Category Archives: Institutions

Northern Lights: Computers and Banks in Nordic Countries

ICT the Nordic Way and European Savings Banks

by J. Carles Maixé-Altés (maixe@udc.es) Universidad da Coruña

Abstract: This paper discusses the world industry of savings banks, a genuine world collaborative consortium, through which, from the 1950s, the International Savings Banks Institute (nowadays, the World Savings Banks Institute and European Savings Banks Group) was highly active in introducing ICT to retail banking. In this environment, Nordic savings banks, Sweden, Norway, Finland and Denmark, their Central Savings Banks and their industry associations occupied a separate place in European movements around developments of computerization and automation in retail financial services. The synergies in Nordic countries were superior to the rest of Europe and collaboration was intense. This paper highlights the leadership and the influence that the ICT development models of Nordic savings banks had on their European retail banking associates.

URL http://econpapers.repec.org/paper/pramprapa/58252.htm

Review by Bernardo Bátiz-Lazo

Introduction

In today’s world Stockholm is rivalling Silicon Valley with a hotbed of technology start-ups. Swedish success stories include familiar names such as file sharing site The Pirate Bay (established 2003), video chat and calls Skype (established 2003) and music streaming Spotify (established 2008). These developments have not gone unnoticed by the media (see article by Forbes) nor by historians. There is a growing and vibrant body of systematic studies on the economic, business and technological history of Nordic computing as reflected by the fourth edition of History of IT in the Nordics (HiNC4) confrence on August, 2014. All of these HiNC conferences have been followed by an edited book of accepted papers, published by Springer’s increasingly succcessful History of Computing series (a series under the stewardship of Martin Campbell-Kelly (Warwick)).

Nordic-Startup-Awards

Summary

The paper by Joan Carles Maixé-Altés contributes to above mentioned literature and was distributed by Nep-His on 2014-11-1. In it he succesfully intertwined topics of great importance which, with the exception of Scott & Zachariadis (2012 and 2013), have been dealt in isolation, namely: not for profit financial institutions, technological innovation in the late 20th century and international competitive collaboration.

Maixé-Altés gained access to previously unexplored archival material from the International Savings Banks Institute (nowadays the World Savings Banks Institute and European Savings Banks Group). The focus of this first instalment of Maixé-Altés’ research deals with the efforts by Nordic savings banks (i.e. Denmark, Finland, Norway and Sweden) to gain scale in information and comunication technology (ICT) through co-operation. Savings banks were born in 1810 in Rothwell, Scotland as part of the 19th century “thrift movement”. This organizational form was replicated across Europe and British colonial dominions. Today savings banks have dissapeared from Australia, New Zealand, the USA and most European countries. This regardless of whether they had narrow (e.g. UK) or broad operations (e.g. Sweden, Spain). However, they remain important players in retail banking in Germany, Norway and Portugal.

Denmark, Norway and Sweden are considered to be the Scandinavian countries and the Nordic Countries are these three plus the Åland Islands, the Faroe Islands, Finland, Iceland and Greenland.

Denmark, Norway and Sweden are considered to be the Scandinavian countries and the Nordic Countries are these three plus the Åland Islands, the Faroe Islands, Finland, Iceland and Greenland.

Analytically, this paper proposes a double point of view. Firstly, Nordic countries are considered early adopters of computer technologies and, simultaneously, ingintegral to the processes of dissemination and appropriation of foreign business models. Secondly and whilst detailing the efforts by Nordic savings banks on computarisation, Maixé-Altés reminds us of the heteregoneity of organizatonal forms in retail finance during the 20th century. Also how the democratic principles behind these particular form of corporate governance led to an “open door” policy for the sharing of best organizational practice as well as to collaborate across borders with “sister institutions” to faclitate their economic and social objetives. But as was pretty much the case across retail banking in the 1960s and 1970s, savings banks in Nordic countries adopted computer technology with the twin hope of increasing efficiency of operation and counter attack the growth of commercial banks within the market for retail deposits.

With those analytical aims in mind the paper structures in four main sections while preceeded by an introduction and finalised by a concluding section. Maixé-Altés starts his story with the first steps of co-operation within national borders. These led, for instance, to the establishment of “central savings banks” or institutions that help gain critical mass in whole sale financial markets. This to substantiate his claim that collaboration is well embeded within savings banks. He then moves to explore co-operation within electronic data processing in general while providing details of an “emblematic case” of this collaboration: Nordisk Spardata.

J. Carles Maixé-Altés

J. Carles Maixé-Altés

Critique / Comentary

I very much liked the paper. However, I will advance a couple of ideas which future work on these archives could bear in mind.

First, Maixé-Altés’ emphasis on changes in hardware as an index for co-operation in data processing suffers from a common shortcoming in this literature (an issue shared by many econometric studies of technological change in financial institutions), namely its focus on back-office transaction processing and an over reliance in hardware and central processing units while “missing .. the choices being made between operating systems, programming languages, network technologies, databases, or the source of application software.” (Gandy 2013: 1228). More could then be said about these choices and the formation of standards and computer networks.

Secondly, I fundamentally disagree with Maixe-Altes’ claims around the use of “real time” computing. As I have argued in Bátiz-Lazo et al. (2014) as well by Martin (2012) (and evidence in Scott & Zachariadis (2012 and 2013)), in the late 1960s and throughout the 1970s distant devices and computers could be connected but the nature of the banking business meant that form of “on line” communitation still required human intervention and therefore it was not “real time”. Moreover, Haigh’s (2006) seminal contribution documents how database and database management systems were still in its infancy in the 1970s. This effectively meant there was no random access to electronic data. Updates had to be run in “batches”. Full digitalization of customer accounts was “work in progress” and very much an effort that starts in the late 1950s in Sweden (as documented by Bátiz-Lazo et al., 2014) but doesnt materialise until at least the late 1980s.

There is some indirect evidence of this in, for instance, the fact that in the 1980s, human tellers at retail branches supplied indiviuals with balance of available funds “as of last night”, that is, once a central processing unit had been able to gather and sort through all the transactions earlier in the working day (Indeed, I have personal recollections of programming with COBOL in the mid 1980s and having to script sorting programmes). Another telling example is that automated teller machines (ATM) relied on combination of information stored on the activation token’s magnetic stripe and a list of overdrawn or otherwise delinquent and cancelled accounts stored on a cassette tape inside the machine itself (see image below). In short, Maixe-Altes’ claims around the use of “real time” computing’could be tone down a notch.

Back of RT650 by Burroughs Corp. (undated)

Back of RT650 by Burroughs Corp. (circa 1980). Source: Charles Babbage Institute (Ascension 90, Series 75, Box 44, Folder 2).)

In summary, Maixe-Altes’ is an interesting part of the history of computing, banking and financial history. It points out there is much more to be said about understanding the technologies of the late 20th century as well as the economic history of competition, cross-border collaboration and not-for-profit financial institutions. On top of this Maixe-Altes ventures into histories of networking and real-time computing, and, more importantly, puts the historical discussions in the context of banking strategy. As such, an intersting new addition to this growing literature.

References

Bátiz-Lazo, B., Karlson, T. and Thodenius, B. (2014) “The Origins of the Cashless Society: Cash Dispensers, Direct to Account Payments and the Development of On-line, Real-time Networks, c. 1965-1985”, Essays in Economic and Business History 32(May): 100-137.

Gandy, A. (2013) “Book Review: Technological Innovation in Retail Finance (2012, Routledge)”, Economic History Review 66(4): 1227-12278.

Haigh, T. (2006) “’A Veritable Bucket of Facts’:Origins of the Data Base Management System”, ACM SIGMOD Record 35(2): 33-49.

Martin, I. (2012) “Too Far Ahead of Its Time: Barclays, Burroughs and Real-Time Banking”, IEEE Annals of the History of Computing 34(1): 2-16.

Scott, S., Zachariadis, M. (2012) “Origins and Development of SWIFT, 1973–2009” Business History 54(3): 462-483.

Scott, S., Zachariadis, M. (2013) The Society for Worldwide Interbank Financial Telecommunication (SWIFT): Cooperative Governance for Network Innovation, Standards, and Community. London: Routledge (Global Institutions Series).

Coming back to @PostOffice #Savings? The #east-west comparative.

Postal financial services, development and inclusion: Building on the past and looking to the future

By

Gonzales d’Alcantara (gonzales.dalcantara@ua.ac.be) Emeritus Professor of Econometrics at the University of Antwerp and d’Alcantara Economic Consulting

Paul H. Dembinski (pawel.dembinski@unifr.ch ) University of Fribourg, Switzerland

Odile Pilley, (odile.pilley@blueyonder.co.uk) International Consultant, formerly with International Bureau of the Universal Postal Union

Abstract: Post offices, inherited from the Industrial Revolution, were monolithic telephone and postal administrations. They were intimately linked to the fabric of nations and made significant contributions to state finances. From the 1960s onwards, integrators, such as UPS and FEDEX, started offering end-to-end express services, thus challenging the postal monopoly in new high added value services. Gradually, the liberalization paradigm gained ground. Telecommunications and sometimes financial services were spun off from postal operations. More recently, new policies and priorities started to emerge especially on the development agenda where financial inclusion has become a top priority in the developing world. The question to be addressed is which role, if any, the posts play or could play in ensuring inclusion. Despite an exceptionally scarce research in the field, this paper provides an overview of how these shifts in paradigm have affected postal policy, the postal financial services regulatory framework, the status of the organizations delivering those services and the offerings themselves in developing as well as in developed countries. After a research review, including the regulatory dimension, the paper focuses on how postal financial services institutions in their legal framework have developed bringing to the fore a panorama of a dozen of promising transformations of financial postal services in developing countries.

URL http://EconPapers.repec.org/RePEc:fri:fribow:fribow00451

Review by Mark Crowley

This paper by d’Alcantara, Dembinski and Pilley was circulated byNEP-HIS on 2014-09-12. The approach is unique in the sense that it seeks to compare the nature of Post Offices in Europe and the developing world, focusing primarily on their role in the savings movement. Its historical approach shows how the western Post Offices developed as a movement that sought to encourage thrift among a profligate working class, whereas in the developing world, the development of a Postal Savings movement was more in line with the growing financial markets across these nations, and the desire for individual customers to express choice in their banking processes. Moreover, it effectively shows how, following a crisis in trust experienced in the banking industry, more people across both the developed and developing world are turning to the government-backed Post Office as a safe haven for their savings in response to the perceived dangers of investing in private banks.

Summary

Citing the latter nineteenth century as the beginning of the Post Office savings movement, with British Prime Minister William Gladstone’s initiative to open a Post Office Savings Bank, this paper demonstrates that the influence of the government over consumer spending has long roots. The authors deftly show that certainly in its embryonic stages, the Post Office savings movement in developed countries focused on the provision of a secure place for working-class savings, while also encouraging thrift. Building on the lack of trust displayed by the working-class towards other alternatives, such as friendly societies, and their exclusion from private sector banks, the savings option offered by Post Offices had fertile ground on which it could flourish.              
 
gladstone 2

The paper also documents the differences between the supervisory natures of the Post Office Savings activities in developing countries, comparing them to that in the developed world. Citing the Asian and Latin American examples, the authors show that the levels of government control over the activities of postal savings banks were significantly more than that in the developed world, with the respective central banks exerting a supervisory role over postal and financial affairs. In the developed world, following with the liberalisation of financial services, the level of central government control over deposits made in postal savings banks has significantly diminished, with initiatives to delegate the administration of post office banking activity to private banks. Although responsibility is still being underwritten by central government (with Bank of Ireland UK as the example for postal savings in the UK) the level of micro-management previously present has now diminished.

d’Alcantara, Dembinski and Pilley also document the necessity of a world legal framework and understanding to evolve with the growing influence of the postal savings movement, especially in the developed world. Citing the aim for legal and financial autonomy to be awarded to postal savings institutions as part of the United Nations millennium goals, it effectively demonstrates the challenges that both the developed and the developing world face in terms of striking the right balance to facilitate the effective supervision of the financial system at a time when the role of private investment banks have been criticised for their excessive risk taking. While many countries in the west still pride themselves on liberal nature of their governments and markets, the definition of this is likely to change in the name of ensuring proportionality and responsibility concerning financial affairs in an age when consumer confidence in private banks is at an all-time low.

imgres

While seeking to emphasise the differences between the postal savings movement in the developed and developing world, this paper also draws on examples of convergence. In the period after the 2008 world financial crisis, there has been evidence that consumers, once more, have come back to the government-backed Post Office savings banks in response to not only their anger about the actions of private banks, but also the perception that government-backed savings institutions are safer in terms of securing deposits during periods of financial crisis. For example, in 2008, much resentment was created in the UK when the government bailed out banks deemed “too big to fail”, costing the taxpayer billions of pounds. While such action ensured that the deposits of savers were guaranteed, many responded angrily that taxpayer’s money was being used to save banks that had shown financial irresponsibility on such a grand scale.

post office uk

The paper ends on an optimistic note for the savings movement in Asia, with particular reference to China. In noting that the Chinese Postal Savings Bank is the fourth largest in China, with its customer base expanding beyond the traditional labouring classes to include students and businesspeople, the authors argue that this has been a triumph for the postal savings movement in the world’s most populous country. While it is worth noting that the level of central government control over all banks in China is possibly significantly more than in any other developed nation, it is a point well made that in a country with a flourishing middle class population, it is the postal savings movement that seems to be gaining the biggest traction.

posb china

Critique

d’Alcantara, Dembinski and Pilley covered a huge chronological and geographical period in their analysis, and have effectively compared the nature of the postal savings movement in the developed and developing world. Perhaps an area that could be explored further is the western government’s ideas of financial liberalisation as a principle that stops short of a full-scale privatisation of Post Office counters (which include financial services)? For example, Margaret Thatcher, despite pursuing a very ambitious privatisation programme in the 1980s, stopped short of privatising Post Office counters, despite taking steps to remove the ‘Giro’ from government control. Deeming the issue to be too much of a political hot potato, Thatcher left financial services at the Post Office largely untouched, encouraging only the intervention of private banks to compete for the option of underwriting (with the support of government) Post Office financial services. Today, both in the US and the UK, Post Office counters, and individual postmasters complain vehemently about their struggle for survival in the face of growing competition from private banks that now include the offers of financial services by supermarkets, and initiatives that have reduced the numerous functions of Post Office counters, including direct debit payments. Perhaps the question the authors could explore is why do western governments, while taking efforts to remove services from the Post Offices (such as bill payments) do not embark on a full scale privatisation, whereas in developing countries, where the extent of government control over the savings movement, including postal savings, is significantly stronger, the movement appears to be going from strength to strength?

Further Reading

Booth, Alan and Mark Billings, ‘Techno-nationalism, the Post Office and the creation of Britain’s National Giro’ in B Bátiz-Lazo, J.C. Maixé-Altés and P. Thomes Technological Innovation in Retail Finance: International Historical Perspectives (Abingdon: Routledge, 2011).

Campbell-Kelly, Martin, ‘Data Processing and Technological Change’ Technology and Culture, 39, 1 (Jan. 1998), pp. 1-32.

Campbell Smith, Duncan, Masters of the Post: The Authorized History of Royal Mail (London: Penguin, 2011).

Crowley, Mark J. Saving for the Nation: The Post Office and National Consumerism, c1860-1945’ in Erika Rappaport, Sandra Dawson and Mark J Crowley (eds.), Consuming Behaviours: Identity, Politics and Pleasure in Twentieth Century Britain (forthcoming Bloomsbury, 2015).

Failed by #EconomicGrowth?

Asia’s Little Divergence: State Capacity in China and Japan before 1850

by Tuan-Hwee Sng (National University of Singapore) and Chiaki Moriguchi (Hitotsubashi University)

Abstract: This paper explores the role of state capacity in the comparative economic development of China and Japan. Before 1850, both nations were ruled by stable dictators who relied on bureaucrats to govern their domains. We hypothesize that agency problems increase with the geographical size of a domain. In a large domain, the ruler’s inability to closely monitor bureaucrats creates opportunities for the bureaucrats to exploit taxpayers. To prevent overexploitation, the ruler has to keep taxes low and government small. Our dynamic model shows that while economic expansion improves the ruler’s finances in a small domain, it could lead to lower tax revenues in a large domain as it exacerbates bureaucratic expropriation. To test these implications, we assemble comparable quantitative data from primary and secondary sources. We find that the state taxed less and provided fewer local public goods per capita in China than in Japan. Furthermore, while the Tokugawa shogunate’s tax revenue grew in tandem with demographic trends, Qing China underwent fiscal contraction after 1750 despite demographic expansion. We conjecture that a greater state capacity might have prepared Japan better for the transition from stagnation to growth.

URL: http://econpapers.repec.org/paper/hithitcei/2014-6.htm

Reviewed by Joyman Lee

Summary

This paper was distributed by NEP-HIS on 2014-09-25 and 2014-10-03. In it Sng and Moriguchi ask why China – with its large population and high levels of technological prowess – was not the first country to industrialize. Existing studies of “divergence” have not explained differences in economic performance between China and Japan. Despite the similarities between the two economies in levels of proto-industrialization, political and legal structures, and living standards. Sng and Moriguchi argue that differences in public finance accounted for important differences in the two countries’ ability to promote economic growth.

In this paper Sng and Moriguchi focus on the important question of size and geography as the central explanatory variable. In particular, the authors develop a context-specific model which suggests that rulers’ need to rely on agents to govern (principal-agent problem) in a pre-modern dictatorship meant that “agency problems increase with its geographical size and heterogeneity” (p5), owing to information challenges which precluded close supervision by rulers of their agents. The model predicts that the larger the polity, the higher the corruption rate, and the lower the tax rate out of fear that subjects will revolt, as expropriation reduces the ruler’s ability to provide social goods commensurate to the tax levied. The higher level of corruption also reduces rulers’ incentives to invest, and hence the provision of public goods per capita. Graft and inefficiencies mean that population and economic growth actually reduces the proportion of the economic surplus available to the ruler. As a result, the size of the polity lowers the tipping point where the negative effects of growth outweigh the positive effects.

Qing military officials. Qing China had a chronic corruption problem.

Qing military officials. Qing China had a chronic corruption problem.

Sng and Moriguchi test their hypothesis against a pool of primary and secondary data, which confirms that tax rates were higher in Japan than China, averaging around 34% in Japan (rising to 50-55% in some domains, p29): more than twice of China’s level in 1700 and approximately six times by 1850. Population growth was far greater in China than Japan, where the population stagnated after 1700. Compared to the Qing, Tokugawa Japan enjoyed a higher level of public services in terms of coinage, transportation, urban management, and environmental management (forestry), and in famine relief the Qing’s strengths were cancelled out by 1850. The authors conclude that the large size of China “imposed increasingly insurmountable constraints on the regime’s capacity to collect taxes and provide essential local public goods as its economy expanded,” and that “this factor alone might have been sufficient in holding back China’s transition from stagnation to growth even in the absence of Western imperialism” (p38). In line with the existing scholarship, Sng and Moriguchi contend that Japan’s healthier tax system provided the Westernizing Meiji regime (1868-1912) with revenues to conduct far-reaching reforms.

Comment

Despite its significance in global history, the comparative history of China and Japan is surprisingly overlooked. The “California school,” for instance, has focused largely on the economic “divergence” between China and the West, whereas Japanese economic historians have labored over Japan-Europe differences (Saito 2010). Sng and Moriguchi’s focus on the comparative history of China and Japan is thus relatively new. The authors join political scientist Wenkai He, whose recent book Paths toward the Modern Fiscal State also explores China’s failure to develop a modern fiscal state in the nineteenth century, in comparison with early modern England and Meiji Japan (He 2013). China’s “failure” is especially puzzling in view of the Qing’s overall success in raising revenue in the late nineteenth century (Wong 1997, 155-56).

Sng and Moriguchi’s argument that a state’s ability to increase revenue is inversely affected by size is persuasive. In the absence of institutions to monitor graft, China had seldom been able to pursue rational fiscal strategies – especially at the county level – since the Tang-Song transition (Hartwell 1982, 395-96). In contrast, Japan’s decentralized polity in the early modern period bore close resemblance to Europe. Perhaps unsurprisingly, early modern Japan’s experiences of proto-industrialization and industrious revolution had clear parallels both in England and in the Netherlands.

A magistrate's office in Jiangxi province. Arguments on the Qing's inadequacies hinge partly on the Qing's ideological goals.

A magistrate’s office in Jiangxi province. Arguments on the Qing’s inadequacies hinge partly on the Qing’s ideological goals.

What this narrative does not explain, however, is why China pursued such an inefficient mode of fiscal management. Given the challenges of graft and the fear of revolt, Sng and Moriguchi assume that it was the most rational or “optimal” course. The authors point to but dismiss lightly the question posed by Qing historians that the goals of the late imperial Confucian state might not have been compatible with “rational” state expansion. In other words, rather than fearing peasant revolt, the choice of tax rate might have to do with ideological reasons. Similarly, the idea that the Japanese state shared a “Confucian” outlook (p4) is overly simplistic, especially as consistently high levels of taxation in Tokugawa Japan undermine the idea that Tokugawa Japan was a “benevolent” state.

While size might have been a key variable in China’s state “weakness,” this does not in itself explain the strengths or weaknesses of China’s overall economy. The large size of China’s internal market, for example, allowed differentiation and specialization which appear to have sustained economic growth even in the absence of an active state. This was true both in the Qing and more recently in China’s informal and private sectors since 1978. Thus there is no reason to assume that the adoption of a “modern” fiscal apparatus was a natural goal for the Qing before 1850. Similarly, by focusing on the state’s fiscal abilities to the exclusion of other factors, Sng and Moriguchi also sidestep an important Japan-centered literature that considers how similarities in economic structures between China and Japan enabled the results of Westernizing experiments in Japan after 1850 to be transferred to China. This point is important because revenues from Japan’s trade with Asia propelled Meiji Japan’s economic growth, no less than the revenues collected by Japan’s indigenous tax structures. Moreover, this was a form of self-sustaining growth built upon constant competitive pressures from below, i.e. from China which was rapidly reproducing strategies developed in Japan (ed. Sugihara 2005).

Despite these criticisms, Sng and Moriguchi’s model offers clear quantitative analysis on an important aspect of a greatly understudied topic, and is recommended for anyone interested in the longue durée economic development of the two countries.

Additional References

Hartwell, R. 1982. “Demographic, Political, and Social Transformations of China, 750-1550,” Harvard Journal of Asiatic Studies, vol. 42, no. 2, pp. 365-442 [Dec, 1982].

He, W 2013. The Paths toward the Modern Fiscal State: Early Modern England, Meiji Japan, and Qing China. Cambridge, MA: Harvard University Press.

Saito, O. 2010. “An Industrious Revolution in an East Asian Market Economy? Tokugawa Japan and Implications for the Great Divergence,” Australian Economic History Review, vol. 2010, vol. 50, issue 3, pp. 240-261.

Sugihara, K. (ed.) 2005. Japan, China, and the Growth of the Asian International Economy, 1850-1949. New York: Oxford University Press.

Wong, R. 1997. China Transformed: Historical Change and the Limits of European Experience. Ithaca, NY: Cornell University Press.

On #Trade, #Globalization, #Development and Steamships

The Wind of Change: Maritime Technology, Trade and Economic Development

by

Luigi Pascali (L.Pascali@warwick.ac.uk) University of Warwick (UK) and Pompeu Fabra University (Spain)

ABSTRACT

The 1870-1913 period marked the birth of the …first era of trade globalization. How did this tremendous increase in trade affect economic development? This work isolates a causality channel by exploiting the fact that the steamship produced an asymmetric change in trade distances among countries. Before the invention of the steamship, trade routes depended on wind patterns. The introduction of the steamship in the shipping industry reduced shipping costs and time in a disproportionate manner across countries and trade routes. Using this source of variation and a completely novel set of data on shipping times, trade, and development that spans the great majority of the world between 1850 and 1900, I …find that 1) the adoption of the steamship was the major reason for the …first wave of trade globalization, 2) only a small number of countries that were characterized by more inclusive institutions bene…fited from globalization, and 3) globalization exerted a negative effect on both urbanization rates and economic development in most other countries.

URL: http://econpapers.repec.org/paper/wrkwarwec/1049.htm

Review by Natacha Postel-Vinay

The 1870-1913 period saw the first significant wave of trade globalization, which introduced important economic and social changes throughout the world. Despite an abundant literature on the causes of globalization at the time, there are significant methodological issues with these studies. Even more surprisingly, very little has been said about the impact of globalization in this era on the economies of countries around the world. In particular, an essential question to ask seems to be whether the increase in trade witnessed at the time was conducive to greater economic development worldwide.  In a highly ambitious move, Luigi Pascali’s paper (distributed by NEP-HIS on 2014-07-13) tackles both issues at the same time, and in so doing contributes significantly to the larger debate on the causes and consequences of trade globalization.

The main challenge in answering these two questions is to deal in each case with an endogeneity problem. Start with the causes of the trade boom. In their attempts to determine whether the rise in international trade could be due to transportation costs, authors have often used freight rates as a proxy for these costs. The problem with this approach is that freight rates are the actual price of transportation. They may be affected by factors which are themselves related to the state of trade (such as demand for goods or economic activity). So causation may not actually run from freight rates to trade – but from other factors related to trade to freight rates.

A similar issue arises when looking at the causal relationship (if any) from trade to economic development. As economic activity may itself have a positive impact on trade – and not just the other way around – a researcher dealing with this question may find a positive correlation between the two but will eventually be faced with a potential endogeneity problem.

Pascali found a creative solution to these difficulties. He did so by making use of the fact that the steamship introduced asymmetric changes (ie. exogenous variation) in trade distances between countries.  Before the steamship, shipping times by sail were mainly determined by wind patterns. The steamship therefore introduced greater changes in shipping times between some countries than between others. Such changes were purely independent of other factors affecting trade, and only linked to such things as the direction of wind and water currents. It thus became possible for the author to examine the effect of a large change in shipping time on trade, independent of other factors linked to trade such as economic activity or market structure.

Clipper ship from the 1850s.

Clipper ship from the 1850s.

To compute such a variable, Pascali built an enormous dataset on sailing times (using such variables as velocity and direction of sea-surface winds) and calculated the likely effect of the adoption of the steamship on shipping times for 129 countries between 1850 and 1900. He also expanded available datasets to include more than 5,000 entries on imports and exports and data on urbanization for more than 5,000 different cities.

What he found was that the introduction of the steamship had a much larger (positive) impact on trade than was previously thought.

Pascali also found that he could use the steamship variable to search for causal links running from trade to greater income levels and development. As mentioned above he had isolated changes in shipping times including the influence of countries’ economic activity. But these changes were strongly related to trade itself. They were then used as instrumental variable in a two-stage least squares (2SLS). In other words, this variable effectively dealt with the endogeneity problem in the analysis of the effects of trade on development.

His results were somewhat surprising. Using this variable as an instrument, the regression of development (urbanization, population density and per-capita GDP) on trade yielded mostly significant but negative coefficients on the explanatory variable. It therefore appears that variation in the intensity of trade between two locations does not have a large impact on development – and may even have a negative one.

Even more interestingly, his findings suggest that whether an increase in trade has a positive impact on development depends on a country’s institutions:  only a few countries having a better established rule of law (as measured by “constraints on the executive” – taken from Acemoglu and Johnson (2005)) benefited from an increase in international trade in terms of development. This finding can be related to relatively recent literature (such as Krugman (1991) or Crafts and Venables (2007)) according to which a reduction in trade costs is only beneficial to a certain set of countries (in particular, those specializing in manufacturing).

A steamship from the 1900s.

A steamship from the 1900s.

Pascali’s paper thus contributes to questioning the positive effects of lowering trade barriers, which are too often taken for granted. He carefully suggests that trade may have a differential impact depending on countries’ institutions. Perhaps some elaboration and discussion on how exactly these relationships play out would have been welcome.  Nevertheless the author’s questions, creative methodology and findings all make for a fascinating read.

Additional References

Acemoglu, D. and S. Johnson (2005). “Unbundling institutions”. Journal of Political Economy 113(5): 949–995.

Crafts, N. and A. Venables (2007). Globalization in Historical Perspective. University of Chicago Press.

Krugman, P. (1991). “Increasing returns and economic geography”. Journal of Political Economy 99: 483-499.

Technology and Financial Inclusion in North America

Did Railroads Make Antebellum U.S. Banks More Sound?

By Jeremy Atack (Vanderbilt), Matthew Steven Jaremski (Colgate), and Peter Rousseau (Vanderbilt).

Abstract: We investigate the relationships of bank failures and balance sheet conditions with measures of proximity to different forms of transportation in the United States over the period from 1830-1860. A series of hazard models and bank-level regressions indicate a systematic relationship between proximity to railroads (but not to other means of transportation) and “good” banking outcomes. Although railroads improved economic conditions along their routes, we offer evidence of another channel. Specifically, railroads facilitated better information flows about banks that led to modifications in bank asset composition consistent with reductions in the incidence of moral hazard.

URL: http://econpapers.repec.org/paper/nbrnberwo/20032.htm

Review by Bernardo Bátiz-Lazo

Executive briefing

This paper was distributed by NEP-HIS on 2014-04-18. Atack, Jaremski and Rousseau (henceforward AJR) deal with the otherwise thorny issue of causation in the relationship between financial intermediation and economic growth. They focus on bank issued notes rather deposits; and argue for and provide empirical evidence of bi-directional causation based on empirical estimates that combine geography (ie GIS) and financial data. The nature of their reported causation emerges from their approach to railroads as a transport technology that shapes markets while also shaped by its users.

Summary

In this paper AJR study the effect of improved means of communication on market integration and particularly whether banks in previously remote areas of pre-Civil War USA had an incentive to over extend their liabilities. AJR’s paper is an important contribution: first, because they focus on bank issued notes and bills rather than deposits to understand how banks financed themselves. Second, because of the dearth of systematic empirical testing whether the improvements in the means of communication affected the operation of banks.

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In 19th century north America and in the absence of a central bank, notes from local banks were substitutes among themselves and between them and payment in species. Those in the most remote communities (ie with little or no oversight) had an opportunity to misbehave “in ways that compromised the positions of their liability holders” (behaviour which AJR label “quasi-wildcatting”). Railroads, canals and boats connected communities and enabled better trading opportunities. But ease of communication also meant greater potential for oversight.

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ACJ test bank failure rates (banks that didn’t redeem notes at full value), closed banks (ceased operation but redeem at full value), new banks and balance sheet management for 1,818 banks in existence in the US in 5 year increments between 1830 and 1862. Measures of distance between forms of communication (i.e. railroads, canals, steam navegable river, navegable lake and maritime trade) and bank location emerged from overlapping contemporary maps with GIS data. Financial data was collected from annual editions of the “Merchants and Bankers’ Almanac”. They distinguish between states that passed “free banking laws” (from 1837 to the early 1850s) and those that did not. They also considered changes in failure rates and balance sheet variance (applying the so called CAMEL model – to the best of data availability) for locations that had issuing banks before new transport infrastructure and those where banks appear only after new means of communication were deployed:

Improvements in finance over the period also provided a means of payment that promoted increasingly impersonal trade. To the extent that the railroads drew new banks closer to the centers of economic activity and allowed existing banks to participate in the growth opportunities afforded by efficient connections.(p. 2)

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Railroads were the only transport technology that returned statistically significant effects. It suggested that the advent of railroads did indeed pushed bankers to reduce the risk in their portfolios. But regardless of transport variables, “[l]arger banks with more reserves, loans, and deposits and fewer bank notes were less likely to fail.” (p.20). It is thus likely that railroads impact banks’ operation as they brought about greater economic diversity, urbanisation and other measures of economic development which translated in larger volume of deposits but also greater scrutiny and oversight. In this sense railroads (as exogenous variable) made banks less likely to fail.

But ACJ note that means of transportation were not necessarily exogenous to banks. Reasons for the endogeneity of transport infrastructure included bankers promoting and investing in railroads to bring them to their communities. Also railways could find advantages to expand into vigorously active locations (where new banks could establish to capture a growing volume of deposits and serve a growing demand for loans).

Other empirical results include banks decreased the amount of excess reserves, notes in circulation and bond holdings while also increased the volume of loans after the arrival of a railroad. In short, considering railroads an endogenous variable also results in transport technologies lowering bank failure rates by encouraging banks to operate more safely.

Comment

The work of AJR is part of a growing and increasingly fruitful trend which combines GPS data with other more “traditional” sources. But for me the paper could also inform contemporary debates on payments. Specifically their focus is on banks of issue, in itself a novelty in the history of payment systems. For AJR technological change improves means of payment when it reduces transaction costs by increasing trust on the issuer. But as noted above, there are a number of alternative technologies which have, in principle, equal opportunity to succeed. In this regard AJR state:

Here, we describe a mechanism by which railroads not only affected finance on the extensive margin, but also led to efficiency changes that enhanced the intensity of financial intermediation. And, of course, it is the interaction of the intensity of intermediation along with its quantity that seems most important for long-run growth (Rousseau and Wachtel 1998, 2011). This relationship proves to be one that does not generalize to all types of transportation; rather, railroads seem to have been the only transportation methods that affected banks in this way.(p4)

In other words, financial inclusion and improvements in the payment system interact and enhance economic growth when the former take place through specific forms of technological change. It is the interaction with users that which helps railroads to dominate and effectively change the payments system. Moreover, this process involves changes in the portfolio (and overall level of risk) of individual banks.

The idea that users shape technology is not new to those well versed in the social studies of technology. However, AJR’s argument is novel not only for the study of the economic history of Antibellum America but also when considering that in today’s complex payments ecosystem there are a number or alternatives for digital payments, many of which are based on mobile phones. Yet it would seem that there is greater competition between mobile phone apps than between mobile and other payment solutions (cash and coins, Visa/Mastercard issued credit cards, PayPal, Bitcoin and digital currencies, etc.). AJR results would then suggest that, ceteris paribus, the technology with greater chance to succeed is that which has great bi-directional causality (i.e. significant exogenous and endogenous features). So people’s love for smart phones would suggest mobile payments might have greater chance to change the payment ecosystem than digital currencies (such as Bitcoin), but is early days to decide which of the different mobile apps has greater chance to actually do so.

Wall Street (1867)

Wall Street (1867)

Another aspect in which AJR’s has a contemporary slant refers to security and trust. These are key issues in today’s digital payments debate, yet the possibility of fraud is absence from AJR’s narrative. For this I mean not “wildcatting” but ascertaining whether notes of a trust worthy bank could have been forged. I am not clear how to capture this phenomenon empirically. It is also unlikely that the volume of forged notes of any one trusted issuer was significant. But the point is, as Patrice Baubeau (IDHES-Nanterre) has noted, that in the 19th century the technological effort for fraud was rather simple: a small furnace or a printing press. Yet today that effort is n-times more complex.

AJR also make the point that changes in the payments ecosystem are linked to bank stability and the fragility of the financial system. This is an argument that often escapes those discussing the digital payments debate.

Overall it is a short but well put together paper. It does what it says on the can, and thus highly recommended reading.