Comparative Advantage and Colonial Monopoly: The Political Economy of Exclusive Trading Companies

This paper analyzes a central colonial institution: the monopolization of foreign trade through exclusive trading companies. We interpret this arrangement as an economic institution that creates a wedge between domestic and international prices—effectively an export tax—allowing metropolitan intermediaries to extract rents from colonial trade. Our primary theoretical contribution demonstrates that the economic and political consequences of this institutional form depend systematically on the structure of comparative advantage between the metropolis and the colony. While colonial export taxation unambiguously worsens the colony’s effective terms of trade, its effect on the metropolis is conditional. When the colony and metropolis are competitors—sharing a comparative advantage in the same sector—a colonial export tax can improve the metropolis’s terms of trade. Conversely, when they are complementary—specializing in different sectors—the same policy can deteriorate the metropolis’s terms of trade by raising the cost of imported inputs. Because these terms-of-trade movements generate distinct distributive effects, the colonial monopoly reshapes political coalitions within the metropolis, influencing whether exclusive trading companies persist or are dismantled. We formalize this mechanism in a parsimonious general equilibrium model and illustrate it through the historical experience of Great Britain, India, and the East India Company (EIC), presenting the EIC as a salient instance of a broader institutional logic.