An American parable: The rise of Venetian inequality and the decline of prosperity

A new book, Why Nations Fail: the Origins of Power, Prosperity and Povertylooks at the historical roots as to why some countries are rich and others are poor. As with all books of this genre, it owes a great deal to Jared Diamond’s ground breaking book Guns Germs and Steel but has the benefit of being written later and providing additional nuances.

One society that it looks at is that of Venice between 800AD and 1600AD.  Venice started as a city of refugees fleeing into the marshlands from Germanic raiders.  It rapidly became one of the richest societies in the world, controlling most of the trade of the Mediterranean and Black Sea. And then it failed.  The authors, Daron Acemoglu and James Robinson, explain why:

By 1050, when Venice had already been expanding economically for at least a century, it had a population of 45,000…By 1330 the population had increased to 110,000; Venice was then as big as Paris, and probably three times the size of London.

One of the key bases for the economic expansion of Venice was a series of contractual innovations making economic institutions much more inclusive.  The most famous was the commenda, a rudimentary type of joint stock company, which formed only for the duration of a single trading mission. A commenda involved two partners, a “sedentary” one who stayed in Venice and one who travelled.  The sedentary partner put in capital into the venture, while the travelling partner accompanies the cargo.  Typically, the sedentary partner put in the lion’s share of the capital. Young entrepreneurs who did not have wealth themselves could then get into the trading business by travelling with the merchandise. It was a key channel of upward social mobility. Any losses in the voyage were shared according to the amount of capital the partners had put in. If the voyage made money, profits were based on two types of commenda contracts.  If the commenda was unilateral, then the sedentary merchant provided 100 percent of the capital and received 75% of the profits. If it was bilateral, the sedentary merchant provided 67% of the capital and received 50% of the profits. Studying official documents, one sees how powerful a force the commenda was in fostering upward social mobility: these documents are full of new names, people who had previously not been among the Venetian elite.  In Government documents of AD 960, 971 and 982 the number of new names comprise 69 percent, 81 percent and 65 percent, respectively, of those recorded.

The authors then go on to describe how this new economic wealth translated into increased political inclusiveness, with power being widely spread.  Eventually, in 1171 a Great Council was created which was to the ultimate source of political power from that point on. Every year 100 new members were nominated to the council.  They continue, describing the benefits of political inclusiveness:

These political reforms led to a further series of institutional innovations: in law, the creation of independent magistrates, courts a court of appeals, and new private contract and bankruptcy laws.  These new Venetian economic institutions allowed the creation of new legal business forms and new types of contracts. There was rapid financial innovation, and we see the beginnings of modern banking around this time in Venice. The dynamic moving Venice toward fully inclusive institutions looked unstoppable.

Then bad things start to happen as the established elites started to react against the new entrepreneurs:

But there was a tension in all this.  Economic growth supported by the inclusive Venetian institutions was accompanies by creative destruction. Each new wave of enterprising young men who became rich… tended to reduce the profits and economic success of established elites. And they did not just reduce their profits; they also challenged their political power. Thus there was always a temptation, if they could get away with it, for the existing elites sitting in the Great Coucil to close down the system to these new people.

And so they did. In 1286 a series of amendments were made to the Great Council rules which gave significant control over new council nominations to elite families. By 1297 rules changed so that if you had been a member of the council in the previous four years you received automatic nomination and approval to the council. The council effectively became sealed to outsiders. This caused political tensions and the first police force was introduced in 1310 to solidify the power of the elites. Having achieved political power they then moved to control economic power:

…they banned the use of commenda contracts, one of the great institutional innovations that had made Venice rich. This shouldn’t be a surprise: the commenda benefited new merchants, and now the established elite was trying to exclude them.

…in 1314, the Venetian state began to take over and nationalise trade. It organised state galleys to engage in trade and, from 1324 on, began to charge individuals high level of taxes if they wanted to engage in trade. Long-distance trade became the preserve of the nobility. This was the beginning of the end of Venetian prosperity. With the main lines of business monopolised by the increasingly narrow elite, the decline was under way. By 1500 the population had shrunk to one hundred thousand. Between 1650 and 1800, when the population of Europe rapidly expanded, that of Venice contracted.

The authors then note wryly:
Today the only economy Venice has, apart from a bit of fishing, is tourism. Instead of pioneering trade routes and economic institutions, Venetians make pizza and ice cream and blow coloured glass for hordes of foreigners. The tourists come to see the .. wonders of VEnice, such as the Doge’s Palace and the lions of St. Mark’s Cathedral, which were looted from Byzantium when Venice ruled the Mediterranean. Venice went from economic powerhouse to museum.

The book is really worth reading and skilfully shifts its focus from broad economic theory to a narrow analysis of a particular country in a particular time period  – such as the Venetian example above.

The main thrust of the argument is that there is always a tension between an inclusive and an exclusive society. Inclusive societies tend to be wealthier for all, including the very rich. Exclusive societies generally result in greater poverty for the overall society but greater relative (and absolute) wealth and political power of the exclusive, controlling, rich.

As a result, as the rich get richer they are more likely to be able to enact laws that consolidate their wealth and power. Over a period of time they can legally acquire so much political and economic power that they can essentially opt out of normal society and live in a parallel, but unequal, country.

This thesis is not just one of historical curiosity.  The problem is alive today and is reinforced by an article by Nicholas Kristof in the New York Times today about inequality in the United States and the emerging two tier society.  The rich can afford the basics of good schools, security and even electricity whilst those that are less well off cannot:

In upper-middle-class suburbs on the East Coast, the newest must-have isn’t a $7,500 Sub-Zero refrigerator. It’s a standby generator that automatically flips on backup power to an entire house when the electrical grid goes out.

In part, that’s a legacy of Hurricane Sandy. Such a system can cost well over $10,000, but many families are fed up with losing power again and again.

More broadly, the lust for generators is a reflection of our antiquated electrical grid and failure to address climate change. The American Society of Civil Engineers gave our grid, prone to bottlenecks and blackouts, a grade of D+ in 2009.

So Generac, a Wisconsin company that dominates the generator market, says it is running three shifts to meet surging demand. About 3 percent of stand-alone homes worth more than $100,000 in the country now have standby generators installed.“Demand for generators has been overwhelming, and we are increasing our production levels,” Art Aiello, a spokesman for Generac, told me.

In the commentary to the article Doug Broome recalls an article from The Economist 20 years back:

If inequality were an hour-long parade the first 10 minutes would be invisible since the marchers have negative worth and consequently are underground. You would then have tiny marchers of up to a foot tall for 30 minutes before people gradually approached “normal” height at the 50 minute mark while the seven-footers start appearing at 55 minutes.

The big surprises of the parade are bunched together in the last seconds. The 200 feet tall giants followed by thousand foot towers and then the three mile high behemoths lost in the clouds, their feet pulverizing buildings.

Rising inequality, whereby the top 1% of US society controls more wealth that the bottom 90% combined is mainly an economic issue at the moment.

Over time, if the Venetian parable holds, countries with these levels of inequality should start to see general economic decline and an increase in the relative and absolute wealth of the elites.

We should then expect new legislation to be enacted which will consolidate and enhance the political power of the elites, enabling them to further lock in their power and wealth.

This is a worrying trend.

History Future Now, ebook edition, is now available from the Apple iBookstore!  So if you have a iPad or iPhone click on this link to download it.  It is currently on at a special offer of 99c.   The Kindle version has been submitted to Amazon and should be available shortly.

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