How Important Historically Were
Financial Systems for Growth in
the UK, US, Germany and Japan?
Franklin Allen, Forrest Capie, Caroline Fohlin,
Hideaki Miyajima, Richard Sylla, Geoffrey Wood
and Yishay Yafeh
Financial Structure and Economic Development
World Bank
June 16, 2011
Historical Financial Revolutions:
Key Components
• Strong Public Finances and Debt Management
• Stable Money
• Effective Central Bank
• Innovative, Growing Banking System
• Vibrant Securities Markets
• Increasing Number of Corporations
UK and US Financial Revolutions
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Parliamentary control of revenues,
spending, debt, 1690s
Coinage reform, 1696
Bank of England, 1694
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Banking established in late 17th
century, but “quite limited”
through 18th century
Securities markets, 1690s—but
mostly government debt markets
until early to mid 19th century
Corporations—a few, but not many,
until late 1850s. Ditto joint-stock
companies until 1820s.
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Hamilton’s implementation of
federal revenue system, 1789ff, and
US debt restructuring, 1790
Specie-based dollar, 1791-1792
Bank of the United States, 1791
Banking--4 banks in 1790, rapid
growth of corporate banking
thereafter: 600-700 banks by 1830s
and 1,500-1,600 banks by 1860
Securities markets in major cities in
1790s; exchanges in Phila. (1790)
and NYC (1792)
Corporations—about 300 new ones
in 1790s, growing to 20,000 or so
by 1860.
Comparing and Contrasting the two
Financial Revolutions
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UK’s was protracted and
incomplete until mid 19th century.
Bank of England does not become a
central bank until mid 19th c.
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Bank of England’s monopoly of
joint-stock/corporate banking until
1825 slowed banking growth.
UK securities markets were mostly
national debt markets until 1830s,
when regional stock exchanges
began to serve business firms.
Joint-stock companies until 1820s
and corporations until 1850s were
slow to develop in England.
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US’s a century later was quick and
complete, in early 1790s.
Bank(s) of the US (1790s-1830s)
were more modern banks and
central banks than Bank of England.
US banking expanded rapidly,
especially in Northeast where
corporate bank entry was relatively
free.
US, with a much smaller national
debt, had a greater balance of
equity and debt financing.
US led the world in chartering
business corporations with
thousands by the early 19th c. and
tens of thousands by 1860.
Some Results of the Differing UK and
US Financial Revolutions
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UK real growth was slow in 18th century,
perhaps 1%/yr, not much above
population growth, and did not reach
3%/yr until second quarter of 19th
century, when modern rates of per
capita real growth of 1+%/yr. took hold.
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US real growth was 3+% in 18th c., not
much above population growth, but
rose after 1790 to overall rates of 45%/yr and modern per capita real rates
of more than 1%/yr.
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Based on its first industrial revolution,
international trade prowess, and
empire, UK becomes the workshop of
the world by mid 19th century, and
reforms its financial system to become
a world leader.
In the 19th and 20th centuries, the US,
Germany, and Japan catch up, and
sometimes surpass, the UK on some
financial and economic metrics.
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US quickly catches up with UK in early
19th century, with parity of real per
capita income by 1830s or 1840s.
Based mostly on internal economic
development, US surpasses UK in total
and per capita product by 1870s or
1880s, and becomes the largest
national economy and industrial leader.
By the early 20th century, the US has
more than a third of world bank
deposits, and more deposits than the
UK, France, and Germany combined.
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Further Comparisons
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Business enterprises in both the 19th-century UK and the US relied heavily on
retained profits as a source of finance, but possibly less so in the US because
of easier access to bank and equity financing and less initial wealth
accumulation than the UK.
Banks and securities markets in both countries were linked and
complementary, not alternative, sources of finance. In both countries, for
example, it seems that investors borrowed from banks to buy stock.
Government was a more important source of finance in the US than in the
“laissez faire” UK. The US government often paid down its debts, returning
funds to the capital markets, and it “spent” its land resources through grants
of land to states and railroad corporations. US state and local governments
accessed capital markets to raise money for banks and “internal
improvements” (canals, RRs, urban infrastructure).
By getting rid of its central bank in the 1830s for political reasons, the US
weakened its financial system just when the UK was strengthening its system
by abandoning earlier draconian regulations and turning the Bank of England
into a modern central bank. In the US, a central bank would not reappear
until 1913, after a period of more frequent financial crises than in the UK.
Germany
Financial and Economic Development
• Until 1871: fragmented group of sovereign states
– Highly variable rates of (proto)industrialization across German states
in 1st half of 19c
– Spotty financial development
– Variety of monetary systems
• Unification in 1871 and thereafter
– Unified monetary systems
– Created central bank and monetary policy
– Promulgated national corporate law
Germany During Heavy Industrialization Period
Financial and Economic Development
• When did Germany start growing?
– Slow but positive growth already in 18th and early
19th centuries
• interrupted by revolution and Napoleonic Wars
– Structural shift to higher growth rates circa 1850
• Early industrialization 1850-early 1870s
• Later industrialization 1870s-1913
– Significant variation in growth across regions
Banks and Other Financial Institutions
• Many types of financial institutions by mid-19th century
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Tiny to large
Private to incorporated
Agrarian to corporate
Personal savings to investment banking
• Universal banks get most of the credit
– Combined investment and commercial banking starting 1850s
• Big growth after liberalization of incorporation and industrial
development spurt of early 1870s
• Strong ties to securities market activity
• Corporate governance role connected with proxy voting system
Securities Markets
• Markets developed early and often
– First ones founded very early (mid-16c)
• Primarily commercial and government paper for first 300 years
– Stocks took off in early 1870s
• Most issues for pre-existing firms, not new enterprise
• Helped existing firms grow and merge
– Performed well (high market quality)
• Helped funnel resources into high return areas
– Listed companies performed better than unlisted ones
• Very likely selection bias
• Selection is helpful for targeting investment
Internal Finance and Alternative
Sources of Finance
• Internal finance key factor in corporate finance
– Liquid assets averaged 20-30 percent of total assets in the
period 1895-1912
• Prevalence of family firms, closely held
– Even some quite large ones (Krupp)
• Trade credits and financing via other non-financial
firms
Government’s Role
• Direct finance
– Nationalization of railroads
– Financing of military and industrial infrastructure
– Creation of banking institutions
• Indirect role
– Regulating and shaping financial and monetary system
– Early shareholder protections
– Stock exchange taxes and ban on futures (1897-1908)
Conclusions
• Germany possessed complex financial system by the later
stages of industrialization
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Banks of many kinds
Active, high-quality markets
Legal protection of shareholders
Strong LOLR
High capitalization and liquidity of banks and corporate firms
• Structure and organization less important than functions
Conclusions
• Feedback mechanism between financial development and
growth
– Cannot draw causal inferences about direction
– Financial institutions couldn’t create growth without industrial base
• Finance-growth relationship varies a lot over time & place
– Cannot say that this type of system was best for all periods
– Or that it would have worked as well in other places
Japan
Three Main Features of its Financial
History
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Japan as an example of a shift in the nature of the
financial system over time (not always “bankbased” or “market-based)
The growth of the Japanese zaibatsu in the interwar period as an example of co-existence of
limited formal investor protection, pyramidal
business groups and equity finance
Japanese financial history offers examples of
trust-generating “informal” institutions
System Evolution over Time
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Pre-World War I: sources of finance included
internal funds for family firms, some use of equity
in modern industry, some merchant/trade and
bank credit in small/mid-sized firms.
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Interwar period: Rise of the Zaibatsu pyramidal
groups and changes in the financial system –
“organ” (group) banks and “related lending”
emerge, as well as (in the 1930s) equity markets
as a major source of funding for the fast growing
groups
Co-existence of Business Groups and
Active Equity Markets
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Japan of the 1930s illustrates something that
would be regarded as an anomaly in the Law &
Finance literature:
Pyramidal business groups raising funding on
equity markets without much fear of minority
shareholder expropriation and without modern
formal mechanisms of investor protection (but
with well-defined property rights)
Explanations: Reputation? Gov’t support of the
groups? Tunneling less pervasive than commonly
portrayed in the literature?
Informal Institutions and Trust
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Early in its development (pre-World War I) Japan
illustrates the importance of alternative, informal
institutions for raising capital (similar to evidence from
other countries)
Example: “business coordinators” (zaikai-sewanin) of the
early 20th century - outside investors (“venture
capitalists”) who took an equity stake in companies and
also marketed their shares to outside investors. Often
senior/respectable members of the business community,
who would monitor newly established firms in the face of
a large number of cases of fraud and also provided
general business advice
This institution as an explanation for the phenomenon of
companies taking the form of joint stock companies with
a relatively dispersed ownership structure even at very
early stages of economic and financial development
Comparison of Germany and Japan
• Despite the fact that today both Germany and Japan
are regarded as “bank-based” systems equity
markets were important at an earlier stage in both
countries
• Trust mechanisms were important in both countries,
in Germany it was the relationships between banks
and firms and in Japan it was agents such as
“business coordinators”
Overall Conclusions
• The role of different types of finance varied across
the four countries. Since all four countries were
successful in terms of growth it is difficult to
conclude that there is a unique optimal financial
structure for a country that should be widely
adopted by other countries going through the
development process.
• Different types of finance can be used to fund real
economic growth. Bank loans and equity finance
were important in all countries but these operated in
different ways.