Colossus (36 page)

Above all—and this is where Roosevelt and other critics of empire got it most wrong—the British Empire was an engine for the integration of international capital markets. Between 1865 and 1914 more than £4 billion flowed from Britain to the rest of the world, giving the country a historically unprecedented and since unequaled position as a global net creditor, “the world’s banker” indeed, or, to be exact, the world’s bond market. By 1914 total British assets overseas amounted to somewhere between £3.1 and £4.5 billion, as against British GDP of £2.5 billion.
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This portfolio was authentically global: around 45 percent of British investment went to the United States and the colonies of white settlement, 20 percent to Latin America, 16 percent to Asia and 13 percent to Africa, compared with just 6 percent to the rest of Europe.
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Out of all British capital raised through public issues of securities, as much went to Africa, Asia and Latin America between 1865 and 1914 as to the United Kingdom itself.
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This pat
tern was scarcely changed by the effects of the First World War and the Great Depression.
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As is well known, British investment in developing economies principally took the form of portfolio investment in infrastructure, especially railways and port facilities. But the British also sank considerable (and not easily calculable) sums directly into plantations to produce new cash crops like tea, cotton, indigo and rubber.

It has been argued that there was therefore something of a Lucas effect in the first era of globalization—in other words, that British capital tended to gravitate toward countries with higher
per capita
GDP, rather than relatively poor countries.
⁶⁵
Yet the bias in favor of rich countries was much less pronounced than it is today. In 1997 only around 5 percent of the world’s stock of capital was invested in countries with
per capita
incomes of a fifth or less of U.S.
per capita
GDP. In 1913 the proportion was 25 percent.
⁶⁶
The share of developing countries in total international liabilities was 11 percent in 1995, compared with 33 percent in 1900 and 47 percent in 1938.
⁶⁷
Very nearly half the total stock of international capital in 1914 was invested in countries with
per capita
incomes a third or less of Britain’s,
⁶⁸
and Britain accounted for nearly two-fifths of the total sum invested in those poor economies. The contrast between the past and the present is striking: whereas today’s rich economies prefer to “swap” capital with one another, largely bypassing poor countries, a century ago the rich economies had very large, positive net balances with the less well-off countries of the world.

Investing money in faraway places is always risky; what economists call informational asymmetries are generally greater, the farther the lender is from the borrower.
⁶⁹
Less developed economies also tend to be rather more susceptible to economic, social and political crises. Why, then, were pre-1914 investors willing to risk such high proportions of their savings by purchasing securities or other assets overseas? One possible answer is that the adoption of the gold standard by developing economies offered investors a kind of “good housekeeping seal of approval.”
⁷⁰
In 1868 only Britain and a number of its economic dependencies—Portugal, Egypt, Canada, Chile and Australia—had currencies that were convertible into gold on demand. France and the other members of the Latin Monetary Union, as well as Russia, Persia and some Latin American states were on the bimetallic (gold and silver) system, while most of the rest of the world
was on the silver standard. By 1908, however, only China, Persia and a handful of Central American countries were still on silver. The gold standard had become, in effect, the global monetary system, though in practice a number of Asian economies, notably India, had a gold exchange standard (with local currencies convertible into sterling rather than actual gold), while some “Latin” economies in Europe and America did not technically maintain convertibility of notes into gold.
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This system of international fixed exchange rates may have encouraged international trade. Adherence to gold was also a signal of monetary and fiscal rectitude that allegedly facilitated access by peripheral countries to West European capital markets. It was a commitment mechanism, a way of affirming that a government would eschew irresponsible fiscal and monetary policies such as printing money or defaulting on debt.
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A commitment to gold convertibility, according to one estimate, reduced the yield on a country’s bonds by around forty basis points.
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To put it simply, that meant that countries on the gold standard could borrow more cheaply when they went cap in hand to the London bond market.

As a
contingent
commitment, however, membership of the gold standard was nothing more than a promise of self-restraint under certain circumstances. Countries on gold retained the right to suspend convertibility in the event of an emergency, such as a war, a revolution or a sudden deterioration in the terms of trade. Such emergencies were in fact quite common before 1914. Argentina, Brazil and Chile all experienced serious financial and monetary crises between 1880 and 1914. By 1895 the currencies of all three had depreciated by around 60 percent against sterling. This had serious implications for their ability to service their external debt, which was denominated in hard currency (usually sterling) rather than domestic currency. Argentina defaulted in 1888–93, and Brazil in both 1898 and 1914. In other words, investors who pinned their faith in a country’s adoption of the gold standard had no guarantee that the country would not default. (Indeed, some countries made the chances of a default more likely by going on to gold during the years of relative gold shortage between the mid-1870s and the mid-1890s, since falling commodity prices made it harder for them to earn from exports the hard currency they needed to service their external gold-denominated debts.)

Altogether different was the kind of commitment that came with the
imposition of direct British rule. This amounted to an unconditional “no default” guarantee; the only uncertainty investors had to face concerned the expected duration of British rule. Before 1914, despite the growth of nationalist movements in colonies from Ireland to India, political independence still seemed a distinctly remote prospect; even the major colonies of white settlement had been granted only a limited political autonomy. Moreover, the British imposed a distinctive set of institutions on their colonies that was very likely to enhance their appeal to investors: not only a gold-based currency but also economic openness (free trade as well as free capital movements) and balanced budgets—to say nothing of the rule of law (specifically, British-style property rights) and relatively noncorrupt administration.
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In other words, while investors who put their money in independent gold standard countries got little more than a promise not to print money, investors who put their cash in colonies could count not just on sound money but on the full range of Victorian “public goods.” It would therefore be rather puzzling if investors had regarded Australia as no more creditworthy than Argentina or Canada as no more creditworthy than Chile.

We can measure the “empire effect” on international capital flows in two ways: the volume of capital that went to British colonies and the interest rates those colonies paid. According to the best available estimates, more than two-fifths (42 percent) of the cumulative flows of portfolio investment from Britain to the rest of the world went to British possessions. The imperial proportion of stocks of overseas investment on the eve of the First World War was even higher: 46 percent.
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It also seems clear that imperial possessions were able to borrow at lower rates of interest than independent countries (or the colonies of other powers). Britain and its principal possessions had among the lowest average bond yields for the period 1870 to 1914. By comparison, the yields on bonds issued by the Latin American economies, which also attracted substantial inflows of British capital without actually coming under British rule, were significantly higher. Argentine yields, to give just one example, were more than two hundred basis points higher than those on Indian bonds.
⁷⁶
Among twenty-three countries for which bond yield figures are readily available for the period 1870 to 1914, it is very striking that the five states that were members of the British Empire had the lowest rates, all averaging less than 4 percent. Only Norway and Sweden were able to borrow in London at rates lower than New
Zealand and Australia. Egypt, which began the period outside the empire but became a
de facto
colony in 1882, saw a dramatic decline in its average yield from to 10.1 percent (1870–81) to 4.3 percent (1882–1914).
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The differential was even more pronounced in the interwar period, which saw major defaults by numerous independent debtor countries, including Argentina, Brazil, Chile, Mexico, Japan, Russia and Turkey.
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By the 1920s, at the latest, membership of the empire was therefore confirmed as a better “good housekeeping seal of approval” than gold.
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Experience showed that money invested in a
de jure
British colony such as India, or in a colony in all but name like Egypt, was more secure than money invested in an independent country such as Argentina. In turn, the low-risk premium paid by British colonies when they raised capital in London made it less likely that they would fall into the kinds of debt traps that claimed other emerging markets, whose interest payments out to foreign creditors exceeded the amounts of money flowing in from new loans and being generated by the foreign-financed investments.

That imperial membership offered better security to investors than mere adoption of the gold standard should not surprise us. At the turn of the century legislation was introduced, in the form of the Colonial Loans Act (1899) and the Colonial Stock Act (1900), which gave colonial bonds the same trustee status as the benchmark British government perpetual bond, the “consol.”
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At a time when a rising proportion of the national debt was being held by Trustee Savings Banks, this was an important boost to the market for colonial securities.
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Moreover, after the First World War, it was agreed between the Treasury and the Bank of England that new bond issues by British possessions should be given preference over new issues by independent foreign states.
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Even colonial constitutions had been drafted with at least one eye on creditor preferences.
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It was inconceivable, declared one colonial governor in 1933, that the interest due on Gold Coast bonds should be compulsorily reduced; why should British investors “accept yet another burden for the relief of persons in another country who have enjoyed all the benefits but will not accept their obligation”?
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When the self-governing dominion of Newfoundland came to the brink of default in the early 1930s, a royal commission under Lord Amulree recommended that its Parliament be dissolved and its government entrusted to a six-man commission and royal governor appointed
from London. Amulree’s report made it clear that he and his committee regarded the end of representative government as a lesser evil than default.
⁸⁵

Small wonder an increasing share of British overseas investment ended up going to the empire after the First World War. In the period from 1900 to 1914, around two-fifths (39 percent) of British overseas capital went to the empire. But after the First World War the balance shifted. In the 1920s the empire accounted for around two-thirds of all new issues on the London market.
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Writing in 1924, John Maynard Keynes observed caustically that it was “remarkable that Southern Rhodesia—a place in the middle of Africa with a few thousand white inhabitants and less than a million black ones—can place an unguaranteed loan on terms not very different from our own [British] War Loan.” It seemed equally “strange” to him that “there should be investors who prefer[red] … Nigeria stock (which has no British Government guarantee) [to] … London and North-Eastern Railway debentures.”
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Keynes’s point was that this state of affairs was not in the economic interests of Britain itself. With unemployment stubbornly stuck above prewar levels and mounting evidence of industrial stagnation, capital export seemed like a misallocation of resources. But Keynes did not consider the benefits reaped by colonial economies from this kind of cheap access to British savings. From an imperial rather than a narrowly national point of view, it was highly desirable that savings from the wealthy metropolis be encouraged to flow to the developing periphery. Besides ensuring that British investors got their interest paid regularly and their principal paid back, the imperial system was conducive to
global
economic growth—more so, certainly, than an alternative policy of the sort Keynes had in mind, which would have prioritized the industrial production and employment of the United Kingdom.