University of Cambridge > > Global Economic History Seminar > Democracy, Autocracy and Sovereign Debt: How Polity Influenced Country Risk in the First Financial Globalisation

Democracy, Autocracy and Sovereign Debt: How Polity Influenced Country Risk in the First Financial Globalisation

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This article tests the hypothesis that democratic regimes produce better borrowers because of the effectiveness of the legislative to limit the power of the executive to credibly commit to its contracts. We test this democratic advantage hypothesis during the first financial globalisation, from circa 1880 to 1914, for 27 independent peripheral (capital-importing) countries that borrowed in London. We regress the sovereign risk premium on indicators of political regime type derived from The Statesmen’s Yearbook, a contemporary publication, and the Polity IV project. We control for variables that capture political stability and economic conditions. The results show that democracies were penalised with a higher risk premium. Moreover, political stability decreased the cost of borrowing. Yet interactions between these variables suggest that creditors marginally preferred democracies in peaceful countries. Moreover, international financial controls and the association with Rothschilds reduced the sovereign risk premium only in autocratic regimes. We deal with endogeneity by lagging years of domestic political stability in three decades and by using it as an instrument of current years of domestic political stability. At odds with the mainstream literature, we conclude that autocracies performed better than democracies in the world financial markets before 1914 because they promoted political stability.

This talk is part of the Global Economic History Seminar series.

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