Financial University lecture, Moscow27.10.10

“Financial development and economic growth: Lessons of History”

Richard Sylla, New York University

Why are there such extremes of wealth and poverty in today’s world?

• Thesis: Financial development—in particular, “financial revolutions” that in brief periods gave some nations modern financial systems early in their modern histories—led them to grow economically much faster than others, producing increased inequality.

• Today’s lecture illustrates the thesis by reviewing financial development in modern history.

TABLE 1REAL GDP PER CAPITA RELATIVE TO WORLD AVERAGE, SELECTED COUNTRIES, 1500-2006(WORLD AVERAGE = 100 AT EACH DATE)

Country

Date Italy Netherlands U.K U.S.A Japan France Germany

1500 195 133 126 71 88 129 120

1600 185 231 164 67 88 142 131

1700 179 343 203 86 93 160 145

1820 167 273 256 188 100 184 159

1870 173 318 368 282 85 216 210

1913 170 268 326 351 92 231 242

1950 166 284 327 452 91 249 184

1973 259 319 293 407 279 320 292

1998 311 354 328 479 358 343 312

2006 274 324 319 430 311 302 277

Source: Derived from Angus Maddison, The World Economy: A Millennial Perspective. Paris: OECD, 2001. Table B-21, p. 264. andMaddison website..

2006 319 430 302 311 84 36 23 97

Year UK US Fran Japa Chin India Afric Latin Americ

1700 203 86 160 93 98 89 65 86

1820 256 188 184 100 90 80 63 100

1870 368 282 216 85 61 61 51 81

1913 326 351 231 92 37 45 39 100

1950 327 452 249 91 21 29 40 121

1973 293 407 320 279 20 21 33 110

1998 328 479 343 358 55 31 24 102

Table 2Real GDP Per Capita Relative to World Average, Selected Countries/Regions, 1700-2006(World average GDP = 100 at each date)Source: Derived from Maddison (2001), Table B-21, p. 264, and Maddison website.

Financial Revolution

What is it? Emergence, in a brief period of history, of a modern financial system with:

• Stable public finances and public debt management• Stable Currency/Money• A good banking system• An effective central bank• Efficient securities markets• Business corporations—financial & non-financial—

authorized by governments and with shareholders and managers

Historical Financial Revolutions

Which countries in modern history had financial revolutions?• Successful cases:

– Dutch Republic, 1550-1620– England, 1688-1740s– USA, 1789-1795– Japan, 1870s-1880s

• Aborted case: – France, 1715-1720 (John Law)

Dutch Republic: first modern system

• Public borrowing (not forced loans) from late 16th century

• Currency stabilization in early 17th century• Central bank: Bank of Amsterdam, 1609• Banks: kassiers by early 17th century• Securities markets: Amsterdam, 1600-10• Corporations: Dutch East India Co. (VOC) and

West India Co., 1600-1620

The Dutch Golden Age, 17th century

• Based in part on financial modernization, the Dutch Republic wins its independence from Spain, a much larger country, in 80-years war, 1568-1648.

• The mid 17th century is the Dutch “golden age”, an “embarrassment of riches.”

• Dutch build an overseas empire.• Dutch found New Amsterdam, today’s New

York City.

England (UK): second to modernize by emulating the Dutch Republic, mostly after 1688

• Public finance: long-term debts, 1688-1720• Currency stabilized: de facto gold standard in

early 18th century (Sir Isaac Newton)• Central bank: Bank of England, 1694• Banking system: London, late 17th century;

nationwide after 1750• Securities markets, 1690s• Corporations: Bank of England, East India

Company, South Sea Co., and others, 1690s ff.

Great Britain’s leadership

• Financial modernization 1688-1740s enables England to win all its wars except one from 1688 to 1815.

• The first Industrial Revolution comes after the English financial revolution, and is aided by it.

• Britain builds a great overseas empire.• Britain becomes “the workshop of the world”

in the 19th century.

The USA’s financial revolution, 1789-1795

• Public finances built and national debt restructured, 1790

• Convertible dollar currency introduced, 1791• Central Bank: Bank of the United States, 1791• Banking system emerges—state-chartered

banks• Securities markets and stock exchanges emerge

(eg, NYSE, 1792)• Numerous corporations are chartered during

1790s

US expansion and economic growth

• US economy expands at modern rates starting in the 1790s and continuing to the present

• Geographical territory of USA more triples by 1867, when Alaska is purchased from Russia

• By the 1870s or 1880s, the USA is the largest economy in the world and the leading manufacturing nation.

• In 1790, the US population is less than 4 million; now it is more than 300 million.

Real GDP Per Capita in the United States, 1790-2006

$100

$1,000

$10,000

$100,000

1790

1798

1806

1814

1822

1830

1838

1846

1854

1862

1870

1878

1886

1894

1902

1910

1918

1926

1934

1942

1950

1958

1966

1974

1982

1990

1998

2006

Year

2000

US

D

Japan’s financial revolution, 1870s-1880s

• Public finance: rice taxes to money taxes; bond issues to pay samurai, 1870s

• Money: Yen currency, silver- and later gold-based, 1870s-1890s

• Central Bank: Bank of Japan, 1882• Banking system: national banks, ordinary banks• Securities markets: Tokyo and Osaka stock

exchanges, both founded 1878• Corporations: many founded during Meiji era

Japan’s expansion

• Japan’s economic growth takes off during the 1870s, and continues to the present era, with a great setback in World War II.

• Before that, Japan wins Sino-Japanese war in 1890s, and Russo-Japanese war in early 1900s

• Japan is the one large non-Western country to equal the West in economic development and growth.

Financial Modernization leads to Crises

• Dutch Republic: Tulip Mania in the 1630s• France: Mississippi Bubble of 1719-20 under John Law’s

modernization plan (next slides)• UK: South Sea Bubble of 1720 (next slides)• USA: First of many crises in 1792, on heels of Hamilton’s

financial modernization plan• Japan: Inflationary crisis of late 1870s, just as finances are

being modernized by reformers• Conclusion is that financial modernization is exhilarating,

leading to excesses that end in financial crises. Pattern recurs: financial innovation, excesses, and then crises.

• But crises end, and modern economic growth continues.

Lessons of History• The Dutch, British, American, and Japanese cases

suggest that financial revolutions precede and promote modern economic growth.

• Other countries imported the innovations of these leaders, and their growth followed.

• Researchers on today’s emerging markets find similar patterns: countries with stable public finances and sound currencies, with effective central banks and banking systems, and with liquid securities markets and ease of forming corporations, grow faster than countries that lack one of more of these key components of modern financial systems.