The Political Economy of Financial Systems

Abstract

Why do countries with similar levels of development have such different financial systems? Some countries, such as the US and UK, rely extensively upon capital markets for mobilizing new capital, while others, such as Germany, France, and Japan, rely heavily on bank lending. I argue that the structure of a country’s financial system depends on the political power of farmers and labor relative to that of large firms, where farmers and labor prefer banks, while big firms prefer capital markets. I present cross-section time-series statistical analysis across 14 OECD countries from 1976-1990, as well as data spanning the twentieth century for France and Japan. The results suggest that labor-rural political power plays the primary role, while international capital mobility, which permits large firms to seek financing abroad, plays a secondary role in determining the structure of a country’s financial system.

Keywords: politics, electoral systems, legal origins, finance, financial development, labor, farmers

JEL Classification: N20, N40, P50, P16, G18, G28, G38