The Origins of National Financial Systems: Alexander Gerschenkron Reconsidered

Published by EH.NET (March 2005)

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Douglas J. Forsyth and Daniel Verdier, editors, The Origins of National Financial Systems: Alexander Gerschenkron Reconsidered. London and New York: Routledge, 2003. xv + 237 pp. $129.95 (cloth), ISBN: 0-415-30168-8.

Reviewed for EH.NET by Richard Sylla, Stern School of Business, New York University.

In what has been called “the battle of the systems,” so-called bank-based financial systems typified by German-style universal banking compete with so-called market-based financial systems of the Anglo-American variety. Bank-based systems, of course, always had securities markets, just as market-based systems always had large banking components. Indeed, a recent scholarly trend has been to emphasize the similarities of the two types of systems rather than their differences, and to see in contemporary developments — an increased role for securities markets in Germany, and leading U.K. and U.S. banks looking more and more like universal banks — a convergence of financial systems.

Be that as it may, the conference volume reviewed here focuses on why financial-system differences emerged in the first place, meaning in the period 1850-1914 when universal banking emerged in Germany. It spread from Germany to other countries in Europe, while the British and the Americans continued to develop in tandem the banking systems and securities markets they had established earlier in history. As the subtitle of the volume suggests, one of its major purposes is to reconsider Alexander Gerschenkron’s influential contention that universal banking, defined broadly in the introduction to the volume as “banks that accept deposits, and engage in both short- and long-term lending” (p. 7), was a substitute in moderately backward countries such as Germany for missing “prerequisites” of economic modernization. Such missing prerequisites for Gerschenkron included a long history of commercial development and an “original accumulation of capital” available to finance modern industrial technologies at the appropriate moment. Today we might say, as Joost Jonker more or less does in his contribution to the volume, that a financial revolution is also among the missing prerequisites. Countries that had financial revolutions — the Dutch Republic, the U.K., and the U.S. — tended to have commercial banking specializing in short-term lending, as well as securities markets specializing in financing longer-term capital needs of companies.

In his introduction to the volume, co-editor Forsyth (a historian at Bowling Green State University in Ohio) characterizes Gerschenkron’s approach as one that focuses on bank assets and loan demand. In relatively backward countries, capital scarcity creates a demand by firms for long-term loans from banks to take advantage of new, large-scale production technologies. Universal banks emerge is such countries to satisfy the demand for long-term financing that otherwise would not be met. In more advanced economies, by contrast, established firms can rely on retained earnings and securities markets for long-term capital, leaving banks to specialize on short-term commercial lending.

An alternative explanation to Gerschenkron’s, an exploration of which motivates the volume, is that of the other co-editor, Verdier, a political scientist at Ohio State University. Instead of emphasizing loan demand and bank assets, Verdier in earlier writings and the first chapter here focuses on the supply of deposits, liabilities of banks that are one source of funds to finance loans to companies. More than Gerschenkron, Verdier bases his explanation on politics. In decentralized polities such as nineteenth-century Germany, the political power of farmers and small business led the state to sponsor non-profit financial institutions such as savings banks and cooperative institutions. That meant that bigger banks serving large-scale industry found it difficult to capture a large share of bank deposits. So the big banks had to rely more on their own capital and retained earnings to fund loans, and that in turn meant that they were less prone to runs on deposits and could thus make more long-term loans. But such banks could still suffer runs, and were particularly vulnerable to them because of their long-term lending. So successful universal banking required the presence of a central bank that would actively provide liquidity by acting as a lender of last resort in financial crises. In a nutshell, Verdier’s alternative to Gerschenkron holds that universal banking arises when the deposit market is segmented between non-profit and profit-oriented institutions (which is more likely in decentralized polities), and when the central bank is active as a supplier of liquidity and lender of last resort. Deposit-market segmentation and a lender of last resort are thus said to be the necessary and (together) sufficient conditions for the emergence of universal banking. Gerschenkron’s relative backwardness has nothing to do with it.

Conversely in Verdier’s model, centralized polities such as the U.K. and France were less likely to allow non-profit financial institutions to capture large shares of bank deposits. Hence, commercial banks obtained most of the economies’ bank deposits. Relying less on their own capital and retained earnings, and more on deposits that might be withdrawn on short notice, such banks abandoned long-term lending in favor of short-term commercial loans.

The remaining nine chapters of the book subject the Gerschenkron and Verdier models to intense scrutiny, and in general find that both models are lacking. Ranald Michie (Chapter 2) and Joost Jonker (Chapter 3) in effect criticize both models for being too narrow in their focus on banking, slighting the important role of securities markets, which are both competitive with and complementary to banks, in modern financial systems. Michie notes that the value of securities in 1913 was three to four times greater than worldwide bank deposits, which has to make one wonder why banks and banking have received such disproportionate attention from financial historians. He also produces an interesting table showing that the U.S., with its peculiar banking system made up of tens of thousands of unit banks, somehow managed by 1913 to have 30 percent of total world deposits and 36 percent of world commercial bank deposits, both totals being far ahead of those of any other country. Knowledge of that might cause historians of American banking to temper their critiques of it. Jonker compares the financial systems of the Netherlands, Britain, France, and Germany. He sees the first three as relatively sophisticated financial systems with securities markets playing central roles in them, while Germany, which he cleverly describes as “building a boat while sailing it,” was hampered by late state formation and retarded securities-market development. These are provocative chapters.

The rest of the chapters are country case studies. Richard Deeg’s study of Germany and Alessandro Polsi’s of Italy are perhaps most favorable to Verdier’s emphasis on the primacy of political factors in shaping financial systems. Germany and Italy were two pillars of Gerschenkron’s banking edifice, and both Deeg and Polsi think Gerschenkron exaggerated the role of universal banks in these countries. Both countries had segmented deposit markets, central banks, and universal banking as Verdier’s model would predict. The results, however, were far better in Germany than in Italy.

Michel Lescure’s interesting essay places France squarely between Britain and Germany. Like Britain, France as a centralized state had national deposit banks concentrating on short-term commercial lending, and investment banks serving large-scale industry. But like Germany, it had local universal banks serving local, small- and medium-sized firms. The Bank of France aided the latter in the manner Verdier contends was necessary.

Sweden and Norway were semi-centralized Scandinavian states that do not fit well either the Gerschenkron or Verdier models. In their essay on Sweden, H?kan Lindgen and Hans Sj?gren show that the country had an early development of non-profit savings banks and a central bank, which would lead Verdier to predict the emergence of universal banking. And that may have happened at the turn of the twentieth century, later than Verdier’s model would imply. The explanation may be that Sweden’s savings banks were linked with its commercial banks, so there was not so much deposit-market segmentation. When universal banking did finally come late to Sweden, it may have been for Gerschenkronian reasons, or it may simply have been in imitation of nearby and admired Germany. Sverre Knutsen’s description of Norway make it sound ripe for universal banking under either Gerschenkron’s or Verdier’s model. It didn’t happen. Foreign capital appears to have substituted for Gerschenkronian universal banks, and the Bank of Norway was too timid a supplier of liquidity and lender of last resort to fulfill Verdier’s second precondition for universal banking.

Imperial Russia, according to Don Rowney’s chapter, had British-type commercial banking in Moscow and German-style universal banking in St. Petersburg. Neither Gerschenkron’s nor Verdier’s model seems very helpful in explaining that mixed outcome. Instead the Russian state seems to have sponsored both types of banking, in imitation of Britain in the 1880s (Moscow) and of Germany (St. Petersburg) in the early 1900s.

Jaime Reis’s essay on Portugal ends the volume. Portugal was a centralized state with a weak non-profit banking sector, so Verdier’s model would predict commercial banking, as in Britain. Instead, Portugal had universal banks. But these banks did not make Portugal grow as Germany did. Portugal’s problems seemed to be that it was a poor, underdeveloped country without many bank deposits of any kind, and that the Portuguese national debt, three times larger than the total of bank deposits, crowded out both banks and industrial investment.

The main lesson of this volume is that it is not easy to come up with simple, or even moderately complex, explanations for differences among national financial systems. That said, Daniel Verdier is surely correct in his emphasis on the importance of political factors in producing history’s diverse financial-system outcomes. I also think Gerschenkron, with whom I discussed these matters many times, would have agreed with him on that.

Richard Sylla is Henry Kaufman Professor of the History of Financial Institutions and Markets at New York University’s Stern School of Business. His latest article, with Peter L. Rousseau, is “Emerging Financial Markets and Early U.S. Growth,” Explorations in Economic History 42 (2005).

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