《国际政治经济学》文献资料（Use of History and Sociology in International Political Economy）The Empire Effect The Determinants of Country Risk in the First Age of Globalization, 1880-1913

The Empire Effect:The Determinants of Country Risk in the First Age of Globalization,1880-1913 NIALL FERGUSON AND MORITZ SCHULARICK This article reassesses the importance of colonial status to investors before 1914 by means of multivariable regression analysis of the data available to contempo- raries.We show that British colonies were able to borrow in London at signifi- cantly lower rates of interest than noncolonies precisely because of their colonial status,which mattered more than either gold standard adherence or the sustain- ability of fiscal policies.The "empire effect"was,on average,a discount of around 100 basis points,rising to around 175 basis points for the underdevel- oped African and Asian colonies.Colonial status significantly reduced the de- fault risk perceived by investors. It was obvious to contemporaries-among them John Maynard LKeynes-that membership in the British Empire gave poor countries access to the British capital market at lower interest rates than would have been required had they been politically independent.For liberal critics of the empire,this "empire effect"seemed detrimental to the economic health of the British Isles,which might otherwise have at- tracted a higher proportion of aggregate investment.Later historians agreed that this was one of the ways in which,by the later nineteenth century,the empire had become a drain on British resources.From the point of the view of the colonies,on the other hand,the ability to raise funds in London at relatively low interest rates must surely have been a benefit-a point seldom acknowledged by critics of imperialism. But did the empire effect actually exist other than in contemporary imaginations?Recent econometric studies of financial markets before the First World War have pointed instead to the gold standard as confer- ring a "good housekeeping seal of approval,"which lowered the bor- The Journal of Economic History,Vol.66,No.2 (June 2006).The Economic History Association.All rights reserved.ISSN 0022-0507. Niall Ferguson is Laurence A.Tisch Professor of History,Harvard University,Minda de Gunzburg Center for European Studies,27 Kirkland St.,Cambridge MA 02138.E-mail: nfergus@fas.harvard.edu.Moritz Schularick is Senior Economist at Amiya Capital,London: and Visiting Lecturer,Free University Berlin;John-F.-Kennedy-Institute,Lansstr.7,14195 Berlin,Germany.E-mail:mschularick@yahoo.de. We are grateful to Nitin Malla for research assistance.We would also like to thank Michael Bordo,Michael Clemens,Warren Coats,Marc Flandreau,Carl-Ludwig Holtfrerich,Trish Kelly. Chris Meissner,Ronald Oaxaca,Thomas Pluemper,Hugh Rockoff,Martin Schueler,Irving Stone,Nathan Sussman,Alan Taylor,Adrian Tschoegl,Marc Weidenmier,and Jeffrey Williamson for comments or assistance with the construction of the dataset.Three anonymous referees provided helpful suggestions. 283

283 The Empire Effect: The Determinants of Country Risk in the First Age of Globalization, 1880–1913 NIALL FERGUSON AND MORITZ SCHULARICK This article reassesses the importance of colonial status to investors before 1914 by means of multivariable regression analysis of the data available to contempo￾raries. We show that British colonies were able to borrow in London at signifi￾cantly lower rates of interest than noncolonies precisely because of their colonial status, which mattered more than either gold standard adherence or the sustain￾ability of fiscal policies. The “empire effect” was, on average, a discount of around 100 basis points, rising to around 175 basis points for the underdevel￾oped African and Asian colonies. Colonial status significantly reduced the de￾fault risk perceived by investors. t was obvious to contemporaries—among them John Maynard Keynes—that membership in the British Empire gave poor countries access to the British capital market at lower interest rates than would have been required had they been politically independent. For liberal critics of the empire, this “empire effect” seemed detrimental to the economic health of the British Isles, which might otherwise have at￾tracted a higher proportion of aggregate investment. Later historians agreed that this was one of the ways in which, by the later nineteenth century, the empire had become a drain on British resources. From the point of the view of the colonies, on the other hand, the ability to raise funds in London at relatively low interest rates must surely have been a benefit—a point seldom acknowledged by critics of imperialism. But did the empire effect actually exist other than in contemporary imaginations? Recent econometric studies of financial markets before the First World War have pointed instead to the gold standard as confer￾ring a “good housekeeping seal of approval,” which lowered the bor￾The Journal of Economic History, Vol. 66, No. 2 (June 2006). © The Economic History Association. All rights reserved. ISSN 0022-0507. Niall Ferguson is Laurence A. Tisch Professor of History, Harvard University, Minda de Gunzburg Center for European Studies, 27 Kirkland St., Cambridge MA 02138. E-mail: nfergus@fas.harvard.edu. Moritz Schularick is Senior Economist at Amiya Capital, London; and Visiting Lecturer, Free University Berlin; John-F.-Kennedy-Institute, Lansstr.7, 14195 Berlin, Germany. E-mail: mschularick@yahoo.de. We are grateful to Nitin Malla for research assistance. We would also like to thank Michael Bordo, Michael Clemens, Warren Coats, Marc Flandreau, Carl-Ludwig Holtfrerich, Trish Kelly, Chris Meissner, Ronald Oaxaca, Thomas Pluemper, Hugh Rockoff, Martin Schueler, Irving Stone, Nathan Sussman, Alan Taylor, Adrian Tschoegl, Marc Weidenmier, and Jeffrey Williamson for comments or assistance with the construction of the dataset. Three anonymous referees provided helpful suggestions. I

284 Ferguson and Schularick rowing costs of the governments of poorer countries regardless of whether they were colonies or not.An alternative hypothesis that has been advanced is that the sustainability of a country's fiscal policy was the prime determinant of market assessments of creditworthiness.Were institutions and investors in the City of London primarily interested in a country's monetary and fiscal policy,regardless of its degree of politi- cal dependence?Or did colonial status have an additional effect on market confidence? It will be seen at once that these things are not easily disentangled because British rule generally implied both currency stability and bal- anced budgets,among other things.This article therefore seeks to reas- sess the importance of colonial status in the eyes of investors before the First World War by means of multivariable regression analysis.We use a new and substantially larger sample of data than previous scholars have used.At the same time,we give priority to variables that we know were available to and heeded by contemporary investors.We show that even when monetary,fiscal,and trade policies are controlled for,there was still a marked difference between the spreads on colonial bonds and those on the bonds issued by independent countries.The main inference we draw is that the empire effect reflected the confidence of investors that British-governed countries would maintain sound fiscal,monetary, and trade policies.We also suggest that British rule may have reduced the endemic contract enforcement problems associated with cross- border lending.Investing in Calcutta was not so different from investing in Liverpool,because both transactions took place within a common le- gal and political framework that served to protect investors'rights.Sov- ereign states,by contrast(and indeed by definition),could not be held to account under English law.This has important implications in the con- text of the emerging consensus among economists that defective politi- cal and legal institutions are one of the major barriers to large,sus- tained,and productive capital flows from rich to poor countries. BRITISH IMPERIALISM AND FINANCIAL GLOBALIZATION BEFORE 1914 Between 1865 and 1914 more than f4 billion flowed from Britain to the rest of the world,giving the country a historically unprecedented and since unequalled position as a global net creditor-"the world's banker"indeed;or,to be exact,the world's bond market.By 1914 total British assets overseas amounted to somewhere between f3.1 and f4.5 See,for example,World Bank,World Development Report 2005

284 Ferguson and Schularick rowing costs of the governments of poorer countries regardless of whether they were colonies or not. An alternative hypothesis that has been advanced is that the sustainability of a country’s fiscal policy was the prime determinant of market assessments of creditworthiness. Were institutions and investors in the City of London primarily interested in a country’s monetary and fiscal policy, regardless of its degree of politi￾cal dependence? Or did colonial status have an additional effect on market confidence? It will be seen at once that these things are not easily disentangled because British rule generally implied both currency stability and bal￾anced budgets, among other things. This article therefore seeks to reas￾sess the importance of colonial status in the eyes of investors before the First World War by means of multivariable regression analysis. We use a new and substantially larger sample of data than previous scholars have used. At the same time, we give priority to variables that we know were available to and heeded by contemporary investors. We show that even when monetary, fiscal, and trade policies are controlled for, there was still a marked difference between the spreads on colonial bonds and those on the bonds issued by independent countries. The main inference we draw is that the empire effect reflected the confidence of investors that British-governed countries would maintain sound fiscal, monetary, and trade policies. We also suggest that British rule may have reduced the endemic contract enforcement problems associated with cross￾border lending. Investing in Calcutta was not so different from investing in Liverpool, because both transactions took place within a common le￾gal and political framework that served to protect investors’ rights. Sov￾ereign states, by contrast (and indeed by definition), could not be held to account under English law. This has important implications in the con￾text of the emerging consensus among economists that defective politi￾cal and legal institutions are one of the major barriers to large, sus￾tained, and productive capital flows from rich to poor countries.1 BRITISH IMPERIALISM AND FINANCIAL GLOBALIZATION BEFORE 1914 Between 1865 and 1914 more than £4 billion flowed from Britain to the rest of the world, giving the country a historically unprecedented and since unequalled position as a global net creditor—“the world’s banker” indeed; or, to be exact, the world’s bond market. By 1914 total British assets overseas amounted to somewhere between £3.1 and £4.5 1 See, for example, World Bank, World Development Report 2005

Empire Effect 285 billion,as against British GDP of f2.5 billion.This portfolio was authen- tically global:around 45 percent of British investment went to the United States and the colonies of white settlement,20 percent to Latin America, 16 percent to Asia and 13 percent to Africa,compared with just 6 percent to the rest of Europe.'Adding together all British capital raised through public issues of securities,as much went to Africa,Asia,and Latin Amer- ica between 1865 and 1914 as to the United Kingdom itself.+ It has been claimed by Michael Clemens and Jeffrey Williamson that there was something of a"Lucas effect"in the period between 1880 and 1914,in other words that British capital tended to gravitate towards wealthy countries rather than relatively poor countries.Yet the bias in favor of rich countries was much less pronounced than it has been in more recent times.In 1997 only around 5 percent of the world's stock of international capital was invested in countries with per capita in- comes of a fifth or less of U.S.per capita GDP.In 1913,according to Maurice Obstfeld and Alan Taylor,the proportion was 25 percent. Very nearly half of all international capital stocks in 1914 were invested in countries with per capita incomes a third or less of Britain's,and Britain accounted for nearly two-fifths of the total sum invested in these poor economies.The contrast between the past and the present is strik- ing.Whereas today's rich economies prefer to"swap"capital with one another,largely bypassing poor countries,a century ago the rich economies had very large,positive net balances with the less well-off countries of the world.8 How important was the empire as a destination for British capital? According to the best available estimates,more than two-fifths(42 per- cent)of the cumulative flows of portfolio investment from Britain to the rest of the world went to British possessions.An alternative measure- the imperial proportion of stocks of overseas investment on the eve of the First World War-was even higher:46 percent.And about half of this amount went to relatively poor British colonies,not to the much 2Cain and Hopkins,British Imperialism,pp.161-63. 3 Maddison,World Economy,table 2-26a. 4 Davis and Huttenback,Mammon,p.46. s According to Clemens and Williamson,"about two-thirds of British foreign investment went to the labor-scarce New World where only a tenth of the world's population lived,and only about a quarter of it went to labor-abundant Asia and Africa where almost two-thirds of the world's population lived":Clemens and Williamson,"Wealth Bias,"p.305.However,see also the different findings in Schularick,"Two Globalizations." Obstfeld and Taylor,"Globalization and Capital Markets,"p.60,figure 10. 7 Schularick,"Two Globalizations,"table 3. 8 Similarly,Schularick and Steger,"Does Financial Integration,"find that financial integration had a positive impact on growth in developing countries before World War I,but not after 1990. The authoritative source for the distribution of British capital exports is Stone,Global Ex- port.See also Schularick,"Two Globalizations,"table 3

Empire Effect 285 billion, as against British GDP of £2.5 billion.2 This portfolio was authen￾tically global: around 45 percent of British investment went to the United States and the colonies of white settlement, 20 percent to Latin America, 16 percent to Asia and 13 percent to Africa, compared with just 6 percent to the rest of Europe.3 Adding together all British capital raised through public issues of securities, as much went to Africa, Asia, and Latin Amer￾ica between 1865 and 1914 as to the United Kingdom itself.4 It has been claimed by Michael Clemens and Jeffrey Williamson that there was something of a “Lucas effect” in the period between 1880 and 1914, in other words that British capital tended to gravitate towards wealthy countries rather than relatively poor countries.5 Yet the bias in favor of rich countries was much less pronounced than it has been in more recent times. In 1997 only around 5 percent of the world’s stock of international capital was invested in countries with per capita in￾comes of a fifth or less of U.S. per capita GDP. In 1913, according to Maurice Obstfeld and Alan Taylor, the proportion was 25 percent.6 Very nearly half of all international capital stocks in 1914 were invested in countries with per capita incomes a third or less of Britain’s, and Britain accounted for nearly two-fifths of the total sum invested in these poor economies.7 The contrast between the past and the present is strik￾ing. Whereas today’s rich economies prefer to “swap” capital with one another, largely bypassing poor countries, a century ago the rich economies had very large, positive net balances with the less well-off countries of the world.8 How important was the empire as a destination for British capital? According to the best available estimates, more than two-fifths (42 per￾cent) of the cumulative flows of portfolio investment from Britain to the rest of the world went to British possessions.9 An alternative measure— the imperial proportion of stocks of overseas investment on the eve of the First World War—was even higher: 46 percent. And about half of this amount went to relatively poor British colonies, not to the much 2 Cain and Hopkins, British Imperialism, pp. 161–63. 3 Maddison, World Economy, table 2–26a. 4 Davis and Huttenback, Mammon, p. 46. 5 According to Clemens and Williamson, “about two-thirds of British foreign investment went to the labor-scarce New World where only a tenth of the world’s population lived, and only about a quarter of it went to labor-abundant Asia and Africa where almost two-thirds of the world’s population lived”: Clemens and Williamson, “Wealth Bias,” p. 305. However, see also the different findings in Schularick, “Two Globalizations.” 6 Obstfeld and Taylor, “Globalization and Capital Markets,” p. 60, figure 10. 7 Schularick, “Two Globalizations,” table 3. 8 Similarly, Schularick and Steger, “Does Financial Integration,” find that financial integration had a positive impact on growth in developing countries before World War I, but not after 1990. 9 The authoritative source for the distribution of British capital exports is Stone, Global Ex￾port. See also Schularick, “Two Globalizations,” table 3

286 Ferguson and Schularick more prosperous areas of white settlement.An obvious hypothesis might therefore be that investors a century ago were more willing to in- vest money in relatively poor countries because a high proportion of these countries were not sovereign states but were under the political control of the investors'own country. Did membership of the British Empire give countries access to the British capital market at lower interest rates than they would have paid as independent states?Contemporaries and an older historical literature had little doubt that it did.Writing in 1924,Keynes noted that "South- ern Rhodesia-a place in the middle of Africa with a few thousand white inhabitants and less than a million black ones-can place an un- guaranteed loan on terms not very different from our own [British]War Loan.”It seemed equally“strange”to him that“there should be inves-. tors who prefer[ed]...Nigeria stock(which has no British Government guarantee)[to]...London and North-Eastern Railway debentures. More recently,Michael Edelstein has argued "that the British capital market treated empire borrowers differently from foreign borrowers." An obvious explanation for an"imperial discount"on bonds issued by British colonies is that they were in some way guaranteed by the British government and therefore in a legal sense indistinguishable from British bonds in terms of default risk.However,Edelstein rejects this expla- nation: Even when London backing and oversight were absent from colonial govern- ment issues...the British capital market charged lower interest rates than com- parable securities from independent nations at similar levels of economic devel- opment....The strong inference is that colonial status,apart from the direct guarantees,lowered whatever risk there was in an overseas investment and that investors were therefore willing to accept a lower retum. Another explanation may lie in the effect of legislation specifically calculated to encourage investors to buy colonial bonds.At the turn of the century,two laws were passed,the Colonial Loans Act (1899)and the Colonial Stock Act (1900),which gave colonial bonds the same "trustee status"as the benchmark British government perpetual bond, the"consol."4 At a time when a rising proportion of the national debt was being held by Trustee Savings Banks,this was an important stimu- lus to the market for colonial securities.5 However,the importance of 10Keynes,“Advice,”pp.204f. 11Edelstein,"Imperialism,"p.205. 2bid,p.206. 13Ibid,Pp.206-07. 14Cain and Hopkins,British Imperialism,pp.439,570.See for a detailed discussion,Keynes. "Foreign Investment,"pp.275-84. is MacDonald,Free Nation,p.380

286 Ferguson and Schularick more prosperous areas of white settlement. An obvious hypothesis might therefore be that investors a century ago were more willing to in￾vest money in relatively poor countries because a high proportion of these countries were not sovereign states but were under the political control of the investors’ own country. Did membership of the British Empire give countries access to the British capital market at lower interest rates than they would have paid as independent states? Contemporaries and an older historical literature had little doubt that it did. Writing in 1924, Keynes noted that “South￾ern Rhodesia—a place in the middle of Africa with a few thousand white inhabitants and less than a million black ones—can place an un￾guaranteed loan on terms not very different from our own [British] War Loan.” It seemed equally “strange” to him that “there should be inves￾tors who prefer[ed] . . . Nigeria stock (which has no British Government guarantee) [to] . . . London and North-Eastern Railway debentures.”10 More recently, Michael Edelstein has argued “that the British capital market treated empire borrowers differently from foreign borrowers.”11 An obvious explanation for an “imperial discount” on bonds issued by British colonies is that they were in some way guaranteed by the British government and therefore in a legal sense indistinguishable from British bonds in terms of default risk.12 However, Edelstein rejects this expla￾nation: Even when London backing and oversight were absent from colonial govern￾ment issues . . . the British capital market charged lower interest rates than com￾parable securities from independent nations at similar levels of economic devel￾opment. . . . The strong inference is that colonial status, apart from the direct guarantees, lowered whatever risk there was in an overseas investment and that investors were therefore willing to accept a lower return.13 Another explanation may lie in the effect of legislation specifically calculated to encourage investors to buy colonial bonds. At the turn of the century, two laws were passed, the Colonial Loans Act (1899) and the Colonial Stock Act (1900), which gave colonial bonds the same “trustee status” as the benchmark British government perpetual bond, the “consol.”14 At a time when a rising proportion of the national debt was being held by Trustee Savings Banks, this was an important stimu￾lus to the market for colonial securities.15 However, the importance of 10 Keynes, “Advice,” pp. 204f. 11 Edelstein, “Imperialism,” p. 205. 12 Ibid., p. 206. 13 Ibid., pp. 206–07. 14 Cain and Hopkins, British Imperialism, pp. 439, 570. See for a detailed discussion, Keynes, “Foreign Investment,” pp. 275–84. 15 MacDonald, Free Nation, p. 380

Empire Effect 287 this legislation should not be exaggerated.The average difference be- tween noncolonial and colonial yields was above 250 basis points be- tween 1880 and 1898 and about 180 basis points between 1899 and 1913-in other words the premium on noncolonial bonds was actually higher before the Colonial Loans Act and Colonial Stock Act came into force.Prior to the First World War,these acts were the only formal en- couragements to investors to favor colonial bonds.16 There are,however,other,less formal reasons why prewar investors may have incorporated an imperial discount when pricing bonds.The Victorians imposed a distinctive set of institutions on their colonies that very likely enhanced their appeal to investors.These extended beyond the Gladstonian trinity of sound money,balanced budgets,and free trade to include the rule of law (specifically,British style property rights)and relatively noncorrupt administration-among the most im- 17 portant "public goods"of late-nineteenth-century liberal imperialism.' Debt contracts with colonial borrowers were more likely to be enforce- able than those with independent states.It would be rather puzzling if investors had regarded Australia as no more creditworthy than Argen- tina,or Canada as no more creditworthy than Chile. For a number of reasons,then,it is possible that the imposition of British rule practically amounted to a"no default"guarantee;the only uncertainty investors had to face concerned the expected duration of British rule.Before 1914,despite the growth of nationalist movements in possessions as different as Ireland and India,political independence still seemed a fairly remote prospect for most subject peoples.At this point even the major colonies of white settlement had been granted only a limited political autonomy.Thus,in the words of P.J.Cain and A.G. Hopkins:"One of the key reasons why the colonies could borrow cheaply [was that]they offered almost complete safety. DETERMINANTS OF BOND SPREADS The possibility exists,nevertheless,that other considerations mat- tered more to investors than the extent to which a country's sovereignty 16It was only after the war that the Treasury and the Bank of England began systematically to give preference to new bond issues by British possessions over new issues by independent for- eign states:see Atkin,"Official Regulation,"pp.324-35. 7Ferguson,Empire,especially chapter 4.A modern survey of 49 countries concluded that common-law countries offered"the strongest legal protections of investors."The fact that 18 of the countries in the sample have the common law system is,of course,almost entirely due to their having been at one time or another under British rule:La Porta et al.,"Law and Finance." See Rostowski and Stacescu,"Wig." 18 Cain and Hopkins,British Imperialism,p.240

Empire Effect 287 this legislation should not be exaggerated. The average difference be￾tween noncolonial and colonial yields was above 250 basis points be￾tween 1880 and 1898 and about 180 basis points between 1899 and 1913—in other words the premium on noncolonial bonds was actually higher before the Colonial Loans Act and Colonial Stock Act came into force. Prior to the First World War, these acts were the only formal en￾couragements to investors to favor colonial bonds.16 There are, however, other, less formal reasons why prewar investors may have incorporated an imperial discount when pricing bonds. The Victorians imposed a distinctive set of institutions on their colonies that very likely enhanced their appeal to investors. These extended beyond the Gladstonian trinity of sound money, balanced budgets, and free trade to include the rule of law (specifically, British style property rights) and relatively noncorrupt administration—among the most im￾portant “public goods” of late-nineteenth-century liberal imperialism.17 Debt contracts with colonial borrowers were more likely to be enforce￾able than those with independent states. It would be rather puzzling if investors had regarded Australia as no more creditworthy than Argen￾tina, or Canada as no more creditworthy than Chile. For a number of reasons, then, it is possible that the imposition of British rule practically amounted to a “no default” guarantee; the only uncertainty investors had to face concerned the expected duration of British rule. Before 1914, despite the growth of nationalist movements in possessions as different as Ireland and India, political independence still seemed a fairly remote prospect for most subject peoples. At this point even the major colonies of white settlement had been granted only a limited political autonomy. Thus, in the words of P. J. Cain and A. G. Hopkins: “One of the key reasons why the colonies could borrow cheaply [was that] they offered almost complete safety.”18 DETERMINANTS OF BOND SPREADS The possibility exists, nevertheless, that other considerations mat￾tered more to investors than the extent to which a country’s sovereignty 16 It was only after the war that the Treasury and the Bank of England began systematically to give preference to new bond issues by British possessions over new issues by independent for￾eign states: see Atkin, “Official Regulation,” pp. 324–35. 17 Ferguson, Empire, especially chapter 4. A modern survey of 49 countries concluded that common-law countries offered “the strongest legal protections of investors.” The fact that 18 of the countries in the sample have the common law system is, of course, almost entirely due to their having been at one time or another under British rule: La Porta et al., “Law and Finance.” See Rostowski and Stacescu, “Wig.” 18 Cain and Hopkins, British Imperialism, p. 240

288 Ferguson and Schularick had been reduced by imperialism.The recent literature on the determi- nants of risk premia has centered on these other factors An alternative approach focuses on monetary policy rather than colo- nial status.Michael Bordo and Hugh Rockoff argued that adherence to the gold standard worked as a credible "commitment mechanism,"reas- suring investors that governments would not pursue time-inconsistent fiscal and monetary policies.Investors rewarded this binding policy commitment by charging-ceteris paribus-lower risk premia.The gold standard worked in this respect as a "Good Housekeeping seal of ap- proval."A commitment to gold convertibility,they calculate,reduced the yield on a country's bonds by around 40 basis points.20 Using a somewhat larger sample,Obstfeld and Taylor confirmed that gold stan- dard membership lowered spreads.21 In this analysis,therefore,it was membership of the informal and voluntary gold "club"rather than membership of the British Empire that lowered the yields paid by some emerging markets.As Obstfeld and Taylor conclude,"Membership in the British Empire was neither a necessary nor sufficient condition for preferential access to London's capital market before 1914.22 As a contingent commitment,however,membership in the gold stan- dard was nothing more than a promise of self-restraint under certain cir- cumstances.Independent countries on gold were not members of some kind of monetary union.They retained the right to suspend convertibil- ity in the event of an emergency such as a war,revolution,or a sudden deterioration in the terms of trade.Such emergencies were in fact quite common before 1914.Argentina,Brazil,and Chile all experienced seri- ous financial and monetary crises between 1880 and 1914.By 1895 the currencies of all three had depreciated by around 60 percent against sterling.This had serious implications for their ability to service their external debt,which was denominated in hard currency (usually ster- ling)rather than domestic currency. A second hypothesis is that investors were primarily interested in the fiscal policies of borrowing countries.Marc Flandreau and Frederic Zumer have recently suggested that the most important risk factors were public debts,the corresponding amount of debt service,and the relation between these burdens and tax revenues.3 They find that,once differ- ences in indebtedness are taken account of,gold standard adherence was insignificant.In addition,they present evidence that contemporary 19Bordo and Kydland,"Commitment Mechanism,"p.56;and Bordo and Schwartz,"Mone- tary Policy Regimes,"p.10. 0 Bordo and Rockoff,“Gold Standard,”p.327. 21 Obstfeld and Taylor,"Sovereign Risk,"p.253. 22Obstfeld and Taylor,"Sovereign Risk,"p.265. 2 Flandreau and Zumer,Making ofGlobal Finance;see also Flandreau et al,"Stability

288 Ferguson and Schularick had been reduced by imperialism. The recent literature on the determi￾nants of risk premia has centered on these other factors. An alternative approach focuses on monetary policy rather than colo￾nial status. Michael Bordo and Hugh Rockoff argued that adherence to the gold standard worked as a credible “commitment mechanism,” reas￾suring investors that governments would not pursue time-inconsistent fiscal and monetary policies.19 Investors rewarded this binding policy commitment by charging—ceteris paribus—lower risk premia. The gold standard worked in this respect as a “Good Housekeeping seal of ap￾proval.” A commitment to gold convertibility, they calculate, reduced the yield on a country’s bonds by around 40 basis points.20 Using a somewhat larger sample, Obstfeld and Taylor confirmed that gold stan￾dard membership lowered spreads.21 In this analysis, therefore, it was membership of the informal and voluntary gold “club” rather than membership of the British Empire that lowered the yields paid by some emerging markets. As Obstfeld and Taylor conclude, “Membership in the British Empire was neither a necessary nor sufficient condition for preferential access to London’s capital market before 1914.”22 As a contingent commitment, however, membership in the gold stan￾dard was nothing more than a promise of self-restraint under certain cir￾cumstances. Independent countries on gold were not members of some kind of monetary union. They retained the right to suspend convertibil￾ity in the event of an emergency such as a war, revolution, or a sudden deterioration in the terms of trade. Such emergencies were in fact quite common before 1914. Argentina, Brazil, and Chile all experienced seri￾ous financial and monetary crises between 1880 and 1914. By 1895 the currencies of all three had depreciated by around 60 percent against sterling. This had serious implications for their ability to service their external debt, which was denominated in hard currency (usually ster￾ling) rather than domestic currency. A second hypothesis is that investors were primarily interested in the fiscal policies of borrowing countries. Marc Flandreau and Frédéric Zumer have recently suggested that the most important risk factors were public debts, the corresponding amount of debt service, and the relation between these burdens and tax revenues.23 They find that, once differ￾ences in indebtedness are taken account of, gold standard adherence was insignificant. In addition, they present evidence that contemporary 19 Bordo and Kydland, “Commitment Mechanism,” p. 56; and Bordo and Schwartz, “Mone￾tary Policy Regimes,” p. 10. 20 Bordo and Rockoff, “Gold Standard,” p. 327. 21 Obstfeld and Taylor, “Sovereign Risk,” p. 253. 22 Obstfeld and Taylor, “Sovereign Risk,” p. 265. 23 Flandreau and Zumer, Making of Global Finance; see also Flandreau et al., “Stability

Empire Effect 289 economic thinking about default risk centered on debt sustainability and the soundness of public finances. A third determinant of risk premia may simply have been political events.According to Ferguson,revolutions,governmental crises and wars were regarded by nineteenth-century investors as increasing the likelihood of defaults by the countries affected.25 Finally,Clemens and Williamson have identified demographic characteristics,natural re- source endowment,and education as significant determinants of yield spreads.26 To determine whether or not membership in the British Empire genu- inely lowered borrowing costs,it is therefore imperative to control for these and other factors.British colonies may simply have been able to borrow at lower rates than other foreign countries because they were on the gold standard,had more sustainable fiscal policies,were less sus- ceptible to political crises,or were simply better situated relative to trade routes and temperate climatic zones. YIELD DATA AND ECONOMIC CONTROL VARIABLES We constructed the largest possible sovereign bond database for the period 1880-1913.Price data for government bonds quoted and traded in the London market were copied by hand from the leading financial publication of the time,the Investor's Monthly Manual.Some addi- tional quotations were taken from the London Stock Exchange Weekly Intelligence,the London Stock Exchange's official weekly gazette.The bonds chosen had to pass three strict criteria to qualify as benchmark is- sues.First,they had to be payable in London in either sterling or gold, enabling us to focus exclusively on country risk and to ignore the cur- rency risk inherent in bonds denominated in other currencies.7 Secondly, 24 Unfortunately,it cannot be excluded that different gold coding is responsible for the in- compatible results.Flandreau and Zumer,Making of Global Finance,used a de facto criterion, i.e.,exchange rate stability over a couple of years,whereas Obstfeld and Taylor,"Sovereign Risk,"looked both at de jure and de facto criteria,following Meissner,"New World Order." 25 See Ferguson,Cash Nexus and"Political Risk." 26 Clemens and Williamson,"Wealth Bias,"table 7,p.322.The authors see colonial status as toreminate Fne d mym opea m mies that issued debt in domestic currency only.The(in)ability of countries to borrow interna- tionally in domestic currency has been explored in detail in the "original sin"literature;see Bordo,Meissner,and Redish,"Original Sin";and Flandreau and Sussman,"Old Sins."For the United States we followed Bordo and Rockoff,"Gold Standard,"by using gold equivalent yields instead of dollar yields.The terms of repayment of U.S.government debt were in doubt: after 1879,all government debt was to be payable in coin-technically silver or gold,but in practice gold.It was not until 1910 that gold was legally declared the only medium of repay- ment in the United States

Empire Effect 289 economic thinking about default risk centered on debt sustainability and the soundness of public finances.24 A third determinant of risk premia may simply have been political events. According to Ferguson, revolutions, governmental crises and wars were regarded by nineteenth-century investors as increasing the likelihood of defaults by the countries affected.25 Finally, Clemens and Williamson have identified demographic characteristics, natural re￾source endowment, and education as significant determinants of yield spreads.26 To determine whether or not membership in the British Empire genu￾inely lowered borrowing costs, it is therefore imperative to control for these and other factors. British colonies may simply have been able to borrow at lower rates than other foreign countries because they were on the gold standard, had more sustainable fiscal policies, were less sus￾ceptible to political crises, or were simply better situated relative to trade routes and temperate climatic zones. YIELD DATA AND ECONOMIC CONTROL VARIABLES We constructed the largest possible sovereign bond database for the period 1880–1913. Price data for government bonds quoted and traded in the London market were copied by hand from the leading financial publication of the time, the Investor’s Monthly Manual. Some addi￾tional quotations were taken from the London Stock Exchange Weekly Intelligence, the London Stock Exchange’s official weekly gazette. The bonds chosen had to pass three strict criteria to qualify as benchmark is￾sues. First, they had to be payable in London in either sterling or gold, enabling us to focus exclusively on country risk and to ignore the cur￾rency risk inherent in bonds denominated in other currencies.27 Secondly, 24 Unfortunately, it cannot be excluded that different gold coding is responsible for the in￾compatible results. Flandreau and Zumer, Making of Global Finance, used a de facto criterion, i.e., exchange rate stability over a couple of years, whereas Obstfeld and Taylor, “Sovereign Risk,” looked both at de jure and de facto criteria, following Meissner, “New World Order.” 25 See Ferguson, Cash Nexus and “Political Risk.” 26 Clemens and Williamson, “Wealth Bias,” table 7, p. 322. The authors see colonial status as significant but less important than these nonpolitical variables. Ibid., p. 319, regressions 6 to 8. 27 This forced us to eliminate France and Germany as well as some smaller European econo￾mies that issued debt in domestic currency only. The (in)ability of countries to borrow interna￾tionally in domestic currency has been explored in detail in the “original sin” literature; see Bordo, Meissner, and Redish, “Original Sin”; and Flandreau and Sussman, “Old Sins.” For the United States we followed Bordo and Rockoff, “Gold Standard,” by using gold equivalent yields instead of dollar yields. The terms of repayment of U.S. government debt were in doubt: after 1879, all government debt was to be payable in coin—technically silver or gold, but in practice gold. It was not until 1910 that gold was legally declared the only medium of repay￾ment in the United States

290 Ferguson and Schularick TABLE 1 SUMMARY STATISTICS OF YIELD DATA.1880-1913 (yield,percent per annum) Observations Mean St.Dev. Minimum Maximum All borrowers 1,461 5.39 2.86 2.86 22.33 Independent countries 909 6.30 3.30 2.97 22.33 Empire borrowers 552 3.89 0.43 2.86 6.35 Sources:Data appendix at http://fas.harvard.edu/--history/facultyPage.cgi?fac-ferguson the selected bonds had to be issued in large volumes and actively traded.Finally,the bonds needed to be long-term,typically of a matur- ity of over ten years,and to have quotations for at least three consecu- tive years. The resulting dataset includes securities from 57 independent coun- tries,colonies,and self-governing parts of the British Empire:in other words,almost the entire universe of foreign borrowing in the London market,reaching not only "from the Cape to Cairo"but also from Bos- ton to Buenos Aires and from Budapest to Beijing.8 The rationale for constructing such a broad sample was to avoid the regional biases that characterized previous studies.Bordo and Rockoff used observations for just ten countries,all either European or American.The two most recent investigations of pre-1914 bond yields by Obstfeld and Taylor and by Flandreau and Zumer were based on samples of around 20 coun- tries.The samples in both cases were predominantly European and American.Quite clearly it is difficult to form robust conclusions about the significance of colonial status without including data for at least some Asian and African countries. Table 1 shows the summary statistics for our current yield series.30 In total,we count about 1,450 observations,roughly 900 for independent countries from Europe,America,Asia,and Africa and about 550 for is- suers from the British Empire,drawn from these four continents as well as Australasia.Immediately obvious from the yield data is the signifi- cantly lower average yield of Empire borrowers (3.89 percent)com- pared with the yields of independent countries(6.30 percent). 28 The complete list of countries and colonies can be found in the data appendix.The coun- tries that were excluded despite the availability of loan quotations fulfilling our criteria were Bolivia,Costa Rica,Paraguay,Honduras,and Cuba as well as some small island empire bor- rowers such as Barbados and Trinidad,mostly for lack of economic control variables. 29 Bordo and Rockoff,“Gold Standard..” 3 We decided to exclude about 20 observations with yields of more than 20 percent,virtually all these refer to Latin American loans that had been in full default for many years.The Annual Reports of the Corporation of Foreign Bondholders indicated that investors reckoned that full repayment was most unlikely in these cases

290 Ferguson and Schularick TABLE 1 SUMMARY STATISTICS OF YIELD DATA, 1880–1913 (yield, percent per annum) Observations Mean St. Dev. Minimum Maximum All borrowers 1,461 5.39 2.86 2.86 22.33 Independent countries 909 6.30 3.30 2.97 22.33 Empire borrowers 552 3.89 0.43 2.86 6.35 Sources: Data appendix at http://fas.harvard.edu/~history/facultyPage.cgi?fac=ferguson. the selected bonds had to be issued in large volumes and actively traded. Finally, the bonds needed to be long-term, typically of a matur￾ity of over ten years, and to have quotations for at least three consecu￾tive years. The resulting dataset includes securities from 57 independent coun￾tries, colonies, and self-governing parts of the British Empire: in other words, almost the entire universe of foreign borrowing in the London market, reaching not only “from the Cape to Cairo” but also from Bos￾ton to Buenos Aires and from Budapest to Beijing.28 The rationale for constructing such a broad sample was to avoid the regional biases that characterized previous studies. Bordo and Rockoff used observations for just ten countries, all either European or American.29 The two most recent investigations of pre-1914 bond yields by Obstfeld and Taylor and by Flandreau and Zumer were based on samples of around 20 coun￾tries. The samples in both cases were predominantly European and American. Quite clearly it is difficult to form robust conclusions about the significance of colonial status without including data for at least some Asian and African countries. Table 1 shows the summary statistics for our current yield series.30 In total, we count about 1,450 observations, roughly 900 for independent countries from Europe, America, Asia, and Africa and about 550 for is￾suers from the British Empire, drawn from these four continents as well as Australasia. Immediately obvious from the yield data is the signifi￾cantly lower average yield of Empire borrowers (3.89 percent) com￾pared with the yields of independent countries (6.30 percent). 28 The complete list of countries and colonies can be found in the data appendix. The coun￾tries that were excluded despite the availability of loan quotations fulfilling our criteria were Bolivia, Costa Rica, Paraguay, Honduras, and Cuba as well as some small island empire bor￾rowers such as Barbados and Trinidad, mostly for lack of economic control variables. 29 Bordo and Rockoff, “Gold Standard.” 30 We decided to exclude about 20 observations with yields of more than 20 percent, virtually all these refer to Latin American loans that had been in full default for many years. The Annual Reports of the Corporation of Foreign Bondholders indicated that investors reckoned that full repayment was most unlikely in these cases

Empire Effect 291 Older research on financial investment in the age of high imperialism looked only at raw yield data,thus leaving open the possibility that lower colonial spreads were a function of better economic "fundamentals" rather than the explicit or implicit guarantees to investors stemming from empire membership.The only way to say for sure that there was an em- pire effect is therefore to regress yield spreads against an appropriate range of additional control variables.The obvious question is which vari- ables to include.In our view,there are powerful methodological objec- tions to the inclusion of anachronistic indicators such as debt to GDP ra- tios.32 Self-evidently,people usually do not base their actions upon concepts that have not yet been invented or upon figures nobody yet cal- culates.33 Rather,if we want to determine how nineteenth-century inves- tors made their decisions,we need to model their behavior deductively on the basis of the data that were available to them at that time.34 The economic data were collected from primary and secondary sources.5 As anyone familiar with the financial press of the period knows, there was a plethora of publications available to investors.Standard refer- ence publications such as Fenn's Compendium,the Investor's Monthly Manual (henceforth IMM),the Stock Exchange Weekly Intelligence and the Corporation of Foreign Bondholders Annual Reports collected and ana- lyzed statistical data on government borrowers in a manner not unlike that of the handbooks on equity investments pioneered by Moody's in the United States.In addition to this dedicated financial press,there was a rap- idly growing number of more general statistical publications.3 31 See Davis and Huttenback,Mammon;and Edelstein,Overseas Investment and"Imperialism." 32 Bordo and Rockoff,"Gold Standard";and Obstfeld and Taylor,"Sovereign Risk." 3This point was advanced in Ferguson and Batley,"Event Risk"and in Ferguson,Cash Nexus,pp.285f.For a more recent development of this theme,see Flandreau and Zumer,Mak- ing ofGlobal Finance,pp.30-35. This is a practical as well as methodological issue.A lot of financial investment went to countries for which no modern GDP reconstructions exist.A more practical problem discussed in greater detail in Schularick,"Two Globalizations,"is the limited comparability of the GDP reconstructions. 35 Special gratitude is due to Trish Kelly,Peabody College,Vanderbilt University,for sharing unpublished data collected from the Corporation of Foreign Bondholders'Annual Reports.Addi- tional data were gathered from historical collections,mainly from the three volumes by Mitchell, Historical Statistics,if the figures were also available to historical investors.For some indicators, we made use of Arthur Banks's Cross-National Time Series Database.Professor Banks confirmed to us in mail correspondence that all pre-1913 indicators we used for our study were originally collected from The Statesman's Yearbook.For some countries,we were happy to rely on material collected by Michael Bordo,Chris Meissner,Maurice Obstfeld,Hugh Rockoff,Nathan Sussman, and Alan Taylor.Despite this collective effort,some gaps in the dataset remained. 36 Having spent considerable time on the collection of late-nineteenth and early-twentieth- century economic data,we found the quantity of indicators available to contemporary investors to be less of a problem than their mixed quality.Indeed,for most countries we found more than one series for the same indicator.Although it was rare that two series turned out to be com- pletely incompatible,differences of the order of 10 percent were not uncommon.The story the

Empire Effect 291 Older research on financial investment in the age of high imperialism looked only at raw yield data, thus leaving open the possibility that lower colonial spreads were a function of better economic “fundamentals” rather than the explicit or implicit guarantees to investors stemming from empire membership.31 The only way to say for sure that there was an em￾pire effect is therefore to regress yield spreads against an appropriate range of additional control variables. The obvious question is which vari￾ables to include. In our view, there are powerful methodological objec￾tions to the inclusion of anachronistic indicators such as debt to GDP ra￾tios.32 Self-evidently, people usually do not base their actions upon concepts that have not yet been invented or upon figures nobody yet cal￾culates.33 Rather, if we want to determine how nineteenth-century inves￾tors made their decisions, we need to model their behavior deductively on the basis of the data that were available to them at that time.34 The economic data were collected from primary and secondary sources.35 As anyone familiar with the financial press of the period knows, there was a plethora of publications available to investors. Standard refer￾ence publications such as Fenn’s Compendium, the Investor’s Monthly Manual (henceforth IMM), the Stock Exchange Weekly Intelligence and the Corporation of Foreign Bondholders Annual Reports collected and ana￾lyzed statistical data on government borrowers in a manner not unlike that of the handbooks on equity investments pioneered by Moody’s in the United States. In addition to this dedicated financial press, there was a rap￾idly growing number of more general statistical publications.36 31 See Davis and Huttenback, Mammon; and Edelstein, Overseas Investment and “Imperialism.” 32 Bordo and Rockoff, “Gold Standard”; and Obstfeld and Taylor, “Sovereign Risk.” 33 This point was advanced in Ferguson and Batley, “Event Risk”; and in Ferguson, Cash Nexus, pp. 285f. For a more recent development of this theme, see Flandreau and Zumer, Mak￾ing of Global Finance, pp. 30–35. 34 This is a practical as well as methodological issue. A lot of financial investment went to countries for which no modern GDP reconstructions exist. A more practical problem discussed in greater detail in Schularick, “Two Globalizations,” is the limited comparability of the GDP reconstructions. 35 Special gratitude is due to Trish Kelly, Peabody College, Vanderbilt University, for sharing unpublished data collected from the Corporation of Foreign Bondholders’ Annual Reports. Addi￾tional data were gathered from historical collections, mainly from the three volumes by Mitchell, Historical Statistics, if the figures were also available to historical investors. For some indicators, we made use of Arthur Banks’s Cross-National Time Series Database. Professor Banks confirmed to us in mail correspondence that all pre-1913 indicators we used for our study were originally collected from The Statesman’s Yearbook. For some countries, we were happy to rely on material collected by Michael Bordo, Chris Meissner, Maurice Obstfeld, Hugh Rockoff, Nathan Sussman, and Alan Taylor. Despite this collective effort, some gaps in the dataset remained. 36 Having spent considerable time on the collection of late-nineteenth and early-twentieth￾century economic data, we found the quantity of indicators available to contemporary investors to be less of a problem than their mixed quality. Indeed, for most countries we found more than one series for the same indicator. Although it was rare that two series turned out to be com￾pletely incompatible, differences of the order of 10 percent were not uncommon. The story the

292 Ferguson and Schularick The subtitle of the 1898 edition of Fenn's Compendium,the self- proclaimed "doyen of all financial books of reference,"neatly summa- rizes what economic indicators the City of London had access to:it was "a handbook of public debts containing details and histories of debts, budgets and foreign trade of all nations,together with statistics elucidat- ing the financial and economic progress and position of various coun- tries."37 In many respects,the main problem for contemporaries was not so much the raw data in the numerator-whether public debts,debt ser- vice charges,or exports-but the denominator.In the absence of a di- rect measure of a nation's output such as gross national product,a con- cept then its infancy,it was far from easy to compare the fundamental resources of different countries.Population was generally acknowl- edged to be an unreliable choice,though it had the advantage of being readily available,thanks to fairly regular and accurate censuses,and was often used to denominate export capacity.However,in more so- phisticated analyses of fiscal sustainability,the debt burden tended to be related to public revenues or to export earnings.3 The same was true of budget and trade balances. Drawing on the records of the Service d'Etudes Financieres of the Credit Lyonnais,Flandreau and Zumer have suggested that debt service to revenue was the contemporary indicator that best measured the cred- itworthiness of borrowers.39 However,for a number of reasons we chose to stick to the more traditional debt to revenue ratio.First,in con- temporary statistical publications,the overall debt burden was far more frequently given,and was also,it seems,less frequently subject to revi- sions.Secondly,as the debt service itself is determined by the interest rate,it is questionable whether it should be used as an independent vari- able to estimate the interest rate.Nevertheless,we can also work with debt service data for a far larger number of countries than previous stud- ies and will show that our key findings do not depend on the choice of a particular fiscal measure. Another indicator watched by contemporaries was the budget deficit to revenue ratio.As Cain and Hopkins have argued,the principles of "Gladstonian finance"-which aimed at budget surpluses during peace- sources tell is that of a market driven not so much by short-term economic information,but by knowledge of long-term structural trends supplemented by short-term political news from which npt e tor coyindicator Be- vised editions of Fenn's Compendium were published in 1883,1889,1893,and 1898.Unfortu- nately,the series was then discontinued,apparently because the main contributor,Robert Nash, emigrated to Australia. For a further discussion of contemporary risk analysis see Flandreau and Zumer,Making of Global Finance. 3 Flandreau and Zumer,Making of Global Finance,p.31

292 Ferguson and Schularick The subtitle of the 1898 edition of Fenn’s Compendium, the self￾proclaimed “doyen of all financial books of reference,” neatly summa￾rizes what economic indicators the City of London had access to: it was “a handbook of public debts containing details and histories of debts, budgets and foreign trade of all nations, together with statistics elucidat￾ing the financial and economic progress and position of various coun￾tries.”37 In many respects, the main problem for contemporaries was not so much the raw data in the numerator—whether public debts, debt ser￾vice charges, or exports—but the denominator. In the absence of a di￾rect measure of a nation’s output such as gross national product, a con￾cept then its infancy, it was far from easy to compare the fundamental resources of different countries. Population was generally acknowl￾edged to be an unreliable choice, though it had the advantage of being readily available, thanks to fairly regular and accurate censuses, and was often used to denominate export capacity. However, in more so￾phisticated analyses of fiscal sustainability, the debt burden tended to be related to public revenues or to export earnings.38 The same was true of budget and trade balances. Drawing on the records of the Service d’Études Financières of the Crédit Lyonnais, Flandreau and Zumer have suggested that debt service to revenue was the contemporary indicator that best measured the cred￾itworthiness of borrowers.39 However, for a number of reasons we chose to stick to the more traditional debt to revenue ratio. First, in con￾temporary statistical publications, the overall debt burden was far more frequently given, and was also, it seems, less frequently subject to revi￾sions. Secondly, as the debt service itself is determined by the interest rate, it is questionable whether it should be used as an independent vari￾able to estimate the interest rate. Nevertheless, we can also work with debt service data for a far larger number of countries than previous stud￾ies and will show that our key findings do not depend on the choice of a particular fiscal measure. Another indicator watched by contemporaries was the budget deficit to revenue ratio. As Cain and Hopkins have argued, the principles of “Gladstonian finance”—which aimed at budget surpluses during peace- sources tell is that of a market driven not so much by short-term economic information, but by knowledge of long-term structural trends supplemented by short-term political news from which investors apparently inferred fiscal and monetary policy changes. 37 Fenn’s Compendium is probably the best overall source for country-risk indicators. Re￾vised editions of Fenn’s Compendium were published in 1883, 1889, 1893, and 1898. Unfortu￾nately, the series was then discontinued, apparently because the main contributor, Robert Nash, emigrated to Australia. 38 For a further discussion of contemporary risk analysis see Flandreau and Zumer, Making of Global Finance. 39 Flandreau and Zumer, Making of Global Finance, p. 31