QUESTION

NBER WORKING PAPER SERIES
EMERGING FINANCIAL MARKETS AND EARLY U.S. GROWTH
Peter L. Rousseau
Richard Sylla
Working Paper 7448
http://www.nber.org/papers/w7448
NATIONAL BUREAU OF ECONOMIC RESEARCH
1050 Massachusetts Avenue
Cambridge, MA 02138
December 1999
The authors thank participants at the October 1999 meetings of the Economic History Association.
The views expressed here are those of the authors and do not reflect those of the National Bureau of
Economic Research.
© 1999 by Peter L. Rousseau and Richard Sylla.  All rights reserved.  Short sections of text, not to exceed
two paragraphs, may be quoted without explicit permission provided that full credit, including © notice, is given
to the source.
Emerging Financial Markets and Early U.S. Growth
Peter L. Rousseau and Richard Sylla
NBER Working Paper No. 7448
November 1999
JEL No. E44, G10, N11, N21
ABSTRACT
Studies of early U.S. growth traditionally have emphasized real-sector explanations for an
acceleration that by many accounts became detectable between 1815 and 1840. Interestingly, the
establishment of the nation’s basic financial structure predated by three decades the canals, railroads, and
widespread use of water and steam-powered machinery that are thought to have triggered modernization.
We argue that this innovative and expanding financial system, by providing debt and equity financing to
businesses and governments as new technologies emerged, was central to the nation’s early growth and
modernization. The analysis includes a set of multivariate time series models that relate measures of banking
and equity market activity to measures of investment, imports and business incorporations from 1790 to
1850. The findings offer support for our hypothesis of “finance-led” growth in the U.S. case. By implication,
the interest today in improving financial systems as a means of fostering sustainable growth is not misplaced.
Peter L. Rousseau Richard Sylla
Department of Economics Department of Economics
Vanderbilt University Leonard N. Stern School of Business
Box 1819 Station B New York University
Nashville, TN 37235 44 W. 4 th Street
and NBER New York, NY 10012
peter.l.rousseau@vanderbilt.edu and NBER
rsylla@stern.nyu.edu
I. Introduction
Traditional studies of the early U.S. economy (North 1961; David 1967; Engerman and
Gallman 1983; Weiss 1994) have emphasized real explanations for what has come to be accepted as a
gradual acceleration in the rate of output growth between 1790 and 1840.  Such factors as increases in
the productivity of labor, the adoption of manufacturing and transportation technologies, the expansion
of foreign commerce, and the growth of cotton exports in particular or westward agricultural expansion
in general are central to these accounts.  Economic historians are becoming increasingly aware,
however, that the emergence of the nation’s modern financial structure predated canals, railroads, and
the widespread use of water and steam-powered machinery by three or four decades.  Within five years
of the ratification of the Federal constitution, the nation had restructured its large revolutionary war
debts, introduced the U.S. dollar as a convertible currency, formed both a banking system and a
national bank with branches, established and linked securities markets in major cities, and gained the
confidence of European investors who transferred capital to the United States.
As state governments proceeded to charter more than 800 new banks and securities markets
grew over the next half century, the financial sector provided short- and long-term debt and equity
financing to businesses and governments for purposes of economic expansion and the implementing of
new technologies (Sylla 1998, 1999).  Securities markets in New York, Boston, Philadelphia and other
cities grew apace with the banking system throughout the period, promoting the mobilization of both
domestic and foreign capital, and infusing the new financial claims with liquidity.  Such financial
development, having occurred on such a scale only in the seventeenth-century Dutch Republic and in
eighteenth-century England, was rare in history.  And nowhere did it occur as rapidly as in the young
United States.  The new republic, effectively bankrupt in the 1780s, over the next three decades
arguably became history’s most successful emerging market.
1
Despite this impressive record, the role of financial innovation and financial-system
development in early U.S. growth is neglected by economic historians or regarded as a relatively
unimportant element of the expansion of a largely agrarian economy.  Further, growth studies have
looked primarily at macroeconomic aggregates such as GNP, and its dominant agricultural as well as
“non-agricultural” components.  Focus on such broad aggregates tends to mask the role played by the
financial system in the rapid development of the initially small commercial, manufacturing, and service
sectors.  More than agriculture, it was these sectors that began to expand rapidly after 1790.
Eventually, we know, their rapid expansion came to dominate the U.S. economy’s overall growth.
Hence, if we pay little attention to these sectors’ expansion until their impact on macroeconomic
aggregates becomes detectable, we miss some crucial aspects of economic modernization.  And we are
likely to miss as well, or to minimize, the importance of the financial development that made this
modernization possible.
Our paper investigates the hypothesis that U.S. economic growth and development were
“finance led.”  In so doing, it offers a strong case in support of a general version of our hypothesis that
has remained at the forefront of economic discourse since Gurley and Shaw (1955), Goldsmith (1969),
McKinnon (1973) and Shaw (1973) first elucidated the channels through which a larger and more
efficient financial superstructure might help to effect favorable macroeconomic outcomes.  We begin
by demonstrating that the United States, which at the time independence was achieved in the 1780s
lacked nearly all the elements of a modern financial system, by the 1820s had a financial system in
place that was innovative and perhaps the equal of any in the world.  What one of us has termed “the
Federalist financial revolution,” led by Secretary of the Treasury Alexander Hamilton in the early
1790s, was at the heart of these developments (Sylla, 1998).  History rightly credits Hamilton and his
allies in the first Congresses with putting the new government’s finances on a solid footing and
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establishing its credit.  Less appreciated is the articulated and rapidly expanding financial system that
emerged along with the strengthening of the nation’s public finances.

1
Next, we make an empirical case for, and test the hypothesis of, finance-led U.S. growth.
Although earlier work has presented evidence favoring this hypothesis for the latter half of the
nineteenth century (Rousseau 1998; Rousseau and Wachtel 1998), limitations of the available data
make it challenging to establish the case for the nation’s early years. For example, until now an
estimate of the U.S. money stock prior to 1820 has not been available, and the wealth of information
contained in newspapers and other private sources about the extent and sophistication of U.S. securities
markets in the antebellum era has only just begun to be uncovered (Sylla 1998; Sylla, Wilson, and
Wright 1997; Atack and Rousseau 1999; Rousseau 1999; Wright 1999).  Our paper synthesizes the
progress made to date in collecting such quantitative information to offer a cohesive, if still sketchy,
view of the U.S. financial system and how it compared with that of England.
Because the full dimensions of financial change in the early United States are only now becoming
clear, comparisons with England are rare.  In the 1830s, the American economist Henry Carey and the
English banker James Gilbart debated the relative merits of the two countries’ banking systems (see
Sylla 1985).  In the modern literature, for comparative discussions pertaining to later periods of the
nineteenth century, see Davis (1966), Davis and Cull (1994), Davis and Gallman (forthcoming), and
Michie (1987).
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1

After presenting some of these quantities and describing their evolution, we explore the size
and nature of dynamic interactions between activity in the real sector and the scope of financial-system
development.  The main statistical results derive from a set of multivariate time series models which
include measures of activity in banks, the money market, and equity markets, as well as indicators of
output,  investment, imports and business incorporations from 1790 until 1850.  Exogeneity tests
examine whether growth in the financial variables led to increases in real activity, and impulse
responses quantify the absolute and relative sizes of these effects.  These tests address the fundamental
and still controversial issue of whether financial development merely proceeds along with, or follows,
economic growth emanating from real-sector forces, or whether growth was “finance led.”
II. The Emergence of U.S. Financial Markets, 1790-1850
By any standard, modern or otherwise, the speed and success with which a banking system and
capital markets emerged in the United States as mobilizers of domestic and international resources
after 1790 is nothing short of remarkable.  In the 1780s, the Confederation government was burdened
by huge debts left over from the Revolutionary War that, because it lacked taxing powers, it could not
service or pay.  Evidences of these debts–essentially junk bonds in default–traded for small fractions of
par value in unorganized and illiquid markets.  The states were in a similar position, but at least they
had revenues to service their debts.  The entire system of organized financial intermediation consisted
of but three just-organized banks (one each in Philadelphia, New York and Boston) that supported
local commercial interests and could not yet be considered a banking system
.  One of these institutions,
the Bank of New York, failed repeatedly to obtain a state charter of incorporation from 1784, when it
was organized, until 1791, when the New York legislature finally relented in fear that branches of the
new federal Bank of the United States might co-opt state-sponsored banking.  Another, Philadelphia’s
Bank of North America, had its 1782 Pennsylvania charter revoked in 1785, obtained a new one from
Delaware in 1786, and then had the Pennsylvania charter re-instituted in 1787.  The nation’s money
stock, if it could be described as such, consisted of foreign coins and specie, fiat paper moneys issued
by each of the thirteen states with varying rates of exchange among them, and locally circulated notes
and deposits of the three banks.  Against this background, a sense of urgency arose among the nation’s
leaders to put mechanisms in place for mobilizing the resources needed to link the nation’s land mass
by means of economic infrastructure, to promote domestic and foreign trade, and to build a productive
modern sector. The new Constitution hammered out at the Philadelphia convention of 1787 and
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adopted by the required number of states in 1788 spoke to these issues.
Hamilton, as the new federal government’s Treasury Secretary in 1789, became the architect of
the nation’s financial strategy.  Congress implemented the federal taxation allowed by the Constitution
and Hamilton built the system of revenue collection.  That system became the basis for a restructuring
of old Confederation and assumed state debts via fresh issues of federal securities which paid interest
quarterly in hard money.  These features raised the value of the new securities to domestic investors
and their appeal to foreign investors.  Hamilton next persuaded Congress to charter a Bank of the
United States, a mixed (publicly and privately owned) corporation whose shares the private investors
could purchase by tendering the new federal debt.  The Bank helped to achieve the dual purposes of
raising the nation’s credit standing and establishing a more uniform currency.  Finally, Hamilton drew
up the plans for the dollar, defined in terms of both gold and silver, as the nation’s monetary unit and
base, and called for establishing a federal mint to make U.S. coins.
Hamilton’s plans, formulated and adopted in a two-year burst of activity from 1789 to 1791,
worked.  By 1792, the new 6 percent securities sold at or above par, the national bank was fully
subscribed, and state governments began to retire their fiat currencies, which were replaced by a
monetary base of specie dollars and bank note and deposit liabilities convertible to the specie base.
The financial revolution launched with these measures was to continue vigorously for decades and
stands among the most sweeping in history, comparable to what England a century and the Dutch
Republic two centuries earlier had achieved at a more leisurely pace.
A. The Rise of State Banking
Starting with only three banks in 1789,  28 new banks obtained state charters in the 1790s, and
another 73 were chartered in the decade that followed (Fenstermaker, 1965a, p. 13).  The profitability
of these early banks, for which annual dividends of more than 8 percent were commonplace, sparked a
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2
900
800
700
600
500
400
300
200
100

Number of State Banks
Paid in Capital (mil. US$)
1790 1795 1800 1805 1810 1815 1820 1825 1830 1835 1840 1845 1850
0
Year
Figure I. The Rise of State Banking, 1790-1850.
rapid expansion that reached a high-water mark of 834 state banks by 1840.  Then, after a brief
decline, the number of state banks nearly doubled again by 1860.  Figure I shows the evolution of the
number of chartered banks and our estimates of their paid-in capital before 1850.
number of banks, the increase in capital from a mere $3 million in 1790 to $426 million by 1840
reflects their growing role in mobilizing resources and providing credit and other financial services.
The state-chartered banks, like the federally chartered Bank of the United States, were
corporations with limited liability, which is a major reason why they were able to attract so much
capital investment.  The early Americans did not invent the banking corporation, but as of 1790 the
Our estimates of paid-in capital extend backward the series for 1837-1850 which appears in
Historical Statistics of the United States (Bureau of the Census, 1975, series X587).  This was done
by using the total number of state banks to “blow up” the paid-in capital for reporting state banks in
each year from 1803-1837 (Fenstermaker, 1965b, p. 406, and Fenstermaker 1965a, pp. 66-68) and
then splicing the result to the Census series. Fluctuations in the authorized capital of all state banks for
1790-1802 (Fenstermaker, 1965a, p. 13) were then used to approximate the series through 1790.
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2
Like the rise in the
world had seen few examples of it, and these were privileged monopolies such as the Bank of England.
What the Americans did, uniquely when they did it, was charter so many banking corporations that
they had to compete with one another rather than enjoy monopolistic privileges.  From the 1790s to the
middle of the nineteenth century, nowhere else in the world was the banking corporation as a
competitive business enterprise developed to the extent that it was in the United States.
or seven decades after the American innovation, did the old nations of the world begin to emulate the
United States by allowing competitive corporate banking (Sylla 1985).

3
For keen insights on how the early U.S. corporate banks became competitive enterprises, see
Schwartz (1947).

4
The significance of these developments is underscored by a comparison with England.
Everyone knows as a stylized fact that England was the financial leader of the nineteenth century, with
the pound sterling the world’s leading currency, London and the Bank of England the center of the
world’s finances, and the London capital market intermediating the international flow of capital.  What
everyone does not know is that as early as 1825, the United States, with a population still smaller than
that of England and Wales (11.1 versus 12.9 million), had roughly 2.4 times the banking capital of the
latter (Sylla 1998, p.93).
4
This was not entirely the result of the financial revolution in the United
States.  English policy, and in particular the monopoly privileges of the Bank of England and the
restriction of all other banks to unlimited-liability partnerships of six or fewer people, retarded banking
development in that country until 1825, when the policy was altered to allow joint-stock banking with
unlimited liability.
B. The Emergence of Securities Markets
The precocity of U.S. banking development was duplicated in the development of securities
Our estimate of the paid-in capital of state banks in 1825, portrayed in Figure I, is $106.9 million.
This is somewhat higher than the estimate of Sylla (1998), which likely underestimated paid-in capital
by using a conservative estimate of 0.6 for the ratio of paid-in to authorized capital.
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3
Only then, six
markets. Following the debt refinancing of 1790 and the launching of the Bank of the United States a
year later, securities markets sprang up virtually overnight in the major cities (Philadelphia, New York,
Boston and Baltimore) to provide regularized trading opportunities for the new debt and equity claims.
The “national market” securities, which then included the U.S. debt issues and Bank stock, were traded
in each city, and were joined by steadily growing lists of “local” equity and debt securities.  With the
securities markets came a tendency for “overtrading” and speculation (Werner and Smith 1991) that
even led to a market crash in early 1792.  Yet the deepening of these markets ensured that ever more
securities could be liquidated at prices that were more consistently fair than those which would have
obtained in their absence.  This leap in asset liquidity allowed investors, both domestic and foreign, to
overcome their reluctance to hold American securities.  By 1803, more than half of the U.S.
government’s debt and the stock of the Bank, and fully half of all American securities issued to that
date were held by European investors (Sylla, Wilson, and Wright 1997, Sylla 1998).

5
A rough measure of the size of securities markets is the number of claims listed therein. The
early government documents that left behind a wealth of information about banks and their condition
are, however, virtually silent on the topic of securities markets.  Fortunately, the newspapers of the time
contain the raw material from which a view of early U.S. securities markets will eventually come into
focus.  Figure II depicts the number of securities that appeared in the New York, Philadelphia and
Boston newspapers on or around June 30 of each year from 1790 to 1850.
The sources of data for New York include the New York Daily Advertiser, the New York Shipping
and Commercial List, and New York Prices Current.  For Philadelphia, the sources include the New
York Shipping and Commercial List, Philadelphia Prices Current, Grotjan’s Philadelphia Public
Sale Report, Poulson’s American Daily Advertiser, and the Gazette of the United States.  Listings for
Boston were compiled from data in Martin (1873).  Early newspaper listings of securities quotations
appear to be samples rather than complete populations of the securities available for trading.  The
listings, it seems, captured the larger and more actively traded issues.  Smaller issues, and issues of
corporations located at some distance from the urban centers of securities trading, did not make it into
the newspaper listings, even though they may have occasionally been traded in the urban centers.
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5
Table I includes the
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Year

6
Though not included in Table I, it is interesting to note that  listings rose at an average annual rate
of nearly 11 percent between 1795 and 1804.  There is some double counting in the totals of securities
listings from newspapers, as issues of U.S. debt and Bank stock–the “national market” securities–were
traded in all cities and were not consolidated in the totals reported here.  Our view is that these issues
were the blue-chip securities in each market, and that consolidation would result in underestimating the
size of the market that emerged in each of the cities.
10
Year
percent in the 1790s, which is double their growth rate in the 1820s, and at a rate of nearly 12 percent
per year in the decade 1800-1809.  This suggests that a fundamental transformation in the way that the
nation mobilized and allocated capital resources began long before the 1830s, a period more often
associated with the rapid expansion of banks.  Listings of transportation securities also grew rapidly
between 1800 and 1809, suggesting that the early capital markets met with some success in raising
funds for internal improvement projects such as turnpike roads and bridges.

7
As with bank capital, we can make a rough comparison of the size of the U.S. and English
securities markets in 1825.  For the three large cities whose markets are portrayed in Figure II, 187
securities entered the 1825 listings.  Adding in the Baltimore (33 securities) and Charleston (12
securities) markets, we arrive at a total of 232 securities listings in 1825.  The newspaper of record for
the English market, Wetenhall’s Course of the Exchange, lists 320 English securities as well as a
number of foreign issues in mid 1825.  On that reckoning, the U.S. markets were smaller than the
English, but already in the same league.
Course of the Exchange also provides sufficient information to make a rough estimate of the
size of the English equity market in 1825.  Our calculations put it at £38 million, or $183 million.
The national debt of the U.K., comprising some 27 of the 320 English securities listed and
including Bank, South Sea, and India stock since these companies were capitalized by government
debt, was vastly larger ( £820 million, or nearly $4 billion) than the U.S. government debt ($84 million)
and indeed all U.S. public debts in 1825.  England had fought many more wars over a far longer period
than had the young United States.  If we look just at equity markets, a different sort of comparison
emerges.  For most of the 293 English securities that were not part of the national debt, Course of the
Exchange lists the par value of shares and the number of company shares, as well as the par value of a
small number of non-national debt issues (which came to £7.2 million or $34.3 million dollars at $4.8
to the pound sterling).  The total value of English equity issues that can be calculated came to £32.79
million.  For 42 of the 293 issues, or about 14 percent of the listings, there was insufficient information
to calculate par value capitalization.  Some of these, perhaps most, were new issues just beginning to
be traded, but if we assume that they were on average of the same capitalization as the issues whose
par value capitalization could be measured, a likely liberal estimate of the total size of the English
equity market in 1825 is some £38 million or $183 million.
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7
This
estimate of English equity in 1825 is not all that much larger than the equity of U.S. banks alone that
year, which including the Bank of the United States and state-chartered banks came to $138 million.
The total U.S. equity market was, of course, larger, but how much larger is not yet known.  A rough
estimate can be derived from the data of Goldsmith (1985), indicating that the U.S. equity market came
to $40 million around 1803 and $890 million in 1850.  If we assume constant continuous growth
(which works out to be 6.6 percent per year over the period), we derive an estimate of $171 million as
the size of the U.S. equity market in 1825.
The conclusion we draw from these exercises is both obvious and perhaps surprising:  By
1825, the size of the U.S. and English equity markets was virtually the same.  And this despite the fact
that the English had been developing their market for fully a century before the Americans got started
on developing theirs. Thus, when the two nation’s financial systems are compared, conventional views
that the English were far and away the financial leaders of the nineteenth century, and that the United
States circa 1825 was just beginning to develop in modern ways, would seem to require some revision.
That the United States had an equity market capitalization virtually the same as England’s in
1825, but with fewer equity securities listed, implies that the average U.S. equity was more highly
capitalized than the average English equity.  This likely was a consequence of the United States taking
the lead in chartering corporations, particularly banks in the early period, with limited liability.  In a
number of ways the U.S. and English equity markets were similar.  Both listed insurance and
transportation companies, a variety of utilities, and miscellaneous companies including manufacturing
enterprises.  The great difference between the two markets was banks.  The Americans had them in
spades.  The English market in 1825 listed but two, one the Bank of England–more a government
security than a private equity, and treated by the English as such–and the other, in the “Miscellaneous”
category, was not an English bank at all, but the Provincial Bank of Ireland.
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C. The Stock of Money
Still another way to measure financial development is through growth in liquid assets, or the
money stock.  This includes obligations of banks to the public and specie outside of banks.  Both
components represent assets that are either acceptable or quickly convertible for use in market
transactions.  Increases in the real value of these assets reflect more widespread use of the market
economy. As the United States modernized, expanded its international trade and gained the confidence
of foreign investors, an inflow of specie and the expansion of bank credits arising from these activities
encouraged imports, modern production activities, and the start of internal improvements.
Any estimate of the money stock before 1850 must necessarily be based on sketchy and
incomplete data.  This is primarily because the most important component in the early years, specie in
the hands of the public, is difficult to determine with confidence.  In this paper, we start with Peter
Temin’s (1969) estimates of the money stock for 1820-1850 and replicate his method as closely as
possible to extend the series backward to 1790.  The result is the first attempt to provide a continuous
view of money growth before 1820, and to our knowledge makes the best possible use of available
data.  Although it is an approximation, we expect that the series captures fluctuations in the money
stock well.  Appendix A offers a detailed description of its construction.
Figure IV plots the series, which indicates a three-fold increase in the money stock between
1790 and 1820, indicating an average annual growth rate of about 3.7 percent.  During the next one
and one-half decades, to the mid 1830s, the money stock rose at a rate of more than 7 percent per year.
From 1836 to 1842 occurred a major collapse, comparable with that of the Great Depression of the
1930s, as the money stock shrank to less than three-fifths of the 1836 level before recovering rapidly at
a rate of 8 percent per year in the late antebellum era (1842-1858).  Over the six decades, 1790-1850,
portrayed in Figure IV, the money stock grew at an annual rate of 4.3 percent.
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14
Year
commercialization and monetization, the Northeast region of the U.S. by the 1820s had, it appears,
become rather like England.
III. Indicators of Economic Growth in the Early U.S.

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If we are to test quantitatively the hypothesis that financial developments jump-started U.S.
modernization in the nation’s early decades, we need to have some measures of modernization for that
period.  Such measures are not numerous, but there are a few.  The ones that we consider here are
estimates of GNP and its investment component, trade data, and data on business incorporations.
A. National Accounts Aggregates
Much of what is now known about the growth rate of output (or income) in the pre-1840 U.S.
“statistical dark age” is the result of discussions in recent decades among economic historians
culminated in Thomas Weiss’s (1994) refinements of Paul David’s (1967, 1977) conjectural estimates.
The consensus view now abandons any notion of a “take off” in favor of a gradual acceleration in the
trend rate of output growth over the 1800-1840 period, although it remains uncertain whether waves of
more active growth occurred in such periods as 1790-1807, 1820-1835, and 1845-1855.  Table II
summarizes the David and Weiss estimates of growth rates, as well as those derived from the GNP
estimates of Thomas S. Berry (1988).  The pre-1840 estimates, particularly Weiss’s, are modest by
later standards, but they offer a sharp contrast to the picture of stagnation before 1840 posited earlier
by Martin (1939) and Taylor (1964).
The differences between the David and Weiss estimates for 1820-1840 derive primarily from
assumptions that underlie their agricultural basis, such as the number of acres under cultivation, the
number of workers per acre, and the productivity of an average worker.  Berry’s GNP estimates, which
These contributions include Martin (1939), Rostow (1960), Parker and Whartenby (1960), North
(1961), Taylor (1964), and Gallman (1971).
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8
that

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Table II
Estimates of Annual Growth in Real Per Capita GNP, 1790-1860
Period David Berry Weiss
1790-1806    1.30%    1.70% NA
1800-1820 0.27 1.27 0.28
1820-1840 1.96 1.63 0.84
1840-1860 1.60 1.58 1.60
1800-1840 1.13 1.45 0.56
1800-1860 1.29 1.41 0.90
The table presents average rates of annual growth in per capita GNP
over the subperiods listed at the left. Sources are the averages published
in David (1967) and in Weiss (1994), and averages computed from the
annual series in Berry (1988).
we used to compute the period averages attributed to him in Table II, are from his published annual
series, which extrapolated the Kuznets-Kendrick-U.S. Department of Commerce estimates backward
from 1875.  Though the annual series is built upon a statistical rather than theoretical model and uses
extrapolators which become less numerous the farther back the series runs,
Berry uses from 10 to 26 extrapolators for his GNP and investment series between 1789 and
1850, with 18 extrapolators available by 1804. His methodology averages the growth rates of a set of
median extrapolators in each year (using 3 series in the 1790s and 6 series after 1800) to compute the
growth rate of a “consensus pattern.” The pattern is then linked with the Department of Commerce
concept of annual GNP for 1876.  The technique thus omits in each year those series that exhibit the
widest and narrowest fluctuations.  The authorized capital and deposits of U.S. banks are the only
financial variables among the extrapolators, and are thus unlikely to have had a large effect on the
evolution of the aggregates.  Indeed, an earlier version of Berry’s GNP series (1968) that does not
include financial variables until 1816 has a correlation coefficient of 0.989 for 1790-1850 and 0.955 for
1790-1815 with the final (1988) series.  See Berry (1968, 1978, 1988) for a complete discussion.
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the results are broadly
consistent with David’s conjectures and may well reflect, at a minimum, fluctuations in the level of
economic activity.  We would note in particular that Berry’s series of real GNP per capita in Figure V
shows a gradual acceleration before 1807 and from 1825 to 1835.
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Year
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Year
capture the internal impact of such “export-based” expansions.  Imports, on the other hand, may reflect
demand-side growth more effectively since they are sensitive to increases in income from exports, re-
export services, and inflows of foreign capital.  Most importantly, imports also reflect changes in
income arising from additional export-induced production that finds its way into domestic markets.
Figure VI includes the annual level of real per capita imports using North’s (1961, pp. 229,
280) index of import prices as a deflator.  The period between 1790 and 1802 saw rapid growth, while
the period 1808-1820, marked by the embargo and non-intercourse policies as well as by war and
postwar adjustments, was one of sharper fluctuations.  Imports revived after 1820 and gradually rose
through the mid-1830s, before falling by nearly 50 percent from 1837-43.  The sharpest growth came
early in the nation’s history and may well have reflected, along with opportunities arising from
European wars, the existence of adequate financial resources for their support.  The decline in real
imports that followed the Panic of 1837, as well as the fall in real investment, coming as they did at a
time when the financial system was stressed by banking failures and a seizing up of securities markets,
lends support to our view that good (and bad) finance matters for real economic performance.
B. Business Incorporations
A different and underutilized approach to studying the development of the modern sector is
through the activities of its most fundamental units–entrepreneurs, broadly construed to include
enlightened statesmen.  These individuals recognized early in the nation’s history the potential of the
corporate form of enterprise for promoting projects that would otherwise remain unstarted or stunted in
development because of indivisibilities (for example, the “lumpiness” of investment) and inadequate
opportunities for diversifying risks.  Historians have called attention to the uniqueness of corporate
development in the United States after the Revolution (Handlin and Handlin 1945; Maier 1993).  Maier
notes that the corporation was moribund in eighteenth-century England, when it was “salvaged” or
“rescued” by Americans who “utilized its capacity to empower individuals whose resources were
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unequal to their imaginations” (Maier 1993, p. 83).

10
Some precursors of general incorporation laws were enacted by states for non-business entities
and for special purpose businesses such as the provision of aqueducts, yet the only general laws
enacted for businesses over the period of our study were by New York in 1811 and New Jersey in
1846.  In New York, 317 of 1,436 incorporations (22.1 percent) between 1811 and 1846 fell under the
1811 act. In New Jersey, 22 of 142 charters (15.5 percent) between 1846 and 1850 were taken out
under the general law (Evans, 1948, p. 12).

11
As the corporate form facilitated the subscription of large amounts of capital, incorporated
firms also provided a stimulus from which smaller unincorporated businesses could arise.  Thus, the
widespread incorporation of businesses had an influence on the modern sector that extended well
beyond firms actually chartered by state governments.  Since the vast majority of charters granted by
states before 1850 were by special acts rather than general laws
Davis’s totals include renewals and incorporations of a single entity by more than one state.
Figure VII adjusts these figures for multiple charters (see Davis, 1917, Table V, p. 30) to reflect the
number of business units that actually received corporate status.  The corporate form was controversial.
The nation’s first bank, the Bank of North America, for example, was chartered by Congress in 1781
and by the legislatures of three states that had doubts about Congress’s authority to enact such a
charter.  In the 1780s, as mentioned earlier in the text, Pennsylvania rescinded its charter, and then
enacted a new one for the bank after Delaware had granted it a charter in the interim.  It was only one
company, but Davis counted and reported it as having five state charters from four states.
20
10
, the legislative nature of the
incorporation process encouraged examination of applicants, which may have led to chartered
enterprises of higher quality than might have otherwise arisen.
Individual state archives are rich sources of information about the granting of early corporate
charters.  Much of the formidable task of organizing this information was completed decades ago by
Joseph Stancliffe Davis (1917) and George Heberton Evans, Jr. (1948).  Davis’s account, which covers
the period from 1781 through 1800 on a sectoral basis for sixteen states, is the most comprehensive,
covering ostensibly all incorporations.  Figure VII presents the number of financial and non-financial
incorporations annually from Davis’s survey.
11
Most striking are the sharp increases in incorporations
after 1790 and the degree to which financial and non-financial incorporations exhibited similar
21
Year

12
Since Evans’s descriptions do not indicate those instances under which firms were incorporated by
more than one state, the index cannot be adjusted for these occurrences.
22
Year
first wave and by railroad and mining firms during the second.

13
Figures VII and VIII present data on the flow of incorporations, but not on the evolution of the
stock of existing corporations over time.  Figure IX approximates this stock in index form by splicing
the incorporations series based on the Davis and Evans samples and then cumulating the annual
changes.  Figure X presents the indices in logs, which make more clear the rapid growth of our stock
measures between 1790 and 1815.  If business incorporations can be taken as an index of economic
modernization, the evidence of Figure X could be construed as indicative of a “take off” in this early
period, fully half a century before Rostow’s much disputed “take off” began in the 1840s.
The cumulations of Figures IX and X can only approximate the stock of corporate entities in
any year because the fragmentary nature of information on corporate failures and non-starts makes a
correction for such happenstances virtually impossible.
Little is known about the life span of corporations prior to 1840. Hutchinson, Hutchinson and
Newcomer (1938), in an examination of business life in Poughkeepsie, New York indicate that 54.6
percent of firms incorporated between 1844 and 1927 survived more than five years and only 29.3
percent survived for more than ten years.  Since the timeline of these figures is not given and the period
covered is one during which New York incorporations were accomplished primarily by general law, it
is uncertain how well these figures reflect business failures in earlier years.
23
13
Nevertheless, the indices of cumulative
incorporations perhaps capture a concept broader than businesses which actually  succeed–namely, the
stock of ideas or projects arising from America’s entrepreneurs.  Long-run trends and fluctuations of
such a measure perhaps reveal something about the evolving business climate of the times.  Growing
access to financial resources, for example, may have provided incentives to develop corporations as
productive outlets for funds.  In the context of this study, where emphasis is on the long-run impact of
financial market development, we think that the stock of ideas reflected in corporate chartering, as it
cumulates over time, could well be related to the size and depth of financial markets (also stock
measures) more closely than year-to-year fluctuations in the flow of incorporations.  For this reason,
our empirical work described below uses cumulative measures of incorporation activity.
24
Year
IV.  Identifying Links Between Financial Markets and Early U.S. Growth
A. Overview
The preceding sections indicate that the foundations of the U.S. financial system were largely in
place by 1800 and that facilities for banking and securities trading had already begun to see regular
use.  U.S. securities markets grew steadily in the decades that followed despite varied and sometimes
severe shocks associated with business cycles and geopolitics.  A modern sector of the U.S. economy
emerged and flourished in the midst of these developments as the social benefits of infrastructure
investments and the productivity of new technologies became increasingly apparent.  In this section, we
more formally examine the hypothesis that growth in the size and sophistication of the financial sector,
and securities markets in particular, played a leading role in promoting U.S. economic modernization
between 1790 and 1850.
The theoretical literature offers strong analytical foundations for a general version of our
hypothesis, namely that financial factors can exert a first-order influence on macroeconomic outcomes.
Gurley and Shaw (1955), in developing the basic insights of Joseph Schumpeter (1911), describe a role
for financial institutions in decreasing individual demand for precautionary money balances through
diversification services and the promise of  higher returns associated with the professional management
of surplus funds.  Their “debt accumulation” channel, which has been formalized more recently by
Bencivenga and Smith (1991) and Rousseau (1998), seems especially applicable to the early U.S.
experience, where fragmentation in the capital markets often tended to limit the size of new
investments to those that could be funded through personal resources and kinship.  Such imperfections
in the early capital market also served to restrict much investment to traditional sectors such as
agriculture and home production.  The rise of chartered banks throughout the nation and securities
markets in the major cities helped to overcome problems of project indivisibilities and satisfy the
25
demand for liquidity among savers, thereby organizing the large blocks of capital that modernization
would require.
McKinnon (1973) and Shaw (1973) reinforce these basic themes, with McKinnon particularly
stressing the impact of the pooling of resources and the screening and monitoring of projects on overall
economic efficiency.  This “total factor productivity channel,” as further developed by Townsend
(1979), Greenwood and Jovanovic (1990), and King and Levine (1993a), was also made operable by a
rapidly deepening U.S. capital market that quickly developed liquid secondary markets.  These in turn
provided an environment that was conducive to business starts and offered a cost-effective mechanism
for re-allocating resources among those investments that appeared to be the most promising.  The
discipline of the capital market also increased the extent to which firm and project managers were
accountable to those who held their claims.  Diamond (1984) focuses on the role of intermediaries and
markets in striking effective arrangements for the sharing of risk between the users and suppliers of
funds.  The types of manufacturing and transport projects that characterized the early United States
involved considerable risk, and many would have surely remained in the drawer without the risk-
sharing arrangements that banks and securities markets made possible.
Other models, both theoretical and empirical, have characterized the interactions between
banks and securities markets as an economy grows (e.g., Goldsmith 1969; Greenwood and Smith
1995; Levine and Zervos 1998; Rousseau and Wachtel 2000).  These contributions suggest that banks
and securities markets can play complementary and mutually reinforcing roles in mobilizing capital,
rather than serving as substitutes for one another.  The experiences of modern emerging markets have
also alerted researchers to the presence of potentially important non-linearities in the relationship
between finance and growth.  Rousseau and Wachtel (1998), for example, present evidence from the
historical experiences of five industrializing countries (the US, UK, Canada, Norway and Sweden) that
26
implies critical roles for both financial intermediaries and financial markets in the early phases of
economic development.  In the case of the early United States, banks served to finance smaller, and
more information-intensive investments until they achieved a size for which direct public investment
was possible.  In addition, banks were able to attract deposits and capital through their ability to
diversify and were thus instrumental in fueling the early securities markets directly.
B. Model Selection and Analytical Framework
Our approach begins with the selection of multivariate systems for examining the plausibility of
channels through which financial markets may have influenced real activity.  The annual nature of our
series and their availability for sixty years facilitates investigation in a vector autoregressive (VAR)
framework.  VARs are reduced forms that are useful for characterizing statistical relationships that
may exist among a set of time series and exploring issues of cause and effect.  To be meaningful,
however, it is critical that economic theory drives the selection of variables to include in each system.
In our case, the recent economics literature described above suggests a  number of theoretical channels
through which the growth of stock markets and financial intermediaries can influence economic
development.  Although our data are not rich enough to distinguish decisively among the individual
channels, they do facilitate the construction of reduced forms to test the joint hypothesis that financial
markets operated through these channels to have positive effects on activity in the real sector.
We begin our investigation with the broadest measures of economic activity and proceed to
those which more closely capture our notion of the modern sector.  To this end, the first tri-variate
system examines the potential role of financial markets in the most general of macroeconomic
performance measures, real per capita output.  The numbers of listed securities per capita in three
(Boston, New York, Philadelphia) and then four (adding Baltimore) cities indicate the breadth of early
U.S. securities markets.  As fluctuations in output may be plausibly linked to the availability of both the
27
circulating medium and the resources of the banking system, our estimate of the real per capita stock of
money serves as a key control variable.
Real per capita measures of gross private domestic investment and imports replace output in
the second set of systems. These specifications allow an examination of the degree to which the data
are consistent with the mechanisms for early growth driven by investment and outward orientation
proposed respectively by Gallman (1986) and North (1961).
We then focus on measures that may reflect activity in the modern sector even more closely,
namely our indices of cumulative total and non-financial business incorporations.  These systems also
include the number of securities listed in the organized securities markets.  As business incorporations
before 1850 are more likely to be influenced by the possibilities for external finance than the stock of
money, we choose the number of state chartered banks as a control variable to reflect the importance of
the banking sector in promoting new businesses.  This choice also allows us to shed some light on the
nature of interactions between banks and securities markets.
The VAR methodology permits an investigation of dynamic interactions in a multivariate
system without imposing a priori structural restrictions.  It involves estimating a separate regression
equation for each variable on its own lags and those of the other variables in the system.  For example,
the first VAR described above has the form
x
x
x
1, t
2 , t
3 , t
’ a
’ a
’ a
1, 0
2 , 0
3 , 0
%
j
k
i ’1
%
j
k
i ’1
%
j
k
i ’1
a
a
a
1, i
2, i
3, i
x
x
x
1 , t &i
1 , t &i
1 , t &i
%
j
k
i ’1
%
j
k
i ’1
%
j
k
i ’1
b
b
b
28
1 , i
2, i
3, i
x
x
x
2, t &i
2 , t &i
2 , t &i
%
j
k
i ’1
%
j
k
i ’1
%
j
k
i ’1
c
c
c
1, i
2 , i
3 , i
x
x
x
3 , t &i
3, t &i
3, t &i
% u
% u
% u
(1a,b,c)

where x
1
is income, x
2
is the money stock, x
3
1, t
2 , t
3 , t
is the number of listed securities, and k is the number of
lags.  We use a series of nested likelihood ratio tests to select the lag order.

14
This method starts with a sufficiently large lag length and then tests successively that the
coefficients on the final lag are zero, stopping when the restrictions are rejected.

15
Tests for Granger causality are used frequently when examining interrelationships among
macroeconomic time series and are easily computed from a VAR model.  Their statistical interpretation
is simple.  For example, if we reject a set of restrictions in (2) for one of the system variables (say the
number of listed securities) when estimating (1a), this implies explanatory power for its lags in current
output beyond that which can be attributed to past values of output and money alone.

16
Augmented Dickey-Fuller (Said and Dickey 1984) tests for unit roots suggest non-stationarity in
levels and stationarity in first differences in  each case.  After determining the order of cointegration in
each of our multivariate systems, Johansen’s test rejects the null hypothesis of stationarity for all
individual variables.  Appendix B includes these results and details of the test regressions.

17
ˆ
l
j ,i
’
ˆ
l
j , i %1
’ . . . ’
ˆ
l
j , k
’ 0 l ’ a, b, c ; j ’ 1, 2, 3 .
Inferences about the cointegration space in each system are based on the technique developed in
Johansen (1991). Appendix B describes this technique and presents the full set of results.
29
14

Stationarity of a VAR is critical in building exact tests for Granger non-causality, that is, the
hypothesis that past values of one variable do not jointly improve one-step ahead forecasts of another.
Specifically, the null hypothesis implies the following joint restrictions on the coefficients in (1):
In general, the distributions of these tests are affected by nuisance parameters (see Toda and Phillips,
1993) and are thus nonstandard when a VAR contains variables with unit roots, and differencing these
variables is usually required to ensure stationarity. However, Sims, Stock, and Watson (1990) show
that Granger tests conform to standard distributions in tri-variate VARs with unit roots so long as a
single cointegrating relationship exists among the system variables.  This result is important for many
of the tri-variate VARs that we estimate here because unit root tests for all of the series in our analysis
do not reject a null hypothesis of non-stationarity and firmly reject a null of stationarity,
appears to be single cointegrating relationship in all but two of the systems.
17
16
and there
Levels specifications
with the automatically-selected lag order are thus appropriate for drawing Granger-causal inferences in
most cases.  The exceptions arise when GNP serves as the measure of macroeconomic performance
15
(2)
and there is only weak evidence of cointegration. For cases in which the order of cointegration in a
system with unit roots is uncertain, Toda and Yamamoto (1995) show the asymptotic consistency of
tests for block exclusion can still be ensured, albeit with some loss in efficiency, by estimating an
“augmented VAR.”  This levels specification uses one additional lag for each possible cointegrating
relationship in the system.  Tests for block exclusion then include only the number of lags that would
be selected with cointegration imposed.  For the systems with GNP, we discuss results which employ
both traditional and augmented VARs.
The ability to construct valid tests for Granger causality from a levels specification of the VAR
is  advantageous in this study since it permits the joint evaluation of both short- and long-term effects
of movements in one variable upon the others which make up each system.  Indeed, as persistent yet
gradual increases in market size  might be expected to have real effects on the performance of the
modern sector that accumulate over time, the implicit inclusion of long-run effects in the cointegrated
VARs makes them particularly well suited for such an exploratory analysis.  The tests must be
interpreted cautiously, however, since as a statistical device a rejection of the null hypothesis does not
necessarily imply “economic causality.”  In particular, the validity of the tests is predicated on the
inclusion of the full information set in the VAR specifications.  Since this condition is necessarily
violated in any finite regression framework, the results presented in the following subsections can only
be interpreted as strongly suggestive of the nature of linkages among the variables in each system.
When an investigator can specify a reasonable causal ordering for the variables (based on
economic theory and perhaps the results of Granger tests), the nonlinear responses of each variable in
the system to one-time shocks in the other variables can be traced through time via orthogonalized
impulse responses.  This facilitates an evaluation of the economic significance (or size) of the dynamic
effects.  For this reason, the results of the Granger tests are augmented with a graphical examination of
30
the impulse responses for those systems in which financial factors appear to matter.
C. The Effects of Securities Markets on National Accounts Aggregates
Our empirical analysis begins with VAR systems that use Berry’s (1988) annual estimates of
real GNP per capita as a measure of macroeconomic performance.  When combined with per capita
measures of the real money stock and the number of listed securities in either three or four cities, a
series of nested likelihood ratio tests select four lags for the systems in logs. Since Johansen tests
indicate that these systems have at most one cointegrating vector but that the presence of cointegration
is uncertain (i.e., the null hypothesis of no cointegration is rejected at only the 15 percent level), we
estimate a standard VAR with four lags which imposes the long-run relationship as well as an
“augmented” VAR with five lags.  Table III presents F-statistics and p-values for each block of
coefficients. There is no evidence of Granger causality from the number of listed securities to output in
any of the four specifications (see the entries for equation 1a under the columns labeled “No. Listed
Securities”), though there is some evidence of bidirectional  Granger causality between money and
output.  Neither money nor output appears to influence the size of securities markets.
One might interpret these findings as indicative of a non-pivotal role for the U.S. financial
sector in promoting the growth of general living standards before 1850.  Such a temptation should be
resisted.  The U.S. financial revolution in its earlier phases did not affect all sectors of the economy
equally. Initially, it was an urban development having its greatest impact on the commercial and
industrial groups that were a small part of the population.  A large majority of the country’s population
was engaged in agriculture, much of it traditional and self-sufficient.  Agricultural production
dominated the nation’s GNP, but the agricultural sector would only gradually come to be affected by
the new financial system as it extended itself beyond cities and spread its influences beyond its urban
roots.  When seen in this light, our statistical results with finance and GNP are quite consistent with the
31
Table III
F-statistics for Granger-Causality in VARs with Real Per Capita GNP, 1790-1850
Three Major Markets Four Major Markets
Estimation      Eq. GNP Money
Cointegrated VAR
(K=4)
Augmented VAR
(K=5)
1a 23.05
(0.000)
1b 5.660
(0.001)
1c 0.724
(0.580)
1a 4.445
(0.005)
1b 5.347
(0.002)
1c 0.721
(0.583)
Stock
No. Listed
Securities
3.682
(0.011)
23.83
(0.000)
0.782
(0.543)
3.242
(0.021)
11.89
(0.000)
0.828
(0.515)
1.683
(0.171)
0.824
(0.517)
47.24
(0.000)
1.320
(0.279)
1.443
(0.238)
25.34
(0.000)
32
R
a
2
GNP Money
Stock
0.973 20.79
(0.000)
0.893 6.968
(0.000)
0.971 0.183
(0.946)
0.971 3.843
(0.010)
0.899 6.389
(0.000)
0.969 0.274
(0.893)
3.277
(0.020)
22.65
(0.000)
0.494
(0.740)
2.905
(0.033)
11.60
(0.000)
0.981
(0.429)
The VARs include GNP, the money stock, and the number of listed securities in three (left panel) or four (right panel) major markets.
The three markets are Boston, New York, and Philadelphia, while the right panel also includes Baltimore. All variables are in per capita
log levels and represent real quantities.  Equation numbers correspond to  the text, with (a), (b) and (c) employing GNP, money, and listed
securities as the respective dependent variables. The columns report the F statistic for Granger non-causality on each variable block with
the p-value in parentheses.  The VAR system in the upper panel imposes a single cointegrating relationship and includes four lags.  The
system in the lower panel allows for uncertainty in the order of integration by adding an additional lag to the specification and computing
the Granger causality tests based on only the first four lags.
No. Listed
Securities
0.862
(0.494)
1.617
(0.187)
59.29
(0.000)
0.392
(0.813)
2.133
(0.095)
26.54
(0.000)
R
a
2
0.971
0.900
0.970
0.968
0.909
0.968
consensus view that a gradual acceleration in the trend of U.S. output growth in the country’s early
decades was too smooth to be explained by the time path of any single economic factor.  Only after an
innovation such as organized finance permeates many facets of economic life should we expect to find
its effects to be detectable in broad macroeconomic aggregates such as GNP (see David 1991).

18
We next examine systems which include real per capita private investment in place of output.
As a narrower measure that reflects expenditure on or improvement of durable factors in the
production process, investment is more likely than output to be affected directly by the availability of
external finance.  Likelihood ratio tests again select log specifications with four lags.  The results
reported in the upper left panel of Table IV indicate that the number of securities in three cities
Granger-causes investment at the 1 percent level and that the money stock Granger-causes investment
at the 10 percent level.  There is no evidence of feedback from either investment or the money stock to
the number of listed securities.  Similar results obtain for the system which includes securities listed in
four cities, with the money stock in this case Granger-causing investment at the 5 percent level.  Thus,
although financial development seems at best to have only a slight influence on GNP growth in the
early U.S., its impact on the investment component of GNP is more pronounced.
We can be more precise in characterizing this influence.  Figure XI presents impulse responses
from the system with securities listings from three cities.
The estimated responses are nearly identical with the number of securities listed in four markets
for this system, as well as those which we consider in section IV.D.  To avoid redundancy in our
presentation and discussion, we  limit explicit examinations of impulse responses to systems which
include securities listings from three markets.  The full set of estimated impulse responses is available
from the authors.
33
18
Impulse responses isolate the effects of a
unit change in a given variable on the other system variables and trace their evolution over subsequent
periods using the estimated coefficients from the VAR.  These nonlinear and often complex functions
allow us to explore the direction and size of  effects which underlie the dynamics in a given system.
Table IV
F-statistics for Granger-Causality in VARs with Investment and Total Imports, 1790-1850
Three Major Markets Four Major Markets
Macroeconomic
Indicator
Eq. Macro Money
Gross Private
Domestic Investment
1a 1.621
(0.186)
1b 1.835
(0.139)
1c 0.792
(0.537)
Imports 1a 7.151
(0.000)
1b 0.140
(0.966)
1c 0.515
(0.725)
Stock
No. Listed
Securities
2.223
(0.082)
21.15
(0.000)
0.758
(0.558)
4.445
(0.004)
13.89
(0.000)
0.610
(0.658)
4.028
(0.007)
0.724
(0.580)
61.88
(0.000)
2.411
(0.063)
1.177
(0.334)
120.38
(0.000)
34
R
a
2
Macro Money
Stock
0.845 1.311
(0.281)
0.861 2.661
(0.045)
0.971 1.001
(0.417)
0.536 6.548
(0.001)
0.840 0.139
(0.967)
0.970 0.766
(0.553)
2.900
(0.032)
24.87
(0.000)
0.731
(0.576)
4.217
(0.006)
18.82
(0.000)
0.877
(0.486)
Each VAR system includes four lags of the macroeconomic indicator listed at the left, the money stock, and the number of listed securities
in three (left panel) or four (right panel) major markets. All variables are in per capita log levels and represent real quantities. Equation
numbers correspond to the text, with (a), (b) and (c) employing investment or imports, money, and listed securities as the respective
dependent variables. The columns report the F statistic for Granger non-causality on each variable block with the p-value in parentheses.
No. Listed
Securities
4.409
(0.004)
1.346
(0.268)
77.90
(0.000)
2.058
(0.103)
1.047
(0.394)
163.72
(0.000)
R
a
2
0.848
0.868
0.972
0.523
0.839
0.971
35
Effect of Securities Listings on Investment
36
Effect of Securities Listings on Imports
interactions using the system with securities listings in three markets.  The plots indicate that increases
in both money and the number of securities have a sharp effect on imports after two years, an effect
that decays after five years.  Specifically, the left panel of Figure XII relates a 10 percent rise in the
number of listed securities to an increase in per capita imports of 11.3 percent after two years, or about
$1.11 from its sample mean of $9.84.  The right panel relates a 10 percent increase in the real per
capita  money stock to a rise of 16.1 percent in per capita imports after three years, or about $1.58 from
its sample mean.
D. The Effects of Securities Markets on the Stock of Entrepreneurial Ideas
We now shift attention to the effects of banks and securities markets on the stock of
entrepreneurial ideas as captured by the number of total and non-financial business incorporations. The
systems reported in Table V include cumulative incorporations, the number of state chartered banks,
and the number of securities listed in three or four cities.  All four systems show clear effects of
expansion in banks and securities markets in the granting of corporate charters. The systems that
include non-financial incorporations also suggest that expanded the use of the corporation encouraged
new banks to form, perhaps to meet the needs of new businesses for additional finance.
Because the number of state-chartered banks is included in the total number of incorporations,
there is a potential problem of collinearity in the systems presented in the upper panel of Table V.  We
therefore focus attention on the impulse responses that arise from the system with non-financial
incorporations and securities listed in three markets.  The responses shown in Figure XIII indicate that
the effects of financial development on incorporations were positive, incremental, and permanent.  For
example, the left panel relates a 10 percent increase in the number of securities, or an increase of about
11.6 securities from the sample mean, to a rise of 2.1 percent after 10 years in the index of non-
financial  incorporations.  In the right panel, a 10 percent increase in the number of state chartered
37
Table V
F-statistics for Granger-Causality in VARs with Measures of Modern Sector Activity, 1790-1850
Three Major Markets Four Major Markets
Modern Sector
Indicator
Eq. Incs. No. State
Business
Incorporations
Non-Financial
Incorporations
1a 285.33
(0.000)
1b 2.829
(0.048)
1c 1.004
(0.399)
1a 346.06
(0.000)
1b 2.730
(0.055)
1c 1.479
(0.233)
Banks
No. Listed
Securities
3.849
(0.015)
24.38
(0.000)
2.114
(0.111)
3.771
(0.017)
29.88
(0.000)
2.094
(0.114)
2.581
(0.065)
0.392
(0.759)
157.41
(0.000)
3.384
(0.026)
0.670
(0.575)
154.99
(0.000)
38
R
a
2
Incs. No. State
Banks
0.999 278.31
(0.000)
0.994 0.464
(0.709)
0.992 1.442
(0.243)
0.999 341.17
(0.000)
0.994 2.723
(0.055)
0.992 2.291
(0.091)
4.242
(0.010)
24.52
(0.000)
3.113
(0.035)
4.196
(0.010)
29.74
(0.000)
3.247
(0.030)
Each VAR system includes three lags of cumulative business incorporations, the number of state chartered banks, and the number
of listed securities in three (left panel) or four (right panel) major markets. All variables are in log levels. Equation numbers
correspond to the text, with (a), (b) and (c) employing the number of cumulative incorporations, state chartered banks and listed
securities as the respective dependent variables. The columns report the F statistic for Granger non-causality on each variable block
with the p-value in parentheses.
No. Listed
Securities
3.266
(0.030)
2.645
(0.060)
126.57
(0.000)
3.992
(0.013)
0.902
(0.448)
138.42
(0.000)
R
a
2
0.999
0.994
0.993
0.999
0.994
0.994
39
Effect of Securities Listings on Non-Financial Incorporations
occurred many times over the sample period, with resulting large cumulative effects on the number of
business incorporations.  Thus, financial development had a persistent influence on this measure of
real-sector activity.
V. Conclusion
Our paper describes in some detail the rather remarkable financial development that took place
in the United States in its earliest decades, starting with the Federalist financial revolution of the 1790s.
In the four decades thereafter, and starting virtually from scratch–although there were, to be sure,
colonial precedents that had to be abandoned as much as amplified (see Perkins, 1994, for a discussion
of these)–the United States built an articulated, innovative, and modern financial system that equaled
that of any other country.  One consequence of financial development and innovation was that the
United States became history’s most successful emerging market, attracting the capital of investors of
older nations seeking higher returns.  Another was that a wide range of American entrepreneurs,
business enterprises, and governments enjoyed more access to financing, domestic and foreign, than
did those of other countries.  These developments, it seems, placed the United States of the early
nineteenth century on a trajectory of economic growth higher than that of other nations.  The die was
cast early, perhaps earlier than most economic historians have thought.  As its financial system
continued to develop (with occasional setbacks) and promote growth over the course of the nineteenth
century, the United States became the world’s largest and, in many dimensions, most advanced
economy.
We then do not merely state this case and document it with traditional historical evidence, but
also treat it as a hypothesis and subject it to the sorts of statistical tests that macro economists now
apply to rich contemporary, multinational data sets in order to make similar arguments about the effects
of financial development on economic growth (e.g., King and Levine 1993b; Levine and Zervos 1998;
40
Rousseau and Wachtel 2000).  Our historical data sets are far more limited than contemporary ones.
But our test results are consistent with modern findings on the key role of financial development in
accounting for differences in the economic growth performance of today’s countries.  The remarkable
economic growth of the United States, we think, may very well have been “finance led.”  Judging by
U.S. history, then, the widespread contemporary interest in developing and improving financial systems
within and between countries to foster economic growth is not misplaced.
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47
Appendix A. Construction of Series for the Money Stock, 1790-1850
This appendix explains the methods used to construct a series for the stock of money over the
period from 1790 to 1850.  We begin with the estimates for 1820-1850 that Peter Temin compiled for
his 1969 book The Jacksonian Economy, and then replicate his technique as closely as possible to
extend the estimates backward to 1790.  Our measure of the broad stock of money sums the total
liabilities of banks to the public and specie in the hands of the public.  At the time, the banking sector
included a central bank (the BUS 1790-1811 and the Second BUS 1817-1839), banks chartered by
individual states, as well as private (non-chartered) banks.  Total liabilities for the latter are generally
unavailable before 1850 but considered to be small.   We discuss each of these components below.
A.1 Obligations of Chartered Banks to the Public
These obligations are estimated by summing notes in circulation, deposits, and amounts due to other
banks, and then subtracting amounts due from other banks and holdings of notes of other banks.
Fenstermaker (1965a, Table 10, pp. 66-7) includes these items from 1819 to 1837 for a reasonably
broad subset of banks, and also provides the total number of banks in each year.  Temin used the ratio
of total state banks to those reporting in each year to “blow up” the bank liabilities for Fenstermaker’s
subset to reflect the nation as a whole.  We compute state bank obligations to the public for 1803-1820
by applying this technique to balance sheet items from Fenstermaker (1965b).  This source is less
representative.  In 1818, coverage includes 43 percent of the state banks, but this falls to 29 percent by
1810, 24 percent by 1805, and only 13 percent by 1803.  For 1803-1804, the sample includes only
state banks in Massachusetts.  Other states enter the sample as follows: Virginia 1805; Mississippi
1811; Pennsylvania, South Carolina, the District of Columbia, and New Hampshire 1814; New York
1817; Kentucky 1818.  The article does not break down the balance sheet items or the number of banks
by state.  We again “blow up” these figures using the actual number of chartered banks to estimate
48
obligations.
We then use the amount of bills discounted at the Massachusetts First National Bank of Boston
(from Gras, 1937, pp. 650-651) to extend bank liabilities and specie inside banks backward through
1790.  Under the strong assumption that the amount of bills discounted by the few banks that had
obtained charters over this period fluctuated similarly to the Massachusetts Bank’s obligations to the
public and specie, we then use the ratio of the capital of the Massachusetts  Banks and total banking
capital in the US in each year to “blow up” bills and discounts to a national level. We then splice this
item onto both the obligations and specie series in 1803.  This places much emphasis on fluctuations in
a single bank’s balance sheet, yet these records are the only ones available prior to 1803.  It is also
important to note that only three banks had obtained state charters as late as 1790, and that the
obligations of state banks thus account for only a small portion of the money stock at this time.
A.2. Obligations of the First and Second Banks of the United States to the Public
The 1985 reprint of James Wettereau’s Statistics of the First Bank of the United States includes
observations for specie holdings, notes in circulation, individual and government deposits, notes of
other banks, and balances due to and from other banks at (or around) the end of each year from 1792 to
1801 from balance sheets of the BUS.  This allows computation of total BUS obligations to the public
until 1802.  Records for 1802-1807 do not appear to have survived, and when observations again
become available in 1808 they include only specie, notes in circulation, and deposits.  It so happens that
the sum of individual and government deposits in 1801 is the same as that for total deposits in 1808.
We fill in the intervening years by repeating the 1801 estimates for 1802-1807.
Notes in circulation are 5.08 in 1801 and 4.5 in 1808. Blodget (1806) includes a series for total
bank notes for 1801-1807.  One way to back out figures for 1801-1807 is to treat BUS notes as a
residual obtained by subtracting state bank notes from total notes. Here, data on notes in circulation
49
from Fenstermaker (1965a, 1984) can be used to estimate those notes attributable to state banks, and
the residual should approximate BUS notes.  Since there is an overlapping observation in 1801, it can
be used to splice the constructed series (1802-1807) to Wettereau’s figure for 1801.  The manipulation
of Fenstermaker’s data is similar to that described above for total obligations of state banks.  Since
notes of other banks and balances due to and from other banks are not available for the BUS after
1801, these cannot be included in the total BUS obligations.  Rather, we compute obligations without
them from 1802-1808 and ratio splice the result to the total for 1801.
Senate Document 128 (35th Congress, 2nd Session, 1838, pp. 208-211) includes all items required
to compute obligations of the second BUS and its branches to the public for 1817-39.
A.3. Specie in the Hands of the Public
Temin obtains official estimates of specie in the hands of the public from 1830 onward, and uses net
specie flows to extrapolate the series backward to 1820.  Temin’s estimate of the specie stock for 1820
(at $41 mil.) is 64 percent higher than that provided by Ezra Seaman for September of that year.  We
use North’s net specie flows to extend Temin’s estimates back to 1807, where Blodget’s continuous
series (1792-1807) ends.  By then, the constructed estimates are 101.5 percent higher than those of
Blodget.  Lacking a more acceptable technique for estimating specie from 1808 to 1820, however, we
apply it back to 1808, and then ratio splice Blodget’s series to the result.  This probably overstates the
level of specie, but the series exhibits the fluctuations of Blodget’s series for 1792-1807.  Note that
continuing to use specie flows before 1807 produces a series which is much less variable than
Blodget’s series and the later estimates. From this series for specie stock we subtract specie holdings
by state banks (constructed with Fenstermaker’s data as above) and specie in the first BUS to obtain an
estimate of specie in the hands of the public.
50
Appendix B.  Time Series Properties of Data Used in the Empirical Analysis
This section presents results of tests for unit roots and cointegration for the series and systems used
in the analysis. We begin with a set of augmented Dickey-Fuller (ADF) tests, which take the presence
of a unit root as the null hypothesis.  If ADF tests are unable to reject the unit root for a series in levels,
yet reject after differencing, there is some justification for treating the series as I(1) in subsequent
modeling. The univariate representations for the ADF tests include four  lags, which conforms with the
“Akaike plus two” criterion.  The trending nature of all series make both constant and trend terms
necessary in the levels specifications, while a constant-only regression is used for the first differences.
The log transformation is applied to all series prior to testing. Table B.1 reports test statistics and
significance levels. The  test rejects the null of a unit root for the data in levels and fails to reject for
first differences.
We next test for cointegration in each of the ten VAR systems that we consider.  A system with
non-stationary variables is classified as cointegrated if a linear combination exists which yields a
stationary series when applied to the data.  In the tri-variate case, a single cointegrating vector also
implies that the error terms of the system are stationary.  The technique developed in Johansen (1991)
provides a regression-based test for determining both the presence of cointegration and the number of
linear stationary combinations which span the space. Each system is modeled as a VAR of the form
where x
t
)x
t
’ µ %
j
k&1
i’1
’
i
)x
51
t&i
% Ax
t &k
% e
t
,
is a vector containing the three potentially endogenous variables and k is adequately large both
to capture the short-run dynamics of the underlying VAR and to generate residuals that approximate
the normal distribution. The lag order for each system is chosen with a series of nested likelihood ratio
tests.  The presence of trends in the data suggest the inclusion of an unrestricted intercept. The
Johansen methodology tests whether the AA matrix in (B.1) is of less than full rank via the trace and
(B.1)
Table B.1
Augmented Dickey-Fuller Test Statistics for Macroeconomic
Indicators and Measures of Market Development, 1790-1850
Levels 1st Difference
Macroeconomic Indicators
Real GNP Per Capita
(GNP)
Real Private Domestic
Investment Per Capita (INV)
Real Imports Per Capita
(IMP)
Cumulative Business
Incorporations (INC)
Cumulative Non-Financial
Business Incorporations (NFINC)
Financial Variables
Real Per Capita Money Stock
52
-3.13 -3.73
-2.50 -4.32
-1.83 -3.95
-2.39 -2.39
-2.81 -2.73
(MSTOCK)
-2.38 -3.65
Number of State Chartered
Banks (NOB)
Number of Listed Securities,
Three Markets (3MKT)
Number of Listed Securities Per
Capita, Three Markets (3MKTP)
Number of Listed Securities,
Four Markets (4MKT)
Number of Listed Securities Per
Capita, Four Markets (4MKTP)
-1.44 -3.67
-1.58 -3.61
-1.55 -3.63
-0.97 -2.95
-0.89 -2.96
All variables are in logs. The test regressions use four lags, and include constant and trend
for the levels variables and constant only for first differences. * and ** denote rejection of
the unit root hypothesis at the 10% and 5% levels respectively, using finite sample critical
values are from Fuller (1976), Table 8.5.2.
**
**
**
*
**
**
**
**
**
**
Table B.2
Johansen Test Statistics for Cointegration, 1790-1850
Trace Max. Eigenvalue
System r=0 r#1 r=0 r#1 r#2
GNP, MSTOCK, and
3MKTP   (K=4) 24.68 11.03 13.65  9.22 1.81
4MKTP   (K=4) 24.13 12.68 11.44 10.82 1.86
GPDI, MSTOCK, and
3MKTP   (K=4) 28.72
*
9.30 19.42
53
*
6.98 2.31
4MKTP   (K=4) 32.45
**
8.95 23.50
**
6.29 2.65
IMPORT, MSTOCK, and
3MKTP   (K=4) 29.35
*
9.63 19.71
*
7.77 1.86
4MKTP   (K=4) 31.72
**
12.21 19.51
*
10.19 2.02
INC, NOB, and
3MKT     (K=3) 36.15
**
10.95 25.19
**
9.01 1.95
4MKT     (K=3) 37.16
**
11.29 25.87
**
9.25 2.04
NFINC, NOB, and
3MKT     (K=3) 41.69
**
12.25 29.44
**
10.03 2.22
4MKT     (K=3) 42.85
**
12.90 29.94
**
10.55 2.35
K is the lag at which the levels terms enter the test regressions.  The columns labeled r=0 test
a null hypothesis of no cointegration, while the r#1 (r#2) columns test a null of at most one
(two) cointegrating vectors. * and ** denote rejections of the null at the 10% and 5% levels
respectively, with critical values from Osterwald-Lenum (1992), Table 1.
maximum eigenvalue statistics.
Table B.2 reports these test statistics for the relevant tri-variate combinations. Rejection of the null
hypothesis of no cointegration (r = 0) coupled with a failure to reject the null of at most one
cointegrating vector (r = 1) provides evidence of a single long-run relationship in a given system.  This
result obtains in all but the first two systems, with rejections of the r = 0 hypothesis at the 10% level or
less.
The Johansen regressions also facilitate a  test for stationarity of the variables in those systems for
which the number of cointegrating vectors is clear.  These tests (not shown here) are able to reject the
null of stationarity at the 1 percent level for the series which comprise the eight systems that can be
characterized by a single cointegrating vector.  Since ADF tests are unable to reject the unit root for a
given series and the Johansen test rejects stationarity in these cases, our decision to treat all variables as
I(1) processes is a reasonable one.
54

SOLUTION

1. Introduction

The current emerging markets have a lot to learn from the developed countries, particularly so that the developed countries were at the same cross roads on their way to achieving high rates of growth. Though each country is different have different strengths and weaknesses but should learn from the developed countries that a sound financial system contributes to financial growth and development.

A sound and strong financial system is the first step in the contribution to the growth and development of a nation. The paper examines the need of a sound financial system and its role in the growth and development of a nation and some programmes that need to be followed by the emerging markets to achieve the same robust growth and development.

2. Need for a Good Financial System

2.1 US Financial System Development

The historical studies in the united states from 1840’s have identified some of the factors contributing to the accelerated growth of the US economy at the time were better network of roads and canals, increase in foreign trade and the development of a sound financial system. Over the years historians have identified the existence of a found financial system as the basis for the accelerated economic growth of the economy.  The robust growth in the 1940 onwards until the 90’s was due to modernization of the US economy and the financial sector in particular.

2.1.1 Development of the US Banking System

To counter the war debts US made dollar into a convertible currency which led to the formation of a national banking system with 800 new banks and countrywide branches. As the number of banks increased , there was also an  increase in capital from a mere $3 million in 1790 to $426 million by 1840.This was an example of their rising role in mobilizing resources and providing credit and other financial services. The banks initially set up in the US were largely state owned, and gradually as the banking system strengthened the banks were also privatised eventually following the English model. This was accompanied by the introduction of securities to attract European investment; this resulted in the formation of a solid financial structure in the United States ultimately making US the world’s fastest growing economy in history.

2.1.2 Development of the US financial Markets

The US financial markets further strengthened with growth of financial and banking sectors like New York, Boston, and Philadelphia etc. this enabled both domestic and international mobilization of capital which contributed to the growth of the financial markets. The US economic development and growth was of nom agrarian nature, and was complete departure from any past economic growth experienced by any nation. This was because of the modernized and industrial nature of growth tightened by a strong financial sector. With the deepening of the financial markets introduced a greater degree of liquidity in the financial markets and gave free road of growth to the US economy. Research has proven the relationship between the stock market growth and the US economic development.

Figure: Average Growth Rates of the US Financial Markets (Rousseau et al, 1999)

The above figure indicates the growth of the consistent financial markets until 1840 which laid the base for the strong growth of the US economy which continued until the 90’s this was particularly evident in the growth of the government securities.

2.1.3 Development of Sound Policy Making in US

Credit also has to be given to the US economic and financial policy making which enabled the growth of a strong financial sector. The US policy makers provided opportunities to the industry through the financial system. These opportunities enabled the economy’s departure from the agrarian nature to a modernized industrial character.

(Rousseau et al, 1999)

2.2 British Financial System Development

Just as the US financial sector contributed to the growth of the US similar was the case with England, France and Japan as well. In fact England can be described as the one of the oldest modern economy. Britain was one country which had an extremely global economy in the 1700’s and 1800s’ owning to the large scale colonial expansion of the economy. Moreover the English economy was the first to experience the industrial revolution in the 1750’s and begins the modernization process, the industrial revolution brought with it nationalised and state owned banking structure which stabilized the British financial market and supported the growth of industry (Rousella et al,2001)

But one country which has the world’s oldest and strongest financial and banking system laid its growth foundations on the basis of these systems is Germany.

2.3 German Banking and Financial System

The main reason for the lack of growth of the German Financials sector in the 1700’s was the lack of unification of the German state. Germany was owned by separate owners and this led to lack of the financial structure development in Germany. In Fact it was only after unification that Germany’s financial system began to grow and develop. The Prussian Bank was the foundation of the central Reichsbank which was founded in 1875. There were also a large number of various private bankers which included such famous houses as the Rothschilds, and this was the beginning of other public and private institutions in Germany. This eventually also brought the development of the securities market in Germany which led to the German industrialization and growth eventually. Though the German banking system served some lags but eventually has developed into the strongest banking system in Europe in the current times owning to the good foundation that was laid in the evolution of the financial system.

Thus , these countries have set the foundations of a good financial system and have laid their importance and why the emerging markets should ensure the development of the financial system if they want to ensure economic growth and development. Some of the characteristics of a good financial system that should be followed by the emerging markets have also been analysed further.

3. Characteristics of a Sound financial System

The developed nations have identified the importance of a good financial system in the growth and development of the economy, this example also needs to be followed by the developing countries in the current. Some of the characteristics of a good financial system have been identified as follows

3.1Stable Money

Stable money has been identified as the essential characteristic of a financial system. The value of money is essential as the money serves as a medium if exchange between the different stakeholders in the economy. Stable money in modern language can be defined as a stabilised currency, a stabilised currency is essential to ensure growth and stability of the economy. Therefore the focus of the policy makers and the governments of the emerging markets should be on the creation of stable money.

3.2 Banks and Banking Systems

The role of the banks and a stable banking system has already been identified as essential for the growth and development of the economy. This role is already evident and can be seen effectively in the case of United States as described of how the banking sector contributed to the growth of the US economy in the long run .Even today it is collapse of the financial and the banking system brought about by the subprime crisis of 2008 that has led to the collapse of the US economy. Also in the case of Germany which was a late developer of the banking system but the strong foundation laid in the past has contributed to the German growth. Therefore banking plays a crucial role in development and the new emerging markets should pay increasing attention to the development of a sound banking structure especially in today’s global economic environment where banking functions resolve a lot of business transactions.

3.3 Central bank

A countries central bank is the determinant of the monitory policy of the country. A stable central bank operation enables the creation of stability in the economy as well. The main role of the central bank is to monitor the functions and operations of the other banks in the economy and act as a watch dog. The central bank should be able to resolve the problems and issues that arise within the banking system of the country. The role of the central banks also extends the mere financial role, the central banks serves as the banker to the government and enables stability in the government policy making. Therefore a sound and watchful central bank operation is also essential for the development of the economy.

3.4 Securities Market

The relationship between the securities market and the growth of the economy has been clearly established by researchers and analysts. It can also been clearly in the case of the robust growth experienced by the US economy owning to the innovative securities and the security market development. With the issue of securities, trading markets provide them with transferability and liquidity that which appeal to investors, both domestic and foreign. The emerging markets should also concentrate of developing a safe and stable securities market, and this would prove to be an indicator of their growth and development.

4. Conclusion

With increased globalization the different economies have intergrated into a global economy.Therfore each economy has become more vulvernable to the changes and instability owing to economic conditions outside the countries. This has also been accompanied with the rise on foreign trade , therefore a stable and sound financial system has become a necessity to facilitate the growth and development of the emerging markets. The financial system provides industries in the developing countries various forms of liquidity and hedging which enable their growth and development. The need for a strong financial system has been highlighted even more with the recent emergence of the subprime crisis which led to the collapse of the US financial system and affected the global economies. Therefore the global economies should pay close attention to the development of a stable and sound financial system.

5. References

• Rousella, Peter, and Richard Sylla. “EMERGING FINANCIAL MARKETS AND EARLY U.S. GROWTH.” NBER Working Paper Series 1.1 (1999): 1-54. Print.
• Rousella, Peter, and Richard Sylla. “Financial Systems, Economic Growth and Globalization.” NBER Working Paper Series 1.1 (2001): 1-53. Print.

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