Academics across multiple disciplines and policymakers in multiple institutions have in recent decades searched for the economic, political, and institutional foundations for financial market strength, seeing financial market prowess as propelling economic well-being. Promising theories and empirics have developed Data thought to be inconsistent with the most basic political economy view — that the polity’s overall left-right political orientation on market issues in western democracies predicts financial market development — has been prominently brought forward, indicating that financial markets deepened when locally left political parties governed. This finding might be interpreted to indicate that time invariant left-right orientation is unimportant in affecting financial development and either nonpolitical institutional issues or other political considerations are more central. We show, however, here first why that view is conceptually incorrect. It’s not relative local placement of the governing coalition on the nation’s left-right spectrum that counts, but whether the polity as a whole — i.e., its political center of gravity or its dominant governing coalition — is left or right on economic issues. If interests and opinion shift in a nation such that its political center of gravity is no longer statist and anti-market, then even locally left parties could implement change. (And conversely, when interests and opinions were once statist and anti-market, one would not have expected locally right parties to push pro-market finance forward.) We motivate the conceptual discussion first with the median voter theorem and illustrate several such shifts in a nation’s left and its political center of gravity. We then bring forward data suggesting that prior methods of measuring a nation’s political position do not account for the substantial movement over recent decades of political parties and governing coalitions. Left-right matters, but the left-right economic shifts over time make an empirical difference. The results thereby further buttress the importance of a nation’s basic left-right political orientation as a first-order factor in explaining financial market outcomes.
Henry Kaufman Professor of Financial Institutions
Professor of Finance / London Business School
Adolf A. Berle Professor of Law