Introduction

Everyone, it seems, has discovered that institutions matter. Academic researchers have launched various 'institutionalisms' and 'new institutionalisms' in economics (North, 1994; Rodrik et al., 2004; Ménard and Shirley, 2005; Beck and Laeven, 2006), political science (Thelen, 1999; Lieberman, 2002), and sociology (Powell and DiMaggio, 1991; Clemens and Cook, 1999; Ingram and Clay, 2000; Schofer, 2003). Practitioners who work for the IMF and World Bank (and other development organizations) have also discovered the importance of institutions and have shifted their policy recommendations away from a narrow focus on macro-economics to encompass institutional issues like corruption and rule-of-law (World Bank, 2002; International Monetary Fund, 2005). While there are many different kinds of institutions, most of the recent practical and academic work has focused on economic and political institutions and how they affect the operation of market economies.

In this paper, I will focus on one particularly influential version of institutionalism from within the economics literature, and examine how the core idea of 'institution' is conceptualized, outline the relation between political and economic institutions, and see how these are supposed to influence economic performance and market growth. Douglass North, who received the Nobel Prize for economics in 1993, has strenuously argued for the importance of institutions in explaining long-term economic growth (North, 1981, 1990, 1994, 2005), and consequently many economists have turned their focus onto institutions (e.g., Rajan and Zingales, 2003; Glaeser et al., 2004; Rodrik et al., 2004; Greif, 2006). Not everyone agrees that institutions are so important, controlling for other determinants of economic growth (e.g., factor endowments, human capital, etc.), and some have explored the causes of institutional development as well as its consequences (e.g., Acemoglu et al., 2001), but institutions now receive much scholarly attention. North has reshaped the field of economic history and his ideas have influenced how contemporary international financial institutions think about economic development. For example, his work is recently cited by both the IMF and World Bank (World Bank, 2002; IMF, 2005), and has been referenced in the World Bank's centerpiece document, the annual World Development Report, since the late 1980s. After reviewing North's influential perspective, I will use a detailed case study to reveal the limitations of this kind of institutionalism. The case wasn't chosen at random, however, for I examine the very same one used in an oft-cited article by North and Weingast (1989)¹ to develop their ideas about how political institutions affect economic growth: Britain at the time of the Glorious Revolution (1688–1689).

North defines institutions in terms of rules, and one limitation of his perspective concerns how 'rules' are understood. Rules operate negatively. They function rather like the Ten Commandments ('thou shalt not...'), as prohibitions that exclude alternatives.² North distinguishes political from economic institutions, but he posits an important connection between them. I will argue that his conception of rules is too limited, and that the case of early modern Britain actually shows a broader relationship between political and economic institutions than his approach acknowledges. But my point is not simply to claim that North missed some details about Britain in 1689, for I also argue that a different conception of rules attunes the researcher to the wider set of connections that actually link political and economic institutions in many settings.

North on institutions

For North and those he has influenced, institutions are akin to the 'rules of the game.' As he put it: 'Institutions are the rules of the game in a society or, more formally, are the humanly devised constraints that shape human interaction.' (North, 1990: 3; see also North, 1994: 360; North, 2005: 48). An institution is an ensemble of rules, and rules (together with their enforcement mechanisms) constrain behavior and limit human action. Rules function 'negatively.' Economic institutions are distinguished from political institutions, presumably because of the particular type of rules they embody. They are not simply different from each other, however, for their relation is a hierarchical one: political institutions set the stage for economic institutions, which set the stage for markets. North explains that: 'The rules descend from polities to property rights to individual contracts' (North, 1990: 52). He gives a sense of what such rules are specifically about when he asserts that: 'It is the polity that defines and enforces the formal economic rules of the game and therefore is the primary source of economic performance. The formal economic rules are broadly speaking property rights defining ownership, use, rights to income, and alienability of resources and assets as expressed in laws and regulations.' (North, 2005: 57). In his view, the institutions that are most important for economic growth consist of an ordered hierarchy of rules, with each level setting limits on the level below, from political constitutions at the highest level, through common law and down to economic contracts at the lowest.

Polities, states, governments, sovereigns, and so on define property rights, which are the basic elements of markets. Markets, in turn, provide the economic base upon which states and rulership depend. States provide the rules and institutions that let markets flourish, and states extract resources from markets via taxation and tribute. One of the biggest dangers comes when governments or rulers themselves break the rules and violate property rights. North and Weingast (1989) argue that financial markets are especially revealing in this regard (see also North, 1990: 69), and claim that political changes in the basic structure of the British polity allowed British sovereigns to credibly commit to respect the property rights of their creditors. A constitutional shift in power from the king to the king-in-parliament gave political power to those who were represented in parliament and so constrained the autonomy of the sovereign that later kings and queens could no longer violate unilaterally the property rights of their subjects. British rulers agreed to protect the sanctity of property, and because they shared political power with parliament that agreement was credible. Those with capital could lend to the king or queen with the assurance that they would be repaid. As a consequence, London's financial markets enjoyed long-term growth and Britain began its ascendency as a world economic and military power (North, 1990: 129).

According to North, change in British political institutions was central to Britain's long-term economic development. New political rules constrained what sovereigns could do. As he stated: 'The key [to long term economic growth] is the establishment of institutions of impersonal exchange that constrain the players and limit political rule making' (North, 2005: 107). The post-Glorious-Revolution rules restricted the discretion of the British crown, and protected financial property rights, as an economic institution, from sovereign predation. The diminished power of the crown was beneficial in the long run, although at the time British sovereigns did not see the matter that way.

North's account is attractively parsimonious, it seems consistent with the broad outlines of British history, and his conceptual framework can certainly be generalized to other cases. But it is worth asking whether there is a little too much parsimony, to the point where important features are being left out. Do economic and political institutions act in ways that are not captured by North's conceptual framework? Does the link between political and economic institutions chiefly consist in political rules, as constraints, limiting economic action? How else might we think about the relationship? Furthermore, by using a very specific historical case, North (and Weingast) invite questions about whether their account offers sufficient fidelity to the historical facts. I shall begin my evaluation of North by returning to the difference between political and economic institutions, and their relation with each other in the early modern period. I shall then consider the case in greater detail, showing the full range of connections between political and economic institutions.

State and economy

The state is an organization which monopolizes the legitimate means of coercion within a geographically bounded area. A market is a physical or virtual space in which actors exchange tangible and intangible assets for money, or for other goods. So at first blush, these two institutions appear to operate according to very different rules. Decision-making in states tends to be centralized at the top (in the hands of the ruler, king, government, or president), whereas in markets it is relatively decentralized (every participant decides whether or not to transact, and on what terms). Political decisions reflect the social differences that undergird political interests (e.g., religion, ethnicity, region, etc.), whereas market decisions are guided by a single economic rationality that ignores such differences (e.g., trade with anyone, so long as their gold is yellow or their money green). States operate through unilateral coercion (or the threat of it) whereas markets operate on the basis of mutual consent. States govern contiguous territories whose mutually exclusive boundaries clearly separate domestic from foreign regions. Markets govern economic activities through overlapping networks of transactions that typically span non-contiguous geographic regions and that have no inside or outside. States grow through an accumulation of power, while markets grew through an increase of economic activity. States are characterized by 'voice' and markets by 'exit' (Hirschman, 1970). In the modern era, policies that enact state control over the economy, like nationalization, are the opposite of market friendly policies, like privatization.

On the basis of these contrasts, it would be easy to conclude that states and markets are contradictory institutions. But despite their differences, the development of states and the growth of markets occurred together. As territorially based, resource-dependent organizations, nation states benefitted from developments that enhanced their ability to extract and mobilize resources. Most obviously, more effective resource mobilization increased a state's ability to control its domestic population, to maintain its own geographical integrity, and to fight wars with other nation states. Especially after the military revolution of the early 17th -century (Parker, 1988), war became an extremely expensive activity, and mass armies were necessary to defeat internal and external rivals. Polities not blessed by geographical protections, adroit leadership, or a system of protective alliances, either had to find some way to muster greater military strength, or faced the likelihood of defeat and dissolution. In special circumstances, the costs of such resource mobilization could sometimes be temporarily externalized (e.g., the kontribution system, in which occupying armies would impose unilateral in-kind taxes on foreign territories; see Jones, 1988: 30–31). But mostly these costs had to be born internally, and burdened the domestic economy.

Extracting resources from a domestic population was rarely a simple task. Tax collectors have never been popular, and so the tasks of assessment and extraction were a challenge. But the extent of tax compliance and the ease with which economic resources passed from 'private' to 'public' hands depended very much on the political relationship between rulers and ruled. In early modern Europe, this relationship was, as Ertman (1997) points out, shaped by the relative timing of the establishment of representative political bodies (like parliaments) and the development of the state bureaucratic infrastructure. Strong representative institutions, like the English parliament, restrained the absolutist aspirations of sovereigns and steered political development in the direction of constitutional government. Parliaments, parlements, and similar institutions gave a voice in government to (some of) the ruled, and with increased participation came greater tax compliance (Ertman, 1997: 111). But representative bodies have their own internal political dynamics, and these can complicate the effect on state resource mobilization.

The connection between resource dependence and power seems unusually stark in the case of early modern public finance. In Pfeffer and Salancik's (1978) classic formulation, organizations are dependent on those who provide critical resources, and the sole supplier of a key resource gains power over the recipient organization. Traditional European fiscal systems typically involved heavy reliance on some form of a land tax or a levy on agricultural production (since land was such an important productive asset), or on the ruler's own estate. Newer revenue sources included taxes on internal (excise) or foreign (customs) trade, and these obviously relied upon the activities of the merchant community. Sovereign borrowing might depend on a small number of bankers, or the larger mercantile community. But in either case, rulers would not be looking to traditional landed elites as the source of loans. Following Pfeffer and Salancik, resource dependence generated political dependence. Rulers who depended on trade as a revenue source would have to come to some kind of political accommodation with the merchants who made trade happen, although this was rarely a straightforward process. New tax sources were good for rulers who wanted to diversify their resource base, but were bad for those whose power in relation to the crown would be thereby threatened.

Resource mobilization depended on economic factors in addition to political ones. The development of market activity generally helped states in two ways. First, market expansion meant a bigger economic 'base' upon which to fund a state apparatus. For a given tax rate, a larger base meant higher revenues. If rulers are 'rational' this gives them a straightforward incentive to craft law and policy so as to grow the economic base and maximize their own revenues (Levi 1988). Second, market exchange offers unique advantages over alternative transactional modes (like gift or in-kind barter exchange) in the assessment and imposition of taxes. Market transactions supply their own metrics for the measurement of economic worth and provide a convenient point-of-assessment for tax authorities (when and where exchange occurs). Market transactions have a visibility and boundedness that make them easier to track.

Certain kinds of markets can be particularly useful for states. In particular, capital markets make it easier for states to borrow money and bridge gaps between income and expenditures. Going into debt allows states to fund a higher level of activities than would otherwise be possible using current revenues. Borrowing means that private lenders voluntarily give resources to the state (as the debtor) in exchange for future repayments, and it allows states to 'soften' their own budget constraints.³ High interest rates obviously make it more attractive for creditors to lend to government but so does liquidity, that is, the ability to resell a government bond on a secondary market. An active capital market confers liquidity upon government (and other) debts (Carruthers and Stinchcombe 1999).

Public debt makes use of liquid capital markets, but it depends on tax revenues. From an strictly economic standpoint, lenders are more willing to lend if they are sure that the government-debtor will receive the future revenue flows sufficient to service the debt. A state with a weak tax system is going to find it hard to borrow money because lenders will not find its promises credible. Furthermore, the state must be deemed both able (by virtue of future tax revenues) and willing to repay. Earmarking revenues to service particular loans is one way to guarantee repayment. Creditworthy states can borrow more money for longer periods of time and at lower interest rates.

Resource mobilization as the primary engine of state development had some built-in limits. Cooperation from subjects and citizens was one of the most basic expressions of political support. Subjects would more readily consent to be taxed when they believed in the legitimacy of the ruler, and so anything that dramatically undermined that political support could have severe fiscal consequences. For example, a ruler who was too successful at resource mobilization risked overexploiting his or her fiscal autonomy and engendering a political backlash. Subjects also recognized that high fiscal dependence could, under some circumstances, give them some influence over political decision-making. Changes that made sovereigns less dependent on suppliers of resources might reduce their political leverage, and for that reason be objectionable.

If markets underpin state-building by providing a revenue base and a mechanism for borrowing, it is also true that states help to build markets (North, 1981). Market activity expands with the provision of a stable medium of exchange, and a legal system that protects property rights and reliably enforces contracts can also facilitate market activity. Sovereigns often tried to cultivate markets by promulgating standardized weights and measures, and thereby provide accurate information to buyers and sellers. These strategies were not invented or pursued independently, for sovereigns learned from each other as well as from their own experience. Institutional innovation that was advantageous to one ruler would often be emulated by others, especially under circumstances of international conflict. Such emulation was limited, however, by perceptions of who constituted the relevant 'peer group' for sovereign rulers. Absolutist rulers were more likely to look to each other than they were to republican polities or city states governed by non-royalty.

The institutional features created by such strategies also spread because they benefitted merchants who, unlike almost any other social group in the early modern era, truly spanned the globe. Long-distance merchants had a highly cosmopolitan outlook, encompassing networks, and could readily compare how easy it was to transact in different markets and jurisdictions. Arbitrage (taking advantage of price differences) was a common mercantile activity (known then as 'forestalling and regrating') that inadvertently made merchants appreciate the differences in how trade was organized in different markets. Merchants were therefore able to diffuse economic practices from one region to the next (e.g., consider how double-entry bookkeeping migrated from northern Italy, where it was invented, to northwestern Europe), and also to make claims on rulers to provide institutions and services that benefitted their market-based activities. When distinct ethnic or religious identities overlapped with mercantile status (as was the case with Huguenots, or Sephardic Jews), strong social networks connected together geographically dispersed communities, creating small worlds through which innovations could rapidly diffuse.

State activities can also encourage market development haphazardly, unintentionally, and by accident. The foregoing lists a number of strategies that, if deliberately followed by rulers, would enhance market activity. However, these do not exhaust the impact that states, rulers, and politics can have on markets. Political conflict is about the exercise of power and the pursuit of divergent political ends. But political activities sometimes influence economic markets, although that is not their intent. In particular, as I shall argue below, the institutional linkages between markets and states offered a channel through which political cleavages, whose forms were rooted in the struggle for control over the polity, ended up animating and shaping market activity.

In the following section, I return to the case highlighted by North and Weingast (1989) and show how the development of state and market institutions intersected in late-17th and early-18th-century England. The first process involved the accumulation of political power and the development of public capacity, while the second entailed the pursuit of private interest. As Scott (2000: 84) points out, the early Stuart realm was fiscally and militarily weak. But under the last of the Stuarts, Queen Anne, England exerted a tremendous military effort made possible by prodigious resource mobilization. Fiscally and militarily Britain had become much stronger (Brewer, 1989: xiii). Over the same period, financial markets experienced comparably dramatic development and so by the end of the 17th century London had emerged as a major financial center.

The motivations behind the development of the London stock market were more complicated than one might imagine. Economic self-interest was bolstered by partisan political interest, and joint-stock companies were used as political vehicles. In the most direct way, the 'monied companies' became politicized because they were created either by royal decree (in the case of the old East India Company) or by an Act of Parliament (in the cases of the new East India Company, Bank of England, Land Bank, and South Sea Company). A political 'birth', as it were, made them political organizations. Admixtures of partisan and economic interests drove various attempts to establish joint-stock companies, even when the attempt failed. In a less obvious and more surprising way, companies were political in that trading in their shares was shaped by political allegiances.

From the standpoint of the 21st century, we view the Market and Politics to be distinct institutions, dominated by homo economicus and homo politicus, respectively. In Douglass North's terms, these are distinct games played according to different rules. Despite their differences, during the early modern period these two institutions co-evolved in ways that affected both. Institutional development and change in one sphere involved the importation of logics of action and interests from the other sphere. Furthermore, their co-evolution involved both 'domestic' and 'international' factors. As Scott (2000) points out, the setting for 17th century English state-building was determined by the European counter-reformation and fears of popery and arbitrary government. Events like Louis XIV's Revocation of the Edict of Nantes (1685) sharpened the Catholic–Protestant conflict and unleashed streams of Huguenot refugees leaving France for destinations like the United Provinces and England. Domestically, English elites wrestled with their own problem of religious toleration and what sort of accommodation (if any) to make to dissenting Protestants or English Catholics. In addition, institutional developments unfolded in the context of England's rivalries with the Dutch and the French. The ability of the United Provinces to sustain a wealthy trading empire on the basis of a small population and few natural resources was the source of envy and wonderment in England. English monarchs, for their part, sought to emulate the power and glory of the Sun King. The Dutch Republic and Bourbon France offered two quite distinct political models for English rulers.

The English state as a growing nexus of power

With the restoration of Charles II to the throne in 1660, England's political experiment with republican government seemed over, and the return to monarchical government complete. Almost all of the traditional rights and powers of the crown were bestowed upon Charles, and his reign started off with a tremendous burst of popularity. The Interregnum was a past that many were eager to put behind them. Yet the break was not so clean or complete as the political rhetoric of the time would suggest. In particular, it was clear that the republic had done certain things rather well, and that it possessed fiscal and military capabilities that exceeded preceding regimes. For one thing, an excise tax imposed in 1643 generated a steady and voluminous revenue stream that eclipsed many of the older, traditional forms of taxation. Borrowed from the Dutch, the excise helped to fund a standing army (Roseveare, 1991: 7–8). England enjoyed military success under Cromwell as it raised an effective army and defeated Holland in the first Anglo-Dutch War (Wilson 1978: 77). Indeed, the parliamentary army and navy of the interregnum period were much more effective than their monarchal predecessors.

The restoration settlement did not entirely bring back the status quo ante, but many institutions and arrangements were restored. Some of Charles II's prerogative powers and institutions were curtailed or extinguished (e.g., the Star Chamber and the Council of the North, see Jones, 1978: 141), but in most other respects the Crown resumed its former powers and dignities. Indeed, Charles began his reign with the overwhelming support of the English political nation (Seaward, 1988: 1). On the fiscal front, the Charles II relied heavily on individual financial intermediaries for borrowing (Nichols 1987), and on fixed-term tax farming syndicates to collect his excise, customs, and hearth tax revenues. Tax farms, a kind of early modern out-sourcing, allowed the king to borrow money (from the syndicate making the winning bid, who would begin their farm by advancing a large sum to the Crown), and to avoid building up an administrative apparatus to collect the revenues (since that was the job of the tax farm), but it did give private groups direct control over the Crown's critical sources of cash. When one particular syndicate gained control over too much of the public revenue, and tried to press its advantage, the Crown reverted to direct collection (Brewer, 1989: 93). On those occasions when the king asked parliament to raise additional funds (typically to cover some kind of military expense), the latter usually turned first to the customs (Chandaman, 1975: 14).

Twenty years before the Glorious Revolution, a number of restoration-era changes helped lay the groundwork for the 'English Financial Revolution' (Dickson, 1967). To begin with, the Treasury asserted more centralized control over public finance. Revenue collections were taken out of the hands of tax farming syndicates and managed directly. After the 1667 death of Southampton, the Lord Treasurer, a Treasury Commission was put in charge and staffed by younger and more energetic individuals (Roseveare, 1962: 19–20). At the behest of Sir George Downing, former resident (ambassador) to Holland and later Treasury Commissioner, a number of administrative reforms were introduced. Downing had learned much from the Dutch and was very impressed with their public financial system. Among other things, he used the market price for Dutch East India Company (VOC) shares as a measure of the overall state of Dutch public credit (Roseveare, 1962: 26–7). In a way that foreshadowed English developments, Dutch joint-stock companies were so closely involved with public finance that their share prices could be used as indices for the latter.

The Additional Aid of 1665 was a landmark funding measure for two reasons (Roseveare, 1962: 23–25). First, all the monies were to be paid directly and completely to the Treasury, with no diversion. Formerly, tax funds were often diverted at source to cover local expenses, but this meant little centralized oversight and created ample opportunity for corruption. Second, the measure institutionalized payment-in-course, which meant that those who loaned money to the Crown on the security of the tax revenues were to be repaid in the same order in which they loaned their money. In particular, Treasury Orders (promissory notes) were numbered consecutively and registered as they were issued, and repaid according to the number. This sharply restricted the discretion of the Treasury to repay whichever crown creditor it pleased, and ensured more predictable repayment. Downing hoped that payment-in-course would lessen reliance on goldsmith bankers and enable the Crown to borrow from a broader set of investors (Seaward, 1988: 126). This was not the first time the Crown attempted to tap into deeper pools of commercial wealth, but prior efforts had not been very successful (Cramsie, 2000).

Downing's innovations were opposed by Lord Clarendon, the Lord Chancellor, on the grounds that although they were appropriate for a commonwealth (like the Dutch Republic), they were not suitable for a monarchy (Roseveare, 1962: 46). The prerogatives of a king brooked no constraint on royal discretion. Nevertheless, Clarendon's objections were overridden and Downing was allowed to press on as Charles' demands for more money continued unabated. Despite these improvements, the fragile limits of restoration public finance were dramatically revealed in 1672 by the Stop of the Exchequer: an event in which Charles II unilaterally suspended repayments to the goldsmith-bankers who had functioned as his primary creditors, in order to free up money and prosecute the Third Dutch War (Carruthers, 1996: 33). That such a drastic measure was necessary, and that the king was able to impose it, reveals much about the inability of the restoration fiscal system to deal with war-driven increases in public expenditure. The goldsmith bankers were mostly ruined, although in some cases the collapse took several years, and the legal difficulties they faced enforcing their claims revealed the weakness of the property rights of public creditors (Carruthers, 1996: 124–126).

After his death, Charles II was followed by his younger brother James II. For a variety of reasons, James started his reign in an enviable position. After the political divisiveness of various exclusion bills and the Popish Plot, James inherited the throne with the strong support of the landed gentry and the Tory party. His financial situation was strong as well. James did not have to go before parliament for additional funds and thus avoided a circumstance that always gave parliament the chance to exercise the power of purse strings. Trade boomed in the mid-1680s, and this led to high customs revenues for the Exchequer. With financial independence came a measure of political independence, and James felt little need to call parliament or to account to it. In some ways, his political independence led to his own undoing.

After the Glorious Revolution, parliament resolved not to make the mistake of granting too generous revenues, as it had at the start of James' reign. William and Mary were thus subject to greater fiscal restraints (Roseveare, 1991: 31–32), and as a good will political gesture William gave up the hearth tax. Despite parliament's reluctance to fund the monarchy generously, war-driven financial demands once again forced it to raise very large sums of money. First the Nine Years War (1688–1697) and later the War of the Spanish Succession (1702–1713) drove a number of financial innovations that greatly enlarged the fiscal capacity of the English state, and underpinned the war effort (Black, 2000). Tax revenues increased, but expenditures increased even faster. The gap was filled through a system of borrowing that led to the establishment of a long-term national debt. Joint-stock companies, traded on a newly emergent London stock market, played a key role in the growth of the long-term public debt.

The land tax, customs and the excise were important contributors to overall tax revenues in the 1688–1714 period (Brewer, 1989: 95,99). Brewer (1989: 67–70) documents the growth of British revenue departments and their conversion into relatively efficient (at least by early modern standards) bureaucratic organizations that could extract resources from various points of the domestic economy and make them available to the central government. These post-1689 reforms often built on the changes made in the restoration period. One indicator of the more bureaucratized nature of the British state, as compared to France for example, was the relative absence of venal offices (Ertman, 1997: 186, 197; Braddick, 2000: 264). In the Exchequer itself, tenure of office was shifted from 'for life' to 'at pleasure', a change that made office-holders more accountable to their superiors (Sainty, 1965). Besides administrative improvements, the burden of taxation was ameliorated, to some extent, by the use of local notables for assessment and imposition (see, e.g., Ward, 1953 on the land tax).

Improvements in tax collection provided the British state with additional resources, but these were still not enough. As much as taxes grew, war-driven expenditures grew even faster. But improved revenues, along with some other necessary changes, did allow the state to borrow. In the post-Glorious Revolution period, public debt grew massively even as it shifted from short-term to long-term, and from unfunded to funded status. The critical changes involved the use of the London stock market, and joint-stock companies in particular, as vehicles for the issuance of long-term public debt, together with parliamentary responsibility for national debts. The Crown had previously used individual and corporate intermediaries for borrowing (e.g., guilds, goldsmith bankers, municipal governments), but now it turned to publicly-traded joint-stock companies on a massive scale.

In the 1660s, Sir George Downing enjoyed only a little success in trying to enlarge the pool of public creditors beyond the small circle of goldsmith bankers. In the latter part of Charles II's reign, and for most of James II's reign, public finances were in good enough shape that large-scale borrowing wasn't necessary. But when deficits soared in the 1690s, the goldsmith bankers were unavailable, and other sources for loans were inadequate. Instead, the state turned to the big joint-stock companies, which in exchange for special rights would lend money to the state.

There were no general laws of incorporation in early modern England, so for a group of investors to enjoy the privileges of incorporation (legal personality, perpetual succession, etc.), they had to obtain a charter either from the king or from parliament. Such privileges were granted rarely and only as part of some kind of political deal. In the case of the largest of the joint-stock companies of this period, the Bank of England, the old East India Company, the new East India Company, and the (infamous) South Sea Company, that deal included long-term loans to the government. When the Bank was founded in 1694, for example, £1.2 million was raised from private investors who subscribed to company stock, and the entire sum was immediately loaned to the government, which was desperate for money, at 8% interest. The principal of this loan was never repaid, although the interest was. When the new East India Company was established in 1698, it loaned £2 million to the government, and when the South Sea Company was founded in 1711, its capital consisted of a £9 million conversion of short-term public debt into long-term debt (Carruthers, 1996: 76–79).

A number of financial instruments existed that would allow individual investors to lend directly to the British state: they could purchase annuities, tallies, or participate in a lottery or tontine loan (all of these instruments were based on foreign models). But these paled by comparison with joint-stock companies as a way for investors to lend to the state. Why? The answer lies in the London stock market and what it, as a financial institution, did for company shares. This market, which was modeled after the Amsterdam bourse and which grew dramatically in the 1690s, imparted to public debt the very attractive feature of liquidity. Here is how.

From the standpoint of a lender, one big disadvantage of a long-term loan is that the lender's capital is 'tied up' for the duration of the loan. Only when the debtor repays does the lender get his/her money back. If debts are negotiable, however, they can be transferred from the original lender to someone else, and the new holder of the debt will have as strong a legal claim on the debtor as the original lender did. With negotiability, long-term debts do not necessarily tie up the funds of long-term lenders, and such debts become liquid. Under common law, debts were traditionally not negotiable since they constituted a personal and enduring relationship between the debtor and the creditor. This situation began to change in the late 17th century with laws like the Promissory Notes Act of 1704, which made written financial instruments like promissory notes freely transferable from one person to the next. The status of lender shifted from involving a particular and enduring personal relationship with someone else (the debtor) to being a general role which anyone could occupy. The role of creditor could now be bought and sold. As a practical matter, however, the instruments that the state directly issued in order to borrow (e.g., life annuities) were not freely transferable, and therefore they were relatively illiquid investments. But joint-stock company shares were another matter. These were liquid both de jure, thanks to the rights granted in corporate charters, and de facto, thanks to the high level of activity on the London stock market.

The London stock market grew dramatically at the end of the 17th century, in terms of how many companies were traded on it, the level of trading activity, the total number of shareholders, and total market capitalization (Carruthers, 1996: 164–167; Michie, 1999: 15–31).⁴ A small group of traders (known as 'stock jobbers') who specialized full time in stock transactions gathered in the coffee houses of Exchange Alley to do their business on a daily basis. Increasingly standardized contracts were used to accomplish share transactions, and more exotic contracts appeared over time (futures and options contracts). Published financial information on share prices became increasingly common and available continuously. In short, the London stock market became an active, centralized market populated by trading specialists reacting to market information in making their decisions to buy or sell. In many cases, the methods, contractual forms, and sometimes even the investors came from Holland.

This active market made joint-stock company shares liquid both in law and in practice. Those who invested in company shares were indirectly lending to the government since the companies themselves turned over large amounts of their capital. By using intermediaries, long-term public lending became an attractive investment. As the wars interfered with overseas trade, some mercantile wealth was diverted into the stock market and gave it an extra boost (Jones, 1988). Furthermore, financial markets were themselves stimulated by the widespread availability of government financial instruments, as Quinn (2001) argues. This kind of positive feedback meant that government borrowing helped to develop the very capital market that made further government borrowing easier and cheaper. And as a consequence, Britain was able to borrow more money to finance its military conflict with France.

Fiscal capacity and political strife

State formation involves not only the build-up of military and fiscal capacities, but it also concerns how these capacities are exploited and deployed through particular political alliances and conflicts. In the early 18th century England, the latter were decisively shaped by party conflict between Whigs and Tories, and by the shift of power from the Crown to Parliament. These political changes were of course not independent of one another, but neither were they simply two sides of the same coin. As the center of political gravity shifted from the king and his court to parliament, the political organization of parliament became more consequential for the nation as a whole. The constitutional change that North stresses granted greater importance to the internal partisan organization of Parliament (something that he does not address).

Financial market development occurred not only because the market provided profitable opportunities for those who wanted to lend or borrow, but also because economic action became a platform for the pursuit of politics. In other words, some people played according to the rules of the political game, even when they operated in the market. As I discuss below, the late 17th and early 18th century was a period of sharp partisan strife. British politics became organized around the struggle between Whigs and Tories, and this political conflict itself shaped the financial market based in London. Keynes famously observed that animal spirits as well as rational calculation motivates market behavior. In this period, these were the spirits of very political animals.

Starting at the end of the 1670s, political conflict in England became increasingly structured around two opposing parties. Older distinctions (court vs country, regionalism, factionalism) did not disappear or become completely irrelevant, but they became submerged within a dominant cleavage that penetrated very deeply into English society (Harris, 1993; Knights, 1997). Political parties did not just divide elites, but also ordinary people. The issues that initially spurred the creation of the Whig party, and later in reaction created the Tory party, were those of religion and the succession (not economics). The counter-reformation in Europe and the power of Catholic France and Spain made English Catholicism especially problematic, even though there were in fact only a few English Catholics (Scott, 2000: 57). Parliament strenuously resisted attempts by Charles II to grant some measure of religious toleration, even for non-conforming Protestants (i.e., Protestants who were not members of the Church of England). MPs also became suspicious that James Duke of York, Charles' brother and heir to the throne, harbored strong catholic sympathies. When parliament learned of secret negotiations with Louis XIV, combined with the hysteria of the Popish Plot (an alleged catholic conspiracy to assassinate the king), the political opposition became organized around the religion issue, and made repeated attempts to pass an Exclusion Bill. Such a bill would have excluded James from succession to the throne (Miller, 1973: 154).

Those in support of exclusion formed the core of the emerging Whig party. They were unable to pass such a bill, in part because Charles refused to support such a measure, but also because of the emergence of a Tory party that viewed Whig actions as an attack on monarchy itself. Tories were staunchly pro-monarchy, pro-Anglican, anti-foreigner, and generally represented the traditional landed elites. Whigs included many non-conformists among their ranks and so sought some measure of religious toleration for non-Anglican Protestants (although not for Catholics). The issue of religion directly linked domestic with international politics because of religious conflict in other countries (viz. Louis XIV's Revocation of the Edict of Nantes in 1685).

Matters cooled off at the end of Charles II's reign not only because tax revenues made him less dependent on parliament, but also because of a backlash against the Whigs. However, once James was on the throne he used his financial independence to pursue an unpopular religious policy and soon dissipated his support. Catholicism at court once again became a contentious issue, as did James' enlargement of the standing army. When his Tory supporters failed to go along with pro-Catholic measures, James turned to dissenters and Whigs. But they were no more in favor of such policies than the others. Eventually, Whigs and Tories alike invited William of Orange, who was married to James' daughter Mary, to take the throne. This set the stage for the Glorious Revolution, in which James II was succeeded by William and Mary.

During the Glorious Revolution, a number of changes marked the shift of power from the Crown to Parliament. For one thing, by settling the succession to the throne (away from James II and his heirs and to William and Mary, then Anne (Mary's younger sister), and eventually to Hanover) Parliament in effect determined who was to be the monarch (working within the constraints of royal kinship and demography). The Triennial Act of 1694 took from the Crown the power to dissolve Parliament freely by requiring new parliamentary elections at least once every three years. And after 1689, it became clear that ministers, and prime ministers in particular, could function as effective political leaders only when they enjoyed the confidence of parliament. Before, the support of the Crown had been sufficient. Since elections determined who sat in the House of Commons, and whose confidence had to be earned by the government, the electorate became a political force that had to be reckoned with (Holmes, 1993: 324).

The Revolution Settlement did little to settle party conflict. If anything, the political battles became even more intense than before. When the Licensing Act expired in 1685, the number of newspapers exploded and many fed the partisanship of the reading public. Party conflict divided the polity but also penetrated into the rest of social life. For example, London had separate Whig and Tory hospitals (Holmes, 1993: 334)! Parliament met often, the Triennial Act ensured frequent elections, and both the Houses of Lords and Commons became organized around parties that had strong boundaries and sharp policy differences. In a nutshell, the Whigs were more supportive of foreign policy than the Tories, the Tories remained the party of the pro-Anglican landed gentry, whereas the Whigs included dissenters, non-conformists, and mercantile and financial interests within their ranks. The Whigs were the better-organized party, stronger in the House of Lords, and coordinated by a group of five lords known as the 'Junto'. By contrast, the Tory party was less well-organized and included large numbers of independent country gentlemen who were not involved in the financial markets and who were in fact predisposed against non-landed forms of wealth and non-traditional forms of influence. It was also harder for Tories to do the Crown's business in this period since so much of that business was politically objectionable to them (e.g., raising taxes, heavy borrowing, expensive war, etc.). For our purposes here, what is important is how public finance and the major joint-stock companies became embroiled in party strife.

One of William's first acts as monarch was to declare war on France. Military conflict, and the financial demands it necessitated, set the political stage for the next 25 years. It also meant that England's monarch's would have to depend on parliament for funding, and so the latter enjoyed the power of purse strings. In a practical anticipation of resource dependency theory, Parliament was careful not to be too generous to the new monarch because it would give William and Mary too much political autonomy. If there was to be war, the Tories preferred it be fought at sea rather than on land, but as it happened England made a 'double forward commitment' of both army and navy. Tories opposed the land tax since it fell on the chief asset of the landed gentry (their core constituency), and they also opposed long-term borrowing first because it ensured that the consequences of the war would go on for a long time, and second because borrowing made the government beholden to the financial markets. Furthermore, unlike tangible, durable land (which possessed both economic and social significance because landed estates supported social status and local political power, as well as income), financial wealth was intangible, ephemeral, and very new. This made company shares and other financial instruments illegitimate in the eyes of many, and therefore de-legitimated those who specialized in them.

Since the 'monied interest' was so strongly associated with the Whig party,⁵ many of the various financial and patronage opportunities associated with heavy public borrowing went chiefly to the Whigs. For example, putting an army on the Continent created financial opportunities since armies in Flanders had to be supplied through a logistics network, and these supplies had to be paid for with funds remitted from England. Thus, when the Whig leader Godolphin fell in 1710, Harley the Tory assigned remittance contracts to his own set of City contacts (Jones, 1988: 85).

The partisanship of the big joint-stock companies was a fact of life. The Bank of England was associated with the Whigs, the Old East India Company was associated with the Tories, and the new East India Company tied to the Whigs (see Carruthers, 1996, chapter 6). Opposition to the Old East India Company was driven by a combination of political and economic motives: the company was closely linked to James II, but it was also highly leveraged, relying on debt rather than equity for its capital. Consequently, many would-be investors were prevented from enjoying a share of the lucrative profits that derived from its monopoly on trade with the East Indies.

Using data from 1712 (see Carruthers, 1996), a detailed examination of the party affiliations of share owners (chiefly whether they voted Whig or Tory in national elections), and the people on the Court of Directors (the Board of Directors), reveals the partisan connections of the Bank and United East India Company. The overall partisanship of companies was obvious to all at the time. For instance, the Tories tried (but failed) to establish a Land Bank to rival the Bank of England (Rubini, 1970; Hill, 1988). Not only was this Land Bank supposed to be under Tory control, but it would allow Tories to take advantage of the benefits of public borrowing and favor a key Tory constituency (land owners). Tories tried again when they engineered the creation of the South Sea Company (Hoppit, 2002: 142). Instead of a bank, they established something that was ostensibly a trading company (like the East India Company). But in reality, the new corporation was part of a giant funding operation that converted short-term public debts into long-term funded debt. Very little trading with the South Seas was ever done, and the company shortly became infamous for the South Sea Bubble, but as an operation in public finance it initially was a success. At the height of their parliamentary political strength in 1711, the Tories unsuccessfully tried to capture the Bank and East India Company through the directors' elections (Clapham, 1945: 75).

Political partisanship affected the establishment and control of joint-stock companies at a time when these were unprecedentedly large and powerful corporate entities. Party connections could hardly be ignored. Partisanship also affected how company shares were traded on the London stock market (see Carruthers, 1996, chapter seven). In particular, party supporters tried to maintain partisan control over share holdings by trading with other party members, for companies that were contested terrain (specifically, the United East India Company, which was formed by a union between the Tory-allied old East India Company and the Whig-connected new East India Company). Whigs tended to trade with Whigs, and Tories with Tories, although in such highly liquid markets they could have just as easily traded across party lines. Politically endogamous trading meant that in the aggregate, the network created by trades in shares contained political clusters. Traders recognized that company shares were not just a form of property, but came with voting rights that allowed for partisan control over the joint-stock companies. And such control was worth fighting for.

The value and significance of company shares were further influenced by international political conflicts centering around the war. This was so because the role the companies played in helping to fund the conflict with France was quite obvious. Were France to win, very likely the Pretender (the son of James II, and his descendants in the male line) would come to the throne. Many people believed that as monarch the Pretender and his heirs would repudiate the British national debt, a debt incurred in part to help keep them off the throne (Hoppit, 2002). Thus, investing in the national debt was both an economic decision and a show of political support. Certainly, many of the foreigners (especially the Huguenots) who invested in England's debt fully knew that their money was helping to combat French Catholic absolutism. Wells and Wills (2000) show that political or military activity by the Jacobites (those who wanted to return James II and his heirs to the throne) had an impact on the market prices of financial assets. As the Jacobite threat grew, prices fell.

It is clear that political motives and identities animated traders on the London stock market. Of course, traders were also acting as investors who wished to turn a profit. But on top of this, and continually sustained and magnified by domestic political strife and international conflict, lay a set of political concerns that helped to propel the market forward. Politically and financially, the British state managed to combine the interests of Britain's traditional ruling elites (landed gentry and aristocracy) with those of its financial and mercantile elites (who dominated foreign trade and the financial markets). This combination also brought together domestic and foreign groups since the financial markets included many individuals who were either foreign themselves (Huguenots, Dutch, Sephardic Jews) or who had strong connections outside the country.

Whigs and the market

Given this close connection between the Whig party and the stock market, it is worth considering two further questions. First, why did Whigs, but not Tories, possess such a strong affinity with financial interests, and consequently play such a critical role in the stewardship of public finance? Was this simply an historical accident or did the linkage between party and market follow from deeper roots? Second, what difference did it make that they were Whigs? What consequences followed from the Whig connection?

As the Whig–Tory difference emerged and sharpened at the end of Charles II's reign and during James' rule, the landed gentry were mostly settled at the Tory end of the political spectrum. Aside from their involvement in the implementation of the land tax, and their role in parliamentary decision-making, this group per se had little to do with public finance or with the increasingly active stock market. The social groups most involved in the stock market were London merchants and financiers, and their political allegiances were predominantly Whiggish. There were exceptions, of course, for those who owned and controlled the old East India Company were strong Tory supporters of James II (Chaudhuri, 1978: 426), and their commercial rivals, who later founded the new East India Company, were also political rivals (Holmes, 1993: 343). London goldsmith bankers also tended to be Tory, although their importance in public finance diminished after the Stop of the Exchequer in 1672, as the new joint-stock companies underwrote massive government loans and as individual goldsmith bankers struggled to deal with the financial repercussions of the Stop.

On the political side, members of the House of Commons were sharply divided between Whig and Tory parties, but relatively few of them were active merchants or financiers. A business career was a time-consuming one that was difficult to combine with an active career as a politician. If an MP did have a business background, then likely he was from London or had some connection to one of the large joint-stock companies (Grassby, 1995: 224). In the House of Commons, business connections were more likely on the Whig than on the Tory side.⁶ Of course, there were no foreigners, Jews, or Huguenots (French Protestants) sitting in Parliament. Wealthy businessmen were more prominent in London politics (which also was divided by Whig and Tory), and usually dominated London's Court of Aldermen (Earle, 1989: 265). Sir Gilbert Heathcote, for example, was a long-time director of the Bank of England, Governor of the Bank in 1710, a well-known Whig, and both an alderman and Lord Mayor of London.

As Dickson (1967) showed, most of the investment in the stock market came from London and the surrounding area, Britain's financial and trading center. Merchants and financiers had liquid wealth available to invest in public debt and company stock, and their familiarity with financial instruments and intangible forms of wealth made them more willing to make such investments. An important part of this community came from overseas, and both Jews and Huguenots were prominent among the wealthiest financiers. Their overseas connections linked them with other financial centers, especially Amsterdam, but these connections also made them particularly sympathetic to the foreign policy goals of the British monarchy and the Whig party (Bosher, 1995). Huguenots, in particular, had suffered directly at the hands of French Catholics, and were eager to support the war against Louis XIV. Many among the native English traders and merchants were nonconformists (Grassby, 1995: 273), and as such favored the more tolerant religious policies of the Whig party. The success of the Bank of England, which raised £1.2 million for the government in 1694, and the subsequent failure of the Land Bank, illustrates the difference between Whig and Tory connections to investors. Both of these institutions sought the privilege of incorporation by combining banking services with a loan to the government. The Whiggish bank succeeded as dramatically as the Tory bank failed.

In sum, for a number of reasons those individuals who most contributed to investment in the national debt were predisposed to support Whigs over Tories. Investors were disproportionately of foreign origin, non-conformist, and members of religious or ethnic minorities. They also tended to be supporters of the war with France, and to possess the kind of liquid assets that could be invested in public debt. This was especially true among the wealthiest financiers, whose ownership of shares was greatest and who were most in control of the joint-stock companies. In short, the connection between monied interests and the Whig party was no accident.

As the stock market grew in volume, both shareholdings and share-trading increased. Greater trading volume meant the emergence of market specialists, that is, those who frequented Exchange Alley full time, worked in the coffee houses, and undertook many transactions (the so-called 'stock jobbers'). They were a separate group from the wealthy shareholders who actually owned the companies, but it was their willingness and ability to buy and sell frequently that created the liquidity that helped make company shares such an attractive investment. Wealthy shareholders, by contrast, would generally pursue a buy-and-hold strategy in order to consolidate ownership and control over the joint-stock companies (this generally required owning at least £500 worth of shares, the minimum required to vote in company elections; see Hancock, 1994: 697). Consequently, the latter were not especially active in the market. They were active, however, in corporate governance.

As discussed above, corporate control was as much a political as an economic strategy. Businessmen did not control joint-stock companies just for the financial dividends they paid but also because of the opportunity to exercise power and patronage. In this regard, joint-stock companies were like mini-states (Grassby, 1995: 218). But these political angles were not pursued by everyone, for political endogamy in share-trading occurred only within East India company stock, not for the Bank of England (there are no data for the South Sea Company). The Bank was already securely under Whig control in 1712 whereas the East India Company was more evenly divided between the two parties (having been created out of a merger of the Tory old East India Company and the Whig new East India Company). Political endogamy held for wealthy shareholders and inactive traders. In other words, the growth of the stock market created the possibility for market specialists, who in turn helped to grow the market. However, they were not the ones conducting political trades.

The London stock market, populated by owners and traders who also had political identities, connected to political institutions, populated by voters and politicians who also had economic identities and interests, in very particular ways. It appears that the oligarchic structure of the Whig party (dominated by peers) articulated effectively with the economic-oligarchic structure of the stock market (dominated in ownership if not in trading activity by big financiers). Both the polity and the stock market had a strong center–periphery structure with a relatively small number of persons at the core. These were two 'small worlds' with critical overlaps. For example, an individual like Charles Montague, Lord Halifax, was one of the Whig Junto Lords and also had strong personal connections to the financial market. His strongest links were to the Bank, the most Whiggish of the three big companies (see Carruthers (1996: Table 6.2) on the political affiliations of Bank directors). Montagu was one of the original subscribers to the Bank, and owned very substantial share holdings (£12,650 worth) in 1712. When he died in 1715, he left £20,150 worth of Bank stock to his heir George Montague (Bank of England Archives M1/91, entry 1365). Montague also owned £4800 worth of East India Company stock in 1712 (India Office Library L/AG/14/5/2), an amount that made him a substantial owner, but which was not as prominent as his Bank holdings. Montague provided a direct channel from the heart of the leadership of the Whig party to the wealthiest owners of the Bank of England and also to the East India Company (Hill, 1988: 35). Other individuals connected the two worlds, although politically they were not as prominent. In 1712 Sir Gilbert Heathcote had been active in London politics, helped manage the Bank, owned £18,531 worth of Bank stock and £8790 worth of East India stock (indeed the entire Heathcote family had substantial holdings of both Bank and East India Company stock).⁷

The legitimacy of such visible political connections was asymmetric. That is, a politician of Montague's social status and stature could wield influence in the financial markets without too much adverse commentary. Tory partisans could (and did) try to capture the Bank of England in the annual directors' elections of 1711 (Carruthers, 1996: 144–5), and were successfully resisted by Whigs, but not on the grounds that such a move was illegitimate. However, a financier who tried too publicly to influence government policy risked a severe backlash. In fact, Sir Gilbert Heathcote as Governor of the Bank of England met with Queen Anne in 1710 and warned her not to shift her government away from the Whigs, on the grounds that this would undermine public credit. His attempt was widely denounced and underscored the limits on the overt exercise of power by the 'monied interest.'⁸ England's traditional ruling elite would not be so easily displaced by financial interests, even though the government had come to be heavily dependent on the latter for resources. Parliament could legitimately influence government policy through its control over the purse strings (i.e., taxes), but creditors were not yet able overtly to control policy through their control over borrowing (Jones, 1994: 71). Their loans made certain policies possible, but they could not explicitly dictate policy.

The dependency of government on the Whiggish financial market was not considered unproblematic. In particular, just as Sir George Downing had tried to lessen Charles II's reliance on goldsmith bankers, in the early 18th century some government ministers tried to reduce the heavy dependence on Whig financiers. In particular, Robert Harley, Earl of Oxford, who headed Anne's government from 1710 until 1714, used the creation of the South Sea Company in 1711 not only as a way to solve the government's short-term financial problems but also as an opportunity to help cultivate over the long term a Tory constituency in the financial market (Hill, 1988: 144; Carswell, 1993: 45). The combination of Whig political dominance after 1714 and the South Sea Bubble in 1720 largely defeated his strategy, but clearly the attempt was made to balance out this critical dependency. The renewal or extension of company charters provided another occasion when the government was able to manage its dependencies, typically by extracting yet another long-term loan from the company.

In sum, the national polity was divided between an effective Whig party that was organized by leaders in the House of Lords and a Tory party that was more numerous but less well organized, and it was lead by a Crown that needed politicians in parliament to do its business but which was reluctant to put itself entirely in the hands of one party or the other. On the other side was the stock market, populated by a small number of wealthy shareholders who held disproportionate control over the joint-stock companies, a large number of small and inactive shareholders, and a small number of active stock jobbers whose trading activities rendered the market liquid. Undergirding the market for government debt was a fiscal apparatus able to generate sufficient tax revenues to service that debt. These two institutions were linked in general by the need for large-scale government borrowing to fund England's expensive wars, so that expansion of the state and growth of the market went hand-in-hand. But they were linked specifically by strong and direct Whig connections to wealthy shareholders. Individuals like Lord Halifax, Sir Gilbert Heathcote, or Sir James Bateman, who were simultaneously in both places, were able to transmit political imperatives to the stock market and bring them into corporate governance. But they were not active market makers. The latter group created market liquidity but did so in a largely apolitical fashion: stock jobbers like Moses Hart and Obadiah Lord did not control the joint-stock companies, nor did they engage in political endogamy. They simply made money. Thus, the polity-market connection involved a direct overlap between two structurally similar (if not equivalent) oligarchic groups.

The Hanoverian Succession of 1714 was threatened by the possibility that the line of James II would try to assert its claims. Once Louis XIV came out publicly in support of James II and his heirs, this threat could not be ignored. When George I came to the throne, the Tory party was quickly discredited by the presence among their ranks of a large number of Jacobites: conservatives who to varying degrees sought to have James III (the old Pretender) or later on Charles Edward Stuart ('Bonnie Prince Charlie') restored to the throne. This was a huge liability that helped to lock in the political ascendency of Whig oligarchs for decades. Furthermore, Tory strength in the Lords (the usual locus of political leadership) declined. The Tories survived through to the middle of the 18th century (Colley, 1982), but not as a viable party of government. As the national debt grew, more and more individuals gained a financial interest in the Hanoverian regime. Dickson (1967) estimates that the total number of public creditors went from about 5000 in 1694 to 60,000 by 1752. This growing vote of confidence conjoined financial stability to political stability and eventually removed partisanship from the entire state-market nexus. People from all over the political spectrum were now public creditors, and the national debt truly encumbered the state, regardless of which party or faction was in power. As time passed, the stock market evolved away from its partisan origins. The defeat of Bonnie Prince Charlie's army at Culloden in 1746 finally extinguished the possibility of a Jacobite succession, and hence the likelihood of a politically inspired repudiation of the national debt.

Going Dutch

The development of the British fiscal-military state depended on foreign wars. But it also was influenced by foreign models. The United Provinces and France offered two quite distinct models for nation-building. The Dutch had no monarch (William of Orange was the closest thing) and a weak aristocracy, the Dutch polity was quite decentralized, and the mercantile community held a lot of political power. France had an absolutist monarch (Louis XIV, the 'Sun King') who held in his own hands executive, judicial, and legislative powers. However attractive the domestic position of Louis XIV must have appeared to Charles II and later James II, it was the Dutch model that proved more influential in the long run. There were three primary points of contact. The first was in the person of Sir George Downing, a man whose career gave him ample experience with commonwealths and republics. Downing recognized some of the achievements of Cromwell's regime (especially in fiscal and military areas), and as ambassador to the Hague got a first-hand view of Dutch success. He tried to import features of Dutch public finance into England during the 1660s (Scott, 2000: 395, 401–402). The second occurred when William of Orange and his Dutch advisors and financiers traveled from Holland to England in 1688, and brought with them capital, connections, and financial expertise (Spufford, 1995). The third unfolded more continuously as international mercantile communities (Huguenots, Sephardic Jews) linked England with Holland and other parts of the world trading system. In general, the Dutch were a puzzle to the English: how could such a small country so lacking in natural resources so thoroughly dominate international trade and become so very wealthy? Dutch taxes were notoriously heavy, and yet the economy was not crushed by their fiscal weight. Dutch international trade supported the financial markets that made possible Dutch borrowing to support its own military efforts.

England's response to Holland was a combination of emulation and opposition. Three Dutch wars occurred in the mid-17th century (1652–1654, 1665–1667, and 1672–1674), and various Navigation Acts tried to undercut the dominance of Dutch shipping (Israel, 1988). The rivalry continued, but when William came to the English throne the two countries became allied militarily against France. Capital and information flowed between Amsterdam and London as the two markets integrated (Neal, 1990). Over the 18th-century Britain surpassed Holland commercially, although Amsterdam remained a center of trade and finance, and Britain was able to check French expansion. This was a tremendous feat of arms, logistics and finance, considering how weak the English nation-state was at the time of the restoration.

Conclusion

Two processes unfolded within the period discussed by North and Weingast (1989), one between state and market, and another within the market. After a period of intense party strife in the early 18th century, the Whig oligarchy settled in control of British government. The Tories continued to oppose them, but were no longer a viable party of government. As the 18th century unfolded, political conflict became less partisan and consisted more of factional strife within the Whig party. Fiscally, the Whig state relied on an expanded tax system and on a developed capital market. Through the latter, the government could borrow extensively and thereby escape, for long periods of time, the hard budget constraint of finite tax revenues. This was the essence of 'Dutch finance.' A more robust fiscal apparatus enabled England to undertake the kind of military state building that made it a world power by the middle of the 18th century. Growth of the capital market was driven by a flood of short-term and long-term government debt. Financial institutions, debt contracts, and commercial law matured as the amount of debt, and the numbers of debt-holders, grew. The fiscal-military state evolved along with London's financial markets, and in the late 17th and early 18th centuries, both sides were deeply shaped by the Whig party, a political group with distinctive organization and goals which was able to bridge directly from the center of political power to the commanding heights of the corporate economy. The Whigs in turn were defined by their political opponents the Tories.

Within the stock market, two distinctive but interdependent groups formed the core, surrounded by a penumbra of small, incidental and inactive investors. One group used share-ownership as a means to secure control over the joint-stock companies, and for them a company share was both a political and economic asset. These owners were linked into the Whig party through partisan financiers and wealthy politicians whose simultaneous political and financial activities connected the two institutions. Their Tory counterparts tried to emulate them, but lacked the means and numbers to do so. However, the economic vitality of the stock market was not supplied by shareholders alone (whether wealthy or not) for markets involve both ownership and exchange. Rather, it derived from the activities of the other core group, the active traders. They were less interested in politics, but their ability to buy and sell gave to shares the remarkable quality of liquidity. Liquidity transformed share ownership, and thus government lending, from an enduring personal relationship between a particular debtor and creditor into an abstract and alienable economic role that could be transacted as a commodity. If the first group developed the partisan aspects of the stock market, the second enhanced its transactional qualities. Markets require things that can be traded, and they also require for trade in those things to occur. These two components were provided by different groups for different reasons. The wealthy shareholders brought enough capital to the stock market to enable the active traders to survive economically, and the latter created liquidity for the assets owned by the former. Together, they successfully created a financial engine that was harnessed to the foreign policy goals of the British government.

Given their demographic makeup and ideological tenor, it is quite likely that the alliance between state and market would have been much less successful had the Tories been politically dominant. Not only were their connections to the domestic mercantile and financial communities weaker, but their religious orthodoxy and xenophobia would have kept the Jewish, Huguenot and non-conformist communities at arm's length. The international connections of these communities funneled critical expertise and capital into London, there to help serve England's fiscal-military state. The Whig–Tory conflict by itself, however, accelerated market development by making political competition yet another reason to establish joint-stock companies, lend to the state, and be active in corporate governance. By fueling the fight, but never establishing dominance, the Tories inadvertently played an important role creating something they could not control.

Britain's financial revolution is an historically important case because of Britain's subsequent role as world leader in the industrial revolution, and as the hegemonic power during the pre-WWI period of capitalist globalization. The early 18th century also marked London's emergence as a world financial center, a status it retains to this day. It is also the empirical showcase for North's arguments about how political and economic institutions affect long-term economic growth. Consistent with his analysis, one can see how changes in political institutions (in particular, the shift of power from the crown to parliament) altered how the political game was played by restricting what the king or queen could do. Furthermore, the new political rules affected financial property rights, as an economic institution, by giving them greater certitude. However, the creditworthiness of government depends on both its ability and willingness to repay debt, and while the latter may have been affected by the political changes wrought by the Glorious Revolution, the former depended on developments in the system of taxation that started in the Restoration period, 30 years earlier.

As valuable as it is, North's framework misses one of the most important connections between political and economic institutions. It is true that these are distinct institutions with their own rules, and that political institutions set the stage for economic institutions, but what is striking about the British case is that people followed political rules even when they were playing the market game, and their willingness to do so helped to accelerate the development of the market. The state promulgated laws that established rights over financial property, and it indeed benefitted from the resulting market growth. In addition, however, people in the stock market applied a political logic to their economic decisions, and so the stock market became a political arena. And these political motivations were not extraneous, illogical distortions; rather they centrally animated market growth. Market-based actions like founding a joint-stock company, accumulating stock holdings, and electing company directors were all pulled into the strife unfolding between Whigs and Tories.

Rules do not simply constrain behavior, but they also enable it. The distinctive ensemble of rules we call an institution forecloses some possible lines of action but opens up others. Rules are generative, and are more like the rules of grammar than the Ten Commandments. Generative rules can be used in unexpected ways. The new political rules that constituted financial property created a set of possibilities that some actors used to pursue political ends in the London stock market. Their willingness and capacity to do so occurred because there were real and strong social connections between Britain's political system and the stock market.

Inspired by North's arguments, and sobered by the Asian Financial Crisis, the IMF and World Bank (and many others interested in economic development) now appreciate the importance of institutions. They understand that political institutions create market institutions, which underpin market growth. But we should appreciate that politics and markets are not always separate games played according to separate rules, where political rules set outer boundaries around economic rules. The connection is stronger because sometimes, people play the market by political rules, and in so doing can actually propel the market forward.

Notes

¹ Dubbed a 'seminal contribution' (Stasavage, 2002: 155).

² It is not a peculiarity of North to view rules as constraints. See, for example, Greif (1998).

³ I am assuming that the distinction between taxes and loans is clear-cut, and so am setting aside complications like 'forced loans.' I am also going to ignore inflation as a strategy of resource extraction.

⁴ Carlos et al. (1998) argue that the foundations for the stock market were laid well before 1689, and use as evidence trading in the shares of the Royal African Company and the Hudson's Bay Company from the early 1670s onward. But their own figures clearly demonstrate a very substantial increase in activity starting in the early 1690s. Before then, trading was relatively infrequent, although it did occur.

⁵ The term 'monied interest' refers quite specifically to financiers involved in public debt and joint-stock companies. As Holmes (1987: xlviii) notes, many private individual bankers were allied with the Tory party. But as public finance changed, and as James II's Tory goldsmith bankers gave way to joint-stock companies during the reigns of William III and later Anne, the political complexion of public creditors also changed. For example, the old East India Company supported James II, and was affiliated to the Tory party. The rival new East India Company was as strongly affiliated with the Whigs, and became equally important as a creditor.

⁶ The business community itself was divided between Whigs and Tories, with financiers favoring the Whigs and domestic merchants, small-scale manufacturers, and old-monied men favoring the Tories (see Grassby, 1995: 207).

⁷ Other examples include Sir James Bateman, who ran as a Whig candidate for the London seat in the House of Commons in 1710, and who in 1712 owned £8100 and £16,747 worth of East India Company and Bank of England stock, respectively, and Sir Thomas Abney, who voted for Bateman and the other Whig candidates in the same 1710 parliamentary election, and who in 1712 owned £500 of East India stock and £6415 of Bank stock.

⁸ For example, in The Examiner Jonathan Swift asked rhetorically: 'Must our Laws from henceforth pass the Bank and East-India Company, or have their Royal Assent before they are in Force?'(Davis, 1940: 134). See also Roberts (1975: 11–13) and Hill (1988: 128).

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Acknowledgements

Thanks to Bruce Kogut, John Padgett, and an anonymous reviewer for helpful comments.