SPEAKER_01: Amazing, fascinating stories of inventions, ideas and innovations. Yes, this is the podcast about the things that have helped to shape our lives. Podcasts from the BBC World Service are supported by advertising.
SPEAKER_02: 50 Things That Made the Modern Economy with Tim Harford
SPEAKER_00: Nicholas Murray Butler was one of the thinkers of his age, a philosopher, Nobel Peace Prize winner, President of Columbia University. In 1911, someone asked Butler to name the most important invention of the industrial era. Steam, perhaps? Electricity? No, he said, they would both be reduced to comparative impotence without something else, something he called the greatest single discovery of modern times. That something? The Limited Liability Corporation. It seems odd to say the corporation was discovered, but they didn't just appear from nowhere. The word incorporate means take on bodily form, not a physical body but a legal one. In the law's eyes, a corporation is something different from the people who own it or run it or work for it, and that's a concept lawmakers had to dream up. Without laws saying that a corporation can do certain things like own assets or enter into contracts, the word would be meaningless. The legal ingredients that comprise a corporation came together in a form we would recognise in England on New Year's Eve in 1600. Back then, creating a corporation didn't simply involve filing some routine forms. You needed a royal charter, and you couldn't incorporate with the general aim of doing business and making profits. The corporation's charter specifically said what it was allowed to do and often also stipulated that nobody else was allowed to do it. The legal body created that New Year's Eve was charged with handling all of England's shipping trade east of the Cape of Good Hope. Its shareholders were 218 merchants. Crucially and unusually, the charter granted those merchants limited liability for the company's actions. Why was that so important? Because otherwise, investors were personally liable for everything the business did. If you partnered in a business which ran up debts it couldn't pay, its debtors could come after you, not just for the value of your investment but for everything you owned. That's worth thinking about. Whose business might you be willing to invest in if you knew that it could lose you your home and even land you in prison? Perhaps a close family member, at a push, a trusted friend, someone you knew well enough and saw often enough to notice if they were behaving suspiciously. The way we invest today, buying shares in companies whose managers we will never meet, would be unthinkable, and that would severely limit the amount of capital a business venture could raise. Back in the 1500s, perhaps that wasn't much of a problem. Most business was local and personal. But handling England's trade with half the world was a weighty undertaking. The corporation Queen Elizabeth created was called the East India Company. Over the next two centuries it grew to look less like a trading business than a colonial government. At its peak it ruled 90 million Indians. It employed an army of 200,000 soldiers. It had a meritocratic civil service. It issued its own coins. And the idea of limited liability caught on. In 1811, New York State introduced it, not as a royal privilege, but for any manufacturing company. Other states and countries followed, including the world's leading economy, Britain, in 1854. Not everyone approved. The Economist magazine was sniffy, pointing out that if people wanted limited liability they could agree it through private contracts. But the limited liability company proved its worth. The new industrial technologies of the 19th century needed capital. Lots of capital. A railway company, for example, needed to raise large sums to lay tracks before it could make a penny in profit. How many investors would risk everything on its success? Not many. But the limited liability corporation has its problems. One of them was obvious to the father of modern economic thought, Adam Smith. In The Wealth of Nations in 1776, Smith dismissed the idea that professional managers would do a good job of looking after shareholders' money. In principle, Smith was right. There's always a temptation for managers to play fast and loose with investors' money. We've evolved corporate governance laws to try to protect shareholders, but they haven't always succeeded, as investors in Enron or Lehman Brothers might tell you. And they generate their own tensions. Consider the fashionable idea of corporate social responsibility, where a company might donate to charity or decide to embrace labour or environmental standards above what the law demands. In some cases that's smart brand building and it pays off in higher sales. In others, perhaps, managers would be using shareholders' money to buy social status or a quiet life. For that reason, the economist Milton Friedman argued that the social responsibility of business is to maximise its profits. If it's legal and it makes money, they should do it. And if people don't like it, don't blame the company, change the law. The trouble is that companies can influence the law too. They can fund lobbyists. They can donate to electoral candidates' campaigns. The East India Company quickly learned the value of maintaining cosy relationships with British politicians, who duly bailed it out whenever it got into trouble. In 1770, for example, a famine in Bengal clobbered the company's revenue. British legislators saved it from bankruptcy by exempting it from tariffs on tea exports to the American colonies, which was perhaps short-sighted on their part. It eventually led to the Boston Tea Party and the American Declaration of Independence. You could say that the United States itself owes its existence to excessive corporate influence on politicians. And arguably, corporate power is even greater today, for a simple reason. In a global economy, corporations can threaten to move offshore. When Britain's lawmakers eventually grew tired of the East India Company's demands, they had the ultimate sanction. In 1874, they revoked its charter. For multinationals with opaque ownership structures, that threat is effectively off the table. We often think of ourselves as living in a world where free market capitalism is the dominant force. Few want to return to the command economies of Mao or Stalin, where hierarchies, not markets, decided what to produce. And yet, hierarchies, not markets,
SPEAKER_00: are exactly how decisions are taken within companies. When a receptionist or an accounts-payable clerk makes a decision, they're not doing so because the price of soybeans has risen. They're following orders from the boss. In the United States, bastion of free market capitalism, about half of all private sector employees work for companies with a payroll of at least 500. Some argue that companies have grown too big, too influential. In 2016, Pew Research asked Americans if they thought the economic system is generally fair or unfairly favours powerful interests. By two to one, unfair won. Even The Economist magazine worries that regulators are now too timid about exposing market-dominating companies to a blast of healthy competition. But let's not forget what the limited liability company has done for us. By helping investors pool their capital without taking unacceptable risks, it enabled big industrial projects, stock markets and index funds. It played a foundational role in creating the modern economy. An excellent guide to how the East India Company grew into
SPEAKER_02: the modern corporation is David Moss's book, When All Else Fails. For a full list of our sources, please see bbcworldservice.com slash 50 things.
