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.

Islamic law and economic development

“…Judges were trained to value the testimony of men over women; this is not to say that women's testimony was completely devalued, just that the benefit of the doubt was given to men. For this reason, men were much more likely to serve as witnesses in legal proceedings (Kuran and Rubin 2017). Similarly, judges were trained to value the testimony of Muslims over non-Muslims, although there is little evidence that strict equivalency rules were ever employed (e.g., one Muslim = two Christians).…”

“…This meant that it was unwise for an ambitious judge to rule against an elite with links to the Sultan unless the weight of evidence against the elite was overwhelming (Imber 2002, ch. 6;Kuran and Rubin 2017).…”

“…How did these judicial biases affect economic outcomes in the Ottoman Empire? Kuran and Rubin (2017) suggest that an unintended consequence of judicial bias was that it raised the cost of credit for those who benefitted the most from it: elites, Muslims, and men. They find that these three groups paid between 2 to 4 percentage points higher interest rates on loans, all else equal.…”

Islamic Finance and Development in Malaysia

“…

From a historical perspective, Islamic economic institutions have not been conducive to capital accumulation in Muslim societies (Kuran 2004(Kuran , 2011. This has been further hampered by a lack of trust among different faith communities, where Muslims were historically charged higher interest rates by non-Muslim financiers (Kuran and Rubin 2018). Despite these institutional legacies, Islamic banking and finance has grown rapidly in the Muslim world over the past few decades.

…”

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.…”