Tag Archives: financial history

Does Bank Competition Lead to Higher Growth?

Bank Deregulation, Competition and Economic Growth: The US Free Banking Experience

By Philipp Ager (University of Southern Denmark) and Fabrizio Spargoli (Erasmus University Rotterdam)

Abstract

We exploit the introduction of free banking laws in US states during the 1837-1863 period to examine the impact of removing barriers to bank entry on bank competition and economic
growth. As governments were not concerned about systemic stability in this period, we are
able to isolate the effects of bank competition from those of state implicit guarantees. We find
that the introduction of free banking laws stimulated the creation of new banks and led to
more bank failures. Our empirical evidence indicates that states adopting free banking laws
experienced an increase in output per capita compared to the states that retained state bank
chartering policies. We argue that the fiercer bank competition following the introduction of
free banking laws might have spurred economic growth by (1) increasing the money stock
and the availability of credit; (2) leading to efficiency gains in the banking market. Our
findings suggest that the more frequent bank failures occurring in a competitive banking
market do not harm long-run economic growth in a system without public safety nets.

URL: http://d.repec.org/n?u=RePEc:hes:wpaper:0050&r=his

Circulated by NEP-HIS on: 2013-12-29

Review by Natacha Postel-Vinay

In this paper, Philipp Ager (University of Southern Denmark) and Fabrizio Spargoli (Erasmus University Rotterdam) ask two very topical questions. Does increased bank competition lead to higher economic growth? And, if so, how? Following the recent crisis, many have wondered whether the alternative to “too-big-to-fail” — having many smaller banks competing with each other — would necessarily be a better one. Clouding the debate has been the difficulty of finding appropriate historical settings in which to test the hypothesis that more competition leads to greater growth. In their paper, Ager and Spargoli focus on what they consider the best instance of intense bank competition without any implicit government bail-out guarantee: the American free banking era.

Between 1837 and 1863 new laws were passed in a number of states allowing just about anyone to set up a bank, with very few requirements to fulfill. Until then, banks wanting to open needed a charter from their state, for which they had to meet relatively stringent criteria. As the authors show using a new quantitative analytical framework, the new laws greatly increased the creation of new banks in the states which passed them. As competition increased, however, a higher proportion of banks ended up failing. Could it still be the case that the introduction of free banking laws led to greater growth in those states?

A satire on Andrew Jackson's campaign to destroy the Bank of the United States and its support among state banks, 1836. It was partly to fill this gap that states allowed free banking.

A satire on Andrew Jackson’s campaign to destroy the Bank of the United States and its support among state banks, 1836. It was partly to fill this gap that some states allowed free banking.

The paper’s most important finding is that increasing competition among banks did lead to higher economic growth. Jaremski and Rousseau’s 2012 paper (previously reviewed in NEP-HIS here) found that a new “free” bank, as opposed to a charter bank, did not have a positive effect on the local economy. While this is an important finding in itself, it is also important to look at the effect of the introduction of free banking laws on aggregate bank behaviour, if only because the new entry of free banks may alter the willingness of charter banks to enter the market and their behaviour once in the market. Charter banks’ behaviour may in turn alter free banks’ behaviour, and so on. Interestingly, Ager and Spargoli’s study finds that in the aggregate, the acceleration in bank entry and resulting greater competition among all types of banks had a positive effect on economic growth.

To arrive at this conclusion, the authors are careful to include a number of controls. First, there is the possibility that growth opportunities led some states to adopt free banking laws, in which case the authors would face a reverse-causality problem. Hence they conduct a county-level analysis in which they include time-invariant county characteristics and state-specific linear output trends (although perhaps it would be nice to see these output trends going further back in time than 1830). Second, they also control for other laws that states might have introduced at the same time as the free banking ones, which could potentially bias the results. Finally, they control for unobserved heterogeneity between states by examining contiguous counties lying on the border of states that introduced free banking. Their results are robust to these different specifications.

Private Bank Note, Drover’s Bank, Salt Lake City, Utah, $3, 1856

Private Bank Note, Drover’s Bank, Salt Lake City, Utah, $3, 1856

Ager and Spargoli are of course also interested in where this growth came from. They find a positive relationship between the introduction of free banking laws and lending, and conclude that one of the main channels through which this increase in growth occurred was the increase in the availability of credit that greater competition fostered. This story is consistent with the finance-growth nexus literature, which argues that greater (and safer) access to credit is conducive to economic development.

Although this seems perfectly reasonable, it would perhaps have been interesting to see when most of the failures occurred. If, for instance, they mainly occurred towards the end of the period under study, say around the 1857 panic, then it is possible that the negative effects of such failures on subsequent growth would not have been picked up by this study, since it ends in 1860. This leaves open the possibility that the positive relationship between free banking and increased access to credit was not a beneficial one for the economy in the long run. Loan growth (and asset growth more generally) is not always a good thing, as the recent crisis has tended to show.

Private Bank Note, Mechanics Bank, Tennessee, $10, 1854

Private Bank Note, Mechanics Bank, Tennessee, $10, 1854

Overall however, Ager and Spargoli’s paper asks a very important question and offers a solid analysis. A natural next step would be to include output data on the periods preceding and following the free banking era, although the occurrence of the Civil War is an obvious obstacle to this study.

 

References

Jaremski, M., and P. L. Rousseau (2012): “Banks, Free Banks, and U.S. Economic Growth,” Economic Inquiry, 51(2), 1603–21.

Accounting for Deception in the Industrial Revolution

Creative accounting in the British Industrial Revolution: Cotton manufacturers and the ‘Ten Hours’ Movement

By Steve Toms and Alice Shepherd (both at the University of Leeds Business School)

Abstract

The paper examines an early case of creative accounting, and how, during British industrialization, accounting was enlisted by the manufacturers’ interest to resist demands, led by the ‘Ten hours’ movement, for limiting the working day. In contrast to much of the prior literature, which argues that entrepreneurs made poor use of accounting techniques in the British industrial revolution, the paper shows that there was considerable sophistication in their application to specific purposes, including political lobbying and accounting for the accumulation of capital. To illustrate lobbying behaviour, the paper examines entrepreneurs’ use of accounting to resist the threat of regulation of working time in textile mills. It explains why accounting information became so important in the debate over factory legislation. In doing so, it shows that a significant element was the accounting evidence of one manufacturer in particular, Robert Hyde Greg, which had a strong impact on the outcome of the parliamentary process. The paper uses archival evidence to illustrate how accounting was used in Greg’s enterprise and the reality of its economic performance. The archival evidence of actual performance is then contrasted with the figures presented by Greg to the Factories Inquiry Commission, convened by the House of Commons in 1833-1834 to hear witnesses from the manufacturing interest. These sets of figures are compared and contrasted and discrepancies noted. Conclusions show that the discrepancies were substantial, motivated by Greg’s incentives to present a particular view of low profits, high fixed costs, and the threat of cheaper overseas competition. The figures appeared to lend some credibility to the apparent plight of manufacturers and to Nassau Senior’s flawed argument about all profit being earned in the ‘last hour’ of the working day. The consequence was a setback for the Ten Hours movement, leading to a further intensification of political struggles over working conditions in the 1840s.

URL: http://econpapers.repec.org/paper/pramprapa/51478.htm

Review by Masayoshi Noguchi

The paper by Toms and Shepherd was distributed by NEP-HIS on 2013-11-22. It makes a welcomed contribution to researching the role of accounting information within the British Industrial Revolution, as great debate still continues over the extent to which accounting technology was used for management decision making during that period.

The aim of Toms and Shepherd is to examine “the use of accounting by entrepreneurs to resist the threat of regulation of working time in textile mills in the early 1830s” (p. 2). This by analyzing the extent of “anti-regulation lobbying on working hours and child labour was influenced by accounting manipulation” (p. 2).

Archival evidence was sourced in the business records of the partnerships of Samuel H. Greg and Sons. As is well known, one distinctive feature of accounting system of partnerships until present day is profit-sharing amongst principals. Toms and Shepherd also examines in detail the level of “sophistication in recording capital appropriations and accumulations” (p. 4) among partners. This as the partnerships’ accounting system recognised implied interest charges of capital and used them to arrive at the balance carried forward. However, this criteria sharply contrasted with the absence of any other criteria for accounting for fixed assets (including depreciation). Fixed assets were treated as part of “[Greg’s] private estate and not assigned to the partnership” (p. 14). The practice at Greg and Sons thus provides a further case to support Pollard’s critical assessment of the limited use of accounting information for decision purposes (p.14).

Business records recording the actual performance of the business are then contrasted with evidence submitted by Robert Hyde Greg to the Factories Inquiry Commission of 1833. Toms and Shepherd then argue that the latter accounting evidence was distorted by the manufacturer’s interest to oppose the introduction of regulation stipulating the working day in textile factories. In particular, Greg manipulated accounting evidence submitted to the Factories Inquiry Commission by exaggerating “the importance of wages as an expense” (p. 22). This by assuming that most of the production costs in general, and wages in particular, were fixed costs and thus “reducing the working day would increase the burden of fixed charges” (p. 21) on profit.

Robert Hyde Greg (1795-1875)

Using the information recorded in Greg’s accounts of the partnership, Toms and Shepherd offer some factual and contra-factual exercises, including the calculation of “implied” rate of return on capital (pp.32-33). They then compare these results with the evidence provided by Greg to the Commission thus providing clear evidence of the manufacturer’s accounting manipulation. However, as the authors themselves admit, the concept of “return on capital is not referred to specifically in Greg’s evidence (only ratios of profit to output)” (p. 31), even though “the committee (sic) could easily draw conclusions from his tabulated appendices” (p. 31). Personally I would like to know more about the effect of writing-off the asset values exercised in 1832 (pp. 27, 30) on Greg’s submission of the accounting evidence to the commission in 1933.

With the skilled manipulation, the evidence submitted by Greg was successful to achieve a political effect with the final report of the Commission incorporated the entrepreneurs’ argument against the regulation on working hours. The authors conclude that accounting information could be used “not so much as an aid to [rational] management decisions, but as a [opportunistic] means of influencing others” (p. 36).

A History of Japanese Audit Firms, 1965–2010

Integrating Personal Expertise: A History of Japanese Audit Firms, 1965–2010

by

Masaru KARUBE (Institute of Innovation Research, Hitotsubashi University, Japan)

Hironori FUKUKAWA (Graduate School of Commerce and Management, Hitotsubashi University, Japan)

ABSTRACT

To examine empirically the knowledge integration process of professional expertise that individuals have in a professional firm, this paper examines the emergence and growth of four large audit firms (ShinNihon, Azusa, Tohmatsu, and ChuoAoyama) in Japan over a period from the mid-1960s to 2010. Known as the Big Four, these firms—the product of a series of mergers between more than 70 audit firms—handled the vast majority of audit services for listed companies during this period. After the dissolution of ChuoAoyama in 2006, the remaining three audit firms have dominated the market.

A longitudinal case study documents how these professional service firms were successful in providing nationwide services through mergers with domestic competitors and the provision of global services in alliance with large international firms, even though they did not sufficiently realize the systematic attainment of individual expertise. The historical account of this process suggests that the two driving forces underpinning the merger growth of the Big Four were strategic intent in (1) systematizing individual expertise and (2) establishing nationwide and global service networks in response to the increase in size and growing diversity and complexity of their client base. Finally, this paper discusses the knowledge tension between localized individual expertise and organizational knowledge in a global context.

URL: http://econpapers.repec.org/paper/hitiirwps/13-07.htm

Review by Masayoshi Noguchi

This paper is an interesting piece of work that intertwines management and accounting history with a focus on post-war developments in Japan. The paper was distributed by NEP-HIS on 2013-04-06.

The main issue is ‘how knowledge workers collaborate and create new knowledge through collaboration’ in general, and ‘how professional knowledge workers collaborate between themselves and how collaboration is organized’ (p. 2) in particular. Then the authors state the research question in this study as follows:

‘Our basic research question concerns why large audit firms through a series of mergers have replaced audit services, as initially provided by a single or limited number of individual accountants’ (p. 2).

The fieldwork in Karube and Fukukawa’s paper moves forward by exploring the official history of accounting firms while, at the same time, looking for stated motivations of mergers during the post-war period. As a result, they state the following views as motivation for mergers amongst accounting firms:

‘(1) to overcome the intrinsic contradiction between economic dependency and the independence of audit opinion,

(2) to enhance their systematized audit capabilities to meet the growing and diverse need for audit services by client firms, and

(3) to acquire new client firms by establishing a reputation for audit services’ (p. 2).

Point (3) above is the most interesting, particularly given the stated aim of Karube and Fukukawa. Point (3) seems to be an important driver that helps to explain the mergers between major large-scale firms, according to the authors; who also state that:

‘…such explicit differences did not exist between major firms in terms of the substance of competence. Rather, it seems that no explicit difference in terms of the substance of competence promoted further competition for scale expansion. In other words, scale itself came to serve as a symbol of competence in the competition process between audit firms, especially large major firms. Scale expansion through merger then emerged as a reflection of the intense competition for the social proof of competence’ (p. 27).

According to Karube and Fukukawa, audit firms expanded through the acquisition of the audit services for the Nippon Telegraph and Telephone Public Corporation, Japan National Railways and the Japan Tobacco & Salt Public Corporation. In this regard, greater detail as to the process and selection of these acquisitions would provide interesting case material and warrant further examination in order to deepen the business history of Japanese corporation. In this regard Karube and Fukukawa state that:

‘…these firms were all large, the expectation was that the designated auditor or auditors would have sufficient human resources to provide audit services for such large firms. Moreover, many audit corporations shared the understanding that audit service was in essence difficult to differentiate, so that the size of the audit firm mattered for gaining these sorts of clients’ (pp.17-18).

A key concept in this study is ‘the social proof of competence’, where acquiring reputation, social status and symbolic outputs is more important than actual results/outputs. Therefore, for Karube and Fukukawa during the post-war period Japanese professional auditors:

‘…are more concerned about gaining social proofs of competence than the substance of competence. To do this, they pursue strategies that win reputation from clients, acquire good clients regarded as having high status, and produce symbolic outputs that are visibly appealing to clients. Reputation also derives from each client’s own experience of audit services, or is inferred from the provider’s past experiences, including their courses of action and results. Thus, past courses of action and experience for providers matter in gaining reputation from clients’.

In spite of this profound understanding, the authors develop the following proposition:

‘…in contrast to consulting services, as audit services derive more from the formal audit procedures decided by government, it is more difficult to differentiate services. Thus, the most symbolic output is the scale of services, as exemplified by the number of clients, the number of good clients, revenues from audit services, and the geographic coverage in providing services’ (pp. 6-7).

To be sure, the author will also consent to the other elements, such as recognition from influential others, such as government, being important, though size is one of the important elements for acquiring reputation.

Finally Karube and Fukukawa find no evidence that expansion through mergers contributed to an improvement in organizational competence nor that it improved the quality of audit services (and reduce accounting fraud. Specifically the authors state that:

‘…in the light of the substantial integration of organizational competence, there should be efforts to remove such weak integration as soon as possible after the merger. In the case of Asahi-kaikeisha Audit Corporation, it took nearly 10 years to dissolve the personalized audit system and to systematize the job and client rotations of junior professionals among audit offices within the firm. … As a result, Japanese audit firms succeeded in gaining social proofs of competence by way of scale expansion through mergers rather than realizing the substance of competence, in that they still faced difficulties with the internal integration of the merged firms’ (pp. 25-26).

‘The fact that this mobility [of accountants caused by the demise of Misuzu Audit Corporation] was observed six years later when Chuo and Aoyama merged in 2000 implies not only the existence of insufficient integration but also the presence of strong relationships between clients and accountants in their operations, suggesting the possibility of insufficient systematization of the substance of organizational competence’ (p. 28).

If the social proof of competence and substance of competence are completely different and scale expansion pursues the former objective, this result of the merger of the audit firms is quite natural. Probably, the relationship of both would not be so simple. The merger between the audit firms should have offered an important opportunity to enhance organizational competence, such as wider risk diversification, enhanced economic independence, strengthened bargaining power, improvement through scale merit, nationwide services, etc. Rather it largely depends on the management after the merger whether this opportunity can be exploited or not. In this sense, the authors’ following indication is appropriate:

‘[w]hile merger can be the “easiest” way for a firm to grow, the process of post-merger integration remains a critical and ongoing issue for management’ (p.29).

The Origins of the Modern Concept of Money

French economists and the purchasing power of money

by Alain Béraud (alain.beraud@u-cergy.fr), THéorie Economique, Modélisation et Applications (THEMA), Université de Cergy-Pontoise (France)

Abstract

When French economists read The Purchasing Power of Money, they were primarily interested in the equation of exchange and the reformulation that Fisher proposed regarding the quantity theory of money. This reading led them to ponder the meaning that should be given to this theory and to study its empirical significance. Some of them, namely Rueff and Divisia, went further still and considered Fisher’s work as a starting point for their own analyses, which were related in particular to the monetary index, the integration of money into general equilibrium theory and the analysis of monetary phenomena in an open economy.

Keywords: quantity theory of money; price index; theory of purchasing power parity; marginal utility of money; integration of money into general equilibrium.

URL http://econpapers.repec.org/paper/emaworpap/2013-10.htm

Review by Bernardo Bátiz-Lazo

This paper was circulated by NEP-HIS on 2013-03-30. Alain Béraud, its author, offers a detailed account of how many French economist criticised Irving Fisher’s (1867–1947) quantity theory of money while others supported it. In particular, he explores the extent to which Firsher’s ideas appear within the work of two great French economists, namely François Divisia (1889-1964) and Jacques Rueff (1896-1978).

Alain Béraud – Professeur de Sciences Économiques
(Université de Cergy-Pontoise)

Fisher’s formulation of the equation of exchange (where the total price of commodities sold equals the total value of the money that was given in exchange) is now part and parcel of every undergraduate programme in economics. It is integral and fundamental to the current understanding of macroeconomic management. Given this plus the rise of digital payments, mobile-phone wallets and crypto-currencies like Bitcoin, it is important to remember and indeed timely, to have an in depth discussion about how our conception of money – then measured as notes and coins – came to be and how it was shaped by dissenting views. In this regard says Béraud:

From the time of its publication through to the 1930s, The Purchasing Power of Money was the reference work for French economists who interpreted it as the modern, rigorous version of quantity theory. But this theory was hardly popular. It is therefore not surprising that many French economists, while recognising its merits, fiercely criticised it. It was only in the 1920s that Rueff and Divisia, both graduates of the École Polytechnique where they had been students of Clément Colson, used this book to develop their own analyses of monetary phenomena. Here, I have defended the idea that their contributions were certainly original but were nonetheless based on ideas that Fisher had supported.

Front of French frank coin (1996), commemorating the life of Jacques Rueff

As noted above, through his narrative Béraud compares and contrasts how the work of Fisher was incorporated into the ideas of French economists. He also offers a rich discussion of the reasons why there was dissent and why many took exception and actively criticised Fisher’s work.

The picture that emerges from Béraud’s work allows us to see how economist of the early 20th century on both sides of the Atlantic are engaging in a type of debate that now dominates the discipline, namely highly quantitative and empirically based. Something that, I thought, only took place after World War II – and thus, happy to be set straight. Moreover, this sort of debate was something that, according to Walter Friedman’s brief biography of Fisher, characterised Fisher’s early contributions to our understanding of macroeconomic phenomena. However, we are not provided by Béraud with enough detail to ascertain if a debate with such characteristics was widespread in France or whether it is Béraud’s reconfiguration of the debate between monetary factors and prices, that which leads us to emphasise its quantitative, formal, empirical aspects.

It was also interesting to know that the contemporary discussion of Fisher’s ideas was hampered by lack of available data. For instance, Béraud notes that at this point in time: “data on bank deposits [was unavialble]. Only some establishments published monthly statements.” Here, in my view, some more context as to how and when such measures came to be mainstream and a brief reference to the overall construction of macroeconomic statistics in France would have given a bit more sense of perspective to the discussion.

In the same vein, I would have liked, as a manner of introduction, some context as to why, how relevant and how widespread the debate of Fisher’s ideas was in France during the interwar period. It seems French economists are very concerned with determining exchange rates and the future of the Gold Standard at the end of the First World War. But this is only mentioned in passing. For the international reader it would have also been helpful to have an introduction as to the broad configuration of French economists groups or lines of work at this point in time.

But for all my comments and on balance, this paper makes an interesting read.

François Divisia (1889-1964) – a founding member of the “Econometric Society”

Knowing the Who: Identifying the effect of entrepreneurs on firms

Do entrepreneurs matter?

Sascha O. Becker (s.o.becker@warwick.ac.uk), CAGE University of Warwick

Hans K. Hvide (hans.hvide@econ.uib.no), University of Bergen, CEPR and University of Aberdeen

Abstract

Within the broad literature on firm performance, economists have given little attention to entrepreneurs. We use deaths of more than 500 entrepreneurs as a source of exogenous variation, and ask whether this variation can explain shifts in firm performance. Using longitudinal data, we …find large and sustained effects of entrepreneurs at all levels of the performance distribution. Entrepreneurs strongly affect firm growth patterns of both very young firms and for firms that have begun to mature. We do not find significant differences between small and larger firms, family and non-family firms, nor between firms located in urban and rural areas, but we do find stronger effects for founders with high human capital. Overall, the results suggest that an often overlooked factor –individual entrepreneurs plays a large role in affecting firm performance.

URL: http://d.repec.org/n?u=RePEc:wrk:warwec:1002&r=his
Review by Beatriz Rodriguez-Satizabal

Promoting entrepreneurship has been fashionable since the 1980s and there are no signs of it going away. Messages about the importance of becoming your own boss, giving something back to the society, and be an active agent of the economy are there to be seen everywhere on a daily basis. Governments around the world are constantly discussing new ways to increase the number of entrepreneurs and we also see on a regular basis articles within broadsheet newspapers and the popular media trying to identify and challenge those who see themselves grow by creating firms and markets.

In this paper, distributed by NEP-HIS on 2013-01-28, Hvide and Becker question the outcomes of investments to promote entrepreneurship during the last 20 years: Do the entrepreneurs really deliver technological change? Is it sustainable for an emerging country to allow a growing number of entrepreneurs? Is the longevity of the firm related to the characteristics of the founder? Should entrepreneurs be employees in their firms?

The idea of the entrepreneur as an important agent is not entirely new. But studying the role of the entrepreneur within the firm and its effect over its performance has been neglected. In this regard evidence documented in this paper is a step towards a better understanding of the effect of the entrepreneur over the performance of the firm.

Picture1

Based on the assumption that the death of an entrepreneur has an immediate effect on the firm due to the changes in corporate governance that it implies, Becker and Hvide constructed a database of Norwegian firms consisting of incorporated, limited liability companies for the period 1999 to 2007. The authors identified a total of 500 firms where the founding entrepreneurs died, providing an opportunity to quantify whether entrepreneurs have a causal effect on firm performance or not.

As a result of a thorough statistical analysis, the authors find that the effects are large and strong. The entrepreneur shapes the firm and affects its growth patterns. Entrepreneurs matter because of the loss of human capital (but, interestingly, the effect could be also negative as higher performance takes place after death of the founder). Surprisingly, Becker and Hvide do not find any difference between small and large firms, family and non-family owned, nor between firms located in rural or urban areas. This last result is certainly, in my view, an open call to bring the individual characteristics of the entrepreneur to the study of the firm, which is a unit that needs the human capital factor to success.

This paper is a valuable contribution to those studying entrepreneurship because it positions the role of the individual deep into the nature of firm performance rather than having it as a separate unit. It calls our attention over the widely spread assumption that entrepreneurs also innovate within the organization (Schumpeter) and have effects in and out of it (Baumol). If entrepreneurs matter, then knowing the who, why and how must be part of the discussion on public policy to promote entrepreneurship. Moreover, when in emergent countries the close relationship between the successful entrepreneurs and the government still persists.