The Financial Power of the Powerless: Socio‐Economic Status and Interest Rates Under Partial Rule of Law

Abstract

Abstract. In advanced economies interest rates generally vary inversely with the borrower's socio-economic status, because status tends to depend inversely on default risk. Both of these relationships depend critically on the impartiality of the law. Specifically, they require a lender to be able to sue a recalcitrant borrower in a sufficiently impartial court. Where the law is markedly biased in favor of elites, privileged socio-economic classes will pay a surcharge for capital. This is because they pose a greater risk to lenders who have limited means of punishing them. Legal power, as measured by privileges before the law, thus undermines financial power, which is the capacity to borrow cheaply. Developing the underlying theory, this paper also tests it through a data set consisting of judicial records from Ottoman Istanbul, 1602-1799. Pre-modern Istanbul offers an ideal testing ground because rule of law existed but was highly partial. Court data show that titled elites, men, and Muslims all paid higher interest rates conditional on various loan characteristics. A general implication is that elites can benefit from instituting impartially enforced rules in financial markets. The beginnings of legal modernization in the Ottoman Empire included the establishment of relatively impartial commercial courts.

Islam and Economic Performance: Historical and Contemporary Links

“…As long as judges were partial to certain groups, contract enforcement would vary in strength depending on the identity of the litigants. Starting from this premise, Kuran and Rubin (2017) explore whether legal power, as measured by privileges before the law, undermines financial power, the capacity to borrow cheaply on the basis of collateral. The article's theoretical argument speaks to finance generally, not merely to Middle Eastern history.…”

Religious minorities and firm ownership in early twentieth‐century Egypt

“…The local courts’ systemic slant towards the political and economic elite was a persistent problem in the broader region. See Kuran and Lustig, ‘Judicial biases’, and Kuran and Rubin, ‘Financial power’, for similar biases in early modern Ottoman courts.…”