Whoda thunk it? A free market in banking means more competition!


Some economists, especially economic historians, have really consistently interesting CVs. You'll look at their publication list because you're interested in their work on the US experience of free banking, and you'll end up finding interesting papers on genetic and cultural diversity on economic growth. Prof. Philipp Ager at the University of Southern Denmark turns out to be one of these types. I came across Prof. Ager November 2013 working paper with Fabrizio Spargoli: "Bank Deregulation, Competition and Economic Growth: The US Free Banking Experience" (pdf) which has a very interesting finding that although US free banking led to more bank failures it also led to more competition and probably higher growth.

We exploit the introduction of free banking laws in US states during the 1837-1863 period to examine the impact of removing barriers to bank entry on bank competition and economic growth. As governments were not concerned about systemic stability in this period, we are able to isolate the effects of bank competition from those of state implicit guarantees.

We find that the introduction of free banking laws stimulated the creation of new banks and led to more bank failures. Our empirical evidence indicates that states adopting free banking laws experienced an increase in output per capita compared to the states that retained state bank chartering policies.

We argue that the fiercer bank competition following the introduction of free banking laws might have spurred economic growth by (1) increasing the money stock and the availability of credit; (2) leading to efficiency gains in the banking market. Our findings suggest that the more frequent bank failures occurring in a competitive banking market do not harm long-run economic growth in a system without public safety nets.

This is particularly interesting, because it suggests that even in a free banking system with fairly important regulations, free banking may outperform the alternative.

As Larry White details on the new blog alt-m most histories of US free banking miss out that many of the major distortions and problems in the US experience stemmed from regulatory interventions—especially restrictions on what kinds of collateral banks could accept and tight restrictions on branching, making banks much more vulnerable to idiosyncratic local risks.

My real issue here is not deciding what side is correct. Basically all of the thoughtful work concludes that free banking is better than the tightly restricted banking we have had outside of a few historical experiences. The 'evidence' I see against consists of stuff like this Philly Fed paper, i.e. nonsense.

My real issue is why this evidence isn't breaking through? Why are so many smart, knowledgeable people opposed to free banking? Why is the ruling tendency now towards practically outlawing bank/debt finance altogether in favour of steps toward equity financing everything? I don't have a good answer.