5

Debt Traps and Foreign Financial Control

Foreign financial control (FFC) following default may exert positive effects on fiscal capacity if foreign administrators reshuffle the local bureaucracy and incorporate new tax technologies and managerial standards.¹ If this is the case, borrowing overseas to finance a major fiscal shock (e.g., war), even if followed by default and FFC, would be beneficial for long-term state building. In this chapter, I cast doubt on this possibility and argue instead that FFC played a key role in pushing countries into a debt trap, or trajectory E in figure 1.3.

I first elaborate on various modalities of financial control and review existing evidence of its performance in Asia, Latin America, Africa, and peripheral Europe. Second, I examine the most ambitious FFC ever attempted in this period, the one imposed on the Ottoman Empire from 1881 to 1914. This case illustrates the risks of easy access to external finance—rapid indebtedness, pledging, and default—and the consequences of losing financial sovereignty. My assessment of FFC in the Ottoman Empire suggests that it was profitable for foreign bondholders but had no quantifiable effect on local tax capacity. Improvements in fiscal performance in the early 1900s in the Ottoman Empire resulted from domestic elite replacement, not foreign control.

FFC is sometimes seen as the culmination of “financial imperialism,” a reflection of the bargaining power of private lenders vis-à-vis vulnerable nations.² That picture is only partial. Foreign control also resulted from poor decisions by local rulers, who preferred to serve a foreign master than sharing powers with taxpayers. The political costs of financial reform proved too big for many rulers in the Global South, who preferred to assume the risks of FFC attached to external finance. This remains clear in the Ottoman case but also in China. In section 5.4, I shed light on the domestic politics underneath the installment of FFC in the East Asian giant in 1911. I conclude by drawing implications of FFC for long-term state building.

5.1 Goal and Types of Financial Control

Foreign control over the finances of a sovereign nation was never taken lightly in the Bond Era.³ Because these interventions could otherwise be interpreted as a form of colonialism, FFC often required a concerted action on the part of European powers.

Implemented by bondholder representatives, foreign states, or agencies acting on behalf of both the bondholders and their governments, FFC occurred in differing degrees, the mildest form of which was the inspection of books and accounts kept by the agency in charge of securing local revenue to service debt. This was, for instance, the option chosen by the British in the negotiation of the 1861 default settlement in Mexico, where direct foreign intervention was regarded as a “national humiliation.”⁴ An intermediate form was participation in receiverships (locally known as régie or caja de recaudación), state banks, and monopoly companies in charge of revenue collection for debt service purposes. This was the model used in Greece after 1893 with the establishment of the Société de Régie des Revenues Affectés au Service de la Dette Hellénique, with which foreign officials monitored the collection of revenue from state monopolies for the purpose of debt service. The strictest form of control involved surrendering to bondholders the power to raise taxes directly in the debtor country until the debt was liquidated. This form of intervention required the establishment of a permanent administration with powers to assess wealth as well as monitor and collect taxes without the intermediation of the local government. The daily operation of financial control was exercised by bondholders’ representatives, who often allowed delegates of the local government to participate on the board of the debt administration council without veto power.

Revenues that had been pledged in defaulted bonds—most often customs and state monopolies—were prioritized in the establishment of FFC. Under unilateral or multilateral European command, this happened in Bulgaria (1904), China (1911), Egypt (1880), Greece (1893), Morocco (1902), Serbia (1895), Tunisia (1869), Turkey (1881), and Uruguay (1903), among others. The United States began exerting FFC in the first decades of the twentieth century. Under the Monroe Doctrine, the US took control over pledged customs receipts in eight Latin American economies as well as in Liberia. Orchestrated directly by the White House, American intervention had an intense political component.⁵

After World War I, the League of Nations (1920–1946) exerted financial control over countries in default. Although financial control before the Great War was primarily designed to protect holders of bonds in default, the measures put forward by the League were meant to reactivate economies and stabilize prices as a means to regain access to the credit market. International control by the League was indeed the closest predecessor of the stabilization programs implemented by the IMF in the second half of the twentieth century (more in chapter 10). Next, I assess the type of intervention implemented by European powers and the United States before WWI.

5.2 Did Foreign Financial Control Build States?

FFC is an invasive policy that may nevertheless produce positive results for local state capacity. Foreign administrators might incorporate new budget and tax technologies that spread beyond the revenues under their control (e.g., double-entry bookkeeping for national budgets). Well managed, these reforms might expand the capacity of the state and persist after the council terminates its activity once debt is liquidated. In other fields, foreign intervention has proved successful, for example, in election monitoring and international peace missions.⁶

Not so well managed, financial control might serve as a mechanism of extraction that leaves the country in worse condition, similar to what occurred under colonial rule.⁷ Krasner and Weinstein argue that foreign intervention must be voluntary (or “contractual”) in order to succeed: if financial control is coerced by bondholders with the support of the creditor governments—as was often the case in the Bond Era—poor performance may be expected.⁸ Even if local elites perceive foreign control as a constrained best, the local populace and political opposition might be reluctant to cooperate with a foreign administration. This constant friction can inhibit transmission of know-how and genuine administrative reform. Recent attempts to induce state building with foreign intervention in the Middle East have failed precisely for the lack of legitimacy of the international mission in the host societies.⁹

In assessing the effect of financial control in the Bond Era, we should recall that one and only one mandate was pursued: mobilizing local resources for debt service. In other words, advancing the bondholders’ interests was the top priority.¹⁰ Improving local conditions was important as long as resource mobilization was facilitated. The order of priorities is well exemplified in the US-Haiti Convention of 1915. Receipts from the American customs receivership on the island were to be allocated in the following order: first, administrative expenses of the receiver (an American national appointed by the US president) and the staff; second, debt service; third, police; and finally, Haiti’s current expenses.¹¹

Existing evidence of the performance of financial control is at best inconclusive: China lost control of its customs receipts in 1911, when the Maritime Customs Service (MCS) became a debt collection agency for European bondholders. Foreign control of customs enhanced fiscal capacity and secured external finance at favorable terms. The success of the MCS, however, predated direct foreign control. By 1911, this agency had a record of 50+ years of professionalism and efficient bureaucratization (I return to the MCS below).

Egypt is another example of “successful” financial control. The British took over its tax administration in 1882 to secure debt service. The Khedivate (as this tributary state of the Ottoman Empire was known) repaid all outstanding debt in decades and quickly regained access to international markets under quite favorable conditions;¹² however, financial control went hand in hand with the loss of political sovereignty, and Egypt became a de facto protectorate of the British government.¹³

The French installed a receivership in Bulgaria in the early 1900s. In 1930, when war reparations represented twice its GDP, Bulgaria implemented a series of fiscal reforms intended to strengthen fiscal capacity. As a result, the budget deficit was drastically reduced; however, these reforms were not dictated or inspired by the French receivership administrators. Efforts to build the state in Bulgaria were implemented precisely to avoid further concessions to French bondholders in return for new debt relief.¹⁴ Still, this could be interpreted as an indirect positive effect of foreign financial control.

Fishlow, Maurer and Arroyo Abad, Reinhart, and Trebesch investigate changes in tax capacity before and after financial intervention with hard data. Fishlow studies the performance of tax revenue among emerging economies that defaulted on their sovereign debt in the nineteenth century, computing the rate of annual revenue growth before and after the settlement. His sample includes ten countries, but only four of them were subject to financial control: Turkey, Egypt, Peru, and Greece. On average, revenue growth dropped from 6.4 percent to−0.2 percent in Turkey, from 9.0 percent to 4.0 percent in Peru, and from 5.1 percent to 2.0 percent in Greece. Only in Egypt, a country that had also lost its political sovereignty, did revenue growth increase, from 1.4 percent to 2.0 percent (a difference not statistically significant).¹⁵

Reinhart and Trebesch, who investigate cycles of indebtedness, default, and settlement in Greece over the last 200 years, discover a recurring pattern of bailout lending that accompanies financial control: “While the foreign creditors succeeded in enforcing debt repayment …, the state of Greek finances remained problematic and the economic conditions unfavorable.”¹⁶ Borrowing from Levandis, they conclude:

Instead of considering the debt problem in broad aspects and of adopting measures to eradicate the endemic disease with which Greek finances were perennially afflicted, they [the bondholder and creditor government representatives] introduced half measures, inadequate to remedy the situation.¹⁷

Reinhart and Trebesch’s critical assessment resonates with Wynne’s evaluation of foreign intervention in that country: the régie put in place to secure tax revenue from state monopolies succeeded in securing debt service but lacked the capacity (or interest) to fight rampant corruption within the tax administration.¹⁸

Maurer and Arroyo Abad study the performance of eight customs receiverships set up by the United States in Latin America: Bolivia, Cuba, Santo Domingo, Ecuador, Haiti, Nicaragua, Panama, and Peru. American intervention was comprehensive: besides customhouses, the Americans had a say in economic policy, internal taxation, debt ceilings, and expenditures.¹⁹ This was a matchless opportunity to implement ambitious reforms and enhance fiscal capacity permanently. Examining customs revenue performance from 1900 to 1931, Maurer and Arroyo Abad show that American receiverships in Latin America failed in “every single case” to raise revenues relative to preintervention times.²⁰ The US did not incorporate newer technologies, raise the salaries of public officials, or introduce a proper sanctioning system for corrupt bureaucrats.²¹

In sum, existing work on FFC casts doubt on its effectiveness. Contributing to this body of work, I evaluate the effect of financial control by studying one intervention in detail—the Ottoman Public Debt Administration, the most ambitious receivership ever run based on the outstanding debt it was meant to liquidate. This case exemplifies key aspects of the argument laid down in chapters 2–4: An economy with weak fundamentals and military needs was presented with an opportunity to access virtually unlimited external capital. As its credit rating deteriorated, it hypothecated multiple assets in issuing new loans. After 20 years of uninterrupted borrowing, it suspended debt service in 1876. Foreign financial intervention and debt-equity swaps were imposed as part of the 1881 default settlement. Tax capacity did not improve under external financial control. It did only after the Young Turks assumed power in the early twentieth century, a process unrelated to the receivership.

5.3 Foreign Financial Control in the Late Ottoman Empire

The Ottoman Empire participated in ten interstate wars and experienced nine large domestic revolts between 1816 and 1913. Continuous military conflict stimulated tax reform, but receipts remained insufficient to pay war expenses. Access to international credit markets allowed sultans to finance war externally and avoid the large interest rates of domestic bankers. The Sublime Porte, as the Turkish government was known, floated its first foreign bond in 1854. Twenty years later the Porte accumulated debt equivalent to 10 times its total annual tax receipts. International financial control was established in the Ottoman Empire in 1881 as part of a default settlement that involved over 50 percent of debt relief.

The account that follows suggests that foreign intervention advanced the interests of bondholders, first and foremost. Foreign control added positive externalities to the local economy because it modernized the sectors under its supervision. In terms of state building, however, tax capacity did not substantially change relative to preintervention years. In other words, although foreign intervention expanded the size of the pie, the state did not improve the capacity to tax a larger portion to fund basic goods and services. Chronic budget deficits and high indebtedness persisted.

5.3.1 THE LONG ROAD TO HIGH INDEBTEDNESS

For the Ottoman Empire, the nineteenth century was one of economic and financial reform necessitated by the accumulation of military defeats in the late eighteenth century—first to Russia, then to Napoleon.²² Catching up with military technology employed by Western powers—or “defensive developmentalism”²³—required funds; however, the tax system in the Ottoman Empire was highly decentralized. Provincial notables controlled taxation and acted independently of the central government. Sultan Mahmud II (r. 1808–1839) initiated a battery of military and financial reforms inspired by Western economies. In the mid-1820s, the sultan dissolved the Jannisaries—by then an obsolete elite army—and replaced them with a modern civil army of 75,000 men. He also withdrew (with limited success) the local nobles’ authority to tax. Reforms regained impetus with the proclamation of the Tanzimat Decree in 1839, which sought to put an end to religion-based legal discrimination, strengthen property rights protection, and end abuses in tax collection by local tax farmers.

Sultan Abdulmejid (r. 1839–1861) continued the reforms initiated by his father. The central administration was reorganized to mirror ministries and departments in European bureaucracies. In the 1840s, an attempt was made to end tax farming definitively by replacing provincial nobles with central government bureaucrats. When this reform failed, tax farming was reestablished, but conditions thereafter were more favorable for the Porte. Reforms continued over the entire nineteenth century. Pamuk estimates central government revenue increased from 3 to 12 percent of GDP between 1808 and 1914. This was a substantial increase;²⁴ however, expressed in grams of gold, tax revenue per capita in the first decade of the twentieth century was between four and five times smaller in Turkey than in France, England, or Prussia.²⁵

The Ottoman Empire went to war frequently in the long nineteenth century. Major internal and external conflicts occurring during this period appear in table 5.1. Military spending constituted the largest outlay of the imperial budget. According to the earliest data available in the 1840s, it represented 46 percent of expenditures; by 1905, it still represented 36 percent of a budget three and a half times larger than that of the 1840s.²⁶

War finance changed over time. In the first half of the nineteenth century, war was financed by debasement—the specie content of gold coins was changed 35 times during the reign of Mahmud II.²⁷ The sultan also borrowed from local financiers, known as the Galata bankers, who made short-term loans. Named after the neighborhood in Constantinople in which they were based, Galata bankers acquired capital in London and profited from the difference between the commercial market rate in London and the 12 percentage points they charged the sultan.²⁸ Debasement, which led to frequent monetary instability and high rates of inflation, was abandoned in the 1840s, when a bimetallic system was adopted. This reform, however, was not enough to stabilize the economy and secure sufficient revenue for war.²⁹ From the 1850s, Turkey looked outside for capital to balance its budget and finance military expenditures, a decision with lasting consequences.

TABLE 5.1. The Ottoman Empire (O.E.) at War

Interstate war	Years		Intrastate war	Years
Turko-Persian	1821–1823		O.E. vs. Greeks	1821–1828
Russo-Turkish	1828–1829		O.E. vs. Montenegrins of 1852	1852–1853
O.E. vs. Egyptians	1831–1832		O.E. vs. Montenegrins of 1858	1858–1859
O.E. vs. Mehmet Ali	1839–1840		Turkey vs. Montenegro	1862–1862
Crimean	1853–1856		O.E. vs. Cretans of 1866	1866–1867
Russo-Turkish	1877–1878		O.E. vs. Christian Bosnians	1875–1877
Greco-Turkish	1897–1897		O.E. vs. Cretans of 1888	1888–1889
Italo-Turkish	1911–1912		O.E. vs. Cretans of 1896	1896–1897
First Balkan	1912–1913		O.E. vs. VMRO Rebels	1903–1903
Second Balkan	1913–1913

Source: Wimmer and Min (2009). Note: This table lists military conflicts with 1,000+ casualties.

The first foreign loan was contracted by Turkey in 1854. The impetus? War with Russia in Crimea. In the 1850s, Turkey was still a “mysterious entity to Western Europe,”³⁰ so the first attempt to float the loan in March 1854 failed. Later that year, the second attempt came with the hypothecation of the Egyptian tribute—the annual contribution of the Egyptian Khedive to the Sublime Porte. Once collateralized, the loan was subscribed successfully, raising £3 million and carrying 6 percent interest; the issuance price was 80 percent. External funds were exhausted almost immediately, and another war loan was necessary within the year. This new loan of £5 million was guaranteed by the British government, which had a strong interest in stopping Russian influence in the Black Sea. This very popular loan, carrying a 4 percent nominal interest rate and sold at 103 percent, helped Turkey win the war. This was the first and last loan guaranteed by a European power. From that moment the Turks were on their own.

In order to alleviate concerns about the state of Turkish finances, the Porte announced a battery of fiscal reforms in the early 1860s. First, it revised the charter of the Imperial Ottoman Bank (IOB) to consolidate monetary policy and centralize tax collection and debt service. The IOB, originally established in 1856 under a royal charter by a group of London bankers—hence Ottoman in name only—acquired a monopoly on the note issues and became the de facto Turkish central bank.³¹ To signal credibility in debt service, the Porte made the IOB the “treasurer-paymaster of the empire.” In other words, all the revenue of the empire was paid into and disbursed through the IOB. Finally, in 1861 the Porte introduced a new budgetary system, which allowed publication of the estimated revenue and expenses on an annual basis.³²

Despite carrying on fiscal reform, budget deficits remained and investors lent on gradually stricter terms.³³ New loans were spent in servicing old debt and new military expenditures. Formally, only four loans were meant to finance war before 1876;³⁴ however, loans were floated for war purposes even if they were not identified as such. For instance, the £22 million floated in Paris in 1869 to officially “balance the budget” was partly used to buy war materials to quash a rebellion in Crete.³⁵ The quotation of new loans for war purposes appears in figure 5.1, in which the occurrence of warfare is plotted against the stock of outstanding debt from 1841 to 1913.

Loans during wartime were followed by new quotations to purchase vessels, equipment, and armaments from Europe. By 1876, the sultan had assembled the third largest navy in the world, much of it imported from British shipyards.³⁶ Military expenses did not help balance the budget. Far from halting the expenditures for military buildup, European ambassadors in Constantinople agreed that the sultan should further equip his army and navy.³⁷ Demand met supply.

FIGURE 5.1. External Debt vs. Tax Revenue in the Ottoman Empire. War data drawn from Wimmer and Min (2009) and tax and debt series from Güran (2003) and Tunçer (2015), respectively.

External debt escalated rapidly. Between 1854 and 1874, Turkey floated 16 loans in total,³⁸ Britain being the first market, followed by France, Austria, Germany, and Italy. Debt grew from £3 million in 1854 to over £200 million in 1871. To overcome investors’ growing reluctance to issue new capital, the Sublime Porte collateralized customs, municipal taxes, tributes from provinces, and state monopolies, some of which would eventually be seized by bondholders—for example, the tobacco monopoly, pledged in the 6 percent imperial loan of 1873.³⁹ By 1876, outstanding debt was one order of magnitude larger than annual government revenue, which was slightly over £20 million (see figure 5.1).

High indebtedness (the largest in the region), a series of bad harvests starting in 1872, and growing military expenditures made debt service almost impossible. The Porte renewed the charter of the IOB for 20 more years and even accepted the creation of an international financial commission to supervise the imperial budget in 1874. All efforts were hopeless. The Porte reduced debt payments in 1875 and announced default in 1876.

5.3.2 DEFAULT AND THE ESTABLISHMENT OF THE OTTOMAN PUBLIC DEBT ADMINISTRATION (OPDA)

Economic mismanagement led to default and a political crisis. The sultan was deposed by his own cabinet in 1876. A nationalist Muslim faction in the state bureaucracy made Abdülhamid II the new sultan and forced him to accept a constitution and to establish a parliament. The First Constitutional Era lasted two years. Coinciding with the Ottoman defeat in the Russo-Turkish War of 1878, the new sultan ended parliamentary rule and concentrated all power around him.⁴⁰

Renegotiation of default was not easy. Meetings were intermittent and extended over six years. While in default, Turkey fought the second Russo-Turkish War. In order to raise funds for it, Turkish delegates returned to London to float a new bond called the Ottoman defense loan, which required arduous negotiation with British bondholders but was ultimately accepted.⁴¹ The new loan did not bring victory. Turkey lost to Russia. In 1878, the Congress of Berlin agreed upon war indemnity and territorial cessions. The British and French governments participated actively in this treaty because they wanted to keep Russia in check while advancing the interests of the bondholders of Turkish public debt. Russia accepted that Turkish bonds hypothecated prior to the war would receive priority once debt service resumed. In return, Russia gained territorial concessions.

Negotiations to settle the defaulted bonds held by British and French investors continued after the Congress of Berlin. A syndicate of French banks invited French bondholders (somewhere between 30,000 and 50,000) to appoint a delegate to negotiate the resolution of the default on their behalf. They chose M. Valfrey, a French diplomat, who traveled to England to request that British bondholders follow suit. The Corporation of Foreign Bondholders (CFB) appointed the Right Honorable Robert Bourke, a member of Parliament and of gentlemanly extraction, as its delegate to negotiate on their behalf. Once organized, the settlement was sealed within months and signed by the Sublime Porte and the bondholders’ representatives in November 1881. The agreement was called the Decree of Muharrem (after the month in which it was drafted).

The Porte agreed to create an independent council run by bondholders’ representatives, who collected tax revenue and serviced the outstanding debt. In return, the Porte regained access to new credit thanks to a sizable debt conversion that included an escalating interest rate from 1 to 4 percent.⁴² Based in Constantinople, the Ottoman Public Debt Administration (OPDA) had seven members on the board: six representing the English, Dutch, French, German, Austro-Hungarian, and Italian bondholders plus one representing the local (i.e., Galata) bankers. The Turkish government had a representative with advisory powers and access to all books, but he could not intervene in the works of the administration.⁴³ The Ottoman Public Debt Administration (OPDA) was granted powers to collect revenue directly from taxpayers without interference of the local government and to redirect tax receipts to debt service.

A bilateral agreement between bondholders and the Turkish government, the OPDA represented first and foremost the interests of the holders of defaulted bonds and as such was committed to safeguarding the investments in Ottoman securities made by private foreign investors in continental Europe and Britain.⁴⁴ All representatives of the French and British bondholders in the settlement negotiations as well as the other members of the board of the OPDA had political experience and maintained tight connections with their embassies.⁴⁵ Despite the potential conflict of interest, the OPDA agreed to remain generally independent from governmental pressure.⁴⁶

In 1907, however, the OPDA assumed a different role, one that advanced not only the interests of bondholders but also—and explicitly—that of their home governments: the OPDA was assigned the responsibility of collecting a 3 percent customs surtax on European imports. This responsibility was never part of the Decree of Muharrem. In the past, the Great Powers had acquired the capacity to limit duties on goods of foreign origin entering the Ottoman Empire.⁴⁷ Negotiations to update the rates began in the 1880s at the request of the Porte, which needed the additional import tariff revenue. Rates were increased by three points, but receipts were to be redirected to bail out Macedonia as originally stated in the Treaty of Berlin of 1878. The powers did not trust that the Porte would channel receipts to the Balkans and requested the OPDA to collect the surtax on its behalf. This task changed the nature of the OPDA and the perception that locals had of the institution. From 1907 onward, the administration was considered an “agent of the powers”⁴⁸ instead of a representative of private bondholders.

5.3.3 THE TERMS OF FINANCIAL CONTROL

As part of the Decree of Muharrem, the Sublime Porte agreed to cede the following revenues to the OPDA: first, indirect taxes from spirits, stamps, fish, and silk and from the tobacco and salt monopolies; second, a battery of “political taxes,” including the tribute of Bulgaria, the annuity of Eastern Roumelia (modern Bulgaria), and the surplus revenues of Cyprus; and third, the product of any increase in the customs revenue resulting from the revision of existing commercial treaties (that happened in 1907) or resulting from the increase of the temettu, or business tax (that never happened).

The decree provided that four-fifths of the tax receipts collected by the OPDA were to be used for payment of interest and the rest in amortization. It had the power to appoint and dismiss its own officials without interference from the Ottoman government. Any change in the tax code that affected the ceded revenues required an absolute majority of its members. In return for the cession of sovereignty, the bondholders’ representatives agreed not to request repayment of the nominal capital stated on the prospectuses—a total of £210 million, £191 million of which was outstanding—but on the contracted loans—namely, the monies that the Turkish government had received net of intermediaries’ commissions and issuance prices below par.⁴⁹ Together, the outstanding debt was reduced by over 50 percent—from £191 million to £97 million. Arrears were also reduced by 85 percent—from £62 million to £9 million—making a total of £106 million in debt to be liquidated by the OPDA. Based on the calculations made at the time, the OPDA was expected to reduce outstanding debt by £1.3 million a year—hence it was meant to stay.

Loans were divided into four groups, and they were to be repaid in order. The loans to be paid last, group 4, were those with no specific pledge. Were the Porte to dishonor the terms of the settlement, “the original rights, positions, and securities were to be restored.” The OPDA would cease its activities when all debts contracted before 1876 were liquidated.

5.3.4 DID THE OPDA IMPROVE FISCAL CAPACITY?

The OPDA had control over three types of revenue. The “political taxes” from Bulgaria, Eastern Roumelia, and Cyprus were fixed contributions agreed upon in international treaties. The OPDA had little room to maneuver to improve the efficiency of these revenues; moreover, these tributes represented small quantities relative to the Turkish budget, and they decreased over time.⁵⁰

The Decree of Muharrem also established that any increase in customs and income tax receipts should be delivered to the OPDA. The customs duties were not increased until 1907, and then they were funneled to Macedonia. The renewed tariff treaty excluded the bondholders from any share in the additional revenue, hence the OPDA had little incentive to change the existing structure of customs receipt collection.⁵¹ The rate of the temettu, a premodern form of business tax levied on shops and stores, remained the same until 1914; hence no additional yield was transferred to the OPDA.

The performance of foreign control should be assessed relative to the management of indirect contributions, the third and largest revenue source administered by the OPDA. The latter farmed out the tobacco monopoly to a French syndicate for an annual rental of £680,000.⁵² The net profits of the régie were limited and had to be divided according to a sliding scale among the monopolist, the government, and the debt council.⁵³ The lion’s share of the indirect contributions was in the salt monopoly, administered directly by the OPDA, as were the four other revenues: stamps, alcohol, fisheries, and silk.

Between 1881 and 1914, receipts from indirect contributions increased by 75 percent⁵⁴—however, this was largely because of the low levels of collection prior to the OPDA takeover. Modernizing the five industries in which it participated,⁵⁵ the OPDA took steps to combat phylloxera, developed an export trade in salt (opening the Indian market), and promoted better methods of sericulture. It also regularized the rule of law in the areas of its jurisdiction and adopted high standards in its own (foreign) management.⁵⁶ The OPDA paid salaries when due and combated bribes and retention of collected receipts by local revenue agents.⁵⁷ And it took a leading role in attracting fresh capital from Europe to finance railways across the country, allowing the generation of more and faster revenue.⁵⁸ Net of operational expenses, revenue of the OPDA increased from £1.8 million in the period from 1882 to 1886, to £2.3 million in the period from 1902 to 1906—enough to meet the debt service target.⁵⁹

In 1889, the OPDA took over the administration of revenues not listed in the Decree of Muharrem. New loans were necessary to suppress another insurrection in Crete. In order to foster credibility, the sultan farmed to the OPDA the collection of hypothecated revenues of previous military and railroad loans.⁶⁰ Proceeds from the “delegated taxes” collected by the OPDA quadrupled from 1889 to 1913.

To evaluate the impact of the OPDA on local tax capacity, all these numbers must be contextualized. To this end, I focus on the ability of the OPDA to mobilize revenue through taxation vis-à-vis the state, the incorporation of know-how, bureaucratic modernization, and fiscal policy.

FIGURE 5.2. Revenue from Ceded Taxes vs. Locally Collected Revenue in the Ottoman Empire. Ceded tax revenue drawn from Tunçer (2015) and locally collected revenue drawn from Güran (2003).

Revenue Mobilization

Tax receipts managed by the OPDA increased over time, but did it outperform the local administration? In figure 5.2, I compare the ratio of ceded to nonceded taxes (i.e., collected by the local government) from 1881 to 1913. The ratio remained fairly stable, oscillating between 12.5 and 15.5 percent, and showed no time trend; that is, it did not improve in favor of ceded taxes over time. This result could mean that the local government adopted administrative reform independently or by emulation of the OPDA, boosting nonceded receipts. No such indication exists as will become clear below.

How substantial were revenue gains under FFC overall? In figure 5.3a, I plot total tax revenue before the imposition of the OPDA in 1881 (thick solid line) followed by the three series that came afterward: ceded, nonceded, and delegated taxes. To maintain perspective, figure 5.3b plots the same series along with outstanding debt. Two interesting patterns emerge: First, tax revenue increased from 1843 (earliest year) to 1876, when the country announced default. This increase is consistent with qualitative accounts and reforms occurring after the Tanzimat Decree in 1839; however, those efforts should not be exaggerated. By 1876, tax receipts lagged behind outstanding external debt by one order of magnitude (see figure 5.3b).

FIGURE 5.3. Tax Revenue and External Debt in the Ottoman Empire. The vertical dotted line indicates the establishment of the OPDA in 1881. Data from Güran (2003). These data represent budgeted revenue. Shaw (1975, table 1) shows that the difference between budgeted and actually collected revenue fell by 13 percentage points.

Second, taxation dropped between 1876 and 1881, coinciding with default, political instability, and war with Russia. Shortly after 1881, when the OPDA was instituted, tax receipts expanded once again. As discussed previously, receipts from ceded and delegated taxes grew over the next decades, but they started from very low levels, hence the large percentage increases in both tax categories. Relative to tax receipts under government control, the share of the OPDA revenue remained rather modest throughout. The difference even widened in the mid-1900s, coinciding with the arrival of the Young Turks, the reestablishment of constitutional order, and an attempt to diminish foreign dependence.

The Young Turks, elites born in Turkey and educated in France, put forward a battery of reforms in the administrative apparatus: public services were purged of superfluous or incompetent officials; extravagant expenses were cut; foreign financial advisers were employed; the departments of the government were reorganized, and the first double-entry budget was instituted.⁶¹ “The difficulties [the new regime had] to surmount were enormous, but the new broom swept clean.”⁶²

Some of the reforms put forward by the Young Turks coincided with new wars in Italy and the Balkan States in 1911–1913. These were financed by external loans and new tax proceeds resulting from the ambitious reform program. This might have presented a unique opportunity to capitalize the war effort and recent tax reform and to catch up with European powers; however, fiscal policy was put in place to serve geostrategic ends when Turkey joined World War I efforts in support of Germany. Debt service to French and British bondholders was suspended in 1915. At the same time, the Turkish government floated seven war loans in Berlin and Vienna for a total of £173 million. These loans were never repaid because they were canceled by the Allied powers after the war, punishing Germany.⁶³ Importantly, external finance of war without repayment unraveled the debt-tax equivalence of public finance once again. The OPDA, as initially conceived, was never reestablished after WWI and was officially disbanded in 1922.

Enforcement and Know-How

One could assess foreign financial intervention based on transmission of managerial practices and know-how. For instance, after the amendment of the Decree of Muharrem in 1903, the Turkish government put forward a series of measures to fight smuggling and contraband, two obstacles to fulfilling the mandate of the OPDA.⁶⁴ Qualitative accounts suggest that the government became less tolerant of smugglers and that the OPDA revenues increased.⁶⁵ To incentivize the Turkish government to combat smuggling, the reform provided that three-quarters of the surplus revenues of the OPDA above a fixed annuity of £2 million would go to the government. Although this reform was sweetened with a new haircut, the revised Decree of Muharrem increased the interest rate of the outstanding principal, the lion’s share of debt service.⁶⁶ All things considered, the net effect of this reform was ambiguous.

The OPDA might have also induced the adoption of double-entry bookkeeping in Turkey.⁶⁷ This budgeting technology, used widely in Europe and also by the OPDA, was received with admiration by Ottoman officials. Would bookkeeping have been introduced in Turkey had the OPDA not been established? Most likely. The first attempt to introduce this technique took place in 1879, two years prior to the establishment of financial control.⁶⁸ Double-entry bookkeeping had also been used by the IOB since its founding in 1863. The OPDA seems neither necessary nor sufficient for the adoption of double-entry bookkeeping in Turkey. In fact, this technique was incorporated into the national budget only after the Young Turks assumed office, 25+ years into FFC.

Bureaucratic Capacity

Did bureaucratic capacity expand under foreign intervention? The sultan did not mirror the internal management of the tax administration under his control. Financial control “did not usher in a period of reform in the financial policy and administration of the Porte.”⁶⁹ Extravagant expenses, corrupt administrations, and the lack of budgetary control remained at least until the late 1900s. If we look at the resources budgeted for the Treasury (or Maliye), this ministry was not better endowed under the tenure of the OPDA than it was before. The major change in the series in table 5.2 followed the arrival of the Young Turks in the early 1900s.

TABLE 5.2. Funding of the Central Treasury in the Ottoman Empire

	Amount in kuruş	% of Public expenses
1846/7	0	0
1861/2	80,744	5.80
1875/6	174,190	6.00
1887/8	103,034	4.50
1905/6	135,033	6.10
1916/7	446,472	11.20

Source: Güran (2003).

FIGURE 5.4. Budget Balance before and after Financial Control in the Ottoman Empire. Negative values indicate deficit in percentage points. The dashed line indicates the onset of foreign financial control. Data drawn from Güran (2003).

Balanced Budget

The OPDA could have stopped the borrowing mania of previous decades, avoided new debt service outlays, and put an end to a history of chronic deficits—by incorporating the “Gladstonian” economic principles professed by European diplomats. Figure 5.4 suggests this did not happen. Unbalanced budgets remained the norm as did the use of external finance as a palliative to poor budget management.⁷⁰ Of the 26 loans floated between 1881 and 1914, 21 were officially issued to balance the budget.⁷¹ Fresh loans were possible thanks to and because of the OPDA. By ensuring strict respect for guarantees, it facilitated the quotation of new external credits. Average interest rates after 1881 dropped from an effective 11 percent to barely over 4 percent.⁷² After 30 years of the OPDA, cheap credit brought the Porte to where it was in 1876—into high indebtedness.

5.3.5 OTHER EVALUATION CRITERIA

If the OPDA is to be judged for keeping the “sick man of Europe” alive, then it was a success. It probably prevented economic collapse and helped Turkey integrate into global trade networks. If the OPDA is to be interpreted as an example of successful FFC, capable of enhancing the capacity to tax the local economy, accumulated evidence does not support that claim. Real change in the administration came from within: under the command of the sultan, tax revenues increased moderately but steadily. In the early twentieth century, under brief constitutional rule, tax receipts increased rapidly on a par with ambitious administrative reform.

One may argue that foreign financial control allowed the Turkish government to expand its military, another form of state capacity; however, a military without a sound fiscal apparatus cannot travel far. The “military-fiscal state” requires a simultaneous growth of military prowess and fiscal muscle. The former needs the latter, as the European experience proved.⁷³ The OPDA allowed the Turkish government to keep expanding its military machine while deepening external dependence. Ottomans were “regularly coerced or seduced [under FFC] into buying the latest weapons from the factories of Vickers or Krupp,”⁷⁴ requiring fresh loans and new hypothecation.

Finally, the analysis of the Ottoman case raises questions about which is the right counterfactual in historical analysis. In the absence of external finance, would the Ottoman Empire have raised enough taxes to fight against the Russians and build a stronger state apparatus? Or would it have been conquered and looted by Russia and experienced worse outcomes than those under the OPDA? This is impossible to know. The decision to borrow money to fund the war may have avoided Russian control; however, that choice had long-term ramifications along the lines of the country’s fiscal capacity. This book sheds light on those lasting consequences.

5.4 Foreign Financial Control in Late-Qing China

Why did the Ottoman Empire end up under foreign control? One reason is easy access to external capital; but another is the sultan’s reluctance to assume the costs of tax reform, as attested by the brevity of the First Constitutional Era, 1876–1878. The Ottoman sultans were not the only autocrats pushing their country into a debt trap. Others followed suit, Imperial China included.

The Qing dynasty accumulated large external debt in the last decades of the nineteenth century and succumbed to foreign pressures in 1911, when its most efficient tax administration was put in the hands of foreign powers for 18 long years. I briefly examine FFC in China by emphasizing the Qing’s reluctance to engage in tax bargaining with provincial rulers. This case illustrates the coupled (although arguably asymmetric) responsibility for FFC: predatory investment and irresponsible local leadership.

5.4.1 FALLING INTO A DEBT TRAP

The Treaties of Nanking (1842) and Tientsin (1858), following the First and Second Opium Wars, respectively, forced China to open its economy and limit tariffs on European imports. Military humiliation against Western powers plus 14 years of devastating civil war⁷⁵ motivated a battery of half-hearted “self-strengthening” administrative and military reforms in the 1860s. Fiscally exhausted, the Qing could not secure enough funds domestically to meet the expenses of modernization programs.⁷⁶ Between 1861 and 1911, China floated 78 bonds overseas.⁷⁷ Some loans went to the coffers of the central government and others to provinces, although all loans were guaranteed by the empire.

Before the Sino-Japanese War of 1894, external finance was largely voluntary and resulted from a combination of political will and possibility. The government’s view about foreign loans is summarized by the statesman and military leader Zuo Zongtang (1812–1885):

To borrow money by a government for wars is common in the West. Foreign traders are willing to lend money [to us], unlike Chinese merchants who are reluctant [to lend for wars]. Also, the more one borrows from foreigners the lower the interest he pays. This is also very different from the Chinese merchants’ practice [who charge more if they lend more].⁷⁸

Accordingly, by 1894, 75 percent of China’s loan issue was intended for military purposes.⁷⁹ The worst was coming: in 1898, sovereign debt quadrupled when the country was obliged to pay a war indemnity of Hk.Tls.200 million to Japan, 2.5 times its total annual revenue. Only three years later, in 1901, war indemnities to European powers for the Boxer Rebellion added Hk.Tls.450 million to China’s external debt. As the financial position of China deteriorated, European creditors required the hypothecation of the main sources of revenue: the likin—the internal toll tax and most lucrative tax in the empire—customs, salt monopoly, and railways. In 1911, at the verge of default, foreign bondholders backed up by their national governments took over the Maritime Customs Service (MCS) and turned it into a receivership, establishing FFC over China.

The MCS was the most efficient tax administration in China. Its origins can be traced back to 1854, when three foreigners were appointed to the Shanghai Customs House on an experimental basis.⁸⁰ Shanghai was one of the ports opened to Western trade after the First Opium War (1838–1842). The Treaty of Nanking stipulated that Britain would appoint consular officers to facilitate trade (e.g., disband trade monopolies) and to assess customs duties (i.e., assure that high tariff rates were not levied on British products).

In 1853, the Shanghai Customs House was shuttered when supporters of the Taiping Rebellion occupied the city. Rebels were expelled by loyal troops within a year, but the customshouse remained closed. The British consul in Shanghai conceived the idea of reopening the port by allowing the local authorities to manage daily operations while maintaining foreign supervision. This agreement was convenient for the British because they lacked the (military) capacity to control and enforce the maritime trade provisions stipulated in the Treaty of Nanking. The agreement was also convenient for the local authorities, who needed to resume trade for economic and military reasons—tariff revenue was needed to meet civil war expenses.

The 1861 Xinyou coup brought Prince Gong to power. He was the sponsor of the self-strengthening movement, an imperial initiative to reshuffle the military and bureaucratic apparatus to resist European powers.⁸¹ To secure the means for modernization, he recognized and institutionalized the Shanghai experiment and extended it to all the open ports. The now “imperial” Maritime Customs Service was led by an inspector general (IG) appointed by imperial edict but of foreign nationality. The IG and his staff were given monitoring powers, but the actual collection of taxes was left to local (native) authorities. The “IG would always have to bow to Chinese supremacy”—until 1911.⁸²

The MCS became one of the most sophisticated administrations in the country. By the same token, it also became increasingly attractive in the eyes of foreign investors, into whose hands the MCS fell after 20 years of trying. It all began with the indemnity loans of the second half of the 1890s—arguably the onset of the “scramble for concessions.”⁸³ In 1894, China was obliged to pay a Hk.Tls.200 million war indemnity to Japan within three years, but annual total revenue was less than half that, Hk.Tls.80 million. To assume reparations, the Chinese government floated three loans in Europe: the 4 percent Franco-Russian loan of 1895, the 5 percent Anglo-German loan of 1896, and the 4.5 percent Anglo-German gold loan of 1898, £16 million each.

The first indemnity loan came with a concession of a link of the Trans-Siberian Railway through Manchuria to the Russo-Chinese Bank, under the influence of the Russian government. This concession carried extraterritorial rights, including exemptions from Chinese taxes and permission to deploy the Russian army to protect the premises if needed. After the Boxer Rebellion, this latter provision was used by Russia to take control over Manchuria.⁸⁴ The second indemnity loan, negotiated by the Rothschilds with British and German official support, was collateralized by uncommitted revenue under MCS supervision plus additional securities if customs proved insufficient. The third and last indemnity loan, also issued by a syndicate of Anglo-German investors, was secured by additional customs revenue under MCS supervision,⁸⁵ a first charge on the likin revenue of four provinces, and sections of the Salt Tax Administration (a state monopoly). The loan contract allowed foreign powers to take over these agencies if China failed to service debt—in other words, extreme conditionality. As if that were not enough, the loan contract extended the British supervision of the MCS to 45 years.

In 1901, China fought in the Boxer Rebellion against an alliance of seven European powers plus Japan. China lost again, and reparations were raised to Hk.Tls.450 million (or £67 million), an inflated figure that nevertheless proved binding.⁸⁶ Lacking the ability to pay, China agreed to a new trade treaty that raised import tariffs to 5 percent ad valorem, increasing customs revenue (to be used for debt liquidation) and confirming the loss of tariff autonomy. Because customs proceeds were insufficient, uncommitted salt tax and a miscellany of other revenues were added to the list of pawned assets. The Boxer Rebellion reparations were cumbersome enough to survive until after World War II.

Opposition to these and other concessions, including ports, land, railways, and sections of the postal service, grew strong and lay at the origins of the 1911 revolution.⁸⁷ Arguably, social turmoil in the late 1910s was the opportunity that foreign financiers had long awaited. Higher political risk combined with poor financial performance caused by the revolution changed the mandate and composition of the MCS. Instead of supervising compliance with international treaties, the MCS took control over customs revenues and sent them to Shanghai to service debt, from which foreign obligations to European bondholders were paid.⁸⁸ The mandate of the MCS was also changed. Whereas foreign loans had been collateralized on customs revenue before 1911, these monies were not necessarily used to service debt. The central government allocated quotations to the administrators of provinces, who decided how to meet them. This changed after 1911 by prioritizing debt service to any other local expense. By switching the priorities of the MCS, the Great Powers had transformed it into a receivership similar to those installed in Egypt and the Ottoman Empire.

To secure foreign control of the institution, local high-ranking officials (or “superintendents”) were removed. Conveniently, for European bondholders, “if in the case of the Ottoman Empire and Egypt, for example, their creditors had to put in place an agency to enforce debt collection, in the Chinese case they did not even have to do that: the Customs Service was already in place.”⁸⁹ That is, FFC in China did not build local capacity but seized it. The revolutionaries accepted and continued these arrangements because the MCS was, after all, their only way to finance a state in fiscal decline since the 1850s. A new loan was floated by the revolutionary government in 1913: the £25 million reorganization loan, another textbook case of extreme conditionality. The government hypothecated all remaining MCS revenue and allowed the MCS to take control of the likin, the Salt Tax Administration (the second largest source of revenue of the central government), and local customs stations near treaty ports. The bond was so popular in European markets that it was four times oversubscribed.

The favorable conditions for investors of the 1911 and 1913 loans cannot be explained without reference to creditor government interference.⁹⁰ Not only did the Foreign Office participate in the negotiation of these loans, but the 1913 prospectus explicitly stated that the loan also had the “satisfaction of the Ministers of Great Britain.”⁹¹

When foreign powers took control of the MCS, the Chinese government was deprived of its most efficient tax administration—the opposite of state building. By keeping China on the brink of a financial meltdown, foreign control assured the government’s dependence on fresh loans. “The cost of capital was low, but it may not have been such a bargain [for China’s interests].”⁹² And in van de Ven’s words:

The consequence [of financial control] was that the Service became not the kernel of a modern administration for China, as Hart [the original IG] had wanted, but a debt-collection agency for foreign bondholders.⁹³

5.4.2 THE DOMESTIC POLITICS OF THE SCRAMBLE

Why did China lose financial sovereignty in 1911 (only recovered in 1929)? Cheap capital and diplomatic pressures were key factors, but not the only ones. The scramble also happened because an autocratic dynasty preferred to assume the risks of foreign finance over the political repercussions of taxation.

The modernization of the fiscal system in China required the centralization of the tax system, which—due to the government’s military weakness—could be done only by bargaining with local elites, specifically by sharing fiscal powers. The Qing refused to consider this option and, exposed to multiple military pressures, lost the modest fiscal power it still retained.⁹⁴ Taking advantage of the government’s weakness, local elites took over the four main sources of revenue: the land tax, the likin, customs, and the state salt monopoly.⁹⁵ Lacking the key to provincial treasuries, the government also lost the monopoly on coercive power.⁹⁶ Tax yields seized by provincial authorities were used to grow militias and provide local public goods, consolidating warlords’ power.⁹⁷ Regional militias facilitated domestic insurrection but also weakened further the country’s ability to respond to foreign aggression.⁹⁸

Self-strengthening reforms in the 1860s bore some fruit, but they were largely insufficient. General government revenue increased from 42.5 million silver taels in 1849 to 292 million in 1908; however, a third of this increase is explained by the appreciation of silver, not improvements in tax capacity; more importantly, only 18 to 28 percent of total revenue was actually sent to Beijing.⁹⁹ Lacking domestic funds, the Qing relied increasingly on foreign capital to balance the budget. The inclusion of pledges in loan contracts proved crucial to overcome credit rationing and to keep rates at competitive levels,¹⁰⁰ but the hypothecation of assets exposed the country to financial control, which eventually occurred in 1911. At the heart of the problem lay the Qing’s reluctance to share fiscal powers with provincial elites.

5.4.3 TOO LITTLE REFORM, TOO LATE

At the turn of the century, China was already in a precarious financial position. The Qing desperately needed more provincial contributions, but local elites—military viceroys and provincial governors—were unwilling to relinquish control over tax revenues unless concessions were granted. In 1901 after two recent defeats, first to Japan and then to Western powers (plus Japan), the Qing set in motion a battery of political reforms somewhat reminiscent of a constitutional monarchy.

Provincial legislatures elected under a highly restricted franchise were inaugurated. A handful of representatives of these legislatures—monopolized by provincial elites—were in turn appointed to the also new National Assembly in Beijing. In principle, these reforms were an opportunity to build power-sharing institutions—facilitators of fiscal centralization in other parts of the world.¹⁰¹ However, provincial elites had expectations for the new chambers different from those of the Qing.¹⁰² The latter saw the new legislatures as an instrument to connect with the populace—an instrument of legitimacy building in times of nationalistic fervor and discontent with international interference and hypothecation of national assets. Provincial elites saw these chambers as an opportunity for the “transfer of considerable local and national power into their own hands.”¹⁰³ In practice, the National Assembly was given only an advisory role. Excluded from national politics, provincial elites distanced themselves from the Imperial Palace and joined the nationalistic constitutional movement that put an end to dynastic rule.¹⁰⁴

The Qing’s aversion to strike deals with domestic elites was also manifested by its reluctance to issue domestic bonds despite the expansion of local credit markets during this period.¹⁰⁵ The Imperial Bank of China was created in Shanghai in 1897. Among its twelve directors, eight were powerful Chinese bankers and merchants.¹⁰⁶ To limit their power over fiscal policy, the bank was denied the monopoly on issuing paper money.

Hesitancy about resorting to domestic credit could be attributed to the first and only negative experience with currency issue in the 1850s;¹⁰⁷ however, this is also an expected behavior if a ruler anticipates domestic creditors’ demands for executive constraints and protection of property rights (i.e., honoring debt contracts) in return for domestic loans, a hypothesis that resonates with Debin Ma’s account of the financial revolution in Republican China in 1911–1949.¹⁰⁸ Ironically, the Qing’s fears were realized. After the revolution, Chinese bankers “attempted at numerous occasions to place constraint on the power of the [new Republican] government with regards to fiscal spending.”¹⁰⁹

5.4.4 STATE UNMAKING IN CHINA

The decay of China during the nineteenth century is best illustrated by its share of world GDP: 30 percent in 1830, 20 percent in 1860, and 6 percent in 1900.¹¹⁰ Commercial and financial openings played a key role:

China emerged out of the 1911 Revolution not proudly as Asia’s first republic but as a state governed by a man who depended on foreign goodwill and foreign money. The Japanese indemnity had taken China to the scaffold of its financial executioners, the Boxer Indemnity had pushed its head through the noose of the hanging rope, and the 1911 Revolution had opened the trapdoor.¹¹¹

External finance is only part of the story, however. The Qing shared some responsibility for state unmaking in China because it preferred to serve a foreign master rather than the people, or trajectory E instead of A/B in figure 1.3. Reluctance to strike tax deals with provincial leaders and domestic financiers proved self-defeating.¹¹² Agreements with foreign financiers at the cost of national sovereignty fueled the nationalistic fervor that eventually put an end to Qing rule.¹¹³ Ironically, the new leadership after the 1911 Revolution collateralized additional assets to avoid credit rationing (e.g., the 1913 reorganization loan). By then, however, China had already fallen prey to foreign investors.

Whether power-sharing institutions would have consolidated fiscal centralization and militarization and avoided the scramble in full or in part is hard to say; however, the Qing’s preference for external finance sheds light on the significance of the political costs for a sitting ruler derived from sharing powers with domestic elites in return for tax compliance. This case speaks also to sitting rulers’ myopia: the short-term low costs of external finance turned fatal in the long run. Foreign loans shrank the tax base of the country and eroded regime popularity, leading to the demise of the Qing dynasty.

5.5 Conclusion

Figure 1.3 depicts various paths to state building and state decay. If countries finance war (or other major fiscal shocks) externally, interrupt debt service, but eventually repay the loan, then the debt-tax equivalence of public finance holds. From this point of view, FFC may facilitate state building by compelling debtor countries to reshuffle the tax administration and amass new sources of revenue to service debt, expanding their fiscal capacity on a permanent basis. This is arguably the mandate of FFC in modern-day interventions led by multilateral organizations like the IMF and the World Bank.¹¹⁴

Things worked differently in the Bond Era. The main if not only goal of financial control was to repay private bondholders based overseas. Reform of local bureaucracies would be considered only if it maximized the profit of foreign private investors. Unsurprisingly, the literature overwhelmingly shows that FFC performed poorly in terms of building tax capacity in the Bond Era. Even the OPDA, which undoubtedly grew the Turkish economy, did not outperform the local administration in mobilizing revenue through taxation.

The mandate of FFC in the Bond Era is important to understand why external finance might exert negative consequences on state building in the long run. If FFC were meant to extract (or loot) local resources to service debt—not to enact fiscal improvement—states would have regained access to international capital markets without having strengthened their capacity to raise taxes. That itself would have challenged the equivalence between debt and war for the purposes of state building. If, in addition, states returned to credit markets having only a portion of their tax base to work with, then new budget deficits were to be expected, fresh loans needed, and tougher conditionality accepted. In order to understand the magnitude of the problem, the second part of the book investigates short- and long-term effects of external finance on fiscal capacity, and how it also influenced political and bureaucratic reform.

Although external finance often preempted state building in the Bond Era, the responsibility cannot be attached to foreign investors alone. The reluctance of autocratic leaders to strike tax bargains with domestic elites is noteworthy and helps us explain why significant advances in state building require unequivocal commitment to power-sharing institutions. I resume this discussion in chapter 9, where I review paths to positive state building as opposed to debt traps and state decay.

1. For the sake of language efficiency, in this chapter I use the acronym FFC.

2. See Hobson (1902) for the strongest defense of this argument.

3. Material in this paragraph is borrowed partly from Borchard (1951, ch. 18).

4. Wynne (1951, p. 25, fn. 29).

5. Maurer (2013).

6. Hyde (2007) and Fortna (2004), respectively.

7. Acemoglu and Robinson (2012); Easterly (2006).

8. Krasner and Weinstein (2014).

9. Lake (2016).

10. Borchard (1951); Feis (1930); Fishlow (1985); Wynne (1951).

11. Waibel (2011, p. 47).

12. Hansen (1983); Lindert and Morton (1989).

13. Kelly (1998, pp. 42–43).

14. Tooze and Ivanov (2011).

15. Fishlow (1985).

16. Reinhart and Trebesch (2015, p. 16).

17. Levandis (1944, p. 102).

18. Wynne (1951, pp. 344–335).

19. For instance, the American administrators had veto power over customs rates in Santo Domingo, Haiti, and Nicaragua; in the latter two cases, the US also supervised internal taxes. In Cuba, Santo Domingo, and Haiti, the US established debt ceilings; in Cuba, Haiti, Nicaragua, and Panama, the US put limits on how the receipts could be spent (Borchard, 1951, p. 294).

20. Maurer and Arroyo Abad (2017, p. 33).

21. Maurer (2013) for an extended treatment.

22. Material in this paragraph is borrowed partly from Pamuk (2018, ch. 4).

23. Gelvin (2005).

24. Pamuk (2018, p. 102).

25. Karaman and Pamuk (2010).

26. Güran (2003).

27. Pamuk (1987, p. 57).

28. Jenks (1927, pp. 305–306).

29. Pamuk (2018, p. 103).

30. Wynne (1951, p. 393).

31. With the 1863 reorganization, control was placed in the hands of a joint Anglo-French directorate. Ten of the 20 members were French and resided in Paris; the remainder were English and resided in London (Blaisdell, 1929, p. 219).

32. The figures presented in this chapter are drawn from the data compiled in these budgets and systematized by Güran (2003).

33. Wynne (1951, p. 416).

34. Suvla (1966).

35. Blaisdell (1929, p. 37).

36. Davison (1963, p. 266). Specifically, Turkey put together 185 vessels carrying 2,370 guns, including four line-of-battle ships, five first-class mailed frigates, twelve corvettes, and five gunboats of modern construction (Farley, 1872, ch. 9). Keeping the fleet up to date, Turkey acquired 20 ironclads from British builders from 1864 to 1871 and introduced submarine mines and torpedo technology, adopting a novel technology used earlier only in the American Civil War. The army was also modernized: the Porte purchased new guns and munitions from Krupp (Prussia) and Armstrong (Britain), including new fortress and siege guns. The carriage department was enlarged, and it replaced wooden gun carriages with wrought iron ones. Quick-firing rifles were also purchased from the British only one year after these rifles were adopted by the British army.

37. Jenks (1927, p. 309).

38. Birdal (2010, table 2.1).

39. Article 7 of the loan contract hypothecated the “surplus of the produce of the Tobacco Monopoly of Constantinople,” which was put into the hands of foreign bondholders as part of the 1881 default settlement.

40. Devereux (1963, ch. 10).

41. Birdal (2010, pp. 39–43).

42. Feis (1930, p. 315).

43. Feis (1930, p. 334).

44. Birdal (2010).

45. Blaisdell (1929); Feis (1930).

46. Birdal (2010); Wynne (1951).

47. For France, this capacity originated in the treaty signed by Suleiman the Magnificent and Francis I of France in 1534 and was confirmed by later treaties with France (Blaisdell, 1929, p. 24). For Britain, the capacity originated in the Trade Treaty of Balta Liman of 1838, by which customs duties for imports were fixed at 3% (Pamuk, 2018, pp. 97–98).

48. Blaisdell (1929, p. 174).

49. Feis (1930, p. 313).

50. Bulgaria never paid the tribute, which was eventually replaced by a tithe on tobacco. In 1885, Eastern Roumelia was annexed to Bulgaria, and irregular service ensued. In 1908, Bulgaria was proclaimed independent and stopped payment of the annuity. Cyprus’s contribution was also reduced by 20% in 1890. This stream of revenue, however, was artificial for the Porte coffers because Cyprus had been under British political and financial control since 1878.

51. Wynne (1951, p. 60, fn. 26).

52. The Societé de la Régie Co-intéressée des Tabacs de l’Empire Ottoman was established in 1883 for that purpose.

53. See Birdal (2010, ch. 5) for an in-depth account of the régie.

54. Tunçer (2015, figure 8.4)

55. Birdal (2010); Eldem (2005).

56. Wynne (1951).

57. Blaisdell (1929, p. 7).

58. Blaisdell (1929, p. 125).

59. Caillard and Gibb (1911).

60. Tunçer (2015, p. 74).

61. Feis (1930, p. 316).

62. Blaisdell (1929, p. 179). See Findley (1980, ch. 6) for additional details of bureaucratic reform under the Young Turks. For the political agenda of this group, which included the restoration of the national parliament and executive control, see Yapp (1987, pp. 189–195).

63. Suter (1992, p. 170).

64. Blaisdell (1929, p. 118).

65. Caillard and Gibb (1911).

66. Feis (1930, p. 315).

67. Birdal (2010, p. 177).

68. The Royal Edict of 1879 replaced the Merdiban method (a local system of accounting with more than a thousand years of history) with double-entry bookkeeping (Guvemli and Guvemli, 2007). This account is consistent with Orten (2006), who argues that the method had been incorporated endogenously by Turkish students dispatched to France years earlier in order to acquire first-rate training in accounting techniques—the Young Turks.

69. Wynne (1951, p. 476).

70. Owen (1981, p. 201).

71. Suvla (1966, pp. 104–106).

72. Blaisdell (1929, pp. 147–153) and Tunçer (2015, ch. 4).

73. Hoffman (2015).

74. Owen (1981, p. 199).

75. The Taiping Rebellion, 1850–1864, was a full-fledged civil war, causing 30–50 million casualties.

76. See Rosenthal and Wong (2011, ch. 6) for the military and fiscal decline in the nineteenth century, and Ma and Rubin (2019) and Sng and Moriguchi (2014) for principal-agent problems in imperial rule in China.

77. Goetzmann, Ukhov, and Zhu (2007, appendix I).

78. The original quote is from Zuo Zongtang (1890), and I drew it from Deng (2015, p. 332), who inserted the text in brackets.

79. von Glahn (2016, table 9.9).

80. van de Ven (2014, p. 26).

81. Rosenthal and Wong (2011, p. 212) for a critical review of the initiative.

82. van de Ven (2014, p. 11).

83. Cain and Hopkins (2016, ch. 13) for a dedicated account.

84. Rich (1992, p. 320).

85. Notice that by 1898 70% of customs revenue in China was hypothecated (van de Ven, 2014, p. 142).

86. King (2006).

87. Young (1970, ch. 2) for a survey of concessions to British, French, German, Belgian, and Russian investors and governments.

88. van de Ven (2014, p. 162).

89. van de Ven (2014, p. 135).

90. van de Ven (2014, p. 164).

91. van de Ven (2014, p. 168).

92. Goetzmann, Ukhov, and Zhu (2007, p. 284).

93. van de Ven (2014, p. 134).

94. Koyama, Moriguchi, and Sng (2018, p. 182).

95. von Glahn (2016, table 9.7) and Wakeman (1975, p. 232).

96. Wakeman (1975, p. 232).

97. Wakeman (1975, pp. 181–182).

98. Dincecco and Wang (2020).

99. He (2013, p. 159).

100. Goetzmann, Ukhov, and Zhu (2007).

101. Dincecco (2011).

102. Wakeman (1975, pp. 234–237).

103. Wakeman (1975, p. 236).

104. Zheng (2018).

105. He (2013, pp. 175–179) and Goetzmann, Ukhov, and Zhu (2007, p. 275).

106. He (2013, p. 175).

107. Goetzmann, Ukhov, and Zhu (2007); He (2013).

108. Ma (2016). See also Goetzmann, Ukhov, and Zhu (2007, p. 280).

109. Ma (2016, p. 16).

110. van de Ven (2014, p. 130).

111. van de Ven (2014, pp. 169–170).

112. Refer to Ma and Rubin (2019) for a deep historical account of absolutist rule in China.

113. Wakeman (1975); Zheng (2018).

114. See Kentikelenis, Stubbs, and King (2016) for a critical assessment of modern-day conditionality.