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Free Banking Laws and Barriers to Entry in Banking, 1838–1860

Published online by Cambridge University Press:  03 March 2009

Kenneth Ng
Kenneth Ng
Affiliation:
California State University at Northridge, Northridge, CA 91330
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Abstract

The thesis that free banking laws lowered barriers to entry in the U.S. banking industry is tested by examining entry of firms and output of banking services before and after the institution of free banking. The output of banking services and the number of banks remained the same or declined after the institution of free banking, in all states with viable free banking laws except New York. In light of this evidence, the belief that free banking in the antebellum United States increased competition and efficiency of the banking industry by lowering barriers to entry must be reconsidered.

Type
Articles
Information
The Journal of Economic History , Volume 48 , Issue 4 , December 1988 , pp. 877 - 889
Copyright
Copyright © The Economic History Association 1988

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References

The author is Lecturer in Economics, School of Business and Economics, California State University at Northridge, Northridge, CA 91330. I would like to thank William Brown, Stanley Engerman, Richard Sylla, Hugn Rockoff, and James gikas for comments.Google Scholar

1 See Rockoff, Hugh, “Varieties of Banking and Regional Economic Development in the United States, 1840–60,” this Journal, 35 (03 1975), pp. 161–62;Google ScholarThe Free Banking Era: A Re-Examination (New York, 1975);Google Scholar“New Evidence on Free Banking in the United States,” American Economic Review, 75 (09 1985), pp. 886–89;Google ScholarRolnick, Arthur J. and Weber, Warren E., “New Evidence on the Free Banking Era” American Economic Review, 73 (12 1983), pp. 1080–91;Google Scholar“The Causes of Free Bank Failures: A Detailed Examination” Journal of Monetary Economics, 14 (11 1984), pp.267–91; and “A New Explanation,” Federal Reserve Bank of Minneapolis, Department Staff Report 79 (1982);CrossRefGoogle ScholarKahn, James, “Another Look at Free Banking in the United States,” American Economic Review, 75 (09 1985), pp. 881–85;Google ScholarHelderman, L., National and State Banks (Boston 1931), pp. 18–26;Google Scholar and Hammond, Bray, Bank and Politics in America from the Revolution to the Civil War (Princeton, 1957), chap. 8.Google Scholar

2 Rolnick and Weber, “New Evidence on Free Banking in the United States,” p. 1082;Google ScholarHelderman, National and State Banks, pp. 18–26;Google Scholar and Hammond, Bank and Politics in America, chap. 8.Google Scholar

3 See Sylla, Richard, The American Capital Market, 1846–1914: A Study of the Effects of Public Policy on Economic Development (New York 1975);Google Scholar and, also, Klebaner, Benjamin, Commercial Banking in the United States (Hinsdale, 1974), p. 9 for another exposition of this view.Google Scholar

4 The evidence does not address the existence, significance, or strength of monopoly power before and after passage of free banking laws. If assets grew after passage of a free banking law and lower entry varriers were the cause, the correlation between higher growth rates and institution of free banking laws gives no precise information about the magnitude of the change in entry barriers or monopoly power due to the free banking law. If assets did not grow after institution of free banking, monopoly power in the banking industry did not change. In either case, the test provides no information about the existence of rentrs earned by firms in the industry.Google Scholar

5 See Rockoff, Hugh, “The Free Banking Era: A Reexamination,” Jorunal of Money, Credit, and Banking, 6 (05 1974), pp. 157–63.Google Scholar

6 Rockoff presents his evidence as suggestive and does not attempt to draw a general conclusion about free banking and barriers to entry from the ohio free banking experience. Rockoff also notes that different levels of risk in bank portfolios, not monopoly, nay have caused a divergence in profits. “The Free Banking Era,” p. 158. More important, his paper is concerned with the existence of monopoly, not the effect of free banking laws.Google Scholar

7 Data on the number of banks chartereed under free bank laws are from Knox, John Jay, A History of Banking in the United States (New York, 1969);Google Scholar and Rockoff, The Free Banking Era.Google Scholar

8 See Rockoff, “The Free Banking Era: A Reexamination,” pp. 141–68, for a detailed examination of wildcat banking under free banking.Google Scholar

9 See Rockoff, The Free Banking Era, pp. 100–4.Google Scholar

10 See Rolnick and Weber, “New Evidence on theFree Banking Era,–75, for another view of the Indiana experience.Google Scholar

11 Although there are insufficient data to perform the growth rate test, there is fragmentary evidence on free banking in these states. Six years prior to the advent of free banking in illinois, total psecie and loans and discounts were $2,365, 599. In 1856, five years after the institution of free banking, specie and total loans and discounts had fallen to $1,097,149. During the same period, the number of banks increased from 15 to 36. The Minnesota free banking law, because of a defect in the law, led to wildcat banking. See Rockoff, The Free Banking Era, pp. 104–14, for details.Google Scholar

12 See Dewey, Davis R., State Banking Before the Civil War (Washington D.C., 1910).Google Scholar

13 See Chaddock, Robert E., The Safety Fund Banking System in New York, 1829–66 (Washington D.C., 1910), chap. 1;Google Scholar and King, Robert, “On the Economics of Private Money,” Journal of Monetary Economics, 12 (07 1983), p. 140, for the New York case.CrossRefGoogle Scholar

14 See Sylla, Richard, “Forgotten Men of Money: Private Bankers in Early U.S. History,” this Journal, 36 (03 1976), pp. 173–88, for a discussion of private banking and attempts to limit entry through legislation in the early part of the nineteenth century.Google Scholar

15 This line of reasoning may explain much of the anecdotal evidence about city/country bank animosity. Rather than the traditional explanation that country banks “overissued” their circulation because their remote location precluded redemption, country banks may have been criticized by city banks because by competing against city banks they made cartels more difficult to establish and maintain. See Redlich, Fritz, The Molding of American Banking (New York, 1968), vol. 1, chap. 5.Google Scholar

16 See Chadbourne, Walter W., A History of Banking in Maine, 1799–1930 (Orono, 1936), p. 235, for an example.Google Scholar

17 See Knox, A History of Banking in the United States, p. 377.Google Scholar

18 My argument regarding the lack of asset growth ignores interaction between the establishment of free banking laws in one state and monopoly power in other states. If out-of-state banks are not close substitutes for in-state banks, then there is no effect. However, if in-and out-of-state banks competed, then free banking would force competitive behavior on banks in neighboring states. In this case, the institution of free banking in one state would force increases in output in all neighboring states. If this ere true, then industry output would increase, but a cross-sectional comparison of output growth rates would show no difference between states with and without free banking.Google Scholar

19 See Sylla, The American Capital Market, appendix A.Google Scholar