The Wealth and Poverty of Nations: Why Some Are So Rich and Some So Poor
Page 31
Rules follow practice. Confronted with these shortcomings, Russian military strategists systematically underestimated the value of firepower. Bodies were seen as more important than arms—bodies and “moral force”—and the bayonet was preferred to guns. “The bullet is a fool,” opined Marshal Suvarov, “but the bayonet is a fine lad.”* The bayonet was surer, and reliance on guns could only weaken resolve and fighting spirit. It would be a mistake, therefore, to change from muzzleloaders to breechloaders. The soldier would only waste a lot of ammunition and forget how to charge. As firepower in other armies shot up, the Russian soldier was being schooled in thrift. The regimental economy mirrored the larger society: dragged down by inefficiency; wasting time and labor in accessory activities (agriculture, gathering wood and hay, construction, haulage); afraid of change.†
The Crimean War (1854-56) was a disaster. The Russians lost what they could afford to lose most—people, six hundred thousand of them. The trivial losses in territory hurt the generals and the tsar more. Some Russians were still using muzzle-loading flintlocks, while the British and French picked them off with percussion rifles that had three and five times the range. Even the Russian generals were sitting ducks. Not that the allies were models of homicidal efficiency. They had their own failures of supply and hygiene (their greatest enemy was disease) and their share of stupidities of command (in those days the British army was still selling commissions), fondly immortalized in Tennyson’s “Charge of the Light Brigade.”
But the Russians were worse.
17
You Need Money to Make Money
One knows how the “first industrial nation” did it. Slow and easy. Britain trained a factory labor force and accumulated capital as it went. In those early days, machines were typically small and cheap. Scale was small. Older buildings could be converted to industrial use. In short, threshold requirements were modest. So British enterprise could grow by plowing back earnings, by pooling personal resources, by borrowing from relatives, by renting facilities. Financial intermediaries, except for such loan brokers as attorney/solicitors, played a very small role. Banks confined themselves to supplying short-term or demand loans to facilitate real transactions. Some of this took the form of lines of credit, renewed as paid down. In good times, such lines were the equivalent of medium-or even long-term credit. In good times. In bad, they could be called in, or maturities could be shortened.
With the passing years, all of this changed: machines got bigger and heavier, required buildings to their measure. Scale economies and throughput grew as transport facilities improved. Still, British enterprise was rich enough to finance these outlays from within; if internal funds fell short, one typically brought in additional partners.* But even Britain had to find special ways to pay for public and quasi-public undertakings like docks, canals, and railways. Because the Bubble Act of 1720, passed in the wake of the notorious South Sea speculation and crash, prevented the creation of a joint stock with freely transferable shares, big projects typically went to large partnerships with assets vested in trustees. Not a happy solution in a commercial world of unlimited liability “to the last shilling and acre.” Yet the absence of serious legal change for a century testifies to the solidity of these undertakings and the general vitality of the British economy. (I am assuming here that if a need for bank financing had existed, a society so responsive to business interests would have changed the rules.)
In the nineteenth century, when things got costlier and risks greater, the most effective device for mobilizing capital was the chartered joint-stock company with limited liability—chartered because limited liability could be conferred only by the crown or Parliament. These large, semipublic enterprises never made much use of long-term bank financing, because no bank was big enough. The charter of the Bank of England provided that no other bank could have more than six partners. Not until 1826, and then only outside a sixty-five-mile radius from London, were joint-stock banks permitted; and only in 1833 were non-note-issuing joint-stock banks permitted inside that radius. Yet these new banks were little different in size and policy from their private counterparts, and even the railway builders didn’t need their help.
That was Britain. By the time Europe’s first follower countries got going (post-1815), Britain had known two human generations of growth and industrial development. That delay was in part an accident of political history, which has a nasty way of interfering with the best-laid plans. Twenty-five years of revolution and war from 1789 to 1815 diverted Continental resources from building to destruction, played havoc with enterprise and trade, generated some invention but delayed much application, inspired projects but then inhibited them—in effect, delayed industrial emulation of Britain an extra generation.
Not that the balance sheet was exclusively negative. The turmoil also promoted social and institutional changes favorable to industrial development. In particular, the French abolition of “feudal” dues and bonds led (obliged) other countries to do the same, freeing people to move in space and across outworn status lines. The economic payoff to these changes did not come until after the peace. By that time, the task of catching up was bigger, but the potential gain as well.
INDUSTRIALIZING EUROPE, C. 1850
The density of the railway networks is the best physical marker of the location and pattern of European industrial development. The earliest industrializers were those nations and regions already experienced in manufacturing: Benelux, northern and eastern France, Rhineland and Ruhr, and Protestant Switzerland.
For this reason, some have argued that it pays to be late: you can skip the mistakes, begin with the latest techniques and equipment.* On the other hand, the time lost lagging also costs. It pays to get started as soon as possible.
So the Continental follower countries felt that they had neither means nor time to grow as Britain had. They were competing in the same arena. Why wait fifty years to catch up with 1815? They needed more capital than Britain had needed, and they wanted it now. They wanted up-to-date factories, machines, engines. From about 1830 on, they wanted railways, canals, roads, and bridges. Where would they get the money?
Four places: (1) personal investment; (2) financial intermediaries and private credit; (3) government assistance; (4) international capital flows.
First, the Continent had its share of rich people. Unfortunately, most of these were landowners who scorned the ungenteel activities of trade and industry. Indeed, many of them had a distaste even for agriculture (they preferred to feel the earth through horses’ hoofs) and hired stewards to manage their estates. The owners lived on rents and produce; sometimes on capital. The stewards got rich.
Yet some gentry and aristocrats did gravitate to industry, partly because they hoped to make money, partly because industry was a logical by-product of estate management and regalian rights. Their land held valuable mineral resources or forests that could provide timber for ships, buildings, or pit props in mines. In central and eastern Europe, their control over a resident serf population provided them with a ready-made factory (or protofactory) labor force. Some of these noblemen actually became industrialists and merchants themselves. One thinks of such families as the Desandrouin and the Arenberg in the Hainaut (in later Belgium), the Fürstenberg and Schwarzenberg in Austria, the Wendel in Lorraine (become French in 1766), the Stroganoff and Demidoff in Russia; or of rulers such as Prince Wilhelm Heinrich of Nassau-Saarbrücken (ruled 1740-68).*
Normally such aristocratic entrepreneurs worked with bourgeois partners, better suited by status and values to do the dirty work—that is, make the money. (Noblemen are better at spending it.) Sometimes these commoners profited from business connections to gild their escutcheon. Take the rules of aristocratic alliance. In theory, noble married noble. But what if a commoner was very rich? Well, then, noble might marry commoner; the higher the noble rank, the more comfortable the misalliance. (Petty noble families had to be careful about that kind of thing.) Luck helped, as when a prince Schwarzenber
g (good name), aged thirty-one, married the eighty-two-year-old sole heiress to a merchant fortune. The lady obligingly died soon after, but then the young prince died too—“without descendants,” of course. So the estate fell to the main branch of the Schwarzenberg clan, which went on to prove its spirit of enterprise, not only by its choice of marriage partners but by setting up industrial ventures, reclaiming land, founding an investment bank.1
Such examples, however striking, fell short of an industrial revolution. That needed a wider range of sources, including banks and other financial intermediaries.
Here commercial experience proved a major asset. After centuries of more or less profitable activity, a network of private banks was in place (personal firms or partnerships), collectively rich and capable of financing medium-and long-term investments in industry and choosing customers not so much by price and terms as by probity, resourcefulness, above all connections. These groups typically hung on religious and cultural affinities: the Huguenot-Calvinist, Sephardic-Jewish, German-Jewish, Greek-Orthodox commercial “families” knew their own kind—whom to trust and whom to worry about, whom to ask and whom to work with.2
These small firms had more scope and surface than met the eye. As in Britain, bank finance on the Continent typically took the form of lines of credit, extended in support of real commercial transactions and covered by discountable commercial paper. But we also have examples of direct long-term funding and participation in company formation: thus the Paris Rothschilds financed French railways and French and Belgian coal mines and forges; the Vienna branch of the bank promoted railways and invested in ironworks and coal mines in Habsburg territory; and the Banque Seillière in Paris joined the merchant house of Boigues to relaunch the ironworks at Le Creusot in 1836.3
One should not underestimate the resourcefulness of these old trading houses. They could fairly smell profit and had built their fortunes on opportunism and variety. To this we should add a flair for profitable marital alliances, which could provide both funds and business contacts.4 Any effort to understand the Industrial Revolution in Europe before the age of public joint-stock companies and stock exchanges must take family and personal connections into account.
In good times, short-term and demand loans could turn into long credit; in bad times, failure to renew such support could push a desperate company into liquidation. Much depended on the robustness and loyalty of one’s creditor, but even the most trusting and determined lender could find his hand forced as other banks began calling in their loans. That is the trouble with a network system: when it is strong, it is stronger than the sum of the parts; but when it weakens, the weakness spreads easily from one link to the next.
This collective danger, and the need for long-term investment, led to the invention of a new financial intermediary, the joint-stock investment bank, or as the French came to call it, the crédit mobilier. The first inspiration for such institutions came from bureaucrats as well as business interests: even before 1820, officials and merchants in Bavaria were calling for a special bank to promote industry. The earliest working examples were quasipublic institutions—the Société Générale in Brussels and the Seehandlung in Berlin. The new form gained considerably in importance with the coming of the railway—a capital-eater if ever there was one, both in itself and for the large-scale industrial enterprises it encouraged. So it was that in the 1830s the Société Générale, until then a quiet commercial bank, turned into a development bank; and that France spawned a gaggle of caisses—joint-stock limited partnerships (commandites par actions) created to finance industry at medium and long term.* Why caisses? The Bank of France was opposed to the use of the word banque for such intrinsically risky ventures. This was also why the brothers Pereire later baptized their bank the Société Générale du Credit Mobilier and thereby gave birth to a generic. If you can’t call a bank a bank, you have to think of something else that will smell as rich.
It was once thought that these new financial institutions came into being over the opposition of the older private banks, which had their own industrial interests. In fact, the private banks actively promoted the credits mobiliers, for the best of reasons. Long-term investments put them at great risk, and the losses and bankruptcies of the business crises of 1837-39 and 1848 convinced them that discretion was the better part of valor. Shift the risk to shareholders of separate firms and if possible get permission to incorporate with limited liability.
After the panic of 1848-49, the Credit Mobilier of Emile and Isaac Pereire seemed a new departure and quickly found imitators.5 Its approval by the regime signaled explicit encouragement for industrial development; also for the arrival of new men. President Louis Napoleon, nephew of the great Napoleon, soon to be Napoléon III, alias le “Petit,” wanted to make his place in history; also to create a counterweight to the older network of top-drawer private banks—the so-called haute banque—which had been thick with the late Orléanist regime. In the same spirit, the regime relaxed the constraints that favored old wealth. In 1867, in a belated response to general incorporation in Great Britain in 1856, the French went over to routine registration of public companies.6
French investors could create and pay for development banks because the country already held a lot of private capital. At that point, in fact—and contrary to historical myth—the Credit Mobilier and its imitators in France were not much needed. The best of the railway lines had already been conceded to syndicates of the older financial powers; the Credit Mobilier got the leavings. Nor did French industrial firms turn to the new investment banks, preferring the discretion of the old-style merchant houses. A company that resorted to long-term bank financing, with its concomitant surveillance and interference, was probably in deep trouble.* None of this helped the new-model institutions; the great Credit Mobilier went bust in 1867.
In Germany and farther east, the development bank came into its own, founding and financing industry, supervising performance, promoting innovation. These new institutions combined investment, commercial, and deposit banking (hence the appelation “universal banks”). The best of them gathered technical intelligence and served as consulting bureaus. Such a mix of functions struck British bankers as a violation of sacred writ. How could one safely combine short-term, even demand, liabilities with long-term immobilization of funds? Surely a recipe for disaster.
The answer lay, first, in the rapid growth of the German economy from the 1830s on—the kind of thing that makes everyone look good; and second, in the preference of these banks for “well-heeled” customers. (The two essentials of successful banking are, first, other people’s money, and second, lending to the rich.)7 The ability of these universal banks to find well-heeled customers and offset risks became legendary. The best and biggest were the famous D-Banken (so-called because their names all began with the same letter): the Darmstädter Bank, Discontogesellschaft, Deutsche Bank, Dresdner Bank. Two of these (Darmstädter and Dresdner) started in provincial centers and moved to Berlin; one finds similar transfers in Britain and France. They signal the strength of local enterprise and capital. Between 1870 and 1913, book value of assets of these mixed banks rose from about 600 million to over 17.5 billion marks—from 6 to over 20 percent of the stock of industrial capital.8 Most of the shares were in heavy industry. Smaller enterprises found help elsewhere; the business of big banks was big business.
But what if the country was too poor to finance the banks needed to finance industry? Well, then the state might step in, either by promoting financial intermediaries or by direct investment and participation. Here the west-east gradient took the form of increasing intervention. At one end, in Britain, enterprise got nothing from the state; even the canals and railways were financed by private investment. Across the Channel in France, manufacturing enterprise got no further direct assistance after 1830; as for railways, a thrifty bourgeois regime—symbolized by a portly Louis-Philippe and his prudent black umbrella—resisted calls for help from promoters and banks. The days of direct
ion and sponsorship were past. The French state sought private enterprise to build the railroads and refused to purchase shares. On the other hand, it agreed to pay for the land and roadbed (including tunnels and bridges), justifying this substantial aid—about 18 percent of total cost as of early 1848—on the ground that the road was going to come back to the state anyway at the end of the concession period. All in all, and counting a few state loans, the French government paid slightly over 25 percent of the cost of railway lines to that date.
In the Germanies, political fragmentation made for a variety of policies. Some regimes continued to subsidize industry, partly because of its technological or strategic interest, partly in the cause of social order; while railway financing varied from purely private to state purchase of shares, to public construction, ownership, and operation. In the United States, too, home rule meant that policy varied from one state to another. Insofar as the individual states wanted to encourage public works, subsidy was the rule, often in the form of land grants along the railroad right of way. In Russia, the state assisted banking and industry, and the railroads were state-built, owned, and operated. Commerce and topography be damned. The emblematic example: the construction of the first important line, from Moscow to St. Petersburg. The tsar was asked to select the route. He took a ruler and drew a straight line between the two cities. But the tip of one finger stuck out, so the line was built with one curved section.