Capital Mobility and the Origins of Stock Markets.

Political institutions play a role in shaping factor mobility across sectors, space, and borders. I provide an illustration of this accepted, though hardly researched, idea by looking at the emergence of modern capital markets in the nineteenth century. The rise of corporate finance threatened to redeploy financial resources away from land and traditional sectors to heavy industry. I argue that mobilized and integrated markets flourished in the absence of blocking coalitions that had an interest in keeping finance local. I argue and show that the power of blocking coalitions was a reverse function of the degree of centralization of state institutions. I start by providing a conceptual interface between the abstract notion of capital used in trade models and the diversity of its actual occurrences as cash, debt, equity, buildings, patent, machinery, and so forth.

Unanswered Questions

The current notion of capital mobility--as conceived by (and used in) the asset specificity literature--is uncertain. Building on the work of Wolfgang Stolper and Paul Samuelson, the asset specificity literature shows that capital mobility--how capital flows across sectors of production--has redistributional effects. [1] For instance, given two factors, labor and capital, and two sectors sing both factors in different proportions, factor mobility homogenizes factor prices--wages and return to capital--across sectors. A corollary is that a change in product prices redistributes income across factors. In contrast, if factors are unable to switch employment across sectors, that is, if factors are (sector-)specific, then factor prices vary across sectors, and a change in product prices redistributes income across sectors. Therefore, lobbying for rents proceeds along sectoral lines with factor specificity and along factor lines--or not at all in light of the collective action dilemma faced by large groups--with fa ctor mobility. [2] Furthermore, building on insights from the industrial organization literature, political economists identify sources of factor specificity in barriers to entry, such as sunk investment costs, R&D intensity, learning by doing, brand name, patent, and so forth. [3] In a study of Norwegian firms, James E. Alt et al. argue that firms with large R&D expenditures create specific assets for the production of products with no close substitutes and difficult to dispose of in case there is no demand for the product. As a result, Alt et al. argue, R&D-intensive firms have a clear propensity to lobby for subsidies or market protection. [4]

The asset specificity literature rests on a notion of capital that is made up of dissimilar elements. Capital comes in two ways: (1) production capital, which includes machinery, stocks, the buildings that house them, and intangibles like patents; and (2) financial capital, referring to all financial assets, long and short term. The asset specificity literature does not deal with the dichotomy well: either it shuns financial capital to concentrate its attention on production capital exclusively, [5] or, alternatively, it treats production and financial capital as separate factors of production, with the latter systematically more mobile than the former. [6]

This classification of capital into its primary elements can only be a preliminary step in the study of capital mobility. The next step is to recombine their interactions--how the mobility of each element impacts that of the others. Production and financial capital are not two separate factors but represent the two sides of the balance sheet of a typical nonfinancial firm, with production capital on the assets side (buildings, machinery, and stocks) and financial capital on the liability side (equity and debt). Capital mobility is that of the side that is more mobile.

Which side is more mobile depends on whether or not there is a financial market. Absent a financial market, investors and creditors have concentrated stakes in few firms and even fewer sectors; they cannot easily exit a money-losing investment in specific (low liquidation value) assets, nor enter a profitable one, making lobbying for the regulatory protection of that investment a plausible option. In contrast, in the presence of a financial market, investors and creditors each own a diversified portfolio of corresponding instruments. [7] Little lobbying is likely to come out of a large number of small claimants; they are more likely to reduce--or write off-a stake in stagnating sectors and concentrate future investments in growth sectors. [8] The initiative to lobby, if any, is more likely to come from management (and labor), whose loyalty to the firm is higher than the investors' and the bankers', in order to prevent investors and bankers from walking away from the firm. In the presence of an efficient finan cial market, lobbying is more likely to reflect high financial capital mobility than low production capital mobility.

Therefore, in the presence of a modern financial market, nothing can prevent a dollar made in one sector from being invested into another sector; capital moves away from declining sectors to growth sectors, irrespective of asset specificity. All it takes is for large investors to modify their relative holdings of stocks in these sectors; the induced change in share values allows the growth sectors to incur more debt while forcing the declining sectors to reimburse past debt. In the presence of a financial market, therefore, capital mobility reflects intersectoral changes in expected profitability, not relative liquidation values of assets employed in different sectors, let alone conversion costs.