A Free Nation Deep in Debt: The Financial Roots of Democracy

By James Macdonald

Published by Farrar, Straus & Giroux

January 2003; $30.00US/$47.00CAN; 0-374-17143-2

Nowadays, the idea that the way a country borrows its money is connected to what kind of government it has comes as a surprise to most people. But in the eighteenth century it was commonly accepted that public debt and political liberty were intimately related. In A Free Nation Deep in Debt, James Macdonald explores the connection between public debt and democracy in the broadest possible terms. He starts with some fundamental questions: Why do governments borrow? How do we explain the existence of democratic institutions in the ancient world? Why did bond markets come into existence, and why did this occur in Europe and not elsewhere?

Macdonald finds the answers to these questions in a sweeping history that begins in biblical times, focuses on the key period of the eighteenth century, and continues up to the present. He ranges the world, from Mesopotamia to China to France to the United States, and finds evidence for the marriage of democracy and public credit from its earliest glimmerings to its swan song in the bond drives of World War II. Today the two are, it seems, divorced -- but understanding their hundreds of years of cohabitation is crucial to appreciating the democracy that we now take for granted.

Author

James Macdonald was an investment banker for many years. This is his first book. He lives in Oxford, England.

Reviews

"This is a profound and original work by an experienced financial practitioner who understands that public debt is not just economically but politically crucial. Macdonald has something exciting to teach all serious students of history -- that the evolution of democratic institutions is not just about taxation and representation but also about investment."

--Niall Ferguson, author of The Cash Nexus: Money and Power in the Modern World, 1700-2000

"In this fresh and informative look at dollars and democracy, Macdonald reminds us why James Carville observed that he hoped, after death, to be reborn as the bond market. Freedom and finance are more closely entwined than we realize. A gloriously rich history."

--Richard Parker, John F. Kennedy School of Government, Harvard University

"Macdonald's wide-ranging exploration of representative political institutions and the ability of states to borrow, survive, and prosper is history at its best. Political liberty, sound public financial policies, and well-functioning securities markets nurture one another, but across human history all three have been hardly gained, easily lost, and therefore rare. It is a deep insight, one that all who cherish freedom should understand and heed."

--Richard Sylla, Stern School of Business, New York University

"James Macdonald reveals democracy's deepest strength: Citizens are willing to lend to governments of their own creation. His closely studied historical episodes show that this practice, when applied to war financing, clinched the advantage over authoritarianism."

--Eric Jones, author of The European Miracle: Environments, Economics, and Geopolitics in the History of Europe and Asia

"This startling and original book traces the evolution of public debt from the Bronze Age to our own, and in clear, lucid prose shows that successful state finances have been both a cause and an effect of the emergence of democratic forms."

--Jonathan Steinberg, Walter H. Annenberg Professor of Modern European History, University of Pennsylvania

Excerpt

The following is an excerpt from the book A Free Nation Deep in Debt: The Financial Roots of Democracy

by James Macdonald

Published by Farrar, Straus & Giroux; January 2003; $30.00US/$47.00CAN; 0-374-17143-2

Copyright © 2003 James Macdonald

Introduction:

The Financial Roots of Democracy

No Man whatever having lent his Money to the Government on the Credit of a Parliamentary Fund has been Defrauded of his Property . . . The Goodness of the Publick Credit in England, is the reason why we shall never be out of Debt. . . . Let us be, say I, a free Nation deep in Debt, rather than a Nation of Slaves owing Nothing.

The author of these words, an anonymous English pamphleteer writing in 1719, was expressing an idea that was just starting to take hold -- that there was a connection between political freedom and public debt. The idea gained ground in the following decades, and one hundred years later it had become almost a commonplace. In 1815, a French Minister of Finance could state simply that "liberty and credit are always united." By that time, France had suffered a century of military defeats, political revolutions, and counterrevolutions as it attempted to come to grips with this political insight.

Nowadays the idea of a link between public debt and democracy comes as a surprise to almost everyone to whom I have expressed it. A number of historians, however, have been looking with renewed interest at the events of the eighteenth century. Their ideas have recently been given a wider audience by the publication of Niall Ferguson's The Cash Nexus, in which he argues (inter alia) that the original cause for the rise of democratic institutions was not rising levels of income per capita, but the requirements of war finance. The Hanoverian state was better than its rivals at assembling the political and financial prerequisites for successful imperial expansion; and one of these was the parliamentary legitimization of public finances that increasingly depended on the ability to borrow. This notion would have come as no surprise to a well-informed eighteenth-century observer. In 1774, a French public official warned that "if people believe [Louis XVI] to be a despot it will be impossible to open loans, or, if that route is taken, they will be so costly that England will always finish by having the last écu in any war."

This statement gets to the heart of the matter. Countries with representative institutions are able to borrow more cheaply than those with autocratic governments. There are several plausible reasons. One is that constitutional governments are (on the whole) constrained by law and are therefore more trustworthy counterparties for the private individuals who lend them money. Another is that elected governments identify their interests with those of society as a whole; and there are advantages for society as a whole in having smoothly running credit markets that go beyond the direct gains accruing to the state. The implication is that once bond markets come into play, the outlook for arbitrary forms of government dims.

Such arguments envisage democratic institutions and credit markets as two distinct forces. The connection between the two is simply that democracies are better able than autocracies to come to terms with the dictates of public credit. This was how the matter was seen in the eighteenth century. When the thinkers of the Enlightenment looked for the roots of political liberty, they did not seek the answer in the history of public credit. They looked instead to ancient political freedoms, which had once been enjoyed by the peoples of Europe, but which had since been usurped by kings. Countries where liberty reigned, such as England and Holland, had merely fought back against royal usurpations more successfully; and it was up to other nations to do the same if they wished to recover their freedom. These ideas have fallen into discredit. Although anthropologists may agree that tribal life is characterized by an absence of autocratic state power, few, if any, political theorists or historians are willing to see a direct chain of descent from such primitive freedom to modern democratic constitutions.

The growth of democracy is now seen not as a recovery of lost freedoms, but as an economic imperative for the advancement of society. High levels of technology require an educated workforce, and a high-output economy requires wealthy consumers. These parallel forces push inexorably toward mass participation in politics; and it seems that above a certain level of income per capita it is hard to prevent democracy from taking root even in autocratic societies. Conversely, societies that insist on retaining rigid state control are unable to advance economically beyond a certain point. This argument can address only the modern world, however. The requirements of an advanced economy cannot explain the English, American, or French Revolutions. After all, these countries were still at "Third World" levels of development.

The alternative theory -- that democratic institutions were a response to the requirements of war finance at a time when the invention of public debt had altered the old political equations -- answers this objection. This line of reasoning, however, leaves unanswered a number of questions. How does one explain the existence of political liberty in other periods of history? After all, the democracy of Athens cannot be explained by either of the theories advanced so far. Is it really true that the political freedoms enjoyed by societies in earlier times have no connection at all with rise of modern democratic institutions, except in the fond dreamings of seventeenth- and eighteenth-century thinkers? And finally, why did bond markets come into existence in the first place, and why in Europe and not elsewhere?

In order to answer these questions, this book looks back centuries, even millennia, before the eighteenth century, and then looks afresh not only at the events leading up to the French Revolution, but at all the military and political upheavals that followed in its wake over the ensuing centuries. It turns out that while the government bond market may be, on one level, an impersonal economic force, it also has a profoundly political dimension. It was this political dimension of public credit that was the vital source of its strength in assisting the rise of democratic forms of government.

In order to understand the role of public credit in history, it is necessary to delve into the origins of the state. When one does so, one thing becomes apparent: for most of recorded history, it would have seemed absurd to predict the long-term success of democratic government at all. The laws of economic efficiency seemed to suggest that the future lay in autocracy, not democracy. The history of the world showed that the most sophisticated societies had invariably been headed by emperors, not elected officials. Apart from a few brief historical moments, as in Athens during the fourth and fifth centuries B.C. and Florence in the fourteenth and fifteenth centuries A.D., civilization and autocratic rule seemed to go hand in hand. Furthermore, it seemed that democratic government could be practiced only in small, intimate societies, such as tribes or city-states, whose existence was always threatened by larger and more powerful empires. Even if a city-state managed, like the Roman Republic, to circumvent the risk of being conquered by conquering others, insurmountable political tensions arose that could be resolved only by one-man rule. Only a lunatic or a clairvoyant would have forecast that the day would come when the world's most advanced and most powerful states would be democracies.

There was, however, a potential chink in the economic armor of the great empires. Few states have found it easy to deal with emergencies (especially warfare) merely by raising taxes, because of the economic disruption and political unrest that this can cause. Until quite recently, the solution to this problem was to store up treasure; and states with the greatest ability to accumulate were assumed to have an inherent advantage in the struggle for survival. But the "treasury" solution contained an in-built economic inefficiency. Societies mined precious metals to act as currency at enormous economic cost. They then proceeded to hoard these same metals for a rainy day in a process that was tantamount to mining in reverse. (The Persian Empire, possibly the greatest hoarder of the ancient world, actually melted down its gold again before burial underground, making the analogy quite literal.) It is not difficult to see the superiority of a system that allowed this hard-earned wealth to circulate in the general economy, to be tapped only insofar as necessary. Hence the economic utility of public debt.

To state that public borrowing is a superior method of dealing with emergencies is not sufficient to explain its existence. With the benefit of hindsight, public borrowing may have the appearance of inevitability; but from a historical perspective, it was not an obvious development. Where did the idea come from? The great states of the ancient world were conspicuous for their ability to store up surpluses (take the story of Joseph in Egypt, for example), but public borrowing was an entirely alien concept. Why would a pharaoh, a god in human form with the power to compel his subjects to build veritable mountains of stone to house his mortal remains, think of borrowing? Whatever he needed was his by right.

What was required was an alternative form of government in which public borrowing was an organic growth. Only then was it conceivable that public debt might flower into a force sufficiently powerful to change the world. The thesis of this book is that the alternative form of government was democracy. Not the democracy that has become familiar since the political revolutions of the eighteenth century, but precisely those earlier forms of democracy whose existence cannot be explained by high levels of income per capita.

What was the crucial element that made public borrowing natural in democracies, but unnatural in autocracies? The answer lies in the identity of borrowers and lenders. Divine, or semidivine, autocrats are unlikely to perceive lenders as their equals. In democracies, the opposite is true. As long as the state borrows from its citizens, there is no divergence of interest between borrower and lenders, for the two are one and the same. This is a far more powerful reason for the inherent creditworthiness of democracies than those listed earlier. But it is important to note that the argument holds good only for domestic borrowing -- when the lenders are citizens. The argument does not apply to external borrowing. A democracy may have a natural inclination to respect the rules of credit when dealing with foreign creditors, because democracies are, on the whole, readier than autocracies to adapt to the purely economic logic of credit markets. But it was not the ability to borrow abroad that counted in the struggle between rival forms of government. It was above all the symbiosis of borrowers and lenders inherent in domestic borrowing that turned public debt into a powerful weapon capable of upsetting the long-term advantage of autocratic government.

While, on one level, then, this book deals with the hard facts of money and credit markets, its underlying motif is the relationship of the state with its citizens. Its hero is the citizen creditor -- a subspecies of Homo sapiens not hitherto recognized or given his due. Indeed the role of the citizen creditor in history did not end in 1789. In many ways, his greatest days were in the twentieth century, not the eighteenth.

But there remains a further mystery. Public borrowing may be a form of public finance naturally suited to democratic government; but where did the idea first come from? The answer is that it always existed in nascent form within the simple customs of primitive tribes. These customs may seem very distant from the complex paraphernalia of modem government, but they contain within them the financial roots of political freedom. This book uncovers a chain of descent that links tribal financial practices to modem public debts; and this leads to an intriguing reflection. The political philosophers of the seventeenth and eighteenth centuries sought the roots of democracy in the political customs of their tribal ancestors. Their views have often been dismissed as unhistorical wishful thinking. But it now seems that the ideas of the old philosophers may have contained an element of truth. Political liberty may have descended from tribal customs -- but for hitherto unsuspected reasons.

*endnotes have been omitted


Copyright © 2003 James Macdonald