Finance and Technology in Early Industrial Economies: The Role of Economic Integration

Abstract

This paper argues that the degree of economic integration may be an important determinant of the emergence of different patterns of both technology and finance in industrializing economies. Drawing on several recent advances in corporate finance, a simple general equilibrium model is developed which investigates how the degree of economic integration may affect firms' choice of technology, entrepreneurs' choice of human capital accumulation, and banker's choice of the way finance is provided. The degree of economic integration is measured by the cost of transacting in goods, securities, and factors markets. It is shown that economies which industrialize when they have already achieved a high degree of integration are more likely to adopt a simple, fungible, technology and rely on arms' length financial relationships (the `British' pattern). Economies which are still fragmented when they industrialize are instead more likely to adopt more specific technology and rely on the close financial ties of relationships banking (the `German' pattern). The model also provides an explanation for the persistence of the patterns of industrialization as economic integration increases. It is argued that the fixed costs of relationship banking, and their effect on the likelihood of early liquidation of firms, explains why integration which occurs after industrialization may exhibit `path-dependence,' and preserve the existing patterns of both technology and finance. These results are used to interpret the early industrialization of Britain and Germany, and the persistence of their patterns with time.