People who know me and people who have read Economic Forces for an extended period of time are by now aware of my affinity for Earl Thompson. In my opinion, Earl was a great and under-appreciated price theorist. Earl was known for his unconventional explanations and provocative ideas. Armen Alchian, who was once his teacher and then later his colleague at UCLA, once described Earl’s work as follows: “What appears upside down at first begins to look right-side up — from the newly acquired but very lonely Thompsonian perspective.”
There are two things that I have always enjoyed about reading Earl’s work. The first is that while it often challenged conventional wisdom, it is always firmly grounded in price theory. Just as importantly, he was also often able to point out where is critics claims were not so well-grounded in price theory. Second, Earl was supremely motivated by explaining “what is” rather than “what should be.” This is not to say that Earl didn’t do welfare economics or make normative claims. Instead, what I mean is that Earl really just wanted to understand the world as it is, using price theory as his guide — and he was committed to it.
To give people a sense of what Earl was like, I would like to discuss Earl’s joint work with Charlie Hickson on European guilds that persisted from the Middle Ages up until around the Industrial Revolution. (Once upon a time, Brian and I recorded a podcast with Charlie Hickson. You can find that here.)
Conventional Wisdom Meets Price Theory
Guilds are associations that regulate and support the practice of a specific trade or craft. They were ubiquitous over this period and dominated trades and crafts in Europe. Although there are notable exceptions, the conventional wisdom on these guilds is that they were inefficient cartels, excluding competitors and limiting innovation.
Thompson and Hickson argue that there are four major flaws with this argument. The first major flaw is that guilds typically imposed maximum prices as well as minimum quality standards. This not only does not sound like an exploitative monopoly, but rather much more like optimal monopoly regulation. If this was a cartel to restrict trade, why would these guilds create such rules for themselves?
A second problem is that if these were inefficient cartels restraining trade, there should be geographic variation in the prevalence of guilds that correspond with conditions for market power. However, Thompson and Hickson point out that even in places in which consumers would be expected to exert some degree of market power, guilds were still present.
A third flaw is that one would expect that merchant guilds would be opposed to craft guilds. If craft guilds were using their market power to restrict output and charge higher prices, this would increase the costs of the merchant guilds. All else equal, one would expect that the strength of merchant guilds would prevent guilds of craftsmen from being created. However, both merchant and craft guilds existed side-by-side.
Fourth, a common argument is that because guilds were inefficient cartels, one would expect that they would deter innovation and growth. As Thompson and Hickson point out, the early period of guilds is coincident with modest, pre-modern economic growth. These modest, pre-modern experiences with growth did not last and were subject to reversals. However, to blame this on guilds would require arguing that guilds reduced growth with centuries-long lags.
These all seem like reasons to question the conventional narrative, but what is the alternative that Thompson and Hickson propose? For those familiar with Thompson’s work, the proposed alternative explanation will not come as a surprise.
An Alternative
A key feature of some of Thompson’s earlier work is that capital (read: wealth) creates a private benefit to its owner, but creates an external cost to the rest of society because that capital has to be defended from destruction and/or plunder. The solution to this externality would be to put a tax on capital equal to its marginal defense cost.
At this period of history, levying such a tax was not feasible. Pre-modern states lacked the bureaucratic infrastructure to collect taxes on capital. However, guild entry restrictions combined with maximum prices could be used to create a substitute for capital taxation.
Of course, typically the tax revenue would be used to pay for defense, should the need arise. Entry restrictions, however, create rents for the guilds that were limited by the maximum prices that were set. Rents to guilds obviously differ from tax revenue to the ruler or the state. So how can one justify the rents and explain the benefit of these rents for defense? Well, guilds had something required for defense: a ready supply of young, able-bodied men (apprentices) that could be relied upon to defend the city if it came under attack. Thus, the guilds effectively cut out the middleman and provided rents directly to the guilds in exchange for the apprentices’ provision of defense.
The long-run entry restrictions served a couple of purposes. The first, as I previously mentioned, is that the entry restrictions served to limit capital to a level consistent with what would prevail under a tax equal to the marginal defense cost.
The second purpose is that an expectation of future military service creates an incentive problem. Labor is mobile. Thus, young men might choose to flee in the event of an invasion rather than stay and defend the city. Furthermore, an expectation of future military service might also lead to a reduction in human capital accumulation. Guilds had a master and apprentice system. This arrangement naturally creates in which young men invest in human capital in expectation of future rents. Entry restrictions provide a source of current rents to the master and future rents to the apprentice. By fleeing the city, apprentices would be forced to give up the present discounted value of all future rents.
Some might argue that this sounds like a “just so” story about guilds. However, there are other characteristics of this system that are hard to explain without Thompson and Hickson’s defense-based explanation. For example, apprentices were never rejected based on a lack of ability in the trade. Apprentices were instead evaluated based on family background and fitness for combat. Many were rejected for being unsuitable for military conflict.
At the same time, the defense-based explanation can explain the use of maximum prices and minimum quality since the essential role of the guild as an institution was to provide expected future rents to those providing a service as a reserve army and current rents for prior service. In addition, this would also rationalize why guilds existed even in places in which consumers seemed to have substantial market power since these consumers might be willing to pay for the defense-based services that the guilds provided.
Critics have argued that Thompson and Hickson are wrong because guilds were not as ubiquitous as they claim in England, for example. The evidence for this is the lack of any mention of guilds or guild-granting powers in various city charters. However, Thompson and Hickson found that this critic cited a source that excluded city charters from the relevant period. In fact, they found that 70 of 73 of the largest towns in England had chartered guilds by 1308. Furthermore, the three exceptions were historical sources of strategic defense and fortification.
The Big Takeaway
Nonetheless, regardless of what you think about this particular argument for guilds, there is a broader lesson here. The lesson is that a major conventional explanation of guilds as inefficient cartels is hard to square with the facts if one understands price theory. If this is really just about monopoly rents, why are the guilds voluntarily doing things that limit those rents? Why do others not utilize their own market power? And why would any group with the market power to form and enforce the rules of a cartel allow its inputs to be supplied by another cartel? These are basic price theoretic questions that call out for explanation.
Therein lies the lesson in Alchian’s quote. Since Thompson’s critiques of conventional wisdom are firmly grounded in price theory, one cannot help but to see things right-side up from the (often lonely) Thompsonian perspective.