Economists agree that capital markets are of fundamental importance to economic development, and most would agree that interest rates of capital markets are a good index of their efficiency — and, given the specific nature of this market, also of the degree of trust in the economy at large. Capital markets are, therefore, a proxy for the efficiency of the institutional framework of an economy and, as is for example argued in the classic paper by North and Weingast (1989) on the Glorious Revolution of 1688 in Britain, radical changes in their performance are a precondition for the acceleration of economic growth.

In a similar way it can be argued that Southeast Asia, Java in particular, seems to be caught in a trap characterized by thin, fragmented capital markets, with high interest rates and (possibly) extensive monopoly power over rural capital markets. Consequently, this is one of the typical features of the underdevelopment of the region. Both examples show that these structures are characterized by strong path-dependencies. Clark (1988) has argued convincingly that in parts of Western Europe, the change in direction towards a regime of low interest rates and a well-developed capital market actually occurred during the late Middle Ages, between about 1350 and 1450 — that is, long before the Glorious Revolution identified by North and Weingast (1989) as the crucial event. Thereafter, Western Europe simply continued on the same path. Interest rates in Java, by contrast, were quite high during the seventeenth, eighteenth, and nineteenth centuries, and rose again in the period after the Second World War (Boomgaard 1986a, 1996). This chapter addresses the question of what happened in the first half of the twentieth century, in particular as an outcome of the reforms in rural (and urban) capital markets implemented under the Ethical Policy in the early 1900s. How successful was Dutch colonial policy in reforming capital markets and facilitating access to capital for Javanese farmers? Did the reforms result in a structural improvement in capital markets, and in a change of course towards low interest rates and easy access to capital for rural inhabitants?