Lending to the Borrower from Hell: Debt, Taxes, and Default in the Age of Philip II (The Princeton Economic History of the Western World)

by Mauricio Drelichman

  Spain’s economic Black Legend is so powerful because the string of bankruptcies under Philip II seemingly bear witness to the disregard for property rights and due process as well as the willful breaking of contracts. Serial default, seen through this lens, showed the absolutist colors of Habsburg Spain, incompetence of its rulers, and unsustainable nature of fiscal excesses. In the work of Carmen Reinhart, Kenneth Rogoff, and Miguel Savastano (2003), Spain emerges as the record holder in terms of defaulting—the key example for their argument that once a default occurs, the next one is more likely because a country’s fiscal infrastructure suffers and the economy declines, undermining sustainability.

  We are not the first to point out the many incongruities in this picture. Our analysis demonstrates that serial defaults did not damage Spain’s fiscal capacity; indeed, they had remarkably few negative effects. As far as the documentary record can tell, it is likely that defaults were anticipated and constituted part of an efficient risk-sharing structure: in good times, bankers were paid well for lending to the Crown, and in bad times, the king could postpone payments or even renegotiate his debts without violating the implicit contract. The fact that the same banking dynasties lent to Philip II throughout his reign—with no sign of any major lenders exiting, contrary to Braudel’s claims—speaks powerfully in favor of our interpretation. Also, the absence of any change in interest rates after the 1575 default (the largest of Philip’s reign) again suggests that lenders did not learn anything negative about the Crown’s behavior or financial situation as a result of the payment stop.

  We are not the first to point out that the institutionalist interpretation suffers from further weaknesses. The economic slowdown of Spain after 1600 is largely a Castilian phenomenon; most other regions under Habsburg rule performed well.6 During the sixteenth century, Castile also showed a remarkable degree of economic dynamism—at the very moment when it was allegedly overtaxed and misgoverned the most. Recent research by Alvarez Nogal and Prados de la Escosura (2007) indicates that per capita incomes expanded between 1500 and 1600, and that population increased rapidly. It was only after 1600 that these growth rates declined, before eventually turning negative. More recently, Grafe (2012) also reassessed the power of the Castilian Crown, reevaluating measures of market integration and economic performance during the early modern period.

  If neither imperial overstretch (Kennedy 1987) nor the willful breaking of contracts was to blame for Spain’s eventual loss of momentum, then what was responsible? Modern-day economic theory argues that institutions conducive to growth should deliver a strong state with a constrained executive (Acemoglu 2005). We argue that imperial Spain’s difficulties do not reflect the evils of an unconstrained executive and were more about the failure to build a consensually strong state—one where those paying taxes gained some degree of control over expenditure in exchange for massively higher contributions. Taxation, while high in Castile, was often low in Aragon, Navarre, Portugal, and the Crown’s other territories—and the resulting inefficiencies did much to misallocate resources. Recent research has pointed out just how economically damaging Spain’s internal fragmentation was. A more successful state could have implemented a tax regime that followed Ramsey’s rule, lowered taxes on Castile, raised them in other territories on the Iberian Peninsula, and abolished internal customs barriers. In our view, the inability to raise state capacity must ultimately be traced back to a resource windfall—silver. It kept the Crown fiscally sound without the need to strike a bargain that would have helped to build a stronger, more capable state in the long run.

  1 For an exception, see the evidence in Tomz 2007.

  2 For a detailed examination of the nature of this bargain, see Gennaioli and Voth 2012.

  3 The term “Black Legend” as well as its critical assessment was introduced in the scholarly literature by Julián Juderías (1914).

  4 For later work on the effect of silver on Spain’s competitiveness, see Forsyth and Nicholas 1983; Drelichman 2005.

  5 A variant of the economic history version of the Black Legend underscores the moral and cultural shortcomings of the Spanish people as a leading cause of economic decline. This view was articulated most recently by David Landes (1998).

  6 The causal effect is likely less; Ugo Panizza and Eduardo Borensztein (2008) estimate it at around 1 percent, similar to the decline in growth rates in countries with debt crises found by Reinhart and Rogoff (2009).

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