Economics 493/593 - History of Economic Thought

The Pirates' Code

This is the article I mentioned in class:

The Pirates’ Code, by James Surowiecki, The New Yorker: ...While pirates were certainly cruel and violent criminals, pirate ships were hardly the floating tyrannies of popular imagination. As a fascinating new paper by Peter Leeson, an economist at George Mason University, and “The Republic of Pirates,” a new book by Colin Woodard, make clear, pirate ships limited the power of captains and guaranteed crew members a say in the ship’s affairs. The surprising thing is that, ... pirates were, in Leeson’s words, among “the most sophisticated and successful criminal organizations in history.”

Leeson is fascinated by pirates because they flourished outside ... the law. They could not count on ... authorities to insure that people would live up to promises or obey rules. Unlike the Mafia, pirates were not bound by ethnic or family ties; crews were ... remarkably diverse... Nor were they held together primarily by violence... [P]irate ships were governed by ... simple constitutions that, in greater or lesser detail, laid out the rights and duties of crewmen, rules for the handling of disputes, and incentive and insurance payments to insure that crewmen would act bravely in battle. ... The Pirates’ Code ... was not, in that sense, a myth, although in effect each ship had its own code.

But rules alone did not suffice. Pirates also needed to limit the risk that their leaders would put individual interests ahead of the interests of the ship... Some pirates had turned to buccaneering after fleeing naval and merchant vessels, where the captain was essentially a dictator... Royal Navy and merchant captains guaranteed themselves full rations while their men went hungry, beat crew members at their whim, and treated dissent as mutinous. So pirates were familiar with the perils of autocracy.

As a result, Leeson argues, pirate ships developed ... democracies. First, pirates ... divided and limited power. Captains had total authority during battle, when debate and disagreement were ... inefficient and dangerous. Outside of battle, the quartermaster ... was in charge—responsible for food rations, discipline, and the allocation of plunder. On most ships, the distribution of booty was set down in writing, and it was relatively equal; pirate captains often received only twice as many shares as crewmen. ... The most powerful check on captains and quartermasters was that ... the crew elected them and could depose them. And when questions arose about the rules..., interpretation was left not to the captain but to a jury of crewmen. ...

Interestingly, ... most corporations since the mid-nineteenth century have behaved more like the Royal Navy, with C.E.O.s who have close to unlimited power and employees who have no say in ... the organization...

This model of C.E.O. leadership is increasingly being questioned, with a greater emphasis being placed, at least rhetorically, on the need for executives to be more responsive to employees and on the value of dividing authority (although no one is seriously considering letting ordinary employees elect the boss). ... You can take this comparison only so far... But it may be only a matter of time before someone publishes “The Management Lessons of Captain Kidd.” I’d read it.

Louis the Pious: Duties of the Coloni, 817

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C.13. As to the coloni, they either serve as serfs of the Church or make some kind of fixed payment: this is the agrarian tax according to the opinion of the steward. The steward sees to it that each gives according to what he has; out of thirty muids he gives three muids, and each pays pascuarium according to the custom of the district. He is to plough, sow, enclose, harvest, haul, and put away the crops from the regular enclosures---which are four ten-foot measuring rods in width and forty in length. He is to enclose, reap, gather, and put away one arpent in meadow. Every colonus ought to collect and put away corn to the value of a triens for seed. He is to plant, enclose, dig up, extend, prune, and collect the harvest of the vineyards. They each pay ten bundles of flax. Four hens they must pay also. They give palfreys or go where they are ordered. They do carriage service with a cart up to fifty leagues; to go further is not expected. They are assigned to the demesne houses, haylofts, farms; they have a reasonable amount of land for earning the tax, and when necessary they pay it in a lump sum.

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Source: From: J. P. Migne, Patrologiae Cursus Completus, (Paris, 1862), Vol. XCVII, p. 412, reprinted in Roy C. Cave & Herbert H. Coulson, A Source Book for Medieval Economic History, (New York: The Bruce Publishing Co., 1936; reprint ed., New York: Biblo & Tannen, 1965), p. 28.

The Church Fathers On Usury, 400-444

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The Church Fathers had already taken a stand on the question of usury in the fifth century, but loans on credit were not widespread transactions during the barbarian conquest.

St. Jerome on Usury, 400: If you gave to a prosperous person you should not have done so: but if (even so) you gave it as to a needy person, why should you demand more on the score of his being prosperous? Some lenders are wont to take small gifts of dilferent value, not realizing that whatever is received over and above what was given is called usury and superabundance. They ought not to take more, however much it be, than was originally given by them.

Pope Leo the Great, 444: Neither do we think that it should be lightly passed over that some people, seized with the desire for filthy lucre, put out their money at usury in order to become rich thereby. And we have to complain of this not only with regard to those in clerical office but we likewise grieve to see that it holds true of lay people who wish to be called Christians. We decree that this should be severely punished in those found guilty, so that all occasion of sin may be washed away.

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Source: From: J. P. Migne, ed. Patrologiae Cursus Completus, (Paris, 1845), Vols. XXV, p. 177, CLXXXVII, p. 959, reprinted in Roy C. Cave & Herbert H. Coulson, A Source Book for Medieval Economic History, (Milwaukee: The Bruce Publishing Co., 1936; reprint ed., New York: Biblo & Tannen, 1965), pp. 170-171.

The Pirates' Code

This is the article I mentioned in class today:

The Pirates’ Code, by James Surowiecki, The New Yorker: ...While pirates were certainly cruel and violent criminals, pirate ships were hardly the floating tyrannies of popular imagination. As a fascinating new paper by Peter Leeson, an economist at George Mason University, and “The Republic of Pirates,” a new book by Colin Woodard, make clear, pirate ships limited the power of captains and guaranteed crew members a say in the ship’s affairs. The surprising thing is that, ... pirates were, in Leeson’s words, among “the most sophisticated and successful criminal organizations in history.”

Leeson is fascinated by pirates because they flourished outside ... the law. They could not count on ... authorities to insure that people would live up to promises or obey rules. Unlike the Mafia, pirates were not bound by ethnic or family ties; crews were ... remarkably diverse... Nor were they held together primarily by violence... [P]irate ships were governed by ... simple constitutions that, in greater or lesser detail, laid out the rights and duties of crewmen, rules for the handling of disputes, and incentive and insurance payments to insure that crewmen would act bravely in battle. ... The Pirates’ Code ... was not, in that sense, a myth, although in effect each ship had its own code.

But rules alone did not suffice. Pirates also needed to limit the risk that their leaders would put individual interests ahead of the interests of the ship... Some pirates had turned to buccaneering after fleeing naval and merchant vessels, where the captain was essentially a dictator... Royal Navy and merchant captains guaranteed themselves full rations while their men went hungry, beat crew members at their whim, and treated dissent as mutinous. So pirates were familiar with the perils of autocracy.

As a result, Leeson argues, pirate ships developed ... democracies. First, pirates ... divided and limited power. Captains had total authority during battle, when debate and disagreement were ... inefficient and dangerous. Outside of battle, the quartermaster ... was in charge—responsible for food rations, discipline, and the allocation of plunder. On most ships, the distribution of booty was set down in writing, and it was relatively equal; pirate captains often received only twice as many shares as crewmen. ... The most powerful check on captains and quartermasters was that ... the crew elected them and could depose them. And when questions arose about the rules..., interpretation was left not to the captain but to a jury of crewmen. ...

Interestingly, ... most corporations since the mid-nineteenth century have behaved more like the Royal Navy, with C.E.O.s who have close to unlimited power and employees who have no say in ... the organization...

This model of C.E.O. leadership is increasingly being questioned, with a greater emphasis being placed, at least rhetorically, on the need for executives to be more responsive to employees and on the value of dividing authority (although no one is seriously considering letting ordinary employees elect the boss). ... You can take this comparison only so far... But it may be only a matter of time before someone publishes “The Management Lessons of Captain Kidd.” I’d read it.

This is the article I mentioned in class today:

The Pirates’ Code, by James Surowiecki, The New Yorker: ...While pirates were certainly cruel and violent criminals, pirate ships were hardly the floating tyrannies of popular imagination. As a fascinating new paper by Peter Leeson, an economist at George Mason University, and “The Republic of Pirates,” a new book by Colin Woodard, make clear, pirate ships limited the power of captains and guaranteed crew members a say in the ship’s affairs. The surprising thing is that, ... pirates were, in Leeson’s words, among “the most sophisticated and successful criminal organizations in history.”

Leeson is fascinated by pirates because they flourished outside ... the law. They could not count on ... authorities to insure that people would live up to promises or obey rules. Unlike the Mafia, pirates were not bound by ethnic or family ties; crews were ... remarkably diverse... Nor were they held together primarily by violence... [P]irate ships were governed by ... simple constitutions that, in greater or lesser detail, laid out the rights and duties of crewmen, rules for the handling of disputes, and incentive and insurance payments to insure that crewmen would act bravely in battle. ... The Pirates’ Code ... was not, in that sense, a myth, although in effect each ship had its own code.

But rules alone did not suffice. Pirates also needed to limit the risk that their leaders would put individual interests ahead of the interests of the ship... Some pirates had turned to buccaneering after fleeing naval and merchant vessels, where the captain was essentially a dictator... Royal Navy and merchant captains guaranteed themselves full rations while their men went hungry, beat crew members at their whim, and treated dissent as mutinous. So pirates were familiar with the perils of autocracy.

As a result, Leeson argues, pirate ships developed ... democracies. First, pirates ... divided and limited power. Captains had total authority during battle, when debate and disagreement were ... inefficient and dangerous. Outside of battle, the quartermaster ... was in charge—responsible for food rations, discipline, and the allocation of plunder. On most ships, the distribution of booty was set down in writing, and it was relatively equal; pirate captains often received only twice as many shares as crewmen. ... The most powerful check on captains and quartermasters was that ... the crew elected them and could depose them. And when questions arose about the rules..., interpretation was left not to the captain but to a jury of crewmen. ...

Interestingly, ... most corporations since the mid-nineteenth century have behaved more like the Royal Navy, with C.E.O.s who have close to unlimited power and employees who have no say in ... the organization...

This model of C.E.O. leadership is increasingly being questioned, with a greater emphasis being placed, at least rhetorically, on the need for executives to be more responsive to employees and on the value of dividing authority (although no one is seriously considering letting ordinary employees elect the boss). ... You can take this comparison only so far... But it may be only a matter of time before someone publishes “The Management Lessons of Captain Kidd.” I’d read it.

"Fibonacci, Fermat, and Finance"

I went to a seminar yesterday in the Physics Department to see the manager of a hedge fund, John Seo, talk about "Fibonacci, Fermat, and Finance: How a Biophysicist Built a Multi-Billion Dollar Catastrophe Bond Fund after Re-Reading the Foundations of Modern Finance" (NY Times magazine story). One thing I learned at the seminar and from asking questions at dinner afterward was about the origins of present value analysis. It goes back to the mathematician Leonardo Fibonacci and chapter 12 of his book "Liber Abaci" written in 1202. Here's a working paper on the topic:

Fibonacci and the Financial Revolution William N. Goetzmann NBER Working Paper No. 10352: ...Traveling Merchant Problems The second type of financial problem is a set of “traveling merchant” examples, akin to accounting calculations for profits obtained in a series of trips to trading cities.

The first example is:

A certain man proceeded to Lucca on business to make a profit doubled his money, and he spent there 12 denari. He then left and went through Florence; he there doubled his money, and spent 12 denari. Then he returned to Pisa, doubled his money and it is proposed that he had nothing left. It is sought how much he had at the beginning.

[Update: the problem isn't clear about this, but 12 denari are spent at each of the three stops, including Pisa] Leonardo proposes an ingenious solution method. Since capital doubles at each stop, the discount factor for the third cash flow (in Pisa) is ½ ½ ½ . He multiplies the periodic cash flow of 12 denari times a discount factor that is the sum of the individual discount factors for each trip i.e. (1/2) + (1/4) + (1/8). The solution is 10½ denari. The discount factor effectively reduces the individual cash flows back to the point before the man reached Lucca.

Notice that this approach can be generalized to allow for different cash flows at different stages of the trip, a longer sequence of trips, different rates of return at each stop, or a terminal cash flow. In the twenty examples that follow the Lucca-Florence- Pisa problem, Leonardo presents and solves increasingly complex versions with various unknown elements. For example, one version of the problem specifies the beginning value and requires that the number of trips to be found – e.g. “A certain man had 13 bezants, and with it made trips, I know not how many, and in each trip he made double and he spent 14 bezants. It is sought how many were his trips.” This and other problems demonstrate the versatility of his discounting method. They also provide a framework for the explicit introduction of the dimension of time, and the foundation for what we now consider finance.

In case you don't see this, though he didn't explicitly use this formula, he realized that the "present value" of the cash flow is:

PV = [R₁/(1+i)¹] + [R₂/(1+i)²] + [R₃/(1+i)³]

where R_j is the cash spent at each point j on the trip, and i is the profit rate. In this case,  R_j = 12 for all j, and i=100%, or 1.0. Thus:

PV = [12/(1+1)¹] + [12/(1+1)²] + [12/(1+1)³]

      = [12/2] + [12/4] + [12/8]

      = 12[(1/2) + (1/4) + (1/8)] (as above)

      = 10.5

But does Fibonacci realize this applies not just to traveling merchants, but also to discounting financial cash flows over time? Yes. All you have to do is convert the problem back to the traveling merchant example. Going back to the NBER paper:

Immediately following the trip problems, Fibonacci poses and solves a series of banking problems. Each of these follows the pattern established by the trips example – the capital increases by some percentage at each stage, and some amount is deducted. For example:

A man placed 100 pounds at a certain [banking] house for 4 denari per pound per month interest and he took back each year a payment of 30 pounds. One must compute in each year the 30 pounds reduction of capital and the profit on the said 30 pounds. It is sought how many years, months, days and hours he will hold money in the house....

Fibonacci explains that the solution is found by using the same techniques developed in the trips section. Intervals of time replace the sequence of towns visited and thus a time-series of returns and cash draw-downs can be evaluated. Once the method of trips has been mastered, then it is straightforward to construct a multiperiod discount factor and apply it to the periodic payment of 30 pounds – although in this problem the trick is to determine the number of time periods used to construct the factor. Now we might use logarithms to address the problem of the nth root for an unknown n, but Fibonacci lived long before the invention of logarithms. Instead, he solves it by brute force over the space of three pages, working forward from one period to two periods etc. until he finds the answer of 6 years, 8 days and [5 and 1/2] hours. The level of sophistication represented by this problem alone is unmatched in the history of financial analysis. Although the mathematics of interest rates had a 3,000 year history before Fibonacci, his remarkable exposition and development of multi-period discounting is a quantum leap above his predecessors.

And, one final example:

Present Value Analysis The most sophisticated of Fibonacci’s interest rate problems is “On a Soldier Receiving Three Hundred Bezants for his Fief.” In it, a soldier is granted an annuity by the king of 300 bezants per year, paid in quarterly installments of 75 bezants. The king alters the payment schedule to an annual year-end payment of 300. The soldier is able to earn 2 bezants on one hundred per month (over each quarter) on his investment. How much is his effective compensation after the terms of the annuity have changed? ...

As before, Fibonacci explains how to construct a multi-period discount factor from the product of the reciprocals of the periodic growth rate of an investment, using the model developed from mercantile trips in which a percentage profit is realized at each city. In this problem, he explicitly quantifies the difference in the value of two contracts due to the timing of the cash flows alone. As such, this particular example marks the discovery of one of the most important tools in the mathematics of Finance – an analysis explicitly ranking different cash flow streams based upon their present value.

David Ricardo: The Iron Law of Wages, 1817

David Ricardo (1772-1823), an English banker was also an important early economist. His most well-known argument was that wages "naturally" tended towards a minimum level corresponding to the subsistence needs of the workers. The attraction of this idea for factory owners is evident. It also influenced Marx in his early pessimistic views about the possibility of workers benefiting from capitalism. Ricardo's views on the "labor theory of value" were also important in Marx's economic thought.

From David Ricardo. On Wages

Money, from its being a commodity obtained from a foreign country, from its being the general medium of exchange between all civilized countries, and from its being also distributed among those countries in proportions which are ever changing with every improvement in commerce and machinery, and with every increasing difficulty of obtaining food and necessaries for an increasing population, is subject to incessant variations. In stating the principles which regulate exchangeable value and price, we should carefully distinguish between those variations which belong to the commodity itself, and those which are occasioned by a variation in the medium in which value is estimated, or price expressed.

A rise in wages, from an alteration in the value of money, produces a general effect on price, and for that reason it produces no real effect whatever on profits. On the contrary, a rise of wages, from the circumstance of the labourer being more liberally rewarded, or from a difficulty of procuring the necessaries on which wages are expended, does not, except in some instances, produce the effect of raising price, but has a great effect in lowering profits. In the one case, no greater proportion of the annual labour of the country is devoted to the support of the labourers; in the other case, a larger portion is so devoted.

Labour, like all other things which are purchased and sold, and which may be increased or diminished in quantity, has its natural and its market price. The natural price of labour is that price which is necessary to enable the labourers, one with another, to subsist and to perpetuate their race, without either increase or diminution.

The Regulations of the Weavers' Gild of Stendal, 1233

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The weavers' law, granted by the city of Stendal, regulated the number of spindles to be used by a craftsman, membership of the gild, and the quality of the work.

The Consuls of Stendal . . . wish it to be known that we have taken the advice of our leading citizens and officials, and have passed the following decree:

1. If any of our burgesses should wish to practice the craft of weaving he ought to have one spindle or as many as two, and he should place them in his house, and for every spindle he should pay three solidi on entry into the fraternity. But if he should not pay the denarii within the said time and he afterwards cease to be of the craft he cannot regain it except with twenty-three solidi.

2. Whoever is not of the fraternity is altogether forbidden to make cloth.

3. But if any brother should make cloth against the institutions of the brethren, and of their decrees, which he ought on the advice of the consuls to observe, he will present to the consuls by way of emendation one talent for each offense or he will lose his craft for a year.

4. But if any one be caught with false cloth, his cloth will be burned publicly, and verily, the author of the crime will amend according to justice.

5. Should any foreigner wish to practice this craft he will first acquire citizenship and will afterwards enter into fraternity with the brethren with twenty-three solidi.

6. But if the heir of any craftsman cease to exercise his father's craft, he will pay three solidi on entrance.

7. Also we decree that every brother will dry his cloth where he can.

8. We concede also that if any one have this craft and cannot set up his implements by any chance, let him prepare and make his cloth on the spindle of another.

9. If any one should marry a widow whose husband was of the craft, he will enter the fraternity with three solidi.

10. And every one who would be of this craft will receive it in the presence of the consuls.

11. Whatever is collected in fines and received in entrance fees will be put to the use of the city, and be presented to the consuls....

Louis the Pious: Duties of the Coloni, 817

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C.13. As to the coloni, they either serve as serfs of the Church or make some kind of fixed payment: this is the agrarian tax according to the opinion of the steward. The steward sees to it that each gives according to what he has; out of thirty muids he gives three muids, and each pays pascuarium according to the custom of the district. He is to plough, sow, enclose, harvest, haul, and put away the crops from the regular enclosures---which are four ten-foot measuring rods in width and forty in length. He is to enclose, reap, gather, and put away one arpent in meadow. Every colonus ought to collect and put away corn to the value of a triens for seed. He is to plant, enclose, dig up, extend, prune, and collect the harvest of the vineyards. They each pay ten bundles of flax. Four hens they must pay also. They give palfreys or go where they are ordered. They do carriage service with a cart up to fifty leagues; to go further is not expected. They are assigned to the demesne houses, haylofts, farms; they have a reasonable amount of land for earning the tax, and when necessary they pay it in a lump sum.

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Source: From: J. P. Migne, Patrologiae Cursus Completus, (Paris, 1862), Vol. XCVII, p. 412, reprinted in Roy C. Cave & Herbert H. Coulson, A Source Book for Medieval Economic History, (New York: The Bruce Publishing Co., 1936; reprint ed., New York: Biblo & Tannen, 1965), p. 28.

The Church Fathers On Usury, 400-444

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The Church Fathers had already taken a stand on the question of usury in the fifth century, but loans on credit were not widespread transactions during the barbarian conquest.

St. Jerome on Usury, 400: If you gave to a prosperous person you should not have done so: but if (even so) you gave it as to a needy person, why should you demand more on the score of his being prosperous? Some lenders are wont to take small gifts of dilferent value, not realizing that whatever is received over and above what was given is called usury and superabundance. They ought not to take more, however much it be, than was originally given by them.

Pope Leo the Great, 444: Neither do we think that it should be lightly passed over that some people, seized with the desire for filthy lucre, put out their money at usury in order to become rich thereby. And we have to complain of this not only with regard to those in clerical office but we likewise grieve to see that it holds true of lay people who wish to be called Christians. We decree that this should be severely punished in those found guilty, so that all occasion of sin may be washed away.

---

Source: From: J. P. Migne, ed. Patrologiae Cursus Completus, (Paris, 1845), Vols. XXV, p. 177, CLXXXVII, p. 959, reprinted in Roy C. Cave & Herbert H. Coulson, A Source Book for Medieval Economic History, (Milwaukee: The Bruce Publishing Co., 1936; reprint ed., New York: Biblo & Tannen, 1965), pp. 170-171.

William Stanley Jevon's Contribution to Index Number Theory

Walter Bagehot responds negatively to William Stanley Jevon's proposal to construct a price index based upon household consumption, and then use the index to adjust contracts to reflect variations in the purchasing power of money. This is from an 1875 edition of The Economist:

A New Standard of Value, by Walter Bagehot, The Economist, November 20, 1875, reprinted in the Economic Journal, volume 2 (1892): Professor Jevons, of Manchester -- so well known in the economical and statistical world by his researches on coal -- has written an excellent treatise on 'Money and the Mechanism of Exchange', which we strongly recommend to our readers. It is extremely clear, brief without being dry, and contains a good deal of very interesting information. And we may add that it is written in a style of scientific modesty rare in currency books. Mr Jevons is perpetually aware that the subject abounds in questions of nicety and difficulty, on which he is quite ready to admit that he may be wrong. It would be a happy thing if persons far less competent than Mr Jevons to write on the subject, but who incessantly do so, could be brought to that admission.

On one point, however, we are at issue with Mr Jevons: he has far more hope from economical science than we have. He thinks that it can point out to mankind a far better theoretical standard of value than gold or silver, and believes that, though it is encumbered with some difficulties, probably the new plan would on the whole, when we got used to it, work better than our present one. But for ourselves we much fear that political economy has no such boon to confer on mankind, and that we must adhere to one or other of the precious metals as a standard of value, like our forefathers. Mr Jevons shall explain his fundamental idea in his own words.