Capital Mobilityand the Origins of Stock Markets Daniel Verdier

Politicalinstitutions play a rolein shapingfactor mobility across sectors, space, and borders.I providean illustration of this accepted, though hardly researched, idea by lookingat the emergence of moderncapital markets in thenineteenth century. The riseof corporateŽ nancethreatened to redeploy Ž nancialresources away from land andtraditional sectors to heavy industry. I arguethat mobilized and integrated markets ourishedin the absence of blocking coalitions that had an interest in keepingŽ nancelocal. I argueand show that the power of blocking coalitions was areversefunction of the degree of centralization of state institutions. I startby providinga conceptualinterface between the abstract notion of capitalused in trade modelsand the diversity of its actual occurrences as cash, debt, equity, buildings, patent,machinery, and so forth.

UnansweredQuestions

Thecurrent notion of capital mobility— as conceived by (and used in) the asset speciŽcity literature— isuncertain. Building on the work of WolfgangStolper and PaulSamuelson, the asset speciŽ city literature shows that capital mobility— how capital owsacross sectors of production— has redistributional effects. 1 For in- stance,given two factors, labor and capital, and two sectors using both factors in differentproportions, factor mobility homogenizes factor prices— wages and return tocapital— across sectors. A corollaryis thata changein product prices redistributes incomeacross factors. In contrast, if factors are unable to switch employment across

IthankFiona McGillivray, Jeannette Money,the editors of IO, andthree anonymousreviewers for bullishand valuable suggestions. The research onwhich this article is basedwas Žnancedby the Research Councilof the European University Institute. 1.Stolper and Samuelson 1941. Works representative of the asset speciŽcity literature include Rogowski1989; Frieden 1991; and Alt et al.1999. For a broaderreview ofthe literature, see Altand Gilligan1994; and Alt et al.1996.

InternationalOrganization 55,2, Spring 2001, pp. 327– 356 © 2001by TheIO Foundationand the Massachusetts Instituteof Technology 328 InternationalOrganization sectors,that is, if factors are (sector-)speciŽ c, thenfactor prices vary across sectors, anda changein product prices redistributes income across sectors. Therefore, lobbyingfor rentsproceeds along sectoral lines with factor speciŽ city and along factorlines— or not at all in light of the collective action dilemma faced by large groups—with factor mobility. 2 Furthermore,building on insightsfrom theindustrial organizationliterature, political economists identify sources of factorspeciŽ city in barriersto entry, such as sunk investment costs, R&D intensity,learning by doing, brandname, patent, and so forth. 3 Ina studyof NorwegianŽ rms, JamesE. Altet al.argue that Ž rms withlarge R&D expenditurescreate speciŽ c assetsfor the productionof productswith no close substitutes and difŽ cult to dispose of incase thereis no demandfor theproduct. As aresult,Alt et al. argue, R&D-intensive Ž rms havea clearpropensity to lobby for subsidiesor market protection. 4 Theasset speciŽ city literature rests on a notionof capital that is made up of dissimilarelements. Capital comes in two ways: (1) productioncapital, which includesmachinery, stocks, the buildings that house them, and intangibles like patents;and (2) Žnancialcapital, referring to all Ž nancialassets, long and short term. Theasset speciŽ city literature does not deal with the dichotomy well: either it shuns Žnancialcapital to concentrate its attention on production capital exclusively, 5 or, alternatively,it treats production and Ž nancialcapital as separate factors of produc- tion,with the latter systematically more mobile than the former. 6 ThisclassiŽ cation of capital into its primary elements can only be apreliminary stepin the study of capital mobility. The next step is to recombine their interac- tions—how the mobility of each element impacts that of theothers. Production and Žnancialcapital are not two separate factors but represent the two sides of the balancesheet of a typicalnonŽ nancial Ž rm, withproduction capital on the assets side(buildings, machinery, and stocks) and Ž nancialcapital on the liability side (equityand debt). Capital mobility is that of the side that is more mobile. Whichside is moremobile depends on whetheror notthere is aŽnancialmarket. Absenta Žnancialmarket, investors and creditors have concentrated stakes in few Žrms andeven fewer sectors;they cannot easily exit a money-losinginvestment in speciŽc (lowliquidation value) assets, nor enter a proŽtable one, making lobbying for theregulatory protection of thatinvestment a plausibleoption. In contrast, in the presenceof a Žnancialmarket, investors and creditors each own a diversiŽed portfolioof corresponding instruments. 7 Littlelobbying is likely to come out of a

2.See Magee 1978;and Irwin 1995. 3.See Frieden1991; and Alt et al.1999. 4.Alt et al.1999, 109. 5.See, forinstance, Frieden and Rogowski 1996, 27. 6.For instance, Frieden writes: “itis consonant with the speciŽ c-factors approachto assume that. .. Žnancialcapital is mobileamong industries, while physical capital is industry-speciŽc.” Frieden 1991, 438.Frieden further separates Žnancialcapital intobonds and debt, said to be mobileacross countries, andstocks, less so(429). The global Ž nance literatureechoes theidea thatŽ nancialcapital, since the repeal ofcapital controlsin the 1970s, is mobile across nationalborders. For a survey,see Cohen1996. 7.The argument was Žrst made bySchonhardt-Bailey 1991; and Schonhardt-Bailey and Bailey 1995. Theyargue that Ž nancialcapital can effortlesslycross sectoral boundariesonly in the presence ofa well-functioningcorporate securities market. Absentsuch a market, individualswilling to adjust their Originsof StockMarkets 329 largenumber of small claimants; they are more likely to reduce— or write off— a stakein stagnating sectors and concentrate future investments in growth sectors. 8 Theinitiative to lobby,if any, is morelikely to come from management(and labor), whoseloyalty to the Ž rm ishigher than the investors’ and the bankers’ , inorderto preventinvestors and bankers from walkingaway from theŽ rm. Inthe presence of anefŽ cient Ž nancialmarket, lobbying is more likely to reect high Ž nancialcapital mobilitythan low production capital mobility. Therefore,in the presence of a modernŽ nancialmarket, nothing can prevent a dollarmade in one sector from beinginvested into another sector; capital moves awayfrom decliningsectors to growthsectors, irrespective of assetspeciŽ city. All ittakes is for largeinvestors to modify their relative holdings of stocks in these sectors;the induced change in sharevalues allows the growth sectors to incurmore debtwhile forcing the declining sectors to reimburse past debt. In the presence of aŽnancialmarket, therefore, capital mobility re ects intersectoral changes in expectedproŽ tability, not relative liquidation values of assetsemployed in different sectors,let alone conversion costs. Onlyif the Ž nancialsystem is undeveloped is this transfer dependent on the degreeof asset speciŽ city— on whetherentry by new Ž rms isor isnot possible. If entryis not limited (low asset speciŽ city), then Ž nancialcapital  owsto growth sectorsin the form ofdirect investment Ž nancedthrough proŽ t retentionby nonŽnancial companies. If entryis limited (high asset speciŽ city), then Ž nancial capitaldoes not move across sectors, and capital mobility then re ects the liquida- tionvalue of physicalassets— or, in the event that the unbolted value is unaccept- ablylow or nonexistent, the conversion costs of these assets. The relationship betweenŽ nancialmarket development and capital mobility with respect to agiven sectoris thus heteroskedastic— Žnancial development is a sufŽcient, though not a necessary,condition for capitalmobility. But considering all sectors together and assumingthat sectors with speciŽ c assetsare equally distributed across national economies,capital mobility is higheron averagein Žnanciallydeveloped economies thanin undeveloped ones. Thekey determinant of capitalmobility across countries, therefore, is the degree ofdevelopmentof the capital market, or, to be precise,corporate securities markets. Whataccounts for theorigins of corporate securities markets? A surveyof the literaturereveals four rival lines of argument:economic development, information asymmetry,government intervention, and legal origins. First, historians generally holdthe general level of economic development as the prime suspect for Žnancial marketdevelopment. 9 Alargerpool of savings implied a higherdemand for

portfolios—that is, to liquidate assets indeclining sectors and/oracquire some inrising ones— face discouragingtransaction costs. 8.Bankers, unlike equity holders, may befew enoughto overcome the collective action dilemma. However,in the presence ofacapital market theirclaims take theform of senior debt, secured bythe Žrm’s capital,and unlikely to induceloyalty in the Ž rm orthe sector. 9.Sylla and Smith 1995, 182. 330 InternationalOrganization investmentinstruments. A secondexplanation points to the seeding role of prior public-debtmarkets. 10 EfŽcient stock markets, in addition to a columnarbuilding andextra phone lines, have to be liquid— acollective dilemma, since each one tradesif he or she anticipates the others will trade. 11 Privateentrepreneurs and investorscould not overcome this free-riding problem but used the services of investmentbankers and institutional investors that had built their reputation dealing withdebt or government-Ž nanced railway bonds in countries where this was the case. Thethird explanation stresses the role of rules favoring disclosure of Ž nancial informationand curtailing insider trading on privileged information. Environments characterizedby information asymmetry between investor and entrepreneur nega- tivelyimpact securities market development. 12 Thefourth and most recent theoret- icalforay into the growth of stock markets emphasizes the common law or civillaw originsof the legal system. Rafael La Porta et al. show that countries with poor investorprotection against expropriation by insiders,as re ected by legalrules and thequality of law enforcement, have shallow and narrow capital markets. 13 These rulesand the quality of theirenforcement, they show, vary systematically by legal origin—common law is more apt than civil law to reduce contracting uncertainty betweenthe parties to a securityissue. 14 Allfour accounts treat markets as an efŽ cient response to an environment characterizedeither by a plentifulsupply of capital (saved wealth) or by low transactioncosts (Ž xed costs defrayed by thestate treasury, investment information, orjudicial enforcement). They treat supply, public debt, and rules as parametric, exogenousto investors’ choice. Missing are the main tools of thepolitical trade— redistribution,con ict, rent seeking, and politicians. And yet, it would be quite unprecedentedif the advent of corporatesecurities markets had no redistributional effects,elicited no opposition, triggered no rent seeking, and yielded no compen- sationin the form ofregulatory obstacles to capital mobility. Inthe following, I offer apoliticalaccount of the origins of corporatesecurities markets.I arguethat markets developed as a resultof aconict between corporate Žnanciersand traditional sectors, mediated by politicians, and of which the outcome was inuenced by the degree of centralizationof stateinstitutions. Financial capital mobilityis embeddedin politicalinstitutions. I assessthe empirical validity of this claim,Ž rst,by developingthe exemplary cases of Britain,France, and Germany in

10.This argument constitutes an auxiliary mechanism inNorth and Weingast’ s interpretationof Britishhistory; their main argumentis about the origins of parliamentaryrule and its consequences for taxrevenues and public debt; North and Weingast 1989. 11.Rajan andZingales point to “achickenand egg problem with liquidity; . ..peoplewill not trade ina particularmarket unlessthey think the market is liquid,but the market willnot be liquidunless they trade.”Rajan andZingales 1999, 17. 12.Sylla and Smith 1995. Baskin and Miranti argue that the heavy reliance onbonds as opposedto commonstocks in the nineteenth century re ected investors’risk aversion in an investment environment characterized bypoor information. Baskin and Miranti 1997, 160. 13.La Portaet al.1997. 14.For a differentformulation of thelegal origins argument, see Rajan andZingales 1999. Originsof StockMarkets 331 somedetail. I thenproceed to test on anine-countrydata set two general hypotheses: thatlocal banks crowded out markets, and that centralization was associatedwith markets.Building on theempirical Ž ndings,I draw severaltheoretical consequences for thestudy of Ž nancialcapital mobility: the relation between various forms of Žnancialcapital mobility, the role of political institutions in locking in factor speciŽcity, and the presumed impact of Ž nancialcapital mobility on the tariff.

The Argument

Thedevelopment of a corporatecapital market was partof a largerŽ nancial revolutioninvolving the creation of a moneymarket and the concentration of banking.Together, these three developments threatened to divert capital away from traditionalsectors— agriculture, artisans, shopkeepers— to heavy industry. The po- tentiallosers had four options: (1) usetheir political power to blockthe development ofŽnancialmarkets, (2) beefup the alternative local banking sector and starve the Žnancialcenter from capital,(3) putpressure on thecentral government to make the newmarkets work for traditionalsectors, or (4) donothing. The path they selected reected two parameters: their political power and the degree of statecentralization. Wherethey had no power, they did nothing and corporate Ž nancedeveloped unhindered.Where the potential losers enjoyed political power, but where the state was centralized,they pursued the third option— they made the market work for them.As aresult,corporate Ž nancedeveloped almost unhindered. Where they enjoyedpolitical power and where the state was decentralized,they pursued the Ž rst twooptions— they regulated the markets out of existence and starved them out of resources.I Žrst providebackground on the Ž nancialcorporate revolution, then enumeratethe available strategies, and last derive market outcomes. Theadvent of corporate securities markets was, alongwith money markets and bankingconcentration, one of threemutually reinforcing components of theŽ nan- cialrevolution of the late nineteenth century. 15 Corporatesecurities markets, Ž rst, were afunctionalresponse to the second industrial revolution. The banks could not Žnancethe large immobilization of capitalin steel, chemicals, electrical machinery, andcommunications (telegraph, telephone) by means of loans— they would have beentoo large and would have undermined the banks’ liquidity (their capacity to

15.Terminology matters. Corporatesecurities markets deal inlong-term instruments (stocks and bonds)issued by corporations.The market forlong-term securities is alsoreferred tointextbooksas the capitalmarket ,incontrast to the moneymarket ,whichincludes short-term instruments (short-term bonds, commercial paper,bank notes, certiŽ cates ofdeposit, derivatives, and so forth). Any long-term instrumentcan serve as collateral toshort-term transactions or provide the basis forderivatives. Corporate refers tothe nongovernment component of the market, whichfor the most advanced industrializedcountries only emerged inthe second half of thenineteenth century. 332 InternationalOrganization callin loans to face eventual deposit withdrawals). Markets allowed banks to transformlong-term loans to industryinto securities, recoup their liquidity, and lend anew.16 Still,few individualswere willingto merelytake over corporate Ž nancing from thebanks and immobilize their savings in theform ofsecuritiesof risky private ventures.They could get an honest return at no risk by buying public debt. The creationof a secondarymarket for corporatesecurities, allowing the owner of a securityto sell it at any time, is what earned stock markets their mass appeal. Secondarysecurities markets, however, needed— and still do— alot of liquid assetsto function well. Stable, reliable pricing requires thick trading, the constant short-termbuying and selling by brokers,market makers, and leveraged speculators, inconstant need of vastsums of short funds. To function well, the securities market hadto beleveragedby thesecond component of corporateŽ nance—an equallywell workingmoney (short-term) market. The long and short markets were linked throughcall loans: security brokers would pledge securities as collateral to callable loansfrom thebanks. 17 Initially,the money market utilized the idle cash found in traders’ current accounts,which the banks would use to extend standardized overnight or fortnight loansto brokers.By themiddle of thenineteenth century, a newsource of liquidity emergedin the form ofindividuals’checking accounts. Individual deposits became thesingle most important source of funding for banksfrom themid-nineteenth centuryonward. The collection of small deposits from millionsof geographically dispersedindividuals required the development of thethird component of corporate Žnancein the form oflarge,joint-stock banks, headquartered in theŽ nancialcenter, drainingdeposits from theperiphery through networks of local branches— our modernmoney-center banks. The point to appreciate is that the corporate Ž nancial revolutionrested on individuals’bank deposits leveraging the stock market as much ason individuals directly purchasing stocks. The two aspects were mutually reinforcing:the more deposits were channeledto the Ž nancialcenter, the more liquidthe stock market, the lower the risk of holding corporate stocks, the more attractivecorporate stocks in relationto public debt, and the greater the demand for liquidity. Arequisitefor thedevelopment of capitalmarkets, therefore, was thatŽ nancial capitalbe geographically mobile; it hadto  owfrom theperiphery to the Ž nancial center,in acentripetalway. Had all producer groups found their interest in corporate Žnance,mobility would have automatically ensued. However, corporate Ž nancehad redistributionaleffects. It beneŽ ted modern industry at the expense of traditional sectors—agrarian, artisans, shopkeepers, self-employed, workers skilled in tradi- tionalcrafts and, more generally, sectors characterized by small enterprises. Traditionalsectors had little to gain from incorporationand stock markets. Considerthe case of the agrarians. Niek Koning argues that the agricultural

16.Market cycles, each cycle lastingabout ten years, addeddynamics to this static description.Banks wouldrenew advances totheir good clients in bear periodsin the hope of transforming them into securities at thenext bull market. 17.Powell [1915] 1966, 594. Originsof StockMarkets 333 depressiondestroyed any prospect for agrariancapitalism in the world. 18 Large farms closedand with their closure early agrarian support for corporateŽ nance ended.Small farmers, whocould work harder and accept lower proŽ ts, became the dominantforce in agriculture. Even Dutch and Danish farms, whichmanaged a conversionaway from traditionalgrains to animalhusbandry, thereby becoming the number-onesupplier of bacon and eggs for theEnglish breakfast table, remained small.Even in the United States, where mechanization allowed farms tobe larger thanin Europe,farms were family-owned,with no prospectfor incorporation.Other traditionalsectors had no prospect for incorporationeither. Too small to enable marketinvestors to evaluatetheir earning potential with a modicumof conŽdence, small-and medium-sized Ž rms exclusivelyrelied on bank loans. Traditionalsectors had no usefor thenewly established joint-stock banks either. Thecenter banks could not accommodate farmers’ demand for long-termŽ nance, neededfor landpurchase, mechanization, or land improvement. Borrowing short, thesebanks could not easily lend long, otherwise a risein interestwould force them topay high interest to depositors while still collecting low interests on borrowers. Theabsence of a secondarymarket in loans also made it impossible for abankto liquidatefarm loans,were itin need of doingso. 19 Thesituation was differentfor industrialŽ rms, asbanks could usually recoup long-term advances to industrial Žrms byturning them into shares. Instead, farms raisedlong-term Ž nanceby mortgagingland with local nonproŽ t banks:savings banks, whose risk was covered bya localgovernment guarantee; and credit cooperatives. 20 Thelatter, known in Germanyas the “ Raffeisensystem,” were createdin the second half of the nineteenthcentury. Every farmer wouldpledge an equalsum and be allowedto bid for aloan,which all the other members would guarantee. A thirdsystem, private mortgagesecuritization, by which a bankwould Ž nancemortgage loans by issuing bonds,was mostlyencountered in the United States and British Dominions. It was unstable,rarely managing to outlast more than one— two at best—business cycles. 21 Likeagrarians, artisans and small business also formed cooperatives or banked withsavings banks and local commercial banks. Belonging to the same parish, bank andŽ rm wouldengage in “ relationshipbanking.” 22 Adurablerelationship, spread acrossa widearray of products,allowed the bank to smoothenthe cost of capitalto theŽ rm overthe Ž rm’s lifecycle. In contrast, center banks’ local agents could not

18.Koning 1994, 26. 19.Prudential rules were thrownto thewind, however, in periods of (andcountries subject to) land speculation.The classic instanceis theAustralian Ž nancialpanic of 1896. 20.On credit cooperatives and savings banks, see Vittas 1997. 21.Snowden chronicles four successive attempts inthe United States todevelop private mortgage securitization,a Žrst inthe 1870s, another in the 1880s, still another with the federal (yetprivate) joint-stockmortgage banks in the 1920s, and at last withthe private issuing of mortgage-backed securities since the1970s (although the latter is mostlyabout housing and commercial real estate). Snowden1995. Of all four,only the last has notended up in collective bankruptcy. Congress also establisheda successful system ofcentral mortgagebanking enjoying federal guarantee,the Federal Land BankSystem in 1916. 22.On relationship banking, see Lamoreaux1994; and Petersen andRajan 1995. 334 InternationalOrganization committo a long-termrelationship. They had to meetlending standards decided by headquarters,with the consequence that their portfolio had to be exibleenough to meetliquidity requirements that kept changing with the overall position of the bank. Mostof the time, they ignored small businesses’ parochial needs, seeing them as poorrisks, since smallness foreclosed underwriting, the bank’ s mainexit strategy. Traditionalsectors not only had nothing to gain from corporateŽ nance;they also hadeverything to lose from bankingconcentration. The centralizing strategies pursuedby the center banks put them in direct competition with the other credit sectors.They threatened to absorb the country banks and to enter the market for savingsdeposits, until then the chassegarde ´e oflocalgovernment-chartered savings banks. Confrontedwith the challenge of corporateŽ nance,the traditional sectors faced fouroptions: First, they could try to hinder the development of stock markets by havinggovernment pass regulations damaging to the markets. Volatility— markets crashedabout every ten years— provided their enemies with an easy battle cry: marketswere speculativeand amoral, like casinos. Second, traditional sectors could tryto defend the local monopolies of local banks by raising center banks’ costs of entryin local markets. Denying center banks access to local cash would starve the moneymarket and indirectly contain the growth of thecapital market. Alternatively, third,they could try to ask for compensationin the form ofsubsidized credit. In thesedays of slim government budgets, this meant having the market work for them. Thegovernment would charter special credit banks with the mission to channel loansin speciŽ c traditionalsectors, Ž nancedthrough issues of attractive, default- free bonds,enjoying state guarantee. Although state banks would crowd out for-proŽt marketparticipants in the short term, they would also help diffuse the practiceof holding bonds among the population, thereby contributing to the enlargementof themarket over time. 23 Fourth,the traditional sectors could accept theverdict of themarkets and seek no redressthrough political action. Confronted withthe traditional sectors’ claims for redress,the potential winners had only one strategyat their disposal— try to blockany rearguard attempt at stuntingthe growth ofŽnancialmarkets. Whetherthe traditional sectors chose to confront, piggyback, or adjustto market pressuresdepended on two parameters: their political power and the degree of centralizationof thestate. Where traditional sectors enjoyed no politicalpower, the politicalroute was closedto them.This ought to havebeen veriŽ ed irrespectiveof thenature of state institutions, though, in practice, decentralization seems to have alwaysempowered traditional sectors— the lower-right quadrant of Figure 1 was empty. Wherethe traditional sectors did enjoy political power, the critical factor determiningtheir course of action was thedegree of state centralization. In centralizedstates, traditional sectors sought compensation in the form ofspecial

23.In accordance withthe seeding effect ofthepublic-debt market, oneof thefour aforementioned linesof argument. Originsof StockMarkets 335

FIGURE 1. Theimpact of politics on corporate security market growth in 1913

creditbanks. No other option was opento them. Defending local banking would havebeen problematic or inefŽ cient. For-proŽ t localbanks were indefensibleshort ofnationalizing them or suspending market competition outright— amuch too radicaloption for thetime. Defending nonproŽ t banks(savings and cooperatives) was inefŽcient in the absence of Ž scallyresponsible local governments. Because theyprovided the deposit guarantee, state regulators were incharge of monitoring nonproŽt banks,with no regard for localpreferences. The state administered the depositscollected by savings banks, in conformity with state treasury priorities. It was easierto ask the central agencies to discriminatebetween sectors than between locales.State administrations ordinarily arrange tasks along functional lines, trans- formingcon icts into sectoral con icts. Furthermore, trying to throw regulatory wrenchesinto the wheels of the securities markets might boomerang in the saboteurs’faces, for specialcredit banks Ž nancedthemselves on that market. In sum,the con ict between new and old Ž nancein centralized states where traditional sectorsenjoyed political power could only be foughtalong sectoral lines. It also had tobe contained,and was actuallyso to adebateon the relative size of thedebt issued bystate-guaranteed entities. Indecentralized states, in contrast,traditional sectors had something to defend— thelocal banks, whether for-proŽ t ornonproŽt. Being well-represented in the board roomsof the local banks and, with respect of the savings banks, in the local governmentsmonitoring these banks, traditional sectors could make the banks work for them.They also enjoyed power at the central government level to block any attemptat dispossessing local governments from theirŽ nancialpowers, as such a decisionwould have had to pass the high chamber, in whichlocal governments were traditionallyoverrepresented. Finally, not needing any of the three components of corporateŽ nanceand being strong in the low chamber as well allowed traditional sectorsto adopt a systematicallynegative attitude toward Ž nancialmarkets and seek toregulate them out of existence. The Ž nancialcon ict was geographic,pitting 336 InternationalOrganization

Žnancialcenter against periphery, and all-out— center banks, money market, and capitalmarket, both public and private, were atstake. 24 From thispolitical dynamic it is easy to predictthat corporate securities markets developedmostly in countries where traditional sectors, agrarians especially, were weakpolitically or, if strong,where state institutions were centralized.In contrast, marketswere leastlikely to develop in countries where traditional sectors were strongand where state institutions were decentralized.

Three ParadigmaticCases

Asomewhatdetailed presentation of theBritish, French, and German caseswill help eshout the argument. These three cases were chosenfor theircloseness of Žtwith theargument. Politically weak traditional sectors in Britain adjusted to market forces.Politically strong traditional sectors in centralized France played the card of thespecial credit bank. Politically strong traditional sectors in decentralized Ger- manysought to strangle the markets. The French and British markets boomed, whereasthe German market stagnated. Traditionalsectors in Britain were politicallyweak. Their main body, the agrarians,lost the tariff battlein 1846and became a spentelectoral force afterward. Theywere acaptiveconstituency of the Conservative party and, in the British majoritariansystem, powerless. Even when the party embraced Tariff Reformin 1907,a programwith something for almosteveryone, not much was init for the agrarians.25 As for theother traditional sectors, it was notuntil the 1920s that their strategiclocation at the center of a partisansystem polarized into two class blocs broughtthem some visibility. 26 Britainalso was acentralizedcountry. Local governmentswitnessed impotent the absorption of local banks by the London banks.27 Thesavings banks were nolocalinstitutions, being forced to redepositall theirresources in an account with the Bank of England.Their share of deposits in 1913represented a meek6 percent;14 percent was withthe Post OfŽ ce savings bank.The rest, 80 percent, went to the commercial banks, half of which with the “BigFive” (see Table 1). The London Stock Exchange was, behindNew York,the secondlargest worldwide. Corporate bonds and stocks represented 9 and30 percent, respectively,of allŽ nancialassets in England and Wales in 1913, adding up to132

24.The Ž nancialdebate in decentralized countries(Germany, Switzerland, the United States) also extendedto the central bankand the gold standard, for the function of the central bankwas tokeep the center banksand the money market liquidand to maintain the gold value of thecurrency at thecost of deation— good for share valueand incorporated sectors butbadfor debt and loan-dependent sectors. On therelationship between decentralizationand late anddisputed central-bank chartering, see Broz1998. 25.Verdier 1994,142. 26.This is whenthe Macmillan Committee discoveredthe eponymous “ gap”in bank funding of small business. 27.The “ BigFive’ s” share ofthe deposit market increased from27 percent in 1890 to 80 percent in 1920;see Capie andRodrik-Bali 1982. Originsof StockMarkets 337

TABLE 1. Breakdownof deposits by type of bank (percentages), circa 1913

Type of bank Englandand Wales France Germany

For-proŽ t Moneycenter 34 39 15 Otherfor-proŽ t 46 27 13 NonproŽ t Savingsand cooperatives 6 23 71 Postalsavings 14 10 1 Total 100 100 100

Note: Thebreakdown within the for-proŽ t sectors between center andcountry banks is nothomo- geneousacross countriesbut includes the top Ž vein Englandand Wales, thetop four in France, and thetop nine in Germany. The year is 1913,except for England and Wales, forwhich it is 1910. Sources: Data forEngland and Wales are fromCapie andRodrik-Bali 1982. For France, the break- downamong for-proŽ t banksis fromBouvier 1973, 125; and the other data are fromMitchell 1992, 774,782. For Germany, Deutsche Bundesbank1976, 16.

percentof grossnational product (GNP). 28 Thelast regulatory attempt at curbing the growthof the exchange, the Bubble Act, was repealedin 1825. The exchange auntedthe most advanced rules of informationdisclosure. 29 Itgrew attheexpense oflocalcommunities and small business. Jonathan Zeitlin points to the disappear- anceof regional banking as a causefor thedisappearance of small Ž rms and industrialdistricts. 30 Traditionalsectors in Francewere strong,thanks mostly to the electoral strength ofagriculture, credited for backingthe Second Empire and forming a three- hundred–member strong farm blocin the Chamber of Deputiesin 1890. 31 Agrarians were instrumentalin extricating France from thefree-trade-oriented bilateral treaty systemlaunched by Cobdenand Chevalier in 1860; they formed an iron-and-wheat alliancewith industry for aprotectionisttariff. 32 AlthoughFrench agrarians were unhappywith Parisian Ž nance,France had a centralizedstate, with weak local banks.Local private banks— few ofthem lent to farmers anyway—lost ground to thelarge banks in the 1890s. 33 Thesavings banks controlled 23 percent of total deposits,but, like their British counterparts, they placed all their resources in a centralstate agency (Table 1). Mutual credit cooperatives failed to take root. As a result,French agrarians did not try to hinderbanking concentration and the draining from theprovinces of theirsavings, but sought instead to havepart of itreturn to the provincesin the form ofstate-subsidized credit. In 1852, the year he was elected

28.According to Goldsmith 1985, 233. 29.According to Sylla 1997, 210. 30.Zeitlin 1995, 105. The issue is contested,though; see Michie1988. 31.Golob 1944, 170. 32.Lebovics 1988. 33.Saurel 1901. 338 InternationalOrganization emperorby a plebiscite,thanks to the rural vote, Louis Napole ´onchartered the Cre´ditFoncier, a privatebank Ž nancingmortgage loans by issuingbonds enjoying stateguarantee. 34 Itrepresented 7 percentof French securities capitalization in 1902. Then,in the 1890s, Parliament laid out the bases for whatbecame the Cre ´dit Agricole—asystem of mutual credit societies that were guaranteed,partially run, andsubsidized by the state. The Republican majority squeezed the required subsidiesout of the privately-chartered Bank of France, as a conditionfor the renewalof its Ž duciaryprivilege in 1897. 35 Frenchsmall businesses saw theiraccess to credit deteriorate with the displace- mentof localprivate banks throughout the period. It was notuntil after 1900, when theRadical faction became the last rampart of the Republican Right against the risingSocialist Left, that small business attracted politicians’ solicitude. The Caillauxcommission of 1911reported that small business was victimof acreditgap andrecommended a seriesof reforms thatwould eventually lead to state-engineered mutualismin theform ofthebanques populaires, combining grass-roots mutualism withthe distribution of statesubsidies to small Ž rms incommerceand industry. 36 In addition,small business got the Cre ´ditNational in 1919, a cre´ditfoncier-like institution,specializing in long-term lending to small business. Frenchagrarians and small business never tried to curb the development of the Paris bourse.They had no crediblelocal nonproŽ t alternativeto thedisplacement of thelocal for-proŽ t banks.They also had a stakein the development of the public componentof themarket, the agrarians in the form oftheCre ´ditFoncier, and small businessin the form ofthe Cre ´ditNational from 1919on. Corporate stocks and bondsrepresented 13 and 14 percent of Ž nancialassets, respectively; the two combinedmade for 135percent of GNP (against132 percent for England/Wales). 37 Thesituation was radicallydifferent in Germany, where the decentralization of thestate made it possible for localgovernments, overwhelmingly controlled by agrariansand small business interests, to protect local banking. German states had fullauthority over the regulation of the savings banks, which they owned. They monopolizedthe local deposit market, investing its proceeds in land mortgages and governmentbonds, local especially. Legally unable to extend loans to individuals untilthe turn of the century, the savings banks witnessed, until then, the rise of seriousgrass-roots competition in the form ofmutual cooperatives. By 1913, the localmarket for creditand deposits was defactomonopolized by thesavings banks andthe cooperatives,each one being a memberof aregionaland national federation, successfullyresisting entry by theBerlin banks and Ž nishingoff theoldlocal private banks.38 Strongfrom thissecure outpost in the countryside, the agrarians pursued a two-prongedstrategy; they vetoed any attempt by the imperial government to

34.According to Karl Born,“ Napole´onwas returninga favourto his supporters among the rural population.”Born 1983, 104. 35.Gueslin 1978. 36.Albert 1997. 37.According to Goldsmith 1985, 217. 38.See Deeg 1999. Originsof StockMarkets 339 centralizebank regulation, and they pursued a policyof verbal and regulatory harassmentof the securities markets. They were successfulon both counts. The Berlinbanks eventually absorbed the local for-proŽ t banks,but they never displaced thelocal nonproŽ t sector—their market share today is aspunyas itwas in1913(see Table 1). TheGerman Agrarianparty (it was nota partyproper but a lobby),whose supportwas essentialtothe survival of almost all imperial governme ntsfrom 1878until World War I,launcheda crusadeagainst “ speculation.”39 The new companylaws of 1884restricte dtheliberal incorpor ationlaw of 1870,raising theminimum size of shares,lengthe ningthe time lag between incorpora tionand listing,and strength eningthe position of the superviso ryboard. 40 Then they turnedtheir guns against the linchpi nofmarketclearing —shortselling, a sale involvinga futuredelivery of goods or stocks. They claimed that short selling fueledbearish speculat ion,depressin gtheprice of produces.Asaresultof their pressure,the law of 1896 prohibit edfutures in grainand  our,dealings for the accountin theshares of miningand industri alcompanie s,andrequested that all partiesto dealsin industrialfuturesenter their names in aregister,denigrat edas the“ gamblingregister. ”41 Thelaw increase dcashtransacti ons,demorali zedthe moneymarket, increased costs and legal uncertai nty,and led to themigration of businessto London. 42 Theupshot was aratherdepressed stock market. Corpo- ratestock and bonds represent ed8 and2 percent,respectiv ely,of totalŽ nancial assets,adding up to about 44 percent of GDP(against132 and 135 percent in England/Walesand France, respecti vely). 43 Localdistricts ,incontrast, performed relativel ybetterin Germany than in Britainor even France. Manfred Hartmann conducte dacomparativestudy of Franceand Germany, at the end of which he conclude dthatthe relativel y decentralizednature of theGerman bankingindustry helped maintain more even levelsof economic developm entbetween regions within Germany than in France.44

Evidence froma Nine-CountryData Set

Mypurpose so far hasbeen to illustrate the argument. I nowtry to assess its generalizabilityto the six other cases for whichwe havedata— Belgium, Denmark, Italy,Norway, Switzerland, and the United States. Stock and bond holdings data are

39.Only under the Caprivi government in the early 1890sdid agrarians suffer seriouspolicy setbacks. 40.See Tilly1986, 126. 41.Dealings for the account are essential tomarket-making, without which markets lack depthand continuity. 42.According to a contemporaryaccount, Emery 1908.Also nervous about speculation was the American public.For technical examples oflegal prohibitions based on popular suspicion, see Parker 1920, 10. 43.According to Goldsmith 1985, 225– 26. 44.Hartmann 1947. 340 InternationalOrganization takenfrom RaymondW. Goldsmith’s studyof national balance sheets, which he establishedfor variouscountries and benchmark years. 45 Goldsmith’s tablesprovide uswiththe relative percentage of Ž nancialassets held as corporate securities, listed ornot. Admittedly, not all stocks and bonds were listedon exchanges, let alone activelytraded. But since exchanges promoted incorporation and incorporation fed exchanges,the country rank-ordering across the two variables cannot have differed bymuch. Measures of corporatebond and stock holdings are available for atleast oneof thethree years directly preceding World War I(see theappendix). Thesmall number of observations— nine— recommends saving degrees of free- dom.To thateffect, I eliminateunnecessary control variables. The earlier survey of theliterature suggested four plausible explanations to the origins of corporate securitiesmarkets: economic development (GNP percapita), government debt (governmentbonds divided by totalassets), asymmetric information (proxied by the proportionof corporatebonds among corporate stocks), 46 andlegal origins (dummy for commonlaw). A lookat thebivariate scatterplots between each control variable andthe ratio of corporate stocks to Ž nancialassets reveals two relations, a Žrst betweenmarket development and economic development (GNP percapita), Ž lling infor thedemand for securities(see Figure2). A secondrelation is also observable betweenmarket development and common law origins— this can be seenin Figure 2aswell,where the common law countries, Britain and the United States, are both locatedat the top of the graph. Although two countries do not make a rule, qualitativeevidence indicates that Australia, Canada, and South Africa alsohad very well-developedstock markets. And they also were amongthe wealthiest countries inthe world, conŽ rming the potential problem of multicolinearitybetween common laworigins and wealth exhibited in Figure 2. The other two control variables, governmentdebt and information asymmetry, show no relation with corporate securitiesmarkets, even when controlling for GNP percapita (results unreported). Thispreliminary analysis suggests the need to control for onevariable in all subsequentexperiments— GNP percapita— proxying both for demandfor securities andcommon law origins. Ithenplot the bivariate relation between stock market development and the local nonproŽt bankingsector in Figure 3. The relation is negative, conŽ rming the crowding-outhypothesis, according to which capital locked out in local networks was unavailablefor redeploymenttoward the Ž nancialmarkets. Visual observation furthersuggests that the data points are aligned on two parallel (undrawn) lines accordingto wealth— the wealthier countries (the United States, the United King- dom,Denmark, and Switzerland) are on a higherline, whereas the countries with lowerGNP percapita (Belgium, France, and Italy) are on a lowerone.

45.Goldsmith also provided data forIndia, Japan, Russia, and South Africa, whichI didnot include forlack ofdata onthe other variables. Goldsmith 1985. 46.I proxiedasymmetric informationby the proportion of bonds among securities inaccordance with Baskinand Miranti’ s Žndingthat poor information led investors to choose bonds over stocks; Baskin and Miranti1997. Originsof StockMarkets 341

FIGURE 2. Wealthand stock holdings, circa 1913

FIGURE 3. Thecrowding-out hypothesis (bivariate scattergram) 342 InternationalOrganization

Icheckthe robustness of this clue by using multivariate regression (OLS), outŽtted with bootstrapped standard errors andconŽ dence intervals to make up for thesmall number of observations. 47 Thedependent variable is the relative size of stockholdings in the Ž nancialsystem. The independent variables are the market sharesof three sectors— country (local for-proŽ t), local nonproŽ t, and postal savings—measured in deposits. Although most data on these sectors are available, theypresent one difŽ culty. Separate data exist for stateand local nonproŽ t banks, but,for mostcountries, data for centerand country banks are aggregated. The difŽculty is notinsurmountable, however. Everywhere, except in theUnited States, centerbanks were allowedto open branches in the periphery and compete for depositsfrom countrybanks or merge with them. The trend was towardthe amalgamationof country by center banks. The United States was uniquein prohibitinginterstate banking and, in many cases, branch banking within states as well.In light of this, I willassume that for-proŽ t banks,whether center or local, were centerbanks, while bearing in mind the U.S. exception. Statisticalresults for thecrowding-out hypothesis are reported in Table 2. The strongestimpact is thatof thelocal nonproŽ t sector.The coefŽ cient is statistically signiŽcant (at the 5 percentlevel in regression 1), and a onestandard deviation increasein that variable corresponds to a decreaseof about half ([0.24* – 0.21]/ 0.09 = –0.56)a standarddeviation in the dependent variable (see appendix for standarddeviations). The coefŽ cient for thepostal savings variable is not signiŽ - cantlydifferent from zero,suggesting no effect. Toget a bettersense of how countries are distributed and to eventually spot outliers,I plotin Figure 4 thepartial plots of regression1 ofTable2. Each graph inFigure 4 plotsthe impact of aright-hand-sidevariable on the dependent variable, otherthings being equal, that is, while holding constant the impact of the other right-hand-sidevariables on the dependent variable. 48 Thetop-left graph shows Franceand the United Kingdom at oneend of thedistribution and Germany at the otherend. The position of theUnited States is wellbelow the line. The reason is that thesavings and loans were notthe only local obstacles to markets;the presence of manystate-chartered for-proŽ t banksalso had a moderatelynegative impact on corporatestock holdings. This last point is conŽrmed in regression2, whichincludes thecountry bank variable among the regressors. Recall that this is aquasi-dummy variable(coded 0.42 for theUnited States and zero for others).These results bring homea factthat I havenever seen mentioned in priorstudies. Controlling for GNP percapita moves the United States from beingthe country with the largest GNP-weighted(let alone unweighted) stock holdings in the prewar worldto a countrywith lower than average holdings, in keeping with the small domestic

47.Bootstrapping makes itpossible to work around the constraint on sample size imposedby the central limittheorem; see Mooneyand Duval 1993. 48.Each plotgenerates acoefŽcient and a Žtthatare equalto thecoefŽ cient and Ž tofthedependent variableagainst the chosen right-hand-side variable, while simultaneously controlling for the effect ofthe otherright-hand-side variables on both variables. See Bollenand Jackman 1990. Originsof StockMarkets 343

TABLE 2. Thecrowding-out hypothesis

Dependentvariable

Corporatestocks, Corporatestocks andbonds, c. 1913 c. 1913

Independentvariables 1 2 3 4

LocalnonproŽ t banks,1913 2 0.21 2 0.20 2 0.44 2 0.44 (0.23)** (0.12)** (0.15)** (0.18)* Countrybanks, 1913 —— 2 0.14 —— 2 0.006 (0.13)* (0.23) Postalsavings, 1913 2 0.11 2 0.10 2 0.33 2 0.32 (0.50) (0.43) (0.43) (0.63) GNP percapita, 1913 0.00023 0.00029 0.0002 0.0002 (0.0002)**(0.0001)** (0.0001)** (0.0002)** Intercept 0.06 0.01 0.24 0.24

Note: OrdinaryLeast Squareswith standard errors andbias-corrected conŽdence intervalscalcu- latedon one thousand bootstraps. Each cell reportsvalues of observedcoefŽ cients; corresponding bootstrappedstandard errors are inparentheses. ConŽ dence intervalsare bias-corrected:*, **,*** indicatecoefŽ cients situatedin the 90 percent, 95 percent, and 99 percentconŽ dence intervals,re- spectively.The number of observationsis nine:Belgium, Denmark, France, Germany, Italy, Norway, Switzerland,United Kingdom, and the United States. See theappendix for data descriptionand sources.

marketshare of itscenter bank sector. 49 Toassessthe robustness of thedependent variable,I ranthe same regressions using all corporate securities (stocks and bonds) asdependent variable. The results are virtually unchanged, with one exception— the U.S. state-charteredfor-proŽ t banksno longer make a difference.I haveno explanationfor thisdifference. Allthe regressions of Table2 conŽrm thepowerful impact of relative wealth on securityholdings; in regression1, for instance,a onestandard deviation increase in GNP percapita ($262) yields an increase in the dependent variable of almostone (84percent) standard deviation ([262*0.0002]/ 0.09 = 0.84).This Ž ndingconŽ rms thehistorians’ hunch that the size of corporatesecurities markets in 1913 strongly reected levels of development. Therefore,the 1913data indicate that the share of corporatestock holdings among Žnancialassets was afunctionof thelevel of economicdevelopment primarily and ofthe size of the local nonproŽ t bankingsector secondarily. The poorer the economyand the stronger the savings banks, the smaller the market. U.S. country

49.This result holds despite the so-called pyramiding of reserves inNew York:a particularrule, mandatingcountry banks to keep cash reserves, yetallowing them tohold this cash inthe form of interest-earningdeposits with center banks;see James 1978. FIGURE 4. Thecrowding-out hypothesis (partial plots for regression 1, Table 2) Originsof StockMarkets 345

TABLE 3. Thestate centralization hypothesis

Dependentvariable

Corporatestocks, Corporatestocks and c. 1913 bonds,c. 1913

Independentvariables 1 2

State centralization,c. 1880 0.19 0.33 (0.17)** (0.32)* GNP percapita, 1913 0.0004 0.0005 (0.00007)*** (0.0001)*** Intercept 2 0.25 2 0.38

Note: See noteto Table 2 formethodology and the appendix for data descriptionand sources. bankswere alsofound to be negatively correlated with stocks. Postal savings, in contrast,were notfound to correlate negatively with markets. Thesecond hypothesis, the state-centralization hypothesis, posits a positive statisticalrelationship between the degree of centralizationof thestate and the size ofthecorporate securities market. The independent variable, state centralization, is measuredby theproportion of governmentrevenues drained by thecentral govern- ment.The exact measure is a fractionhaving as numerator the sum of central governmentreceipts and as denominator the sum of all government receipts calculatedfor 1880.The date was chosento allayany suspicion about the direction ofthecausal relationship (I initiallywanted data for 1850but had to give up). At any rate,state centralization is a variablewith a longmemory, most unlikely in the short runto be endogenous to Ž nancialdevelopment. Resultsare reported in Table3. Inboth speciŽ cations of thedependent variable, theimpact of wealth,on theorder of one(one standard deviation increase in wealth correspondsto aonestandard deviation increase in stockholdings), is strongerthan thatof state centralization, on the order of 40 percent. The partial plots for regression1 areshown in Figure 5. Once again, it is theoretically gratifying to observethe proximity between the German and U.S. observationsin theupper graph ofFigure5. Despitehosting the largest corporate securities market in theworld, the UnitedStates was noexception to the fact that decentralization had a negative inuence on the development of Ž nancialmarkets. This negative in uence was hiddenby thecontrary in uence of wealth.It so happened that the United States also was amongthe wealthiest countries in the world. Thepresent Ž ndingshave an implication for theinstitutionalist interpretation advancedby Douglass C. Northand Barry R. Weingast.They argue that the existenceof checks and balances was arequisitefor treasuriesto issue debt on a largescale and that the public debt was instrumentalin thelatter acceptance of the 346 InternationalOrganization

FIGURE 5. Thestate centralizing hypothesis (partial plots for regression 1, Table 3)

privatedebt. It is also the case, however, that a particulartype of checks and balances,decentralization and the concomitant representation of localgovernments inpowerful upper chambers, had a largelynegative impact on the development of corporatesecurities markets. The eradication of local Ž nancialprivileges was necessaryto release local capital from itslocal uses. Furthermore, the bond market indecentralized countries was toonarrow to accommodatetoo large a publicdebt; alargepublic debt would easily crowd out private debt, as it did in Italy. State Originsof StockMarkets 347 centralizationthus had to comebefore checks and balances, for theintroduction of checksand balances froze state centralization at its existing level, empowering local interestsin decentralized countries. 50

Consequences forthe Studyof CapitalMobility

Thepaucity of casestudies and inaccuracy of thedata make the preceding Ž ndings tentativeat most. Assuming for thesake of argument that they bear some resem- blanceto reality, I nowdevelop implications for thestudy of Ž nancialcapital mobility.The research follows Cheryl Schonhardt-Bailey and Andrew Bailey’s pioneeringquest for anempiricalreferent to, and a directmeasure of, the notion of capitalmobility. It argues that capital mobility is a functionof securitization— the transformationof Žrms’liabilities into Ž nancialinstruments of anymaturity that can becontinually traded in deep, broad, and impersonal markets. Liquid and broad securitiesmarkets provide investors with the capacity to switch their holdings of stocksacross Ž rms, sectors,climes, and latitudes— and this is the closest we get empiricallyto capital mobility. Morefundamentally, the study of Ž nancialmarkets allows us torestoreto capital mobilitya conceptualunity threatened by the asset speciŽ city literature. Financial capitalis themobile form ofproductioncapital. That “ anautomobilefactory cannot costlesslybe convertedinto a brewery”would indicate that capital is speciŽc only ina nonmonetaryeconomy. 51 Ina monetaryeconomy, the liquidation value of the former couldin theory sufŽ ce to pay for thelatter. More realistically, the proŽ ts generatedby carmanufacturing may be investedin the construction of abreweryif brewingis expected to be more proŽ table than the assembling of cars. The same outcomeis instantaneously reached in the presence of a Žnancialmarket through institutionalinvestors modifying their relative holdings of stocks in each sector; the inducedchange in relative share values allows the rising sector to incur new debt, whileforcing the declining sector to reimburse past debt. Production and Ž nancial capitalare, so to speak,the two sides of thesame coin rather than separate factors ofproduction. Notonly are various forms ofcapitalrelated, but so are various types of mobility. Centripetalmobility was aprerequisiteto cross-sectoralmobility. Absent a nation- widebranch-bank network and the well-capitalized Bourse des valeurs in Paris, the widowof a winemakerfrom Bordeauxwould not have invested in railroads. Centripetalmobility also was aprerequisiteto cross-bordercapital  ows. 52 France wouldnot have been a creditorto the world in the absence of a Žnancialsystem

50.One betterappreciates thepredicament of the French and Spanish monarchies during the eighteenthcentury. The Bourbons “ failed”to match Albion’s Žnancialresources byconceding enough powerto Parliament perhapsbecause theFrench and Spanish states hadnot yet reached alevelof centralizationcomparable toEngland.See Hoffmanand Norberg 1994. Limited government may have backŽred, merely reinstatinglocal privileges and past impediments to exchange. 51.The phrase is fromFrieden 1991, 436. 52.See Verdier 1998. 348 InternationalOrganization centralizingFrench savings in Paris. Conversely, Canada— still centralized by then—would not have been host to the largest net in ow of foreign investments (weightedby GNP) beforeWorld War Ihadinvestment opportunities there been dispersedamong local markets with no connectionto theMontreal stock exchange. ThatGermany lacked a similarcentralizing mechanism may have explained the modestyof itsglobal Ž nancialreach. 53 Thecorrelation between securitization and internationalizati onis more than a speculation—itis afact.A measureof Žnancialinternationalizati onatourdisposal isthe stock of foreign investment (portfolio mainly) held in 1914, divided by GNP.54 Iuseabsolute values, so as to measure the relative dependence of the economyon foreigninvestment in andout, without distinction between debtor and creditorstatus, but add a dummyvariable coded 1 for creditorand zero otherwise toguard against a possiblebias. A perusalof the partial regression plots points to anoutlier— Switzerland (Figure 6). Switzerland is an exception, a countrywith an unusualshare of international banking owing to factors that are left out of the presentargument— international Ž nancialspecialization, low tax rate, political stability,and neutrality in foreign affairs. Runagain without the Swiss observation, theregression reveals strong coefŽ cients for wealthand stocks (results unreported). Didsecuritization invite internationalizati on,or did internationalizatio nfoster securitization?Neither was thecase. Both were theproduct of onecommon cause: theexistence of a broad,centripetal money market— domestic capital mobility. Stateinstitutions lent a historicalunity to various categories of capital mobility. Theresearch provides an illustration of the well-known, though hardly re- searched,idea that political institutions play a rolein locking in factor speciŽ city: factorspeciŽ city is embedded in politicalinstitutions. 55 Altand Michael J. Gilligan haveargued (though not shown) that the electoral rule shapes the scope of public policyand the degree to which a Žrm willinvest in speciŽ c assets.If membersof Parliamentare tied to single-memberdistricts, they provide the protection that keeps Žrms tiedto a speciŽc location.If theydo not represent geographically based constituencies,but are elected from anationallist of candidates, they may still provideprotection, yet not of the kind that ties Ž rms toa location. 56 The present studyargues and shows that the degree of centralization of the state has a similar effect.Federalism increases the power of local governments in policymaking. Regulationenhancing the welfare oflocaldistricts has the effect of reducing capital mobilitynationwide. Centralized states, in contrast, either do not try to regulate

53.The debilitating effect ofstate decentralizationon globalmarket policieswas alsonoted by Robert Bates inhis contrast of Brazilian andColombian coffee policies;Bates 1997,48, 86. 54.To theextent that most foreign investment was inportfolioform makes itan acceptable proxyof Žnancialinternationalization. Foreign direct investment, in contrast, would be improper, for it was not mediated byŽnancialmarkets. 55.This proposition was developedin Altand Gilligan 1994, 183; Verdier 1995;and Alt et al.1996, 703;in contrast to theview that capital mobilityis apurelyeconomic parameter heldin Rogowski 1989; andFrieden 1991. 56.Verdier makes asomewhat similar argumentwith regard to the scope of state subsidiesto industry, usingthe intensity of electoral competitionas institutionaldeterminant. Verdier 1995. FIGURE 6. Securitizationand internationaliza tion(partial plots for a regression ofthe form: For_Inv = b 1 + b 2Stocks + b 3GNPpc + b 4Creditor + e) 350 InternationalOrganization

Žnancialcapital mobility or they do so, like the French, by creating sectoral incentives,which cut down mobility across sectors but not space. Thepresent study also offers aplausiblemechanism by which a policyrestricts orexpands capital mobility. Well-understood in the case of labor, where social regulationfavors trade unions and trade unions curb labor mobility, this mechanism, inthe case of capital,has been shrouded in abstraction. Alt and Gilligan’ s ideaof Žrms creatingpolitical commitment through deliberate investments in speciŽ c assets isan intriguing hypothesis, albeit one that, to my knowledge, is unresearched and untested.57 Myearlier notion that factor speciŽ city is not an attribute of real (or Žnancial)assets, but a sociopoliticalconstruct, re ected in asset holders’ member- shipin networks,places too much weight on thenotion of network. 58 Itis unlikely thatcountry club membership has an effect on Žnancialcapital mobility other than marginal.It just seems more plausible that the organization of theŽ nancialsystem shouldbe the key determinant of Žnancialcapital mobility. The difŽ culty lay in how tolink Ž nanceand politics, a difŽculty that the present work claims to have overcome. Last,the Ž ndingsamplify the futility of themuch-asked question of theimpact of capitalspeciŽ city on the tariff. 59 Theprediction is that capital mobility gives investorsthe capacity to “ exit”out of import-sensitive sectors, thereby diminishing “voice”for protection. 60 However,a cross-nationaltabulation of tariff levelsand corporatesecurities holdings in 1913would have failed to uncoverany relation: the Frenchtariff was higherthan the German. 61 If speciŽcity added investors’ and bankers’voice to that of theprotectionists, why was theGerman tariff lower? Theprediction that factor speciŽ city left money with no otherchoice than “ talk” was actuallyupheld in corporate boardrooms. Rather than using markets to spread theirresources thin over a diversiŽed portfolio, as in countries of high capital mobility,large investors in Germany and Italy, J. P.Morganin the United States, usedmarkets to concentrate their resources in a few companiesand control and monitormanagement. 62 Boughtat primary auctions, shares were keptindeŽ nitely, admittedlystunting growth in the secondary market, but providing holders with voicein the boardroom. Smaller investors held debt in the form ofbonds or, when concernedabout staying liquid, bank deposits, implicitly delegating to banks the taskof monitoringŽ rms’performance. 63 Bankshad a specialincentive to monitor borrowers,because of theirchronic illiquidity, stemming from theabsence of liquid Žnancialmarkets.

57.See Altand Gilligan 1994; and Alt et al.1996, 703. 58.Verdier 1995. 59.Recall thatthe study of capital mobilityoriginated with respect toits impact onthe tariff. See Stolperand Samuelson 1940. 60.Schonhardt-Bailey 1991. 61.I triedseveral speciŽcations, alternatively controlling for wealth, size oftheeconomy, or export dependence,but found no signiŽ cant relationshipbetween corporatesecurities markets andvarious measures oftariff rates foundin Bairoch1993. 62.On J. P.Morgan,see De Long1991. 63.The classic accounton Germany is Riesser 1911,725. See alsoCalomiris 1995. Originsof StockMarkets 351

Investors’and bankers’ voices, however, were notheard in Parliamen tand governmentlobbies. French and English bankers never did much for industry. German bankerswere barelyinstrume ntalin facilita tingthe carteliza tionof industrialsectors,and they took no partin thetariff debate.In theUnited States, J.P.Morganhelped carteliz ecertainsectors of industry ,butnever did he, nor anyprominen tbanker,take a publicposition on the tariff. 64 Thereason, I believe,is thatcenter banks in Germanyand the United States were intimidated bythe radicalis moftheagrarian movemen t—the populist battle cry against the “moneytrust” , thejunkers’ recurrent harassmen tofthe markets and the Reichsbank.This radicali sm was notfortuito us,but re ected the power of the peripheryand the decentra lizednature of state institut ionsin these two coun- tries.In sum, whereas Barclays and Cre ´ditLyonnai sneglectedindustryand ignoredthe tariff debate,Deutsche Bank and J. P.Morganhad more stakes in it butkept quiet nonethe less,lest they invite agrarian abuse. Mobilit ycaused neglect,speciŽ city advised caution. 65

Summaryand Future Research

Inthis article, I haveturned a modelingtool— the notion of capital mobility acrosssectors and borders— into a realitywith deep roots sinking into economic history—the centripe talmobilit yofŽ nancialcapital in 1900. I broughta rich andwell-dev elopedŽ eldof study— banking and Ž nancialhistory— to bear on thestudy of how Ž nancialcapital  ows.Converse ly,I usedthe single concept ofcapitalmobility to bringunity to whatis generallyconsideredtobeacomplex Želd—involvi ngsavers, various types of banks, money and capital markets, governmentregulati onof banksand markets, and foreign investme nt,to name themost importan t. Iarguedthat Ž nancialcapital mobility was endogenousto policym aking.It was astakein the redistrib utivecon ict pitting new against traditio nalsectors. Theindustri alrevoluti ontouched off acorporateŽ nancialrevoluti onthat threatenedtodivertcapital from traditionalsectors. Blockin gcoalitionsoflocal banksand producers formed to keep Ž nancelocal in decentra lizedcountrie s, wherethey had a chanceof winning.Incentralizedcountrie s,traditionalsectors merelypressured governme nttosetaside a pieceof theaction. In sodoing,they transformedwhatwas acenter-peripherycon ict into a debateon the relative

64.On the United Kingdom, see Kennedy1987, 56, 110, 120, 139 –41.On France, see Bouvier1968, 221.For a debunkingof Hilferding’s claim thatGerman bankscartelized industry,see Wellho¨ner1989. Foran opposite conclusion with respect toGerman bankson a differentissue (exchangerates) ina differentera (postwar),see Henning1994, 28 –31.On Morgan, see Corey1930. 65.There is asecond,more generalreason for why tariff levels didnot negatively re ect Žnancial capital mobility.Although Ž nancialcapital mobilitymay reduce investors’preference forprotection, it increases thatof therelatively less mobilefactors— management andlabor— whose income is dependent onthe sector’ s fortune.The latter havea twofoldincentive to lobbyfor a rent:they cannot exit and they wishto make thesector attractive tofootloose investors by raising expected earnings through a tariff. 352 InternationalOrganization sizeand merits of thepublic and private banking sectors— acleavage that would dominateŽ nancialdebates in centrali zedcountrie sfrom the1930s until the 1960s. Twoseries of evidencewere offered,a three-countrydetailed analysis of the impliedcausal mechanis ms anda nine-countrytest of two correlati ons:the negativeassociat ionbetween markets, on the one hand, and local banking and statedecentra lization,onthe other hand. Controll ingfor relativewealth, two broadgroups of countrieswere visible—countrie swithlarge corporate markets (Franceand the United Kingdom) and countrie swithsmaller markets (Germany, Italy,and, notwiths tandingits absolute size, the United States). Futureresearch should test the applicab ilityof the present Ž ndingsto the presentera. Financia lderegulationin recentdecades has placed stock markets at thecenter of investme ntand growth, causing a dividebetween companie sthat arelisted on the exchange s—because they are large or operate in growth sectors—and those that depend on bank loans— small companie soperatingin traditionalsectors. Fiscal retrenchm entmakes the latter ever more depende nton localgovernme nts.However, somethin gisdifferent between the days prior to WorldWar Iandtoday. The half-cent uryof statecontrol over large companie s, inthe form ofstate ownership or price control, may have added a twistto the model.State control is much too tolerant of lowerreturn on capital to make the sharesof thus-con trolledŽ rms attractivetoinvestor s.Since state control is somehowlinked to state centrali zation,the aggregat eeffectof statecentraliz a- tionon stock markets may have become indeterm inate,for favoringcapital mobilityto theŽ nancialcenter while denying investo rs plumstocks in which to invest.Only when privatiza tionand deregula tionhave advance dfar enoughto purgethe corporat esfrom theiraddicti onto state interven tionwill the center- peripherylogic seize center stage again. 66

Appendix

TABLE A1. Thenine-country data set

(1)(2) (3) (4) (5) (6) (7) (8) (9)

Belgium 0.210.27 815 0.01 0.40 0 0.851.20 1 Denmark 0.150.16 885 0.51 0 00.64N.A. N.A. France 0.130.27 670 0.23 0.10 0 0.830.99 1 Germany 0.080.10 775 0.71 0.01 0 0.490.52 1 Italy 0.030.05 455 0.40 0.33 0 0.550.20 0 Norway 0.110.12 615 0.51 0 0 0.60 0.56 0 Switzerland 0.160.18 895 0.61 0 0 0.37 1.96 1

66.Verdier 2001. Originsof StockMarkets 353

TABLE A1. continued

(1)(2) (3) (4) (5) (6) (7) (8) (9)

U.K. 0.300.39 1070 0.06 0.14 0 0.701.66 1 U.S. 0.290.40 1350 0.25 0 0.420.33 0.09 0 Mean 0.160.21 837 0.35 0.11 0.05 0.60 0.90 0.63 Standarddeviation 0.09 0.13 262 0.24 0.16 0.14 0.18 0.68 0.52

DataDescription and Sources: (1)Corporate stocks. (2) Corporate stocks and bonds: both vari- ables are calculated as apercentage ofall Žnancialassets, circa 1913;Goldsmith 1985. (3) GNP per capita; Bairochand Le ´vy-Leboyer1981, 10. (4) Local nonproŽ t banks.(5) Postal savings. (6) Coun- trybanks: values are themarket share ofthese respective categories calculated indeposits, except assets inthe Swiss case. Sourcesare, forBelgium, Socie ´te´des nations1931, 116; and Mitchell 1992, 781,784; Britain, Socie ´te´des nations1931, 260; Denmark, Socie ´te´des nations1931, 125; France, Mitchell1992, 774, 782; Germany, Deutsche Bundesbank1976, 57, 63, 65, 76, 102, 112, 120; Italy, Mitchell1992, 774, 782; and Socie ´te´des nations1931, 187; New Zealand,Socie ´te´des nations1931, 447;Norway, Socie ´te´des nations1931, 199; and Mitchell 1992, 782; Switzerland, Ritzmann 1973, tab.1; theUnited States, Socie ´te´des nations1931, 346; and Mitchell 1983, 775, 785. (7) State cen- tralization:it measures central governmentrevenues as apercentage ofgeneralgovernment revenues, circa 1880.Sources are, forWestern Europe,Flora 1983, 273; and the United States, U.S. Bureau of theCensus 1975, 1119. (8) Absolute value of foreigninvestment stock weighted by GNP: all data are grossforeign investments stocks as of1914,except in thecase ofthe United States, the only country withknown signiŽ cant two-way ows,for which data are net.Foreign investment stocks in 1914 U.S.dollars were foundin Cameron 1991,13, except Norway, for which the data were foundin BloomŽeld 1968, 43– 44, and converted in U.S.dollars at theold gold parity of 0.2680 krone to the dollar,Svennilson 1954, 318. Data usedin the computation of stocks for Norway only start in1871, withthe effect ofslightlyoverestimating Norwegian liability. GNP data for1913: 1913 GNP data in currentprices (Mitchell1983, 1992) were convertedin U.S.dollars using 1913 exchange rates (Sven- nilson1954, 318 –19).(9) Creditor: dummy variable coded 1 ifnet foreign investment stock is posi- tive,and zero ifnegative.

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