Rousseau and Sylla (2001) contend that for an economy to experience financial development, it must have a sound financial system. The five crucial elements of a good financial system are:
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- Good public debt and finance management,
- Stable currency,
- A robust banking system with local international orientations,
- A central bank to manage international financial relations and stabilize local fiancés, and
- A fully-functioning securities market.
From a financial globalization point of view, such a financial system may attract foreign investments by either directly providing the necessary facilities or by indirectly stimulating growth prospects. In their article, Rousseau and Sylla (2001) show how countries that decided to develop sound financial systems (like the one described above) early in their histories, witnessed tremendous economic growth. Besides, they were also able to attract foreign capital flow, in effect further improving their growth.
In the 17th century, the Dutch Republic became the 1st nation to develop and implement such a system. Despite its small size, the Dutch Republic rose to become a leading economic and political leader not just in the 17th century, but also in the early 18th century. Great Britain was the first country to adopt the financial system of the Dutch Republic, in the late 17th century. However, the British government made a few changes to the Dutch financial system to suit its structure (Lamoreaux 1994). Later in the 18th century, Great Britain experienced the first-ever industrial revolution in the world. As a result, the country was able to build a global empire. Moreover, it also overtook the Dutch Republic as the leading powerhouse in the world.
By the close of the 18th century, the United States gained its independence from Great Britain. Because the country wished to repay the huge debt that it had incurred during the war, it also developed a financial system similar to that of Great Britain. At the time, Europe dominated the global political and economic activities, not to mention that almost half of the globe lived in Europe. On the other hand, only about 5 percent of the global population lived in the United States. We need to appreciate the fact that the physical size, economic and political power of the U.S was comparatively smaller, relative to that of Europe (Rousseau & Sylla 1999). However, within a century, the United States was already the largest economy in the world, even though it only had less than 5 percent of the global population.
Emerging markets can learn valuable lessons from the United States that a rising banking system would go a long way to enhancing economic growth and trade. In 1789, the United States only had 3 banks but by the 1790s, an additional 28 new banks had already sought state charter. Within the following decade, the United States would see an additional 73 banks receiving a charter. Soon enough, these banks were recording profitability, with the shareholders getting dividends of nearly 8 percent. As a result, this led to a rapid expansion in the banking sector and by 1840 the United States had an astonishing 1840 banks (Perkins 1994). This was no mean fete, considering that the country was newly independent, in comparison with such other governments as the United Kingdom and the Netherlands that had been in operation for a few centuries. Within 20 years, the number of banks in the United States had almost doubled.
The increase in the number of banks translated into increased capital, and this is indicative of the growing role of banks in providing credit facilities, among other financial services, as well as the key role of mobilizing the much-needed resources. As the number of banks in the United States increased, this sparked the emergence and development of securities markets. The major cities where securities markets sprang up first include New York, Boston, Philadelphia, and Baltimore. The securities markets helped to regularize trading opportunities to facilitate the payment of the new debts that the United States was faced with, as well as to facilitate equity claims.
Although the emergence of the securities markets also ushered in a propensity to speculate and overtrade, which almost resulted in the near crashing of the market in early 1792, nonetheless, as the securities markets, became more entrenched in the various cities of the United States it became easier to liquidate theses securities at consistent and fair prices (Levine & Zervos 1998). Consequently, there was a massive rise in asset liquidity and this helped to quell the fears of foreign and local investors who were hitherto reluctant to invest in American securities.
From the 1850s onwards, Germany, France, and Japan started to implement financial innovations and as a result, the three nations realized huge economic ability and growth. Soon enough the three aforementioned countries had become leaders in the capital export market (Rousseau & Sylla 2001). By 1914, when the first era of globalization came to an end, the Dutch Republic, Great Britain, Germany, France, and the United States were responsible for more than 90 % of the global capital exports.
Rousseau and Sylla (2001) have found a strong connection between financial factors and economic growth. Moreover, research by the two authors indicates that countries with sophisticated financial systems are likely to engage in more trade in comparison with their counterparts who have less sophisticated financial systems. Moreover, such countries are also more likely to be closely integrated with the economies of other countries.
Rousseau and Sylla (1999) hypothesize that economic growth and development in the United States were largely “financed led”. The authors have attempted to show how by the time the United States gained independence from Great Britain in the 1780s the country was deficient in virtually all the vital components of a financial system. Also, the country was already faced with a huge debt that had been incurred during the war. Furthermore, the country’s money stock consisted of foreign species and coins, while each of the thirteen states issued fiat paper money whose rates of exchange varied significantly. Besides, the bank noted circulated among the three local banks. As a result, the nation’s leaders felt that there was a dire need to design a system of mobilizing the necessary infrastructure, to enhance foreign and domestic trade, and to establish a productive modern sector (Rousseau & Wachtel 1998).
The new U.S Constitution allowed Congress to adopt a federal tax system that would facilitate revenue taxation to assists in paying the debt. Soon enough, the Federal Bank was established. This gave way to the rise of state banking. Moreover, the development of the banking system ushered in the securities markets (Ferguson 2001). The ensuing increase in asset liquidity enabled local and foreign investors to hold more American securities. This was due to the robustness of the US’s securities market. The United States also took the initiative of chartering corporations with limited liability, resulting in highly capitalized equity.
The modernization of the United States led to expanded international trade. Also, the country won the confidence of foreign investors. Consequently, there was an expansion in international trade. With time, bank credits started flowing. This encouraged modern production activities, imports. It also ushered in internal improvements (Ferguson 2001).
Merging market economies can borrow a lot from the experienced of the aforementioned economies. To start with, it is important to have a fully functioning financial system with all the five components intact. Also, it is important to be innovative because regardless of the size of a country, any nation can achieve enhanced global growth and expansion.
The experience of the countries covered shows that sound public finance is crucial as a way of not only raising enough revenue to fund the various government projects but also to allow for the control of public expenditure. Additionally, emerging economies can borrow the idea of ensuring stable money from the countries covered. There is a need to ensure that money does not depreciate and fluctuate such that it loses its value. A banking system is also important, to consolidate public finance, and also to offer credit facilities to entrepreneurs, in effect growing the economy.
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However, it is important to ensure that the banking system is regulated and that is how the central bank comes in. it prevents alleviate or prevent some of the common problems facing banks such as lending and borrowing risk, and which could result in their collapse. As such, the central bank helps to stabilize the currency of a country. The development of the securities market is also crucial as they allow for the issuance of private and public securities, as well as private equity securities. This helps to attract foreign and domestic investors.
Ferguson, N 2001. The cash nexus: Money and power in the world, 1700-2000, Basic Books, New York.
Lamoreaux, N 1994. Insider Lending: Banks, Personal Connections, and Economic Development in Industrial New England, Cambridge University Press, New York.
Levine, R & Zervos, S 1998, ’Stock Markets, Banks, and Economic Growth,’ American Economic Review, vol. 88, pp. 537-558.
Perkins, E J 1994. American Public Finance and Financial Services, 1700-1815, State University Press, Columbus: Ohio.
Rousseau, P & Wachtel, P 1998, ’Financial Intermediation and Economic Performance: Historical Evidence From Five Industrialized Countries’, Journal of Money, Credit and Banking, pp. 657-678.
Rousseau, P., & Sylla, R 1999, ’Emerging financial markets and early U.S. growth’, Explorations in Economic History, vol. 42 no. 1, pp.1-26
Rousseau, P., & Sylla, R 2001, Financial systems, economic growth, and globalization, Web.