Article | Financial History Review | April 2010

Endowments, Fiscal Federalism, and the Cost of Capital for States: Evidence from Brazil, 1891-1930

by Andre C. Martinez Fritscher and Aldo Musacchio


There is a large literature looking at the determinants of country risk (defined as the difference between the yield of a sovereign's bonds and the risk-free rate). In this paper, we contribute to the discussion by arguing that an important explanatory factor is the impact that commodities have on the government's capacity to pay. We use a newly created database with state-level fiscal and risk premium data for Brazil states between 1891 and 1930 to show that in Brazilian states that exported commodities that were in high in demand (e.g., rubber and coffee) the state governments ended up having higher tax revenues per capita and, thus, lower cost of capital. We also explain that the variation in revenues per capita was both a product of the variation in natural endowments and a commodity boom that had asymmetric effects among states. These two effects generated variation in revenues per capita at the state level thanks to the extreme form of fiscal decentralization that the Brazilian government adopted in the Constitution of 1891, which gave states the sole right to tax exports. We also use indices of export prices for each state as instruments for revenues per capita. Our instrumental variable estimates confirm our results that states with commodities that had higher price increases had lower risk premia.

Keywords: Bonds; Performance Capacity; Taxation; Revenue; Governance; Geographic Location; Trade; Price; Cost of Capital; Risk and Uncertainty; Public Administration Industry; Brazil;


Martinez Fritscher, Andre C., and Aldo Musacchio. "Endowments, Fiscal Federalism, and the Cost of Capital for States: Evidence from Brazil, 1891-1930." Financial History Review 17, no. 1 (April 2010). (Winner of the Gerry Feldman Young Scholar Prize for the best paper of (a) young scholar(s) of the European Association of Banking and Financial History, 2010-2011.)