In The Long Process of Development: Building Markets and States in Pre-industrial England, Spain and their Colonies, my co-author and I show that smugglers in New Spain (current Mexico plus much more) conducted virtually all trade with Europe in the 1600s, including much of the exportation of silver. In fact, it is estimated that in some decades over 50% of the silver sent to Europe was shipped illegally from Mexico. Because this trade was illegal, it didn’t bring about a growing system of laws, rules, & regulations enforceable in a judicial system.
As Douglass North wrote, it is important to have property rights that are internalized in people’s consciousness and unconsciousness, embodied in multi-volume codes of laws and regulations, and enforced by impartial courts and professional bureaucracies. That Mexico did not have because of its smugglers ’ economy.
In principle, the de facto legalization of trade between Mexican ports and the United States during the war with France should have been highly beneficial to the development of a commercial culture in Mexico. It was, in fact, advantageous, but the benefits were limited by the fact that Mexico had few ships on the East coast to use in trade with either the US or anyone else.
An excellent new working paper shows that perhaps illegal trading wasn’t so bad after all, even if it didn’t give rise to good institutions. Daphne Alvarez Villa and Jenny Guarded, in “The Long-Run Influence of Institutions Governing Trade: The Case of Colonial and Pirates’ Ports in Mexico,” show that:
“The presence of trade, either in its legal or illegal form, leads to significantly better development outcomes compared to neighboring areas where such activities were absent.”
They note that conventional wisdom would assume that “smuggling may be detrimental for long-run economic growth and development for numerous reasons: first, by fostering a culture of informality and illegality in detriment of revenue collection; second, the weaker presence of the state may make it difficult to enforce contracts and protect property rights thus depressing economic activity; and finally, colonial smuggling was at times accompanied by piracy and these ports were often subject to armed attacks and pillage, particularly during the 16th and 17th century.”
However, “smuggling during colonial times may have created the necessary conditions to benefit from trade liberalization in the late 18th century (comercio libre) and after independence (1821). For instance, merchants with the “know-how” and experience of clandestine networks had an advantage in the business once trade restrictions were lifted. Such an early start in commercial activities (either legal or illegal) may have compensated for the damaging effects of a weak state presence and supports an emphasis on increasing returns to scale mechanisms.”
The paper is quite good and well worth reading in full.