This article, which has just appeared in World Development, highlights the essential role played by governments in kick-starting financial development in Europe and Asia. In the case of London and Amsterdam, the emergence of financial markets was a by-product of the rise of large trading monopolies. These monopolies, partly created to improve public finances, were responsible for all the major financial innovations of the time. In London, for example, the East India Company (EIC), which was granted a royal charter by the monarch to all trade east of the Cape of Good Hope in 1600, was the first to issue permanent stock; this development allowed investors to benefit from risk diversification offered by multiple voyages which, as a result, made investment more attractive. In turned, this helped to boost savings mobilisation, a key to kick starting financial development. The advent of stock trading – which made shares more liquid and therefore more attractive to investors – was facilitated by another EIC innovation, namely a simplified procedure for transferring the ownership of shares.
The paper demonstrates that the EIC’s shares were traded as early as 1661 in the coffee houses of Exchange Alley, before the strengthening of investors’ property rights associated with the ‘Glorious Revolution’ of 1687, emphasised by previous literature as the main turning point in financial history. It ascribes the emergence of London’s financial markets to a deeper cause – the need of the government to improve the state of the public finances and the inability of the monarchy to borrow from investors’ directly due to the erosion of their property rights vis-à-vis the state. It shows that creating profitable and powerful monopolies with close links to government, such as the EIC and later on the Bank of England, was a key not only to the improvement in public finances that ensued but also to the emergence and development of financial markets. The paper also shows that these developments set in motion a virtuous finance-trade-growth cycle that transformed England from a weak state in the early part of the 17th century into Europe’s foremost military power by the beginning of the 18th century.
The experience of Amsterdam was similar to that of London. It also provides an important counter-factual for the analysis relating to the importance of monopolies. The VOC – the Dutch equivalent of the EIC – was established in 1602 following pressure by competitor companies to amalgamate their operations into a monopoly, in order to address the erosion of their profits by excessive competition. Historical sources confirm that the VOC was as much the creation – and later extension - of the Dutch state as it was of the merchants who opened up the East India trade. The birth of the stock market in Amsterdam is firmly linked to trading in VOC shares and so are financial innovations of the time.
In Hong Kong, where the financial development model was bank-based, a large banking monopoly with close links to both the British and Chinese governments, set up to finance international trade played a similar role.
The paper argues that the cases of London, Amsterdam and Hong Kong were not exceptions. The emergence of strong finance in various parts of the world had little, if anything, to do with 'laissez-faire' approaches. Instead it was firmly linked to governments. To illustrate this point, the paper reviews the cases of the Italian city states of Genoa and Venice during the Renaissance, the US state banks in the 18th and 19th centuries and the emergence of strong banking systems in 20th century Japan, Korea and Taiwan.
The paper has been co-authored by Svetlana Andrianova (Leicester) and Chenggang Xu (Hong Kong). The research was funded by the ESRC's World Economy and Finance Research Porgramme.
Reference
Andrianova, S., P. Demetriades and C. Xu. Political Economy Origins of Financial Markets in Europe and Asia, World Development (2010), doi:10.1016/j.worlddev.2010.10.001. (
available online at Science Direct).
