The Second Reversal: The ebb and flow of financial repression in Western Europe, 1960-91

In: http://hdl.handle.net/10016/5537

Abstract

Paper presented at: The Sixth Conference of the European Historical Economics Society (EHES), Istanbul, September 9-10, 2005 ; Securities markets in Continental Europe remained relatively underdeveloped throughout the 20th century as compared with those of Anglo-Saxon countries. The "law and finance" strand of literature argues that their secular stagnation can be traced back to legal origins and explained in terms of path dependency. Recent studies, however, provide ample evidence that the long-term development pattern of securities markets in Europe was not monotonical, but rather followed the ebb and flow of globalization. In fact, capital markets were well developed in a number of civil law countries on the eve of WW1. According to Rajan and Zingales, a "Great Reversal" occurred in the interwar period, from which financial markets did not fully recover until the 1990s. The paper argues that this view of a long-term U-shaped pattern does not reflect accurately the historical experience of European securities markets. In fact, a W-shaped pattern can be observed: securities markets noticeably recovered in the 1960s, only to be marginalized again in the 1970s and early 80s, until financial reforms allowed them eventually to thrive later in the same decade. The paper explains this post-war reversal with the rise of encompassing regimes of financial repression in many Western European countries, of which the underdevelopment of securities markets was one, but hardly the only facet. An index measuring the intensity of financial repression, covering both banking intermediation and capital markets, is constructed for a panel of 16 European countries in the period 1950-1991. The determinants of financial repression are then empirically assessed by using panel data which control for a wide set of fiscal, institutional and political variables. Results point to a public finance explanation of the reversal, according to which financial repression was basically motivated by governments' attempt to impose implicit taxation on domestic currency- and debt-holders, including their banking systems.