The Growth and Decline of the Modern Sector and the Merchant Class in Imperial China

• Date: 01 February 2014
• Author: Kenneth S. Chan,Jean‐Pierre Laffargue
• Published date: 01 February 2014
• DOI: http://doi.org/10.1111/rode.12066

The Growth and Decline of the Modern Sector and

the Merchant Class in Imperial China

Kenneth S. Chan and Jean-Pierre Laffargue*

Abstract

This paper offers an explanation of why, in Imperial China, the merchant class expanded and the economy

modernized up to the 13th century, and why it entered into decline from the 14th century onward. The

modernization of China required the accumulation of public capital and the building of good institutions,

upon which a vibrant class of merchants and entrepreneurs could gradually emerge. This class contributed

to the enrichment of the society and the emperor, but its activities also weakened the dominance of the

emperor and the élite, who would then prefer to block the modernization of China and to restrict the size of

the merchant class, putting the economy into long-run stagnation. However, when the emperor faced

severe foreign military threats and when he realized that a modern sector improved the defense capabilities

of China, he made the opposite choice.

1. Introduction

China had a vibrant class of merchants (entrepreneurs, craftsmen) and what was then

considered as a modern economy during the Tang (618–907 AD), Song (960–1279)

and Jin (1115–1234) dynasties. This class entered into sharp decline during most of

the Ming (1368–1644) and Qing (1644–1912) dynasties. How did China succeed in

developing a modern economy, trading wide varieties of sophisticated goods across

the empire and with foreign nations until the beginning of the 15th century and why

did China’s modern economy fall into sharp decline thereafter?

These questions have led to a huge literature.1Our paper proposes a new answer,

which is based on the following three arguments. First, the emergence of a merchant

class, and more generally of a modern sector, needs and must be preceded by costly

investments in public capital by the government: the building of roads and canals, the

development of institutions favoring trade and manufacturing, the protection of the

property of the merchants and entrepreneurs, etc. We will call this process here primi-

tive accumulation.2Once the modern sector has developed, it can be taxed, which

increases the income of the emperor. The emperor compares the immediate costs

with the future gains before deciding if he will or not initiate a policy of primitive

accumulation.

Second, the emperor’s decisions are driven by more than economic motivations. He

also obtains satisfaction from being at the top of the strong hierarchical structure of

the Chinese society and from the submissive behavior of his subjects. We will call this

attitude the preference for dominance. The modernization of the country erodes the

* Laffargue: University of Paris 1, Maison des sciences économiques, 106–112 boulevard de l’Hôpital, 75647

Paris cedex 13, France. Tel: +33-648869815; Fax: +33-144078109; E-mail: jean-pierre.laffargue@orange.fr.

Chan: City University of Hong Kong, 83 Tat Chee Avenue, Kowloon, 220 Hong Kong. The authors wish to

thank Jean-Pascal Bénassy, Elise Brézis, Bharat Hazari, Vikas Kakkar, Bertrand Wigniolle and an anony-

mous referee for their very useful criticisms and advice. A preliminary version of this paper was presented

at the Asia-Pacific Economic and Business History Conference at Berkeley, 2011.

Review of Development Economics, 18(1), 13–28, 2014

DOI:10.1111/rode.12066

© 2014 John Wiley & Sons Ltd

dominance of the emperor, making him, to paraphrase Jones (2003), progressively

more like the head of a corporation than a surrogate god.

Third, we introduce an important exogenous shock into our explanation, which is

the sudden rise of a foreign military threat. To face this threat China must develop a

strong defense system. A modern economy contributes not only to the financing of

military costs, but also induces positive externalities, upon which the efficiency of the

Chinese defense system can be improved. The reality that economic backwardness

creates military backwardness is part of the impetus behind the modernization of a

country when it is threatened by its neighbors (Acemoglu and Robinson, 2012).

To summarize the key arguments, when a dynasty was under no foreign threat, the

taste of the emperor for dominance impeded the primitive accumulation process even

if it was justified on purely economic grounds. However, in times of war, a modern

economy provided the resources to finance the defense system and the technological

and logistical means to improve its efficiency. The emperor then accepted a reduction

in his dominance and engaged in a process of primitive accumulation.

In addition to the above key conclusions, there are a few other results in our analy-

sis that are of interest. As the size of the merchant class increases with the stock of

public capital, the tax return for the emperor of the primitive accumulation process is

much lower at its beginning than when it is well advanced. This induces an underde-

velopment trap for moderate foreign threat. The emperor will continue to accumulate

public capital if its stock is already high, otherwise he will prefer to leave it depleting

until the disappearance of the modern sector.

Also, if foreign threat suddenly increases to a high level we still obtain an underde-

velopment trap: the urgency of the situation leads the emperor to spend most of his

income on the immediate strengthening of his army, even if primitive accumulation

and the modernization of the economy would be a more efficient way to defend his

throne in the long run.

Finally, we establish that the taxation rate of the modern sector increases with its

size, a result which is consistent with the low taxation of the merchants and a small

modern sector during the Ming and Qing Dynasties.

In a previous paper (Chan and Laffargue, 2012), we assumed that public capital

accumulation strengthened the defense capabilities of China, first by directly raising

the efficiency of its army, and second by improving Chinese technology. In this paper

we prefer to assume that it is the presence of merchants and their output which

improve the efficiency of the defense system of China. The accumulation of public

capital enhances the productivity of potential merchants in both papers. However,

here the emperor is hostile to the development of a merchant class, which can

threaten his dominance. Thus, he faces a tradeoff between developing the merchant

class, increasing his income and improving the defense of China on the one hand, and

preventing the expansion of this class to maintain his dominance on the other. In both

papers low (high) foreign threat leads to the evanescence (the emergence) of a

modern sector. A new result in this paper is that intermediary or very high foreign

threat can induce an underdevelopment trap.

Our analysis is consistent or complements the theoretical models by Edwards

(2004), Chaudhry and Garner (2006), Karayalçin (2008) and Chu (2010). It also adds

to the literature on institution and development (Acemoglu and Robinson, 2012), by

providing an alternative explanation on how bad economic institutions can arise.

This paper is organized as follows. Section 2 presents historical facts that can justify

the main assumptions of the model. Section 3 develops a model of primitive accumu-

lation where the production of merchants and their number depend on the stock of

14 Kenneth S. Chan and Jean-Pierre Laffargue

© 2014 John Wiley & Sons Ltd