The Origins of Central Banking: Solutions to the Free-Rider Problem

Certain domestic institutions are sources of international power, by way of their abilities to encourage investment and to mobilize social resources in wartime. For example, states with democratic institutions almost always win the wars they ght, a regularity known as the ‘‘democratic advantage.’’1 This result is intriguing since it rests on intuition about the effects of military competition on domestic institutions: rivalry among states may put pressure on sovereigns to provide the political founda-tions for secure markets in order to enlarge future military capabilities. In this article I address the role of war in inducing domestic institutions that al-lowed governments to credibly commit to promises to pay their debts—a probable source of democracies ’ edge in war. Rather than investigate the entire range of pro-tections affected by democratic institutions—a life’s endeavor, as the work of Doug-lass North attests—I focus on a single nancial element of the reforms: the innova-tion of central banking. Britain’s superior nancial, economic, and military performance after 1689 rested in large part on the establishment of the Bank of England.2 The central bank provided a commitment technology that improved th