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Mobilizing Money:
How the World’s Richest Nations Financed
Industrial Growth
Caroline Fohlin
Johns Hopkins University
Cambridge University Press, 2012
Why study financial systems?
• Financial systems have significant impact on
our financial well-being
• They contribute to economic growth
• How they are organized and designed may
influence how much they contribute to
growth
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Why study their long-run evolution?
• Things change
• Initial conditions affect paths of
development
• We’d like to know how things might work in
the future
• We want to understand impact of shocks
and regime changes
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Three key conclusions
1. Modern financial systems are rooted in the
past, are idiosyncratic to specific countries,
and are highly path-dependent.
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Three key conclusions
2. Financial institutions and markets do not
create economic growth without significant
first steps in industrial development and
supporting institutions.
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Three key conclusions
3. There is no ‘one-size-fits-all’ solution to
financial system design and industrial
development.
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The main policy lesson of history
• Policy makers should aim to develop a strong,
stable, and legally protected financial system
with a rich diversity of institutions and vibrant
markets that can adapt to changing needs.
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Continuing themes
• Distant roots of modern financial systems
• Idiosyncrasies in political interventions
• Long-term persistence, punctuated by
disruptions
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Plan for the seminar
1. The problem of classifying financial systems
2. The roots of financial structure
3. Financial structure and growth
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Topic 1
Classifying Systems
Key results
– few countries fit stereotypes: stop thinking in terms of dichotomies
– loose relationship among scope of services, extent of bank relationships,
prevalence of stock markets
– short-run upheaval but long-term stability
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Legal tradition
• Vast majority of the world has one of two
types of legal tradition
– Common law
– Civil law
• Many countries of one type have influences
from the other type
– Canada
– Louisiana (U.S.)
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Legal tradition
• But substantial variation
within types
– Is the U.S. common law the
same as the U.K.?
– Is German civil law the
same as French or Spanish?
• Is there a true dichotomy
of legal tradition?
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Source: ictregulationtoolkit.org
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Hypothetical effects of legal tradition
• Two key channels (Beck, Demirgüç-Kunt, and Levine,
2002)
– “political” channel:
common law legal tradition gives higher priority to the rights
of individual investors compared with the state
• Hastens development of property rights and financial markets.
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Hypothetical effects of legal tradition
– “adaptability” channel:
common law tradition adjusts more rapidly to emerging
commercial needs
• quickly provides new contracting means
• fosters financial development
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Political systems
• Typical dichotomies
– Federal versus unitary
– Centralized versus decentralized
– Autocratic versus representational
• You can have various
combinations
– E.g. federal doesn’t imply
centralized
• Big changes over time
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Hypothetical effects of political systems
• Political centralization may lead to creation of
national institutions such as central banks
– This is good
• But it could signify desire to control economy (can be
confused with autocracy)
– This might not be so good
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Financial system dichotomies
• Universal versus specialized banks
• Relationship versus arms-length banking
• Banks versus markets
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Universal versus specialized banking
• Universal banking: provision of a wide range of
financial services by the same institution.
– typically combines standard commercial banking functions (shortterm credit, deposit taking, payments clearing, bill discounting) with
underwriting and trading in securities.
– Modern universal banks also sell insurance, mortgages and
investment funds (usually through affiliates)
• Specialized banking: banks restrict their activities to
one or a small portfolio of services
– E.g., exclusive provision of loans or investment services.
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Relationship versus arms-length banking
• What exactly is relationship banking?
– remains quite vague in the literature on financial system design
• I formalize the concept using three main characteristics:
– proxy voting
– equity shares
– board positions
• Also can have informal relationships without the visible signs
– E.g.?
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Banks versus markets
• In a “bank-dominated” financial system, banks
provide the majority of external finance
• In a “market-oriented” system, markets take
the leading role
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Financial system dichotomies
• Bank-dominated
• Universal banks
• Relationship oriented
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• Market-oriented
• Specialized banks
• Arms-length banking
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Economic, Political, and Legal Factors:
Hypothetical Relationships
La Porta et al/Dietl
Common law
tradition
Banking
specialization
Market
orientation
Rajan and Zingales
January 2014
La Porta et al/Dietl
State
decentralization
Caroline Fohlin, Johns Hopkins
Verdier
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Universal banks
• Universal banking emerged in the mid- to late- 19th
century.
– Germany and Italy key examples
• Spread over many parts of the world in 19th c.
– has existed in nearly all continental European countries to
some extent.
– did not supplant other types of institutions
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Geography of universal banking
• Belgium’s pattern common in many moderately
industrialized countries of the mid- to latenineteenth century:
– small number of large-scale, typically limited-liability
universal banks
– good number of smaller specialized banks focusing more
on narrower range of services
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Geography of universal banking
• Similar mix of institutions emerged elsewhere to
varying degrees
– continental Europe (at least in Denmark, France, Greece,
Italy, the Netherlands, Spain, Sweden, and Switzerland)
– parts of Latin America (Argentina, Brazil, and Mexico, for
example)
– in limited way, even in Australia, New Zealand, and the
United States before various financial crises and regulatory
actions damped it out.
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Geography of universal banking
• Germany at extreme
– dozen or more large-scale universal banks,
remained at the extreme until the major
concentration movement of World War I.
– even Germany had many banks that provided
little if any investment banking services.
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Banking institution scope
Specialized
Universal
Mixed
Australia
before 1890s
Australia
1895-1950s
Argentina
esp. after 1890
Austria-Hungary
since 19th c.
Canada
esp. after WWI
Belgium
1830s-1934
Brazil
post-1900
England
esp. after 1850s
Brazil
1850-1900
Finland
1920s-1980s
Finland
pre-WWI
Canada
1900-13
France
1800-1880
France
1941-1984
Denmark
1870-1913
Germany
since 19th c.
Greece
1928-1962
France
1880-1913
Italy
1890's-1920's
India
esp. after 1850s
Greece
pre-WWI
Japan
pre-WWII
Ireland
esp. after 1850s
Netherlands
1860-1920s g
Mexico
1897-1913
Italy
1930's-1980's
New Zealand
1870-1895
Portugal
since 19th c.
Japan
post-WWII
Spain
esp. after 1890s
Russia
1890s-WWII
New Zealand
1895-
Sweden
esp. after 1850s
United States
before 1933
Norway
pre-WWII
Switzerland
esp. post-1890s
United States
1933-1990s
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Legal Tradition, Political Centralization, and Banking Structure
Cross Tabulations of Universality circa 1990
Common law
Civil law
Total
Specialized banking
4
7c
8
Universal banking (no restriction)
3a
11
17
Specialized banking
7
16c
23
Universal banking (no restriction)
8a
13
21
Original sample (pre-1913 industrializers):
Expanded sample:
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Legal Tradition, Political Centralization, and Banking Structure
Cross Tabulations of Universality circa 1990
Common law
Civil law
Total
Specialized banking
1
3
4
Partial universal banking
9
13
22
Universal banking
5b
13
18
Total
15
29
44
T-tests:
Common law
Civil law
P(t-test)
State centralization, 1880
0.58 (6)
0.69 (12)
0.15
Equity-deposit ratio, 1913
0.22 (4)
1.17 (11)
0.10
Market orientation, 1990's (original sample)
0.11 (7)
-0.09 (18)
0.00
Market orientation, 1990's (expanded sample)
0.06 (28)
-0.04 (40)
0.14
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Conclusions
– Few countries fit stereotypes: stop thinking in terms of dichotomies
– Loose relationship among scope of services, extent of relationships,
prevalence of stock markets
– Short-run upheaval but long-term stability
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Topic 2
The roots of financial system design
Economic, Political, and Legal Factors
• Economic factors
– ‘economic backwardness’ and the ‘Gerschenkron
hypothesis’
• Political factors
– state centralization, market orientation, and universality
• Legal factors
– common law traditions, property rights, and financial
development
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Findings
• Importance of ‘backwardness’ in late nineteenth century
• Relationship between legal system and both banking scope
and market orientation
• The English connection (simultaneity or causality?)
• Link between state centralization and market orientation
• Insignificant relationship between state centralization and
both banking design and legal tradition
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Models and Testable Implications
1.
Economic Factors: Gerschenkron (augmented)
•
need for financial institutions is greatest for ‘moderately backward’
economies
most- and least-developed economies have lowest rates of financial
growth
•
» inverted U-shaped relationship between level of economic
development and growth rates of financial system assets
» positive, linear relationship between financial and economic growth
(slow growers are most and least economically advanced)
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Models and Testable Implications (continued)
2. Political Factors: Verdier
• universality more likely with credible lender of last resort
• universality more likely with segmented deposit market
(equity to fund universal banks)
• LOLR positively related to state centralization
• deposit market segmentation negatively related to state centralization
» inverted U-shaped relationship between state centralization and
universality
» path dependence: no permanent relationship between state
centralization and universality of banking system
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Models and Testable Implications (continued)
3. Legal Factors: LaPorta, et al and Dietl
• common law aids devolution of power to the periphery
• common law countries protect property rights, investors
• common law aids transparency
» common law tradition supports faster growth of financial systems
» common law tradition supports greater market orientation (NB: Rajan & Zingales –
state centralization is proximal cause, not legal system)
» markets supercede banks in common law countries
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Economic, Political, and Legal Factors:
Hypothetical Relationships
La Porta et al/Dietl
Common law
tradition
Banking
specialization
Market
orientation
Rajan and Zingales
January 2014
La Porta et al/Dietl
State
decentralization
Caroline Fohlin, Johns Hopkins
Verdier
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Historical factors in modern financial
system structure
Main findings:
• main predictor of modern banking structure is structure at start of century
•
•
•
– (for countries with a long-established banking system)
U-shaped relationship between modern financial institution structure and
economic development at the start of the twentieth century
– moderately wealthy countries of 1900 tend to have universal banks and tend to be less
market oriented
countries with historically centralized governments more likely to have universal
banking and less likely to be market oriented.
legal traditions correlate with both market orientation and banking type
– strongest connection among pre-1913 industrializers (common law countries imported
range of institutions/norms from England)
– legal system variable may proxy for true source of influence on the financial system:
e.g., adoption from colonizing powers, adaptation from neighbors or trading partners,
innate cultural and social beliefs.
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Legal Tradition, Banking Structure, Financial Development, and GDP Growth
Common law
Civil law
Total/P(t-test)
Specialized banking
7
3
10
Universal banking
0
16
16
Specialized banking
4
0
4
Partial universal banking
3
12
15
Universal banking
0
7
7
Total
7
19
26
State centralization, 1880
0.58 (6)
0.69 (12)
0.15
Equity-deposit ratio, 1913
0.22 (4)
1.17 (11)
0.10
Market orientation, 1990's
0.74 (7)
0.01 (18)
0.02
FI/GNP growth (1880-1900)
0.57 (5)
0.96 (10)
0.30
FI/GNP growth (1900-1913)
0.17 (6)
0.37 (14)
0.12
GDP per capita growth, 1820-1850
0.011 (5)
0.005 (12)
0.03
GDP per capita growth, 1890-1900
0.008 (8)
0.016 (19)
0.03
GDP per capita growth, 1900-1913
0.014 (9)
0.016 (27)
0.26
GDP per capita growth, 1950-1980
0.024 (12)
0.035 (29)
0.01
GDP per capita growth, 1980-1992
0.019 (12)
0.017 (29)
0.42
Cross tabulations:
T-tests:
56
Conclusions
Factors in financial system development
• importance of ‘backwardness’ in late nineteenth century
• relationship between legal system and both banking scope
and market orientation
• the English connection (simultaneity or causality?)
• link between state centralization and market orientation
• insignificant relationship between state centralization and
both banking design and legal tradition
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Topic 3
Financial structure and growth
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Patterns of economic growth
• Inequality between countries rose from 1820 to 1950 and also
during the 1960s
– Cf Pritchett (1997) and O’Rourke (2001)
• Still, some catching up over long-term for limited sample
(data as of 1870 or 1900)
– High levels of GDP/capita in 1870 or 1900 relate negatively to growth
rates up to 1994
• Lindert and Williamson (2001) find some convergence in
growth rates in late 20th c.
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Figure 8.3: GDP per Capita, 1870 vs. GDP per Capita Growth,
1870-1994
0.03
Growth of real GDP per capita 1870-1994
0.025
0.02
0.015
0.01
0.005
0
6.8
7
7.2
7.4
7.6
7.8
8
8.2
8.4
Log of Real GDP per capita 1870
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Figure 8.4: GDP per Capita, 1900 vs. GDP per Capita Growth,
1900-1994
Growth of real GDP per capita 1900-1994
0.035
0.03
0.025
0.02
0.015
0.01
0.005
0
6
6.5
7
7.5
8
8.5
9
Log of Real GDP per capita 1900
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Patterns of economic growth
• Sample composition matters a lot to results
• Growth rates vary considerably from year to year
– Can have large disparities among countries at shorter intervals
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Patterns of economic growth
• Long-run growth appears similar among countries with very
different institutions
– E.g., Germany versus U.S.
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Source: R.J.Gordon (2004)
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Financial systems and growth
• The chicken and egg problem
– Finance leads growth?
– Industrial development leads financial development?
• Feedback makes sense
– Increasing industrial activity increases demand for finance
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Financial development
• Hard to quantify financial development
– Variation in institutional design
– Differences in accounting and reporting
• Use financial institution assets as proxy
– Excludes securities markets
• Average of financial assets/GNP ratio nearly tripled (40 to
109) between 1860 and 1913
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Financial development
• Big ups and downs in financial development over 20th century
– Financial assets/GNP declined during depression
– Took many decades to fully rebound (1990s)
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Financial system type and growth?
• Hypothetically, “bank-based” or “universal” systems may
offer a number of advantages in promoting economic growth:
–
–
–
–
superior access to private information
managing and diversifying risk
monitoring firms and reducing post-lending moral hazard
exerting control over bank managers (in the case of long-term equity
stakes)
– substitutes for weak contract enforcement for independent investors
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Financial system type and growth?
• Also advantages of “market-based” systems:
– aggregating information signals
– transmitting info efficiently to investors
• Rajan and Zingales (1998)
– “bank-based” systems better at promoting growth in countries with
poor legal systems
– market based systems become better growth promoter as legal
systems develop
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Financial system type and growth?
• “financial services view” emphasizes
– financial arrangements (contracts, markets, intermediaries) all reduce
market imperfections in the provision of financial services
– financial arrangements develop to provide essentially the same
‘goods’
• assessment of potential investment opportunities, exertion of corporate
control, facilitation of risk management, liquidity enhancement and
allocation of savings/investment funds.
– role of all financial systems, whether market or bank based, is to
provide such services effectively.
• focus on good environment, not on whether the system is bank or market
based.
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Financial system type and growth?
• Empirical support for financial services perspective in recent decades:
distinction between bank based or market based systems is immaterial for
long run growth outcomes
– Germany and Japan had largely the same long run growth experience as U.S.
and U.K.
– no cross-country empirical support for either the bank or the market based
view
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Economic factors in financial
development
• Industrial development may also spur financial development
– New/expanding businesses create demand for finance
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Conclusions about finance and growth
• Financial system design and legal traditions cannot explain cross-country
growth differences over the last 100 years or more
• Differences among financial system types, rates of financial development,
and legal orientation, but long run growth rates are remarkably similar for
most of the 20th century.
• Development of an effective and efficient financial system must be
important for sustained modern economic growth, but the type of
financial system that develops is not crucial.
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Three key conclusions of the book
• Distant roots & idiosyncracies of financial
structure
• Feedback between finance and growth
• ‘Many ways to skin a cat’
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