Working Paper: CEPR ID: DP2783
Authors: Raghuram Rajan; Luigi Zingales
Abstract: We show that the development of the financial sector does not change monotonically over time. In particular, we find that by most measures, countries were more financially developed in 1913 than in 1980 and only recently have they surpassed their 1913 levels. This pattern is inconsistent with most recent theories of why cross-country differences in financial development do not track differences in economic development, since these theories are based upon time-invariant factors, such as a country?s legal origin. We propose instead an ?interest group? theory of financial development. Incumbents oppose financial development because it breeds competition. The theory predicts that incumbents? opposition will be weaker when an economy allows both cross-border trade and capital flows. This theory can go some way towards accounting for the cross-country differences and the time series variation of financial development.
Keywords: financial development; history of equity market; political economy
JEL Codes: G30; M20; O16
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| incumbents oppose financial development (O16) | financial development stagnates (O16) |
| trade openness mitigates opposition from incumbents (F41) | financial development increases (O16) |
| financial development is correlated with trade openness (O16) | financial development increases (O16) |
| historical context of financial repression (G18) | incumbents resist financial development (O16) |
| absence of trade and capital flow openness (F32) | financial development stagnates (O16) |