Since the late 1970s, the growth of the financial sector has accelerated in most advanced economies. At the same time however, there has been considerable cross-country heterogeneity underlying this aggregate trend. As a result, on the eve of the 2008 financial crisis, the size of the financial sector differed markedly across countries. And yet, the determinants of both the strong growth in the financial sector, and the divergence across countries, are so far not well understood. This project aims to fill this void using the toolkit of quantitative economic history. Specifically, we will study the long-run growth of the financial sector in 15 advanced economies since the late 19th century and analyze the structural change of financial intermediation over time. Such a historical cross-country perspective will allow us to distinguish between country-specific and cross-country developments and will therefore provide a better understanding of the causes and consequences of these changes.
We will study the growth of the financial sector in the Western world in three steps:
- The main function of finance is the provision and trading of financial instruments. In this process, financial intermediation pools the risks and transfers resources across time, from actors who have them to those who need them. The costs of these services, and hence the income of the financial sector, has varied substantially over the past century and has increased particularly strongly during the last few decades (Philippon, 2015). This part of the research project analyzes the evolution of the income and profits from financial intermediation for 15 OECD economies from 1870 to today based on historical national accounts and other historical sources. These data will help us to systematically understand the growth of the financial sector throughout the Western world.
- Examining the value added of the financial sector provides only one perspective on the growth of finance since the late 19th century. In the second part of the project, we will analyze the evolution of the sector’s output, i.e. the production of financial services for households and businesses. We are particularly interested in two main questions: First, how has the volume of financial intermediation changed over the past 140 years? And second, what is the relative importance of equity and debt financing in this development?
- Much of the growth of finance has taken place relatively recently, during the decades following 1970. The third part of the project zooms in on these past four decades to study the country-specific determinants of this trend. We will particularly focus on the following two driving factors (Greenwood and Scharfstein, 2013). First we will examine the growth of professional asset management. It is important to note that the increase in financial assets under professional management was directly related to changes in the structure of pension systems, i.e. from contribution-based to funded pension schemes. As a second main determinant, we will study the expansion of household credit since the 1970s. The empirical evidence shows that most of this increase was associated with an increase in mortgage debt of households (Jorda, Schularick and Taylor, 2016). For a comprehensive historical analysis of these two factors it is thus essential to analyze the political factors that fostered these structural changes and study the interaction of the growth of finance with other secular trends, such as the rise in income inequality and globalization.