Book V, Chapter I, 10

The company might prefer that its own servants and dependents enjoy either the pleasure of wasting or the profit of embezzling whatever surplus remained after payment of the proposed eight per cent. dividend, rather than see it pass into the hands of people with whom those resolutions could scarcely fail to set them at odds. The interests of these servants and dependents might gain enough sway in the court of proprietors to induce it at times to defend those responsible for thefts committed in direct defiance of its own authority. For a majority of proprietors, even upholding their court's authority might sometimes matter less than supporting those who had defied it.

The regulations of 1773, accordingly, did not end the disorder of the company's government in India. Though in a brief spell of good management it had once gathered more than £3,000,000 sterling into the treasury at Calcutta; though it had subsequently extended either its dominion or its plundering over a vast addition of some of India's richest and most fertile lands, all was squandered and destroyed. It found itself wholly unprepared to halt or resist Hyder Ali's incursion. Because of these disorders, the company is now (1784) in greater distress than ever and, to avert immediate bankruptcy, is once more reduced to pleading for government assistance. The different parties in parliament have put forward different plans for improving the management of its affairs; all appear to assume what had always been abundantly clear: it is wholly unfit to govern its territorial possessions. Even the company itself seems sufficiently convinced of its incapacity to be willing, on that account, to surrender them to government.

The right to hold forts and garrisons in distant and supposedly barbarous countries necessarily carries with it the right to make peace and war there. Joint-stock companies possessing the first right have invariably exercised the second, which has often been expressly conferred on them. Recent experience has shown only too clearly how unjustly, capriciously, and cruelly they have generally exercised it.

When merchants undertake, at their own risk and expense, to establish a new trade with a remote and supposedly barbarous nation, it may be reasonable to incorporate them into a joint-stock company and, if they succeed, grant them a monopoly of that trade for a specified number of years. This is the easiest and most natural means for the state to repay them for risking a dangerous and expensive experiment from which the public will later benefit. A temporary monopoly of this sort can be justified on the same principles as the monopoly granted to the inventor of a new machine or the author of a new book. But when its term expires, the monopoly must certainly end. Any forts and garrisons that proved necessary should pass into government hands, with the company paid their value, and the trade should open to every subject of the state. A perpetual monopoly taxes every other subject of the state, quite absurdly, in two different ways: first, through the high prices of goods that they could buy far more cheaply under free trade; and second, by excluding them entirely from a line of business that many might find both convenient and profitable to pursue. The purpose for which they are taxed in this fashion is the most worthless imaginable. It is merely to enable the company to sustain the negligence, extravagance, and misconduct of its own servants, whose disorderly behavior seldom lets its dividend exceed the ordinary rate of profit in wholly free trades, and very often causes it to fall considerably short of that rate. Yet experience seems to show that without a monopoly a joint-stock company cannot long conduct any branch of foreign trade. Buying in one market for profitable sale in another, with many competitors in both; watching not merely the occasional shifts in demand but the much larger and more frequent shifts in competition, or in the supply that others are likely to offer in response to that demand; and adjusting with skill and judgment both the quantity and the quality of every assortment of goods to all these circumstances—this is a kind of warfare whose operations continually change. It can scarcely be conducted successfully without a sustained vigilance and attention that cannot long be expected of the directors of a joint-stock company. By act of parliament, the East India company has the right, after its funds have been redeemed and its exclusive privilege expired, to remain a corporation with a joint stock and to trade as a corporation with the East Indies alongside its fellow subjects. But under those conditions, the greater vigilance and care of private merchants would in all probability soon make it weary of the trade.

An eminent French author with great knowledge of political economy, the Abbe Morellet, lists fifty-five joint-stock companies engaged in foreign trade, established in different parts of Europe since the year 1600, all of which, he says, failed through mismanagement despite having exclusive privileges. He has been misinformed about the histories of two or three: they were not joint-stock companies and did not fail. In compensation, however, he omits several joint-stock companies that did fail.

The only trades a joint-stock company seems capable of conducting successfully without an exclusive privilege are those whose entire operations can be reduced to what is called a routine, a uniform method allowing little or no variation. They are, first, banking; second, insurance against fire, loss at sea, and capture in wartime; third, the construction and maintenance of a navigable cut or canal; and fourth, the similar business of bringing water to supply a great city.

Though the principles of banking may seem somewhat difficult to grasp, its practice can be reduced to strict rules. Departing from those rules on any occasion in pursuit of a tempting prospect of extraordinary gain is almost always extremely dangerous and frequently fatal to the bank that tries it. But the structure of joint-stock companies generally makes them more faithful to established rules than any private partnership. Such companies therefore seem particularly well suited to banking. Accordingly, Europe's principal banks are joint-stock companies, many of them trading very successfully without an exclusive privilege. The bank of England has no exclusive privilege other than the rule that no other banking company in England may consist of more than six persons. The two banks of Edinburgh are joint-stock companies without any exclusive privilege.

The value of the risk of fire, loss at sea, or capture may not admit of a very exact calculation, but it can be estimated roughly enough to be governed to some extent by strict rule and method. Insurance can therefore be carried on successfully by a joint-stock company without any exclusive privilege. Neither the London Assurance nor the Royal Exchange Assurance companies possess such a privilege.

Once a navigable cut or canal has been built, its management becomes quite simple and easy and can be governed by strict rule and method. Even its construction can be so governed, since it can be contracted out to builders at a set price per mile and per lock. The same can be said of a canal, an aqueduct, or a large pipe supplying a great city with water. Such undertakings can therefore be, and often are, very successfully managed by joint-stock companies without any exclusive privilege.

It would certainly not be reasonable, however, to establish a joint-stock company for an undertaking merely because it might manage that undertaking successfully, or to exempt a particular set of dealers from some general laws applying to all their neighbors merely because they might prosper under that exemption. To make such an establishment entirely reasonable, two other conditions must accompany the possibility of governing it by strict rule and method. First, there must be the clearest evidence that the undertaking is of greater and more general benefit than most ordinary trades; second, it must require more capital than a private partnership could easily raise. If moderate capital sufficed, even the undertaking's great utility would not justify establishing a joint-stock company, for private merchants would readily and easily meet the demand for its product. Both additional conditions are fulfilled in the four trades mentioned above.

The great and general benefit of prudent banking has been fully explained in the second book of this Inquiry. But a public bank that must support public credit and, in particular emergencies, advance government the entire proceeds of a tax—perhaps several millions—a year or two before the tax comes in needs more capital than any private partnership could easily raise.

Insurance gives great security to private fortunes. By distributing among many people a loss that would ruin one individual, it makes that loss light and bearable for society as a whole. But to give this security, insurers need a very large capital. Before the two joint-stock insurance companies were established in London, a list was reportedly submitted to the attorney-general of one hundred and fifty private usurers who had failed within a few years.

That navigable cuts and canals, and the works sometimes needed to supply a great city with water, are of great and general benefit, while often costing more than private individuals can afford, is plain enough.

Apart from the four trades mentioned above, I can recall no other in which all three conditions needed to justify establishing a joint-stock company come together. The English copper company of London, the lead-smelting company, and the glass-grinding company cannot even claim any great or exceptional usefulness in what they seek to accomplish; nor does pursuing their aims appear to demand an expense beyond the means of many private people. Whether the trades these companies conduct can be brought under rules and methods strict enough to suit the management of a joint-stock company, or whether they have any grounds to boast of extraordinary profits, I do not claim to know. The mine-adventurers company went bankrupt long ago. A share in the British Linen company of Edinburgh now sells far below par, though not as far below as it did some years ago. Joint-stock companies established with the public-spirited aim of promoting a particular manufacture not only manage their own affairs poorly, reducing society's general stock, but in other respects can scarcely fail to do more harm than good. Despite the most upright intentions, their directors are inevitably partial to certain branches of the manufacture, swayed and deceived by the people conducting them. This genuinely discourages the other branches and necessarily disrupts, to some degree, the natural relation that would otherwise arise between well-directed industry and profit—a relation that is the strongest and most effective of all encouragements to the country's industry as a whole.

ART. II.—On the Expense of the Institution for the Education of Youth.

Institutions for educating the young may likewise provide enough revenue to cover their own expenses. The fee or honorarium a pupil pays a teacher naturally provides revenue of this kind.

Even when the teacher's compensation does not come wholly from this natural source, it need not come from the general revenue of society, whose collection and use are assigned in most countries to the executive power. Thus, across most of Europe, endowing schools and colleges places either no burden or only a very small one on that general revenue. Their funding everywhere comes chiefly from local or provincial revenues, the rent of landed property, or interest on a sum of money set aside for this particular purpose and entrusted to trustees, sometimes by the sovereign himself and sometimes by a private donor.

Have these public endowments, in general, helped advance the purpose for which they were established? Have they encouraged teachers' diligence and improved their abilities? Have they guided education toward subjects more useful to individuals and the public than those it would naturally have pursued on its own? It should not be very difficult to give at least a plausible answer to each of these questions.

In every profession, the effort most practitioners put forth is always proportionate to their need to make that effort. That need is greatest among those who rely on the earnings of their profession as the sole source of the fortune they hope to make, or even of their ordinary income and livelihood. To make that fortune, or merely to earn a living, they must perform within a year a certain quantity of work of known value. Where competition is free, rivalry among competitors, all striving to displace one another, obliges everyone to perform that work with some degree of precision. The great rewards attainable through success in certain professions may sometimes, no doubt, inspire a few people of exceptional spirit and ambition to exert themselves. But great rewards are plainly not necessary to bring about the greatest efforts. Rivalry and emulation make excellence an object of ambition even in humble professions, and frequently elicit the very greatest efforts. Great rewards alone, by contrast, without any necessity for sustained application, have seldom been enough to produce any substantial effort. In England, success in the legal profession leads to some very great prizes of ambition; yet how few people born to comfortable fortunes have ever become eminent in that profession here?

The endowments of schools and colleges have necessarily reduced, to some degree, teachers' need to apply themselves. Insofar as their livelihood comes from salaries, it plainly comes from a fund wholly independent of their success and reputation in their particular professions.

The company might prefer to let its own employees and dependents enjoy wasting or pocketing any surplus left after paying the proposed dividend of eight per cent. It might not want the money to go instead to people with whom those resolutions would almost certainly cause some conflict. The employees and dependents might have enough influence at the owners' meetings to make them sometimes support people who had stolen from the company in open defiance of those meetings' authority. For most owners, even defending their own meeting's authority might sometimes matter less than supporting the people who had defied it.

The regulations of 1773 therefore did not end the disorder in the company's government in India. For a brief time, when it managed its affairs well, it collected more than £3,000,000 sterling in the Calcutta treasury. Later, it extended either its rule or its plunder over vast additional areas, including some of India's richest and most fertile lands. Yet everything was wasted and destroyed. The company was completely unprepared to stop or resist Hyder Ali's invasion. Because of these disorders, the company is now (1784) in worse trouble than ever. To avoid immediate bankruptcy, it has again been forced to ask the government for help. Different parties in parliament have proposed different plans for managing its affairs better. All these plans seem to take for granted what has always been abundantly clear: it is completely unfit to govern its territories. Even the company seems to recognize its inability to do so and, for that reason, seems willing to give the territories up to the government.

The right to hold forts and garrisons in distant countries called barbarous necessarily includes the right to make peace and war there. Joint-stock companies that have held the first right have always exercised the second, and have often been explicitly granted it. Recent experience has made all too clear how unjustly, unpredictably, and cruelly they have usually used that power.

When merchants undertake to establish a new trade with a distant nation called barbarous, bearing the costs and risks themselves, it may be reasonable to form them into a joint-stock company. If they succeed, they might be granted a monopoly on that trade for a fixed number of years. This is the easiest and most natural way for the state to reward them for taking the risk of an expensive and dangerous experiment from which the public will later benefit. Such a temporary monopoly can be justified on the same grounds as a similar monopoly granted to an inventor for a new machine or to an author for a new book. But when the term expires, the monopoly must end. The government should take over any forts and garrisons it proved necessary to establish, pay the company their value, and open the trade to everyone in the country. A permanent monopoly effectively imposes two unreasonable costs on everyone else. First, it makes them pay high prices for goods they could buy much more cheaply under free trade. Second, it completely bars them from a business that many of them could profitably and conveniently pursue. Worse still, these costs serve the most worthless purpose of all. They merely allow the company to support the carelessness, waste, and misconduct of its employees. Their disorderly behavior seldom lets its dividend rise above the normal profit rate in completely open trades, and very often leaves it well below that rate. Experience suggests, however, that without a monopoly, a joint-stock company cannot carry on any branch of foreign trade for long. It must buy in one market and sell at a profit in another while facing many competitors in both. It must track not only occasional changes in demand but the much greater and more frequent changes in competition and in the supply that others are likely to provide. It must skillfully and sensibly adjust the quantity and quality of every selection of goods to all these conditions. This is like a campaign whose operations change constantly. It can hardly succeed without continuous care and attention that the directors of a joint-stock company cannot be expected to maintain for long. Once its funds have been repaid and its exclusive right has expired, the East India company has a right under an act of parliament to remain a corporation with a joint stock. It may trade as a corporation with the East Indies alongside everyone else. But in those circumstances, private traders' greater care and attention would probably soon make the company tire of the trade.

The Abbe Morellet, a noted French author highly knowledgeable about political economy, lists fifty-five joint-stock companies for foreign trade founded in various parts of Europe since the year 1600. According to him, all failed through bad management despite having exclusive rights. He has been given incorrect information about the history of two or three: they were not joint-stock companies and did not fail. On the other hand, he leaves out several joint-stock companies that did fail.

The only businesses a joint-stock company seems able to run successfully without an exclusive right are those whose operations can all be organized into a routine. Their methods must be so uniform that they need little or no variation. These are, first, banking; secondly, insurance against fire, losses at sea, and capture in wartime; thirdly, building and maintaining a navigable channel or canal; and, fourthly, a similar business that brings water to a large city.

The principles of banking may seem somewhat hard to understand, but its everyday operations can be governed by firm rules. Departing from those rules in pursuit of an appealing prospect of exceptional gain is almost always extremely dangerous and often fatal to the bank that tries it. Because of the way joint-stock companies are organized, however, they generally stick to established rules more firmly than any private partnership. Such companies therefore seem particularly well suited to banking. Accordingly, Europe's main banking companies are joint-stock companies, and many operate very successfully without any exclusive right. The bank of England's only exclusive right is that no other banking company in England can have more than six members. The two banks of Edinburgh are joint-stock companies with no exclusive right.

It may not be possible to calculate exactly the size of the risk of fire, loss at sea, or capture. But one can make a rough estimate that allows these risks to be handled, to some degree, by firm rules and methods. Insurance can therefore be successfully provided by a joint-stock company without any exclusive right. Neither the London Assurance nor the Royal Exchange Assurance companies have one.

Once a navigable channel or canal has been built, managing it is quite simple and easy and can follow firm rules and methods. Even its construction can be managed this way: contractors can be hired for a specified amount per mile and per lock. The same applies to a canal, an aqueduct, or a large pipe bringing water to a big city. Joint-stock companies can therefore manage such projects successfully, and often do, without any exclusive right.

Still, it would not be reasonable to form a joint-stock company for any venture simply because it could manage that venture successfully. Nor would it be reasonable to exempt certain businesses from laws that apply to all their neighbors simply because that exemption would help them prosper. Two more conditions must accompany the ability to follow firm rules and methods before forming such a company is fully justified. First, there must be the clearest evidence that the venture is more useful to more people than most ordinary businesses. Second, it must require more capital than a private partnership can easily raise. If a modest amount of capital were enough, the venture's great usefulness would not justify forming a joint-stock company. Private traders could then readily and easily meet the demand for its products. All three conditions are met in the four businesses mentioned above.

The great and widespread usefulness of well-managed banking has been fully explained in the second book of this Inquiry. But a public bank that supports public credit may need to advance the government the entire proceeds of a tax, perhaps several millions, a year or two before the tax is collected. That requires more capital than a private partnership can easily raise.

Insurance protects private people's fortunes. It spreads among many people a loss that would ruin one individual, making the burden on society as a whole light and manageable. To provide this protection, however, insurers need very large capital reserves. Before the two joint-stock insurance companies were founded in London, it is said, a list of one hundred and fifty private lenders who had failed over a few years was given to the attorney-general.

Navigable channels and canals, and the works sometimes needed to supply a large city with water, are plainly of great and widespread use. They also often cost more than private individuals can afford.

Apart from the four businesses mentioned above, I cannot think of another that meets all three conditions needed to justify forming a joint-stock company. The English copper company of London, the lead-smelting company, and the glass-grinding company cannot even claim that their activities have any unusual or especially great public value. Nor does what they do seem to require spending beyond the means of many private individuals. I do not claim to know whether their businesses can follow rules and methods firm enough to suit joint-stock management, or whether they have any grounds for boasting of exceptional profits. The mine-adventurers company went bankrupt long ago. A share of the British Linen company of Edinburgh currently sells well below its nominal value, though not as far below as it did some years ago. Some joint-stock companies are founded with the public-minded aim of promoting a particular manufacture. They manage their own affairs badly and thereby reduce society's overall stock. Beyond that, they can hardly avoid doing more harm than good in other ways. However honest their directors' intentions, they inevitably favor particular branches of the manufacture. The people running those branches mislead and take advantage of them. This favoritism discourages the rest and inevitably disrupts, to some extent, the balance that would otherwise arise between productive work and profit. For a country's overall industry, that balance is the greatest and most effective encouragement.

ARTICLE II.—On the Cost of Institutions for Educating Young People.

Institutions that educate young people can likewise earn enough revenue to cover their own costs. The fee or payment a student gives a teacher naturally provides revenue of this kind.

Even when a teacher's pay does not come entirely from this natural source, it need not come from society's general revenue, which most countries assign the executive government to collect and spend. Across most of Europe, support for schools and colleges draws nothing from that general revenue, or very little. It comes mainly from local or provincial revenue, rent on landed estates, or interest on sums of money set aside and placed under trustees' management for that specific purpose. Sometimes the ruler provides these funds, and sometimes a private donor does.

Have these public endowments generally helped institutions achieve their purpose? Have they encouraged teachers to work hard and improve their abilities? Have they steered education toward subjects more useful to students and the public than the subjects it would otherwise have followed? It should not be very hard to give at least a likely answer to each question.

In every profession, how hard most people work depends on how much they need to work hard. That need is greatest for people who rely on earnings from their profession for their expected fortune, or even for their regular income and livelihood. To earn that fortune or even make a living, they must perform a certain amount of work of known value each year. Where competition is free, rivals all try to win work from one another. This forces each person to do the work with a certain degree of care. The great rewards available to successful people in certain professions may sometimes inspire a few exceptionally ambitious and energetic people. But great rewards clearly are not necessary to produce the greatest efforts. Competition and the desire to excel can make excellence an ambition even in humble professions, often prompting the very greatest efforts. On the other hand, great rewards alone, without any need to apply oneself, have rarely produced much effort. In England, a successful legal career offers some very great prizes to ambitious people. Yet how few people born to comfortable fortunes have become distinguished in that profession here?

Endowments for schools and colleges have inevitably reduced, to some degree, teachers' need to apply themselves. Insofar as their livelihood comes from salaries, it is paid from a fund entirely independent of their success or reputation as teachers.