‘Pawn’ states: Exploring the costs of external debt in nation building

Yale political scientist Didac Queralt’s scholarship focuses on the role of public finance — government spending, borrowing, and taxation — on the formation and strength of national states.  

In his debut book, “Pawned States: State Building in the Era of International Finance” (Princeton University Press), Queralt considers the role of foreign lending in state building, covering both the benefits and potentially harmful consequences of external capital. And he offers a compelling historical analysis supporting the conclusion that states built on external loans are weaker than those built with domestic capital.

Among other honors, the book has received the William H. Riker Book Award from the Political Economy Section of the American Political Science Association (APSA), the Best Book Award of APSA’s International Collaboration Section, and the Gaddis Smith International Book Prize for best first book by a Yale ladder faculty member.

Queralt, an assistant professor of political science in Yale’s Faculty of Arts and Sciences, recently spoke to Yale News about the book’s development, conclusions, and his continued exploration of global finance. The interview has been condensed and edited.

How did the book take shape?

Didac Queralt: It grew organically from a paper I wrote about war finance, which examined the consequences of state building or financing war with debt or taxes. I had an opportunity to offer a more comprehensive examination of international credit markets in the 19th century, and that’s how the book was created. It’s a book that chases two goals: explaining why countries in the Global South had access to cheap credit in the 19^th century, and examining the long-term consequences of that access.

Why is it important to identify the role of external capital in state building?

Queralt: There has been a lot of research on state building that has focused on taxation: the idea is that if you invest in your tax administration, you can adopt an income tax, which is a progressive form of taxation. You can pay everybody, you can create a welfare state, and you can secure public health and public education. The thing is that taxation is only one way to fund the state. For example, accruing debt is very popular among governments — even in the United States. These governments accrue a lot of debt, but we know very little about how amassing debt contributes to state building. What we know tends to focus on rich countries, like in Europe and the United States, but we don't exactly know whether or how accruing debt in the Global South helps those countries succeed in building capacity.

What I do in this book is explore why debt in the West has been so good for state building, whereas in the Global South it has sometimes led to very poor outcomes. The argument that I make is that a lot of the debt that built states in the West was domestic debt as opposed to external debt, which has often been used in the Global South. I argue that the political incentives of domestic and external debt are very different. If you are a ruler who borrows from domestic creditors, you are more constrained about what you do with that money because the domestic creditors can replace you for another ruler. Although external borrowers in the 19^th century could take possession of collateralized assets, they could not replace the ruler, so the political constraints attached to domestic and external debt were and are very different. We cannot assume that they are both going to have positive effects on state building, so that’s why I focus so much on debt, because we know way more about the consequences of taxes.

How do you see your theories about external finance manifesting today?

Queralt: International credit markets today function differently than in the past. That said, there are two main things that I think should concern anybody who is interested in credit markets and politics today.

One is the way that early access to cheap credit in the 19^th century distorted incentives to build fiscal capacity. This can be seen today in countries that relied a lot on foreign debt: they have weaker tax systems. There is this persistence in the negative effects of external public credit.

The other thing that still applies today is that despite the many economic advantages of external credit, we need to understand the politics of access to this pot of money overseas for sitting rulers. Usually, rulers don’t want to tax for two reasons: one is that people resist taxation for probably obvious reasons. One way that rulers can tax their people is to spend a lot of resources in coercively extracting money from them, but that’s very inefficient. Or they can come to an agreement with the large taxpayers or the taxpayers in general by which they will have more political rights in return for their taxes. But rulers don’t tend to like to share their power, so when they have this access to external finance, they can get this money that they need without having to make having to make those kinds of compromises. And the problem that happens at that time is that debt has to be repaid, but if you have not improved your capacity to tax in order to repay, then there is risk of default, which is not good for anybody.

What do you hope that readers take away from the book?

Queralt: We should always keep in mind that there is no single policy that is good or bad, that it depends on how it’s used. For example, we should understand that a public deficit is necessary sometimes. When the economic conditions are bad, for instance, the state must step in, like the Biden administration did during the pandemic. But that kind of deficit spending should be used with moderation and with the understanding that at the end of the day, governments are going to repay that money with interest to lenders who are already very rich, including big financial corporations. You have to use it with caution.

When countries receive funding from external institutions, we need to understand that rulers react to external finance in different ways than they react to taxation. We cannot assume that all rulers are going to spend this external capital in the right way. Meanwhile, lenders need to make sure that any loan conditionality, like that imposed by the International Monetary Fund, is reasonable and balances the borrower’s financial needs with their political incentives. The book is a cautionary tale. Debt can be good for economic and political goals, but we need to remain cautious about perverse political incentives.

What are you working on now?

Queralt: Nowadays I’m working on the origins of foreign aid. It begins in the late 1920s and with the British giving, for the first time, “free” money to its colonies. I’m trying to understand why they did that. Before 1929, they didn’t give aid to the colonies. Why did they change course? I’m also trying to understand the short-term consequences of British imperial aid on things like public education in the colonies, or whether it grew tax capacity in the colonies. Because one of the conditions to receiving that aid was that the colonies had to make a fiscal effort to match some of the aid funds. I’m also trying to identify the long-term consequences of early access to foreign aid for democratic stability or lack thereof.