How Did Democracy Emerge? What Financial Markets Tell Us

Thanks to the “historical turn” in the study of democratization, political scientists have accumulated a great deal of knowledge about how the bundle of institutions we now call “democracy” – including legislatures, a broad-based franchise, fair electoral procedures, and so forth – first emerged historically.

But there is a big debate in the literature that political scientists have yet to hammer out. On the hand, an important body of thought suggests that democracy emerged “from above” as an elite project, as prospering commercial elites sought to place limits on arbitrary rule by monarchs or dilute the political power of the traditional landowning aristocracy. On the other hand, redistributive theories of democratization suggest that democracy emerged “from below” as the threat of revolution by disenfranchised workers forced ruling political elites to make institutional concessions in the form of broad-based political rights.

Which view is right? A fundamental challenge for political scientists is to adjudicate between rival interpretations of critical reforms. For instance, should we take Lord Grey at his word – “The principal of my reform is to prevent the necessity of revolution. I am reforming to preserve, not to overthrow.” – regarding his motives for pushing for the 1832 Reform Act in Britain? Or is the 1832 Reform Act better seen as a maneuver on the part of commercial elites in industrializing Britain to shift political power from the countryside to the rapidly growing cities? Trying to recover the motives and perceptions of historical protagonists and disentangle different interpretations of what really happened in the distant past is one of fundamental problems of historical research.

As an alternative to trying to “get into the heads” of historical protagonists, we can turn to the reactions of financial markets. The emergence of large-scale financial capitalism alongside the emergence of democracy between the 1600s and 1900s means that we have abundant data from financial markets on how the prices of sovereign bonds and interest rates on loans to governments changed in response to political shocks. We can use these price movements as a revealed-preference barometer of what investors with money on the line really thought about major democratizing reforms. In this post, I will look at what we learn from studies – including a new paper entitled “Capital Meets Democracy: The Impact of Franchise Extension on Sovereign Bond Markets” by myself and Daniel Ziblatt, forthcoming at the American Journal of Political Science – which take this approach.

Publications like the Investor’s Monthly Manual published detailed information on market prices for sovereign bonds as well as political events.

Parliaments and the financial revolution

Perhaps the most important study to take this approach is the canonical paper of North and Weingast (1989), which looked at how lending to the English government changed after the Glorious Revolution of 1688, which established the principle of parliamentary supremacy in England. They found that lending boomed, and interest rates fell, as investors became less afraid of unilateral monarchical expropriation under the new regime. What this suggests is that the Glorious Revolution can be seen as an institutional reform engineered by wealth holders represented by Parliament seeking protection against arbitrary expropriation. This is very much a case of democratization “from above”. North and Weingast’s paper kicked off many important paths of research, one of them the literature on “democratic advantage” which suggests that democratic political regimes, the security of property rights, commerce, and financial capitalism are mutually reinforcing phenomena.

Subsequent research has refined North and Weingast’s important insights. Pincus and Robinson (2011), for example, suggest that increased investor confidence was reflected not so much in falling interest rates but in diminished credit rationing and expansion in the volume of credit they were willing to offer the English government. The work of Stasavage (2007) has shown that what really mattered was not just the establishment of parliamentary sovereignty but the nature of the elites who comprised parliament – the Whigs, the predominantly protestant, commercially-oriented faction that dominated English politics and which cemented the capital-friendly orientation of the English government during their reign.

Bond market reactions to franchise extensions

However, the creation of parliaments across countries was just one aspect of democratization. Another critical reform that was followed was the extension of political rights from property-owning elites to non-elites through franchise reforms that took place in the nineteenth century. We lump these distinct innovations under the label of democratization because they both broaden the distribution of political power relative to the status quo ex ante. But it is important to remember that they were separate historical innovations representing two very different dimensions of democratization – according to the well-known framework offered by Dahl (1971), the deepening of elite contestation in the case of parliamentarization and the expansion of political participation to non-elites in the case of franchise extensions.

There is reason to think that the logic of franchise extension might be more consistent with “redistributive” theories of democratization and therefore pose a risk to concentrated wealth held in the form of financial capital. For instance, unlike the creation of parliaments, which empowered commercial elites, franchise extensions did precisely the opposite – they lowered the income threshold required to vote and in doing so typically empowered new, poorer voters, often from the working classes, who did not have the same vested interest in debt repayment that financial elites did and who might prefer policies at odds with those favored by investors. The emergence of mass democratic politics was a messy, often unpredictable, and sometimes violent affair, resulting in the type of political instability that investors detested.

In a new paper with Daniel Ziblatt, we look at how sovereign bond markets reacted to franchise reforms across 26 countries in Europe and the Americas between 1800 and 1920 – the so-called “first wave” of democracy. In this paper, we find that investors saw franchise extensions as threatening to the prospect of repayment, and demanded a higher implicit rate of return (bond prices fell/yields rose) in order to hold a country’s bonds after major franchise extensions in order to compensate for this increased credit risk.

This was not just about destabilizing constitutional reform – we show that on average after major franchise extensions, yields rose (prices fell) but that after major franchise reversals, yields fell (prices rose). This suggests that it was not constitutional change per se but the direction of changes in the size of the electorate to which investors were responding. Interestingly, the time-path of effects suggests that while some of this credit risk emerged in the short run much of it emerged in the long run, due to an observable increase in the long-run occurrence of default and financial instability following democratization.

However, something we find is that bond markets became less sensitive to franchise extensions over time. This could be for a variety of reasons, as yields on sovereign bonds displayed to some extent a pattern of secular decline over the course of the nineteenth-century. But part of this was due to the strategic adoption of institutions like the gold standard, which limited the fiscal and monetary discretion of government and which investors saw as a “good housekeeping seal of approval” or credible signal of sound fiscal and monetary management.

In the paper, we show that adherence to the gold standard improved following major franchise reforms, especially after 1870, when the gold standard came widely to be seen as the anti-inflationary monetary standard relative to bimetallism (due to the plummeting price of silver). We look at other institutional changes too, including the level of institutionalization of political parties. Institutionalized political parties provided a means for established elites to participate in and manage the pressures of mass electoral politics, while preserving and protecting key elite interests. Sure enough, the level of institutionalization of political parties tended to improve following major franchise reforms too.

The strategic adoption of these (and surely other) institutions helped make mass democracy increasingly “safe” for investors, we argue, and this was reflected in the diminishing marginal credit risk that sovereign bond investors attached to franchise extensions over time. Indeed, ultimately global capital markets thrived during the nineteenth century despite the first wave of democracy.

Cumulative lessons for the study of democratization

What we take away from this is that financial markets reacted differently to different forms of democratization. They may have liked elite-dominated parliaments and the establishment of limited government but they were, at least initially, threatened by the extension of political rights to non-elites through franchise reforms. However, the strategic adoption of institutions which protected financial interests made mass democracy less threatening to their interests and therefore less risky over time.

These cumulative findings reconcile contradictory impulses in the literature. As discussed, some canonical accounts regard “democracy” as a mechanism of emerging propertied classes to protect themselves from an over-reaching state. Others important accounts regard democracy as an inherent threat to propertied and wealthy classes. Our work suggests that much of this disagreement is only apparent. What we call today democracy is in fact a complex bundle of institutions which emerged at different points in history for different reasons. Some parts of this institutional complex – e.g. parliamentary institutions – were a project of commercial elites, and were perceived as beneficial to the protection of financial property rights. Other parts of the institutional amalgam – e.g. suffrage rights – represented a clear transfer of political power from elites to non-elites, and were perceived as a source of political risk that had to be compensated for in the form of higher sovereign borrowing risk premia or mitigated through counter-majoritarian institutional engineering.

From this historical perspective, the complex contemporary relationship between democracy and financial capitalism also makes more sense. Some studies in the “democratic advantage” tradition find a positive association between democracy and the ability to borrow on credit markets. But in certain cases, for instance in the case of financial crises afflicting Argentina or Greece, we see a sharp conflict between democratic policy pressures and the strictures demanded by mobile financial capital come into play. The reality is that some features of democracy are capital-friendly and others are potentially capital-threatening and that all societies have developed a complex set of counter-majoritarian institutions designed to insulate financial markets from the democratic process entirely.

There is a lot more research to be done on this topic. But I hope I have persuaded you of two points. First, it is worth “unbundling” the institutional features of democracy when we think about how democracy emerged historically and what its consequences for property rights and markets might be. Different aspects of democratization may have been governed by different political logics, with democratization occurring “from above” in some cases and “from below” in others. Second, financial markets can provide a fascinating window into the past when we are trying to understand what really drove important historical processes.


  • I am an assistant professor of political science at the University of California, Merced. My research is on comparative political and economic history/development. I work on three main topics: (i) democratization; (ii) technological change; (iii) and state capacity. Much of my work is on rural India, including my book project on the political consequences of technological change, but I also work comparatively. I am building a lab on the Political Economy of Agriculture and Rural Societies (PEARS).

One thought on “How Did Democracy Emerge? What Financial Markets Tell Us

Leave a Reply