The Scottish lesson, rarely mentioned in history
books, shows what else can be behind economic miracles other than the factors -
migration of hard-working, skilled people, stable money and significantly lower
taxes - indicated in the second part of this series.
Scotland in 1750 was a very poor country. The land was of poor quality, and illiterate people engaged in near-subsistence agriculture; there were no navigable rivers; barren mountains and rocky hills hindered communication. The main export at the time was processed tobacco. Yet, less than a century later, Scotland stood with England at the forefront of the world's industrial nations. Its standard of living was the same as England's, whereas in 1750 it was about half. How did the Scots do it?
The Union of 1707 made Scotland part of England. It came under England's system of taxes, laws and currency and was allowed access to English markets - a mini version of the later European common market.
The union also abolished the Scottish parliament, leaving Scotland without a distinct administration until 1885. That turned out to be the biggest blessing (reminding one of Hong Kong's later success under distant British rule: no democracy there, but the closest approximation of low, flat taxes, a stable currency and open, but held accountable, financial markets), as it prevented the banking system and financial markets from becoming an instrument of government finance. The result was a financial market that developed in response to the demands of the private economy.
By 1810 there were 40 independent banks. The orthodoxy of the times held that banks should lend only if the loans were backed by the security of goods in transit or in process, and for no more than 90 days. In contrast, the Scottish banks were free to lend for unspecified periods of time with no requirement to be backed by securities. Briefly: the Scottish banks offered the precursors of junk bonds, venture capitalists, and perhaps "angel investing".
Bills of exchange, the main assets of banks in other countries at the time, were the least important ones for the Scottish banks. The largest volume of loans was made to manufacturers and merchants, who got credit backed only by their own signature with two or more people as sureties. The banks flourished with tiny reserves (1% of liabilities in specie), and irregular financial reports (annual balance sheets were prepared starting only in 1797).
The Scottish financial historian, A W Kerr, captures the specific feature of the country's financial markets:
Scotland in 1750 was a very poor country. The land was of poor quality, and illiterate people engaged in near-subsistence agriculture; there were no navigable rivers; barren mountains and rocky hills hindered communication. The main export at the time was processed tobacco. Yet, less than a century later, Scotland stood with England at the forefront of the world's industrial nations. Its standard of living was the same as England's, whereas in 1750 it was about half. How did the Scots do it?
The Union of 1707 made Scotland part of England. It came under England's system of taxes, laws and currency and was allowed access to English markets - a mini version of the later European common market.
The union also abolished the Scottish parliament, leaving Scotland without a distinct administration until 1885. That turned out to be the biggest blessing (reminding one of Hong Kong's later success under distant British rule: no democracy there, but the closest approximation of low, flat taxes, a stable currency and open, but held accountable, financial markets), as it prevented the banking system and financial markets from becoming an instrument of government finance. The result was a financial market that developed in response to the demands of the private economy.
By 1810 there were 40 independent banks. The orthodoxy of the times held that banks should lend only if the loans were backed by the security of goods in transit or in process, and for no more than 90 days. In contrast, the Scottish banks were free to lend for unspecified periods of time with no requirement to be backed by securities. Briefly: the Scottish banks offered the precursors of junk bonds, venture capitalists, and perhaps "angel investing".
Bills of exchange, the main assets of banks in other countries at the time, were the least important ones for the Scottish banks. The largest volume of loans was made to manufacturers and merchants, who got credit backed only by their own signature with two or more people as sureties. The banks flourished with tiny reserves (1% of liabilities in specie), and irregular financial reports (annual balance sheets were prepared starting only in 1797).
The Scottish financial historian, A W Kerr, captures the specific feature of the country's financial markets:
The comparative immunity from legislative interference which characterizes banking in Scotland until the year 1844 had been an unmistakable blessing to the country, and has saved the banks from those vexatious and unnecessary distinctions and restrictions which have hampered and distorted English banking. In Scotland, banking was permitted to develop as the country advanced in wealth and in intelligence. Nay, it was even enabled to lead the nation on the path of prosperity, and to evolve, from practical experience, a natural and healthy system of banking, which would have been impossible under close state control similar to that followed in other countries.
The country showed how,
starting from scratch, to become prosperous quickly through trade and finance,
unhindered by tariffs - but covered by reliable English political and legal
umbrella (recall, Adam Smith was a Scot).
Contrast Scotland in that period with France, where a great majority of requests for charters for financial institutions, pouring to the Conseil d'Etat (State Council), were rejected until 1857. Only a severe depression that year led to the liberalization of procedures (which led Francois Mitterand to make a 360-degree change and re-privatize the banks after nationalizing them. Perhaps current President Francois Hollande will follow in Mitterand's steps - who was his mentor).
Yet even in 1870, banking services in France were not what they had been in Scotland at the beginning of that century, and regulations denied small industrialists access to credit.
Scotland stands out not only with its unique banking system, but also with the emphasis it put on education. In a piece titled "The Output of Scientists in Scotland", R H Robertson shows the relevant statistics. The output of "outstanding Scottish scientists" was at its height between 1800 and 1850, diminishing rapidly after 1870. The reason? The most brilliant Scots migrated - and there was no more Scottish miracle.
Scotland's relative decline in the 20th century has been correlated with the increasing assimilation of Scottish education and banking practices into those of England (with banking starting slowly in 1845). If a large fraction of a region's most energetic and bright are not given incentives to stay, and access to credit of those who remain is constrained, what can one expect but decline?
For a while, the decline may be mitigated if other countries are making even stupider mistakes and see their skilled people move out, perhaps even to Scotland. This seems to be happening now: whereas Britain saw its biggest brain drain since the 1970s during the first decade of 2000, France's perhaps bigger blunders helped to some extent mitigate the effect.
There are other lessons to be drawn from the Scottish case.
Savings were certainly not a pre-condition for its prosperity. The Scots did not have any to speak of. Neither did they get any foreign aid. But once opportunities were open and financial markets developed relatively unhindered, allowing people to borrow against future income, not only did the Scots save but their savings were put to much better use than elsewhere.
In Scotland, savings moved to more-accountable private enterprises, whereas in England and elsewhere they went to less-accountable governments. No state interference was needed to encourage the Scottish entrepreneurial spirit.
In contrast to the previously mentioned miracles, there was no large-scale movement of talent from around the world to Scotland. However, the miracle did end with the emigration of Scottish talent, more regulated financial markets and higher taxes.
Contrast Scotland in that period with France, where a great majority of requests for charters for financial institutions, pouring to the Conseil d'Etat (State Council), were rejected until 1857. Only a severe depression that year led to the liberalization of procedures (which led Francois Mitterand to make a 360-degree change and re-privatize the banks after nationalizing them. Perhaps current President Francois Hollande will follow in Mitterand's steps - who was his mentor).
Yet even in 1870, banking services in France were not what they had been in Scotland at the beginning of that century, and regulations denied small industrialists access to credit.
Scotland stands out not only with its unique banking system, but also with the emphasis it put on education. In a piece titled "The Output of Scientists in Scotland", R H Robertson shows the relevant statistics. The output of "outstanding Scottish scientists" was at its height between 1800 and 1850, diminishing rapidly after 1870. The reason? The most brilliant Scots migrated - and there was no more Scottish miracle.
Scotland's relative decline in the 20th century has been correlated with the increasing assimilation of Scottish education and banking practices into those of England (with banking starting slowly in 1845). If a large fraction of a region's most energetic and bright are not given incentives to stay, and access to credit of those who remain is constrained, what can one expect but decline?
For a while, the decline may be mitigated if other countries are making even stupider mistakes and see their skilled people move out, perhaps even to Scotland. This seems to be happening now: whereas Britain saw its biggest brain drain since the 1970s during the first decade of 2000, France's perhaps bigger blunders helped to some extent mitigate the effect.
There are other lessons to be drawn from the Scottish case.
Savings were certainly not a pre-condition for its prosperity. The Scots did not have any to speak of. Neither did they get any foreign aid. But once opportunities were open and financial markets developed relatively unhindered, allowing people to borrow against future income, not only did the Scots save but their savings were put to much better use than elsewhere.
In Scotland, savings moved to more-accountable private enterprises, whereas in England and elsewhere they went to less-accountable governments. No state interference was needed to encourage the Scottish entrepreneurial spirit.
In contrast to the previously mentioned miracles, there was no large-scale movement of talent from around the world to Scotland. However, the miracle did end with the emigration of Scottish talent, more regulated financial markets and higher taxes.
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