------------ EH.NET BOOK REVIEW --------------
Published by EH.NET (July 2008)

Stephen Haber, Douglass C. North, and Barry R. Weingast, editors, 
_Political Institutions and Financial Development_. Stanford, CA: 
Stanford University Press, 2007. xii + 304 pp. $30 (paperback), ISBN: 
978-0-8047-5693-8.

Reviewed for EH.NET by Claudia Rei, Department of Economics, 
Vanderbilt University.


Much has been written about institutions and their impact on 
countries' economic performance, to the point that some institutions 
are labeled good and others bad for economic development. Much, 
however, is still unclear. What institutions? What mechanisms? What 
channels? The existence of correlations between certain institutional 
arrangements and economic growth has been well demonstrated, but the 
economic incentives that bring about institutions and the historical 
context in which they are constructed have been somewhat neglected. 
_Political Institutions and Financial Development_ tackles the second 
of these issues, taking into account the impact of the political 
history of several countries on their early financial institutions, 
which are correlated with subsequent economic growth. The book 
consists of essays organized in four parts: 1) an introduction of the 
theme by the editors; 2) three historical studies exploring the 
evolution of political institutions and banking systems in the U.S. 
and Mexico; 3) three empirical studies on the interactions between 
governments and financial-banking institutions beyond the U.S. and 
Mexico; and 4) two case studies on Brazil.

In Chapter 1, the editors start by stating the undeniable importance 
of a country's financial development on its level of economic growth, 
and also the lack of consensus about causes for the observed variance 
of financial systems across countries. The legal origins view argues 
that a country's financial development is largely determined by the 
country's colonial heritage, whereas the political institutions view 
suggests that laws and regulations resulting from political 
institutions are a far more relevant determinant. The remaining 
chapters side with the political institutions view and further 
investigate which political institutions matter and how they matter.

In Chapter 2, Stephen Haber points at the government's role in 
overcoming market failures in the banking sector, but notes that the 
government is subject to conflicting interests which can often lead 
to less than first best outcomes. Haber argues that political 
institutions that check and limit government have a positive impact 
in the development of the banking system. The author proceeds with a 
theoretical framework and case studies in order to explain the 
divergent performances of Mexico and the U.S.

Chapter 3 focuses on the early political features of the U.S. Richard 
Sylla provides an analytical narrative of the historical events that 
led to the foundation of the U.S. financial system shortly after 
independence, not forgetting the political context in which the 
events took place. The subsequent emergence, development and 
expansion of corporations formed a distinctive feature of the U.S. 
financial development with an extraordinary ability to generate 
wealth. Sylla concludes that even though limited government seems to 
have facilitated a more effective financial system in the U.S., the 
counter examples of Canada and Mexico show that this is by no means a 
sufficient condition for financial development.

In Chapter 4, John Wallis brings forth historical facts of early 
American banking to show divergent institutional paths in the 
northern and southern U.S. Wallis argues that the non-uniform 
institutional pattern within the U.S. raises concerns about the 
importance of legal origins on financial development.

In Chapter 5, Philip Keefer uses regression analysis to show that 
political checks and balances, incentives to provide public goods and 
security of property rights determine financial sector development, 
even after controlling for legal origin. Keefer uses objective 
measures of political institutions to account for the degree of 
government capture, which render legal origin insignificant.

In Chapter 6, Barth, Caprio, and Levine focus on the impacts of 
different approaches to banking supervision on banking efficiency and 
corruption. Using cross-country data on efficiency and supervision 
measures, and controlling for country-specific factors, the authors 
find that powerful supervisory agencies aimed at market failure 
amelioration are associated with increasing bank corruption and 
decreasing efficiency.

Chapter 7 analyzes the effects of minority shareholder protection by 
the government on corporate governance. Using a sample of thirty-nine 
countries of different legal families, Gourevitch and Shinn find that 
high minority shareholder protection and strong neo-liberal economic 
policy are more likely to create shareholder diffusion. The legal 
origin variable is found to exhibit much variation with respect to 
the conditions in the importing country, that is, the former colony.

Chapters 8 and 9 consist of two case studies centered on Brazil, an 
emerging country of civil law origin with a surprisingly developed 
financial system in the nineteenth century. In Chapter 8, William 
Summerhill analyzes the role of institutions in establishing state 
credibility. Summerhill studies the evolution of Brazil's credit risk 
from 1825 to 1890 and finds several structural breaks consistent with 
the country's political history. In Chapter 9, Aldo Musacchio takes 
into account the political economy of Brazil in the late nineteenth 
and early twentieth centuries in order to convincingly document the 
country's institutional path. By analyzing Brazil's corporate bond 
markets, Musacchio concludes that the factors at play in the 
Brazilian financial system go far beyond the inherited legal family.

Reading _Political Institutions and Financial Development_ one can 
learn about the political histories behind the foundation of 
financial institutions -- especially in the U.S., Mexico and Brazil 
-- and the expected correlations regarding economic growth. Do not 
expect a unified theory on how political choices may affect financial 
systems, or on how financial systems impact economic development. The 
channels at work in the U.S. do not seem to be at play in Brazil, and 
even within the U.S. there is considerable variation. The importance 
of country/region specific historical paths is reinforced, and the 
degree of government capture is suggested to be of major importance 
in explaining the divergence between good financial systems that 
enhance economic growth and deficient financial systems that impair 
economic performance.


Claudia Rei recently completed her Ph.D. at Boston University and 
will be joining the economics department at Vanderbilt University as 
an assistant professor in the fall. Her work focuses on the 
incentives behind the organization of fifteenth to seventeenth 
century merchant empires and the impacts on their long run economic 
performance.

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Published by EH.Net (July 2008). All EH.Net reviews are archived at 
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