3. 65 per cent of the banks accounting for 20 per cent of banking assets were outside the Federal Reserve System until 1929.
In the current phase of financial globalization led by the USA, the stock market has become the symbol of capitalism. When Communism was overthrown, many transition economies rushed to establish stock exchanges and sent promising young people abroad to train as stockbrokers, even before they had founded other more basic institutions of capitalism. Likewise, many developing country governments have tried very hard to establish and promote their stock markets, and to open them up to foreign investors, in the belief that this would allow them to tap into a hitherto unavailable pool of financial resources.[107]
Of course, many people, most famously John Maynard Keynes in the 1930s, have argued that capitalism functions best when the stock market plays a secondary role. Indeed, since the 1980s, there has been a heated debate on the relative merits of the stock-market-led financial systems of the Anglo-American countries, and the bank-led systems of Japan and the Continental European countries.[108] However, the orthodoxy remains that a well-functioning stock market is a key institution necessary for economic development – a view that was recently boosted thanks to the stock-market-led boom in the US, although this boom is fading fast due to the rapid slowing-down of the US economy.
Whatever importance one accords to the stock market and other securities markets, establishing institutions that regulate them effectively is unquestionably an important task. Given that stock markets recently became an extra source of financial instability in developing countries, especially when they were open to external flows, establishing the institutions to regulate them well is now an urgent task. So how did the NDCs manage the development of such institutions?
The early development of the securities market in Britain (established in 1692) led to a similarly early emergence of securities regulation. The first such attempt, made in 1697, limited the number of brokers through licensing and capped their fees. In 1734, the Parliament passed Barnard’s Act, which tried to limit the more speculative end of the securities market by banning options, prohibiting parties from settling contracts by paying price differentials and stipulating that stocks actually had to be possessed if the contracts that had led to their sales were to be upheld in a court of law. However, this law remained ineffective and was finally repealed in 1860.[109]
Subsequently, except for the 1867 Banking Companies (Shares) Act forbidding the short-selling of bank shares – which in any case remained ineffective – there were few attempts at securities regulation until 1939, when the Prevention of Fraud (Investments) Act was legislated. The act introduced a licensing system for individuals and companies dealing with securities by the Board of Trade, which had the power to revoke, or to refuse the renewal of, a licence if the party gave false or inadequate information in their application for it or when trading. The act was strengthened over time, with the Board of Trade being granted the power to establish rules concerning the amount of information that dealers had to give in offers of sales (1944) and to appoint inspectors to investigate the administration of unit trusts (1958).[110]
It was only with the 1986 Financial Services Act that the UK introduced a comprehensive system of securities regulation (brought into force on 29 April 1988). This act required the official listing of investments on the stock exchange and the publication of particulars before any listing; it also established criminal liability of those who gave false or misleading information, and prohibited anyone from conducting investment business unless authorized to do so.[111]
In the USA, organized securities markets dated from the 1770s. Early Institutions and Economic Development 99 attempts at regulation were directed against insider trading. In 1789, for example, Congress passed a bill banning treasury officials from speculating in securities; in introducing such legislation it was ahead of even the UK. Although the federal government made periodic threats to introduce securities regulation, such regulation was left to the individual states throughout the nineteenth century. However, not all states had laws regulating securities transaction (the best example being Pennsylvania, economically one of the most important states of the time), and what laws did exist were weak in theory and even weaker in enforcement.[112]
Fraud in securities transactions, especially misrepresentation of information, was made a property fraud in the mid-nineteenth century, but full information disclosure was not made mandatory until the 1933 Federal Securities Act. In the early twentieth century, 20 states instituted ‘blue sky laws’, which required investment bankers to register securities with state authorities before selling them, and which penalized misrepresentation, but the laws were ineffective and there were many loopholes. The first effective federal securities regulation came with the 1933 Federal Securities Act, which gave the Federal Trade Commission the authority to regulate security transactions – an authority that was then transferred to the new Securities and Exchange Commission in 1934.[113]
Continuing fiscal crisis in many developing countries has been a great obstacle to development since the 1970s at least. The IDPE believes that the nature of the fiscal problem in these countries stems from their profligacy, but in most cases there is a deeper problem, namely the incapacity to tax.[114] This argument is also supported by the fact that budgetary outlays in developing countries are proportionally much smaller than in developed countries, whose governments are able to spend – and tax – far more.
The ability to tax requires, at the deepest level, the ability to command political legitimacy , both for the government itself and for the particular taxes concerned. For example, the Community Charge (‘Poll Tax’) that Margaret Thatcher tried to introduce in the UK failed because most British taxpayers thought it was an ‘unfair’ (and thus illegitimate) tax, rather than because they thought they were being taxed at too high a rate, or because they thought her government was illegitimate.
However, ensuring the political legitimacy of a regime and of individual taxes is not enough to increase tax collection capability. It also requires the development of the requisite institutions, such as new taxes and administrative mechanisms for better tax collection. How then did the NDCs manage this process?
In the early days of their development, the NDCs suffered from very limited fiscal capabilities; in this regard they probably suffered even more than most developing countries suffer these days. Their power to tax was so limited that tax farming was widely accepted as a cost-effective means of raising government revenue in the seventeenth and eighteenth centuries. Many contemporaries justified it as a way of saving administrative costs, stabilizing revenue, and reducing corruption in tax collection; these were probably not unreasonable arguments, given how poorly developed public finance institutions were in these countries at the time.[115]
Overall, in many NDCs government finance – particularly local government finance – was in a mess during most of the period in question. A very telling example is that of the defaults by a number of US state governments on British loans in 1842. After these defaults, British financiers put pressure on the US federal government to assume the liabilities (which reminds us of the events in Brazil following the default of the state of Minas Gerais in 1999). When this pressure came to naught, The Times poured scorn on the US federal government’s attempt to raise a new loan later in the year by arguing that ‘[t]he people of the United States may be fully persuaded that there is a certain class of securities to which no abundance of money, however great, can give value; and that in this class their own securities stand pre-eminent’ .[116]
108
Zysman 1983; Cox 1986; Hutton 1995; Dore 2000 provide sophisticated up-to-date discussions of this debate.
114
Di John and Putzel 200; Toye 2000 provides a very illuminating up-to-date survey of fiscal issues in developing countries.
115
See Kindleberger 1984, pp. 161-2 (Britain), pp. 168-70 (France); ‘T Hart 1997, 29, and Kindleberger 1996, p. 100 (the Netherlands).