capital mobility and the origins of stock markets

Capital Mobility and the Originsof Stock MarketsDaniel Verdier

Political institutions play a role in shaping factor mobility across sectors space andborders I provide an illustration of this accepted though hardly researched idea bylooking at the emergence of modern capital markets in the nineteenth century Therise of corporate nance threatened to redeploy nancial resources away from landand traditional sectors to heavy industry I argue that mobilized and integratedmarkets ourished in the absence of blocking coalitions that had an interest inkeeping nance local I argue and show that the power of blocking coalitions wasa reverse function of the degree of centralization of state institutions I start byproviding a conceptual interface between the abstract notion of capital used in trademodels and the diversity of its actual occurrences as cash debt equity buildingspatent machinery and so forth

Unanswered Questions

The current notion of capital mobilitymdashas conceived by (and used in) the assetspeci city literaturemdashis uncertain Building on the work of Wolfgang Stolper andPaul Samuelson the asset speci city literature shows that capital mobilitymdashhowcapital ows across sectors of productionmdashhas redistributional effects1 For in-stance given two factors labor and capital and two sectors using both factors indifferent proportions factor mobility homogenizes factor pricesmdashwages and returnto capitalmdashacross sectors A corollary is that a change in product prices redistributesincome across factors In contrast if factors are unable to switch employment across

I thank Fiona McGillivray Jeannette Money the editors of IO and three anonymous reviewers forbullish and valuable suggestions The research on which this article is based was nanced by theResearch Council of the European University Institute

1 Stolper and Samuelson 1941 Works representative of the asset speci city literature includeRogowski 1989 Frieden 1991 and Alt et al 1999 For a broader review of the literature see Alt andGilligan 1994 and Alt et al 1996

International Organization 55 2 Spring 2001 pp 327ndash356copy 2001 by The IO Foundation and the Massachusetts Institute of Technology

sectors that is if factors are (sector-)speci c then factor prices vary across sectorsand a change in product prices redistributes income across sectors Thereforelobbying for rents proceeds along sectoral lines with factor speci city and alongfactor linesmdashor not at all in light of the collective action dilemma faced by largegroupsmdashwith factor mobility2 Furthermore building on insights from the industrialorganization literature political economists identify sources of factor speci city inbarriers to entry such as sunk investment costs RampD intensity learning by doingbrand name patent and so forth3 In a study of Norwegian rms James E Alt etal argue that rms with large RampD expenditures create speci c assets for theproduction of products with no close substitutes and dif cult to dispose of in casethere is no demand for the product As a result Alt et al argue RampD-intensive rmshave a clear propensity to lobby for subsidies or market protection4

The asset speci city literature rests on a notion of capital that is made up ofdissimilar elements Capital comes in two ways (1) production capital whichincludes machinery stocks the buildings that house them and intangibles likepatents and (2) nancial capital referring to all nancial assets long and short termThe asset speci city literature does not deal with the dichotomy well either it shuns nancial capital to concentrate its attention on production capital exclusively5 oralternatively it treats production and nancial capital as separate factors of produc-tion with the latter systematically more mobile than the former6

This classi cation of capital into its primary elements can only be a preliminarystep in the study of capital mobility The next step is to recombine their interac-tionsmdashhow the mobility of each element impacts that of the others Production and nancial capital are not two separate factors but represent the two sides of thebalance sheet of a typical non nancial rm with production capital on the assetsside (buildings machinery and stocks) and nancial capital on the liability side(equity and debt) Capital mobility is that of the side that is more mobile

Which side is more mobile depends on whether or not there is a nancial marketAbsent a nancial market investors and creditors have concentrated stakes in few rms and even fewer sectors they cannot easily exit a money-losing investment inspeci c (low liquidation value) assets nor enter a pro table one making lobbyingfor the regulatory protection of that investment a plausible option In contrast in thepresence of a nancial market investors and creditors each own a diversi edportfolio of corresponding instruments7 Little lobbying is likely to come out of a

2 See Magee 1978 and Irwin 19953 See Frieden 1991 and Alt et al 19994 Alt et al 1999 1095 See for instance Frieden and Rogowski 1996 276 For instance Frieden writes ldquoit is consonant with the speci c-factors approach to assume that

nancial capital is mobile among industries while physical capital is industry-speci crdquo Frieden 1991438 Frieden further separates nancial capital into bonds and debt said to be mobile across countriesand stocks less so (429) The global nance literature echoes the idea that nancial capital since therepeal of capital controls in the 1970s is mobile across national borders For a survey see Cohen 1996

7 The argument was rst made by Schonhardt-Bailey 1991 and Schonhardt-Bailey and Bailey 1995They argue that nancial capital can effortlessly cross sectoral boundaries only in the presence of awell-functioning corporate securities market Absent such a market individuals willing to adjust their

328 International Organization

large number of small claimants they are more likely to reducemdashor write offmdashastake in stagnating sectors and concentrate future investments in growth sectors8

The initiative to lobby if any is more likely to come from management (and labor)whose loyalty to the rm is higher than the investorsrsquo and the bankersrsquo in order toprevent investors and bankers from walking away from the rm In the presence ofan ef cient nancial market lobbying is more likely to re ect high nancial capitalmobility than low production capital mobility

Therefore in the presence of a modern nancial market nothing can prevent adollar made in one sector from being invested into another sector capital movesaway from declining sectors to growth sectors irrespective of asset speci city Allit takes is for large investors to modify their relative holdings of stocks in thesesectors the induced change in share values allows the growth sectors to incur moredebt while forcing the declining sectors to reimburse past debt In the presence ofa nancial market therefore capital mobility re ects intersectoral changes inexpected pro tability not relative liquidation values of assets employed in differentsectors let alone conversion costs

Only if the nancial system is undeveloped is this transfer dependent on thedegree of asset speci citymdashon whether entry by new rms is or is not possible Ifentry is not limited (low asset speci city) then nancial capital ows to growthsectors in the form of direct investment nanced through pro t retention bynon nancial companies If entry is limited (high asset speci city) then nancialcapital does not move across sectors and capital mobility then re ects the liquida-tion value of physical assetsmdashor in the event that the unbolted value is unaccept-ably low or nonexistent the conversion costs of these assets The relationshipbetween nancial market development and capital mobility with respect to a givensector is thus heteroskedasticmdash nancial development is a suf cient though not anecessary condition for capital mobility But considering all sectors together andassuming that sectors with speci c assets are equally distributed across nationaleconomies capital mobility is higher on average in nancially developed economiesthan in undeveloped ones

The key determinant of capital mobility across countries therefore is the degreeof development of the capital market or to be precise corporate securities marketsWhat accounts for the origins of corporate securities markets A survey of theliterature reveals four rival lines of argument economic development informationasymmetry government intervention and legal origins First historians generallyhold the general level of economic development as the prime suspect for nancialmarket development9 A larger pool of savings implied a higher demand for

portfoliosmdashthat is to liquidate assets in declining sectors andor acquire some in rising onesmdashfacediscouraging transaction costs

8 Bankers unlike equity holders may be few enough to overcome the collective action dilemmaHowever in the presence of a capital market their claims take the form of senior debt secured by the rmrsquos capital and unlikely to induce loyalty in the rm or the sector

9 Sylla and Smith 1995 182

Origins of Stock Markets 329

investment instruments A second explanation points to the seeding role of priorpublic-debt markets10 Ef cient stock markets in addition to a columnar buildingand extra phone lines have to be liquidmdasha collective dilemma since each onetrades if he or she anticipates the others will trade11 Private entrepreneurs andinvestors could not overcome this free-riding problem but used the services ofinvestment bankers and institutional investors that had built their reputation dealingwith debt or government- nanced railway bonds in countries where this was thecase

The third explanation stresses the role of rules favoring disclosure of nancialinformation and curtailing insider trading on privileged information Environmentscharacterized by information asymmetry between investor and entrepreneur nega-tively impact securities market development12 The fourth and most recent theoret-ical foray into the growth of stock markets emphasizes the common law or civil laworigins of the legal system Rafael La Porta et al show that countries with poorinvestor protection against expropriation by insiders as re ected by legal rules andthe quality of law enforcement have shallow and narrow capital markets13 Theserules and the quality of their enforcement they show vary systematically by legaloriginmdashcommon law is more apt than civil law to reduce contracting uncertaintybetween the parties to a security issue14

All four accounts treat markets as an ef cient response to an environmentcharacterized either by a plentiful supply of capital (saved wealth) or by lowtransaction costs ( xed costs defrayed by the state treasury investment informationor judicial enforcement) They treat supply public debt and rules as parametricexogenous to investorsrsquo choice Missing are the main tools of the political trademdashredistribution con ict rent seeking and politicians And yet it would be quiteunprecedented if the advent of corporate securities markets had no redistributionaleffects elicited no opposition triggered no rent seeking and yielded no compen-sation in the form of regulatory obstacles to capital mobility

In the following I offer a political account of the origins of corporate securitiesmarkets I argue that markets developed as a result of a con ict between corporate nanciers and traditional sectors mediated by politicians and of which the outcomewas in uenced by the degree of centralization of state institutions Financial capitalmobility is embedded in political institutions I assess the empirical validity of thisclaim rst by developing the exemplary cases of Britain France and Germany in

10 This argument constitutes an auxiliary mechanism in North and Weingastrsquos interpretation ofBritish history their main argument is about the origins of parliamentary rule and its consequences fortax revenues and public debt North and Weingast 1989

11 Rajan and Zingales point to ldquoa chicken and egg problem with liquidity people will not tradein a particular market unless they think the market is liquid but the market will not be liquid unless theytraderdquo Rajan and Zingales 1999 17

12 Sylla and Smith 1995 Baskin and Miranti argue that the heavy reliance on bonds as opposed tocommon stocks in the nineteenth century re ected investorsrsquo risk aversion in an investment environmentcharacterized by poor information Baskin and Miranti 1997 160

13 La Porta et al 199714 For a different formulation of the legal origins argument see Rajan and Zingales 1999


some detail I then proceed to test on a nine-country data set two general hypothesesthat local banks crowded out markets and that centralization was associated withmarkets Building on the empirical ndings I draw several theoretical consequencesfor the study of nancial capital mobility the relation between various forms of nancial capital mobility the role of political institutions in locking in factorspeci city and the presumed impact of nancial capital mobility on the tariff

The Argument

The development of a corporate capital market was part of a larger nancialrevolution involving the creation of a money market and the concentration ofbanking Together these three developments threatened to divert capital away fromtraditional sectorsmdashagriculture artisans shopkeepersmdashto heavy industry The po-tential losers had four options (1) use their political power to block the developmentof nancial markets (2) beef up the alternative local banking sector and starve the nancial center from capital (3) put pressure on the central government to make thenew markets work for traditional sectors or (4) do nothing The path they selectedre ected two parameters their political power and the degree of state centralizationWhere they had no power they did nothing and corporate nance developedunhindered Where the potential losers enjoyed political power but where the statewas centralized they pursued the third optionmdashthey made the market work forthem As a result corporate nance developed almost unhindered Where theyenjoyed political power and where the state was decentralized they pursued the rsttwo optionsmdashthey regulated the markets out of existence and starved them out ofresources I rst provide background on the nancial corporate revolution thenenumerate the available strategies and last derive market outcomes

The advent of corporate securities markets was along with money markets andbanking concentration one of three mutually reinforcing components of the nan-cial revolution of the late nineteenth century15 Corporate securities markets rstwere a functional response to the second industrial revolution The banks could not nance the large immobilization of capital in steel chemicals electrical machineryand communications (telegraph telephone) by means of loansmdashthey would havebeen too large and would have undermined the banksrsquo liquidity (their capacity to

15 Terminology matters Corporate securities markets deal in long-term instruments (stocks andbonds) issued by corporations The market for long-term securities is also referred to in textbooks as thecapital market in contrast to the money market which includes short-term instruments (short-term bondscommercial paper bank notes certi cates of deposit derivatives and so forth) Any long-terminstrument can serve as collateral to short-term transactions or provide the basis for derivativesCorporate refers to the nongovernment component of the market which for the most advancedindustrialized countries only emerged in the second half of the nineteenth century


call in loans to face eventual deposit withdrawals) Markets allowed banks totransform long-term loans to industry into securities recoup their liquidity and lendanew16 Still few individuals were willing to merely take over corporate nancingfrom the banks and immobilize their savings in the form of securities of risky privateventures They could get an honest return at no risk by buying public debt Thecreation of a secondary market for corporate securities allowing the owner of asecurity to sell it at any time is what earned stock markets their mass appeal

Secondary securities markets however neededmdashand still domdasha lot of liquidassets to function well Stable reliable pricing requires thick trading the constantshort-term buying and selling by brokers market makers and leveraged speculatorsin constant need of vast sums of short funds To function well the securities markethad to be leveraged by the second component of corporate nancemdashan equally wellworking money (short-term) market The long and short markets were linkedthrough call loans security brokers would pledge securities as collateral to callableloans from the banks17

Initially the money market utilized the idle cash found in tradersrsquo currentaccounts which the banks would use to extend standardized overnight or fortnightloans to brokers By the middle of the nineteenth century a new source of liquidityemerged in the form of individualsrsquo checking accounts Individual deposits becamethe single most important source of funding for banks from the mid-nineteenthcentury onward The collection of small deposits from millions of geographicallydispersed individuals required the development of the third component of corporate nance in the form of large joint-stock banks headquartered in the nancial centerdraining deposits from the periphery through networks of local branchesmdashourmodern money-center banks The point to appreciate is that the corporate nancialrevolution rested on individualsrsquo bank deposits leveraging the stock market as muchas on individuals directly purchasing stocks The two aspects were mutuallyreinforcing the more deposits were channeled to the nancial center the moreliquid the stock market the lower the risk of holding corporate stocks the moreattractive corporate stocks in relation to public debt and the greater the demand forliquidity

A requisite for the development of capital markets therefore was that nancialcapital be geographically mobile it had to ow from the periphery to the nancialcenter in a centripetal way Had all producer groups found their interest in corporate nance mobility would have automatically ensued However corporate nance hadredistributional effects It bene ted modern industry at the expense of traditionalsectorsmdashagrarian artisans shopkeepers self-employed workers skilled in tradi-tional crafts and more generally sectors characterized by small enterprises

Traditional sectors had little to gain from incorporation and stock marketsConsider the case of the agrarians Niek Koning argues that the agricultural

16 Market cycles each cycle lasting about ten years added dynamics to this static description Bankswould renew advances to their good clients in bear periods in the hope of transforming them intosecurities at the next bull market

17 Powell [1915] 1966 594


depression destroyed any prospect for agrarian capitalism in the world18 Largefarms closed and with their closure early agrarian support for corporate nanceended Small farmers who could work harder and accept lower pro ts became thedominant force in agriculture Even Dutch and Danish farms which managed aconversion away from traditional grains to animal husbandry thereby becoming thenumber-one supplier of bacon and eggs for the English breakfast table remainedsmall Even in the United States where mechanization allowed farms to be largerthan in Europe farms were family-owned with no prospect for incorporation Othertraditional sectors had no prospect for incorporation either Too small to enablemarket investors to evaluate their earning potential with a modicum of con dencesmall- and medium-sized rms exclusively relied on bank loans

Traditional sectors had no use for the newly established joint-stock banks eitherThe center banks could not accommodate farmersrsquo demand for long-term nanceneeded for land purchase mechanization or land improvement Borrowing shortthese banks could not easily lend long otherwise a rise in interest would force themto pay high interest to depositors while still collecting low interests on borrowersThe absence of a secondary market in loans also made it impossible for a bank toliquidate farm loans were it in need of doing so19 The situation was different forindustrial rms as banks could usually recoup long-term advances to industrial rms by turning them into shares Instead farms raised long-term nance bymortgaging land with local nonpro t banks savings banks whose risk was coveredby a local government guarantee and credit cooperatives20 The latter known inGermany as the ldquoRaffeisen systemrdquo were created in the second half of thenineteenth century Every farmer would pledge an equal sum and be allowed to bidfor a loan which all the other members would guarantee A third system privatemortgage securitization by which a bank would nance mortgage loans by issuingbonds was mostly encountered in the United States and British Dominions It wasunstable rarely managing to outlast more than onemdashtwo at bestmdashbusiness cycles21

Like agrarians artisans and small business also formed cooperatives or bankedwith savings banks and local commercial banks Belonging to the same parish bankand rm would engage in ldquorelationship bankingrdquo22 A durable relationship spreadacross a wide array of products allowed the bank to smoothen the cost of capital tothe rm over the rmrsquos life cycle In contrast center banksrsquo local agents could not

18 Koning 1994 2619 Prudential rules were thrown to the wind however in periods of (and countries subject to) land

speculation The classic instance is the Australian nancial panic of 189620 On credit cooperatives and savings banks see Vittas 199721 Snowden chronicles four successive attempts in the United States to develop private mortgage

securitization a rst in the 1870s another in the 1880s still another with the federal (yet private)joint-stock mortgage banks in the 1920s and at last with the private issuing of mortgage-backedsecurities since the 1970s (although the latter is mostly about housing and commercial real estate)Snowden 1995 Of all four only the last has not ended up in collective bankruptcy Congress alsoestablished a successful system of central mortgage banking enjoying federal guarantee the Federal LandBank System in 1916

22 On relationship banking see Lamoreaux 1994 and Petersen and Rajan 1995


commit to a long-term relationship They had to meet lending standards decided byheadquarters with the consequence that their portfolio had to be exible enough tomeet liquidity requirements that kept changing with the overall position of the bankMost of the time they ignored small businessesrsquo parochial needs seeing them aspoor risks since smallness foreclosed underwriting the bankrsquos main exit strategy

Traditional sectors not only had nothing to gain from corporate nance they alsohad everything to lose from banking concentration The centralizing strategiespursued by the center banks put them in direct competition with the other creditsectors They threatened to absorb the country banks and to enter the market forsavings deposits until then the chasse gardee of local government-chartered savingsbanks

Confronted with the challenge of corporate nance the traditional sectors facedfour options First they could try to hinder the development of stock markets byhaving government pass regulations damaging to the markets Volatilitymdashmarketscrashed about every ten yearsmdashprovided their enemies with an easy battle crymarkets were speculative and amoral like casinos Second traditional sectors couldtry to defend the local monopolies of local banks by raising center banksrsquo costs ofentry in local markets Denying center banks access to local cash would starve themoney market and indirectly contain the growth of the capital market Alternativelythird they could try to ask for compensation in the form of subsidized credit Inthese days of slim government budgets this meant having the market work for themThe government would charter special credit banks with the mission to channelloans in speci c traditional sectors nanced through issues of attractive default-free bonds enjoying state guarantee Although state banks would crowd outfor-pro t market participants in the short term they would also help diffuse thepractice of holding bonds among the population thereby contributing to theenlargement of the market over time23 Fourth the traditional sectors could acceptthe verdict of the markets and seek no redress through political action Confrontedwith the traditional sectorsrsquo claims for redress the potential winners had only onestrategy at their disposalmdashtry to block any rearguard attempt at stunting the growthof nancial markets

Whether the traditional sectors chose to confront piggyback or adjust to marketpressures depended on two parameters their political power and the degree ofcentralization of the state Where traditional sectors enjoyed no political power thepolitical route was closed to them This ought to have been veri ed irrespective ofthe nature of state institutions though in practice decentralization seems to havealways empowered traditional sectorsmdashthe lower-right quadrant of Figure 1 wasempty

Where the traditional sectors did enjoy political power the critical factordetermining their course of action was the degree of state centralization Incentralized states traditional sectors sought compensation in the form of special

23 In accordance with the seeding effect of the public-debt market one of the four aforementionedlines of argument


credit banks No other option was open to them Defending local banking wouldhave been problematic or inef cient For-pro t local banks were indefensible shortof nationalizing them or suspending market competition outrightmdasha much tooradical option for the time Defending nonpro t banks (savings and cooperatives)was inef cient in the absence of scally responsible local governments Becausethey provided the deposit guarantee state regulators were in charge of monitoringnonpro t banks with no regard for local preferences The state administered thedeposits collected by savings banks in conformity with state treasury priorities Itwas easier to ask the central agencies to discriminate between sectors than betweenlocales State administrations ordinarily arrange tasks along functional lines trans-forming con icts into sectoral con icts Furthermore trying to throw regulatorywrenches into the wheels of the securities markets might boomerang in thesaboteursrsquo faces for special credit banks nanced themselves on that market Insum the con ict between new and old nance in centralized states where traditionalsectors enjoyed political power could only be fought along sectoral lines It also hadto be contained and was actually so to a debate on the relative size of the debt issuedby state-guaranteed entities

In decentralized states in contrast traditional sectors had something to defendmdashthe local banks whether for-pro t or nonpro t Being well-represented in the boardrooms of the local banks and with respect of the savings banks in the localgovernments monitoring these banks traditional sectors could make the banks workfor them They also enjoyed power at the central government level to block anyattempt at dispossessing local governments from their nancial powers as such adecision would have had to pass the high chamber in which local governments weretraditionally overrepresented Finally not needing any of the three components ofcorporate nance and being strong in the low chamber as well allowed traditionalsectors to adopt a systematically negative attitude toward nancial markets and seekto regulate them out of existence The nancial con ict was geographic pitting

FIGURE 1 The impact of politics on corporate security market growth in 1913


nancial center against periphery and all-outmdashcenter banks money market andcapital market both public and private were at stake24

From this political dynamic it is easy to predict that corporate securities marketsdeveloped mostly in countries where traditional sectors agrarians especially wereweak politically or if strong where state institutions were centralized In contrastmarkets were least likely to develop in countries where traditional sectors werestrong and where state institutions were decentralized

Three Paradigmatic Cases

A somewhat detailed presentation of the British French and German cases will help esh out the argument These three cases were chosen for their closeness of t withthe argument Politically weak traditional sectors in Britain adjusted to marketforces Politically strong traditional sectors in centralized France played the card ofthe special credit bank Politically strong traditional sectors in decentralized Ger-many sought to strangle the markets The French and British markets boomedwhereas the German market stagnated

Traditional sectors in Britain were politically weak Their main body theagrarians lost the tariff battle in 1846 and became a spent electoral force afterwardThey were a captive constituency of the Conservative party and in the Britishmajoritarian system powerless Even when the party embraced Tariff Reform in1907 a program with something for almost everyone not much was in it for theagrarians25 As for the other traditional sectors it was not until the 1920s that theirstrategic location at the center of a partisan system polarized into two class blocsbrought them some visibility26 Britain also was a centralized country Localgovernments witnessed impotent the absorption of local banks by the Londonbanks27 The savings banks were no local institutions being forced to redeposit alltheir resources in an account with the Bank of England Their share of deposits in1913 represented a meek 6 percent 14 percent was with the Post Of ce savingsbank The rest 80 percent went to the commercial banks half of which with theldquoBig Fiverdquo (see Table 1) The London Stock Exchange was behind New York thesecond largest worldwide Corporate bonds and stocks represented 9 and 30 percentrespectively of all nancial assets in England and Wales in 1913 adding up to 132

24 The nancial debate in decentralized countries (Germany Switzerland the United States) alsoextended to the central bank and the gold standard for the function of the central bank was to keep thecenter banks and the money market liquid and to maintain the gold value of the currency at the cost ofde ationmdashgood for share value and incorporated sectors but bad for debt and loan-dependent sectors Onthe relationship between decentralization and late and disputed central-bank chartering see Broz 1998

25 Verdier 1994 14226 This is when the Macmillan Committee discovered the eponymous ldquogaprdquo in bank funding of small

business27 The ldquoBig Fiversquosrdquo share of the deposit market increased from 27 percent in 1890 to 80 percent in

1920 see Capie and Rodrik-Bali 1982


percent of gross national product (GNP)28 The last regulatory attempt at curbing thegrowth of the exchange the Bubble Act was repealed in 1825 The exchange aunted the most advanced rules of information disclosure29 It grew at the expenseof local communities and small business Jonathan Zeitlin points to the disappear-ance of regional banking as a cause for the disappearance of small rms andindustrial districts30

Traditional sectors in France were strong thanks mostly to the electoral strengthof agriculture credited for backing the Second Empire and forming a three-hundredndashmember strong farm bloc in the Chamber of Deputies in 189031 Agrarianswere instrumental in extricating France from the free-trade-oriented bilateral treatysystem launched by Cobden and Chevalier in 1860 they formed an iron-and-wheatalliance with industry for a protectionist tariff32 Although French agrarians wereunhappy with Parisian nance France had a centralized state with weak localbanks Local private banksmdashfew of them lent to farmers anywaymdashlost ground tothe large banks in the 1890s33 The savings banks controlled 23 percent of totaldeposits but like their British counterparts they placed all their resources in acentral state agency (Table 1) Mutual credit cooperatives failed to take root As aresult French agrarians did not try to hinder banking concentration and the drainingfrom the provinces of their savings but sought instead to have part of it return to theprovinces in the form of state-subsidized credit In 1852 the year he was elected

28 According to Goldsmith 1985 23329 According to Sylla 1997 21030 Zeitlin 1995 105 The issue is contested though see Michie 198831 Golob 1944 17032 Lebovics 198833 Saurel 1901

TABLE 1 Breakdown of deposits by type of bank (percentages) circa 1913

Type of bank England and Wales France Germany

For-pro tMoney center 34 39 15Other for-pro t 46 27 13

Nonpro tSavings and cooperatives 6 23 71Postal savings 14 10 1

Total 100 100 100

Note The breakdown within the for-pro t sectors between center and country banks is not homo-geneous across countries but includes the top ve in England and Wales the top four in France andthe top nine in Germany The year is 1913 except for England and Wales for which it is 1910

Sources Data for England and Wales are from Capie and Rodrik-Bali 1982 For France the break-down among for-pro t banks is from Bouvier 1973 125 and the other data are from Mitchell 1992774 782 For Germany Deutsche Bundesbank 1976 16


emperor by a plebiscite thanks to the rural vote Louis Napoleon chartered theCredit Foncier a private bank nancing mortgage loans by issuing bonds enjoyingstate guarantee34 It represented 7 percent of French securities capitalizationin 1902Then in the 1890s Parliament laid out the bases for what became the CreditAgricolemdasha system of mutual credit societies that were guaranteed partially runand subsidized by the state The Republican majority squeezed the requiredsubsidies out of the privately-chartered Bank of France as a condition for therenewal of its duciary privilege in 189735

French small businesses saw their access to credit deteriorate with the displace-ment of local private banks throughout the period It was not until after 1900 whenthe Radical faction became the last rampart of the Republican Right against therising Socialist Left that small business attracted politiciansrsquo solicitude TheCaillaux commission of 1911 reported that small business was victim of a credit gapand recommended a series of reforms that would eventually lead to state-engineeredmutualism in the form of the banques populaires combining grass-roots mutualismwith the distribution of state subsidies to small rms in commerce and industry36 Inaddition small business got the Credit National in 1919 a credit foncier-likeinstitution specializing in long-term lending to small business

French agrarians and small business never tried to curb the development of theParis bourse They had no credible local nonpro t alternative to the displacement ofthe local for-pro t banks They also had a stake in the development of the publiccomponent of the market the agrarians in the form of the Credit Foncier and smallbusiness in the form of the Credit National from 1919 on Corporate stocks andbonds represented 13 and 14 percent of nancial assets respectively the twocombined made for 135 percent of GNP (against 132 percent for EnglandWales)37

The situation was radically different in Germany where the decentralization ofthe state made it possible for local governments overwhelmingly controlled byagrarians and small business interests to protect local banking German states hadfull authority over the regulation of the savings banks which they owned Theymonopolized the local deposit market investing its proceeds in land mortgages andgovernment bonds local especially Legally unable to extend loans to individualsuntil the turn of the century the savings banks witnessed until then the rise ofserious grass-roots competition in the form of mutual cooperatives By 1913 thelocal market for credit and deposits was de facto monopolized by the savings banksand the cooperatives each one being a member of a regional and national federationsuccessfully resisting entry by the Berlin banks and nishing off the old local privatebanks38 Strong from this secure outpost in the countryside the agrarians pursued atwo-pronged strategy they vetoed any attempt by the imperial government to

34 According to Karl Born ldquoNapoleon was returning a favour to his supporters among the ruralpopulationrdquo Born 1983 104

35 Gueslin 197836 Albert 199737 According to Goldsmith 1985 21738 See Deeg 1999


centralize bank regulation and they pursued a policy of verbal and regulatoryharassment of the securities markets They were successful on both counts TheBerlin banks eventually absorbed the local for-pro t banks but they never displacedthe local nonpro t sectormdashtheir market share today is as puny as it was in 1913 (seeTable 1)

The German Agrarian party (it was not a party proper but a lobby) whosesupport was essential to the survival of almost all imperial governments from1878 until World War I launched a crusade against ldquospeculationrdquo39 The newcompany laws of 1884 restricted the liberal incorporation law of 1870 raisingthe minimum size of shares lengthening the time lag between incorporation andlisting and strengthening the position of the supervisory board40 Then theyturned their guns against the linchpin of market clearingmdashshort selling a saleinvolving a future delivery of goods or stocks They claimed that short sellingfueled bearish speculation depressing the price of produces As a result of theirpressure the law of 1896 prohibited futures in grain and our dealings for theaccount in the shares of mining and industrial companies and requested that allparties to deals in industrial futures enter their names in a register denigrated asthe ldquogambling registerrdquo41 The law increased cash transactions demoralized themoney market increased costs and legal uncertainty and led to the migration ofbusiness to London42 The upshot was a rather depressed stock market Corpo-rate stock and bonds represented 8 and 2 percent respectively of total nancialassets adding up to about 44 percent of GDP (against 132 and 135 percent inEnglandWales and France respectively)43

Local districts in contrast performed relatively better in Germany than inBritain or even France Manfred Hartmann conducted a comparative study ofFrance and Germany at the end of which he concluded that the relativelydecentralized nature of the German banking industry helped maintain more evenlevels of economic development between regions within Germany than inFrance44

Evidence from a Nine-Country Data Set

My purpose so far has been to illustrate the argument I now try to assess itsgeneralizability to the six other cases for which we have datamdashBelgium DenmarkItaly Norway Switzerland and the United States Stock and bond holdings data are

39 Only under the Caprivi government in the early 1890s did agrarians suffer serious policy setbacks40 See Tilly 1986 12641 Dealings for the account are essential to market-making without which markets lack depth and

continuity42 According to a contemporary account Emery 1908 Also nervous about speculation was the

American public For technical examples of legal prohibitions based on popular suspicion see Parker1920 10

43 According to Goldsmith 1985 225ndash2644 Hartmann 1947


taken from Raymond W Goldsmithrsquos study of national balance sheets which heestablished for various countries and benchmark years45 Goldsmithrsquos tables provideus with the relative percentage of nancial assets held as corporate securities listedor not Admittedly not all stocks and bonds were listed on exchanges let aloneactively traded But since exchanges promoted incorporation and incorporation fedexchanges the country rank-ordering across the two variables cannot have differedby much Measures of corporate bond and stock holdings are available for at leastone of the three years directly preceding World War I (see the appendix)

The small number of observationsmdashninemdashrecommends saving degrees of free-dom To that effect I eliminate unnecessary control variables The earlier survey ofthe literature suggested four plausible explanations to the origins of corporatesecurities markets economic development (GNP per capita) government debt(government bonds divided by total assets) asymmetric information (proxied by theproportion of corporate bonds among corporate stocks)46 and legal origins (dummyfor common law) A look at the bivariate scatterplots between each control variableand the ratio of corporate stocks to nancial assets reveals two relations a rstbetween market development and economic development (GNP per capita) llingin for the demand for securities (see Figure 2) A second relation is also observablebetween market development and common law originsmdashthis can be seen in Figure2 as well where the common law countries Britain and the United States are bothlocated at the top of the graph Although two countries do not make a rulequalitative evidence indicates that Australia Canada and South Africa also had verywell-developed stock markets And they also were among the wealthiest countriesin the world con rming the potential problem of multicolinearity between commonlaw origins and wealth exhibited in Figure 2 The other two control variablesgovernment debt and information asymmetry show no relation with corporatesecurities markets even when controlling for GNP per capita (results unreported)This preliminary analysis suggests the need to control for one variable in allsubsequent experimentsmdashGNP per capitamdashproxying both for demand for securitiesand common law origins

I then plot the bivariate relation between stock market development and the localnonpro t banking sector in Figure 3 The relation is negative con rming thecrowding-out hypothesis according to which capital locked out in local networkswas unavailable for redeployment toward the nancial markets Visual observationfurther suggests that the data points are aligned on two parallel (undrawn) linesaccording to wealthmdashthe wealthier countries (the United States the United King-dom Denmark and Switzerland) are on a higher line whereas the countries withlower GNP per capita (Belgium France and Italy) are on a lower one

45 Goldsmith also provided data for India Japan Russia and South Africa which I did not includefor lack of data on the other variables Goldsmith 1985

46 I proxied asymmetric information by the proportion of bonds among securities in accordance withBaskin and Mirantirsquos nding that poor information led investors to choose bonds over stocks Baskin andMiranti 1997


FIGURE 2 Wealth and stock holdings circa 1913

FIGURE 3 The crowding-out hypothesis (bivariate scattergram)


I check the robustness of this clue by using multivariate regression (OLS)out tted with bootstrapped standard errors and con dence intervals to make up forthe small number of observations47 The dependent variable is the relative size ofstock holdings in the nancial system The independent variables are the marketshares of three sectorsmdashcountry (local for-pro t) local nonpro t and postalsavingsmdashmeasured in deposits Although most data on these sectors are availablethey present one dif culty Separate data exist for state and local nonpro t banksbut for most countries data for center and country banks are aggregated Thedif culty is not insurmountable however Everywhere except in the United Statescenter banks were allowed to open branches in the periphery and compete fordeposits from country banks or merge with them The trend was toward theamalgamation of country by center banks The United States was unique inprohibiting interstate banking and in many cases branch banking within states aswell In light of this I will assume that for-pro t banks whether center or localwere center banks while bearing in mind the US exception

Statistical results for the crowding-out hypothesis are reported in Table 2 Thestrongest impact is that of the local nonpro t sector The coef cient is statisticallysigni cant (at the 5 percent level in regression 1) and a one standard deviationincrease in that variable corresponds to a decrease of about half ([024 ndash021]009 = ndash056) a standard deviation in the dependent variable (see appendix forstandard deviations) The coef cient for the postal savings variable is not signi -cantly different from zero suggesting no effect

To get a better sense of how countries are distributed and to eventually spotoutliers I plot in Figure 4 the partial plots of regression 1 of Table 2 Each graphin Figure 4 plots the impact of a right-hand-side variable on the dependent variableother things being equal that is while holding constant the impact of the otherright-hand-side variables on the dependent variable48 The top-left graph showsFrance and the United Kingdom at one end of the distribution and Germany at theother end The position of the United States is well below the line The reason is thatthe savings and loans were not the only local obstacles to markets the presence ofmany state-chartered for-pro t banks also had a moderately negative impact oncorporate stock holdings This last point is con rmed in regression 2 which includesthe country bank variable among the regressors Recall that this is a quasi-dummyvariable (coded 042 for the United States and zero for others) These results bringhome a fact that I have never seen mentioned in prior studies Controlling for GNPper capita moves the United States from being the country with the largestGNP-weighted (let alone unweighted) stock holdings in the prewar world to acountry with lower than average holdings in keeping with the small domestic

47 Bootstrapping makes it possible to work around the constraint on sample size imposed by thecentral limit theorem see Mooney and Duval 1993

48 Each plot generates a coef cient and a t that are equal to the coef cient and t of the dependentvariable against the chosen right-hand-side variable while simultaneously controlling for the effect of theother right-hand-side variables on both variables See Bollen and Jackman 1990


market share of its center bank sector49 To assess the robustness of the dependentvariable I ran the same regressions using all corporate securities (stocks and bonds)as dependent variable The results are virtually unchanged with one exceptionmdashtheUS state-chartered for-pro t banks no longer make a difference I have noexplanation for this difference

All the regressions of Table 2 con rm the powerful impact of relative wealth onsecurity holdings in regression 1 for instance a one standard deviation increase inGNP per capita ($262) yields an increase in the dependent variable of almost one(84 percent) standard deviation ([26200002]009 = 084) This nding con rmsthe historiansrsquo hunch that the size of corporate securities markets in 1913 stronglyre ected levels of development

Therefore the 1913 data indicate that the share of corporate stock holdings among nancial assets was a function of the level of economic development primarily andof the size of the local nonpro t banking sector secondarily The poorer theeconomy and the stronger the savings banks the smaller the market US country

49 This result holds despite the so-called pyramiding of reserves in New York a particular rulemandating country banks to keep cash reserves yet allowing them to hold this cash in the form ofinterest-earning deposits with center banks see James 1978

TABLE 2 The crowding-out hypothesis

Independent variables

Dependent variable

Corporate stocksc 1913

Corporate stocks and bondsc 1913

1 2 3 4

Local nonpro t banks 1913 2 021 2 020 2 044 2 044(023) (012) (015) (018)

Country banks 1913 mdashmdash 2 014 mdashmdash 2 0006(013) (023)

Postal savings 1913 2 011 2 010 2 033 2 032(050) (043) (043) (063)

GNP per capita 1913 000023 000029 00002 00002(00002) (00001) (00001) (00002)

Intercept 006 001 024 024

Note Ordinary Least Squares with standard errors and bias-corrected con dence intervals calcu-lated on one thousand bootstraps Each cell reports values of observed coef cients correspondingbootstrapped standard errors are in parentheses Con dence intervals are bias-corrected indicate coef cients situated in the 90 percent 95 percent and 99 percent con dence intervals re-spectively The number of observations is nine Belgium Denmark France Germany Italy NorwaySwitzerland United Kingdom and the United States See the appendix for data description andsources


FIGURE 4 The crowding-out hypothesis (partial plots for regression 1 Table 2)

banks were also found to be negatively correlated with stocks Postal savings incontrast were not found to correlate negatively with markets

The second hypothesis the state-centralization hypothesis posits a positivestatistical relationship between the degree of centralization of the state and the sizeof the corporate securities market The independent variable state centralization ismeasured by the proportion of government revenues drained by the central govern-ment The exact measure is a fraction having as numerator the sum of centralgovernment receipts and as denominator the sum of all government receiptscalculated for 1880 The date was chosen to allay any suspicion about the directionof the causal relationship (I initially wanted data for 1850 but had to give up) At anyrate state centralization is a variable with a long memory most unlikely in the shortrun to be endogenous to nancial development

Results are reported in Table 3 In both speci cations of the dependent variablethe impact of wealth on the order of one (one standard deviation increase in wealthcorresponds to a one standard deviation increase in stock holdings) is stronger thanthat of state centralization on the order of 40 percent The partial plots forregression 1 are shown in Figure 5 Once again it is theoretically gratifying toobserve the proximity between the German and US observations in the upper graphof Figure 5 Despite hosting the largest corporate securities market in the world theUnited States was no exception to the fact that decentralization had a negativein uence on the development of nancial markets This negative in uence washidden by the contrary in uence of wealth It so happened that the United States alsowas among the wealthiest countries in the world

The present ndings have an implication for the institutionalist interpretationadvanced by Douglass C North and Barry R Weingast They argue that theexistence of checks and balances was a requisite for treasuries to issue debt on alarge scale and that the public debt was instrumental in the latter acceptance of the

TABLE 3 The state centralization hypothesis


Dependent variable


Corporate stocks andbonds c 1913

1 2

State centralization c 1880 019 033(017) (032)

GNP per capita 1913 00004 00005(000007) (00001)

Intercept 2 025 2 038

Note See note to Table 2 for methodology and the appendix for data description and sources


private debt It is also the case however that a particular type of checks andbalances decentralization and the concomitant representation of local governmentsin powerful upper chambers had a largely negative impact on the development ofcorporate securities markets The eradication of local nancial privileges wasnecessary to release local capital from its local uses Furthermore the bond marketin decentralized countries was too narrow to accommodate too large a public debta large public debt would easily crowd out private debt as it did in Italy State

FIGURE 5 The state centralizing hypothesis (partial plots for regression 1Table 3)


centralization thus had to come before checks and balances for the introduction ofchecks and balances froze state centralization at its existing level empowering localinterests in decentralized countries50

Consequences for the Study of Capital Mobility

The paucity of case studies and inaccuracy of the data make the preceding ndingstentative at most Assuming for the sake of argument that they bear some resem-blance to reality I now develop implications for the study of nancial capitalmobility The research follows Cheryl Schonhardt-Bailey and Andrew Baileyrsquospioneering quest for an empirical referent to and a direct measure of the notion ofcapital mobility It argues that capital mobility is a function of securitizationmdashthetransformation of rmsrsquo liabilities into nancial instruments of any maturity that canbe continually traded in deep broad and impersonal markets Liquid and broadsecurities markets provide investors with the capacity to switch their holdings ofstocks across rms sectors climes and latitudesmdashand this is the closest we getempirically to capital mobility

More fundamentally the study of nancial markets allows us to restore to capitalmobility a conceptual unity threatened by the asset speci city literature Financialcapital is the mobile form of production capital That ldquoan automobile factory cannotcostlessly be converted into a breweryrdquo would indicate that capital is speci c onlyin a nonmonetary economy51 In a monetary economy the liquidation value of theformer could in theory suf ce to pay for the latter More realistically the pro tsgenerated by car manufacturing may be invested in the construction of a brewery ifbrewing is expected to be more pro table than the assembling of cars The sameoutcome is instantaneously reached in the presence of a nancial market throughinstitutional investors modifying their relative holdings of stocks in each sector theinduced change in relative share values allows the rising sector to incur new debtwhile forcing the declining sector to reimburse past debt Production and nancialcapital are so to speak the two sides of the same coin rather than separate factorsof production

Not only are various forms of capital related but so are various types of mobilityCentripetal mobility was a prerequisite to cross-sectoral mobility Absent a nation-wide branch-bank network and the well-capitalized Bourse des valeurs in Paris thewidow of a winemaker from Bordeaux would not have invested in railroadsCentripetal mobility also was a prerequisite to cross-border capital ows52 Francewould not have been a creditor to the world in the absence of a nancial system

50 One better appreciates the predicament of the French and Spanish monarchies during theeighteenth century The Bourbons ldquofailedrdquo to match Albionrsquos nancial resources by conceding enoughpower to Parliament perhaps because the French and Spanish states had not yet reached a level ofcentralization comparable to England See Hoffman and Norberg 1994 Limited government may haveback red merely reinstating local privileges and past impediments to exchange

51 The phrase is from Frieden 1991 43652 See Verdier 1998


centralizing French savings in Paris Conversely Canadamdashstill centralized bythenmdashwould not have been host to the largest net in ow of foreign investments(weighted by GNP) before World War I had investment opportunities there beendispersed among local markets with no connection to the Montreal stock exchangeThat Germany lacked a similar centralizing mechanism may have explained themodesty of its global nancial reach53

The correlation between securitization and internationalization is more than aspeculationmdashit is a fact A measure of nancial internationalization at our disposalis the stock of foreign investment (portfolio mainly) held in 1914 divided byGNP54 I use absolute values so as to measure the relative dependence of theeconomy on foreign investment in and out without distinction between debtor andcreditor status but add a dummy variable coded 1 for creditor and zero otherwiseto guard against a possible bias A perusal of the partial regression plots points toan outliermdashSwitzerland (Figure 6) Switzerland is an exception a country with anunusual share of international banking owing to factors that are left out of thepresent argumentmdashinternational nancial specialization low tax rate politicalstability and neutrality in foreign affairs Run again without the Swiss observationthe regression reveals strong coef cients for wealth and stocks (results unreported)

Did securitization invite internationalization or did internationalization fostersecuritization Neither was the case Both were the product of one common causethe existence of a broad centripetal money marketmdashdomestic capital mobilityState institutions lent a historical unity to various categories of capital mobility

The research provides an illustration of the well-known though hardly re-searched idea that political institutions play a role in locking in factor speci cityfactor speci city is embedded in political institutions55 Alt and Michael J Gilliganhave argued (though not shown) that the electoral rule shapes the scope of publicpolicy and the degree to which a rm will invest in speci c assets If members ofParliament are tied to single-member districts they provide the protection that keeps rms tied to a speci c location If they do not represent geographically basedconstituencies but are elected from a national list of candidates they may stillprovide protection yet not of the kind that ties rms to a location56 The presentstudy argues and shows that the degree of centralization of the state has a similareffect Federalism increases the power of local governments in policymakingRegulation enhancing the welfare of local districts has the effect of reducing capitalmobility nationwide Centralized states in contrast either do not try to regulate

53 The debilitating effect of state decentralization on global market policies was also noted by RobertBates in his contrast of Brazilian and Colombian coffee policies Bates 1997 48 86

54 To the extent that most foreign investment was in portfolio form makes it an acceptable proxy of nancial internationalization Foreign direct investment in contrast would be improper for it was notmediated by nancial markets

55 This proposition was developed in Alt and Gilligan 1994 183 Verdier 1995 and Alt et al 1996703 in contrast to the view that capital mobility is a purely economic parameter held in Rogowski 1989and Frieden 1991

56 Verdier makes a somewhat similar argument with regard to the scope of state subsidies to industryusing the intensity of electoral competition as institutional determinant Verdier 1995


FIGURE 6 Securitization and internationalization (partial plots for a regressionof the form For_Inv = b 1 + b 2Stocks + b 3GNPpc + b 4Creditor + e)

nancial capital mobility or they do so like the French by creating sectoralincentives which cut down mobility across sectors but not space

The present study also offers a plausible mechanism by which a policy restrictsor expands capital mobility Well-understood in the case of labor where socialregulation favors trade unions and trade unions curb labor mobility this mechanismin the case of capital has been shrouded in abstraction Alt and Gilliganrsquos idea of rms creating political commitment through deliberate investments in speci c assetsis an intriguing hypothesis albeit one that to my knowledge is unresearched anduntested57 My earlier notion that factor speci city is not an attribute of real (or nancial) assets but a sociopolitical construct re ected in asset holdersrsquo member-ship in networks places too much weight on the notion of network58 It is unlikelythat country club membership has an effect on nancial capital mobility other thanmarginal It just seems more plausible that the organization of the nancial systemshould be the key determinant of nancial capital mobility The dif culty lay in howto link nance and politics a dif culty that the present work claims to haveovercome

Last the ndings amplify the futility of the much-asked question of the impact ofcapital speci city on the tariff59 The prediction is that capital mobility givesinvestors the capacity to ldquoexitrdquo out of import-sensitive sectors thereby diminishingldquovoicerdquo for protection60 However a cross-national tabulation of tariff levels andcorporate securities holdings in 1913 would have failed to uncover any relation theFrench tariff was higher than the German61 If speci city added investorsrsquo andbankersrsquo voice to that of the protectionists why was the German tariff lower

The prediction that factor speci city left money with no other choice than ldquotalkrdquowas actually upheld in corporate boardrooms Rather than using markets to spreadtheir resources thin over a diversi ed portfolio as in countries of high capitalmobility large investors in Germany and Italy J P Morgan in the United Statesused markets to concentrate their resources in a few companies and control andmonitor management62 Bought at primary auctions shares were kept inde nitelyadmittedly stunting growth in the secondary market but providing holders withvoice in the boardroom Smaller investors held debt in the form of bonds or whenconcerned about staying liquid bank deposits implicitly delegating to banks thetask of monitoring rmsrsquo performance63 Banks had a special incentive to monitorborrowers because of their chronic illiquidity stemming from the absence of liquid nancial markets

57 See Alt and Gilligan 1994 and Alt et al 1996 70358 Verdier 199559 Recall that the study of capital mobility originated with respect to its impact on the tariff See

Stolper and Samuelson 194060 Schonhardt-Bailey 199161 I tried several speci cations alternatively controlling for wealth size of the economy or export

dependence but found no signi cant relationship between corporate securities markets and variousmeasures of tariff rates found in Bairoch 1993

62 On J P Morgan see De Long 199163 The classic account on Germany is Riesser 1911 725 See also Calomiris 1995


Investorsrsquo and bankersrsquo voices however were not heard in Parliament andgovernment lobbies French and English bankers never did much for industryGerman bankers were barely instrumental in facilitating the cartelization ofindustrial sectors and they took no part in the tariff debate In the United StatesJ P Morgan helped cartelize certain sectors of industry but never did he norany prominent banker take a public position on the tariff64 The reason Ibelieve is that center banks in Germany and the United States were intimidatedby the radicalism of the agrarian movementmdashthe populist battle cry against theldquomoney trustrdquo the junkersrsquo recurrent harassment of the markets and theReichsbank This radicalism was not fortuitous but re ected the power of theperiphery and the decentralized nature of state institutions in these two coun-tries In sum whereas Barclays and Credit Lyonnais neglected industry andignored the tariff debate Deutsche Bank and J P Morgan had more stakes in itbut kept quiet nonetheless lest they invite agrarian abuse Mobility causedneglect speci city advised caution65

Summary and Future Research

In this article I have turned a modeling toolmdashthe notion of capital mobilityacross sectors and bordersmdashinto a reality with deep roots sinking into economichistorymdashthe centripetal mobility of nancial capital in 1900 I brought a richand well-developed eld of studymdashbanking and nancial historymdashto bear onthe study of how nancial capital ows Conversely I used the single conceptof capital mobility to bring unity to what is generally considered to be a complex eldmdashinvolving savers various types of banks money and capital marketsgovernment regulation of banks and markets and foreign investment to namethe most important

I argued that nancial capital mobility was endogenous to policymaking Itwas a stake in the redistributive con ict pitting new against traditional sectorsThe industrial revolution touched off a corporate nancial revolution thatthreatened to divert capital from traditional sectors Blocking coalitions of localbanks and producers formed to keep nance local in decentralized countrieswhere they had a chance of winning In centralized countries traditional sectorsmerely pressured government to set aside a piece of the action In so doing theytransformed what was a center-periphery con ict into a debate on the relative

64 On the United Kingdom see Kennedy 1987 56 110 120 139ndash41 On France see Bouvier 1968221 For a debunking of Hilferdingrsquos claim that German banks cartelized industry see Wellhoner 1989For an opposite conclusion with respect to German banks on a different issue (exchange rates) in adifferent era (postwar) see Henning 1994 28ndash31 On Morgan see Corey 1930

65 There is a second more general reason for why tariff levels did not negatively re ect nancialcapital mobility Although nancial capital mobility may reduce investorsrsquo preference for protection itincreases that of the relatively less mobile factorsmdashmanagement and labormdashwhose income is dependenton the sectorrsquos fortune The latter have a twofold incentive to lobby for a rent they cannot exit and theywish to make the sector attractive to footloose investors by raising expected earnings through a tariff


size and merits of the public and private banking sectorsmdasha cleavage that woulddominate nancial debates in centralized countries from the 1930s until the1960s

Two series of evidence were offered a three-country detailed analysis of theimplied causal mechanisms and a nine-country test of two correlations thenegative association between markets on the one hand and local banking andstate decentralization on the other hand Controlling for relative wealth twobroad groups of countries were visiblemdashcountries with large corporate markets(France and the United Kingdom) and countries with smaller markets (GermanyItaly and notwithstanding its absolute size the United States)

Future research should test the applicability of the present ndings to thepresent era Financial deregulation in recent decades has placed stock markets atthe center of investment and growth causing a divide between companies thatare listed on the exchangesmdash because they are large or operate in growthsectorsmdashand those that depend on bank loansmdashsmall companies operating intraditional sectors Fiscal retrenchment makes the latter ever more dependent onlocal governments However something is different between the days prior toWorld War I and today The half-century of state control over large companiesin the form of state ownership or price control may have added a twist to themodel State control is much too tolerant of lower return on capital to make theshares of thus-controlled rms attractive to investors Since state control issomehow linked to state centralization the aggregate effect of state centraliza-tion on stock markets may have become indeterminate for favoring capitalmobility to the nancial center while denying investors plum stocks in which toinvest Only when privatization and deregulation have advanced far enough topurge the corporates from their addiction to state intervention will the center-periphery logic seize center stage again66

Appendix

TABLE A1 The nine-country data set

(1) (2) (3) (4) (5) (6) (7) (8) (9)

Belgium 021 027 815 001 040 0 085 120 1Denmark 015 016 885 051 0 0 064 NA NAFrance 013 027 670 023 010 0 083 099 1Germany 008 010 775 071 001 0 049 052 1Italy 003 005 455 040 033 0 055 020 0Norway 011 012 615 051 0 0 060 056 0Switzerland 016 018 895 061 0 0 037 196 1

66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)

UK 030 039 1070 006 014 0 070 166 1US 029 040 1350 025 0 042 033 009 0Mean 016 021 837 035 011 005 060 090 063Standard deviation 009 013 262 024 016 014 018 068 052

Data Description and Sources (1) Corporate stocks (2) Corporate stocks and bonds both vari-ables are calculated as a percentage of all nancial assets circa 1913 Goldsmith 1985 (3) GNP percapita Bairoch and Levy-Leboyer 1981 10 (4) Local nonpro t banks (5) Postal savings (6) Coun-try banks values are the market share of these respective categories calculated in deposits exceptassets in the Swiss case Sources are for Belgium Societe des nations 1931 116 and Mitchell 1992781 784 Britain Societe des nations 1931 260 Denmark Societe des nations 1931 125 FranceMitchell 1992 774 782 Germany Deutsche Bundesbank 1976 57 63 65 76 102 112 120 ItalyMitchell 1992 774 782 and Societe des nations 1931 187 New Zealand Societe des nations 1931447 Norway Societe des nations 1931 199 and Mitchell 1992 782 Switzerland Ritzmann 1973tab 1 the United States Societe des nations 1931 346 and Mitchell 1983 775 785 (7) State cen-tralization it measures central government revenues as a percentage of general government revenuescirca 1880 Sources are for Western Europe Flora 1983 273 and the United States US Bureau ofthe Census 1975 1119 (8) Absolute value of foreign investment stock weighted by GNP all data aregross foreign investments stocks as of 1914 except in the case of the United States the only countrywith known signi cant two-way ows for which data are net Foreign investment stocks in 1914US dollars were found in Cameron 1991 13 except Norway for which the data were found inBloom eld 1968 43ndash44 and converted in US dollars at the old gold parity of 02680 krone to thedollar Svennilson 1954 318 Data used in the computation of stocks for Norway only start in 1871with the effect of slightly overestimating Norwegian liability GNP data for 1913 1913 GNP data incurrent prices (Mitchell 1983 1992) were converted in US dollars using 1913 exchange rates (Sven-nilson 1954 318ndash19) (9) Creditor dummy variable coded 1 if net foreign investment stock is posi-tive and zero if negative

References

Albert Elisabeth 1997 Les Banques Populaires en France 1917ndash1973 Paris EconomicaAlt James E and Michael J Gilligan 1994 The Political Economy of Trading States Factor Speci city

Collective Action Problems and Political Institutions Journal of Political Philosophy 2 (2)165ndash92Alt James E Fredrik Carlsen Per Heum and Karingre Johansen 1999 Asset Speci city and the Political

Behavior of Firms Lobbying for Subsidies in Norway International Organization 53 (1)99ndash116Alt James E Jeffry Frieden Michael Gilligan Dani Rodrik and Ronald Rogowski 1996 The Political

Economy of International Trade Enduring Puzzles and Agenda for Inquiry Comparative PoliticalStudies 29 (6)689ndash717

Bairoch Paul 1993 Economics and World History Myths and Paradoxes Chicago University ofChicago Press

Bairoch Paul and Maurice Levy-Leboyer eds 1981 Disparities in Economic Development Since theIndustrial Revolution London Macmillan

Baskin Jonathan B and Paul J Miranti Jr 1997 A History of Corporate Finance CambridgeCambridge University Press

Bates Robert H 1997 Open-Economy Politics The Political Economy of the World Coffee TradePrinceton NJ Princeton University Press

Bloom eld Arthur L 1968 Patterns of Fluctuation in International Investment Before 1914 PrincetonStudies in International Finance No 21 Princeton NJ Princeton University


Bollen Kenneth A and Robert Jackman 1990 Regression Diagnostics An Expository Treatment ofOutliers and In uential Cases In Modern Methods of Data Analysis edited by John Fox and J ScottLong 257ndash91 Newbury Park Calif Sage

Born Karl Erich 1983 International Banking in the 19th and 20th Centuries Leamington Spa BergPublishers

Bouvier Jean 1968 Naissance drsquoune banque le Credit Lyonnais Paris Flammarionmdashmdashmdash 1973 Un siecle de banque francaise les contraintes de lrsquoEtat et les incertitudes des marches

Paris HachetteBroz J Lawrence 1998 The Origins of Central Banking Solutions to the Free-Rider Problem

International Organization 52 (2)231ndash68Calomiris Charles W 1995 The Costs of Rejecting Universal Banking American Finance in the

German Mirror 1870ndash1914 In Coordination and Information Historical Perspectives on theOrganization of Enterprise edited by Naomi R Lamoreaux and Daniel M G Raff 257ndash315 ChicagoUniversity of Chicago Press

Cameron Rondo 1991 Introduction In International Banking 1870ndash1914 edited by Rondo Cameronand V I Bovykin 3ndash21 New York Oxford University Press

Capie Forrest and Ghila Rodrik-Bali 1982 Concentration in British Banking 1870ndash1920 BusinessHistory 24280ndash92

Cohen Benjamin J 1996 Phoenix Risen The Resurrection of Global Finance World Politics 48 (2)268ndash96

Corey Lewis 1930 The House of Morgan New York G Howard WattDe Long J Bradford 1991 Did J P Morganrsquos Men Add Value An Economistrsquos Perspective on

Financial Capitalism In Inside the Business Enterprise Historical Perspectives on the Use ofInformation edited by Peter Temin 205ndash36 Chicago University of Chicago Press

Deeg Richard E 1999 Finance Capitalism Unveiled Banks and the German Political Economy AnnArbor University of Michigan Press

Deutsche Bundesbank 1976 Deutsches Geld- und Bankwesen in Zahlen 1876ndash1975 Frankfurt amMain Fritz Knapp

Emery Henry C 1908 Ten Years Regulation of the Stock Exchange in Germany Yale Review 17(May)5ndash23

Flora Peter 1983 State Economy and Society in Western Europe 1815ndash1975 Vol 1 LondonMacmillan

Frieden Jeffry A 1991 Invested Interests The Politics of National Economic Policies in a World ofGlobal Finance International Organization 45 (4)425ndash52

Frieden Jeffry A and Ronald Rogowski 1996 The Impact of the International Economy on NationalPolicies An Analytical Overview In Internationalization and Domestic Politics edited by Robert OKeohane and Helen V Milner 25ndash47 New York Cambridge University Press

Goldsmith Raymond W 1985 Comparative National Balance Sheets A Study of Twenty Countries1688ndash1978 Chicago University of Chicago Press

Golob Eugene O 1944 The Meline Tariff French Agriculture and Nationalist Economic Policy NewYork Columbia University Press

Gueslin Andre 1978 Les origines du Credit Agricole (1840ndash1914) Nancy BialecHartmann Manfred 1977 Raumwirtschaftliche Implikationen der Orgnizationen des Kreditwirtschaft

Berlin Duncker und HumblotHenning C Randall 1994 Currencies and Politics in the United States Germany and Japan

Washington DC Institute for International EconomicsHoffman Philip T and Kathryn Norberg 1994 Conclusion In Fiscal Crises Liberty and Represen-

tative Government 1450ndash1789 edited by Philip T Hoffman and Kathryn Norberg 299ndash312Stanford Calif Stanford University Press

Irwin Douglas A 1995 Industry or Class Cleavages over Trade Policy Evidence from the BritishGeneral Election of 1923 NBER Working Paper 5170 Cambridge Mass National Bureau ofEconomic Research


James John A 1978 Money and Capital Markets in Postbellum America Princeton NJ PrincetonUniversity Press

Kennedy William P 1987 Industrial Structure Capital Markets and the Origins of British EconomicDecline Cambridge Cambridge University Press

Koning Niek 1994 The Failure of Agrarian Capitalism Agrarian Politics in the UK Germany theNetherlands and the USA 1846ndash1919 London Routledge

La Porta Rafael Florencio Lopez-De-Silanes Andrei Shleifer and Robert W Vishny 1997 LegalDeterminants of External Finance Journal of Finance 52 (3)1131ndash50

Lamoreaux Naomi R 1994 Insider Lending Banks Personal Connections and Economic Developmentin Industrial New England New York Cambridge University Press

Lebovics Herman 1988 The Alliance of Iron and Wheat in the Third French Republic 1860ndash1914Baton Rouge Louisiana State University Press

Magee Stephen 1980 Three Simple Tests of the Stolper-Samuelson Theorem In Issues in InternationalEconomics edited by Peter Oppenheimer 138ndash53 London Oriel Press

Martin-Acena Pablo 1995 Spanish Banking in the Inter-War Period In Banking Currency andFinance in Europe Between the Wars edited by Charles H Feinstein 502ndash27 Oxford ClarendonPress

Michie Ranald 1988 The Finance of Innovation in Late Victorian and Edwardian Britain Possibilitiesand Constraints Journal of European Economic History 17 (3)491ndash530

Mitchell B R 1983 International Historical Statistics The Americas and Australasia Detroit MichGale Research Company

mdashmdashmdash 1992 International Historical Statistics Europe 1750ndash1988 3d ed New York Stockton PressMooney Christopher Z and Robert D Duval 1993 Bootstrapping A Nonparametric Approach to

Statistical Inference Sage University Papers No 07-095 Newbury Park Calif SageNorth Douglass C and Barry R Weingast 1989 Constitutions and Commitment The Evolution of

Institutions Governing Public Choice in Seventeenth-Century England Journal of Economic History49 (4)803ndash32

Parker William 1920 The Paris Bourse and French Finance New York Columbia UniversityPetersen Mitchell A and Raghuram G Rajan 1995 The Effects of Credit Market Competition on

Lending Relationships Quarterly Journal of Economics 110 (2)407ndash43Powell Ellis T [1915] 1966 The Evolution of the Money Market 1385ndash1915 Reprint London Frank

CassRajan Raghuram G and Luigi Zingales 1999 The Politics of Financial Development Unpublished

manuscript University of ChicagoRiesser J 1911 The German Great Banks and their Concentration in Connection with the Economic

Development of Germany Senate Document No 593 61st Cong 2nd sess Washington DC USGovernment Printing Of ce

Ritzmann Franz 1973 Die Schweizer Banken Geschichte Theorie Statistik Berne Paul HauptRogowski Ronald 1989 Commerce and Coalitions Princeton NJ Princeton University PressSaurel Maurice 1901 Societes de credit contre banques locales Paris Arthur RousseauSchonhardt-Bailey Cheryl 1991 Speci c Factors Capital Markets Portfolio Diversi cation and Free

Trade Domestic Determinants of the Repeal of the Corn Laws World Politics 43 (4)545ndash69Schonhardt-Bailey Cheryl and Andrew Bailey 1995 The Buck in Your Bank Is Not a Vote for Free

Trade Financial Intermediation and Trade Preferences in the United States and Germany InPreferences Institutions and Rational Choice edited by Keith Dowding and Desmond King179ndash210 Oxford Clarendon Press

Snowden Kenneth A 1995 Mortgage Securitization in the United States Twentieth-Century Develop-ments in Historical Perspective In Anglo-American Financial Systems Institutions and Markets in theTwentieth Century edited by Michael D Bordo and Richard Sylla 261ndash98 Burr Ridge Ill IrwinProfessional

Societe des nations 1931 Memorandum sur les banques commerciales 1913ndash1929 Geneva ServicedrsquoEtudes economiques


Stolper Wolfgang F and Paul A Samuelson 1941 Protection and Real Wages Review of EconomicStudies 9 (1)58ndash73

Svennilson Ingvar 1954 Growth and Stagnation in the European Economy Geneva UN EconomicCommission for Europe

Sylla Richard 1997 The Rise of Securities Markets What Can Government Do In ReformingFinancial Systems Historical Implications for Policy edited by Gerard Caprio Jr and Dimitri Vittas198ndash211 Cambridge Cambridge University Press

Sylla Richard and George David Smith 1995 Information and Capital Market Regulation in Anglo-American Finance In Anglo-American Financial Systems Institutions and Markets in the TwentiethCentury edited by Michael D Bordo and Richard Sylla 179ndash205 Burr Ridge Ill Irwin Professional

Tilly Richard H 1986 German Banking 1850ndash1914 Development Assistance for the Strong Journalof European Economic History 15113ndash52

US Bureau of the Census 1975 Historical Statistics of the United States Colonial Times to 1970Washington DC US Government Printing Of ce

Verdier Daniel 1994 Democracy and International Trade Britain France and the United States1860ndash1990 Princeton NJ Princeton University Press

mdashmdashmdash 1995 The Politics of Public Aid to Private Industry The Role of Policy Networks ComparativePolitical Studies 28 (1)3ndash42

mdashmdashmdash 1998 Domestic Responses to Capital Market Internationalization Under the Gold Standard1870ndash1914 International Organization 52 (1)1ndash34

mdashmdashmdash 2001 Social Against Mobile Capital Explaining Cross-National Variation in Stock Market Sizein the OECD Working Paper No SPS 20012 Florence European University Institute

Vittas Dimitri 1997 Thrift Deposit Institutions in Europe and the United States In Reforming FinancialSystems Historical Implications for Policy edited by Gerard Caprio Jr and Dimitri Vittas 141ndash78Cambridge Cambridge University Press

Wellhoner Volker 1989 Gro b banken und Grob industrie im Kaiserreich Gottingen Vandenhoeck undRuprecht

Zeitlin Jonathan 1995 Why Are There No Industrial Districts in the United Kingdom In Small andMedium-Size Enterprises edited by Arnaldo Bagnasco and Charles F Sabel 98ndash114 London Pinter


sectors that is if factors are (sector-)speci c then factor prices vary across sectorsand a change in product prices redistributes income across sectors Thereforelobbying for rents proceeds along sectoral lines with factor speci city and alongfactor linesmdashor not at all in light of the collective action dilemma faced by largegroupsmdashwith factor mobility2 Furthermore building on insights from the industrialorganization literature political economists identify sources of factor speci city inbarriers to entry such as sunk investment costs RampD intensity learning by doingbrand name patent and so forth3 In a study of Norwegian rms James E Alt etal argue that rms with large RampD expenditures create speci c assets for theproduction of products with no close substitutes and dif cult to dispose of in casethere is no demand for the product As a result Alt et al argue RampD-intensive rmshave a clear propensity to lobby for subsidies or market protection4

The asset speci city literature rests on a notion of capital that is made up ofdissimilar elements Capital comes in two ways (1) production capital whichincludes machinery stocks the buildings that house them and intangibles likepatents and (2) nancial capital referring to all nancial assets long and short termThe asset speci city literature does not deal with the dichotomy well either it shuns nancial capital to concentrate its attention on production capital exclusively5 oralternatively it treats production and nancial capital as separate factors of produc-tion with the latter systematically more mobile than the former6

This classi cation of capital into its primary elements can only be a preliminarystep in the study of capital mobility The next step is to recombine their interac-tionsmdashhow the mobility of each element impacts that of the others Production and nancial capital are not two separate factors but represent the two sides of thebalance sheet of a typical non nancial rm with production capital on the assetsside (buildings machinery and stocks) and nancial capital on the liability side(equity and debt) Capital mobility is that of the side that is more mobile

Which side is more mobile depends on whether or not there is a nancial marketAbsent a nancial market investors and creditors have concentrated stakes in few rms and even fewer sectors they cannot easily exit a money-losing investment inspeci c (low liquidation value) assets nor enter a pro table one making lobbyingfor the regulatory protection of that investment a plausible option In contrast in thepresence of a nancial market investors and creditors each own a diversi edportfolio of corresponding instruments7 Little lobbying is likely to come out of a

2 See Magee 1978 and Irwin 19953 See Frieden 1991 and Alt et al 19994 Alt et al 1999 1095 See for instance Frieden and Rogowski 1996 276 For instance Frieden writes ldquoit is consonant with the speci c-factors approach to assume that

nancial capital is mobile among industries while physical capital is industry-speci crdquo Frieden 1991438 Frieden further separates nancial capital into bonds and debt said to be mobile across countriesand stocks less so (429) The global nance literature echoes the idea that nancial capital since therepeal of capital controls in the 1970s is mobile across national borders For a survey see Cohen 1996

7 The argument was rst made by Schonhardt-Bailey 1991 and Schonhardt-Bailey and Bailey 1995They argue that nancial capital can effortlessly cross sectoral boundaries only in the presence of awell-functioning corporate securities market Absent such a market individuals willing to adjust their





















The Argument











17 Powell [1915] 1966 594






































Total 100 100 100










































Dependent variable



1 2 3 4



Postal savings 1913 2 011 2 010 2 033 2 032(050) (043) (043) (063)

GNP per capita 1913 000023 000029 00002 00002(00002) (00001) (00001) (00002)

Intercept 006 001 024 024










Dependent variable



1 2


GNP per capita 1913 00004 00005(000007) (00001)












































Appendix


(1) (2) (3) (4) (5) (6) (7) (8) (9)


66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References





























































































The Argument











17 Powell [1915] 1966 594






































Total 100 100 100










































Dependent variable



1 2 3 4



Postal savings 1913 2 011 2 010 2 033 2 032(050) (043) (043) (063)

GNP per capita 1913 000023 000029 00002 00002(00002) (00001) (00001) (00002)

Intercept 006 001 024 024










Dependent variable



1 2


GNP per capita 1913 00004 00005(000007) (00001)












































Appendix


(1) (2) (3) (4) (5) (6) (7) (8) (9)


66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References
















































































17 Powell [1915] 1966 594






































Total 100 100 100










































Dependent variable



1 2 3 4



Postal savings 1913 2 011 2 010 2 033 2 032(050) (043) (043) (063)

GNP per capita 1913 000023 000029 00002 00002(00002) (00001) (00001) (00002)

Intercept 006 001 024 024










Dependent variable



1 2


GNP per capita 1913 00004 00005(000007) (00001)












































Appendix


(1) (2) (3) (4) (5) (6) (7) (8) (9)


66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References














































































































Total 100 100 100










































Dependent variable



1 2 3 4



Postal savings 1913 2 011 2 010 2 033 2 032(050) (043) (043) (063)

GNP per capita 1913 000023 000029 00002 00002(00002) (00001) (00001) (00002)

Intercept 006 001 024 024










Dependent variable



1 2


GNP per capita 1913 00004 00005(000007) (00001)












































Appendix


(1) (2) (3) (4) (5) (6) (7) (8) (9)


66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References
















































































































Dependent variable



1 2 3 4



Postal savings 1913 2 011 2 010 2 033 2 032(050) (043) (043) (063)

GNP per capita 1913 000023 000029 00002 00002(00002) (00001) (00001) (00002)

Intercept 006 001 024 024










Dependent variable



1 2


GNP per capita 1913 00004 00005(000007) (00001)












































Appendix


(1) (2) (3) (4) (5) (6) (7) (8) (9)


66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References

















































































Dependent variable



1 2


GNP per capita 1913 00004 00005(000007) (00001)












































Appendix


(1) (2) (3) (4) (5) (6) (7) (8) (9)


66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References


















































































































Appendix


(1) (2) (3) (4) (5) (6) (7) (8) (9)


66 Verdier 2001


TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References










































































TABLE A1 continued

(1) (2) (3) (4) (5) (6) (7) (8) (9)



References










































































capital mobility and the origins of stock markets

Documents