The Secret of Venetian Success: a public-order, reputation-based institution

After our first full day in Venice, we went into the doge’s palace were the institutions and the Republic of Venice was located. The amount of power and wealth the Venetians had is astonishing.

My article focused on how public-order, reputation-based institution contributed to Venice’s commercial success during the late medieval period. It allowed merchants to commit to the city of Venice and not flee to another state with the investor’s capital, despite limited reach of the legal system and not breach their contracts despite investor’s inability to directly monitor them. Venice managed to prevent these problems by using a public-order, reputation-based institution and motivating merchants to submit to Venetian authorities. Now, before I go too deep into that, lets gains some more information.

Between 1050 and 1350, Venetian trade expanded due to their active financial market. Politically, Venice was the more stable due to power distributed among councils and magistrates whose members held elected terms. Population was booming. But how did they manage to become one of the largest and richest city in Northern Italy during the medieval period? Trade requires a lot of capital and involves high risks. Trips took about 6 to 9 months with the risk of possible loss through shipwreck, piracy or confiscation by foreign rulers. Most of the capital was raised using sea loans and commenda contracts. One thing that was unique about these investments was that a large range from the poor, lower-classes to the rich, upper-classes could invest in trade. In Genoa, mainly the upper-class invested in overseas trade.

Now that you have a little bit of background knowledge, lets address the commitment problems with overseas trade. Again, merchants could flee with investor’s capital to another state and even if they returned to Venice, the merchant could misreport the gains and keep it for himself. Our group discussed some solutions to prevent merchants from committing such actions. One was commission. Giving merchants incentives to properly report the inventory and return to Venice. But why take 25% when you can flee and get 100% of the profits? What about harsh punishments for cheaters? The problem is that merchants could embezzle the investor’s capital and escape to another jurisdiction. Venetian court could not force him to pay. A second problem with the legal system is the court’s ability to enforce trading contracts requires verifiable information. Investors could not directly monitor merchants abroad because they often remained in Venice. So, what caused merchants to submit to Venetians authorities?

Venice generated economic rents, verifiable information to see if a contract has been breached, and punishment for merchants who cheated others. Let’s focus on economic rents. Venice generated economic rents, net gains in their commerce, by implementing several policies. One is staple rights in the northern Adriatic. This meant that all wares exchanged there had to be brought to Venice, unloaded, taxed and sold wholesale. Venice benefited economically from being the middlemen in the transit trade. The second policy is protecting convoys. Venice sent out fleets to protect the trade goods and merchants which gave Venetian merchants were provided with protection at a lower cost than at other cities. The last one is exclusive commercial privileges. Privileges with Romania, the Crusader States, and Alexandria reduced the cost and risk to Venetians in some of the most profitable trading regions. To maintain the high economic rent, Venice implemented barriers such as regulations excluding non-Venetians from their overseas trade, tightened regulations on citizenship, and limited the amount new citizens could invest. Venice also implemented administrative controls to gather the necessary information of whether a sea loan or commenda contract has been breached. Also, the state supported the threat that they would punished merchants who fled and voluntarily returned to Venice to deter merchants from breaching their contracts.

Overall, the Venetians seemed to have everything well thought out and provided enough motivation for the merchants to commit to the city and obey their laws and regulations.