Financial Institutions and Economic Growth in the

7/31/2019 Financial Institutions and Economic Growth in the

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ABSTRACT

The role of finance in economic growth is assessed here as part of a comparison between

two European peripheries Scandinavia and southern Europe- in the second half of the

nineteenth century. It reveals that financial development was much greater in the former

region, a fact explained because Scandinavian financial institutions were better not only at

mobilizing the funds of the public but also at transforming them into credits available to the

non-financial private sectors of the economy. Different per capita income levels, through

savings, influenced this outcome but exogenous factors arising out politics, society andculture appear to have been more important still in this process.

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Financial Systems in the Periphery:A Nineteenth Century Comparison of Scandinavia and

Southern Europe 1

Jaime Reis

Instituto de Cincias SociaisRua Miguel Lupi, 18 r/c1200 LisboaPortugal [email protected]

1.Introduction

1 For valuable help, the author wishes to thank, Andres Hoyo Aparicio, Sverre Knutsen, DanielWaldenstrom, Per H. Hansen, Peter Hertner, Luis Castaeda, Pedro Tedde de Lorca, Hkan Lindgen, HansSjgren, Dermot OBrien, Anders Sjlander, Duncan Ross, Gjis Kessler and Luciano Amaral. He is particularly grateful for the opportunity of a stay at the Research Department of the Bank of Portugal,where this paper was written.

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mailto:jaime.reis@icsmailto:jaime.reis@ics


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instruments, while the southern European countries have been portrayed as emerging late

and slowly in this respect.

In what follows, we deal with two issues. The first is to establish, in as rigorous a way as

possible, how large in fact was the financial gap between southern Europe and Scandinavia

during the period. Given that national financial systems can be highly idiosyncratic, this

means cutting through the variety of forms and appearances in them and focusing on an

objective yardstick that is both applicable in all economies and relevant to the problem of

long term growth. In accordance with the recent literature, we have adopted the per capita

volume of credit supplied by all the components of the financial system to the non-statenon-bank sectors. Having established that this difference was indeed stark, the second aim

of the paper is to account for the differences in performance of these systems and in

particular for the role of the exogenous causes. We do not seek to measure the actual

impact of finance on the growth of these economies, an important task but one for which,

as argued above, adequate data is not yet available.

In what follows our steps are guided by two concerns. One is that the only proper

framework for this study is the financial system as a whole, i.e. comprising therefore every

type of institution and instrument, rather than, as often happens, only some. Recognition is

hereby given to the essential fact that in different countries similar institutions may not

always have performed the same function, just as apparently analogous functions may have

been performed by different institutions (Nordvik, 1993; Eichengreen, 1998). The second is

that though individual institutions may be formally identical, they can still diverge

considerably in terms of their success in playing their designated roles within the economy.

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This difference can depend on a variety of factors, including regulatory, political and

cultural ones, and even the timing of their development (Guinnane and Henriksen, 1998).

The paper is divided into four parts. The first one outlines the size and structure of the

financial systems of the six countries considered, and compares the respective degree of

financial sophistication as measured by their aggregate financial liabilities. These data are

presented in per capita terms, at ten yearly intervals, and converted to a common currency

(sterling). The second part analyses, again comparatively, to what extent these resources

were transformed into credits and made available to the economy. The crucial distinction

here is between those that were supplied to the productive sector and those that were not, because they were absorbed by the state, were retained by the non-state financial system, or

employed in foreign operations. Parts three and four advance reasons for the inter-country

differences encountered in the preceding two sections and are followed by a conclusion.

2.Financial systems: size and structure

Over the course of the second half of the nineteenth century, a variety of financial agents

were active in every European country with the aim of mobilising savings in order to make

them available for use by others. These funds were actively competed for by different sorts

of institutions whose efforts had a profound influence on the shape of the national financial

systems which emerged (Forsyth and Verdier, 2003). Analytically, one should differentiate

between broadly three groups of actors, according to their institutional nature, the

instruments they used, and the applications they made with these resources. These are the

corporate financial sector, the market for issues by the non-financial, non-state sector of the

economy, and the state. The aim of this first part of the paper is to measure the size of each

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of these sectors in order to gauge, finally, the latters overall size. At this point, we are not

making any distinction regarding who supplied these funds, in particular whether their

origin was national or foreign. The concern is simply to examine the capacity of each

national system to persuade the public to accept the claims it issued. This is our first

measure of systemic efficiency.

One of the main features of the financial development of Europe during the nineteenth

century was the emergence of a myriad of types of corporate institution in this field. These

differed as to legal form and ownership, the sorts of guarantees they offered to their

depositors and shareholders (if any), the operations they were legally allowed to carry out,and whether or not their object was profit. Table 1 presents data between 1860 and 1910, at

ten yearly intervals, on the aggregate liabilities of corporate financial institutions in all the

countries in our sample. Every type of corporate financial institution then in existence is

included joint stock commercial banks, savings banks, co-operative banks, postal savings

banks, pledge banks, industrial and artisans banks, mortgage banks, credit associations and

so on. Our intention here is not to portray the precise evolution of these systems over time

but merely to provide a set of benchmarks to enable us to see roughly how they behaved in

the course of this period of momentous change. For the sake of comparability between

countries, these data are expressed in per capita terms and have been converted into pounds

sterling. The latter choice is justified on the grounds that these resources had a high degree

of international mobility and that the period was one of exchange rate stability. It would

thus seem that the differences between this option and one employing purchasing power

parities would not be relevant to the argument presented here. 44 The data in table 1 diverge from those in Goldsmith (1969) in two respects. The latter suppliesinformation only for 1880, 1900 and 1913 and does not include Portugal, Spain at all or, for some years,Sweden. It also contains some substantial over or underestimations. For example, the error in the case of Denmark is 11 % for 1880 and 49% for 1913, while for Italy, it is 25 and 22 % respectively.

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[table 1 about here]

The first thing to note is that by the earliest date (1860), a considerable gap already

separated Scandinavia from the southern European countries. Even though Norway was far

behind Denmark and Sweden, its financial institutions still managed to almost double the

efforts of Portugal and Italy though not Spain, then undergoing an exceptional banking

boom. On this showing, it seems clear that the former might fairly be termed early

financial sophisticates relative to the latter, particularly if we bear in mind that GDP per

capita levels were not so dissimilar.5

Neither the passage of time nor the long-term processof economic growth, eroded this advantage, rather the contrary happened. In terms of group

averages, the ratio between the per capita corporate financial liabilitites of the two regions

rose from 3 to 5:1 between 1860 and 1910. Relative to GDP instead of population, the

southern European countries fell back even further. In this case, the inter-regional gap

increased by 100 per cent.6 Within the two groups, per capita distances also changed

somewhat. Italy significantly outdistanced Spain and Portugal, while Denmark pulled away

from Sweden, and Norway converged on both of them.

As in the more industrialised nations, this period also witnessed a strong expansion of stock

markets in these six countries and therefore of new ways of mobilising financial resources

for productive investment. Even on the periphery of Europe, significant numbers of

corporate non-financial firms issued claims against themselves and placed them in the

hands of the public through these markets. In 1900, close to 200 such entities were active in

Denmark, of which one fifth were banks (Neymark, 1903: 190), while in Sweden, these

5 On this reading, it was Denmark that was the leading 'financial sophisticate', not Sweden, the classic pretender to the title (Sandberg, 1979; Fisher and Thurman, 1989).6 Calculations involving GDP per capita were made with data from Maddison (2001).

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sophisticated south, bonds and shares helped to mobilize a larger volume of financial

resources compared to the banking sector than happened in the north. Until the beginning

of the twentieth century, the financial liabilities registered on the stock exchange in Spain

and Portugal were almost equal to those of their financial corporations (table 1), while in

Italy they were half as large. In Scandinavia, these proportions lay between one seventh

and one half.

During this period, the single most important source of claims on the stock exchange, in

any European country, was the state, a player which tends to be forgotten in these

calculations. Table 3, which makes this abundantly clear, also shows the varying extent towhich, in different countries, public debt imstruments were sought after by savers in search

of financial applications. In contrast with table 2, the figures presented here are based not

on the face values of the bonds in question, but on their current market value. In the case of

Scandinavia, where these instruments were usually close to par, this matters little. The

same cannot be said, however, for Europes southern rim, where public bond prices were

normally subject to hefty discounts at issue, and fluctuated quite strongly thereafter,

reflecting lack of investor trust, even when they were denominated in gold and quoted

abroad. The result is a fairly strong downward revision of the Italian, Spanish and

Portuguese nominal data, throughout the period in the cases of Portugal and Spain, or

during its earlier decades in the case of Italy.


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One unexpected conclusion is that prior to 1880, despite their reputation for profligacy, the

public debt of the southern European countries did not absorb real resources to the same

extent as Denmark although it was clearly ahead of Norway and Sweden. After the 1870s,

however, the situation changed radically and the activity of the state as financial actor

became so intense in these countries that it managed to attract, via the market, a volume of

savings that was often two to three times greater than that captured by the corporate

financial sector. In Scandinavia, the opposite happened. After 1870, bank type institutions

gathered resources that were altogether several times greater than those the state managed

to place with the public.Table 4 puts together the information displayed in tables 1-3 and provides us with a

complete picture of the financial systems of our six countries as they evolved over time.

What emerges is that although the Scandinavian economies led the southern ones, they

were less the financial sophisticates that one might have thought judging simply from

corporate activity levels.10 Whilst the north/south ratio of table 1 steadily rose over the

second half of the 19th century and reached circa 5:1 by 1910, that of table 4 remained more

or less steady at a far lower level, around 2:1. Considering that the corresponding regional

GDP per capita ratios were never in excess of 1.5:1, this seems reasonable. A surprise

indeed would have been if we had had to conclude from the data that the Scandinavian

economies succeeded in mobilizing four or five times more financial resources and yet

only managed in the long run to grow a half percentage point a year faster.


10 This enables us to avoid Sandbergs (1978) exaggerated claim of Swedish superiority based only onlevels of bank activity and ignoring savings and other non-profit institutions, as well as the stock exchangeand the public debt.

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The contents of table 4 suggest three further remarks. The first concerns the vast

superiority of the state in southern European in raising funds through the market, which

compensated for much of the backwardness of the two other sectors and overall rendered

these countries less unsophisticated financially than if we had ignored this dimension.

This occurred because in Italy, Spain and Portugal the state provided investors with a

superior guarantee - the public revenue - and had no limits as to the price it was prepared to

offer not unusually 6 per cent or more. On the other hand, it confirms the presence of a

serious problem of crowding-out of the private sector by the public one in thesecountries.11 The second comment is the speculation that the southern European countries

private intermediaries could have done better had their respective public debts been a good

deal closer to the level of their northern counterparts. A simple counterfactual based on the

assumption that both banks and the state drew their funds from the same pool of savings

a view that some, e.g. Verdier (1997), would not accept suggests an interesting result. In

1910, if Spain had had a Scandinavian scale of public debt and channelled the resulting

surplus funds into its corporate financial sector, the latters liabilities would have been,

ceteris paribus, nearly three times larger than was the case. In Italy, they would have been

almost twice the actual size. Such was the price paid in terms of the underdevelopment of

corporate banking before World War I for the exceptional financial power of the state. The

third reflection has to do with the feedback mechanism that is usually assumed from the

growth of an economy to the expansion of its financial system. On the assumption that this

was part of a structural relationship, one might have expected the relatively slower growth

11 This view is widely accepted. See Comin (1988), for an example. For a discordant and thought provokinganalysis in the case of Portugal, however, see Esteves (2002).

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of per capita GDP in Italy, Spain and Portugal to be matched by a slower expansion of their

financial systems. Yet, table 4 shows the opposite. Over the long run, although they did not

converge, neither did fall back relative to the Scandinavians. Consequently, despite a weak

start on the financial league table, southern European financial growth exceeded what

might have been expected of countries where the economy that drove financial

development was advancing more slowly than in the north of Europe.

3. Recycling liabilities into credits

Knowing the size of a countrys financial system tells us about its capacity to marshalresources but is of little help in establishing its contribution to economic growth. A given

financial system might have been large in terms of its liabilities but could have given a

relatively weak impulse to growth, and conversely. This would depend largely, though not

exclusively, on what proportion of the funds gathered was made available, through these

intermediaries, to economic agents in the productive sectors of the economy for purposes

of capital formation and technological development.12 This varied considerably among the

constituent parts of each system, as well as, in each case, over space and time. One reason

is that apparently similar institutions can yield different economic outcomes depending on

the context in which they develop.13 In the second place, financial systems are rarely

structured in identical fashion. In some countries, savings institutions were more important

than in others, where commercial banks prevailed, while in still others it was the central

bank that wielded the greatest influence. Why this diversity occurred depended first and

foremost on their individual histories, but not only. They were also shaped by law and

12 This approach was first adopted in the literature on the contemporary situation by Beck et al. (2000).13 Fohlin (1999), p.142.

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politics, by the demand profile of credit users, by the underlying structure of the economy,

by culture and by the amount of human capital present in the society.

In each country, the proportion of financial liabilities that became credits depended

therefore on the structure of its financial system and on the efficiency with which its

various components recycled financial resources into credits and made these available. In

order not to overload the exercise, we shall confine our attention here to the situation in

1900 in the six countries under observation and will start with the corporate financial

segment. Sweden provides a good illustration of what can be encountered in the corporate

sector of Scandinavian countries. Among commercial joint stock banks, the ratio of credits(to the non-bank non-state sectors) to total assets was around 76 % (Statistik rsbog for

Sverige, 1900). The remaining assets were employed in cash reserves, foreign trade

operations, other assets, includingbricks and mortar, and bonds and shares, which are

excluded from this analysis to avoid double counting. The Riksbank, still a commercial-

cum-central bank, could only manage a value of 59 % for this ratio, mainly owing to the

higher reserves required by it note issue. On the other hand, mortgage banks supplied 92 %

of their liabilities in the form of loans while savings banks reached the 87 % mark. Such

high rates of transformation were possible because in the case of not-for-profit institutions,

cash reserves and fixed capital requirements were small while foreign operations were not

part of their core business. Investments in bonds and shares came to relatively little too.

In the south of Europe, the distribution of these ratios was similar but in each segment the

level of financial efficiency was lower. Commercial banks in Spain, for example, lent about

40 % of their assets to the non-state, non-bank sector (Tortella, 1974). In the case of the

Bank of Spain, this ratio was a mere 15% in 1900. This was an exceptional figure due to

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the Banks holding of an unusual amount of Public Debt associated with the Cuban war,

but in a normal year it lay between 20 and 25 %. Comprehensive data for savings banks

and some monographic information indicate that although reserves were small, most

available funds were invested in state bonds and railway shares and bonds. At the turn of

the century therefore ordinary loans absorbed no more than 30 per cent of total deposits.

(Nadal and Sudri, 1983; Martnez Soto, 2000). Finally, the mortgage sector supplied 59%

of its assets to the credit market.

Table 5 displays the considerable variety of situations to be found in the six economies

under consideration, in 1900, as regards the structure of their respective financial corporatesectors. In Spain and Portugal, joint stock commercial banks (including banks of issue) had

a crushing weight compared with the rest, while Sweden, though less pronounced, followed

in this group. In Italy and Norway, on the other hand, there was a better balance between

profit and not-for-profit institutions, whereas in Denmark the latter, more efficient

segment was heavily dominant. The figures in column 1 of table 6 are the result of

combining these shares with the corresponding sectors 'transformation ratio' and for the

benchmark year they give us the global 'transformation ratio' for each countrys corporate

sector. The point is that in the late 19th century Scandinavian corporate financial institutions

were not only far better at mobilising savings than their southern European counterparts, as

we saw in the preceding section. They also succeeded in converting these liabilities into a

relatively larger mass of credits to the productive part of the economy to use for investment

purposes.


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The above is only part of the efficiency story of intermediation in these six financial

systems, however. To be complete we still have to incorporate the contributions of their

remaining components, namely those created by the issue of credit instruments by the state

and by the non-bank corporations. Regarding the flow of funds originated by the latter and

for want of better information, it seems fair to assume a 1:1 correspondence between

credits supplied to borrowers and the liabilities issued on the stock market, although a

slight overestimation may be the result. The public debt is harder to handle given the

difficulty in establishing what part of the revenue from its placement was applied to productive investment. Certainly not all of it was dissipated in useless current expenditure,

as the concept of 'sterilisation', so frequently used in this context, insinuates (King and

Levine, 1993). A part was certainly used to create social overhead capital that would

enhance the economys output and raise total factor productivity, mainly through rail, road,

telegraph and port construction. Mata (1993: 273) has estimated that in Portugal, perhaps

an extreme case of deficit financing, between 1852 and 1914 some two thirds of the

resources raised in this way were absorbed by the repayment of pre-existing debt and the

financing of current debt. For Spain a comparable proportion is quoted (Comin, 1988: 637

and 652) and we have therefore extended this ratio to all three southern European

countries, since Vicarelli (1979:144-5) also suggests for Italy a similar situation. By

contrast, Scandinavian governments borrowed little to finance budget deficits since these

were small and infrequent. We have therefore assumed for all of them, conservatively, that

two thirds of these funds were directed towards productive investment.14

14 This is confirmed, for example, by Neymarcks (1903: 145) mention that a large part of Norways publicdebt was used for public works.

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Putting all this together brings to light (table 6, cols. 4 and 5) a dramatic contrast in the

efficiency with which Scandinavian and southern European systems performed their role as

financial intermediaries. The formers global capacity to recycle liabilities into credits was

twice as great. Combined with a greater aptitude to mobilize savings, this meant, in

absolute per capita terms, the ability to provide the non-state, non-bank sectors of their

respective economies with three times the financial resources. Relative to GDP thisadvantage was almost as substantial, since at this time the Scandinavian economies by this

yardstick were ahead by only one third.

There were two reasons for this stark difference in recycling capacity. To begin with,

whichever type of financial institution is considered, the Scandinavian ones were always

more effective. In the second place, in terms of the structure of the system, those of the

southern European countries were all biased towards the type of institution with the lower

transformation ratios. They had a greater weight of the public debt relative to corporate

finance and the stock exchange, and among corporate institutions, central banks were

dominant over the rest, while the highly productive non-profit sector was generally less

developed than the profit one.

By the turn of the century, the Scandinavian countries had thus become 'financial

sophisticates' but in a broader sense than has been argued to date. In a growth perspective,

no doubt it made some difference that they enjoyed a greater use of monetary instruments,

had a higher density of banking outlets and could muster a more substantial volume of

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deposits. What was decisive, however, was their enormously superior ability to inject

financial resources into the real economy and this is something that most of the literature

has missed. Thus, even without a rigorous estimation of the finance- growth relationship

for all six economies, it is hard to escape the conclusion that finance could not but have

played a significant role in the divergence of growth patterns that distinguished the two

peripheries during the 1850-1910 period. The issue this raises is why these two sets of

countries moved so far apart in their financial performance and to what extent this was the

result of exogenous forces? The second point is of particular interest because it raises the

counterfactual question: did these backward economies really have to be so? The followingsections attempts to address some of these problems.

4. Why Scandinavian financial systems mobilised savings better

Given its broad sweep, the discussion in the following two sections does not pretend to

exhaust the subject. Its aim is to identify the main inter-country differences that shaped the

long-term development of these six financial systems. In this section we look at two

aspects which appear to have been determinant. One is the volume of resources that were

available in these economies to be mobilised. The other is the propensity of savers to

acquire the liabilities issued by their national financial systems

The quantity of savings that an economy is able to accumulate is a function, among other

things, of its per capita income level and its growth rate (Loayza et al., 2000). Other things

being equal, better-off and more dynamic societies have not only a larger amount of

available resources out of which to save but also a higher propensity to do so. Throughout

these years, the Scandinavian countries would appear to have been at an advantage in both

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respects relative to southern Europe. Before we analyse this relationship, however, we must

deal with two potential distortions.

The first concerns the probability that not all the financial resources considered in the

preceding sections originated domestically. At a time of great international factor mobility,

a poorer economy might well have a weaker domestic supply of savings to fuel its financial

development, but be able to compensate this by attracting foreign-owned capital. On the

other hand, more developed financial systems might reinforce their advantage by drawing

in, additionally, large amounts of funds from abroad. Table 7 shows that at the end of our

perio such net inflows were indeed contributing significantly to the growth of all financialsystems but far more in the Scandinavian case. The latters superiority in attracting

domestic resources was thus matched by a similar strength in the international sphere, a

fact that has been noted before (Rousseau and Sylla, 2001). On the other hand, this did not

alter much our previous ranking of these countries and still leaves to be explained the

considerable gap between the two groups of countries in terms of financial liabilities per

capita.


A second potential source of distortion was the effect of hoarding on financial activity.

Given the alleged inclination of southern Europeans towards this form of storing wealth, as

might befit traditional peasant societies, it seems fair to ask how much of the regions

weaker institutional savings performance was due to this. For the sake of argument, we

suppose that Scandinavian countries were too advanced, socially and culturally, to engage

in such practices. We further assume that in southern Europe this concealed wealth would

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Three features of any financial system are bound to affect the inclination of savers to enter

into lasting relationships with its institutions and markets and, in particular, to entrust them

with funds. One is accessibility to users, another is suitability to their specific needs, a third

is trust. In what follows we shall concentrate exclusively on the corporate financial sector

because, in contrast, differences among countries in the development of their respective

stock markets appear relatively minor. In the Scandinavian countries, the volume of private

securities was considerably greater than that of state bonds, whereas in Spain, Portugal and

Italy the opposite prevailed. Yet when we put all of these financial instruments together,

the aggregate volume per capita is relatively uniform throughout the sample. Moreover, theinformation regarding national stock markets suggests that inter-country regulatory

divergences were not substantial at this time and where they existed, this would not have

made much difference to global outcomes (Fohlin, 2002).16

Recent research on the post 1960 period has argued that 'cross country differences in legal

and accounting systems help account for differences in financial development' (Levine et

al, 2000: 31) and similar claims have been made in a far broader historical perspective

(Sandberg, 1978; Sylla, Tilly and Tortella, 1999). An overview of the legislation governing

corporate financial activity does not suggest, however, that this was a major cause of the

divergence we have been examining here. This is not to say that there was absolute

regulatory uniformity within the sample or that the legal framework had no impact on other

aspects of the financial history of these countries. Rather, there could and was an influence

but the effect was not necessarily important in the present context. The Norwegian-

Swedish comparison illustrates this. Regulation restricted the lending policies of savings

16 For Portugal see Justino (1994); for Italy, see Curioni (1995); for Sweden, see Waldenstrom (2002); for Spain, see Hoyo Aparicio (2001) and Castaeda (2001).

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banks in the latter country while it was quite liberal in the former. As a result, the

Norwegian savings sector flourished and even took on the functions of commercial banks.

In Sweden, on the other hand, it did only half as well and was overshadowed by the

commercial sector, which in Norway was comparatively weak (Egge, 1983; Nordvik,

1993). Globally, however, the two countries achieved very similar results in terms of the

assets gathered by the financial corporate sector as a whole, only through different

structures.

There are three ways in which the time-path of regulation could have influenced the

evolution of commercial banking, yet in all of them a surprising degree of internationaluniformity is encountered. Barriers to entry is one of them. After a highly restrictive first

half of the nineteenth century, which was dominated by specially chartered national

privileged banks of issue created to deal with pressing monetary and fiscal problems, in the

1850s and 1860s it became relatively easy to found joint stock commercial banks with

limited liability. This new ease of incorporation opened the system to competition, vastly

increased the number of institutions and allowed them the freedom to open branches, which

in some countries proliferated and in others not. The second area is that of the limits placed

on the scope and type of business banks might undertake. Typically, rules defining lending

policies were few and on the whole were quite liberal. In some cases, banks were simply

governed by the general law on joint stock companies, while in others they were placed

under a specific banking code (Grossman, 2001). Towards the end of the 19th century,

however, and as a consequence of various crises, regulation was tightened in some

countries, but it is unclear whether this entailed much change. The evidence is that the

enforcement of bank legislation was on the whole lenient, in the spirit of Liberalism, and

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the institutions dealt with were often allowed to evade it when this was found expedient

(Fritz, 1988). The ease with which Norwegian banks overcame the strictures of usury laws

is an eloquent illustration of this (Knutsen, 2003).17 Finally, a fully centralised note issuing

regime does not appear to have produced results that were inferior, in terms of financial

development, to those where multiple issue was in place. Despite the contemporary belief

that commercial banks that had a right of issue enjoyed a business advantage over deposit

banks, one finds instances of both regimes both in Scandinavia and southern Europe with

no obvious impact on global financial performance.18

Mortgage banking based on the issue of bonds, which was for profit in some countries, butnot in others, displayed the most significant degree of regulatory variety. In Spain and

Portugal, national monopolies were established from the start, while Italy experimented

with regional ones and went over to a national one in 1890. They therefore tended all

towards large loans and large denomination bonds. In Scandinavia, Sweden and Denmark

were very liberal on this score, but Norway had a state mortgage bank. Table 5 reveals that

in the long run, however, this mattered less to the respective shares of this sector than

might be expected. In Denmark, mortgage bonds were very important but Sweden was on

the level of the monopolistic countries, while Spain, with a similar set of rules, did frankly

worse than all others, including Portugal,.

When it comes to non-commercial, small scale, local and often cooperative banking, it is

essential to remember first that this was a era in which two quite different types of saver

supplied the resources of financial institutions and arguably constituted quite separate

17 For another Scandinavian example of how legislation in this case, prohibiting the ownership of realestate or shares -could easily be circumvented, see Lindgren and Sjgren (2002).18 Italy still had multiple issue in 1914, though very restricted after 1893. Portugal went over to a monopolyin 1891, while Sweden only abandoned the multiple issue of the Enskilda banks in 1897. Norway, Denmark and Spain, after 1874, had a fully centralised regime.

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segments of the market (Verdier, 1996)19. The well-to-do deposited with or bought the

shares of commercial banks, while middle and low income people prefered to entrust their

savings to local savings banks, credit co-operatives and the like (Vittas, 1997). This being

so, in societies where both kinds of institution had a significant presence, as happened in

Scandinavia, the financial system was likely to collect a larger portion of savings. In Spain

and Portugal, the weakness of the savings sector was such that it meant that a majority of

the population in effect had little access to the system as a whole. Consequently, the

volume of savings per capita gathered was smaller. Italy was able to do better than the

Iberian peninsula because of a considerable and varied movement of thrift organisations prevalently in the northern half of the country that tapped, the savings of the humble and

middle class people, whether rural or urban.

It is far from evident, however, that national dissimilarities in legislative framework were

responsible for this kind of institution to evolve to such contrasting extents. In all countries

considered, thrift institutions were supported by local or national authorities in a variety of

ways, with deposit guarantees and, perhaps most important of all, with tax exemptions.

Arguably though, on the assumption that there was market segmentation, this would hardly

have diverted funds from the commercial joint stock sector, which was the principal

alternative. Until the 1880s, the general norm was absence of legislation, complete ease of

entry, an enormous multiplicity of statutory arrangements and only slight restriction on the

uses to which savings could be applied. Full and proper regulation had to await the 1880s -

1875 in Sweden - but, in the event, was of a very mild nature.20 Supervision, accounting

19 This is confirmed by Titos (1992: 168), for the case of Spain. In Madrid, in 1900, 60% of depositors inthe local savings bank were socially inferior, i.e. minors, widows, house servants, workmen, artisans andwomen generally.20 Guinnane and Henriksen (1998: 52), for example, describe the Danish law of 1880as remarkably lowkey and as effecting few meaningful changes.

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rules and some operating limits were introduced, against the solid resistance of the thrift

institutions themselves, but by most accounts this barely influenced the sectors level of

activity (Brck et al., 1995; Hansen, 2001).

One of the principal aims of regulation was to stimulate trust in the system by deterring

irregularities and imposing transparency on its operations. As we have just seen,

Scandinavia's superiority in mobilising resources does not seem to have owed much to a

better set of rules and regulations. From the public's point of view, a more reassuring

indicator of trustworthiness was how a system performed, not its rules, and here stability of

markets and institutions was doubtless the factor that would affect the inflow of savings.Whilst all countries were prone to turbulence and its savers and investors suffered losses as

a result, between 1860 and the First World War, the southern European record seems to

have been by far theworst. One instructive sign of this is the mortality of commercial

banks. Complete data are only available for Spain, Italy and Denmark but are highly

revealing. In Spain, aside from the earlier devastation wrought by the crisis of 1864-6, of

the 117 banks founded after 1874, only 60 were still open in 1914 (Tortella, 1974). The

losses to Italian commercial banking during three critical periods were similarly

substantial: 42 out of the 143 in existence, in 1873-9; 21 out of the 161, in 1888-93; and 11

out of the 163, in 1902-4 (Mattia, 1967). In Denmark, of the 160 banks created between

1845 and 1914, only 20 failed. A second measure is the variance around the trend of a

global systemic indicator such as total assets. Available information covers only the same

three countries but the result, now comprehending all types of banks, fully confirms the

earlier finding.21 The stability of the Danish financial system was significantly greater than21 For this comparison, we applied the Hoderick-Prescott filter to the log of the series and calculated thestandard deviation of the differences between the original and the filtered series. The results are 0.024 for Denmark, 0.032 for Italy and 0.495 for Spain. National banks of issue are excluded from these globalassets as it is assumed that their survival was not in question.

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that of the Italian one, with the Spanish one a long way behind. If a stable financial

environment meant anything to savers, then Scandinavia appears to have enjoyed a

considerable from this point of view.

Several factors can explain this contrast but two especially should command our attention.

One is structure, the other is policy. As regards the first, Scandinavian economies enjoyed

the benefit - which, in southern Europe, Italy had over Portugal and Spain of a relatively

larger not-for-profit financial sector, which was less crisis prone than commercial banks.22

This was due to several characteristics inherent in such institutions. They had better and

cheaper information on the risks posed by clients, lower costs of administration and greater ease in enforcing repayments. Moreover they were less likely to suffer runs by depositors,

who knew them well. In addition, they often enjoyed some form of group deposit-

insurance, and normally enjoyed deposit guarantees from governments, local authorities or

simply groups of local notables. Lastly, because unlike commercial banks they were not

under pressure from shareholders to produce high dividends, they did not have to lend to

projects with higher returns but also higher risks. Their image of conservatism more often

than not was matched by reality even though they had to contend with the instability that is

usually associated with a small scale.23

Given how frequent and severe national bouts of financial instability could be, one has to

ask whether domestic counter cyclical policies might not have influenced the attractiveness

of these financial systems. As regards government intervention, the low priority given at

the time to such policies rules out a significant role for this factor. On the other hand,

national banks of issue were just beginning to play the part, informally, of money market22 Vittas (1997: 159) gives the example of Germany, where between 1895 and 1910 commercial banks were33 times more likely to fail than rural credit cooperatives. See also Polsi (1996) and Titos (1992).23 Mller and Topp (2002) show that because of a much riskier portfolio, commercial banks spread wasseveral times that of credit associations which tended to lend more safely.

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regulators, something that would only be enshrined in their charters after the First World

War. The timing of their assumption of lender of last resort status matches poorly the way

in which these economies responded to financial shocks. In Denmark and Sweden, two

highly stable systems, came to this early, between the 1860s and the 1870s, but so did in

Portugal and Italy - the Banca Nazionale, the Bank of Italys predecessor was already

behaving as a bankers bank in the 1860s (Hansen, 1991; Lindgren and Sjgren, 2002;

Reis, 1999; Polsi, 1996). On the other hand, Norway and Spain were both latecomers to

this field, respectively in the late 1890s and just before the War and yet were at opposite

ends of the league table for financial stability (Egge, 1983; Tortella, 1974).24

While proto-central banking may not have been a major determinant of the closeness

between savers and financial institutions, accessibility clearly was. The ease with which

economic agents could approach the system mattered a great deal in establishing a

relationship with it. One dimension was physical - location, distance, ease of travel and

this was an important reason for the success of the Danish parish savings banks

(Guinnane and Henriksen, 1998). Another was the suitability for those involved of the

institutions available to them. Savers would more readily supply an institution with funds

if, other things being equal, they felt welcome, understood the procedures, knew the people

they had to deal with and could easily satisfy burocratic requirements, e.g. minimum size

of deposit. In other words, not all institutions and markets served equally well for everyone

and this must have had an impact on the propensity to accept the liabilities offered by the

system.

24 This chronology of the emergence of lender of last resort roles differs from those proposed by Capie etal. (1994:6) and Verdier (2003:36).

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As Table 8 shows, a considerable disparity existed during these years in the supply of

outlets that each system offered. This is one more aspect of the enormous distance that

separated our two groups of countries, in this case the number of inhabitants per financial

outlet, and also brings to light a ranking that matches exactly the ranking presented in table

1. In particular, Italy, which had a density five to eight times that of Portugal and Spain but

was five times below the levels of Denmark, Norway or Sweden, had the financial system

that managed to attract the greatest volume of savings of southern Europe. Besides the

number, the spatial distribution of these outlets also seems relevant. In Spain and Portugal,

financial institutions were an urban phenomenon and were concentrated in the major centres. In Scandinavia, the opposite was the case. A large proportion of financial outlets

was in small towns and hamlets. They were therefore close to country people, who were

the majority of the countrys population. Thrift institutions were local organizations,

formed and run by local people to further what they saw as local goals (Guinnane and

Henriksen, 1998: 52).

.


Altogether then, perhaps the most important factor in explaining differences in financial

development lay in each societys propensity to accept non-commercial banking in its

midst. Scandinavias greater overall capacity to mobilise funds mainly derived from the

strength of its thrift sector in all its forms, and this arose because so many people there

were prepared to join these movements. Since this cannot be ascribed to major income

dissimilarities, nor to diversity in regulation, nor even to the rise of central banking, only

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two explanations seem to remain available. Verdiers (1996) standpoint is that it was

political struggles that lay at the heart of the matter. In Denmark, Sweden and Norway,

centrifugal political forces were important and prevented the states wish to centralize

banking, thereby absorbing the resources of the periphery in order to finance central public

expenditure. As a result decentralized thrift banking flourished. In the south of Europe, the

opposite happened and consequently non-profit banking was suffocated by the pressure

from a centralizing state intent on draining the financial resources of the periphery.

There are two objections to this. The first is that what the state wanted these resources for

was to finance the public debt, not central public expenditure, and here the contrast between the two regions could not have been greater. As we saw earlier, southern European

countries were indeed voracious consumers in this respect. Secondly, we must also not

ignore that in these countries finance for the public debt typically does not seem to have

come from their peripheries, nor from provincial banks. Rather, it tended to be held

personally and was accumulated at the centre, where saving propensities were apparently

higher. This would explain why provincial commercial banking was able to expand in

Portugal, Spain and Italy during this period, in spite of their huge public debt commitments

(Reis, 2003).

Perhaps a more fruitful enquiry should ask why, in the latter countries, except for a small

group of wealthy and educated citizens, most of the provincial population appeared remote

from institutional saving. For this we have to try and understand the roots of the stronger

impulses in Denmark, Norway and Sweden to create small thrift organisations in terms of

the stronger presence of certain social and cultural conditions in these countries (Guinnane,

1994; Galassi, 2000). A basic ingredient was trust, a form of social capital that involved a

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readiness to accept peer control and to enter into common ventures with other economic

agents beyond ones immediate social circle, which required that direct monitoring and

control was left to others. Societies, like in Scandinavia, founded on a prosperous middle

sized peasantry, that experienced successful agrarian reform at the end of the Ancien

Regime, and where a more even distribution of income was present, seem to have provided

an environment in which such attitudes could flourish. In contrast, apparently this was not

the situation in Portugal and Spain, or Italy 's south. In Italy, where in some regions only

limited liability credit cooperatives (banche popolare) were common, by the 1880s clearly

those in the south had much greater difficulty in attracting members and their deposits. Asa result, they relied much more on share capital and rediscounts at large banks, and tended

therefore to have to hide defaults in their accounts. This in turn exacerbated the problem of

trust between members and management, the latter usually from a higher social stratum,

and fostered a low-trust equilibrium (A'hearn, 2000).

A second element in this approach emerges from the analysis of the early development of

modern financial intermediaries, which appeared in Scandinavia already in the first half of

the nineteenth century and which very much depended on the degree of human capital

endowment present. Nilsson, Pettersen and Svensson (1999) have shown how literacy in

the Swedish countryside before 1850 was associated with the rise in the use of

sophisticated credit instruments and probably created a fertile seed-bed for the activity of

localised credit institutions. Again, southern Europe was woefully behind in this field, with

rates of illiteracy that were still 50 per cent or more in 1900 compared to negligible figures

in their northern counterparts. A greater readiness on the part of Danes, Norwegians and

Swedes to accept contract money, particularly in small denominations, may be another

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expression of this cultural dimension.25 Finally, one should not neglect the influence of the

strength of local sentiment in this matter. Its importance has been remarked upon a propos

of Denmark (Hansen, 1982), as it has in the case of Italy, the only southern economy where

local thrift organizations developed to a significant degree (Polsi, 1996).

5. Why Scandinavian systems recycled liabilities better

In comparing national differences in financial intermediation, the second major question of

this paper has to do with the efficiency with which the funds gathered by each system were

transformed into credits to the private sector. From this point of view, three circumstanceshelp us understand the efficiency loss of about one half the measures the distance in this

respect between the two groups of countries. Possibly the most important one was the more

or less chronic difficulty associated with public finance in southern Europe, in contrast to

its generally healthy condition in Scandinavia. For the former, this meant a crushing weight

of Public Debt holdings and a scant application of these resources to growth inducing

purposes. For the second group, not only was this burden far lighter but the resources thus

absorbed were also used more effectively for investment. A further implication, of a more

structural nature, was that the problem of an oversized public debt stimulated the

emergence in Italy, Spain and Portugal of oversized national banks of issue, which

dominated their respective commercial banking sectors, as we saw in section 3, and were

the least efficient of all corporate institutions at recycling funds into credits.

Why Italy, Spain and Portugal should have been consistently unable to break the grip of

budget deficits and of a pyramiding Public Debt is an issue which plunges its roots deeply25 What is relevant here is its voluntary acceptance, in contrast to the obligation in Spain and Italy, for mostof the period, to use bank notes owing to the imposition of inconvertibility. Portugals inconvertibility,declared in 1891, clearly reveals this problem. Before that date, notes were convertible but little used.After, they became universal but then there was no choice.

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possible for the Scnadinavian ones to immobilise smaller proportions of total assets as

reserves, or to avoid tying up resources in safe state bonds. The goals and the quality of

management is the second circumstnace to account for differences in the proportion of idle

assets in the portfolios of corporate financial institutions. Possibly, southern European

managers were simply reacting reasonably to a riskier investment climate by allocating

funds with greater prudence and conservatism than Scandinavian ones needed to. On the

other hand, it has been hypothesized (Berthelemy and Varoudakis, 1996: 301) that the

technical efficiency of the financial sector is an increasing function of the collected volume

of savings [and] that learning-by-doing effects also exist in intermediation activities. Poor management has been claimed for both Portugal and Spain (Reis, n.d.; Sudri, 1994)

though comparisons with Scandinavia have yet to be carried out and the case therefore

remains open. As regards Portugal in particular, it has been shown, following Hinderlitter

and Rockoff (19..), that, after taking risk differences into account, the share of unused

funds in the balance sheet of commercial banks was greater than could be justified by

reference to practices in contemporary major financial centres. Finally, the high returns on

government issued liabilities in southern European caused resources to be diverted away

from private credit operations in contrast to Scandinavia where the yield of such holdings

was comparatively less attractive and better alternative investment opportunities seem to

have been more numerous.

6. Conclusion

During the course of the 'long second half of the 19th century', the southern and the northern

peripheries of Europe followed contrasting paths of financial development. This led to

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from the Stockholm stock exchange, Explorations in Economic History,39, pp. 1907-1939.Zamagni, V. (1993) The Economic History of Italy, 1860-1990. Oxford: Clarendon Press.

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Statistical sources

Annaes de Estatistica. Vol.I. Serie I Finanas. N.1 Estatistica Bancaria (1858-1892)(Lisboa, Imprensa Nacional, 1894).

Anuario Estatistico de Portugal (several years).

Anurio Financiero y de Sociedades Anonimas de Espaa (Madrid, Sopec, 1916).

Pierluigi Ciocca and A.M. Biscaini Cotula (1994), Italian Financial Structures: Long-TermQuantitative Aspects (1870-1970) in Giovanni Federico (ed.), The EconomicDevelopment of Italy since 1870 (Aldershot: Edward Elgar).

Boletin de Cotizacion Oficial de la Bolsa de Comercio de Madrid (several years)

Historisk Statistik fr Sverige (1960) (Stockholm: Statistika Centralbyrn).

Norge. Statistik Sentralbyra, Historisk Statistik: 1968 (Oslo, Statistik Sentralbyra, 1969).

Statistik rsbok for Sverige Forsta Argangen 1914 Utgiven av Kungl. StatistikaCentralbyran (Stockholm, Norstedt och Soner, 1914)

Statistical Appendix

Table 1

Data onDenmark is entirely taken from Johansen (1985). Data onSpain is from Tortella(1974), vol. 2 and Martn Acea and Titos Martinez (1999), except for the figures for 1860

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and 1870, which are actually for 1864 and 1873, respectively and are taken from Tortella(1982). For Italy, de Mattia (1967) is used, not including data from the Cassa de depositi e prestiti. Data onNorway comes from the Norwegian Statistical Yearbooks and Historisk Statistikk: 1968 (1969). Data onSweden is from Sandberg (1978), including the Riksbank,enskilda banks, filial banks and joint stock banks, and from Historisk Statistik fr Sverige

(1960), for the remaining institutions. Data onPortugal is from Anurio Estatstico(several years) and from Annaes de Estatistica (1894). Since full information on theliabilities of Portuguese financial institutions is not available, they are approximated with avariable obtained by adding notes in circulation,capital and deposits. These three itemstogether represent most of these liabilities but an underestimation is unavoidable.

Table 2

Spains figures for 1860 and 1870 are from Tortella (1982) and includes industry andrailways. The figures for shares are an average of 1859 and 1861. For railway bonds they

are for 1861 and bonds are valued at 50%, in accordance with Tortella (1982: 172). Thefigure for 1870 corresponds in fact to 1866 and is therefore the peak of a speculative boom.For 1900, the source is Neymarck (1905). For 1910, it is a combination of the 1916 sharecapitalization taken from the Anurio Financiero y de Sociedades Anonimas de Espaa(1916); and the bond totals in the Boletin de Cotizacion Oficial (1913)Portugal is fromDiario do Governo, with gaps filled in by some major company annual reports.Norwegiandata is from Knutsen (2003: 28). For Sweden, data is provided by Waldenstrom and comesfrom the Svenska Aktie-bolag series.Denmark is taken from Neymarck (1903), except for 1910 (1914).Italy is taken from Ciocca and Biscaini Cotula (1994) for the years 1860,1880 and 1910. The remaining benchmarks are from Polsi (1996).

Table 3

The market price of State public debt instruments in the Scandinavian countries can bederived from information in Homer and Sylla (1996). Total nominal amounts are found inHistorisk Statistik:1968 (1969) for Norway , in Swedish Statistical Yearbook (1914) for Sweden , and in Johansen (1985), for Denmark . Both amounts and prices for Spain comefrom Carreras (1989), for Italy, from Zamagni (1993). For Portugal , the amounts are inMata (1993) and the prices are in Esteves (2002).

Table 4

Compiles all data from tables 1-3.

Table 5

Same as for table 1.

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Table 6

Same as for table 1 and text, complemented by the following sources. For Denmark ,Hansen (1982). For Sweden , Nygren (1982). For Norway , Egge (1983). For Spain , thecontribution of stocks and bonds is based on their 1910 total as that for 1900 is missing.

Some data for Portugal comes from Lains (2002).Table 7

Col. 1 is from table 4. For col. 2 the following sources were used.Sweden - according toSandberg (1978), p.655, between 1860 and 1914, over 80% of the Public Debt was heldabroad and in 1908 it was 89.2%, ie 9.7.per capita. Local govt and mortgage bonds were55% in hands of foreigners. Other bonds were held 13% by foreigners. Not countingmunicipal bonds, this comes to 14.9 in 1910. Schn (1989)s figure of 28.2 is derivedfrom cumulative balance of payments evidence, and is the one used here.Spain s figure isgiven by Broder (1976: 62) and represents the aggregate of public and private capital that

entered the country during the years 1851-1913, not including the Floating Debt of theState. It is an overestimate since it does not take withdrawasl into account. There are twosources for Denmark . We have prefered Johansen (1991) to Hansen (1970) as being morerecent and reliable. It is based on the balance of payments deficits during 1870-1910 andtherefore goes beyond just bonds and shares.Norway s data is taken from Knutsen (2002)for shares and from Historisk Statistik: 1968 (1969) for bonds.Italy is derived fromZamagni (1993: 128 and 177). For Portugal , the share of the Public Debt in the hands of foreigners is from Mata, (1993: 259) rather than Esteves (2002: 90), which is inferred onthe basis of a less convincing argument. The percentage of foreign held shares and bonds isestimated only for the major companies, which are presumed to have a large particpation of this type. The corporate financial sector is assumed to be held practically all by nationals.

Table 8

Financial Institutions and Economic Growth in the

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