When the State is Untrustworthy: Public Finance and Private Banking in Porfirian Mexico

Abstract

All sovereign governments face a commitment problem: how can they promise to honor their own agreements? The standard solutions involve reputation or political institutions capable of tying the government's hands. Mexico's government in the 1880s used neither solution. It compensated its creditors by enabling them to extract rents from the rest of the economy. These rents came through special privileges over banking services and the right to administer federal taxes. Returns were extremely high: as long as the government refrained from confiscating all their assets (let alone repaying their debts) less than twice a decade, they would break even.