Banks and banking - History ; Banks and banking - Germany ; Banks and banking - Great Britain ; Germany ; Great Britain

Peter Temin

English

Research Papers in Economics

FEDERAL  RESERVE  BANK  OF  ST. LOUIS
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MAY/JUNE  1998
Commentary
Peter Temin
I
n this article, Fohlin continues her
exploration of the role of the German
banking system during pre-World War I
industrialization—a system that has been
celebrated among economists and eco-
nomic historians for many years.  A gener-
ation ago, Gerschenkron (1962) argued
that Germany needed banking to mobilize
savings in the nineteenth century because
of its relative backwardness, which was
manifest in a poorly developed capital
market and a scarcity of savings.  When
universal banks mobilized savings, this
stimulated the growth of heavy industry.
The German banking system has also been
acclaimed by economists who have argued
that the integrated, universal banks of
Germany and other countries provide the
most efﬁcient intermediation.
Fohlin does not start from Ger-
schenkron, although I—as one of Ger-
schenkron’s students—will.  She adopts 
a separation that Pagano (1993) used in
a survey of models of ﬁnancial insti-
tutions and economic growth.  He pro-
posed a simple linear model in which
growth was equal to the product of the
level of technology, the savings rate, 
and the cost of ﬁnancial intermediation.
Taking the ﬁrst of these as given, he
argued that we can evaluate ﬁnancial
institutions by their effects on the 
volume of savings and by their efﬁ-
ciency in intermediation.  Increasing 
the volume of savings often is termed
mobilization, while more efﬁcient inter-
mediation equalizes the rate of return
across the economy and yields greater
output for a given amount of savings.
Fohlin calls these outcomes the quantity
and quality of investments, and she
discusses them in turn.
Gerschenkron emphasized the role of
banks in mobilizing savings.  Fohlin shows
that the ratio of ﬁnancial assets to GNP was
higher in Britain than in Germany before
World War I.  Banks also had fewer assets
relative to GNP in Germany than in Britain,
although their assets rose more quickly and
passed those of the British banks before the
war.  Fohlin concludes from these data and
from data on bank reserve ratios that ﬁnan-
cial institutions in Germany did not play the
role in mobilizing savings that they played
in Britain, or at least not until Germany had
caught up with Britain in many dimensions.
But is Britain the right standard of com-
parison for the question of savings mobiliza-
tion?  Gerschenkron, were he here, would
have admitted happily that Germany had
fewer ﬁnancial intermediaries than the
British. That was why it needed universal
banks, in his view.  In other words, the rele-
vant comparison is not with Britain, which
did not need universal banks, but with a less
developed country that could not mobilize
its savings.  From the perspective proposed
by Gerschenkron, one possible conclusion
from Fohlin’s data is that the German banks
were doing a very good job of mobilizing
savings, thereby bringing Germany into 
the same ballpark as the more advanced
British economy.
Fohlin turns next to the efﬁciency of
intermediation.  The distinction she makes
is clearer in theory than in practice, because
the mobilization of savings is itself a mea-
sure of efﬁcient intermediation.  Fohlin
looks at the particular question of supplying
capital to industrial ﬁrms and argues that
German banks held no more equity in
industrial ﬁrms than their British counter-
parts.  This is an important ﬁnding and a
thought-provoking conclusion.
One obvious point Fohlin makes is
that other countries that did not have the
German banking structure—speciﬁcally,
Anglo-Saxon countries—were not pre-
cluded by banking regulation from having
this structure.  British banks could have
Peter Temin is the Elisha Gray II Professor of Economics at the Massachusetts Institute of Technology.MAY/JUNE 1998
organized themselves the way German
banks did in the nineteenth century if they
had wished.  The same is true of American
banks, some of which did so.  It is instruc-
tive to combine this observation with
Fohlin’s data.
If the British did not adopt the German
banking structure, why not?  Two answers
are possible: The ﬁrst, in the spirit of Ger-
schenkron, is that the British banking struc-
ture was preferable to the German.  The
German banking structure, in other words,
was a second-best system forced on the 
Germans by their relative backwardness.
The large British capital market allowed
banks to specialize for reasons Adam Smith
would have recognized.  But German banks,
in the more constricted German capital
market, did not have this luxury.  By this
metric, it is impressive that the German
banks did almost as well as the British, 
that they were catching up to the British
before the war.
This view suggests that current attention
to German universal banking may be mis-
placed—that nineteenth-century German
institutions were used only because conditions
would not allow better ones to ﬂourish.  It
suggests that comparison of the British and
German capital markets in the late nine-
teenth century will reveal greater, rather than
smaller, costs of intermediation.  Even if
such a difference is not apparent, there is no
reason to expect to ﬁnd that German capital
markets worked better than British ones.
This view, however, conﬂicts with that
of Calomiris (1995), who argued that, in
comparison to the cost of intermediation in
American banks, the cost in Germany was
very low.  He did not compare Germany and
Britain as Fohlin did, so his work does not
bear directly on this issue.  But if the costs 
of intermediation were similar in the two
Anglo-Saxon countries without universal
banking—or with very limited universal
banking—then his conclusion is relevant.
Fohlin did not collect data on the cost of
intermediation, so she does not consider
this aspect of efﬁciency.  But if the cost of
intermediation by issuing equity in Germany
was low, then it is surprising that there was
not more intermediation.
There is, however, another possible
answer to the question of why Britain did
not have universal banks.  Relying on the
concept of complementarity of Milgrom
and Roberts (1990), we may conclude 
that British conditions may not have been
conducive to German-style banking.  This
choice may not have been due to the advan-
tages and disadvantages of the respective
banking structures, but rather to how well
each complemented the other institutions
in its own country.  German banks would
not have worked well in Britain, just as
British banks would not have worked well
in Germany.
This is a more complex situation.  In a
world ﬁlled with complementarities, there
is no way to evaluate speciﬁc institutions
and practices in isolation.  Each of them is
good or bad in speciﬁc contexts; they do
not stand isolated in the world.  To the
extent that British or German banking was
located within such a web of complemen-
tarities, it does not make sense to compare
them with each other independent of the
rest of the capital market.
Complementarities are relevant here
because the German equity market was
not as well developed as the British in the
late nineteenth century—and it may not 
be as well developed even now.  German
ﬁrms relied more heavily on debt than
British ﬁrms; that is, they were more highly
leveraged.  The composition of debts in the
economy as a whole therefore must have
differed in the two countries.  Fohlin sepa-
rates assets into debt and equity as she
describes bank assets, but not for the
economy as a whole.
For example, Fohlin shows that banks
in Britain and Germany held approximately
the same small share of their assets in the
form of equity in nonﬁnancial ﬁrms.  Since
the equity market was less developed in
Germany, German ﬁrms relied more heavily
on debt ﬁnancing than did their British
counterparts.  Edwards and Ogilvie (1996),
using data from Goldsmith (1985), calculate
that shares of domestic joint-stock compa-
nies were 12 percent of national assets in
Britain in 1895 and 2 percent in Germany.
These shares had changed slightly to 10
FEDERAL RESERVE BANK OF ST. LOUIS
50MAY/JUNE  1998
percent and 3 percent, respectively, by
1913.  The share of business equity held
by banks in Germany then may have been
larger than in Britain.
Alternatively, many observers have
argued that German banks provided capital
to industrial ﬁrms through what has been
translated as the “current account.”  This
was a deposit with automatic overdraft priv-
ileges.  The interest rate on overdrafts was 1
percent above the market rate; on deposits,
it was 1 percent below the market rate.  If
this practice was used widely in Germany
but not in Britain, then the comparison of
equity holdings would reveal less about
German banks than about British banks.
This discussion leads to another point
Fohlin makes.  As this is a new point, I
need to back up and work back to the issue
of the “current account.”  The literature
typically assumes that the great German
banks wanted to dominate the economy,
just as the Money Trust and J. P. Morgan are
alleged to have wanted to do in the United
States.  But why did they want to do this?
Fohlin assumes they wanted to exert this
inﬂuence to make money—like any other
ﬁrm in the economy.
This assumption leads Fohlin to ask
how German banks could have made
money from dominating industrial ﬁrms.
They could have held the equity of these
ﬁrms, which would have provided a direct
line to their growth and proﬁts.  But Fohlin
found that the German banks did not hold
much equity—certainly not more than the
British banks.  If they exerted inﬂuence
over managers, they must have done so by
voting shares deposited with them but not
owned by them, or by force of personality.
How, then, did they make their money?
As I have noted, German banks loaned
extensively through the “current account.”
This was a debt instrument, not equity, in
which the interest rate was ﬁxed and rather
low; there was little money to be made here.
German bankers were not, so far as I know,
active in politics.  They were not men of
great wealth independent of their banks,
and their wealth was not increased by the
action of borrowing ﬁrms.  German bankers
lived well, but then so did British bankers.
Fohlin therefore has posed a question
that the literature on banking needs to
take seriously.  Were the German universal
banks that have been both gloriﬁed and
viliﬁed over the years simply banks along
the lines that we know them, loaning
money to ﬁrms and earning money by
choosing good risks?  Or were they like
the man pulling the levers behind the cur-
tain in The Wizard of Oz?  And if they were
pulling the levers of industrial power, how
were they being paid for doing so?
REFERENCES
Calomiris, Charles.  "The Costs of Rejecting Universal Banking: 
American Finance in the German Mirror, 1870-1914,"
Coordination and Information: Historical Perspectives on the
Organization of Enterprise, Naomi Lamoreaux and Daniel Raff, eds.,
University of Chicago Press, 1995.
Edwards, Jeremy, and Sheilagh Ogilvie.  “Universal Banks and 
German Industrialization: A Reappraisal,” Economic History Review
(August 1996), pp. 427-46.
Gerschenkron, Alexander.  Economic Backwardness in Historical
Perspective, A Book of Essays, Harvard University Press, 1962, 
pp. 5-30.
Goldsmith, Raymond W.  Comparative National Balance Sheets,
University of Chicago Press, 1985.
Milgrom, Paul, and John Roberts.  “The Economics of Modern
Manufacturing: Technology, Strategy, and Organization,” American
Economic Review (June 1990), pp. 511-28.
Pagano, Marco.  "Financial Markets and Growth: An Overview,"
European Economic Review (April 1993), pp. 613-22.
FEDERAL RESERVE BANK OF ST. LOUIS
51

Comparative National Balance Sheets,

Economic Backwardness in Historical Perspective, A Book of Essays,

Financial Markets and Growth: An Overview,&quot;

The Costs of Rejecting Universal Banking: American Finance in the German Mirror, 1870-1914,&quot; Coordination and Information:

Universal Banks and German Industrialization:

Banking systems and economic growth: lessons from Britain and Germany in the pre-World War I era - commentary

http://research.stlouisfed.org/publications/review/98/05/9805pt.pdf

Banking systems and economic growth: lessons from Britain and Germany in the pre-World War I era - commentary

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