We are not the first to argue that silver was bad for Spain. Contemporaries already saw American silver as a poisoned chalice. Writing in 1600, Martín González de Cellorigo (1600) observed that
Our Spain has set her eyes so strongly on the business of the Indies, from where she obtains gold and silver, that she has forsaken the care of her own kingdoms; and if she could indeed command all the gold and silver that her nationals keep discovering in the New World, this would not render her as rich and powerful as she would have otherwise been.
There can be no question that in general, many countries around the globe and throughout history suffered from a “resource curse.” Figure 35 illustrates the basic pattern in a cross-section of countries today: growth is systematically lower the higher the share of primary exports in GDP. The resource curse theory’s origins can be traced back to the 1950s’ dependency theory of H. W. Singer (1949) and Raúl Prebisch (1950). The fact that resource abundance and poor economic performance go hand in hand is well documented in the empirical literature.25 The resource curse literature first underscored the deterioration in the terms of trade—a phenomenon labeled “Dutch disease” after the 1970s’ natural gas boom in the Netherlands (Corden and Neary 1982). Yet this rise in the terms of trade is an optimal response: a country that becomes richer will increase its consumption; in the face of a relatively inelastic supply of domestic factors of production, this can only be accomplished through increased imports of traded goods and a corresponding deterioration in the terms of trade. This situation is reversed if the resource abundance disappears; Dutch disease on its own cannot account for long-term economic decline.
FIGURE 35. The resource curse
Instead, the literature offers three alternative explanations. One strand argues that resource-abundant countries invest less abroad and lose out as a result. A second approach emphasizes learning by doing in the traded goods sector (van Wijnbergen 1984; Krugman 1987). Efficiency losses here are a result of agents optimizing their utility and ending up in an equilibrium that is socially suboptimal. Similarly, Patrick Asea and Amartya Lahiri (1999) emphasize the detrimental effects of resource booms on human capital accumulation decisions. A third strand in the literature considers negative political economy externalities, such as greater incentives for rent seeking (Baland and Francois 2000; Torvik 2002). Halvor Mehlum, Karl Moene, and Ragnar Torvik (2006) generalized this approach, introducing institutional quality as a determinant of rent seeking. James Robinson, Ragnar Torvik, and Thierry Verdier (2006) explicitly model the incentives of politicians, as shaped by institutions, as a conduit for the resource curse.26
FIGURE 36. Crown treasure, 1503–1650. Sources: Hamilton 1934; Drelichman 2005.
Spain experienced a resource boom that was large even by modern standards. Silver revenues became significant in the 1540s, and then reached values of 4 million ducats or more in every quinquennium from the 1560s onward. Eventually, imports were so large that the Crown’s share reached more than 2 million ducats per year at its peak, or more than 10 million every five years (figure 36). For comparison, Henry VIII’s sales of confiscated church lands produced revenues of only 375,000 pounds over six years—or no more than 4 million ducats (Hoyle 1995).
How does this resource boom compare with modern-day examples? In table 29, we compare the share of revenue from silver in Castile at the peak (1587–89) with contemporary oil exporters and mineral producers. Castile was never as dependent on silver as Saudi Arabia and Nigeria in 2000–2003 were on oil, but it still generated a higher proportion of revenue from resources than Norway. Compared to the mineral-rich countries, Castile scores near the top; only diamond-exporting Botswana has a higher share of government revenue derived from a mineral resource.
Table 29. Government revenues from hydrocarbon and mineral sources in selected resource-rich countries, as percentage of total fiscal revenue
Source: IMF Guide on Resource Revenue Transparency, June 2005.
Silver had an enormous impact on the economy of Castile, Europe, and indeed the whole world. The silver price differentials between Europe and the Far East stimulated long-distance trade. Some scholars see this period as the “birth of globalization” (Flynn and Giráldez 2004). The bullion that was retained in Europe roughly doubled the monetary stock in the course of a century; the ensuing “price revolution,” a sustained increase in the price level of virtually all European economies, had large effects on fiscal systems, trading arrangements, and monetary institutions (Hamilton 1934; Flynn 1978; Fisher 1989).
The strongest effects of the resource windfall were felt in Castile. The large increase in the supply of silver coupled with the new sources of demand from the Far East prompted factors of production to be diverted from export industries, such as fine wool and manufactures, and into the extraction and service industries associated with the silver trade. This classic case of Dutch disease afflicted Castile for much of the second half of the sixteenth century (Forsyth and Nicholas 1983; Drelichman 2005), but the resource boom had costs in terms of economic as well as political development that went far beyond factor allocation and balance of payments effects.
Silver’s greatest downside was that it weakened the bargaining position of the Cortes vis-à-vis the Crown. Because of silver revenues, Castile’s rulers could spend freely using borrowed funds and effectively present the Cortes with the bill. Throughout the sixteenth century, the Crown resorted twice to the same “hardball” bargaining. It borrowed short term through asientos against silver and other extraordinary revenues, without the Cortes’ consent. As a debt crisis loomed and short-term loans became hard to roll over, it requested increases in ordinary taxation to be able to issue more long-dated juros. Long delays or outright refusals to approve these tax increases would have resulted in a rapid deterioration of the military situation—a political cost that the Cortes was seldom prepared to bear. Also, debt holders in the cities—many of them of elevated social status—were affected by the default and probably saw a tax rise as a much smaller evil than a continued moratorium.
The first such episode was triggered by the suspension of payments of 1575. As we discussed in chapter 4, the proximate cause of rapid borrowing was the flare up of the Dutch Revolt.27 Philip convened the Cortes and requested a threefold increase in the value of the alcabalas sales tax. During the payment suspension, the military situation in the Netherlands deteriorated. The Cortes eventually granted a doubling of the alcabalas with an additional extraordinary levy in the first two years. Despite hard bargaining, the Cortes received no additional control over the Crown’s expenditures.
One might ask whether silver was instrumental in this outcome. Ultimately, the Cortes was forced to grant a tax increase. Couldn’t Philip II have borrowed against these future tax revenues, used the proceeds to lead Castile into the same expensive campaigns, and requested money from the Cortes later? We argue that the nature of the early modern sovereign debt markets ruled out such a scenario. Sixteenth-century monarchs who wanted to venture into the international credit markets had two options. The first one was to hand over control of the revenue sources that guaranteed repayment. This usually happened in the framework of a multiyear arrangement and secured the lowest interest rates. Castilian juros were usually issued under such arrangements.
The second route was uncollateralized, short-term borrowing with high interest. Bankers typically imposed tight credit limits; neither Henry VIII nor Charles V borrowed more than twice their annual revenues. American bullion taxes were paid to the Crown, leading to massive increases in its ability to borrow short term. Genoese bankers would not have lent to Philip II on the chance that the Cortes might later pay; they took a calculated gamble in lending to him because the steady silver flows meant that the Crown would be liquid enough to repay a good part of the loans. Silver allowed borrowing to take place, war to be declared, and Philip to lead Castile into military adventures that left the Cortes with little choice but to grant additional taxes in case events took a
turn for the worse—as they often did. Without silver, Spain’s military adventures under Philip II would almost certainly have been fewer and cheaper.
The second example is similar. After the Armada’s defeat in 1588, Philip again convened the Cortes and requested emergency taxation to protect Castile. The millones, as the new excises were called, departed from earlier practice. The Cortes succeeded in attaching strings to the millones’ renewal (Jago 1981). The scheme consisted of multiyear agreements negotiated between the Crown and Cortes. The new taxes were collected at the local level and, in theory, transferred to the Crown provided that the conditions in the previous agreement had been met. An independent commission staffed by city representatives was to monitor compliance.
The revival of parliamentary authority took place mainly on paper and did not make itself felt in the Crown’s coffers. Although the millones commission repeatedly sought instruments to control the use of the funds, it never gained the ability to restrain the Crown from diverting them to its preferred uses. Starting in the 1620s, the king gradually packed the commission with his own representatives. As the Crown declared its sixth bankruptcy in 1647, the Council of Finance absorbed the commission (Jago 1981). The following year the Peace of Westphalia would mark the end of Castile’s imperial adventures, and usher in a period of internal strife and disintegration of state institutions. The Cortes never recovered the influence it lost; after 1663, it was only convened on ceremonial occasions.
Silver made it harder to strike the mutually advantageous deal that emerged in other countries—a bargain that saw the representative assembly agreeing to greater centralization and higher taxes in exchange for effective oversight as well as control. City-states first overcame the collective bargaining problem and created “consensually strong” executives; the Dutch Republic and England eventually followed suit. Such a bargain could not be struck in Spain, despite false starts. Ultimately, because of silver revenues, the Crown’s hand was just too strong to compromise. A better tax system, funding a more effective executive, would have also been a more equitable system—one that distributed burdens more equally between Castile and the other territories ruled by Philip II, leading to less distortionary taxation within Castile.
DETERMINANTS OF DECLINE
Spain’s decline as an economic and military power is one of the critical themes of early modern history. It has variously been claimed as a case in point by monetary historians emphasizing the negative effects of inflation and terms-of-trade effects, cultural historians arguing for the dilatory effects of enforced insularity, financial historians and macroeconomists highlighting the dangers of default and fiscal overstretch, and institutional economists underlining the dangers of unconstrained, absolutist monarchs.
Compared to the other great European powers after 1500, Spain’s fiscal policy showed no signs of imperial overstretch. We demonstrated that its finances were no worse—and better in a variety of ways—than those of other countries at the height of their power. According to several criteria, Castilian finances were managed with greater probity than even those of Britain, with primary surpluses being maintained during wartime and rapid improvements in the budget position when debts accumulated. There is also no evidence of the supposedly deleterious effects of serial default; after each payment stop, the Crown’s revenues increased, suggesting no decline in fiscal capacity.
Castilian rulers’ despotic powers mainly exist on the movie screen and pages of scholarly journals. It was the weakness of the imperial center, not the omnipotence of Habsburg rulers, that was crucial for economic and political decline—its inability to force through change, centralize, streamline, and tax effectively and evenly (Grafe 2012; Epstein 2000). The failure to build a more capable state on the Iberian Peninsula reflects two underlying weaknesses: initial heterogeneity and the influx of silver. The first made it more costly for the ruler of a composite state to wrest control from local power holders as well as to abolish ancient privileges and freedoms, remove internal customs barriers, and expand the tax net (Gennaioli and Voth 2012). Second, silver revenues were large enough to give the Crown a way out of having to compromise with the Cortes; a consensually strong executive did not emerge west of the Pyrenees because an efficiency-enhancing grand bargain between the representative assembly and ruler was not struck (Drelichman and Voth 2008). The situation was made worse by major strokes of bad luck in the military arena.
1 One of Drake’s soldiers published a sketch of the coat of arms in A Summarie and True Discourse of Sir Francis Drake’s West Indian Voyage (Bigges 1589). The English apparently amused themselves by repeatedly asking the Spaniards to translate the Latin inscription (Parker 2001).
2 In recent years, the decline of Spain in the seventeenth century has continued to attract scholarly attention. For three recent examples, see Kamen 2003; Marcos Martín 2000; Yun Casalilla 2004. Robert Allen (2001) provides a long-run comparative analysis of the economic performance of several European economies, including Spain.
3 This argument is found, for example, throughout the work of Stanley Stein and Barbara Stein (2000, viii), who write, “While Spain’s silver-based transatlantic system at first provided a primary source of Hapsburg preeminence, it was also a basic structure of Spain’s relative political, social, and economic backwardness as the metropole grew dependent on its colonial world.”
4 Robert Barro (1987) argued for Ricardian equivalence. Some authors have considered that “crowding out” was unimportant (Heim and Mirowski 1987), in contrast to the arguments by Jeffrey Williamson (1987) and Peter Temin and Hans-Joachim Voth (2005).
5 See the discussion in chapter 1.
6 For an analytic narrative comparing Castile to other contemporary European nations, see Yun Casalilla 2004.
7 We draw on several sources from the “European State Finance Database” (Bonney 2007) as well as fiscal estimates in other work.
8 Calculated from the data in the “European State Finance Database” compiled by Marjolein ’t Hart (1999).
9 Inferred from figure 1 in Sargent and Velde 1995.
10 We compare the cases of Spain and the United Kingdom in greater depth in Drelichman and Voth 2008.
11 While we are biasing this number downward by taking the effects of the restructurings into account, we show in chapter 4 that even if we added the debt service saved by them back in, the overall numbers would look similar.
12 Note that by 1815, Britain’s ratio was probably much higher; using the debt-to-GDP estimate by Barro (1987) suggests approximately 185 percent. By excluding the period of the Napoleonic Wars, we are biasing our results against finding high fiscal pressure in France and Britain.
13 By the late eighteenth century, this figure was actually lower in France than in Britain, amounting to 52 percent in 1788.
14 Prerevolutionary France also achieved significant primary surpluses under Anne-Robert-Jacques Turgot, if only for a time. See White 1989.
15 For a further discussion of this issue, see Drelichman and Voth 2008; Temin and Voth 2008.
16 In our fiscal accounting exercise in chapter 4, we calculated debt accumulation as a residual of a fiscal identity. Because of this, whenever the primary surplus increases, our estimate of debt accumulation automatically goes down.
17 Our conclusions echo those of White (2001b), who also emphasized that France’s position was nowhere near as poor compared to the British one, as much of the literature has made it out to be.
18 A more subtle argument holds that “absolutist” tax regimes were not predatory as such but instead poorly designed—putting extreme pressure on some activities while exempting others. In this context, strong property rights can be distortionary. This is the contention in Hoffman and Rosenthal 1997. We would argue that these are common difficulties. Many tax systems (including modern ones) have to contend with them. Deviations from the principles of Ramsey taxation may or may not have been more common under the Old Regime, but they are different from predatory behavior and
distortions that come from poor property right protection.
19 It could be claimed that the French Revolution shows that the French model could not work in the long run. We believe that there is more scope for accident in history than this reasoning allows. For example, the final fiscal crisis of the ancien régime could arguably have been avoided if fiscal consolidation had not been abandoned in the 1770s and 1780s (White 2001b).
20 This is not to deny that making Scotland pay was not a trivial act. As late as the 1750s, during the debate of the Scottish bill, the lord chancellor said, “Some method should be taken to make Scotland pay the taxes but could any ministry hit upon that method?” (Walpole 1822).
21 Under an arrangement know as patronato, Spanish kings could appoint bishops; they were effectively political heads of the church in Spain. For further discussion, see chapter 2.
22 María Alejandra Irigoín and Regina Grafe (2008) have called this mode of interaction “bargaining for absolutism.”
23 On the evolution of tax farming and tax collection in England, see also Noel D. Johnson and Mark Koyama (2012).
24 We do not count Wales as an independent predecessor state.
25 See, for example, Sachs and Warner 1995; Auty 2001.
26 For another examination of the institutionally detrimental effects of resource windfalls, see Tornell and Lane (1999).
27 See also Lovett 1980, 1982.
EPILOGUE
FINANCIAL FOLLY AND SPAIN’S BLACK LEGEND
Financial folly. The very words conjure up images of overpaid bankers, venal politicians and ruined savers, economic chaos and disastrous collapses in market confidence. Financial folly is a common explanation for booms and busts, bubbles and irrational exuberance in stock and bond prices. Reinhart and Rogoff’s monumental This Time Is Different puts excessive optimism of financiers at the heart of financial crises. Recurrent crises, in their view, reflect swings in investor sentiment: as good returns accumulate, initially skeptical investors gradually become blue-eyed optimists who start to believe that this time is indeed different. Once a crisis hits, sentiment collapses and extreme pessimism reigns. For decades, risky behavior all but disappears; stability gradually convinces everyone of a new age of high, stable returns. Investors let down their guard, and the cycle repeats.
Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (The Princeton Economic History of the Western World) Page 32
