Thus far this week (see here and here), we have seen Adam Smith’s survey of two historic overseas trading firms organized as joint-stock companies: the Royal African and Hudson’s Bay companies. Today, we turn to Smith’s survey of the ill-fated South Sea Company. Smith devotes four paragraphs to this infamous chapter in the history of mercantilism: paragraphs 22 to 25 of the last part of his 1784 pamphlet (Part #13).

Smith begins his survey of the South Sea Co. (para. 22) by telling us what he is not going to do — he is not going to rehash the “knavery and extravagance” that led to the so-called South Sea bubble: “The knavery and extravagance of their stock-jobbing projects are sufficiently known, and the explication of them would be foreign to the present subject.” (Smith 1784, p. 63) Instead, the Scottish scholar is going to provide what he thinks was the root cause of the collapse of the South Sea Company:

“The South Sea Company never had any forts or garrisons to maintain, and therefore were entirely exempted from one great expense to which other joint stock companies for foreign trade are subject. But they had an immense capital divided among an immense number of proprietors. It was naturally to be expected, therefore, that folly, negligence, and profusion should prevail in the whole management of their affairs.” (Id. at p. 63, my emphasis)

Simply put, it was not just “[t]he knavery and extravagance of [the South Sea Company’s] stock-jobbing projects” that led to its ultimate demise. It was destined to fail because of the structure of its business model. Unlike the Hudson’s Bay Company (see my previous post), which had a “moderate” amount of capital “divided among a very small number of proprietors” (id. at p. 62), the South Sea Company had an “immense” amount of capital “divided among an immense number of proprietors.” (Id. at p. 63)

In addition to its bad business model, the South Sea Company also made bad business deals. A case in point is the South Sea Company’s first business deal: the Asiento de Negros (see here), a 30-year monopoly contract granted by the Spanish Crown in 1713 via the Treaty of Utrecht, which gave the South Sea Company the exclusive right to transport enslaved Africans to the colonies in the Spanish Americas. Here is how Adam Smith describes this sordid chapter in this history of mercantilism:

“Their [the South Sea Company’s] mercantile projects were not much better conducted. The first trade which they engaged in was that of supplying the Spanish West Indies with negroes, of which (in consequence of what was called the Assiento contract granted them by the Treaty of Utrecht) they had the exclusive privilege. But as it was not expected that much profit could be made by this trade, both the Portuguese and French companies, who had enjoyed it upon the same terms before them, having been ruined by it, they were allowed, as compensation, to send annually a ship of a certain burden to trade directly to the Spanish West Indies. Of the ten voyages which this annual ship was allowed to make, they are said to have gained considerably by one, that of the Royal Caroline in 1731, and to have been losers, more or less, by almost all the rest.” (Smith 1784, p. 63, my emphasis)

Why did the South Sea Company lose money on nine out of ten slave shipments? Smith speculates that it was internal corruption and bad management that led to this state of affairs:

“Their ill success was imputed, by their factors and agents, to the extortion and oppression of the Spanish government; but was, perhaps, principally owing to the profusion and depredations of those very factors and agents, some of whom are said to have acquired great fortunes even in one year.” (Id. at pp. 63-64)

According to Smith, the South Sea Company lost so much money on these slave shipments that it petitioned the British king to let the firm sell off its rights under the Asiento: “In 1734, the company petitioned the king that they might be allowed to dispose of the trade and tonnage of their annual ship, on account of the little profit which they made by it, and to accept such equivalent as they could obtain from the of Spain.” (Id. at p. 64)

In the next paragraph (para. 23), Smith cites another example of the South Sea Company’s bad management:

“In 1724, this company had undertaken the whale-fishery. Of this, indeed, they had no monopoly; but as long as they carried it on, no other British subjects appear to have engaged in it. Of the eight voyages which their ships made to Greenland, they were gainers by one, and losers by all the rest. After their eighth and last voyage, when they had sold their ships, stores, and utensils, they found that their whole loss, upon this branch, capital and interest included, amounted to upwards of two hundred and thirty-seven thousand pounds.” (Id. at p. 64, my emphasis)

But while the South Sea Company was losing money on its Asiento contract and whale-fishery business, it was also lobbying the government for special favors. Smith writes (para. 24):

“In 1722, this company petitioned the Parliament to be allowed to divide their immense capital of more than thirty-three millions eight hundred thousand pounds, the whole of which had been lent to government, into two equal parts: The one half, or upwards of sixteen millions nine hundred thousand pounds, to be put upon the same footing with other government annuities, and not to be subject to the debts contracted, or losses incurred, by the directors of the company in the prosecution of their mercantile projects; the other half to remain, as before, a trading stock, and to be subject to those debts and losses. The petition was too reasonable not to be granted. In 1733, they again petitioned the Parliament that three-fourths of their trading stock might be turned into annuity stock, and only one-fourth remain as trading stock, or exposed to the hazards arising from the bad management of their directors.” (Id.)

After Parliament granted both of these favors, only one-fourth of the company’s stock remained exposed to active trade and potential losses. But the company was so poorly run and so riddled with corruption that it finally ceased to exist in 1748. It was in that year, Smith tells us, that “[a]n end was put to their trade with the Spanish West Indies” and that “the remainder of their trading stock was turned into an annuity stock.” (Id. at pp. 64-65) In short, “the company ceased in every respect to be a trading company.” (Id. at p. 65)

Next (para. 25), Smith concludes his postmortem of the South Sea Company with the following observation:

“It ought to be observed that in the trade which the South Sea Company carried on by means of their annual ship [under the Asiento contract], the only trade by which it ever was expected that they could make any considerable profit, they were not without competitors, either in the foreign or in the home market. At Carthagena, Porto Bello, and La Vera Cruz, they had to encounter the competition of the Spanish merchants, who brought from Cadiz, to those markets, European goods of the same kind with the outward cargo of their ship; and in England they had to encounter that of the English merchants, who imported from Cadiz goods of the Spanish West Indies of the same kind with the inward cargo. The goods both of the Spanish and English merchants, indeed, were, perhaps, subject to higher duties.” (Smith 1784, p. 65)

In other words, the South Sea Company faced some stiff competition from Spanish and English merchants, but it (the South Sea Co.) enjoyed a comparative advantage over them because its competitors had to pay higher duties on the goods and slaves they transported. But in the eloquent and immortal words of Adam Smith: “… the loss occasioned by the negligence, profusion, and malversation of the servants of the company had probably been a tax much heavier than all those duties.” (Id.) Smith then concludes his survey of the South Company with the following sweeping generalization about joint stock companies writ large:

“That a joint stock company should be able to carry on successfully any branch of foreign trade, when private adventurers can come into any sort of open and fair competition with them, seems contrary to all experience.” (Id., my emphasis)

Between the lines, Smith is making a deeper point here: the South Sea Co. was destined to fail not because of external factors but because of its internal business structure: it was a joint stock company with too many shareholders. And why are too many shareholders bad? Because no one shareholder has the incentive to monitor the day-to-day micro-conduct of the company’s agents or the big macro-decisions of the board of directors.

Nota bene: Three down: the Royal African, Hudson’s Bay, and South Sea companies. One to go: the East India Co. We will turn to the East India Company and then wrap up my Adam Smith series next week. (To be continued …)