Voting rights and financial systems: Evidence from two centuries of suffrage reforms

by Thomas Lambert (Erasmus University Rotterdam)

Extending voting rights to broader segments of the population considerably affects the way countries finance their economies. This is the key finding of our new research recently published in the Economic Journal, available here

Financial systems fulfil a number of key functions in the economy, thereby contributing to its growth. By transferring funds from savers/investors to borrowers such as households and firms, financial systems are the oil for the wheels that keep the economy turning.

Therefore, it is vital to have a clear understanding of the fundamental factors that support the development of financial systems. The research shows that suffrage institutions – that is, the institutions defining who holds the right to vote in the population – play a critical role.

Financial systems encompass financial institutions (such as banks) and financial markets (such as stock markets). However, the population is composed of corporate stakeholders (workers, investors, managers) and thus is not indifferent about whether governments should promote – through their policy choices – the development of stock markets or the banking sector. Indeed, both fulfil similar functions in the economy, but have a different impact on corporate stakeholders as they affect differently the degree to which each corporate stakeholder bears corporate risk. Stock markets lead to riskier but more profitable investments, at the cost of potentially higher labor-risk bearing. In contrast, banks have a tendency to limit risk-taking behavior of corporate managers because, as debtholders, they do not benefit from the upside potential of riskier investments.

The voting population will prefer politically to support bank finance if it relies more, in the aggregate, on labor income. However, the voting population will prefer relying on stock market finance if it has a sufficient amount of capital income relative labor income. By defining who has the right to vote in the population, suffrage institutions thus play a pivotal role in the way countries finance their economies.

Our research analyzes the gradual extensions of suffrage to various segments of the population over the nineteenth and twentieth centuries in 18 countries. It demonstrates that suffrage extensions change the political preferences of the voting population and, thereby, policy choices supporting either stock market finance or bank finance. Specifically, it provides empirical evidence that extending suffrage to broader segments of the population hampers the development of stock markets. In contrast, broadening suffrage is conducive to banking sector development.

Further evidence reveals longer-term effects produced by the extension of suffrage: A 25-year delay in the introduction of women universal suffrage increase today’s importance of stock markets relative to the banking sector by 17.5%.

Overall, these findings are consistent with the insight that small elites pursue economic opportunities by promoting capital raised on stock markets. In contrast, a broader political participation empowers a middle class which prefers bank finance as it is composed of voters with proportionally more exposure to labor income relative to capital income.

The research has broader implications. The scope of voting rights may drive the adoption and content of financial regulation shaping the way that financial intermediation takes place. This ultimately determines the long-term performance of economies.

To contact the author: t.lambert@rsm.nl