An Examination of the Supply of Financial Credit to Entrepreneurs in Colonial India. Susan Wolcott

Transcription

1 An Examination of the Supply of Financial Credit to Entrepreneurs in Colonial India Susan Wolcott Scholars of Indian history suggest that the main deterrent to entrepreneurial activity in colonial India was the absolute shortage of capital. A large body of theoretical and empirical research suggests that the key to mobilizing capital is a well functioning financial market. Using various bank records of the colonial state, I determine that the credit markets which supported colonial era Indian entrepreneurs were actually efficient, at least relative to the US financial markets of the mid-nineteenth century. This is a relevant comparison as it was then that the US began to grow at modern rates. I explore how India s caste system may have affected credit markets. I argue that caste ties gave Indian financiers a method of contract enforcement which was "extra-legal" and thus led to the continuance of informal credit provision. This can explain the underdevelopment of India's formal credit structures. A paper prepared for the History of Entrepreneurship conference held at NYU October 19 to 21, organized by William Baumol, David Landes and Joel Mokyr, and sponsored by the Kauffman Foundation. I wish to thank Howard Bodenhorn as well as all participants for useful comments. 1

2 An Examination of the Supply of Financial Credit to Entrepreneurs in Colonial India Susan Wolcott In 1968 William Baumol called for a renewed focus on the determinants of the payoff to entrepreneurial activity. Understanding the allocation of entrepreneurial talent was crucial as the entrepreneur is the key to the stimulation of growth. In a 1990 paper, on a less optimistic note, he argued that an inappropriate payoff structure, one which rewards unproductive entrepreneurship, is empirically associated with very slow growth. 1 How are these insights relevant to India? The Indian economy until very recently has certainly experienced very slow growth. Thus it is a useful case history to identify correlates of misallocated entrepreneurial energy. The post-independence period, however, yields few new insights. The independent Indian government adopted a wide range of growth-reducing strategies, which it only abandoned in the 1990s due to pending bankruptcy. In these years the payoffs to unproductive entrepreneurship are so obvious as to render the question almost uninteresting. The case of colonial India is potentially much more interesting. Though the British usurped India s sovereignty, by at least the late 19 th century they had also established peace throughout the subcontinent, imposed a fairly low level of taxes (accompanied, admittedly, by a low level of services), imposed contract and property laws similar to those in England, and had the whole administered by what most report as having been a reasonably noncorrupt civil service. Laissez-faire and free trade governed England s dominions no less than Albion herself. Colonial India unlike post-independence India had consistent trade surpluses and the government had a balanced budget. The British also put in place a massive railroad system connecting India s interior to its ports. The transport system had been financed largely with English capital at low rates which were perhaps due to the political stability which it was assumed would characterize an English colony. (CITE) Yet even though the formal institutions appear to have been designed to support 2

3 entrepreneurship, the colonial Indian economy grew very slowly, more slowly in fact than under the flawed policies of independent India. Could there still be a role for misaligned payoffs to entrepreneurs? In the 19 th century Max Weber famously argued that the Hindu social system failed to reward entrepreneurism and it was this which stifled capitalist growth. 2 He noted that the Hindu caste system was tied to an acceptance of an immutable world order, and this coupled with an expectation of reincarnation led to a disinterest in the mundane. Much of Indian business scholarship has been devoted to correcting the view that Indians were unconcerned with material gain. But scholars acknowledge that Indian business networks are affected by the caste system. In 1955 Helen B. Lamb claimed that the vast majority of Indian entrepreneurs were drawn from just 3 communities: the Marwaris of Rajasthan, the Vaishas of Gujarat and the Parsis. 3 This pattern continues even today, with every study showing that these same three communities controlling the lion's share of India's industries, the only change being that three other communities, the Punjabis, Chettiars and Maharashtrians have been added to the list as lesser, but still important groups. 4 In this article I will argue that the caste system affected the payoffs to at least some types of entrepreneurism in India, and these cultural factors may have had a part to play in the slow development of colonial India despite the ideal institutional environment fostered by the colonial government. This article focuses on financial entrepreneurism. It would be impossible to give a complete history of Indian entrepreneurship, or even the role of caste in Indian entrepreneurism within the limits of one article. Moreover Drijendra Tripathi, the noted business historian, has recently published a book which is a masterful treatment of the business history of India, so another general history would be 1 Baumol, William. May "Entrepreneurship in Economic Theory." American Economic Review 58(2): And, Oct "Entrepreneurship: Productive, Unproductive, and Destructive." Journal of Political Economy 98(5, pt. 1): Weber, Max, The Religion of India: The Sociology of Hinduism and Buddhism, ETC. 3 Lamb, Helen B. June "The Indian Business Communities and the Evolution of an Industrialist Class." Pacific Affairs 28(2): Parsis are Zorastrians and not Hindus. But the caste system so permeated traditional India that the social relations of even non-hindu groups exhibited certain caste-like features. Thus scholars speak of Moslem "castes" and Christian "castes" in India. (CITE) 4 Khanna, Tarun and Krishna Palepu. June The Evollution of Concentrated Ownership in India Broad Patterns and a History of the Indian Software Industry. National Bureau of Economic Research Working Paper 10613, p

4 redundant. 5 Given that the scope must be narrowed, there are several compelling reasons to focus on the financial sector. First, this subject is relatively underrepresented in analyses of Indian business history, which have tended to focus on industrialization more directly. 6 Secondly Rousseau and Sylla claim that there is a growing consensus among economic historians that a well functioning financial system promotes entrepreneurial efforts in industry. 7 Modern financial institutions reduce information asymmetries between impersonal investors and savers, and thus allow capital to be allocated to its best use. The role of financial intermediation would have been especially important in India as Tirtankar Roy has recently cited India s absolute lack of capital as the main inhibiting factor to economic growth in the colonial period. 8 And a final reason to focus on the financial system is that in India this sector was largely an indigenous enclave, unlike much of the rest of the economy. Below the level of the exchange banks, and that was most of the system, virtually all participants were native Indians. The seeming relegation of Indian entrepreneurs to internal commerce and credit operations is itself an interesting aspect of Indian development. Morris Morris has argued that the payoff structure directed Indian entrepreneurs away from industrial activity and toward the desh - the countryside. He argued that indigenous entrepreneurs focused on internal markets and the British focused on the export markets not because of discrimination as has sometimes been asserted but because these two types actually faced idiosyncratic levels of expected profit. The Indians lack of knowledge of world markets and their great knowledge of the interior meant that their realized profit rates were higher there, and the exact opposite held for the British in India. 9 Early in this century, D. R. Gadgil had argued that Indian entrepreneurs focus- however rational- on commerce and the internal supply of credit slowed industrial 5 Tripathi, Drijendra The Oxford History of Indian Business. Oxford University Press. 6 Major works on Indian economic growth in the colonial period include: Bagchi, Amiya Private Investment in India Cambridge University Press. Ray,Rajat K Industrialization in India, Growth and Conflict in the Private Corporate Sector. Oxford University Press. And Morris, Morris The Growth of Large-Scale Industry to 1947, in the Cambridge Economic History of India 2, edited by Dharma Kumar, Rousseau, Peter and Richard Sylla. Jan "Emerging Financial Markets and Early US Growth." Explorations in Economic History 42(1): Roy, Tirtankar. Summer Economic History and Modern India. Journal of Economic Perspectives 16(3): Morris, Morris, The Rashomon Effect, Explorations in Economic History 16 ():

5 growth. In Gadgil s pioneering book on Indian industrialization, first published in 1924, he observed that India had followed an industrialization path similar to Western economies. The only thing, then, remarkable about the industrial evolution of India, has been its slowness. According to Gadgil the slowness was due to the following factors. The smallness of India s capital resources, the competition for these from both agriculture and industry, the high profits to be obtained in money-lending and commerce, and the particularly high rates that ruled for money accommodation at harvest. (emphasis mine). 10 Note that in the economic and policy literature of 19 th and early twentieth century India, the term moneylender was used to describe any type of private lending, large scale or small. I believe the moneylending referenced in this quote were the activities of the large class of what were called indigenous bankers, or sometimes shroffs. These businessmen were very similar to the private bankers Richard Sylla notes as being important to development in the antebellum US, and who had been prominent in England. 11 But echoing Gadgil, in his recent book Tripathi clearly indicates that he views these business activities as inferior in terms of modern development. In his final chapter, he writes that the more benign business environment of the early twentieth century not only caused many Indians from traditionally nonbusiness occupations to become entrepreneurs, but it also induced large sections of mercantile elements to leave the cosy world of trading and moneylending and enter the more competitive field of industry. 12 Thus we have two views. On the one hand, financial intermediation is seen as the handmaiden of entrepreneurism. On the other, such activities are seen as a distraction from innovative entrepreneurism. While I will not even pretend to determine definitively which view is correct, I can offer a descriptive and quantitative analysis of the Indian financial system using the voluminous records of the Provincial Bank Enquiry Committees (PBEC) as well as interest rate data available from the colonial Comptroller of the Currency. These data indicate that though unlike its Western counterpart in form, the Indian system was reasonably efficient and competitive relative to the mid 19 th century US financial 10 Gadgil, D.R The Industrial Evolution of India in Recent Times. Oxford University Press, p Sylla, Richard, Forgotten Men of Money: Private Bankers in Early U.S. History, Journal of Economic History, vol. 36, no. 1 (March 1976), pp Tripathi, History of Indian Business,

6 market. If a well developed financial system was as Richard Sylla has argued the key to allowing the US to exploit its extensive resources between 1780 and 1840, then it seems that the provision of a similarly well functioning system in India was not an entrepreneurial distraction. 13 But though I will show that the system was efficient, the provision of financial capital in India was distinctively Indian. It remained largely informal. Though Indian financial entrepreneurs operated under a British colonial legal system which permitted incorporation and limited liability, and there were incorporated banks in India as well as stock and security markets, most financial capitalists chose to operate as private entities. Contemporaneous analysts suggest that the Indian caste system acted as a deterrent to cheating, and this deterrent effect may have supported India s unusual credit structure. This represents yet another channel by which the caste system shaped the Indian economy. I. A Comparison of the Institutional Environment of Colonial and Modern India A major new "research program"- exemplified by the work of Stanley Engerman and Kenneth Sokoloff, and Daron Acemoglu, Simon Johnson and James Robinson- suggests that the key institutional characteristic is "the breadth of access to opportunities for social and economic advancement- the ability to own land, obtain schooling, borrow, and innovate". What is crucial, in this view, is that laws and government policies promote broad participation in entrepreneurism. It is claimed that such a breadth explains the odd fact that the United States and Canada surged ahead of other American states which were more research rich. 14 It may seem surprising, but many of the US and Canadian characteristics cited as growth enhancing reasonably describe the colonial Indian economy, though not the post-independence economy, at least not until the reforms of the 1990s. 13 Sylla, Richard. May/June U.S. Securities markets and the Banking system, St. Louis Federal Reserve Review: Hoff, Karla. Fall "Paths of Institutional Development: A View from Economic History." World Bank Research Observer 18(2): 207 and 208, respectively. 6

7 When Indians took over the governance of India in 1947, the main policy makers were determined not to repeat what they perceived to be the mistakes of the British. T. N. Srinivasan and Suresh D. Tendulkar write that the Nationalists thought that the British policies of laissezfaire and free trade were the major reasons for India's lagging industrial growth. They quote Nehru as describing world trade as a "whirlpool of economic imperialism". The Nationalists replaced the British policies with what came to be known as the "License Raj". This system required entrepreneurs to obtain a permit for any large industrial investment. Though it was originally put in place in an attempt to control and direct the economy for the public good, this system "degenerated into a tool for political and other patronage dispensation". 15 Moreover, licensing limited capacity and restricted supply. Firms could sell anything they could produce to domestic consumers, and thus had little incentive to improve quality or lower price. Labor management policies were also strictly circumscribed by government dictums. Independence meant that the mass of Indians gained the right to vote, a right which has been associated with good economic policies in many countries, says the new research agenda. But for whatever reasons, the Indian electorate supported economic policies which clearly stifled entrepreneurism and innovation. Compare this to the colonial regime. Though in terms of absolute numbers there were many educated Indians, the majority of Indians were illiterate, and that was almost certainly not good for growth. Also, native Indians were largely excluded from government. Enfranchisement was limited, and the politician's that were elected primarily had advisory roles. 16 On the other hand, the policies which Britain imposed upon its colony most economists would describe as growth enhancing, such as the laissez-faire and free trade decried by the Nationalists. The legal structure of colonial India, in particular the law of contracts, has been described as an improved 15 Srinivasan, T.N. and Suresh D. Tendulkar Reintegrating India with the World Economy. Institute for International Economics, 13 and 14, respectively. 16 Chaudhary, Latika "Social Divisions and Public Provision: Evidence from Colonial India." Working Paper. 7

8 version of British civil laws. The Indian Contract Act of 1872 was a simplified and codified version of existing British practices. When the British codified their own laws by the statutes of 1890 and 1893, Sir George Rankin writes "Sir Frederick Pollock had before him the [Indian] Commission's draft of 1866." 17 The Indian law was modified in turn by the Indian Act of 1932 to bring it more exactly in line with British statutes, but, once again, Rankin argues that certain components of the Indian Act, in particular how it treated firms, were an improvement in clarity and completeness over existing British laws. Another point in favor of growth was that Indians were, largely, landowners. There were certainly many large estates and plantations in India. But the vast majority of Indian agriculturalists owned at least some land. Thus Indians were given good policies and good laws, and through their landownership should have had access to credit. The large literate population, at least, should have been poised to innovate. Still, was their subordinate status in their own country an impediment to growth? Some authors, such as Subramanian Swamy and Amiya Bagchi, have claimed the British government "placed hurdles" in front of native Indian entrepreneurs. 18 But these authors' complaints are not that the British placed actual hurdles, but rather that the British failed to help entrepreneurs with subsidies and protective tariffs. More modern scholars- and certainly those concerned with productive paths of institutional development- would probably argue that the British failure in this regard during their tenure as rulers of India was actually the best help that could have been given to Indian entrepreneurs. II. Colonial India s Industrial Development In absolute terms, there was a great industrial expansion in India in the early twentieth century. Rajat Ray has shown that by the paid-up capital of joint-stock companies 17 Rankin, George Claus, Sir Background to Indian Law. Cambridge University Press, 93ff and 97, respectively. 18 Swamy, Subramanian. Feb "The Response to Economic Challenge: A Comparative History of China and India." Quarterly Journal of Economics 93(1): And Bagchi, Private Investment. 8

9 registered in India had increased four-fold from its 1914 level. It increased an additional 50 percent beyond the level by The annual rate of increase between 1914 and 1946 was percent. 19 The registered companies included industrial firms, but also were involved in banking, transport, plantations, mines and estates. Bagchi notes, however, that as India had no indigenous machinery manufacturers, imports of machinery give an accurate index of physical investment specifically in industry. Denominated in Rs., the accumulated total gross physical capital imported into India across the first four decades of the twentieth century was nearly 4 billion Rs.. 20 In this absolute sense, then, there was certainly impressive industrial investment. But the industrial sector remained small relative to India s overall economy. Net investment in the colonial period constituted only 2 to 4 percent of national income, as opposed to an average of around 23 percent of Indian GDP in recent years. Machinery investment in the colonial period was especially low in relative terms, only 0.5 percent of national income. 21 And even by Independence in 1947, despite the war-time surge in company registrations, the manufacturing sector represented just 16 percent of India s Net product, and the largest part of that, 8.9 percent, was small-scale manufacturing. 22 Between 1911 and 1951, the share of India s workforce in manufacturing actually dropped, from 10.1 to 8.7 percent. It should be noted, however, this was primarily due to a fall in female laborers in manufacturing. The percent of the male laborers in manufacturing was relatively stable: 9.5 percent in 1901 and 9.1 percent in Ray, Industrialization in India, Table 9, p Bagchi, Private Investment, table Roy, Economic History and Modern India, p. 121, for the colonial data, and International Monetary Fund, International Financial Statistics Online for the data Heston, Alan "National Income." In Cambridge Economic History of India, edited by Dharma Kumar, table 4.3B. 23 Krishnamurty, J "The Occupational Structure." In Cambridge Economic History of India, edited by Dharma Kumar, table

10 What is perhaps more important, productivity growth was minimal. Heston gives figures for the change in value added between 1900 and 1947 in all of the major sectors of the Indian economy. 24 Heston estimates that agriculture, which constituted about 70 percent of employment and GDP, may have even had a slightly negative annual growth in real value added per worker in this period. Manufacturing and commerce growth in real value added per worker was only about 1 percent. From this perspective, India hardly represented a dynamic economy. Tirthankar Roy argues that India s resource endowments explain both the low investment levels and resulting lack of productivity growth. According to Roy, the scarcity and resulting high cost of capital and skilled labor in India meant that Indian industry was best suited to be, and was, a vast world of traditional manufacturing, consisting of tool-based industrial production performed in homes or small workshops. 25 His argument echoes that of Morris Morris. Morris points out that though the official figures suggest that small-scale industry was both a bit larger and a bit more dynamic in terms of productivity than large-scale industry, due to serious underreporting in workshop activities in the interwar period, it may even have been more dynamic than the official figures would suggest. Further, the fact that Indian entrepreneurs were focusing on such workshops was not an indication of backwardness, but: the introduction of modern (if often technically outmoded ) machinery into a workshop context was the rational and quite efficient response by private entrepreneurs to cost and demand conditions as they existed over wide parts of the Indian economy. 26 According to Roy and Morris, India was developing. It was just that India s development path was a bit different than that of Western economies (a point in which they differed from Gadgil), and that difference was due to the much greater cost of establishing modern industrial plants in India. 24 Heston, "National Income", table Roy, "Economic History and Modern India," Morris, Morris David "Indian Industry and Business in the Age of Laissez Faire." In Entrepreneurship and Industry in India, Oxford University Press,

11 Morris adds another reason for Indian entrepreneurs avoidance of large scale industry, and that is their much greater familiarity with commerce and workshops. Morris most recent statement on the development of industry in India was a 1987 article, but he has long claimed that the uncertainties of large scale manufacturing were too great given the lack of infrastructure in India. Although Morris never cites him directly, Morris is obviously referring to Knightian uncertainty, the distinction between "risk" (randomness with knowable probabilities) and "uncertainty" (randomness with unknowable probabilities). 27 Morris points out that developed countries have futures markets, statistical and other forms of specialized services that reduce risks and minimize uncertainties. 28 Indian entrepreneurs had, according to Morris, no such services. Thus, a new enterprise had to promise a very high rate of return not only to meet the cost of scarce capital but also to allow for the greater risks. The higher the rate of return required to offset the general uncertainties of novel enterprises, the fewer were the opportunities that promoters and investors found promising. 29 Morris statement, however, highlights the need for financial entrepreneurs in India. The main purpose of well functioning financial markets is to minimize risk to individual savers so as to maximize the utilization of capital. There is greatest need for them when the payoffs to investments are most uncertain. Consider for example the theoretical model of Jeremy Greenwood and Boyan Jovanovic. 30 In their model, individuals have the opportunity of investing in their own projects, or giving their endowment to a bank. The job of the bank in this model is to accumulate costly knowledge on the uncertain aggregate state of technology. Through a research-type process intermediaries collect and analyze information that allows investors resources to flow to their most profitable use. As banks are relatively large players, they have more incentive to pay the research costs than individuals. Also, as they 27 Knight, Frank Risk, Uncertainty and Profit. Hart, Schaffer; Houton Mifflin Co.. 28 Morris, "Indian Industry and Business," 202. It should be noted that there were futures markets in colonial India, which appear to have been almost the exclusive domain of native merchants. 29 Morris, "Large-Scale Industrial Development,"

12 are large players banks perform the obvious role of pooling risks across individual projects. For both reasons, in an economy with well functioning credit markets there is more saving and the return to saving rises. Consequently there is more growth. In the absence of risk and uncertainty banks would have no economic role. This line of argument suggests that colonial India would not have been a congenial environment for innovative entrepreneurs if there were insufficient financial entrepreneurs to take on the task of researching the unknown, or if for some reason financial entrepreneurs performed their task inefficiently. On one point Morris is obviously misjudging the sophistication of the Indian economy. Futures markets for cotton had been widespread in northern India since at least the very early 19 th century. 31 By the end of the century there were deep futures markets for all agricultural products in all parts of India. 32 But what of other forms of intelligence gathering? The remainder of this paper will examine the extent and efficiency with which India s credit markets researched and pooled risk. III. Financial Markets of Colonial India When the Europeans arrived in India in the 16 th century, they found a sophisticated financial market already in place. Few writers describing this market fail to quote the following colorful observation by the great 17 th century traveler Tavernier. The Jews engaged in money matters in the Turkish Empire are usually considered to be exceptionally able, but they are scarcely fit to be apprenticed to the money changers of India. 33 The Indians had developed a system to transmit large sums across the great distances of India and even further. It was called the hundi system. Tripathi describes the hundis as a sort of bill of exchange drawn 30 Greenwood, Jeremy and Boyan Jovanovic. Oct Financial Development, Growth, and the Distribution of Income. Journal of Political Economy 98(5): Bayly, Christopher A Rulers, townsmen and Bazaars. Oxford University Press, p The Indian futures markets appear to have been almost the exclusive domain of native merchants. (Ray, Rajat K. July-Sept "The Bazaar: Changing Structural Characteristics of the indigenous Section of the Indian Economy Before and After the Great Depression." The Indian Economic and Social History Review 25(3): Tripathi, History of Indian Business,

13 by a party on his agent or correspondent elsewhere asking the latter to pay to the drawee a specified sum of money the equivalent of which the drawer must have already received. 34 Tripathi further writes that by 1700 this system covered all of India and a market for saleable hundis was developing. Ray claims that the network stretched from Surat to Dacca, and in the other direction over the Persian Gulf and the Red Sea to Makha. 35 Both the shroffs, or professional private bankers, and merchants were involved in selling and accepting hundis. It is thought that this system may have originated with the need of the many regional rulers of India to pay their troops. 36 This network continued to operate under the British. The 1931 Central Banking Enquiry Committee estimated that 90 percent of India s inland trade was financed by indigenous bankers. 37 The activities of indigenous bankers were not limited to transmitting funds. They were crucial for supplying production credit for India s agriculture and workshops. Official descriptions of India's informal credit network break the system into three levels: village moneylenders, town moneylenders and, at the apex, private bankers. Bankers are typically distinguished from moneylenders in that the former accept deposits and the latter do not. However, this is not a hard and fast rule, and can be broken on either side. 38 The most prominent caste groups of bankers include the Marwaris who were originally from the Northwest regions, but spread to all parts of India, and were especially prominent in eastern India, the Nattukottai Chettis of Madras, who were also the main financial agents in Burma, the Khatris and Arora bankers of the Punjab, and finally the Bohras of Gujarat and the Multanis of Sind. (Note that with the exception of the Parsis and Maharashtrians, these are exactly the communities which have 34 Tripathi, History of Indian Business, Ray, "The Bazaar," Ray writes that though some had thought that the term hundi was a corruption of Hindi or Hindu, that is incorrect, and that the word is instead a derivative of the Sanskrit hundika, which itself is derived from the root verb hund, meaning to collect. (Ray, "The Bazaar," 305.) 37 Chandavarkar, A.G "Money and Credit." In Cambridge Economic History of India, edited by Dharma Kumar, Jain notes that some moneylenders took deposits from their clients though this was on a very small scale. (Jain, L.C Indigenous Banking in India. Macmillan and Co., 35.) Before the Assam PBEC, an agriculturist money-lender noted that he accepted deposits. (India Banking Enquiry Committee (Assam). Report, , Evidence 2, 158.) Baker notes that in evidence before the Madras PBEC, it was reported that local moneylenders accepted deposits as a social obligation, not because they needed them for their business. (Baker, 13

14 continued to dominate Indian entrepreneurism.) Timberg writes that the seminal treatment of the indigenous banking system of India remains L.C. Jain s 1929 book, which was an outgrowth of Jain s Ph.D. thesis at the London School of Economics. Jain, a Marwari himself, gives the following description of indigenous bankers' activities. Their offices and branches are spread all over the country in important centres like Calcutta, Bombay, Delhi, Rangoon, etc., where they have their munims and gumashtas or agents, who look after their business. The munims are invested with very wide powers. They are not highly paid, but their industry, integrity, and efficiency are remarkable and proverbial. They submit periodical returns and reports of their doings to their head offices and receive from them occasional instructions. Some of the bankers even have correspondents outside India, at Aden, Djibuti in Africa, Addis Ababa in Abyssinia, Paris, in Japan and other places. 39 Even among the bankers, there were divisions between the large and the small. In a discussion of the Marwari diaspora, Tripathi notes that the migrants from Rajasthan were as a rule the small operators. The big bankers, who enjoyed the patronage of the Rajput chiefs, stayed in place, and their family members set up branches in other centers. 40 Timberg likens this latter group to the Rothschilds studied by David Landes or the New England merchant migrants studied by Bernard Bailyn who founded their businesses on lines of credit from their London creditorrelatives. 41 The small operators were those who perhaps started as clerks to a larger house, accumulated capital, and then set up in business for themselves. The indigenous bankers of India performed many of the same functions a formally incorporated bank would perform. They bought and sold hundis. They offered lines of credit to their customers. Much of this business was done on personal account. They sometimes, but not always took deposits. Consider the example of Mr. Motiram Narasidas of Surat, interviewed by the Bombay Provincial Bank Enquiry Committee He was a pure banker in that banking Christopher John An Indian Rural Economy The Tamilnad Country side. Clarendon Press, 280.) 39 Jain, Indigenous Banking, Tripathi, History of Indian Business,

15 was his only business. He received deposits, for which he paid 4 ½ percent. The joint-stock banks were paying, according to Mr. Narasidas, 5 percent at this time. He loaned only against personal security. His rate to other shroffs was also 4 ½ percent, going to 5 ½ percent at times, to merchants at 9 percent and to agriculturists at 6-9 percent. Mr. Narasidas, though a private individual, reported that he issued annual balance sheets. 42 The indigenous bankers were unlike more formal banks in that they typically operated chiefly from their own capital, even if they took deposits. And the issuance of checks was extremely rare, and where issued those checks were not accepted by formal banks, that is the joint-stock banks and the Imperial Bank (the latter being the quasi-government bank of India). 43 But these characteristics were not unlike the early New England banks studied by Naomi Lamoreau. She noted that for these banks, both banknotes and deposits held a relatively insignificant position among banks liabilities. The bulk of their liabilities, as in Indian indigenous banks, was the bank s own capital. 44 Another difference between indigenous banks and formally incorporated banks was that indigenous bankers typically also carried on other business. Mr. Narasidas, referred to earlier, is somewhat unusual in that he was a pure banker, though apparently that was less unusual in Gujarat. Jain writes that most indigenous bankers were simultaneously engaged in another allied business, and these included virtually every line of industry, trade and commerce. They are grain dealers, general merchants, commercial agents, brokers, goldsmiths, jewelers, land-owners, industrialists and traders. 45 Ray notes that the two largest families of cotton textile mill-owners in the Gujarat center of Ahmedabad, the Sarabhais and Kasturbai Lalbhai, continued with their indigenous banking business despite adding industrial pursuits to their portfolios. And the very wealthy Birla Brothers who were jute mill owners among other industrial activities, engaged in 41 Timberg, Thomas A The Marwaris. From Traders to Industrialists. Vikas Publishing Hourse, Bombay PBEC, Evidence, Jain, Indigenous Banking, Lamoreaux, Naomi Insider Lending. Banks Personal Connections and Economic Development in Industrial New England. Cambridge University Press, Jain, Indigenous Banking,

16 trade and most especially spot and forward transactions in the bazaar in the 1930s which were at least as large as their industrial interests. 46 In both of these latter two cases, Ray writes that the financing available from their close connections to the indigenous banking sectors were instrumental in financing their industrial activities. I will return to the link between indigenous banks and Indian industrial financing in a later section, but here I want to note the similarities of this Indian system with the banks of New England described by Lamoreaux. She argued that buying commercial bank stock in antebellum New England amounted to joining an "investment club" in which members savings were directed to the enterprises of the directors of the bank. Each firm acted independently, according to Jain. They did, however, have guilds, sometimes called Mahajans. These institutions were part caste panchayat, or council, and dealt with religious and social matters, and part trade dispute and insolvency courts. 47 In some parts of India, the Mahajans evolved in the interwar period into associations, but performed exactly the same role that the medieval guilds had performed. Jain notes that the Bombay Shroffs Association settled between 20 and 25 disputes a day. They had a form in which all of the details of the case were noted, including the parties to the dispute. The secretary of the Association investigated, and handed down a decision. Jain writes that these decisions were accepted by all. On the few occasions when the parties took the dispute to a formal court, the decision of the Association was typically upheld as it had been arrived at from personal knowledge. In Gujarat, also in western India, the Association set the hundi rate, which all members abided by. The setting of intra-shroff rates was apparently also the practice of the Bombay Association Ray, Rajat K Introduction. In Entrepreneurship and Industry in India, , edited by Rajat K. Ray, Oxford university Press, Tripathi notes that one difference between the mahajans and a caste panchayat is that the bankers were actually from several different castes. The panchayat, though, was the model for the mahajan. (Tripathi, HIstory of Indian Business, 22, and fn. 28.) 48 Jain, Indigenous Banking, for Gujarat. India Provincial Banking Enquiry (Bombay), Evidence 3, 506. This might suggest that the guilds acted as cartels. Perhaps they did. As will be discussed in a later section, however, the rates they set were strongly influenced by the rates of the Imperial Bank of India. 16

17 David Rudner's study suggests that the Nakarattar Chettiars had the most formalized overarching organization of all of the communities of indigenous bankers. 49 The Nakarattar Chettiars were and are a caste based in Chettinad in Madras. They were the main financiers of this region, but were even more famous for their widespread operations in Burma, Ceylon and Malay. At least before the 1930s, the bulk of their collective funds were employed outside of India. The Nakarattar Chettiars held monthly meetings to discuss the current financial situation and set interest rates, as did other groups. But the Chettiars, unlike other banking groups were a single caste rather than a caste group, and the meetings were held at their temple. The caste panchayats of the Chettiars were used to settle disputes between Nakarattar businessmen over payment of interest on loans, return of deposits, or other business matters. The Chettiars were unlike other banking groups in another way. There were two formal layers of bankers. A small number of Chettiars, Rudner estimtes something like 10 percent, were designated as adathis, or parent bankers. 50 These acted as clearinghouses between individual Nakarattar Chettiar bankers, much as a large New York City or Philadelphia bank might have served as a correspondent bank for small rural banks in the antebellum US. Two bankers did not have to know one another if they had a common adathi. Further, excess funds could be deposited with an adathi who would have the most up to date and complete commercial knowledge. These organizations of bankers would in many ways have mitigated the uncertainty of business operations in India. Due to the British administration, for a poor country, India had unusually good information on agricultural prices and population since the 1870s. And in the 1920s, labor bureaus were started in the various adminstrative centers and researched and published all information that was considered relevant to the labor markets. 51 Still it is likely that there was a lack of formal private or government sponsored commercial intellegence relative to 49 Radner, David West Caste and Capitalism in Colonial India. The Nattukottai Chettiars. University of California Press. Berkeley. 50 Rudner, Caste and Capitalism, 128ff. 51 Mehrban 17

18 more developed contemporaneous countries. And because the Indian economy remained till well past independence dominated by small workshops and farmers who were only partly producing for the market, it was almost certainly less knowable than those same developed contemporaneous countries. The organizations of bankers, however, had contacts in every part of India, and in the case of the Chettiars, in many other parts of Asia as well. Their meetings were opportunities not just for setting interest rates and settling disputes, but also for exchanging information. Rudner claims that caste gatherings at weddings and funerals were just as important for learning of new business opportunities as they were for cementing social ties. The organizations themselves would not have conducted the "research" Greenwood and Jovanovic envisioned for commercial banks, but it seems unlikely that any good industrial opportunity which presented itself to any individual indigenous banker would lack for funds even if he alone could not supply the investment capital. Individual indigenous bankers were independent, but not isolated. I would also argue that the informal nature of India's financial system did not harm its ability to support agricultural production and commerce. In an important article, Ray gives a thorough discussion of the workings of the bazaar credit system for financing India's agricultural trade in the interwar period. He argues that the system while unorganized by Western standards, was perfectly suited to the monsoon economy and rural production organisation of India. According to Ray, the greater riskiness of agriculture in India meant that it was necessary to spread out the risk over many different agents. He cites one example pulled from the records of the Bihar and Orissa Provincial Banking Enquiry Committee of which is a particularly nice description of how the system worked. The Province of Bihar and Orissa was just west of the Province of Bengal. Coconuts were one of the main crops of the Puri district, which were sold to confectioners, chiefly in the nearby Central Provinces (CP). Four coconut dealers at the railhead, one Marwari and three Oriyas, bought up the coconuts from local Brahman agriculturists who collected the produce of 18

19 other ryots and moved the nuts by road to the railhead. The four coconut dealers financed one quarter of the nuts by advances which carried no stipulation of exclusive right of purchase and they paid cash down for the other three-quarters. When the mandi [market town] merchant at the railhead filled an order from a CP confectioner by railing the ordered coconuts, he telegraphed the buyer, who wired back that he should draw a hundi on a particular merchant in Bombay or Calcutta. The coconut merchant drew a hundi accordingly and sold it locally in Puri to a merchant willing to remit money to either Calcutta or Bombay. He usually got a premium for a hundi drawn on Calcutta, to which plenty of merchants wished to remit. By contrast, he had to sell hundis at a discount in Bombay where fewer merchants wanted to remit money. 52 Thus the mandi merchants were first engaged in financing the coconut growers, and then participated in the financing of the final sales through the hundi market. To me, this system does not appear to be either unorganized or particular to India. It seems very similar to the way cotton production, for example, was financed in the 19 th century US. Harold Woodman describes a two tier system. 53 For large planters in the antebellum period, there were agents who supplied credit beforehand, and sold the cotton after the harvest. Like the Marwaris and Oriyas of India, they had no legal right to market the crops, but often did. These were called factors. Smaller planters appear to have dealt more with the local storeowners, who supplied credit, and then sold the crops. But the store owners themselves typically received credit from a factor. It is true that Indian farmers did not rely on commercial banks for agricultural credit, but then neither did farmers in the antebellum US South. The mainstay of Indian rural credit were the rural moneylenders- the bottom rung of India's credit ladder. These were an extremely diverse group. Jain writes, so far as money-lending is concerned, any one and every one takes to it. A member of any caste who may have a little money in hand can hardly resist the temptation of lending it out to neighbours. 54 This is a common theme in official documents. 52 Ray, "The Bazaar," Woodman, Harold D King Cotton and His Retainers. Financing and Marketing the Cotton Crop of the South, Univ. of Kentucky Press, especially pp Jain, Indigenous Banking,

20 Peter J. Musgrave quoted an early1860s statement of the Deputy Commissioner of Rae Bereli, which is in the United Provinces, north India, on this point. Almost every man appears to be in debt, and he who saves a rupee puts it out upon interest. 55 Neil Charlesworth writes that though people assume the moneylenders of the Deccan in southwest India were Marwaris or Gujarati Vanias, this was grossly incorrect as everyone dabbled in moneylending." He quotes a 1916 settlement report of the Junnar taluka, or administrative subdivision, of the Poona District in Western India. Outside the towns and large villages the professional money-lenders are very few. Agriculturists and the artisan classes borrow and lend amongst themselves. 56 C. J. Baker, quoting evidence given at the Madras PBEC, also noted that moneylenders do not form a special class. Roughly speaking all those who have spare money- ryots, merchants, retired officials, shopkeepers and vakils- lend it. 57 Elizabeth Whitcombe in her study of the rural economy of the United Provinces quotes William Crooke from his report on the Etah district in 1888 who listed these income sources for a Muslim Teli [oilmen] family: pressing oilseeds, Rs. 100 per annum; returns from 3 acres, 2 roods of land (an average size Indian farm), Rs. 50, 6 annas; and from moneylending, Rs. 3,500 per annum. (Rs per year is the minimum income required to pay income tax, and is considered very wealthy by Indian standards of the time.) She also tells of a Thakur family, a rich agriculturist caste, who held 98 acres. Their income from agriculture was Rs. 1,231 per annum, while that from money-lending was also quite substantial, Rs Musgrave gives a long list of lenders in the United Provinces. In the 1920s, telis continued to lend money... Although the 570 cultivators also borrowed from a zamindar in a neighboring village, from banias, Brahmins, Thakurs and Chamars [an untouchable, leatherworking caste]. Elsewhere much of the money lending was in the hands of the Brahmin family priests, while in Edalpur, the local shrine was, through its pandit, the leading source of credit. In Arrana,, the school teacher 55 Musgrave, Peter J "Rural Credit and Rural Society in the United Provinces, " In The Imperial Impact, edited by Clive Dewey and A.G. Hopkins. University of London, the Athlone Press, Charlesworth, Neil "Rich Peasants and Poor Peasants in Late Nineteenth-Century Maharashtra." In The Imperial Impact, edited by Clive Dewey and A.G. Hopkins. University of London, the Athlone Press, Baker, Indian Rural Economy, Whitcombe, Elizabeth Agrarian Conditions in Northern India, vol. 1. University of California Press,

21 established a very considerable lending business on his government salary, while the subordinate agents of the estate bureaucracies sometimes used their salaries- and sometimes the estates money- in credit dealings. In Bhensa,, the difficulties of the professional mahajans and salukars in the neighbouring village of Mawana led them to abandon the loaning of money to the Jat cultivators, who were constrained to borrow from the behwaris (butchers). 59 It was not just the rich who engaged in rural money-lending. Prominent among India s credit sources for the poor were widows, who apparently operated the equivalent of pawn shops. Jain was particularly impressed with the widows ability to keep track of their many very small loans despite their almost complete illiteracy. 60 Note that this would suggest that illiteracy was not an insurmountable obstacle to financial interactions in India. Jain is not the only one to write of women lenders. Neeladri Bhattacharya cites the evidence before the Punjab PBEC of Ahmed Shah, an inspector for a Cooperative in the Punjab on the loans of women, here not restricted to widows, in amounts from Rs. 25 to 300, usually on the security of jewelry. 61 IV. Efficiency of Colonial India's Financial Markets. To efficiently provide financial capital for both industry and agriculture, the Indian system would have to have been integrated across its layers and across geographic distances. There was the appearance of different spheres and thus a separation between the formal and the informal sector. But anecdotal data suggest that there were channels for funds to flow across functional spheres. The Imperial Bank, exchange banks, and joint-stock banks were at one extreme. They handled the export trade. There are also indications that they handled the less risky parts of Indian business. Consider the evidence of Mr. Rai Surana before the Bihar and Orissa Provincial Banking Enquiry Committee on October 26, Mr. Surana was the manager of the Bhagalpur 59 Musgrave, Rural Credit, Jain, Indigenous Banking,