Wolfgang Keller and Carol Shiue, University of Colorado and NBER, and Xin Wang, University of Colorado

Capital Markets in China and Britain, 18th and 19th Century: Evidence from Grain Prices (NBER Working Paper No.21349)

Capital markets allow surplus income to be invested into productivity-enhancing projects. Despite their prominence in general accounts of growth little is known on their role in the emergence of modern economic growth. In this paperKeller, Shiue, and Wang ask whether capital market performance might explain why Britain surged ahead of China in the 18th century. The researchers employ an asset-pricing model together with information on regional grain prices to derive interest rates, and then compare capital market development in large parts of Britain and China. The researchers first calibrate the method and show that it can replicate key features of the United States' early 19th century capital market, where more systematic data from bank interest rates is available. Using this approach they estimate interest rates for Britain that are at least 20% lower than those for China, for the years 1770 - 1860. Moreover, the regional integration of British capital markets, measured in terms of bilateral interest rate correlations, was far greater than it was in China. The Yangzi Delta correlations come close to the British average at distances below 200 kilometers, but at larger distances interest rate correlations in Britain are twice those of the Delta, and three or more times as high as elsewhere in China. The authors also find that Britain's advantage over China in terms of market integration existed already in the late 18th century. Backcasting on the 19th century trends suggests capital market divergence started by the year 1690. Overall, the results provide support for the hypothesis that divergence in capital market development occurred before income divergence, and may therefore be an important factor in explaining the Great Divergence.