Political transformations had important effects on sovereign credit risk. Both fiscal centralization and limited government typically led to notable improvements in yield spreads. But by what means? So far, the analysis does not identify the precise mechanisms by which institutional changes led to credit gains. This chapter analyzes two channels through which risk reductions occurred: increases in government revenues per head and improvements in fiscal prudence.

Ferguson (2006) argues that there is a dearth of information about European macroeconomic conditions before the 1870s. Budgetary figures are one unique source of data that are readily available across countries. The first mechanism concerns the amount of tax revenues that national governments collected on a per capita basis. The key conceptual reason to scale by population rather than by some measure of national production is to capture the state’s ability to extract tax revenues per head, and not government size relative to that of the economy. There is, moreover, an issue of feasibility. As Ferguson (2006) notes, nineteenth-century GDP measures were still in their infancy, and modern reconstructions of pre-1815 GDP levels tend toward educated guesses at best (see Acemoglu et al., 2005).