In seeking to understand the economic basis of the Brexit vote, we should concentrate not on globalisation but on the long-term impact of de-industrialisation.
The evidence is certainly strong that economic disadvantage played a significant part in the patterns of voting in the referendum (though age and educational qualifications seem to have played a large, independent role). But this disadvantage seems best linked to de-industrialisation, which has left a legacy of a much more polarised service sector labour market, with large numbers of people condemned to poorly paid and insecure jobs.
Globalisation has contributed to de-industrialisation, but it is only one contributor, and historically not the most important. De-industrialisation began in Britain in the 1950s. It was driven by shifts in patterns of demand and technological change, most strikingly in increasing the growth of productivity (and lowering the relative price) of manufactured goods. (Total industrial output has not fallen, but grown slowly on trend.)
These broad trends have affected all industrial countries, so that industrial employment has fallen substantially even in successful industrial countries with a manufacturing trade surplus, such as Germany. Industrial employment as a share of the total has more than halved in that country since its peak in 1970.
The long-run nature of these trends is illustrated by the fact that many more coal-mining jobs were lost in Britain under Harold Wilson’s government of the 1960s than under Margaret Thatcher’s government of the 1980s.
Similarly, the big collapse of industrial jobs in Lancashire began in the 1950s and accelerated in the 1960s; across the country, textiles and clothing lost 123,000 jobs between 1964 and 1969.
Proportion of workers in industrial employment in the UK
Serious errors of policy have undoubtedly accelerated this process, and compressed it into short time periods (most obviously, the extraordinary appreciation of the pound in 1979-81 as a result of the Thatcher government’s policies). But overall the process has not mainly been policy-driven.
In responding to the economic problems that underpinned the Brexit vote, it is important to be clear that globalisation is only one part of the story. To put it crudely, if globalisation were somehow reversed, it would not return Britain to having anything like the number of industrial jobs that existed in the 1950s.
While there are certainly powerful arguments for seeking to offset the impact that globalisation has had on particular groups of workers, the biggest challenge is how to make a service-dominated economy deliver much better outcomes for those who currently occupy the lousy jobs in the service sector.
by Alexandra López Cermeño, Lund University / Universidad Carlos III de Madrid
Universities generate growth spillovers beyond simply the local market. Analysing data on the universities founded in the United States between 1930 and 1980, my research shows that these drove growth of GDP and population not only in the counties that hosted them, but also in their neighbouring regions. But analysis of their longer-term impact suggests that although there are growth spillovers, the positive effect wears out if it is not periodically renewed.
The role of universities in generating growth is rarely contested. But most research tend to associate the presence of a university with long-term path dependency. In the era of knowledge and information, the role of universities as producers of new ideas and technologies is crucial to productivity. New light on this subject is required not only to understand the role of cultural amenities but also to explore the spatial dynamics around them.
Long-term analysis that compares recipient counties of their first universities between 1930 and 1980 with statistically similar counties that never got an institution shows that the effect of these new universities implies 20% more growth in terms of GDP. Moreover, the analysis shows that the new amenities eventually had an impact neighbouring counties. These dynamics seem to be related to population migration.
This sizeable increase of GDP in these counties is corresponded by a similar size increase in population: new universities generate migratory movements of workers, which eventually lead to higher housing prices and costs to use other infrastructures. Higher costs motivate many workers to relocate to nearby areas where housing and infrastructures are less expensive and access to the amenity is still feasible.
The positive effect of new universities is therefore neutralised in the longer term unless further investments reduce congestion costs. Indeed, the role of infrastructures such as roads seems to explain a large share of the effect of universities.
But the interaction of universities and infrastructure seems to be defined by the decreasing importance of the latter: whereas physical access to infrastructure seemed to constrain the impact of new amenities before the 1950s, more recently established institutions seem no longer dependent on face-to-face contact.
There is further evidence on the role of knowledge dynamics in my study: in the earlier half of the period 1930-80, all that mattered was getting a new university in the county, whereas in the latter half of the period, the quality of the institution seems to have become much more relevant. Counties where research-intensive institutions were established during the period 1950-80 grew almost 40% more.
My analysis shows that the effect of new academic institutions during the twentieth century induced regional spatial dynamics in terms of migration and GDP. But it indicates that the impact of these new amenities was seriously constrained by the congestion of utilities, which limited the extent of growth to the short run.
Thus, it questions the extent of the impact generated by these institutions that is so praised in recent literature since it suggests that their growth dynamics are not self-sustaining: further investments are needed to keep up with the agglomeration forces that attract population and firms to these counties.
by Matthias Blum (Queen’s University Belfast ) and Claudia Rei (Vanderbilt University)
At Europe’s doorstep, the current refugee crisis poses considerable challenges to world leaders. Whether refugees are believed beneficial or detrimental to future economic prospects, decisions about them are often based on unverified priors and uninformed opinions.
There is a vast body of scholarly work on the economics of international migration. But when it comes to the sensitive topic of war refugees, we usually learn about the overall numbers of the displaced while knowing next to nothing about the human capital of the displaced populations.
Our study, to be presented at the Economic History Society’s 2017 annual conference in London, contributes to this under-researched, and often hard to document, area of international migration based on a newly constructed dataset of war refugees from Europe to the United States after the outbreak of the Second World War.
We analyse holocaust refugees travelling from Lisbon to New York on steam vessels between 1940 and 1942. Temporarily, the war made Lisbon the last major port of departure when all other options had shut down.
Escaping Europe before 1940 was difficult, but there were still several European ports providing regular passenger traffic to the Americas. The expansion of Nazi Germany in 1940 made emigration increasingly difficult and by 1942, it was nearly impossible for Jews to leave Europe due to mass deportations to concentration camps in the east.
The Lisbon migrants were wartime refugees and offer a valuable insight into the larger body of Jewish migrants who left Europe between the Nazi seizure of power in Germany in January 1933 and the invasion of Poland in September 1939.
The majority of migrants in our dataset were Jews from Germany and Poland, but we identify migrants from 17 countries in Europe. We define as refugees all Jewish passengers as well as their non-Jewish family members travelling with them.
Using individual micro-level evidence, we find that regardless of refugee status all migrants were positively selected – that is, they carried a higher level of health and human capital when compared with the populations in their countries of origin. This pattern is stronger for women than men.
Furthermore, refugees and non-refugees in our sample were no different in terms of skills and income level, but they did differ with respect to the timing of the migration decision. Male refugees were more positively selected if they migrated earlier, whereas women migrating earlier were more positively selected regardless of refugee status.
These findings suggest large losses of human capital in Europe, especially from women, since the Nazi arrival in power seven years before the period we analyse in our data.
The civil war in Syria broke out six years ago in March 2011, making the analysis of the late holocaust refugees all the more relevant. Syrian refugees fleeing war today are not just lucky to escape, they are probably also healthier and coming from a higher social background than average in their home country.
The House of Commons has voted overwhelmingly to trigger Article 50, on the explicit basis that this process will be irrevocable and that, at the end of the negotiations, Parliament will have a choice between a hard Brexit (leaving the Single Market and the EEA) and an ultra-hard Brexit (WTO terms, if available).
It follows that arguments about whether the UK should remain in the EU, or should stay in all but name (the so called Norwegian option) are now otiose. What role can economic historians play as the terms of exit unfold? I think that there is an important role for scholars in seeking to analyse the promises of the Brexiteers and how feasible these appear in the light of previous experience.
Thus far, the economic debate over Brexit has been conducted on a very general basis. Remainers have argued that leaving the EU spells disaster, whereas Leavers have dismissed such concerns and promised a golden economic future. But what exactly will this future consist of? Doing the best one can, the Brexit proposition must surely be that the rate of economic growth per capita will be significantly higher in the future than it would have been if the UK had retained its EU membership. Since, at the same time, there was to be a massive and permanent reduction in EU and non-EU immigration (from c.330,000 p.a. net immigration to ‘tens of thousands’), it is per capita improvements that will have to be achieved.
The path to this goal will, it is said, be clear once the UK leaves. In particular:
the UK will be able to make its own trade deals and become a great global trading nation;
the UK can develop a less restrictive regulatory framework than that imposed by the EU;
industries such as manufacturing, fisheries and agriculture will revive once the country is no longer ‘tethered to the corpse’ of the EU;
the post-referendum devaluation will provide a boost for exporters.
In relation to each of these claims, there is plenty of helpful evidence from economic history. After all, the UK was the first nation to embrace a global trading role. As Keynes pointed out in a famous passage, in 1914:
The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, in such quantity as he might see fit, and reasonably expect their early delivery upon his doorstep; he could at the same moment and by the same means adventure his wealth in the natural resources and new enterprises of any quarter of the world, and share, without exertion or even trouble, in their prospective fruits and advantages…
Yet, despite this background, and despite the economically advantageous legacies of Empire, the UK spent the period between 1961 and 1973 making increasingly desperate attempts to join a (then much smaller) Common Market. British policymakers were initially dismissive of the European Community. Exports to the Six were thought less important than trade with the Commonwealth. Britain’s initial response was to establish EFTA as a rival free trade area. However, it soon became apparent that this arrangement was lopsided: Britain was part of a free trade area with a population of 89m (including its own 51m), but stood outside the EEC’s tariff walls and population of 170m. Will the 2020s be different from the 1960s? In any event, ‘free trade’ is an elusive concept. As John Biffen, a Tory Trade Minister in the Thatcher government (and no friend of the EU), acknowledged, free trade has never existed ‘outside a textbook’.
As regards to decoupling from EU regulations, the UK was, of course, completely free to devise its own regulatory framework prior to accession to the EU in 1973. Nonetheless, in this period, much of the current labour market structure, such as protection against unfair dismissal and redundancy, was enacted. EU regulations, such as the Social Chapter, have complemented, not undermined, this domestic framework. In any event, does the evidence suggest that a mature economy, such as the UK, will be able to establish a more rapid rate of growth with a looser regulatory framework? The obvious comparisons in this respect are the developed North American and Japanese economies. The data suggests that the UK has performed extremely well within the EU framework.
Table: GDP per capita (current US $, source: World Bank
Of course, much higher rates of growth have recently been achieved in developing economies such as China and India. But it cannot seriously be argued that an economy like the UK, which underwent an industrial revolution in the eighteenth century, can achieve rates of progress comparable to economies that are industrialising now. The whole course of economic history shows that mature economies have much slower rates of growth and that the increases achieved by the USA and the UK over the last few decades are close to optimum performance.
The maturity of the UK economy is also germane to arguments suggesting that it will be possible to revive industries that have suffered long term decline, such as manufacturing, agriculture and fisheries. After all, one consequence of the UK’s early start in manufacturing is that primary industries declined first and most rapidly here. Economic historians have been pointing out since the 1950s that in advanced economies the working population inevitably drifts from agriculture to manufacturing and then from manufacturing to services. In 1973, the American sociologist Daniel Bell greeted the arrival of the post-industrial society. He pointed out that the American economy was the first in the world in which more than 60% of the population were engaged in services, and that this trend was deepening in the USA and elsewhere. Brexit is scarcely likely to reverse these very long-term developments.
The British economy has also had considerable past experience of enforced devaluation (for example in 1931, 1949 and 1967). Research following the 1967 devaluation suggested that a falling pound gave only a temporary fillip to the trade balance, whilst delivering a permanent increase in inflation. Over the same period the West German economy performed extremely strongly, despite a constantly appreciating currency.
Finally, one may question whether the UK can achieve an economic miracle whilst, at the same time, pursuing a very restrictive approach to immigration. Successful economies tend to be extremely open to outsiders, who are both a cause and a consequence of growth. After all, in the pre-1914 golden age to which Keynes referred, there were no controls at all, and the British businessman ‘could secure forthwith, if he wished it, cheap and comfortable means of transit to any country or climate without passport or other formality…and could then proceed abroad to foreign quarters…and would consider himself greatly aggrieved and much surprised at the least interference’. Our putative partners in trade deals are not likely to be offering such access and, if they do, they will want substantial concessions in return.
Of course, past performance is no guarantee of future prosperity. Historic failure does not preclude future success. And sections of British public opinion have, it appears, ‘had enough of experts’. Even so, economic historians can hold up to scrutiny some of the more extravagant claims of the Brexiteers.
From Timothy Hatton, Professor of Economics, Australian National University and University of Essex. Originally published on 9 May 2014
The height of today’s populations cannot explain which factors matter for long-run trends in health and height. This column highlights the correlates of height in the past using a sample of British army soldiers from World War I. While the socioeconomic status of the household mattered, the local disease environment mattered even more. Better education and modest medical advances led to an improvement in average health, despite the war and depression.
The last century has seen unprecedented increases in the heights of adults (Bleakley et al., 2013). Among young men in western Europe, that increase amounts to about four inches. On average, sons have been taller than their fathers for the last five generations. These gains in height are linked to improvements in health and longevity.
Increases in human stature have been associated with a wide range of improvements in living conditions, including better nutrition, a lower disease burden, and some modest improvement in medicine. But looking at the heights of today’s populations provides limited evidence on the socioeconomic determinants that can account for long-run trends in health and height. For that, we need to understand the correlates of height in the past. Instead of asking why people are so tall now, we should be asking why they were so short a century ago.
In a recent study Roy Bailey, Kris Inwood and I ( Bailey et al. 2014) took a sample of soldiers joining the British army around the time of World War I. These are randomly selected from a vast archive of two million service records that have been made available by the National Archives, mainly for the benefit of genealogists searching for their ancestors.
For this study, we draw a sample of servicemen who were born in the 1890s and who would therefore be in their late teens or early twenties when they enlisted. About two thirds of this cohort enlisted in the armed services and so the sample suffers much less from selection bias than would be likely during peacetime, when only a small fraction joined the forces. But we do not include officers who were taller than those they commanded. And at the other end of the distribution, we also miss some of the least fit, who were likely to be shorter than average.
Understandably, 2014 has seen (and will yet see) many reflections on the ‘Great War’ of 1914-18. In a lecture given to the Economic History Society Annual Conference on 28th March, Mark Harrison1 identified a number of widely-held myths about that tragic event. This is a shortened version of that lecture, which is available at: http://warwick.ac.uk/cage/research/wpfeed/188-2014_harrison.pdf.
Perceptions of the Great War continue to resonate in today’s world of international politics and policy. Most obviously, does China’s rise show a parallel with Germany’s a century ago? Will China’s rise, unlike Germany’s, remain peaceful? The Financial Times journalist Gideon Rachman wrote last year:
The analogy [of China today] with Germany before the first world war is striking … It is, at least, encouraging that the Chinese leadership has made an intense study of the rise of great powers over the ages – and is determined to avoid the mistakes of both Germany and Japan.2
The idea that China’s leaders wish to avoid Germany’s mistakes is encouraging, certainly.3 But what are the ‘mistakes’, exactly, that they will now seek to avoid? The world can hardly be reassured if we ourselves, social scientists and historians, remain uncertain what mistakes were made and even whether they were mistakes in the first place.
In this lecture I shall review four popular narratives relating to the Great War. They concern why the war started, how it was won, how it was lost, and in what sense it led to the next war.
by Mark Mazower Published on the Financial Times Online, 6 November 2016
The historian Fritz Stern fled the Nazis and helped pioneer the study of German history in the US. Before his death this year, he had been warning for some time of the signs of a resurgent fascism. He was not talking about the land of his birth.
Fascism in the US? The fear is surely overblown. Before we write it off, though, we might ponder what we have learnt about fascism in general, thanks to the work of Stern and others.
In some ways, it is hard to see any parallel between the Weimar Republic or Mussolini’s Italy and the world we live in. No one is calling for a single party state. There are no serried ranks of black- or brownshirts marching through the streets. There are no royalists who will embrace anyone rather than fall into the abyss of Bolshevism. If one thing lay behind the rise of the far right in the 1920s it was the shadow of the Russian Revolution and fear that it would spread. Vladimir Putin’s shadow may be long but it is not that long. Russia is a member of international society in a way that Lenin’s Soviet Union never was.
Conference Report: University of Cambridge, 13-14 September 2016
by Sabine Schneider, University of Cambridge
Retracing the path to the Great Recession, Barry Eichengreen has observed how ‘The historical past is a rich repository of analogies that shape perceptions and guide public policy decisions.’ Certainly, recent years have shown that analogies drawn from historical experience are most in demand ‘when there is no time for reflection.’ Beyond the study of banking crises and financial regulation, the past decade of economic turmoil has generated renewed scholarly interest in the evolution and politics of financial capitalism. While the legacy of the Great Recession has profoundly shaken established tenets of mainstream economics, it has also stressed the need for new historical narratives that understand the world economy within the specific cultural contexts, economic ideas and political debates of the past. On 13 and 14 September, the Centre for Financial History at Darwin College, Cambridge, hosted an early career conference to foster an interdisciplinary dialogue about histories of finance, global trade and monetary policy. Over the two conference days, twenty early career scholars and doctoral researchers presented papers that ranged, in period and geography, from medieval Catalonia and eighteenth-century Scotland to pre-war China and post-war Britain. This review will reflect on three major themes of the conference: the art and science of central banking, studies in political economy, and cultural approaches to the history of finance.
Central banking and the formation of monetary policy have resurfaced as key concerns for economic historians since the 2007/8 financial crisis. The debate over the Bank of England’s evolving role as Lender of Last Resort, for instance, was re-examined by Dr Paul Kosmetatos (Edinburgh). His paper analysed Adam Smith’s and Henry Thornton’s differing recommendations for crisis containment as a starting-point for evaluating the Bank’s conduct in 1763 and 1772. Kosmetatos concluded that the Bank’s timely injection of liquidity via the banknote channel during the latter crisis showed that ‘the attitude and means of intervention described by Thornton were already practically in place.’ Pamfili Antipa (Banque de France/Paris School of Economics) presented new Bank of England balance sheet data that adds considerably to our knowledge of how the British government financed the Napoleonic and Revolutionary Wars. Her joint research with Professor Christophe Chamley (Boston) revealed that the Bank strategically operated in the secondary market for Exchequer bills in order to re-direct funds to the Treasury. For the post-war period, Oliver Bush’s paper (Bank of England/LSE) investigated Britain’s approach to monetary and macroprudential policies in the years after the UK Radcliffe Report (1959). Based on collaborative research with Dr David Aikman (Bank of England) and Professor Alan M. Taylor (California), Bush presented new findings on the ‘causal impacts of interest rates and credit controls’ on inflation and economic activity.
The evolution and management of modern central banks in mainland Europe and Great Britain formed the focus of three further papers. Starting with the foundation of Germany’s Reichsbank in 1876, Ousmène Mandeng (LSE) explored the role of competition and monetary stability as integral elements of the operation of Germany’s central bank prior to 1890. Mandeng argued that the Reichsbank’s flexible reserve requirements, as well as its rivalry with regional note issuing banks in the market for bills, created an effective, incentives-based system of central banking. Enrique Jorge-Sotelo (LSE) took a micro-historical approach to the Spanish banking crisis of 1931, assessing the criteria the Banco de España employed for the provision and conditions of its emergency loans. In her closing keynote, Dr Anne Murphy (Hertfordshire) examined the origins of modern management practices at the Bank of England. Shedding light on the Bank’s working processes, recruitment, and staff training during the 1780s, Dr Murphy demonstrated that the Bank took important steps towards fostering and monitoring good managerial practice, which over the long run may have aided ‘the development of trust in the British public finances.’
The politics of currency, taxation, and trade shaped a second major strand of the conference. Professor Martin Daunton (Cambridge) delivered a wide-ranging keynote on ‘Bretton Woods Revisited: Currency, Commerce and Contestation’. Shifting the focus away from the predominant narrative of US-UK rivalry at Bretton Woods, Daunton re-evaluated the specific domestic concerns of several Western European and Commonwealth countries, which affected their negotiating positions at the 1944 summit and at subsequent international trade conferences. The League of Nations’ work in the field of trade finance in the years leading up to the Great Depression was re-examined by Jamieson Gordon Myles (Geneva). His paper investigated the League’s failed internationalist efforts, and traced how economic nationalism and beggar-thy-neighbour policies could take hold in the inter-war period. New research on France, China, and Germany prompted further reflections on the impact of global integration in capital markets, and its effect on nations’ public finances. Jerome Greenfield (Cambridge), for example, investigated the political economy of France’s fiscal constitution between 1789 and 1852. Greenfield’s paper elucidated the central government’s rationale for re-introducing and extending indirect taxes after they had been abolished during the French Revolution. Ghassan Moazzin (Cambridge) discussed the Chinese state’s practice of raising capital for public expenses through foreign bond markets in the early twentieth century. His paper demonstrated that the interventions of Western bankers to uphold China’s credit had a critical influence on the political outcome of the Republican Revolution of 1911. Considering the nexus between finance and diplomacy, Sabine Schneider (Cambridge) appraised the role of cosmopolitan financial elites in Germany’s conversion to a gold standard. Her paper examined the semi-official position of Gerson von Bleichröder, private banker and economic advisor to Bismarck, and his interventions in the monetary reforms Germany pursued after unification.
Several papers pointed to the underexplored potential of cultural and social history to broaden our understanding of how economic cultures, ideologies and policies are themselves socially constructed. Owen Brittan’s paper (Cambridge) drew on autobiographical evidence to assess men’s anxiety over bankruptcy and debt in later Stuart England, and revealed how such fears were mediated through ideals of masculinity, honour and economic independence. Henry Sless (Reading) discussed the news reporting of financial events in the Victorian era, while Damian Clavel (Geneva) revisited the speculative bubble in Latin American bonds that gripped investors in the 1820s, focusing, in particular, on how underwriters constructed the notorious story of the ‘fictitious country of Poyais’. Exploring changing cultural attitudes to speculation, Kieran Heinemann (Cambridge) traced the practices of brokers and investors in Britain’s grey market for stocks and shares during the half-century leading up to the Prevention of Fraud Act of 1939. Heinemann recovered a largely forgotten ‘discursive struggle over the boundaries between investment, speculation and gambling’, which still resonates with the concerns of investors and regulators today.
Credit, Currency & Commerce brought together thirty-six junior researchers and senior academics from across history, economics, development economics, business management, and philosophy. Their contributions from a variety of disciplinary angles and methodologies produced lively exchanges on the trajectory of financial and monetary history, and the opportunities it holds for mastering a deeper understanding of the world economy.
The conference was generously funded by the Economic History Society, the Centre for Financial History and the Faculty of History at the University of Cambridge. For more information on grants and conference funds: www.ehs.org.uk
 Barry Eichengreen, Hall of Mirrors: The Great Depression, the Great Recession and the Uses and Misuses of History (New York: Oxford University Press, 2015), 377.
 David Aikman, Oliver Bush, and Alan M. Taylor, ‘Monetary Versus Macroprudential Policies: Causal Impacts of Interest Rates and Credit Controls in the Era of the UK Radcliffe Report’, NBER Working PaperNo. 22380 (June 2016).
 Anne Murphy, ‘The Bank of England and the Genesis of Modern Management’, eabh Working Paper, No. 16-02 (August 2016); see also, Anne Murphy, ‘“Writes a fair hand and appears to be well qualified”: the recruitment of Bank of England clerks, 1800-1815’, Financial History Review, 22 (2015), 19-44.
 Murphy, ‘The Bank of England and the Genesis of Modern Management’, 29.
 Carmen M. Reinhardt and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly (Princeton: Princeton University Press, 2009), 93.
Post global financial crisis, there has been increased importance on exploring financial history of advanced economies and emerging markets to identify episodes of boom, crisis and regulatory responses from which parallels can be drawn today. In this blog, Tehreem Husain discusses an episode from early twentieth century Indian financial history which narrates the tale of a crisis and the evolution of a regulatory institution-the central bank in its wake.
The importance of India amongst the pool of emerging market economies can be gauged from the fact that it contributed 6.8 per cent to global GDP on PPP basis in 2014. Sustaining this growth track requires robust financial regulatory frameworks which can only come with a thorough understanding of its history and the events which led to the evolution of its crucial building block-the central bank. Researching early twentieth century Indian financial history suggests that the onset of the Great War and the financial crisis that ensued in India gave impetus to the creation of a central banking institution in the country.
The Great War, one of the most expensive wars in history, caused untold loss of human life and damages to economic and social resources. Britain at the forefront of the war went through insurmountable stress to meet financing needs of the war. Stephen Broadberry and other eminent economic historians have estimated that the cost of the Great War to Britain exceeded one-third of the total national income of war years. As the war continued in Europe, its stress spilled over the boundaries of mainland Britain and British colonies also became entangled in human and financial costs. For instance, not only did India contribute approximately 1.5 million men recruited during the war, but Indian taxpayers also made a significant contribution of £146 million to Britain to finance the war.
War times impose huge costs on the entire economy but more so for banks, due to the key role that they play in financing it. The National Bureau of Economic Research published a special volume on the effect of war on banking in 1943. One of the chapters, ‘Banking System and War Finance’, highlighted the crucial importance of commercial banks for Treasury borrowing. Banks constituted the largest purchasers of government obligations in addition to being the single most important outlet for the sale of government obligations to the public during World War II. Going back, similar to the experience of other countries, during the Great War Indian treasury borrowed heavily from the banking system. Debt archives from 1918 show that Rs 503.3 million were raised in the form of loans, Treasury Bills and Post Office Cash Certificates. At the same time government continued to issue fresh currency notes, which contributed to extraordinary liquidity flushing the banking sector (evidenced by a high cash-to-deposit ratio).
Studying the Indian economy during that time period using macro-financial indicator analysis, the relation between the British involvements in the Great War and the evolution of central banking is explored in India. Evidence suggests that exigencies of war-finance and government resorting to banking system to finance expenditures, the latter came under huge strain. A stressed macro and financial environment during the war years further weakened the fragile and fragmented Indian banking system. It led to a contagion like financial crisis accelerating bank failures in the war years and beyond. This crisis went unabated due to lack of a formal regulatory structure.
The near absence of regulatory oversight leading to financial crisis gave impetus to the creation of a central banking authority. Although the idea of a ‘banking establishment for India’ dates back to 1836, as a consequence of this episode, restructuring and reforms process ensued. This led to the introduction of a quasi-central banking institution, the Imperial Bank of India in 1921 and finally the creation of a full fledged central bank – the Reserve Bank of India, in 1935. In general, as argued by economists Stijn Claessens and M. Ayhan Kose (2013) deficiencies in regulatory oversight leading to currency and maturity mismatches and resultant financial crisis are applicable to this episode as well.
Interestingly, this episode was not unique to India. In the presence of no regulatory institutions, management and resolution of financial crisis becomes increasingly complex. Historian Harold James has written that the global financial panic of 1907 demonstrated the necessity to America the need to mobilize financial power themselves in the form of a central bank analogous to the Bank of England. The Federal Reserve was created in 1913.
To conclude, one can argue that absence of a formal central banking institution in India resulted in many stressed scenarios for Indian financial system and missed opportunities for the imperial government. This meant that at that time there was no liquidity support available to the failing commercial banks, no control and coordination of credit creation (i.e. no reserve requirements), no mechanism or support for price discovery of the securities to be traded in the primary and secondary markets, etc. A similar argument was given by Keynes in his book ‘Indian Currency and Finance’ supporting the idea of an Indian central bank. Had there been a central bank in India it would have performed three essential functions: (a) assist the government in flotation of bonds or other government securities to the commercial banks, (b) provide direct lending to treasury in the form of ways-and-means advances or by purchase of government securities, and (c) provide reserves to the commercial banks to help them buy government obligations and offer them guidance and support to carry on as much of their traditional task of financing trade and industry as was compatible with a maximum war effort.