Financing Long-Distance Trade without Banks: The Joint Liability Rule and Bills of Exchange in 18th-century France
Abstract
By the close of the seventeenth century international trade had expanded beyond the reach of the personal networks on which it had previously depended. How was long-distance trade among strangers financed without banks or international enforcement? I argue that a particular seventeenth century legal innovation, the joint liability rule, enabled the medieval bill of exchange to become the dominant means of payment and credit in the early modern period, thus supporting an unparalleled expansion of trade. The joint liability rule speci ed that every party who used a bill of exchange to pay for goods or settle a debt was liable for the face value of the bill if it was not paid at maturity. This paper examines the role that joint liability played in ameliorating three fundamental problems in long-distance trade nance: moral hazard between issuers and payers, adverse selection in the market for bills, and imperfect enforcement of international contracts. To this end, I have compiled a new dataset spanning the period from 1780 to 1790 that includes thousands of original bills of exchange, notices of defaulted bills, court records, and business letters of Maison Roux, a large French merchant house. I show that the joint liability rule put in place a formal mechanism that linked otherwise distinct personal networks so that trade could expand beyond the limits any single network could support. Despite evidence of ongoing problems of adverse selection and moral hazard, my ndings demonstrate that bills of exchange worked to broaden trade in the sense that agents used them across business networks.
1 Introduction
By the close of the seventeenth century international trade had expanded in volume, in variety,
and in geographic scope. Faced with growing business opportunities in distant and unconnected areas, merchants could no longer solely rely on the limited reach of their personal networks. This development raises an important question: How was long-distance trade financed among strangers at a time when modern deposit banks did not exist and international enforcement was weak?
Contemporaries unfailingly noted the central role that Bills of Exchange played in the transformation of trade. Echoing their views, in the first half of the twentieth century historians spilled a lot of ink to reconstruct the modus operandi of Bills of Exchange, considering them to be the foundation and the distinctive feature of modern capitalism [De Roover, 1953; Sayous, 1933; Postan, 1928; Lane,1944]. In contrast, today's economic historians have displayed little interest in Bills of Exchange, implicitly assuming that Bills of Exchange per se were su ffcient to sustain the expansion of trade in the early modern period. This paper challenges this assumption by considering the legal institution that allowed Bills of Exchange to circulate across ever greater social and geographic distances, triumphing in an environment dominated by private information, spatial separation and limited communication.
The term Bill of Exchange (BofE) refers to a financial instrument whereby a merchant (the
issuer) ordered his agent abroad (the payer) to make a payment in a different currency on his
behalf to another merchant (the beneficiary), often in a third location, at a set date in the future.
The beneficiary could further transfer his claim to another party, an endorser, in exchange for
currency, debt or merchandise. This set-up raises three important questions: 1) Given the spatial separation between issuers and payers, how could issuers be sure that the agents responsible for payment (the payers) would honor their bills? 2) In the presence of asymmetric information about the issuer's solvency and the payer's reliability, how could endorsers further pass on bills as a means of payment, remittance, and credit? Asymmetric information between buyers and sellers implies that bills will only circulate within environments where information is common knowledge. 3) In the absence of courts with international jurisdiction, how could holders rely on foreign courts to enforce a debt?
