Constitutions and Commitment: Evidence on the Relation between Institutions and the Cost of Capital

34 Pages Posted: 23 Jun 2004

See all articles by Nathan Sussman

Nathan Sussman

Graduate Institute Geneva, Centre for Finance and Development

Yishay Yafeh

Hebrew University of Jerusalem - Jerusalem School of Business Administration; European Corporate Governance Institute (ECGI); Centre for Economic Policy Research (CEPR)

Date Written: June 2004

Abstract

This Paper challenges the North and Weingast (1989) view that institutional reforms and better protection of property rights lead to economic growth through a reduction in interest rates, and that a mechanism of this type accounted for Britain's ascendancy to economic supremacy. We show that, in contrast with North and Weingast, the risk premium on British sovereign debt remained high and even increased in the decades following the Glorious Revolution, and that during much of the 18th century, interest rates in Britain fluctuated considerably in response to wars and political instability. We also show that debt per capita - a measure of financial deepening - remained lower in Britain than in Holland for over a century after the institutional changes described by North and Weingast. Finally, we show that British interest rates moved in tandem with interest rates in Holland, suggesting that Britain did not embark on a different path following the institutional changes of the late 17th century. We conclude that, in the short run, institutional reforms do not lead to higher growth by lowering the cost of capital.

Keywords: Institutions, financial development

JEL Classification: G20, N20, N23

Suggested Citation

Sussman, Nathan and Yafeh, Yishay, Constitutions and Commitment: Evidence on the Relation between Institutions and the Cost of Capital (June 2004). Available at SSRN: https://ssrn.com/abstract=558641

Nathan Sussman (Contact Author)

Graduate Institute Geneva, Centre for Finance and Development ( email )

Switzerland

HOME PAGE: http://https://graduateinstitute.ch/academic-departments/faculty/nathan-sussman

Yishay Yafeh

Hebrew University of Jerusalem - Jerusalem School of Business Administration ( email )

Mount Scopus
Jerusalem 91905
Israel
+972 2 588 3081 (Phone)
+972 2 588 1341 (Fax)

HOME PAGE: http://bschool.huji.ac.il/facultye/yafeh/

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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