LIBRARY OF THE MASSACHUSETTS INSTITUTE OF TECHNOLOGY Digitized by the Internet Archive in 2011 with funding from Boston Library Consortium Member Libraries http://www.archive.org/details/formationoffinanOOkind MASS. INST. S^ft 12 1973 QEWEY LIBRARY orking paper department of economics THE FORMATION OF FINANCIAL CENTERS: A STUDY IN COMPARATIVE ECONOMIC HISTORY C. P. Kindleberger Number 114 August 1973 massachusetts institute of technology 50 memorial drive Cambridge, mass. 02139 THE FORMATION OF FINANCIAL CENTERS: A STUDY IN COMPARATIVE ECONOMIC HISTORY C. P. Kindleberger Number 114 August 1973 Draft. Comments, corrections, criticism welcome. 1. I. Introduction It is a curious fact that the formation of financial centers is not studied today in economics. Partly it falls between two stools. Urban and regional economics which concern themselves with cities discuss the location of commerce, industry and housing but rarely that of finance. (An exception should perhaps be made for Canada [Kerr, 1965, 1967] and for i France [Labasse].) A recent United States survey of urban economics men- tioned finance only once in the text, and referred to no book on the subject in a bibliography of 438 items [Goldstein and Moses]. At the same time, a vigorous new literature on money and capital markets and their role in eco- nomic development takes no interest in geographical location or the relation- ships among financial centers [Goldsmith, McKinnon, Sametz, Shaw]. Apart from a sentence or two, one would think that the money and capital market was spread evenly throughout a given country. Such general analytical literature as I have found goes back to World War I. In a 1912 study, Marco Fanno has a chapter on the centralization process in banking and money markets, including the geographic centralization. A 1915 volume on The Evolution of the Money Market presents an elaborate account of the processes by which congeries of isolated banks were formed into a financial hierarchy centered on London, with liberal use of physiological analogies, including "natural selection" and "survival of the fittest." In his general work on economic history, Gras describes the development of metropolitan economy from town economy and village economy, and specifies that the metrop- olis adds the function of finance [Gras, chaps v, vi]. His work demonstrates an interest in the functions of and relations among financial centers which is rare in current research. 2. The problem is of considerable historical interest, and not without relevance to contemporary issues. Historically, for example, explanation is needed why money and capital markets were centered at the capital in Great Britain, France and Germany, but not in Italy, Switzerland, Canada, the United States, Australia, etc. Or one can formulate an aspect of the issue as a riddle: what do the Midlands Bank, the Credit Lyonnais, the Dresdner Bank, the Banca Tiberina, the Bank of Nova Scotia and the First of Boston Corporation have in common? The answer is that their executive offices are located in a different place than that implied by their name - the Midlands Bank in London, the Credit Lyonnais in Paris, the Dresdner Bank in Berlin from 1892 to 1945, the Banca Tiberina (after 1879) in Turin, not along the Tiber, the Bank of Nova Scotia in Toronto, and the First of Boston Corporation in New York. The two historical curiosities can be com- bined: a year after the Midlands Bank transferred its headquarters from Birmingham to London (in 1891) , there was a simultaneous movement of the A. Schaffhausen'scher Bankverein from Cologne to Berlin, i.e. from provincial city to the capital, and of the Eidgenttssiche Bank from Berne, the capital, to Zurich. The affinity of finance and locations is underlined by the fact that so many banks have places, rather than functions (Merchants, Farmers, etc.) in their names. (For private banks where confidence is all-important banks are named for people.) Contemporary relevance is provided partly by the tasks of building money and capital markets in developing countries, which McKinnon and Shaw regard as vital to economic development and more important than foreign aid or export expansion. Of interest to the writer is the question of predicting which center, if any, will emerge as the leading money and capital market of the European Economic Community if its monetary integration is achieved. For the purposes of such prediction it is necessary to have a model of the formation of financial centers. In the pages that follow a comparative analysis is presented in literary rather than statistical or econometric form. It is perhaps unneces- sary to defend the comparative method after having shown that the adminis- trative capital sometimes serves as the financial center, and sometimes does not, I go further, however, and suggest that the study of single cases, valuable as It is, frequently tempts the economic historian to rely too heavily on single analytical models, and that the comparative method, for limited prob- lems at least, is of value in showing what in historic process is general and what special. The qualification that the comparative method is most effective with limited problems - as a rule of a partial-equilibrium sort - reflects scepticism that general-equilibrium issues like business cycles, stages of growth, and backwardness embody too many degrees of freedom as one moves from one to another country, society, polity and economy to enable the analyst to generalize with confidence. As an aside, let me note the conviction that the comparative method is best pursued by dealing with broadly similar countries rather than those of widely differing cultures, traditions and stages of development and put- ting the several cases through one head. Useful work is done by assembling different experts on different countries and asking them to follow a single outline. The two volumes edited by Cameron on the role of banking in the early stages of industrialization show this method at its best, with the editor seeking to generalize on the basis of separate studies [Cameron, 1967, 1972]. With multiple authorship, it is possible, of course, to go 4. wider and deeper. On the other side of the argument, however, I contend that a number of similarities and disparities of analytical interest will be missed with collective authorship, which relate to material examined but not recorded by separate writers. The paper which follows is thus, to an extent, an example of a method which is perhaps more widely appli- cable, as well as a study of financial markets in themselves. That the comparative historical account is qualitative rather than quantitative derives from the limitations of the writer, the enormity of the task of rendering the data comparable - both financial data and those for geographic entities, and my interest in process more than outcome. Such an impressive financial study as Goldsmith's Financial Structure and Development shows conclusively that financial machinery becomes more elab- orate as a country grows in productive capacity, but it does not examine the detailed processes. To extend this study from the qualitative to the quantitative - a highly desirable goal - would make it unduly long. The section which follows briefly reviews the literature on the location of metropolitan cities, their functions, the roles of money and capital markets in the development process, and the evolution of banks and banking. In what follows banks and banking are central with little explicit attention to other elements of money and capital markets. There will be some reference to clearing houses, stock exchanges, government security markets, mortgages, foreign bonds and insurance, though none to factoring, consumer finance, pension funds, and other sections of the market. With growth, the importance of banks as financial intermediaries diminishes relative to other institutions, but it is always strategic. The next section also attempts to indicate the benefits of centralization of money . 5. and capital markets, and the limits to those benefits beyond which new financial centers tend to be created rather than the old enlarged. After section II, there follows a series of case studies on the centralization process. Sections III, IV and V deal with Britain, France and Germany, where the capital became the financial center. The contrast between the British and French cases on the one hand, and the German on the other, is furnished, of course, by their respective political histories and late unification of Germany in 1870. Sections VI and VII deal with the Italian and Swiss examples, both with late unification in 1848 and 1860 respectively, where the financial center turns out to be altogether different from the political capital. Canada and the United States come next in sections VIII and IX, where again Ottawa and Washington are not financial centers. The Canadian experience is particularly of interest as the country freed itself successively to a considerable degree from money-market reliance on London and New York - a decentralization process - experienced an incom- plete shift from an established financial center, Montreal, to a new one, Toronto, and has recently begun to develop a relatively independent market in Vancouver. Section X treats cursorily the changes of the world financial center from London to New York, and from New York to the Euro-currency market. A concluding section XI summarizes the evidence and seeks to indi- cate its usefulness in forecasting the evolution of a European financial center II. Banking Development and the Metropolis A recent spate of books has thrown new light on the role of banking in economic development. Two of the earliest writers in the field were Hoselitz and Gerschenkron who emphasized especially the role of the Credit Mobilier in 6. 1852 in France in stimulating rapid industrial expansion. German banking was said to be as powerful as the steam engine [Gerschenkron, 137], These leads were followed up and developed by Cameron, both in his book on France and the case studies he edited [Cameron, 1956, 1967, 1972].