Working Paper Series
Political Economy Origins of
Financial Markets in Europe and Asia
World Economy & Finance Research Programme
▪ Birkbeck, University of London ▪ Malet Street ▪ London ▪ WC1E 7HX ▪
Political Economy Origins of
Financial Markets in Europe and Asia∗
Svetlana Andrianova,† Panicos Demetriades,‡ and Chenggang Xu§
This version: January 8, 2008
This paper contributes to the ﬁnance-growth literature by
examining the political economy origins of some of the most successful
ﬁnancial markets in Europe and Asia. It provides historical evidence from
London, Amsterdam and Hong Kong that highlights the essential role
played by the government sector in kick-starting ﬁnancial development.
We show that the emergence of ﬁnancial systems did not occur through
laissez-faire approaches and that secure property rights alone were not
suﬃcient for ﬁnancial development. In the cases of London and Amster-
dam, governments created large trade monopolies which were responsible
for all the major ﬁnancial innovations of the time. In the case of Hong
Kong, where the ﬁnancial development model was bank-based, large bank-
ing monopolies with close links to the state were created. We argue that
the three examples are not special cases and the role of government in the
early stages of ﬁnancial development has been widespread world-wide.
Keywords: Monopoly, politics, institutions, ﬁnance
JEL: G18, N20, O16
∗We acknowledge ﬁnancial support from the ESRC under the World Economy and Finance Re-
search Programme (Award reference RES-156-25-0009). We have beneﬁted from helpful discussions
with historians Huw Bowen and Anne Murphy, and also comments by Stjin Claessens and Steve
†Department of Economics, University of Leicester, University Road, Leicester, LE1 7RH, United
Kingdom. Email: firstname.lastname@example.org.
‡Department of Economics, University of Leicester, University Road, Leicester LE1 7RH, United
Kingdom. Email: email@example.com.
§Department of Economics, LSE, United Kingdom. Email: firstname.lastname@example.org
A broad consensus has emerged in the ﬁnance-growth literature suggesting that well
functioning banking systems and capital markets help to enhance long-run growth.1
Moreover, the positive causal impact of ﬁnance on growth appears to have been
present from the earliest stages of ﬁnancial development in the Netherlands, Eng-
land, United States and Japan (Rousseau 2002). This literature is, therefore, increas-
ingly shifting its focus towards understanding the mechanisms that promote ﬁnancial
development. Recent contributions suggest that political economy factors, such as
the role of industrial and ﬁnancial incumbents, may hold the key to successful ﬁ-
nancial development. Rajan and Zingales (2003), for example, suggest that trade
and ﬁnancial openness, which curtail the power of incumbents and change their in-
centives, may be a useful mechanism of ﬁnancial development. Acemoglu, Johnson
and Robinson (2005a) sketch a dynamic political economy framework in which eco-
nomic institutions that facilitate economic development are social decisions chosen
for their consequences by the interaction between powerful political and economic
forces. These authors strongly emphasize the role of broad based property rights pro-
tection for economic development in general and the development of ﬁnancial markets
in particular. Much of this literature utilizes a variety of stylised facts or historical
examples, mainly drawn from the colonial period, which are primarily aimed at ex-
plaining the factors that explain institutional development in the ‘colonies’. With
one important exception (Acemoglu, Johnson and Robinson 2005b) there has been
little attempt to gain an understanding of the factors that explain successful ﬁnancial
development in the colonizing powers themselves.
This paper aims to contribute to the ﬁnance-growth literature by examining the
political economy origins of some of the most successful ﬁnancial markets in Europe
and Asia, drawing on a variety of historical sources. Speciﬁcally, it provides historical
evidence primarily from London, but also from Amsterdam and Hong Kong, that
1See Levine (2003) and Demetriades and Andrianova (2004) for recent surveys of this literature.
highlights the essential role played by the government sector in kick-starting ﬁnancial
development. While there are important diﬀerences between these examples, we show
that the emergence of ﬁnancial systems did not occur through laissez-faire approaches
and that secure property rights alone were not suﬃcient for ﬁnancial development. In
the cases of London and Amsterdam governments created large trade monopolies—
the English East India Company and its Dutch equivalent—which became the leading
joint-stock companies and were responsible for all the important ﬁnancial innovations
of the time, including the emergence of trade in shares. In the case of Hong Kong,
where the ﬁnancial development model was bank-based, large banking monopolies
with close links to the state were created (e.g. the Hongkong and Shanghai Bank-
ing Corporation). These were modelled on the Bank of England—itself a banking
monopoly for ﬁfty years with close links to government—which also became a tem-
plate for the development of many other banking systems around the world (Goodhart
We argue that the three examples we provide in this paper are not special cases.
The role of government in the early stages of ﬁnancial development has been widespread
world-wide, including the Italian city-states of Venice and Genoa, the United States,
and, more recently, in the newly industrialized East Asian economies such as Japan,
South Korea and Taiwan.
The idea that the government can play an important positive role in the ﬁnancial
system is of course not a new one, see for example Stiglitz (1993). What is new in
our paper is that the emergence itself of successful ﬁnancial systems owes a lot to the
involvement of governments, an aspect that has been neglected by previous literature
on ﬁnance and growth. We ﬁnd support for our view in the writings of classical
economists. Adam Smith has been widely quoted for emphasising the importance
of protecting property rights. However, his other important point, often overlooked,
was that the security of property rights alone is not suﬃcient for economic develop-
ment. Instead he believed that there must be government involvement in business.
He pointed out that “property and civil government very much depend on one an-
other...” and “...the preservation of property and the inequality of possession ﬁrst
formed it, and the state of property must always vary with the form of government...”
(Smith 1763). Speciﬁcally, Smith argued that the government should erect and main-
tain certain public works and certain public institutions, “which it can never be for
the interest of any individual, or small number of individuals to maintain because the
proﬁt could never repay the expense to any individual or small number of individu-
als...” (Smith 1776, p. 688). Here, by ‘public works’ Smith refers to companies (or
new property rights) created by Royal (and later parliamentary) charter.
This paper is organised as follows. Section 2 documents the emergence of London
as a ﬁnancial market, highlighting the role of politics, institutions and ﬁnance, which
include the rise of the trading and banking monopolies with close links to government.
Sections 3 and 4 analyse the cases of Amsterdam and Hong Kong, while Section 5
highlights other cases. Finally, Section 6 summarises and concludes.
The Emergence of London as a Financial Market
A variety of historical sources suggest that London’s stock market emerged during
the latter part of the 17th century and continued to develop during the early part of
the 18th century. Drawing on these sources, this section documents (i) the emergence
of trading in stocks; (ii) the institutional changes that, as has been previously ar-
gued, facilitated the development of the stock market, (iii) the improvement in public
ﬁnances and its relationship to stock market development. In so doing, it identiﬁes
the key players in the private and public sectors in this process, namely the leading
joint stock companies, the monarch and parliament. This examination reveals the
following two inter-related political economy aspects, which played a critical role in
the emergence of London as a major ﬁnancial market:
• The monopoly rights granted by the public sector (initially by the monarch and
subsequently by parliament) to all the leading joint stock companies.
• The long-term loans provided by the leading joint stock companies to the public
sector in exchange for their monopoly positions.
Additionally, our analysis also highlights the role of foreign trade in the process, in
the light of the fact that all but one of the leading joint stock companies in that
period were involved in trade with diﬀerent parts of the world.
The Emergence of Trading in Stocks: 1661–1703
Even though the London Stock Exchange was formally established in 1773, there
is evidence of stock transfers taking place as early as 1661 while the publication of
security price movements began in 1681.2 Scott (1912)—one of the most author-
itative historical studies of the emergence of joint-stock companies in Britain and
Ireland—provides, among other rich information, a useful list of tables described as
“Statistics of the Chief Joint-Stock Companies if England, Scotland and Ireland to
1720”. The data, which include capitalisation ﬁgures and other useful information
on each company show that by far the largest joint stock company throughout the
17th century was the East India Company (EIC), founded in 1599 to carry out trade
with the East Indies and incorporated by Royal Charter in 1600. The second largest
joint-stock company up to 1694 was the Royal African Company (RAC), founded
in 1662 to carry out trade with Africa (Scott 1912, p. 325). Table 1 summarises
the available data for share transfers of these two companies alongside Hudson’s Bay
Company, which was the third largest foreign trade company and is considered by
historians as representative of smaller joint-stock companies at the time. In 1694, the
2Neal (1990b) identiﬁes Whiston’s The Merchants Remembrancer of 4 July 1681 as the ﬁrst
printed evidence which documents that stock exchanges were taking place. This particular pub-
lication, which was a sheet listing current prices of goods on the London market, also included
information on the prices of the shares of the East India Company (EIC) and the Royal African
Company (RAC) in the form of symbols that suggested that the price of the former was at its highest
ever while that of the latter was at its lowest. The ﬁrst listing of actual stock prices was in the 3
January 1682 issue of the same publication.
market valuation of these three companies was £1,212,720 (EIC), £185,175 (RAC)
and £52,762 (Hudson’s Bay).3 All three companies had monopoly rights granted to
Table 1: Transfers of stock in the foreign trade joint-stock companies, 1661–1689
East India Company
Royal African Company
Hudson’s Bay Company
Source: Carruthers (1996, Table 7.1, p. 167) and Carlos, Key and Dupree (1998, p. 326, p. 337)
them by the monarch in their charter. The EIC was granted monopoly rights over all
English trade to the east of the Cape of Good Hope. The RAC was given monopoly
rights over all English trade from Sallee to the Cape of Good Hope. Hudson’s Bay
Company, incorporated in 1670, had a monopoly over trade in the region watered by
streams ﬂowing into Hudson Bay in Canada.
The stock exchange was highly localised, with the trades and the circulation of
information about the current share prices and proﬁtability prospects for joint stock
companies taking place in the coﬀee houses of Exchange Alley. Table 1 shows that a
market for EIC shares existed as early as 1661, while trade in the shares of the other
two companies emerged in the 1670s, soon after their establishment.
3Scott (1912, Vol. I, p. 325).
In 1694 the Bank of England (BoE) was established by parliamentary statute
which provided it with a monopoly right to issue paper money and to take deposits.
With an initial capital of £1.2 million, BoE overtook RAC as the second largest joint-
stock company. By the end of 1695 there were in excess of 140 joint stock companies
with a total market capitalisation of £4.25 million.4 50.3% of stock market capitali-
sation or £2.14 million was accounted for by three foreign-trading companies (EIC,
RAC and Hudson’s Bay). The BoE’s capitalisation was £0.72 million or 16.9% of
total market capitalisation. Thus, between them these four monopolists accounted
for more than two thirds of stock market capitalisation, while other chartered compa-
nies (also monopolies in their spheres of activity) accounted for 10.0% of the market.
Monopolies, therefore, accounted for more than three quarters of the capitalisation
of the emerging stock market.
By 1703 total stock market capitalisation had reached £8.5 million. By that
time the East India Company had been absorbed by the New East India Company
(NEIC), which was initially set up to rival the old EIC.5 The combined stock of
the two companies accounted for 26.6% of total market capitalisation. The second
and third largest joint stock companies were BoE, which accounted for 21.2% of the
market, and RAC which accounted for 13%. Thus, even by 1703 the three largest
monopolies accounted for over 60% of stock market capitalisation.
Smith (1929) quotes historical documents which provide evidence that a spe-
cialised class of stock brokers was developing in the latter part of the 17th century;
4See Scott (1912, Vol. I, p. 336). Although it is known that 150 joint-stock companies were
in existence by the end of 1695, due to fragmentary information for some of these companies it is
possible to estimate total market capitalisation for only 140 of these.
5Even though The New East India Company was initially set up to compete with the ‘old’ East
India Company, and succeeded in being granted monopoly rights over the trading route to India by
parliament, the two companies traded in parallel for a short period and eventually merged in 1702.
During their co-existence trade with India was managed by a joint committee, i.e. it appears that
they acted jointly as a monopolist (Scott 1912, Vol. III, p. 479).
a regular tariﬀ for dealing in securities seems to have existed certainly by 1694. The
activities of the brokers and the growth of speculation attracted the attention of the
government. In 1697 there was the ﬁrst attempt to regulate the activities of stock
brokers through legislation that took the form of “An Act to restrain the numbers
and ill-practices of stock-jobbers”. The Act limited the number of brokers to 100
and provided for licensing arrangements by the lord mayor of London. Thus, his-
torical sources conﬁrm that organised, albeit unregulated, trading in stocks existed
as early as 1661 and that by the end of the end of the 17th century trading became
regulated. Moreover, it appears that monopoly was the modus operandi for all the
leading joint-stock companies at the time.
Politics, Institutions and Finance
The emergence and steady expansion of the stock market in the 1670s and 1680s
in London, as discussed above, prompts the question: What were the factors that
brought about the market emergence? A well-established explanation of the develop-
ment of ﬁnancial markets in England, due to North and Weingast (1989), highlights
the credibility of secure property rights, following the Glorious Revolution of 1688
when constitutional changes substantially shifted the power in favour of parliament
and away from the monarch.6 In England under the Stuarts, the monarch was ex-
pected to fund the government (“live of his own”) and had considerable discretionary
power, largely unchecked by Parliament, to obtain funds for the Crown. As England
was embroiled in the wars of the late 16th (the war with Spain in 1588, with its last-
ing debt legacy well after Elisabeth’s death) and the ﬁrst half of the 17th centuries,
the legacy of ﬁnancing the war eﬀort left a chronic gap between the Crown’s revenue
and expenditure and was forcing the monarchy to search for ever-inventive ways of
6For a detailed historical account of political and economic realities of the 17th century England
see Smith (1984) and Holmes (1993). A compact but highly informative account can also be found
in Roseveare (1991).
obtaining revenue: the sale of Crown’s lands, hereditary titles, and monopoly licenses,
as well as forcing loans on favourable terms for the Crown which in many instances
were only partially repaid. These measures, coupled with the unique position of the
monarch as the ultimate enforcer of the law, created a permanent tension between
the Crown and wealth holders many of whom were members of Parliament.
The gradual erosion of the monarch’s credibility to honour loan obligations through-
out the ﬁrst part of the 17th century reached its logical end in January 1672, when
Charles II, unable to obtain further loans, had to resort to the temporary suspension
of all loan repayments (known as the Stop of the Exchequer). The tension between
the Crown and the Parliament was eventually resolved in 1688 when the two main
English factions (Tories, the landed elite, and Whigs, the monied interests), who were
alienated by the reigning King James II (the successor of Charles II), invited Mary
and William of Orange to seize the throne in exchange for important constitutional
concessions. This event became known as the Glorious Revolution of 1688, and its
role in making England into the Great Power of the 18th century is well-documented
by historians. The key of this momentous historical event was the monarchs’ accep-
tance to respect Parliament and Parliament’s laws: constitutional constraints were
solidiﬁed in 1689 when the English Bill of Rights, the Toleration Act and the Mutiny
Act were passed, while the ﬁscal constraints on the crown were ﬁrmly established by
1697 with Parliament given the power to authorise taxation and audit revenues.
There is consensus in the literature (see North and Weingast (1989) and Dickson
(1967), among others) that the Glorious Revolution led to a substantial improvement
in public ﬁnances by removing the possibility of default by the monarch/government
witnessed before 1688.7 Parliament gained the power to scrutinise all government
7Note, however, that Roseveare (1991) strongly argues that the two decades before the Glorious
Revolution constitutional, administrative and ﬁnancial innovations paved the way for subsequent
developments in public ﬁnance and institutional changes of the 1690s: “The philosophy of account-
ability which was to shape post-Revolution ﬁnancial control [on government spending] was clearly
articulated in the reign of Charles II” (p. 15, bottom).