This Explains Why Modern Markets Developed Where They Did

We sort of take it for granted. I'm very interested in the subject because I often wonder, you know, if you were to go around to market participants and ask them, why do we have a stock market in the first place? Why did we invent this thing? I'm always curious what the answers would be, because I still don't think I

have a stelid grip on why they exist. Yeah, and if you think about it, if you think real hard about it, it's kind of a weird construction, right, the idea that a bunch of strangers are going to get together and share or sell each other shares in particular companies, or things like why do we do that? And why

do we trust the other participants involved? Totally? Like every time there's an I P O or something and It's like, wait, if you're selling and you know more about the company, If you think the insiders and the company are selling, why should I be buying? I guess of that a

bad sign. And of course there's various mechanisms that we've built to learn about companies, mandatory regulatory disclosures, quarterlia reports, earnings calls, presentations, outside auditors, but we're still essentially buying into companies that at best we only have partial information of what's really going on. Right, So that's the other side of the story, Right, There's two things. There's trust

and there's information involved. So we are going to take a journey back in time for this particular edition of Odd Lots and figure out how those two things kind of came together at a particular moment in time to create some of the first modern markets. Really, I can't wait, because as hard as it is right now to really have a grip on what's going on with the companies we invest in, you know, you think back to hundreds of years ago and how much worse disclosure would have been,

and auditing and standards of data reporting. Right now, we all basically all counting think about accounting in like the sixteen hundreds accounting and P and L statements and balance sheets. We have the we have machines that can part this in very standard ways of reporting this stuff. But at the beginning, how did anyone believe anything exactly? All right? So I'm glad you're on board. So to discuss all

of this, we have Partique Raj for our guest. He is a PhD student over at the University College London. He's also a research fellow at the Stickler Center for the Study of the Economy and the State at the University of Chicago Booth School of Business. And he is also the author of a paper called the Origins of Impersonal Markets in Commercial and Communication Revolutions of Europe. And it's going to be really interesting, I promise. Let's bring

him on all right, Critique, thanks for joining us today. Hi, Tracy and Joe. Great to be here. So, uh, did we get the intro? Right? Were trust and information kind of the two pillars of importance when it came to creating the first modern market? So when you think about trust, trust is generally a much more complicated construct, right, because you can have trust in your family members and you

can have trust in strangers. So I think trust it's created when you have one some incentives to really trust strangers. So if you don't have any incentive to go out and do business with people who you don't know, why why would you need to trust them? So incentives really mattered. And then on the other hand, of course, you need to know about something about them, something about the markets they work in. You need to have certain trust in

the markets and so forth. So yes, trust is really important, but then the key question is how do you create that trust. So in your paper, and before we talk about how impersonal markets or stock markets were created, you talk about the pre existing structures that were in place to essentially solve the trust problem or to partially solve it, and you talk about the role of I think trade guilds in this. So can you explain what these guilds were,

what they did and they're important to comers. So not just in Europe but around the world. Traditionally business has happened through networks. So you have kabilahs in Arabic world, you have jattas in India, you have guangs or clans in China, and you have had guilds in Europe. And the central role that they play is that one you generally are interacting with people you know, or at least people you know who know other people. So what it does is that it creates a repeated interaction and that

kind of creates trust. So that's the simplest reason why you can have you want to do business in networks. Can you give an example to really help us understand it of an industry you know, a lot of your writing is in europe An industry that would have been dominated by a guild and how specifically it would have facilitated trade within that area. Basically all sorts of trading

industries would be dominated by guilds or networks. I think an sample in the modern world is like these taxi associations you are These are associations where basically entering is rather difficult. You need to have a high license fee to pay if you wanted to enter these taxi associations. And one of the reasons you have these was because you wanted reliable people to enter the taxi industry, because who knows if you have a taxi driver who is

not very reliable. So taxi associations are an example of a good modern day guild. And then you have something like Uber or Lift disrupting that. So in a modern world, I think taxi associations are like a favorite example that I like to use. So in the sixteen hundreds in Europe, you have these powerful merchant guilds and there's a lot of influence and a lot of money presumably tied to

them because it's almost a monopoly. I suppose that they have over particular areas of trade in a similar way to the taxi medallions have a monopoly nowadays, with the exception of the disruptive forces that are Uber and Left. What happened in the sixteen hundreds to dislodge the power of the merchant guilds. So generally, when people think about guilts or any of such network institutions, there tends to

be these two extreme views. The one view is that all guilts were really nice institutions which were building, which were communities in which people would do business and rely on each other, and um kind of capitalism came in and created this very atomist world. That's one way of

looking at guilts. And then the other way of looking at gils is that, well, these guilts were these networks of nepotism and monopoly, and basically free market comes in and rains in their power, and you have people who can come from anywhere or any background can enter a

business and excel in it. So when you want to understand why the guilts deadline, we have to identify the things that they were really good at, which is providing information to people or basically protecting people from a lot of risks because you were basically trading with people who if they cheated on you, you could kind of ostracize them or make their reputation go bad. So this kind of reliability and information helped guilts survive for so long.

So when you think about how would guilds deadline, you have to go back and look at situations where people had suddenly a new incentive to start to do business with new people, because guilts were not very good at providing you with new opportunities or situations where you could get new information. So you have to look at the interaction between incentives to go outside of guilts and the

need to they wily did to get information. And so in your paper you identify two key factors that sort of demonstrated grand unified theory, and you look at where these impersonal networks took off, and the two factors seemed to be a in the cities that had an opportunity to trade with the outside world, so key trading ports, geographic exposure to trade routes, and then the other thing is proximity to the town where Guttenberg invented the printing press.

And so the combination of places that sort of had access to printing press the new vector of information and places that were on these trade routes. Combining those two is where you see the first impersonal networks germinated, yes, exactly. So that's that's the story. The big question is that why is it that it's northwestern Europe where the first stock markets or the first joint stock companies immerged. Why not Spain or why not in Italy or why not

in Germany? And that's where you want to look at this combination of factors. For example, Spain had all the benefits of Atlantic trade. So when it comes to the incentive to go out of gills and do business, I think like Amsterdam, even in southern cities of Spain, you had such incentives. On the other hand, if you want to go after a theory that oh, well, access to information made it easier for people to talk to each

other and to talk to strangers. Then you would have to ask why did this not happen in Germany where basically that's the hub for the printing press. And so it is the combination of these two things that, well, you need to have incentives to go out and do business with people you don't know, and you need to have information about the markets and the commodities you're trading and somewhat the people you're working with. That's really important.

So it's the two things when they come together that at least in this paper, I argue, create the uh conditions that are favorable for the rise of such markets. Okay, so if I'm a trader in Antwerp or Amsterdam and I'm looking at all these opportunities taking place in the new world, is the basic idea that in addition to having that exposure to new types of trade or new potential businesses, I can now pick up a printed book or pamphlet and I can learn how to trade or

I can learn more information about those particular businesses. Yes, so that's sort of the idea. So obviously, when the printing press came in, all sorts of things were being printed. UM. A lot of it was religious books, and the smallest part of it was things like merchant manuals and books

in economics, etcetera, etcetera. And what was happening is that when you happen to be at a place where trade is really desirable, the content that gets produced in these kind of places are related to those which helped trade or out. For example, Amsterdam was emerging as a good hub where a lot of navigation related UM books were being printed. Or for example, in Antwerp, uh there was a lot of printing of economics books, or it emerged

as a hub for double entry bookkeeping. So basically the incentives to do trade was driving once you had the access to printing, it was driving the content that was helpful for creation of information that could help with trade. What happened to the merchant guilds in these areas, in areas like Antwerp and Amsterdam, did they try to fight the change or was it just sort of a slow dissolving of the role that they played in facilitating trade.

So it could differ from place to place. Like one of the interesting historical stories that I learned while doing this research was this virgence between Hamburg and Lubeck, and which kind of tells you how. For example, in Lubek, guilts tried to push back on the idea of opening of impersonal markets, while in Hamburg they were not able to have that kind of resistance. And the reason why I think that was the case is because these two

cities happened to be at a very interesting geography. So they are on two sides of the Jutland Peninsula in the northern Germany, and Hamburg is on the Atlantic coast while Luebeck is on the Baltic coast. So the basic idea is that because Hamburg was at the Atlantic coast, so this side of the of the Jutland Peninsula had greater incentives to basically or exposure to the Atlantic trade and its benefits. While Luebeck, while it was a major city, it didn't get that kind of exposure because it was

on the Baltic side of the sea. And these two cities were just sixty five apart from each other. So in Lubec you have a lot of resistance to new merchants coming in and they start to proper privileges, they start to fight against the Danish and the Dutch who are giving them competition. So yes, um, the guilts in more established cities fight to fight back, while in a place like Hamburg this slowly basically dissolved a way. You know, I noticed particularly kind of introduced this as talking about

the origins of the stock market. You've been very specific using this term in personal markets. Can you talk just a little bit about what sort of the distinction is. I mean, I imagine that the early impersonal markets aren't really recognizably what we would call stock markets today. So what precisely was being traded here? So the first stock market was the Amsterdam Stock Exchange, which was specifically just made to raise capital for the Dutch East India Company.

So it was for this one giant end company that essentially a stock market was created. Before that, there existed, for example, these commodity bourses where so for example in Antwerp, where people would basically trade commodities in start uh in

spot kind of situations. So the key, the reason why I like to use the term in personal markets is because from a historical point of view, Um, my view is that sixteenth century and thereafter was a major historical break in terms of how the world was doing business, which was that while until now you had relationships that drove how business was done, but now suddenly at least an opportunity emerged that somebody from some part of the world could just come in and start to do business

in some other city. So basically this kind of lowered the entry barriers for people who might not have been privileged enough in the prior centuries to do trade. So it is a major part of this sorry that how impersonal markets, by making things more individualistic, make it easier for people who are probably more motivated to come and

do business. So for example, in case of Hamburg, it was a major hub for foreign merchants, but Lubec had this problem that they didn't want to have foreign merchants because they wanted to keep all their privileges for the locals. So that's why I like to use the term in personal markets, because the rise of stock market can be like a side effect of this broader change in history.

But so for example, when you think about the Wall Street, people from all parts of the world just come in and then work at these banks, and it's not that you have to be it's a pretty diverse place, and and it's because your networks don't necessarily need to be so important as long as you are really good making money. So how much of the rise of impersonal markets had to have happened along with strengthening of legal and governmental institutions, because I imagine that that took care a part of

the trust problem as well. Right, Yes, So there's sort of a code of evolution that is happening that you especially see in cities like Antwerp in Amsterdam and also Hamburg and London, where basically, when you already have an incentive to attract new people whom you don't have any historical or you know, familial ties with to your city, then in order to attract these new merchants, you start

to make your institutions better. You essentially say, well, okay, until now, our courts were so designed that you would only allow for you will only do provide these legal services to a certain group of merchants coming from a specific group places, so you will give out privileges. Now suddenly you started to build these institutions which were more generalized.

What it means is that instead of giving legal services to a specific set of merchants, all your laws would now apply to all merchants that come there, and there is no special privilege that exists too a few set of merchants. So there's this sort of a democratization of institutions where you could simply get the legal services of of that particular city if you happen to be a merchant.

So legal institutions start to evolve, and obviously it takes a long time before they start to look the way they look now, but that's in my view of time when there's a big start of this legal evolution as well. So listening to all this, it's pretty obvious that the lessons that you drew out from this period there are so many that apply to markets today and some of

the changes that we're saying. You already mentioned uber and now I could get in someone's car without knowing who they are, and I don't have to see that they're part of some taxi guild, and I could have a pretty good trust that they're going to get me to where they are. So that's a big change. But it's funny you mentioned Wall Street, which is of course highly relevant to us. And even though the stock market and all the markets we talk about are on in some sense,

in personal markets for a long time. Even still there's been this important personal element, and people on Wall Street, financial advisors, brokers, they're always talking about it. We bring you the personal element and we have a personal relationship with clients. And if there's one of the biggest tensions that we're seeing right now on finance, it's this question of whether that's overrated and will we still need financial

advisors or whether it'll all be robo advisors. So it seems to me there's still this very big personal element to it, and the same you know, this build up of new information is once again, you know, really threatening that. So I think relationships are always going to matter. Um, that's just always going to be the case, because there is always going to be some informational advantage that you're going to have with building relationships and building personal trust

with people. But I think this issue becomes relevant when you want to build Wall Street kind of institutions in other parts of the world. So, for example, there is an interesting paper by Raguram Rajan and Luigi's in Galis about the Asian banking crisis in the late nineties where they basically talk about how this relationship based nature of uh of trade or business in the in Asian stock markets was responsible partly for the weakness of the financial

institutions in that region. And what they need is better contract through institutions to make sure that the overreliance on relationship kind of goes away. So it is a spectrum where certain societies kind of have too much of reliance on the relationships versus some which have were limited. So it would never be the case that they will all go away, but you could be in a world where relationships really really matter and you could do nothing without

having them. What about the information side of things, because quite a few people have drawn an analogy between what we've seen recently with the power and rise of the Internet and fake news and the ability of basically everyone to disseminate information at will with the revolution that was the printing press. Um So if we have another big spurt in the democratization of information or the dissemination of information, what does that mean for the development of markets this

time around? So when you think about the Internet, it's obviously has already and the mobile phone it has already kind of democratized information for a lot of people. For example, in India, um landline phones were available to like a very small fraction of people, but now about like a lot of majority of Indians have a mobile phone and with it access to basic internet spacilities. So there's already

this democratization of information happening. But one of the conclusions that I drew, especially after the last year, of the way political economy has evolved, is that there is no such thing that information technology would have a blanket positive or a negative effect. And once again it goes back to the question of incentives. So what kind of content people develop once they have Internet in their hands depends

a lot on other things that is around them. So if in case you have economic opportunities, opportunities to do business, etcetera, etcetera, you will basically try to seek information that is financially relevant for you. But I guess if in case you would you are in a place which is economically not growing, the same information technology can be used for other stuff. For example, in sixteenth century europ most of the places were primarily printing stuff about old religious texts or analysis

of something that was happening in the past. So the incentives drive your content in the end, and the same is true today. Was there fake news and Antwerp. So what I know is that there's this new book by Jared Rubin who talks about the fact that, for example, in the Ottoman Empire, they didn't really like the printing press a lot because they basically thought that printing would lead to a lot of fake religious books and would

kind of corrupt the existing pristine religious materials. So certainly there existed people who would have this concern for fake news in a different version, and they were rumors and there were things like that, and so yeah, so that's something that I got really interested in the last year because I honestly didn't really think that fake news and

this kind of fraudulent information would be so relevant. But looking at the way things have moved over time, I think that's something which is probably a topic of a future paper, that how do institutions deal with our people. People trust the media itself, so why did people trust the printing present the books being printed in the first place. That's an interesting research topic in itself. In my view, We'll have to have you back on once you publish

that paper. Critique. I'll be happy to come, all right. Critique. Raja PhD student over at the University College London. Thank you so much for joining us today. Thanks a lot, Thank you. Critique. That was great, So Joe, I thought that was a really fascinating conversation with so many modern parallels, especially when it comes to the idea of trust of course and of course disseminating information, because the Internet has

really revolutionized both those things, and so has new technology. Absolutely. I mean, I think, like, intuitively, it's not a surprise that the rise of the Internet and new communication technologies would have a profound effect on trade and disintermediation of trust,

networks and all that that we sort of get. But I think that what's really interesting about critiques research is the sort of rigor with which he demonstrates the mechanism between the new information technology and the evolution of trade. And if you look at his paper, you could see that there's sort of some very statistical meat on the bones, you could say, in terms of really establishing where these impersonal markets flourished and these towns and where they were

in proximity to the printing press and trade. So it really sort of bolsters and really strengthens this sort of intuitive idea. Yeah, and there's a really nice map in it as well. Where he sort of overlays a lot of these ideas on seventeenth century Europe. So it's well worth reading that paper when you have a chance. You know what, what, I'm surprised about that we didn't go over to the blockchain conversation, because blockchain, of course, is

both about trust and information. Yeah, you know what, I'm actually impressed you say that you're surprised that we didn't go there. I'm actually impressed with us for not going there, because so many conversations do ultimately go back these days to something related to block chains or whatever. So we actually showed a little bit of restraint. But no, absolutely,

I'm sorry I ruined it. No, yeah, you did ruin it. No, but you're totally right and thinking about the importance of bookkeeping and being able to actually believe what a network is doing. It seems like a lot of these the problems that a lot of people are still looking to solve, and a good reminder that for his impersonal as markets have gotten, as Partique mentioned, there's still a pretty big

personal relationship and a lot of these things. Yeah. Absolutely, Okay, you know what I'm gonna say, Let's let's leave it there, because otherwise we really are going to start doing a blockchain episode and then I'll feel really bad. Yeah, we got it. We gotta ended there. All right. This has

been another edition of the Odd Lots Podcast. You can follow me on Twitter at Tracy Alloway, and you can follow me on Twitter at the Stalwart, and you should follow Critique on Twitter at Critique Raj Underscore, and I want to thank our producers to for Foreheads. You can follow him on Twitter at Foreheast and the head of podcast at Bloomberg, Francescallip, Thanks for listening.