender.2 Moreover, in a small tribe, helping close tribe members survive would also be a matter of self-interest. These would be the people one would trade and work with over time. The bonds of friendship aside, if one’s trusted associates perished in hard times, one would have to build relationships with unfamiliar others, a potentially costly endeavour. Given the tribesmen’s choice between freely given mutual help and debt bondage, with uncertainty about who would come out as master and who would be enslaved, perhaps it is not surprising that they might have chosen to prohibit the latter. In a sense, therefore, the prohibition on usury created a rent, or surplus – the interest that could not be charged – that would be shared within the community to strengthen bonds.

Of course, a lender could get around the usury prohibition by disguising interest; for instance, a lender could finance the unlucky tribesman’s purchase of additional goats but demand milk every day in lieu of interest. This is where religion came in. Knowing that God saw what the tribal authorities might overlook, in an age when the fate of the soul was more important than earthly existence, the fear of retribution in afterlife played an effective role in ensuring the usury prohibition was respected in letter and spirit.

The prohibition on charging interest thus helped strengthen communal bonds and mutual support in small poor communities where anyone could be hit by adversity, and the identities of those in need fluctuated almost randomly over time. To be your brother’s keeper, to practice a kind of communism, made sense.

The prohibition was also a form of early consumer protection vis-à-vis outside lenders. With the poor borrower not knowing how to read, having a very rudimentary understanding of interest, and also often being in a position of deep distress, the possibility that dispassionate lenders from outside the community could take advantage of him was substantial. Better, socially conscious thinkers would have argued, to force the community to take responsibility for the poor than to deliver them into the clutches of the moneylender. Indeed, all these reasons also played out in the Church’s attack on usury in Europe in the Middle Ages.

FEUDALISM AND THE CHURCH’S ATTACK ON USURY

In Europe, from the early Middle Ages till about the eleventh century CE, the Church frowned upon the charging of interest on loans but did not prosecute moneylending as a sin.3 However, from about the middle of the eleventh century, the Church moved aggressively to curb usury, regarding any interest as a sin, prohibited by the Bible. The usurer had to repay all interest received during his life in full before he could aspire for salvation. The attempts to suppress usury reached their apex in the Church Councils of Lyon in 1274 and Vienna in 1312. The punishment for moneylenders included not only refusal of confession, absolution, or burial in hallowed ground – terrible penalties in those times of deep faith – but also excommunication of rulers or magistrates of states that permitted usury. The economic historian Richard Tawney writes about ‘innumerable fables of the usurer who was prematurely carried to hell, or whose money turned to withered leaves in his strong box or who … on entering a church to be married, was crushed by a stone figure falling from a porch, which proved by the grace of God, to be a carving of another usurer and his money-bags being carried off by the devil …’ 4

What accounted for the Church’s greater zeal in enforcing the ban on usury from the eleventh century onward? And why did it become far less passionate about rooting out the usurer from the late fourteenth century onward? An understanding of these shifts will give us a better sense of why attitudes toward markets change. First, though, we need to understand the quintessential community in those times in Europe: the feudal manor.

The Feudal Community

Under feudalism, everyone except the king held his share of land in trust from his overlord. Because land, the principal source of value, was not freely saleable, it was allocated to trusted supporters. In return for the use of the land and the overlord’s protection, the vassal swore fealty to the overlord and paid him in kind. If the vassal was capable of fighting, payment was through military service; if he was a peasant, payment was through produce from the land or labour. In a sense, feudal obligations and relationships arose from the land and the produce it generated, neither of which could be marketed.

Feudalism in Europe reached its zenith as the Muslim expansion from the seventh century onward shut off Europe’s access to traditional overseas markets. The proliferation of little principalities as well as banditry reduced the size of markets and increased the cost of transporting goods for trade.5 With little to buy, market transactions and the use of money diminished, and feudal relationships proliferated.

The feudal manor was thus a closed, hierarchical community, producing much of what it consumed. The peasant’s land holdings were typically in the form of strips in two or three large open fields, intermingled with those of his neighbours. Each peasant followed the same rotation of crops as the others, and had free access to common pastures and woods where each peasant had grazing rights for a certain number of cattle, sheep, or pigs, as well as the right to collect firewood. All this required a fair amount of coordination and give-and-take (the strips were not separated by fences and the commons were open to all in the manor), which required building consensus in the community.

Each peasant had enough to ensure a subsistence existence. There was little incentive to produce more, since there was not much of a market to sell the surplus in.6 Because the peasant was tied to the land, though, the feudal community was stable, albeit poor. As one historian noted, ‘Most men have never seen more than a hundred separate individuals in the course of their whole lives, where most households live by tilling their great-grandfather’s fields with their great-grandfather’s plough.’7

The Commercial Revolution

The nonmonetary feudal economy did relatively well when there were few trading opportunities. Over time, though, Europe learned to trade with, and through, the Muslim lands. Moreover, demand for agricultural products from the growing towns, as well as travel routes that were safer from brigands, helped the revival of trade and commerce. Feudal lords now not only had the opportunity to convert the manor’s produce into money, the money could buy an increasing variety of goods. The growing attraction of producing for, and consuming from, the market did not sit well with traditional feudal practice.

For key to the feudal system was that the individual did not own the land outright; instead, the peasant managed it while he was able-bodied and passed the management on to his kin when he could no longer manage.8 Everyone in the family had customary rights to the land, which made those rights difficult to sell or turn over. In turn, this ensured that a long-lived community built around that land, but productivity was generally low, since a farmer’s kin were not necessarily good farmers. In fact, the absence of a market protected the peasant – his low productivity hurt his household’s production, but did not jeopardize his right to farm land.

As feudal lords became more attracted to monetary income, and as land became easier to sell, this changed. In order to enhance production, the feudal lord had to be able to transfer land to more productive tenants or owners. In England, soon after the turn of the millennium, the courts started overlooking the customary rights of kin, making freehold land easier to bequeath or sell.9 Even tenancy that was tied in with feudal obligations, known as copyhold tenancy, became better defined and easier to transfer over time.10 Scholars argue over whether there was a dramatic change in the legal treatment of property, or whether England was intrinsically more favourable to sales. Whatever the reason, the interests of the Church also lay in freeing property from customary entanglements. If the rights of inheritance, for example, narrowed to direct relatives rather than residing with all kin, land would be easier to bequeath to third parties or to sell. And a primary beneficiary of bequests to third parties was the Church. An elderly childless widow or widower could easily be persuaded that their route to salvation lay in willing the bulk of their property to the Church. Even if they were not persuadable, often the only one who could write down a will or hear last orders was the not entirely disinterested parish priest.11

The net effect of a freer land market was that less-productive peasants had an incentive to sell or were strong-armed into doing so, often to larger landowners who had surplus cash, and who could farm the combined land more profitably. Land holdings became more concentrated in fewer hands but agriculture also became more productive. Unfortunately, a number of peasants were forced into marginal holdings or entirely out of the manorial community as they sold, or were evicted from, the land that tied them to it. At the bottom, holdings became smaller as the size of the peasant family grew. As the small peasant’s holdings were subdivided and average incomes fell, a growing number of second and third sons had to fend for themselves outside the feudal manor. The expansion of the market, as is sometimes its wont, resulted in growing inequality.

These were therefore extremely difficult times for many European peasants, especially those who no longer had the protection of the manorial community. Average incomes were not only barely above the level needed for subsistence but also were highly variable over time.12 The failure of a harvest or the death of livestock were not infrequent events. One estimate suggests that even the relatively wealthy English peasant could expect to face serious calamity every thirteen years.13 Some work did open up outside farming, especially in the growing towns where merchants and artisans prospered, but it was rarely enough.

Despite their low and highly variable incomes, death by starvation was surprisingly rare among the peasantry. The reason was simple: informal community support within the manor for those who still belonged to one, and formal charitable institutions run by the Church, such as almshouses, leper houses, pilgrim centers, educational institutions, and monastic hospitals, for those outside the manor, constituted a social safety net. Harder times for the poor explain why the Church became more aggressive in its fight against usury.14

Usury prohibitions limited the profits that anyone with excess wealth could make by lending to those in difficulty. At the same time, a lender faced a loss of social status and even excommunication if he was condemned as a usurer. Perhaps the businessman was willing to take this risk when young. As he grew older and came closer to the feared inevitable meeting with his Maker, the graphic pictures painted by the clergy of the torments that awaited him in hell were an increasing source of worry. The prohibition on usury thus helped channel the wealth of the rich away from making usurious consumption loans and toward helping poorer unfortunates. Such help could be given informally, or formally through charitable donations to the Church. As in the Hebrew tribes, the prohibition on usury suppressed the market in favour of the community. Thus as the commercialisation of agriculture created greater numbers of the poor, the Church took their side by restricting the debt market.

The Church’s actions were also not unrelated to the political battles it was fighting at that time with the secular authorities. The reforms initiated by Pope Gregory VII in 1075 – the so-called Papal Revolution – attempted to separate the Church from the feudal hierarchy, especially the domination of the Holy Roman Emperor.15 The details of the conflict, which culminated in the victory of the Church, need not concern us but some aspects are important. In order to attract support for their cause, Church scholars systematised and rationalised the Church’s vast legal traditions. A comprehensive body of canon law emerged, which could now guide ecclesiastical courts, and which helped reaffirm that all Catholic authorities, including the powerful emperor, were constrained by a higher, principle-based, law. Furthermore, in response to competition from the now-more-reliable ecclesiastical courts governed by canon law, feudal rulers developed their own legal system.

Both the Church and the ruler competed to offer better justice to attract plaintiffs into their courts. Since the poor and the powerless benefited disproportionately from the law, courts consequently became more sympathetic to their problems. Better-enforced usury prohibitions became one element of that competition.

The Church’s actions thus had mixed effects on the poor peasant. The Church may have helped make property more alienable in order to expand its own wealth.16 Easier alienability allowed feudal lords to move unproductive peasants off their land, rendering them destitute. However, the Church was probably also motivated by the welfare of these very same peasants and concerned about the stability of the community when it banned usury and exploitative market transactions. And it did use some of the wealth it accumulated to provide charity to the destitute.

The Intellectual Support for the Ban on Usury

The Church could appeal to a long line of thinkers, past and present, for support for the ban on usury. The Greek philosopher Aristotle, who was being rediscovered in this period, was firmly against interest on loans. He saw the production of goods to satisfy physical wants such as food and clothing as useful economic activity. Farming, the raising of livestock, and manufacturing were all productive. In contrast, trade, which simply exchanged goods for one another; hire, which lent out goods for money; and usury, which lent out money for money, produced nothing that satisfied physical wants. Of the three, ‘The most hated sort, and with the greatest reason, is usury, which makes a gain out of money itself, and not from its natural use of it. For money was intended to be used in exchange, but not to increase at interest.’17

St Augustine, a guiding light of the early Church, similarly warned about the three sins of fallen men: the lust for power, sexual lust, and the lust for money. Of these, he was most ambivalent about the lust for power, which if accompanied by a sense of civic duty and honor, could protect the community against external attack.18 He also discussed in his startlingly frank Confessions how his private desires such as sex – as a young man, he was sexually active, and later, he lived with a mistress who bore him a son – came in the way of his relationship with God. Here too he seemed to be ambiguous, if not understanding. About the lust for money, though, he was clear in his condemnation.