The Legacy of War on Fiscal Capacity∗ Didac Queralty January 18, 2018 Abstract This manuscript revisits the relationship between war and state-making in mod- ern times by focusing on types of war finance. Tax-financed war exerts lasting effects on state capacity because new taxes require enhancements of the state apparatus and complementary fiscal innovations. Loan-financed war may not contribute to long-term state capacity because countries might default once the war ends, preempting any persistent fiscal effect. I advance two mechanisms of transmission of war effects: one being political—tax-financed war transforms taxation into a nonzero-sum game|, the other bureaucratic. To address concerns of endogeneity in access to war participation and war finance, I exploit unanticipated, historical crashes in international financial markets, which temporarily dried up capital flows around the globe and precluded war- ring states from borrowing irrespective of their (un)observed characteristics. Results suggest that the advent of a genuinely global capital market in the early nineteenth century undermined the association between war and state making. ∗First Draft: June 2015. I am grateful to Ben Ansell, Laia Balcells, Thomas Brambor, Carles Boix, Allan Dafoe, Alexandre Debs, Mark Dincecco, Hector Galindo, Aina Gallego, Francisco Garfias, Scott Gates, Maria Jose Hierro, Margaret Levi, Pilar Nogues-Marco, Shanker Satyanath, Peter Schram, Ken Scheve, David Stasavage, Hans-Joachim Voth, Tianyang Xi, and seminar participants at Columbia University, Carlos III, Universitat de Barcelona, EUI, Lund, Peking, Sciences Po, Stanford, Vanderbilt, and Yale for comments and suggestions. yYale University, Political Science;
[email protected] 1 1 Introduction War, although devastating, offers a matchless opportunity to transform the state.