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Research
Feature
What impacts from war and high debt?
Some surprising lessons from history
High debt levels and violent conflicts are two of the
themes that have been dominating the headlines
for months. It goes without saying that both are
seen as indicators of failure or decline. But as
economic historian Hans-Joachim Voth shows, this
does not always hold true. On the contrary, there
were times when military conflict acted as an en-
gine for development and high debt levels spurred
economic growth.
The relationship between conflict and development
is the focus of Voth’s new article
State Capacity
and Military Conflict
(co-authored with Nicola
Gennaioli). By analyzing a wealth of data from the
sixteenth to the early nineteenth centuries, he
comes up with a rather bleak overall picture:
Europe was characterized by high debt, drastic
increases in tax rates, and long and expensive
wars. The situation looked particularly dramatic
for Britain: Between 1692 and 1815, Britain was
involved in wars abroad in two out of every three
years. Following the Glorious Revolution of 1688,
Britain’s sovereign debt increased dramatically,
from 5% in 1700 to 200% in 1820 (see Fig. 1).
Tax rates also increased rapidly, but not quickly
enough to keep pace with the increased expendi-
tures.
However, readers well versed in history will be
aware of the fact that the very same time period
also saw the emergence of both the modern state
and the Industrial Revolution. The leading nation
in both developments? Britain. How can these
unexpected patterns be explained?
States made war, and war made states
From the sixteenth century onwards, the so-called
"Military Revolution" started to fundamentally
change the way European powers waged wars:
Gunpowder was invented, the legions of merce-
naries from the Middle Ages were replaced by more
professional, standing armies, and on top, these
armies became much larger. All of these develop-
ments increased the cost of equipping and main-
taining armies, so that money became an evermore
dominating factor. As a result, only rulers who
could procure large funds – either by creating an
efficient tax system or by being able to borrow large
sums – could hope for military success.
Because the ability to finance war was now key for
survival, armed conflicts forced monarchs to create
large funding bases, more professional bureaucra-
cies, and better legal institutions – in other words,
to lay the foundations for modern states as we
know them today.
However, this growth in state capacity was highly
uneven. It was the already stronger, less fragmented
powers that were able to invest more in greater state
capacity, while weaker powers rationally dropped
out of the competition. Britain, France, and Prussia
belonged to the strong, cohesive states, while Spain
and Poland were unable to build-up their state
capacity decisively. These divergences led to dra-
matic differences in military clout and determined
their political fate.
Sovereign debt may be good if financial markets are
dysfunctional
Britain was a case in point for the link between
state capacity and success in the battlefield. How-
ever, as Britain raised most of its funds in the form
of government bonds, its debt levels had reached
an eye-watering 200% of GDP (see Fig. 1) when it
defeated Napoleon at the Battle of Waterloo. While
such prolific fund-raising was a crucial factor for its
military success, surely though such debt levels must
have been a huge drain on the country’s economy.
"Wrong again," seems to be the answer we get
from another one of Voth’s research projects. In the
working paper
Debt into Growth: How sovereign
debt accelerated the first industrial revolution
, Voth
and his co-author Jaume Ventura argue that
At that time, England was characterized by a dys-
functional financial market. The banking sector was
still small, inefficient, and burdened with restrictions
on credit provision (for example by the usury laws).
Additionally, the South Sea Bubble that had struck
Britain’s stock market in 1719 led to the introduc-
tion of heavy-handed regulations that henceforth
stifled the country’s capital markets severely. This
meant that the new and highly profitable technolo-
gies – cotton manufacturing, iron production, coal
high sovereign debt may actually
have accelerated structural change
and economic growth in eighteenth-
century Britain.