Is All Finance Good Finance? What are the Lessons of Antebellum US History?

15 02 2013

Common sense tells us that financial institutions can create value.  There is rigorous academic research demonstrating that the existence of financial institutions has a strongly positive impact on economic growth. It would be hard to run a modern economy without financial institutions.  That finance is, within limits, a good thing, a no-brainer. That being said, there may be a law of diminishing returns to financialization.  In 2009, the head of the Financial Services Authority in the UK said that “some of the financial activities which proliferated over the last ten years were socially useless.” Needless to say, this idea has been robustly contested. The debate continues.

Can historians contribute to this debate?  You bet.  Chris Colvin, an economic historian who works at the Queen’s University Management School in Belfast, has published a review of a recent article by Matthew Jaremski (Colgate University) and Peter Rousseau (Vanderbilt University). The article, “Banks, free banks, and U.S. economic growth” examines the impact of the creation of banks on the economic performance of US counties in the period between 1837 and 1862. During this period, the legal barriers to establishing a bank were quite limited and the number of banks in the US increased dramatically. The authors attempt to determine whether the free banking regime actually helped the economy to develop.  You can read an ungated version of the paper here.


The “Federalist financial revolution” may have jump-started the U.S. economy into modern growth, but the Free Banking System (1837-1862) did not play a direct role in sustaining it. Despite lowering entry barriers and extending banking into developing regions, we find in county-level data that free banks had little or no effect on growth. The result is not just a symptom of the era, as state-chartered banks seem to have strong and positive effects on manufacturing and urbanization.

In an earlier draft of the article, Jaremski and Rousseau wrote:

Even our most optimistic estimates indicate  that a 10% increase in the number of free banks would have increased the growth of manufacturing capital by less than 0.5% per decade, compared to a 3.3% increase in growth for a  10% increase in charter banks. The results lead one to ask if the National Banking Acts of 1863 and 1864 and the 10% tax on state bank notes that followed had significant impacts on economic  development by encouraging the exit of banks that were not growth promoting and replacing them with new banks that were.

In other words, simply expanding the number of banks in a community isn’t going to boost its overall economy. The special tax on banknotes that the federal government imposed during the Civil War appears to have had a positive effect on the real economy by forcing some of the free banks out of business.

The piece by Jaremski and Rousseau will doubtless interest many historians of banking.  I suppose it also speaks to the broader debate about whether the financialization of the economy is necessarily a good thing. At a time when policymakers in many countries are talking about rebalancing the economy away from financial services and towards the production of visible goods, the article provides important food for thought.  This paper may even interest proponents of the Tobin Tax.



Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

%d bloggers like this: