------------ 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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