In the previous chapter we explored how, as a theoretical matter, governments and some subgroup of asset holders can create an economic system in which property rights are specified and enforced as private goods. We also explored how the implicit contract between the government and these select asset holders can be made credible via the creation of a coalition with a third group, which receives a stream of rents from the asset holders and provides the government with crucial political support. Finally, we explored why the property rights system laid down by such a coalition might be impervious to changes in the identity and ideology of the government.

Empirical reality is, of course, inevitably messier than any model of it. In order to make models tractable, it is necessary to assume that the actors are behaving as if they are playing a game whose rules and strategies are common knowledge. In the real world, however, it is often the case that some actors have a good sense of the game at hand, while others do not. (Indeed, casual empiricism suggests that many actors in social situations do not even know that there is a game.) Even those who ultimately figure out the rules of the game and the strategies for winning do not start out with that knowledge. They learn the game as they play.

Agriculture played a dominant role in the Mexican economy from precolonial times until well into the 20th century. In 1910 two-thirds of the population earned its livelihood from farming or farm work.

Agriculture's importance is perhaps matched only by the relative dearth of quantitative evidence about it. Because virtually all agricultural production took place in family-owned enterprises, there are no corporate financial data on which to draw. In addition, agricultural output was not subject to the excise taxes that were levied on producers in other sectors, so we cannot develop the range of firm-level data sets that we can for other sectors of the Mexican economy. We are, however, able to use U.S. and British trade records to put together data sets on Mexico's importation of capital and intermediate goods for agricultural use. We are also able to use those sources to estimate the net imports and exports of Mexican agricultural products to the United States. This means that we can develop data sets on the flow of new investment and on the economic performance of Mexican staple and export agriculture.

The data sets we have developed, when coupled with the extant secondary literature, allow us to capture the basic outlines of Mexico's agricultural history. Before the revolution, the federal government played an important role in the specification of agricultural property rights. The federal government played a very small role, however, in the enforcement of the property rights system.

This book has addressed the puzzle of how economies can grow amid political violence and disorder. In order to resolve this puzzle, we employed a somewhat heterodox approach, combining methods from history, economics, and political science. We concluded that political instability does not have a systematic impact on economic performance.

The resulting approach to evidence and theory – what some researchers call an analytic narrative – involved three steps: we built a theoretical framework; we gathered systematic quantitative and qualitative data about a polity – Mexico from 1876 to 1929 – that passed from a long period of political stability into a prolonged period of instability; and we used our theoretical framework, coupled to analytic techniques drawn from economics, to analyze the historical evidence in a coherent manner. We specified explicit hypotheses and the counterfactual propositions that emanate from them and then compared the results that one should expect from theory with the results that were obtained in the real world. The result is a book that offers, on the one hand, an analytic economic history of Mexico and, on the other, a generalizable model of the interaction of political institutions and economic performance.

We would venture that the combination of methods and evidence that we have employed is outside the mainstream of research in all three fields on which we have rather shamelessly trespassed. Our trespassing across disciplinary boundaries requires that we say something at this point about the implications of our substantive findings for each of these disciplines.

All governments – stable and unstable – face a commitment problem: if they are strong enough to arbitrate property rights, they are also strong enough to confiscate them. If the population does not believe that the government will refrain from exercising its power, then it will not invest. If there is no investment, there will be little economic activity, and there will be insufficient tax revenues to sustain the government.

The commitment problem is essentially a problem of contract enforcement. In a stable political system, a sovereign government offers property rights protection in exchange for some kind of benefit, typically a stream of tax revenues, from the holders of those property rights. The government and the asset holders assume contractual obligations, much in the same way that any two individuals or corporate bodies can. In a contract between two private parties, of course, the government, typically through the court system, ultimately serves as the third-party enforcer of the contract. A thorny problem arises, however, when the government is itself a party to the contract: the government has a monopoly over the enforcement of property rights but will only enforce those rights when it is in its interest to do so. Even if there is a promise of full enforcement, a sovereign government will be tempted to break it afterward. Private actors can, of course, anticipate government opportunism and therefore choose to invest less or not at all.

Financial systems are especially vulnerable to political instability. Under instability, governments and factions aspiring to be governments have strong incentives to steal bank reserves, force financial institutions to make them loans, engage in the unrestrained printing of currency (thereby setting off an inflationary tax on holding cash), and change the rules that regulate banking and the securities markets to maximize the government's access to funds.

The Mexican financial system was indeed negatively affected by political instability but only in the short run. The fight against Huerta in 1913–14 and the ensuing civil war among the victors from 1914 to 1917 brought about a near total collapse of the banking system. The governments that came to power after 1917, however, regardless of their stated ideologies, all recognized the need to accommodate the bankers. These governments understood that they needed a source of credit in order to restore political order. They also understood that without a functioning financial system there could be no economic growth, and without economic growth there would be no tax revenues. In short, the post-1917 governments realized that restoring the financial system was crucial to their own political survival.

The Obregón and Calles governments therefore recreated the vertical political integration (VPI) arrangements that underpinned banking during the Porfiriato. Just as Díaz had done, they selectively enforced property rights and allowed the bankers themselves to write the laws regarding entry into banking.

No sector of the Mexican economy was as immune to political instability as petroleum. In fact, crude oil production increased every single year from 1910 to 1921. By the time the upward rally in output began to reverse in the early 1920s, Mexico was the world's second most important producer (behind the United States), controlling 25 percent of world output. Even with the decline in output from its 1921 peak, oil output for the decade 1921–30 was more than 2 times what it had been during the decade 1911–20, and more than 87 times what it had been in the decade 1901–10.

This feat of production was remarkable because it took place under two major threats to property rights. First, petroleum, like other industries with high sunk costs, was particularly vulnerable to predation. The very nature of the industry rested on the ability of asset holders to claim and enforce a politically created property right, specifically the rights to wealth in the subsoil. Governments could abrogate those rights, allocate them to a third party, tax the rents they produced, or diminish them by permitting offset drilling on an adjoining property. Second, the oil industry was a ready source of revenue for revolutionary factions. Large infusions of cash were needed – and were needed badly. Moreover, the oil companies were an ideal target for predation. They could easily be taxed, because it was easy to monitor the value and volume of production.

We began this book in order to address a puzzle in political economy: why is it that political instability does not necessarily translate into economic stagnation? In the process of answering this question, we found that we had to draw on methods and approaches from what are usually thought of as three distinct disciplines: political science, economics, and history.

First, we had to develop a theory. That theory had to explore the conditions under which political violence, coupled with unpredictable and recurring change in the identity of the government, did not affect the underlying property rights system. Constructing that theory required, in turn, that we develop a theory about how governments can specify and enforce property rights as private (not public) goods. It also required that we explore the mechanisms that would make such selective commitments by governments credible – even if the identity of the government changed repeatedly.

Second, we needed to test that theory. Testing the theory required that we explore the functioning of a real-world case of such a selective property rights system under conditions of political stability and political instability. We therefore focused on Mexico, which created a selectively enforced property rights system during the long dictatorship of Porfirio Díaz (1876–1911) and which then underwent a prolonged period of revolutions, civil wars, political assassinations, and coups from 1911 to 1929.

What impact did Mexico's long period of instability have on its manufacturing industries? What strategies did manufacturers and political factions employ to mitigate the impact of adverse institutional change on their businesses? How successful were those strategies?

Our analysis indicates that political instability had only a short-run impact on investment and economic performance. Firm- and industry-level data indicate that the size, ownership structure, and productivity growth of the manufacturing sector was little affected by political turbulence, except for the period 1914–17. In the medium term, however, Mexico's manufacturers were able to mitigate the effects of instability by recreating the vertical political integration (VPI) coalitions that had sustained investment under Díaz. The one major difference was the third party that enforced the coalition. During the Porfiriato, the third-party enforcers of VPI were politically crucial individuals. After 1918 the third-party enforcer was the labor movement, acting as an institutionalized entity embedded into the country's governance structure.

In our argument we discuss first the development of large-scale industry in Mexico during the two decades prior to 1910 and then the direct impact of violence and the indirect impact of institutional change on Mexican manufacturers during and after the revolution. We then employ firm- and industry-level data and econometric techniques to assess the effects of these institutional changes before advancing an argument to explain why extreme political instability and dramatic institutional change had little impact on the performance of industry over the medium term.

The political instability of 1911–29 did not have a long-term impact on mining. There was a short-term decline in output during 1913–17. That downturn, however, was short-lived and was mostly caused by the interdiction of the railway system by warring factions, which made it extremely difficult to get ore and coal to smelters, or metals to the United States. In addition, during the early years of World War I, the markets for Mexico's major minerals were so depressed that, even had there not been a revolution, Mexico's mines could not have been run at a profit.

By 1918, when the railways returned to functioning and international prices recovered, Mexico's mining companies began to get back to work. They quickly resumed their pre-1911 growth path and Mexico ended the 1920s producing more copper, silver, and lead (its three most important mineral exports) than it had produced in any year before 1911. When Mexico's mining boom came to an end, it was the product not of the political instability of 1910–29 but of the Great Depression, which decimated metals prices.

Four reasons explain why the mining sector was able to weather political instability. First, the amount of technical knowledge required to run a modern mining and refining enterprise was extremely high, and Mexico's warring factions, as well as the governments of the 1920s, did not have the ability to run the mines and smelters themselves.