Abstract and Keywords
The book asks when financial development is good for growth. It turns to industrializing England for an answer, using London goldsmith bankers as a case study. The book traces the early history of domestic banking in eighteenth-century London. It reveals how goldsmiths learned to be bankers in the tumultuous early years of the century, how a few of them prospered in the South Sea Bubble, and how the banks operated after mid-century. Financial repression by the government—a response to the pressing need to finance ever longer and more expensive wars—was a key constraint for private financial development. The usury laws restricted the ability to lend; war-time borrowing shocks crowded out private loans. Based on new evidence from historical bank archives, especially those of Hoare's Bank, the authors compile a rich new dataset with micro-level information on lending decisions, cash ratios, and profitability. Their conclusions shed light on one of the great unsolved puzzles of the Industrial Revolution—if technological change was fast, why was growth itself slow? Their answer emphasizes the important difficulties thrown up the institutional context in Hanoverian England—a “warfare state” bent on repressing financial development to facilitate its access to private savings.
THIS BOOK is about banking in eighteenth-century London, a topic that is interesting for several reasons. Changes in society and economy in the eighteenth century set the stage for the Industrial Revolution, one of the two major events—the other being the Agricultural Revolution—that stands out in any long-run account of human population or economic activity. Curiously, the growth of banking has largely been ignored in most accounts of the Industrial Revolution, in contrast to the extensive study of banks’ role in later economic events. We resolve this paradox in the following pages and explain why banks were marginal to the Industrial Revolution.
Modern commercial banking grew out of the activities of London goldsmiths at the beginning of the eighteenth century. If it seems natural that goldsmiths turned into bankers, it is only because the assertion has been repeated so often. Discussions of the twenty-first-century economy distinguish between the manufacture of goods and the provision of finance, a distinction that is illuminating for earlier years as well. Banking is not at all like the production and sale of jewelry. What we call “goldsmith banking” was a new economic activity in the seventeenth and eighteenth centuries; it flourished before the term banking was used to describe the taking of deposits and the making of loans (Melton 1986). We describe how this activity arose and, after trials and tribulations, eventually began to prosper.
Examining this evidence in even more detail reveals the extent to which the growth of goldsmith banking occurred in the shadow of government policies. The British government of the eighteenth century was concerned with containing the superpower of the age, France. Louis XIV and Napoleon were very different, but they were both expansionist French rulers. The English rose to the occasion from the beginning of the eighteenth century, and these efforts affected goldsmith banks and through them the economy as a whole. Early on, the government's fumbling efforts to increase tax revenues produced a new monopoly (the Bank of England), a string of increasingly stringent bank (p.4) restrictions, and then the South Sea Bubble. Later, the urgent need for resources to fight the French retarded economic growth during the Industrial Revolution.
Incomes per person had only grown slowly and intermittently before the Industrial Revolution. After it began, growth eventually accelerated—rapidly after 1830. Economists interested in the theory of economic growth have puzzled over what generated the transition to sustained economic growth in the first place. Historians of technology have documented the numerous inventions in processes and products. Economic historians have spent decades documenting that while rapid growth was the eventual outcome, the transformation of the English economy between 1750 and 1850 was slow. Institutional economists have emphasized the rapid improvements in property rights following changes in constitutional arrangements in Britain after the Glorious Revolution of 1688. Social historians have documented the repercussions that massive structural change had for the working lives of ordinary people.
This book tries to fill an important hole in this extensive literature. There is no good explanation why, at a time of impressive technological change, growth overall was remarkably slow. We propose to fill this gap by examining a factor on which scholars have often remained silent—private-sector finance. In Arthur Conan Doyle's Silver Blaze, Sherlock Holmes points to the remarkable behavior of the dog in the night. What was remarkable was that the dog did not bark, which led directly to the discovery of the murderer. Many research papers have documented the importance of private finance for economic development, both in the present and in the past. And yet banks and other forms of intermediation are hardly ever mentioned in modern treatments of the Industrial Revolution.1
We argue that the absence of an effective domestic financial system helps to explain the slow progression of the Industrial Revolution in England. Public finance enabled Britain to become a world power in the eighteenth century; private finance was not so lucky. The divergent development of the two was related: the progress of public finance hobbled private financial development. Banks were invisible in the Industrial Revolution because government regulations prevented banks from playing a more creative and productive role. Worse, they were part of the mechanism by which the government appropriated resources for warfare that could have flowed instead into industry and commerce.
We are not the first to argue that England's financial system in the eighteenth century compares unfavorably with those in the United States, Holland, and Scotland at the same time and with countries undergoing Financial (p.5) Revolutions that aided industrial growth later, such as Japan and Germany (Cameron 1967; Rousseau and Sylla 2006). Our analysis is foreshadowed by Cameron's classic overview in his comparative Banking in the Early Stages of Industrialization. There he and his collaborators concluded that the English financial system had severe flaws compared to other countries, including Scotland. Nonetheless, alternative arrangements and institutional innovations in the provision of finance—such as country banks and the bill market—eventually allowed economic growth to proceed. Government regulation and the resulting flaws in England's financial system, in their view, did not block the flow of credit; it only slightly impeded and diverted it. Our analytical strategy is different, and so are our conclusions. Instead of broadly comparing national financial systems, we examine detailed, firm- and individual-level evidence about how banks lent how much, when, and to whom, how securities were traded, and who profited. It is through the lens of this archival evidence that we assess the impact of wars and government regulations such as the usury laws. We conclude, based on wealth of new micro-evidence hand-collected from historical archives, that the heavy hand of “financial repression” (McKinnon 1973; Shaw 1973) and the adverse impact of war caused serious distortions in the functioning of England's financial system. These distortions were visible in the allocation of credit, in the pricing of loans, in “boom-and-bust cycles” in credit provision, and in the—largely nonexistent—financing of enterprise. As a consequence, debt sustainability was high but growth suffered (Drelichman and Voth 2008).
To make this case we have taken a long view of British economic history. We describe events in the early eighteenth century to explain conditions later. These earlier events affected the private financial system in important and long-lasting ways. They set the stage for the Industrial Revolution as we now know it, and they undermined the very real chances of rapid economic change, given the scale of innovation.
We set the stage in chapter 1 by describing the emergence of a nascent middle class in early-eighteenth-century London. The contrasting views of a contemporary artist and modern historians clarify the sources of our story. In chapter 2 we survey the Financial Revolution—the growth of war finance and the different elements of England's nascent financial system, among which were goldsmith banks. We describe how goldsmiths learned to be bankers in chapter 3. We highlight one successful bank that has lasted until today: Hoare's Bank. The records of Hoare's Bank are the most complete, both because the bank still operates and because it is still located at the same address on Fleet (p.6) Street. Partial records of other, similar banks reveal both similarities and divergences in early bank history. We turn to the demand for credit in chapter 4, asking who took advantage of these new financial intermediaries. Credit was available equally to all classes of people, but not to all degrees of risk; the usury law—the thread that runs through our account—precluded bank lending for risky projects. We conclude our description of the early eighteenth century with an analysis of the South Sea Bubble, a memorable result of rapidly increasing government borrowing gone wrong. The South Sea Bubble crisis affected early goldsmith banks, and it marks the turn from experimentation and change to more normal banking.
Our account of banks in the later eighteenth century begins in chapter 6 with a description of banks cruising in the more placid economic waters that followed the South Sea Bubble. They operated within the restraints imposed on them during the preceding economic turbulence and with conservative policies designed to get them through possible future crises. We explore the interaction of banking regulation and the economy in chapter 7, showing how government financial policies pushed banks into particular activities. As a result, banks were much less involved in the Industrial Revolution than they could have been. The banks’ difficulties and restraints illuminate the mechanism behind the retarding effect on growth of the credit stringencies produced by the revolutionary and Napoleonic wars.
We conclude that the devil is in the details, to quote another aphorism. It is noteworthy that public finance and banks grew apace in the eighteenth century. But it is even more noteworthy that their interaction forced early industrialists to go outside what had become normal channels to raise funds for new innovations. In addition, organized finance was used to starve these new producers for capital during the wars that coincided with the Industrial Revolution. However useful finance is to economic growth in other contexts, our study reveals that England's Financial Revolution in public borrowing enabled concurrent government activities to retard economic growth during the Industrial Revolution.