Posted by: Dirk | October 10, 2011

How Scotland lost its shirt – and independence

Paul Krugman has written about Adam Smith and bank regulation yesterday:

First of all, bank regulation is important even in the absence of bailouts. Don’t trust me, trust Adam Smith. Scotland invented modern banking; it also invented modern banking crises; and Smith, having witnessed such a crisis, favored bank regulations, declaring that

Such regulations may, no doubt, be considered as in some respect a violation of natural liberty. But those exertions of the natural liberty of a few individuals, which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments; of the most free, as well as or the most despotical. The obligation of building party walls, in order to prevent the communication of fire, is a violation of natural liberty, exactly of the same kind with the regulations of the banking trade which are here proposed.

This was a lesson (from 1776) that Scotland forgot over just a generation. Natural liberty might call for the freedom of entrepreneurs to collect as much money from investors as they are able to, however, society might want to protect itsself from putting all eggs into one basket through the use of bank regulation. It did not. Scotland paid dearly for the next big financial crisis (starting in 1798), eventually losing sovereignty in the merger with England (United Kingdom). BBC History has a small section on this, and the following paragraphs are taken from there:

The man who came up with the answer was a financial adventurer called William Paterson, a Scot who had made his name down south as one of the founding directors of the Bank of England. Paterson returned to Edinburgh with an audacious scheme to turn Scotland into the major broker of trade across the Pacific Ocean. Whilst in London, he had met a sailor called Lionel Wafer, who had told him about a wonderful paradise on the Isthmus of Panama, with a sheltered bay, friendly Indians and rich, fertile land – a place called Darien.

The Darien Venture was a complete disaster for Scotland. The blow to Scottish morale was incalculable. Those colonists who returned found themselves cast as pariahs in their own land. Roger Oswald, disowned by his father, wrote to a friend: ‘Since it pleased God that I have preserved [my life], and had not the good fortune (if I may term it so) to lose it in that place, and so have been happy by wanting the sight of so many miseries that have come upon myself… I never intended, nor do intend, to trouble my father any more.’

It was an economic disaster too. The company had lost over £232,884, made up of the life savings of many of the Scottish people. Scotland was now completely incapable of going it alone. Just 7 years after the failure at Darien, it was forced to concede to the Act of Union, joining Scotland with England as the junior partner in the united kingdom of Great Britain. As part of the deal, England paid off Scotland’s debts with the ‘Equivalent’, a sum of £398,000, most of which went to cover the Company of Scotland’s losses. The institution established to administer this money eventually became the Royal Bank of Scotland.

Perhaps this makes it clear why politicians today are so eager not to waste the financial crisis. Euro zone member countries are coerced into policies they otherwise would not adopt. Look at Spain’s debt brake, Italy’s austerity packages, and Greek privatization plans.

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