Since Max Weber, Confucianism has been widely viewed as being in opposition to capitalist or modern growth in historical China, especially in comparison with the rise of Western Europe after the Protestant Reformation. In pre-19th century China, the absence of industrialization or capitalism is partially attributed to the conservative nature of Confucian culture, particularly the emphasis on the ‘adjustment’ to the world and the depreciation of pursuing wealth, among others. And perhaps more importantly, the clan as a tangible organization of Confucianism restricted interpersonal cooperation to the family or lineage scope. Such ‘kinship-based morality’, in contrast to the ‘generalised morality’ enforced by market institutions in the West, paved the way for China’s divergent developmental path from the West.
In a recent study, Zhiwu Chen, Andrew Sinclair, and I find another channel through which Confucianism inhibits capitalism: competition in financial markets. By providing a well-functioning ‘internal financial market’, the Confucian clan minimized the demand for external finance in traditional China. Consequently, not only did arm’s-length finance not endogenously develop in China, it was hampered by the pre-existing clan finance when it was introduced to China in the late 19th century.
Clan finance is entrenched in the risk-mitigation nature of Confucianism. To deal with the prevailing survival risks in a pre-industrial society, the Chinese chose to rely on biological kinship to establish a rigid social order. To this end, Confucius (551–479 BCE) and his successors prescribed many rules that entail each person’s position in a stratified family and society. The position was assigned to a set of obligations and responsibilities that remained unchanged for life. So, from the very beginning, Confucianism prioritized stability over ‘development’. For this purpose, Confucianism aimed to hedge various life-threatening risks by intra-kinship resource pooling and risk sharing.
From the 10th century on, Confucian scholars and imperial authorities popularised the Confucian way of life, especially the rule of clan, to all social strata. People were encouraged (and instructed) to construct ancestral halls, compile genealogy books, and practice periodic ancestor-worship rituals. The Confucian clan became a dominant social organization and, accordingly, played a pivotal role in resource pooling and risk sharing for its members.
For instance, by owning land and other rental properties, many clans established funds in support of their children’s education (aiming to achieve high civil exam qualifications), maintained private granaries for disaster and poverty relief, and provided loans for business and other financial needs at negligible interest rates. In many cases, a clan’s ancestral hall functioned as a corporate entity similar to a British trust. Such internal financial services were effectively enforced by blood ties and the rigid Confucian rules of filial piety, loyalty and subordination.
The Long Shadow of the Confucian Clan
Confucianism worked so well in risk mitigation that China could sustain steady population growth from circa the 14th century, a time when Confucianism had been institutionalized as state orthodoxy. However, the success of Confucianism rendered Chinese elites capable of ignoring the development of the impersonal, contract-based institutions that are crucial for modern finance. Why indeed? Confucianism had solved most if not all financial needs before the Industrial Revolution. As a result, when modern banks, joint-stock (limited-liability) corporations, and securities markets were transplanted from the West to the Celestial Empire in the late 19th century, they were largely substitutable competitors with the clan incumbents. Where Confucian clans dominated and functioned well, modern finance would find a higher entry cost.
By analyzing data on the distributions of Confucian clans and modern banks across 283 Chinese prefectures in 1897 to 1936, we find a significant negative relation between the number of clans and the number of banks. We use the genealogy book as the proxy for clan, and instrument its geographic distribution using the distance to Zhu Xi’s (1130–1200 CE) teaching places―the fountainheads of the clan culture. After controlling for the underlying factors that bear upon the distributions of both clans and banks, we find that fewer modern banks were started in regions where Confucian clans dominated. Doubling the number of clans reduces the number of banks by about 13%.
The negative effect of Confucianism on modern finance works through the resource-pooling activities within the clan. We find that there are more clan lending in regions where more genealogy books were compiled. Moreover, given that the clans had provided enough intermediation between members, the interest rates on loans in regions with strong clans were significantly lower. This suggests that Confucianism depressed the price of external capital by reducing the demand for it.
Certainly, modern finance should outperform Confucian clans in the scale of resource pooling and risk mitigation. Why did Chinese gentry and patriarchs not adopt advanced financial institutions? A possible reason is that the marginal benefits of modern finance may not exceed the switching costs (from clan to bank), especially when and where financial needs were not that high. But ultimately, with sustained industrialization and modernization in the 20th century, the market would win in the competition with kinship. Indeed, modern banking had expanded to 70% of cities in China proper by 1936.
That said, given the persistence nature of culture, Confucianism still sheds a long shadow on contemporary financial markets. In regions with an ever strong presence of Confucian clans, people still less prefer to borrow money from banks, and the share of banking business in local GDP is also smaller, relative to regions with a weak clan presence.