Economic Foundations of the Territorial State System ∗

The contemporary world is organized into a system of territorial states in which rulers exercise authority inside clearly defined boundaries and recognize the authority of other rulers outside those boundaries. We argue that this system can be rationalized as an economic cartel in which self-interested and forward-looking rulers maintain high tax revenues by reducing competition in the “market for governance.” Our theory explains how the major economic and military developments in Europe starting in the 15th century contributed to the development of this system.