Wednesday, 17 June 2015

Financing steady disbursements with a credit line and an option for long-term funded debt: an asiento of Philip II

Philip II of Spain
Philip II ruled the first global empire with the limited state resources of the early modern age. As for any state before Waterloo, expenditures were mostly military. The celebrated silver and gold from the Americas were no more than 20 percent of his revenues, and a bit less in the first half of his reign. The fleet, a convoy, brought the precious metals once a year in the early Fall but the quantity was highly variable and unpredictable. The most stable part of the revenues (about a third) was raised through sales taxes that were controlled by the main cities of Castile. The rest was collected by scattered sources, tax farming, ad hoc contributions of the Church, etc... And in this state building period, there was no administration for the collection, monitoring and enforcement of taxation. In order to bridge the gap between expenditures, at designated locations and timings, and these erratic and scattered sources, Philip II used financial contracts, asientos.

In a new EHES working paper, Carlos Álvarez-Nogal and Christophe Chamley analyze a contract that provides a splendid illustration of this matching between regular expenditures, erratic revenues from the fleet and scattered but stable local revenues. The contract also provides an example of smooth conversion of short-term debt into long-term funded debt, long before the debt refinancings in England.

The asiento, a financial contract used
by Philip II
The method of investigation of Álvarez-Nogal and Chamley is grounded on a careful and thorough examination of all the documents that are available in the archives of Simancas, which were set by Philip II himself. These archives contain extraordinary details in the contract (14 pages), in the attachments (47 pages) next to the contract, with the reports of the monitoring royal accountants, and, in a different part of the archives, in the audits that were done years later by the Chamber of Accounts (more than 350 pages). From the archives a new and logical structure of the contract emerges that completely contradicts the data reporting and cash-flow method by Drelichman and Voth (2011) about the same contract.

The Maluenda brothers were successful merchants from Burgos who used their network in trade to develop financial activities. On July 13, 1595, they signed an asiento that committed them to deliver twelve monthly disbursements, of 27,000 ducats each (the first was doubled), in Lisbon. (For simplicity, all the numbers are rounded here. The exact numbers are reported in the paper). The total was therefore 350,000  ducats which is in the upper range of asientos for that period. To put this amount in perspective, a total of 5 million ducats of asientos for a given year would be high, the revenues of the Crown, net of Americas' income, were about 10 million ducats,  and GDP per capita in Castile was probably not lower than 2  ducats per month.

The financing of the disbursements (350,000 ducats) was divided in three parts. First, the Crown made an immediate cash payment for the disbursements until August:  75,000 ducats was paid from the royal coffers in Madrid which the bankers had to deliver in Lisbon as soon as possible. This transfer may have been used for urgent or start-up costs.

The credit part of the contract was therefore only for 275,000 ducats. This part operated like a credit line today with a monthly interest of one percent. The contract identified sources of revenues on which it had first claim. The Crown had much flexibility for the use of these sources of revenues and for the timing of the repayments. Whatever the choices of the Crown, a central and repeatedly emphasized principle of the contract was that an interest of one percent had to be charged on the balance due in each month. The rich documentation shows that this principle was strictly applied.
The repayment of the principal of the credit was divided in two tranches, which can be called here Tranche A for 100,000 ducats, and Tranche B for 175,000 ducats. (In addition, interests would have to be paid). Tranche A paid for, roughly, the rest of the monthly disbursements in Lisbon until the end of the year 1595, while Tranche B paid for the disbursements of the following year, until June. The contract devotes much space to the explicit connection between tranche and disbursements.
Each tranche had a first claim on the incom
Lisbon in the early modern period
e of the fleet of its year, the fleet of 1595 for Tranche A, and the fleet of 1596 for Tranche B. However, and this is the most interesting part of the contract, the Maluendas could also collect Tranche B by the sale of long-term funded debt instruments on behalf of the Crown, and they could choose the source of funding. These were to be taken from a menu: annuities on one head, to be chosen by the banker, at 14%, on two heads at 12%, perpetuals at 7% or 6%, and claims on the Casa de Contratación that managed the Crown's revenues from the Americas. Such were the terms of the asiento in the archives. The application of the contract is described in minute details by its attachments and by the final report of the Chamber of Accounts (Contaduria Mayor de Cuentas).

The Maluenda brothers exercised the option soon after the signature of the contract and, not surprisingly, in the menu of instruments, they selected almost exclusively the annuities on two heads. The sales proceeded briskly and were recorded, following a contractual requirement, in trimestral reports, with the names of the buyers, amounts of each annuity and dates of sale. (All this data is in the attachments).

The asiento illustrates the remarkable flexibility of the credit line with a monthly fixed interest rate. The fast sales of the annuities, even before the bankers had made any disbursement on Tranche B (about 105,000 of ducats sold at the end of 1595, before the disbursement of Tranche B), had freed the fleet of 1596 from the claims of Tranche B. It was therefore decided to shift 40,000 ducats in Tranche A from the fleet of 1595 to the fleet of 1596. The payments from the fleet of 1595 were staggered, beginning in December 1595. The attachments to the contract report the careful computations of the royal accountants about the interest on the balance due, prorated for the exact days of payment by the Crown. It is remarkable that for Tranche B, the cumulated sales of annuities exceeded at any time the cumulated disbursements to the Crown!

In November 1596, Philip II stopped the payment on all asientos, for the third time. On Tranche A, 40,000 ducats was still due. They were eventually paid by the Crown.

The method of Álvarez-Nogal and Chamley, to extract from the archives all available information and to focus on one contract, can be compared with the "coding" procedure of all asientos by Drelichman and Voth (2011), as presented in a study that received a prize. In that study, they take the same asiento as a standard bearer for their method which produces tables of "agreed upon cash-flows" from which they compute their own measure of a rate of return. Their method is not historical and in their data reporting, they do not respect the archival evidence in the contract, from page 3 on. The "coding" misses the elegant and logical structure that has been described here, and it turns the contract on its head since the payments depended on the interest, one percent per month, that is specified in the contract and precisely observed in its execution. They inexplicably dismiss the most interesting option for the long-term funded debt (which had already been described in the literature). Ignoring the attachments, they claim instead ("we know with certainty") that Tranche B had not been paid by the payment stop of November 1596, and that it was subject to a debt reduction, when actually, it had entirely been paid, in advance, by selling annuities. In fact, the Chamber of Accounts found in 1606 that for the entire asiento, the Maluenda brothers had been overpaid 4000 ducats.

This blog post was written by Carlos Álvarez-Nogal,  Associate Professor of Economic History at Universidad Carlos III de Madrid and Christophe Chamley, Professor of Economics at Boston Universtiy.

The working paper can be downloaded here:

Sunday, 14 June 2015

Inequality and poverty in a developing economy: Evidence from regional data (Spain, 1860-1930)

New EHES Working paper by Francisco J. Beltrán Tapia and Julio Martínez-Galarraga

Societies that enter on the path of ‘modern economic growth’ undergo profound transformations. Although most of the changes that accompany this process favour the achievement of higher living standards in the long run, it can also generate some social tensions, especially during the first stages. One of the outcomes associated with growing incomes is the increase in inequality, as stated by Simon Kuznets in his classical work, where he argues that the forces unbounded by economic growth and structural change could initially lead to an upswing of income disparities. Only in more advanced stages of the development process, this trend would be reversed, thus creating the conditions for a more equal distribution of income. Yet, the existence of a U-inverted shape relationship between economic growth and inequality still remains an open debate. While some research provides evidence in favour of the Kuznets’ curve, other work finds conflicting results, so this issue is far from being settled. An important drawback of these studies is that they are mainly focused on the period after World War II due to data availability. However, economic historians have recently made significant efforts to achieve a better understanding of the long-term evolution of inequality.

Following their lead, our article analyses the evolution of inequality and poverty in Spanish regions between 1860 and 1930. This study presents a series of advantages compared to the existing literature. First, the period of analysis corresponds to the early stages of economic growth, which is the centre of Kuznets’ theory. Second, distributional policies were almost non-existing at that time, thus allowing us to focus on the role of economic forces. Third, most international studies employ country-level information, so regional differences are overlooked. This is particularly important in the case of Spain, a country that hides sharp regional disparities, especially in the timing and intensity of industrialisation. Lastly, by focusing on just one country, we reduce the problems that different legal and political regimes impose in cross-country comparisons. Our data also come from the same statistical agencies and thus avoids problems of comparability between different economies, especially acute when comparing data originated in developed and developing countries, or the troublesome conversions of incomes across countries using the purchasing power parity.

In the absence of household surveys or social tables, our inequality measure for each Spanish province is the Williamson Index (WI), an indirect indicator of inequality defined as the ratio between the average income per worker and the wage of unskilled workers. The WI thus compares the bottom of the distribution to the average income. The figure below plots each province’s WI against their level of real income per capita in 1860, 1900 and 1930. Economic growth does not appear to be beneficial for inequality, at least during the early stages of economic growth: the Williamson index increased as incomes grew, a relationship which weakened over time as the Spanish economy developed.

To better assess the distinctive impact of growing incomes on inequality levels, we estimate the determinants of inequality using a panel data set (1860, 1900, 1910, 1920 and 1930) that includes other potential factors influencing this process. The results seem to confirm the presence of the Kuznets curve. However, although growing incomes did not directly contribute to reducing inequality, at least during the early stages of modern economic growth, other processes associated with economic growth significantly improved the situation of the bottom part of the population. In this sense, the population shift from rural areas to urban and industrial centres, the demographic transition and the spread of literacy, among other factors, all partly counterbalanced the initial negative impact of economic growth and helped building a more equal society.
Focusing now on the link with poverty, the literature usually agrees that economic growth is pro-poor. However, recent research promoted by the World Bank stresses that, although growing incomes usually translate into poverty reduction, that relationship is mediated by the presence of inequality. Hence, this strand of literature recognises the importance of both growth and distribution in determining poverty levels. Once again, the links between economic growth, inequality and poverty reduction remain subject to an open debate. Although the lack of information on commodity prices prevents us from being able to compute a subsistence basket for each Spanish province, following Milanovic, Lindert and Williamson (2011), we construct a poverty ratio that compares the unskilled wage to a subsistence wage computed in reference to a fixed subsistence line of 300 $PPP per capita at 1990 prices. Our indicator assesses how far the subsistence wage stands from the earnings of the bottom part of the population. If we plot our poverty measure for each province against the level of real income in 1860, 1900 and 1930, we find that higher incomes per capita were clearly related to lower poverty levels, thus depicting a more positive image of economic development than in the case of inequality. This positive association however almost vanishes as the country developed.

We then carry out a more systematic analysis of the relationship of economic growth and inequality with poverty levels, considering also other variables that might have a direct link with poverty levels. Economic development seems to have opened up new opportunities to wider layers of the population and reduced the poverty ratio, although this positive relationship weakened as incomes per capita grew. Our results also show that inequality and poverty went clearly hand in hand.

To sum up, this article provides two main contributions. We offer new evidence of the evolution of inequality and poverty in Spanish provinces between 1860 and 1930, a period which usually lacks information on these issues and has thus impeded to follow their evolution, as well as a proper assessment of the relationship between these variables and economic development. In this regard, this paper also attempts to assess the causes behind the evolution of these indicators. While growing incomes appear to have fostered inequality (although at a decreasing rate), other processes associated with economic development, such as the rural exodus to urban and industrial centres, the demographic transition and the spread of literacy helped improving the living standards of the lower classes. In addition, the analysis also shows that reducing inequality also contributed to the reduction of poverty levels, so a combination of growth and distribution policies would be doubly beneficial for reducing poverty. Interestingly, the other processes associated with economic growth mentioned above also helped reducing poverty via their effect on inequality. Therefore, the potential of economic growth to improve the lot of the bottom part of the population becomes conditional on its ability to expand the opportunities available to increasingly wider segments of the population.

This blog post was written by Julio Martínez-Galarraga and Francisco J. Beltrán Tapia. 

Francisco J. Beltrán Tapia is 
Junior Research Fellow in Economics, 
Magdalene College, 
University of Cambridge
Julio Martínez-Galarraga is
associate professor at Universitat de València

The working paper is downloadable here: