Banks as Catalysts for Industrialization

Much of the recent growth and development literature is based on the notion that economies may exhibit multiple equilibria. An economy may get stuck in a vicious circle of poverty as a result of a coordination failure. Little attention has been given to which economic institutions may solve such coordination failures. Motivated by some historical examples from 19th century Europe, we examine the role of banks as ‘catalysts’ for industrialization. Assuming only complementarities among investments of different firms, we show that banks can act as catalysts provided that they are (i) sufficiently large to mobilize a critical mass of firms, and (ii) possess sufficient market power to make profits from costly coordination. Universal banks are shown to have a lower cost of inducing coordination.