This post is from Raghuram G. Rajan of the University of Chicago.
Recently, in the Law, Economics, and Organization Seminar here at the Law School, I presented my paper, co-authored with Rodney Ramcharan, entitled Landed Interests and Financial Underdevelopment in the United States.
In our paper, we explore how the structure of banking across counties in the United States was shaped in the early part of the twentieth century by local landowners, who wanted to limit free access to credit. We focus on banks because they were, and in many areas, still are, the most important source of local finance. Likewise, we focus on the influence of landowners because agriculture was still a key sector at that time in the U.S. economy, and agricultural interests were a powerful political constituency. From a research design standpoint, this focus is also appropriate because we believe we can isolate exogenous factors that determined the nature of land holdings. Specifically, counties varied in the extent to which land holdings were concentrated or widely distributed. In part, the distribution of land holdings was driven by rainfall, with large-scale plantation-like agriculture being favored in areas with high rainfall, and small scale farming in areas with moderate rainfall. Therefore, in some counties, a few large farmers held much of the land, while in other counties land was widely dispersed among many smaller farmers. Large, wealthier landowners had reasons to restrict access to credit by limiting the spread of banks, and had the economic and political power to implement those interests.
We find that landed interests appeared to be an important influence in constraining bank competition and thus limiting access to finance. We provide a variety of tests showing that their impact was most pronounced in situations where they had the greatest incentive and ability to exert influence. We also argue that our results cannot be easily explained as resulting from the supply of banking services responding to the underlying demand. Finally, we show these constraints on financial development persisted long after the interest groups driving them faded away.
While our paper is on financial development, it has broader implications. A recent trend in explaining the underdevelopment of nations has been to attribute it to the historical weakness in their political institutions such as democracy and constitutional checks-and-balances. While U.S. political institutions in the 1920s were far from perfect, they were also far from the coercive political structures that are typically held responsible for persistent underdevelopment. Yet even in the United States, we find large variations in the development of enabling economic institutions such as banking between areas that had different constituencies but were under the same political structures. The significant, and potentially adverse, influence of constituencies even in such environments suggests that fixing political institutions alone cannot be a panacea for the problem of underdevelopment.
The full paper is available for download here.
