The Great Reversals

We attempt to identify and explain the broad patterns of financial development in developed countries over the twentieth century. We find that, contrary to the predictions of most existing theories, indicators of financial development do not seem monotonic over time. In particular, we find that by most measures, countries were more financially developed in 1913 than in 1980 and that a major reversal took place between 1913 and 1950. To explain this we outline a simple theory of the political economy of financial development. Empirically, our analysis suggests that the forces opposing financial development will be weaker when a country is open to international trade and capital flows. We find this to be true both in the cross-section and over time. In periods of free capital movement world-wide, a country’s level of financial development is directly related to its openness to trade. Similarly, the low frequency movements of financial development over time appear to be correlated ...