The Modern State and the Rise of the Business Corporation.

AuthorZhang, Taisu

ARTICLE CONTENTS INTRODUCTION 1973 I. THEORY 1978 A. Definitions 1978 B. Literature Review 1982 C. The Conditions of Demand for the Corporate Form 1986 1. Economic Conditions 1986 2. The Inadequacy of Communal Institutions 1989 D. The Role of State Institutions 1995 1. The Value of Uniformity 1996 2. The Limitations of Network-Based Alternatives 1998 3. The Capacity of Modern States to Achieve Uniformity 2000 II. HISTORICAL CASE STUDIES 2004 A. Late Imperial China 2005 1. Commerce and Business in Late Imperial China 2005 2. Early Twentieth-Century Legislation and Its Economic Impact 2011 3. Takeaways 2016 B. Nineteenth-Century Ottoman Empire 2017 1. The Dearth of Corporations 2018 2. Possible Explanations 2019 3. The Role of Limited State Capacity 2020 C. Early Modern England 2024 1. Early Modern English Business Organizations 2024 2. The Role of the State 2027 D. Early United States 2031 1. Corporations and Individual Charters 2031 2. State-Building and General Incorporation Acts 2034 E. Premodern Mediterranean Prototypes 2038 1. Medieval Italian City-States 2038 2. Ancient Rome 2041 CONCLUSION 2045 INTRODUCTION

The two great institutions of modernity are the business corporation and the state. They dominate, respectively, the private and public sectors of modern societies. The goal of this Article is to understand the historical connection between these two institutions. We focus on the genesis of the corporation to argue that the rise of the modern state was a necessary condition for the rise of the modern corporation.

As a large academic literature has shown, modern states were the product of intensive state-building that began in Western Europe in the seventeenth century, spreading to the rest of the world over the next two to three centuries. (1) The central feature of a modern state is its comparative strength in achieving its objectives: in terms of fiscal, administrative, and legal capacity, nearly all modern states are qualitatively stronger than nearly all premodern states. (2) The business corporation emerged at around the same time, originating in Northwestern Europe in the seventeenth century and institutionally maturing in the later eighteenth century. (3) A central feature of a modern corporation is its comparative success in combining the ownership interests of many shareholders who are socially disconnected from one another. Together, these two institutions embody the bureaucratic socioeconomic ordering that defines modern private and public life.

Unlike preexisting theories that view the relationship between the two as a predominantly negative one--that the state's primary role in the rise of the corporation was to credibly constrain its own use of coercive power (4)--we argue that the state also contributed to the corporation's emergence positively. In fact, the modern state's positive contributions were so significant that they were likely indispensable. It is no coincidence that the business corporation did not become socioeconomically prominent until after the ascendancy of modern state-building. As we argue below, the state played a central role in the rise of corporations in numerous major economies.

Our thesis has two parts. The first is theoretical and consists of two primary arguments. First, we argue that there can be significant demand for the modern corporate form only after complex, long-duration business collaboration between strangers becomes economically prominent. Business activities within closely knit communities--the dominant form of collaboration prior to the rise of modern states--was unlikely to produce enough demand for corporate legal technologies like asset partitioning and tradable shares. Instead, these technologies emerged only in response to business relationships that breached traditional communal boundaries, of which the paradigmatic early modern example was interregional Eurasian and transatlantic trade.

Second, we argue that, within the context of transcommunal business relationships, the business corporation can only emerge with robust institutional support from a sufficiently modern state, in the form of legal enforcement, dispute resolution, and information sharing. In particular, we argue that modern state-building is necessary to the success of the modern corporation because the legal arrangements that enable corporations require uniform enforcement among strangers.

The essence of a corporation is the collective ownership of a pool of resources by a large number of people who are mostly unknown to one another. As we argue, there is, in theory, much less need for corporate legal technologies outside of those conditions. Under them, the possibility that a corporation's many owners might be treated differently from one another poses grave risks. Since the owners of a corporation all share a residual claim on the same pool of resources, any deviations from uniformity tend to be zero-sum: more resources for one owner means less for the others. Deviations from uniformity thus undermine trust and discourage investment. A modern state--that is, one with strong coercive power, centralized lawmaking, extensive geographical reach, and commitment to formal equality before the law--can solve this problem because of its unique capacity to ensure uniformity.

The second part of our thesis is descriptive. We survey six case studies--twentieth-century China, (5) the nineteenth-century Ottoman Empire, (6) early seventeenth-century England, (7) the nineteenth-century United States, (8) early modern Italian city-states, (9) and ancient Rome (10)--and show that in none of these historical places have the formal legal technologies that enable corporations been used successfully at a large scale without the enforcement power of a functionally modern state. Rarely does anything resembling corporate law appear on the books of a premodern state. And when such law was recorded in a premodern state, it was rarely, if ever, used widely among business enterprises and, thus, rarely accomplished its intended purposes.

This thesis significantly enriches our understanding of the rise of the corporate form. To date, economic historians have tended to attribute the rise of the corporate form either to the growth of economic activities that demanded the corporate form or to the achievement of limits on state power that encouraged private investment by securing it against state-sponsored expropriation. We do not deny the necessity of these forces as conditions for the rise of the corporation. But we add to them by showing that the strong legal and administrative capacities of a modern state represent another, heretofore unrecognized, necessary condition in the process of modern corporate development. We show that economic demand alone cannot compel the rise of the modern corporation and that the influence of the state on the corporation was positive as well as negative.

The power of our thesis is perhaps most evident in our study of twentieth-century China. (11) China enacted a modern corporate-law statute as early as 1904, but almost no businesses actually used the corporate form until decades later. The reason was not that economic activity in China remained insufficiently developed. By 1904, interregional trade and other complex and long-lasting activities had thrived in China for centuries. Nor was the reason that the state threatened to expropriate the value created by private corporations. The early twentieth-century Chinese state was too weak to enforce even modest forms of taxation, let alone to expropriate large shares of the value created by corporate enterprise. (12) Rather, the main issue was that the Chinese state was simply not strong enough--not modern enough--to make its corporate law meaningful. Few firms with large numbers of owners trusted the Chinese state to enforce its corporate laws with the uniformity and vigor required to sustain the cooperation among large groups of strangers that characterizes modern corporate ownership. The corporation was not widely used by businesses in China until much later in the twentieth century, after the state had become powerful enough to make it meaningful.

While this Article is primarily interested in theories of the corporation, its thesis has broader implications for private-law theory. It suggests, in particular, that private legal institutions--that is, legal institutions that order relationships between private parties--can be separated into two groups: those that can socioeconomically proliferate without state support and those that cannot. As much scholarship has demonstrated, many segments of private law, especially those in the realm of contract and property, have long existed in human communities even when institutional support from the state was meager or absent. (13) In fact, numerous full-liability partnerships also fall into this category. (14) But what differentiates these institutions from state-dependent legal forms like corporations? We suggest here that the differentiating factor is the existence, or lack thereof, of private demand: many private legal institutions are indispensable even within closely knit communities, but others, like the corporation, become significantly useful only in the context of cooperation between strangers.

Our thesis comes with at least two caveats and limitations. First, we acknowledge that the relationship between the corporation and the state has more facets than we have identified here. (15) The modern state might have been necessary to the rise of the modern corporation for any number of reasons; the value of uniform and strong law enforcement may have been just one of them. The threads of possible connection between the state and the corporation are as innumerable as the forces that pushed the world into modernity more generally. (16) In arguing for the plausibility of our legal and economic thesis about uniformity, we mean not to deny the importance of these other...

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