By Mark Koyama
Paper given at Brown University in February 2010
Abstract: How do credit markets function in societies where legal contract enforcement is weak? This paper uses a model to examine how the institution of personal pledging aided the development of credit markets in medieval England. It demonstrates how the practice of pledging improved repayment rates by lowering enforcement costs, mitigating the problems associated with adverse selection, and provides an additional source of mutual insurance. By combining the model with historical evidence, it can be shown that pledging helped to enable illiterate peasants to gain access to capital markets.
Introduction: How did credit markets emerged in medieval England? This is the puzzle addressed in this paper. It is a puzzle because credit markets developed in England in the absence of institutions like notary credit or widespread access to debt registries, which played important roles in the development of credit in continental Europe. Most peasants were illiterate and rural credit was typically based oral contracts. Moreover, the legal institutions responsible for enforcing contracts were weak.
For this reason the study of rural credit was neglected by historians until recently comparatively. They emphasized the importance of a non-market economy based on the manor in which money was not the dominant medium of exchange and land was held by customary tenure and was rarely permanently alienated. Research in the past few years, however, suggests that a rural credit markets did exist in medieval England and that they were comparatively effective enabling a broad swathe of the population to access capital.
How was this possible? Is it possible to identify the economic mechanisms that enabled medieval peasants to use credit markets? To answer these questions, this paper builds on insights drawn from recent work in development economics and economic history. Studies of microcredit institutions in the developing world suggest that practices like group insurance can be effective in overcoming many of the problems that affect credit markets in weakly institutionalized economies. Furthermore, Greif documents how a system of community responsibility helped to enforce inter-regional trade in the medieval period. Community responsibility meant that individual merchants were held responsible for the behaviour of their peers. Under this system of vicarious liability, the goods of a merchant could be seized simply because another merchant from the same town had refused to repay a loan or had cheated another merchant. As a consequence, the cost of an individual merchant’s cheating was bourn by the entire community, and this meant that internal community enforcement could be relied upon to effectively deter domestic merchants from cheating foreigners.