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Endowments, fiscal federalism and the cost of capital for states: evidence from Brazil, 1891–19301

Published online by Cambridge University Press:  23 March 2010

André C. Martinez Fritscher  and
Aldo Musacchio
André C. Martinez Fritscher
Affiliation:
Banco de México, amartinez@banxico.org.mx
Aldo Musacchio
Affiliation:
Harvard Business School and NBER, amusacchio@hbs.edu
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Abstract

There is a large literature that aims to explain what determines country risk (defined as the difference between the yield of a sovereign's bonds and the risk free rate). In this article, we contribute to the discussion by arguing that an important explanatory factor is the impact that commodities have on the capacity to pay. We use a newly created database with state-level fiscal and risk premium data (between 1891 and 1930) to show that Brazilian states with natural endowments that allowed them to export commodities that were in high demand (e.g. rubber and coffee) ended up having higher revenues per capita and lower cost of capital. We also explain that the variation in revenues per capita was both a product of the variation in natural endowments (i.e. the fact that states cannot produce any commodity they want) and a commodity boom that had asymmetric effects among states. These two effects generated variation in revenues per capita at the state level thanks to the extreme form of fiscal decentralisation that the Brazilian government adopted in the constitution of 1891, which gave states the sole right to tax exports. We also run instrumental variable estimates using indices of export prices for each state. These estimates confirm our findings that states with commodities that had higher price increases had lower risk premia.

Type
Articles
Information
Financial History Review , Volume 17 , Issue 1 , April 2010 , pp. 13 - 50
Copyright
Copyright © European Association for Banking and Financial History e.V. 2010

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18 Paraná had coffee as its main export in the 1920s; it was mainly a mate tea exporter in the first two decades of our study.

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20 It is not clear that in a dynamic game states would have wanted to charge higher taxes. Brazil was losing its comparative advantage to new producers in Southeast Asia and higher tax rates could have speeded up the process. In fact, one could speculate whether Brazil would have lost its competitive edge in natural rubber so fast (around 1910).

21 F. T. Fernandes, ‘Taxation and welfare: the case of rubber in the Brazilian Amazon (1870–1910)’, mimeo presented at the 69th meeting of the Economic History Association (2009).

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27 Ibid.

28 Brazil, Diretoria Geral de Estatística/Ministerio da Agricultura, Industria e Commercio, Estatística das finanças do Brasil (Rio de Janeiro, 1926).

29 Taken from Musacchio, A., Experiments in Financial Democracy: Corporate Governance and Financial Development in Brazil, 1882–1950 (Cambridge and New York, 2008)Google Scholar, data appendix.

30 Note that in this setup increases in exports increase capacity to pay not only through higher export tax revenues, but also because higher exports could make the private sector expand other activities that also yielded tax revenues for state coffers.