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The Secret of Venetian Success: A Public-order, Reputation-based Institution

The Secret of Venetian Success: A Public-order, Reputation-based Institution

By Yadira González de Lara

Paper given at the IX International Conference of the Spanish Economic History Association (2008)

Abstract: This paper examines the institutional foundations of the financial market underpinning Venice’s commercial success during the late-medieval period. A public-order, reputation-based institution enabled merchants to commit (i) not to flee with investors’ capital, despite the limited geographical reach of the legal system and (ii) not to breach their contracts, despite the investors’ inability to directly monitor them. Economic rents in Venice motivated merchants to submit to the city’s authorities, while tight administrative trading controls provided the information required to verify a contractual breach. These institutional arrangements differed from other public-order and reputation-based institutions that have been considered in the literature.

Introduction: The expansion of Venetian trade during the late medieval period (1050-1350) had a lasting impact on the development of Europe. Crucial to this expansion was an active financial market through which Venetians of various means, ranks and occupations mobilized their savings into risky investments in overseas trade. This mobilization, however, required merchants to commit ex-ante not to embezzle the invested capital ex-post. What arrangements enabled such commitment? What were the institutional foundations of the Venetian financial market?

Some scholars, such as Raymond de Roover, Roberto S. Lopez, and Douglass C. North, have argued that the legal system supported the emergence of a market economy during this period. Yet, asymmetric information and the geographical boundaries of the courts’ jurisdictional power limited the ability of such public-order, coercion-based institutions to enforce financial contracts for overseas trade. Other scholars, particularly Avner Greif, have emphasized the role of informal monitoring and reputation among traders in supporting late-medieval overseas trade in the absence of an effective legal system. However, the legal system often reinforced such private-order, reputation-based institutions. With respect to Genoa, for example, Greif has noted how, by punishing observable transgressions such as outright embezzlement of an investor’s capital and holding a merchant’s family liable for these transgressions, the legal system supplemented a bilateral reputation mechanism. This mechanism relied on the investor’s ability to reward an honest merchant with a sufficiently high rent and to punish a cheater by excluding him from this privately-generated rent. The institutional system prevailing in Genoa, that is, the Genoese institution thus combined public coercion with private reputation.

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