Saturday, 25 June 2011

Overview: The Long Divergence

A few months ago Niall Ferguson appeared on Newsnight and when talking about the problems facing the Middle East stated that
It is far more illuminating to talk about the legacy of long term of the Ottoman rule than of British, French or Italian imperialism. We want to beat ourselves and say its all our fault that these problems exist [but] they are far more deep rooted... The culture that exist in the Middle East today bears very few resemblances to the culture that the Europeans tried to implant there.. and that owes far more to the long lasting impact of Islam which has had the biggest impact on the region of any empire. Arguing that its the fault of British imperialism is to misdiagnose the problem.  
And as far as the economic situation of the Middle East goes, Timur Kuran in his book 'The Long Divergence' shows that Ferguson is indeed right about the long lasting effects of Islam. What follows is more of an overview of the book than a review of the book. The Middle East is economically and developmentally backward, especially compared with the West; in terms of GDP per capita ($9,418 against the OECD $33,755), adult literacy (74.7% against 99%), life expectancy (69.4 against 77.8), Human Development Index (0.73 against 0.93).

Kuran’s explanation is that while Islamic institutions were suitable for commerce before, began to impose burdens and impede economic growth and development which caused the current divergence and lag between the West and the Middle East. This is also not to say that Islamic law is static: there were reinterpretations but these were mere ‘ripples in the pond.’ This is not to say that there is no economic advancement, rather its relative economic growth and global contribution is waning. Indeed, from 1820 to 1913, per capita income grew by about two-thirds and then tripled between 1950 and 1990. Yet, its share of GDP decreased from 10% in 1000 to 2.2% in 1700. It is the consequential position that the book concerns.

Kuran dismisses the idea that colonialism and ‘machinations of Europeans’ are the source for the economic lag experienced by the Middle East as they ‘miss vital ingredients of the historical record.’ It is based on two false premises: firstly, that social interactions are of a zero sum quality and secondly, ‘they leave unexplained why the region succumbed to imperialism at that time and not before.’ Indeed, it was the Middle East’s colonial era that brought fundamental transformation in the institutions described below; it was this change that brought rising literacy, education and enrichment at unprecedented rates (between 1000 and 1820, GDP fell but between 1820-1870 had an annual increased average of 0.4% and between 1870-1913 the annual increased average was 0.7%). This is of course, not an argument for colonialism but against the Islamic institutions which fostered stagnation.

Early Commerce under Islamic Rule

Islam is not incompatible with capitalism; indeed, there are various Quranic verses and Hadiths which encourage trade, private property and commerce:
4:29: ‘Believers, do not consumer your wealth among yourselves in vanity, but rather trade with it by mutual consent’
Mohammed turned the annual pagan pilgrimage in Mecca to an Islam’s most scared sanctuary and kept the pagan tradition of conducting trade. This pilgrimage became the most important commercial forum in early Islamic history as on their way, merchants would sell and cooperate. Its economic effectiveness was vast; 200,000 people gathered in Mecca. And this economic success remained until the 19th century; now its importance is limited to western Arabia. This should not be overstated either; the importance of the pilgrimage to commerce also had disadvantages: it meant that secular trading fairs would be considered sacrilegious. The equivalent of the European Champagne fairs could not have been established in the Middle East for this very reason.

Institution 1: Islamic Partnerships

There were two types of contract agreements; (i) Mudaraba; money would be provided by an active investor who would have a managerial role or (ii) Musharaka; the merchants also provided some of the investment. These Islamic partnerships often had prearranged calculations of how to split the profit; a passive investor was not responsible for any third party damage nor was the merchant liable for the loss of his investment. Kuran notes that these methods of risk allocation were also used in Italy and resembled the Commenda. The Islamic partnerships, thus, in their early usage were ‘globally optimal’. The religious practices also made them more reliable to their fellow Muslims and helped foster mutual trust enhancing trade.

However, these Islamic partnerships are unsuited to today: they support ventures of finite length, they are unsuited to large organisations with large investments and parties deal with each other as individuals not as members of a firm. This lack of legal personhood is an anomaly – even in today’s least developed countries. The agreements meant that individuals would be liable for their mistakes; the barista at Starbucks being responsible for losses is something which a worker would find unbearable. Legal personhood brings with it collections of people acting as single unit able to uphold commitments.

By the 19th century, Islamic partnerships were no longer optimal and the West began to dominate. Kuran says the source of these is that in the 10th century (when the partnerships had served so well), impersonal exchange was not a pressing concern – the formation, adjudication primarily concerned known individuals. In this classical form (with the aforementioned disadvantages) no changes were made all the way until the era of industrialisation and impeded progress. Islamic partnerships were unsuited to large and long-lasting organisations for several reasons: partners could unilaterally terminate contracts and their death would also mean termination. This means that the age of a merchant would bring risks up and thus they were limited to short-lived ventures. 77.1% of partnerships in Islamabad had only 2 partners in the 1600s; this was while Europe was developing vast organisations. Commercial Islamic partnerships could last up to 2 years but most ended within months. Even the resource pooling across families did not outlast the founders. As a result, ‘before the twentieth century, the region did not produce a single case of mass financial mobilisation through non-governmental channels except insofar as foreigners were involved.’

By contrast, the West transformed agreements like the Commenda (and ipso facto the Mudaraba) so that they could continue after founders’ deaths. This allowed for a transformation into long commercial ventures. The ‘hub-and-spoke’ system developed in Italy was also vital for allowing large organisation; it meant that enterprises with legally linked subsidiaries could exist. They reported to the centre meaning they essentially operated as single enterprise. The Italian Medici and the German Fugger conglomerate serve as examples of durable, large agreements which did not exist in the Middle East. These served as pre-unlimited partnerships. These types of partnerships were used by unrelated individuals and would be responsible to all creditors. These partnerships became more complex allowing for a greater move to impersonal exchanges, larger and longer organisations.

Joint stock companies also arose which allowed for transferable shares. Some had hundreds of members and reorganisation was common. This allowed for infinite ventures; the English Levant Company had 53 merchants (which relatively was large). In this process, buying and selling shares become depersonalised. There were drawbacks: they still had no independent identity but this spawned the corporation which had a legal identity. In culmination, these changes made Western institutions amiable to change, growth, pooling resources and exploiting commercial opportunities

Institution 2: Inheritance Laws

Part of the reason why private enterprise remained so atomistic in the Middle East can be explained also by Islamic inheritance law. The law is elaborate and indeed is a lot more egalitarian that previous norm: it allowed women to gain half of what a man would get. But, this egalitarian distribution led to fragmentation of businesses. It meant that there could be more than a dozen owners of a business, often leading to disputes. It meant that wealthy families did not last more than two generations. While aristocracies developed all over Europe, almost none existed in the Ottoman Empire. A further disadvantage is that inheritance law meant that each heir was entitled to a fraction of every asset – including indivisible ones. This meant that partners may have had to sell things at inconvenient times to give the fraction and thus further stifling enduring commercial ventures because the living partner would want to avoid selling assets to pay unknown heirs.

It did not help that the wealthiest merchants were more likely to have more children and wives and thus made it more likely to have their organisations fragmented. Thus inheritance laws contributed to making commercial agreements short through limited contracts and small through fragmentation. The West also had these problems but because Christian canon law was not as standardised, it allowed for modification without trespassing on religious ground. This allowed for primogeniture (preference in inheritance to eldest son) laws to be implemented across Europe. This allowed, unlike in the Middle East, the wealthy families to stay intact over generations.

As a result of being able to have more durable, larger associations, commerce became increasingly impersonal. Problems did arise but their solutions helped the West became increasingly able to sustain complex organisations: accounting and the rise of the business press to help keep track of liabilities and profits (agreements were no longer small nor did they involve known individuals).

(Lack of) Institution 3: Corporations

The first Muslim-owned stock company was created in 1851 in the Ottoman Empire. The advantages of a stock company essentially cured many of the ills of the Islamic partnership: unlike the partnership, the stock company could withstand changes in membership without termination of the agreement.

Corporations give legal personhood which not only simplifies things in litigation but provides both limited liability for shareholders and limited liability for the company itself (partnerships had the former but not the latter). As a result of not allowing for limited liability for the company, it meant that a single shareholder could force the company to liquidate. It was only after 1908 when the Ottomans passed a corporation law did the amount of publically traded companies rise from 2 (1850-1908) to over 25 (1908-1920).

The between the West and the Middle East was again clear: organisations with legal standing before the law had legal standing as far back as the Roman era. This was partly low to the decentralisation that existed in Europe which meant that state power was not as strong (this was exacerbated by the power vacuums left). This meant that communities banded together in order to regulate themselves; this was the start of the corporation. 

Christianity legitimised subcommunal government; ‘render unto Ceasers what is Ceasers.’ Islam, however, was at least perceived as comprehensive which avoided the emergence of separate man-made law (and hence the relevance of the lack of corporations in the Quran). Islam also avoided the emergence of tribal lines and promoted pan-tribal cooperation because it was based on the Ummah’s unity. Muslims treated each other the same and were identified as Muslims (a reason why national self-awareness came later in the Middle East).


There were however institutions which allowed for indefinite existence in the Middle East: waqfs. These financed innumerable services without state backing: pavements, water and even clothes for poor brides. But, they had three main differences with corporations: (1) the founder was ordinarily an individual, (2) this individual would continually control it (it could not alter its membership), further the terms of waqf could not be changed once ordained as such (once the waqf provides water, it cannot be changed to provide something else or be sold on) and (3) the rules of operation were fixed.

This accommodated the aforementioned concept of Ummah-unity: an individual tasked with providing one service would not cause friction as much as groups of individuals acting with the freedom of association. It also avoided the fragmentation by inheritance laws (described above). It was also a balance between rulers and individuals: the latter could keep their endowments and the former could rely on certain public services being provided. The fact that the rules of operation and goals of the waqf were largely fixed meant that eventually services could not be provided for that original amount and thus they would entail a loss.

It was a combination of all the factors above: the inheritance laws and partnerships meant that business ventures were short lived. Kuran says that this is not to state that the institutions could not change; rather, there was no impetus for such change because people were storing and maintaining their wealth in waqfs and the inheritance laws meant there was never a desire for institutions which would allow for durable organisations. Waqfs could have emerged as corporations but they, as stated above, had several disadvantages including that it was not a profit-maximising entity, it did not have legal personhood and kadis (people who managed the services) had an incentive to resist change: they received rents for their job. Neither were waqfs open to managerial innovations.

Institution 4: Credit Markets and Interests

Kuran says that the ban on interest was not a key reason why the Middle East did not progress compared to the West because: the lack of financial modernisation and progress spanned across religious lines, there were restrictions on credit markets even in the West and there were evasions. However, the ban on interest was detrimental. 

Islam bans riba which is giving more than the amount lent if the party failed to make restitution on time. This often ended up with enslavement or confiscation of assets which could fuel communal tension (something Islam sought to avoid). However Kuran does not overplay this ban. There was essentially de facto interest; there were several evasions including double sells (A sold x to B for £100 and B then sold it back for £115 – holding a collateral). However, this did have some down shots: it meant double costs in litigation. The result meant that loans which could have powered economic growth were not available in the Middle East.

In the West, there was a liberalising of the religious interpretations, enhancement of property rights, larger institutions with larger resources meant that interest rates were lower which encouraged loaning. Agricultural interests rates in England were 3% compared with Middle Eastern rates of 20-100% which impeded investment for the larger, newer or long-lasting organisations. 

Institution 5: Consuls

Consuls were people who existed to help foreigners while they conducted their business in the Middle East; they helped with security, commercial opportunities, representation. Individuals would not be able to have the necessities by themselves and because they grouped, they could all use consuls collectively who would act in their interests. 

These simply did not exist for Middle Easterners in Europe; because of all the previously named factors, commercial associations were short lived, small and they could not pool large resources. As a result, there was no demand for rights to be placed for them in other countries. This contrasts with merchants in the Middle East who obviously wanted their institutions transplanted in the Middle East. And here the West managed to steam ahead not only because of those consuls which made trade aid development but also the advantage of incumbency. This is where the first to enter the market is at a clear advantage: Middle Easterners would have become accustomed to European law, but that would not happen at the other side, the costs of import and export are reduced when its only one ship (i.e., the Europeans) doing both. This incumbency advantage is lost when there is market growth (and this explains how other Europeans started their own consulates).

The Position of Minorities

Minorities in the Middle East were in the same position as the Muslim majority in terms of economic position before the 18-19th century. If an institutional explanation is given for the economic lag then one would expect that minorities who had access to their own courts to move away institutionally and thus be unaffected. 

However, Kuran shows that before the 18-19th century, minorities had an incentive to Islamisize their law in order to make contracts more certain. The Pact of Umar allowed minorities to manage their own commercial and family dealings so long as one of the parties was not a Muslim. However, they also allowed ex post facto changes to Islamic law. Thus, to ensure certainty in contracts, there was an Islamisation of minority proceedings. Jewish law, for example, started to allow inheritance to women in response to Islamic inheritance.

Then in the 18th century, there was a sudden upsurge in the minorities’ economic position; they managed in many areas to dominate commercial activities. For example, in Beirut, despite the Muslim population being 45%, 90% of the importers and exporters were non-Muslim. Despite being 81% of the population in the Ottoman Empire, Muslims only made up 15% of the major local traders. 

In the 18th century there was a move of westernisation; including in jurisdictional matters. Minorities started being protected under foreign treaties which meant they could switch legal jurisdiction. In this way, they moved toward the advantages of Western institutions and law which proved advantageous. The reasons Muslims did not do the same was because of the primacy of Islamic law; it would have been seen as a challenge. Apostasy also contributed to this: Muslims would not be able to move legal jurisdiction. Thus both processes of the Islamisation of minority-practices and the Westernisation of minority-practices can be explained by Islamic legal pluralism rooted in the Pact of Umar.


Kuran concludes by saying that Islam is not static and there can be reinterpretations which allow for classical Islamic institutions to be compatible with economic success. Inheritance, for example, need not be a problem if corporations were established; fragmentation of shares would not have lead to the disestablishment of whole companies. Corporations, as mentioned above, while not ordained by Islamic law are not prohibited either.

Why does the Middle East continue to be economically lagging despite the changes made to the classical Islamic institutions cited above? Kuran gives three reasons: (1) the reforms were incomplete; high corruption, nepotism and low trust in organisations. The legal culture was more focused on having a natural individual as opposed to a judicial person. And the corruption remains prevalent (Transparency International: 6.7 vs. OECD 3.0). These all stem from the aforementioned Islamic institutions: judges were not sophisticated, nor were the court proceedings because there were no law schools (in the modern sense); personal exchange meant differentiations lack of documentation.

(2) Weak civil society and political systems with low capacity for innovation: the waqf system because it was so stringent avoided making powerful (political) groups of people in the individuals who ran the trusts and also by preventing mergers of waqfs which could have fostered coalitions of political influence. Kuran says as a result, the state led in development where private initiatives might have. This state development was over-and-misregulated. Political events also mattered; minority population movements (Greek-Turkish, Israel) meant that the private sector started from a lower base.

(3) Reactions to the underdevelopment have led to socialist, protectionist and Islamist responses. These have hindered progress (both economically and developmentally). Islamism particularly has fostered political uncertainty which puts off investment; it also means that governments are willing to suppress dissent to avoid criticism and rise of those voices.

No comments: