Introduction

Why do advanced democracies have such different financial systems? For example, why have the US and UK relied so much on equities markets during the past century, while other countries, such as Germany and Japan, have relied more on bank-based financial arrangements? And why do financial systems change, sometimes dramatically and quickly? For example, the French and Japanese financial systems exhibited many surprising similarities to the contemporary United States before World War II; after the war, they went through radical transformations. Understanding the structure of national financial systems has attracted attention from across the social sciences in the past decade for two main reasons. First, research has clearly linked economic growth to financial development: the more developed a nation’s financial system (i.e., the more sophisticated a nation’s capital markets and banking services), the more economic growth it generates (King and Levine, 1993a, 1993b; Levine, 1997, 1998; Levine and Zervos, 1998; Rajan and Zingales, 1998; Levine et al., 2000). Second, the structure of national financial systems is a central distinguishing feature of national varieties of capitalism – coordinated market economies (CMEs) and liberal market economies (LMEs) – which support specific kinds of strategies on the part of firms in international markets. In CMEs, equities markets are less important than in LMEs for firm financing (Hall and Soskice, 2001). The dominant view to explain differences among financial systems is the legal origins perspective (La Porta et al., 1998, 2008), which argues that contemporary levels of financial development are largely determined by a country’s legal tradition; British common law provides better protection to minority shareholders and hence leads to larger financial systems (and equities markets) than civil law. However, alternative political economy explanations have emerged that emphasize the role of political institutions and/or interest groups. The political institutions view suggests that financial development depends on how political institutions mediate conflicts of interest over the security of property rights which then affects the structure of the financial system (e.g., Verdier, 2003; Acemoglu et al., 2004; Lamoreaux and Rosenthal, 2005; Acemoglu and Robinson, 2006; Haber et al., 2007). Interest group explanations take a step back in the causal chain by focusing on the preferences of specific actors and the political coalitions

they may form (e.g., Rajan and Zingales, 2003; Roe, 2003; Gourevitch and Shinn, 2005). Both perspectives have merit: allow political institutions to vary while holding actors constant and financial outcomes will vary accordingly; the converse is also true. This book begins with the premise that institutional inertia has shaped modern financial arrangements in ways that cannot be accounted for by looking solely at contemporary political cleavages or institutions. To understand the causal mechanisms that have produced modern financial arrangements it is necessary to examine the origins, and to consider which actors were most important at that time. But in those moments, not only were new bargains struck over the design of financial institutions, often political institutions were also restructured, as in many countries following World War II (e.g., France, Germany, Austria, and Japan). For this reason, this study places greater emphasis on actors and coalitions. By looking back to when bargains were struck over the design of modern financial institutions among advanced democracies, it becomes clear that landed interests (farmers) have had a substantial, though frequently overlooked, impact. As a result, this book argues that political battles fought between landed interests, labor, and owners of capital at formative moments in a nation’s institutional development have substantially shaped modern financial arrangements. The resultant financial institutions depend upon which actors formed a winning political coalition at that moment. When these battles occur in the wake of a crisis that leads to new political institutions, dramatic changes to the structure of financial institutions are possible; when in the context of pre-existing political institutions, financial outcomes are constrained. The details of the argument are presented in Chapter 2. This argument differs from the alternatives highlighted above with its focus on the origins of contemporary financial institutions, as well as with its focus on farmers as a key actor. It shows that farmers have had a substantial impact not only on national banking systems, but also on corporate ownership and equities markets. Further, the study clearly demonstrates that financial arrangements really were different before World War II in many advanced democracies, and offers a parsimonious explanation for the variety of financial arrangements observed across space and time. In contrast to many other studies which emphasize the causal role of political institutions, I see the actors as critical – particularly at those moments when both financial and political institutions change. Once new political institutions are in place, they preserve and bias the evolutionary path of the financial system. This is consistent with Acemoglu and Robinson’s (2006) argument that political institutions enable credible commitments to new bargains; but the key causal mechanism is the de facto power that groups wield when the new institutional bargains are struck (as opposed to de jure power, which is granted by the institutions). A final contrast with the aforementioned arguments is with this book’s focus on general financial characteristics. That is, financial institutions are seen as complementing one another, and arising from a common political origin.1 Like varieties of capitalism, financial

systems fall along a continuum: at one end, financial institutions complement one another in generating incentives for actors to focus on the short term, as in LMEs; at the other end, financial institutions foster a longer term focus, as in CMEs.2 The “patient” capital of CMEs allows employment to be more stable and longer term, and enables workers to devote more of their time and energy to cultivating job-specific skills.3 In this way, financial arrangements complement industrial relations, vocational training, and other dimensions of capitalist systems. Indeed, the varieties of capitalism literature points to the reliance on equities markets and related corporate governance rules as central distinguishing features of capitalist ideal-types. As a result, understanding the origins of financial institutions offers insight into how national varieties of capitalism have emerged and persisted.