The False Dichotomy in the Comparative Political Economy of Finance: Why Is Bank-Based and Capital Market-Based Dichotomous Framing Flawed?

This paper shows that John Zysman’s (1983) bank-based and capital market-based dichotomous framing that has been highly influential in comparative political economy literature is flawed due to two main weaknesses. First, Zysman and his followers, who make a distinction between bank-based and markets-based financial systems, use data that focus on financial deepening (e.g., share of bank credit, equity market capitalisation and bond market capitalisation in GDP) rather than the share of bank finance (and capital markets-based finance) in net sources of finance for non-financial corporations (NFCs). Second, Zysman’s emphasis is on external sources of corporate finance (e.g., bank-based and market-based finance) ignoring the significant role of internal sources of funding (e.g., retained earnings). There is little empirical evidence to support the view that neither Germany, France, and Japan have a bank-based financial system nor the US and UK have markets-based financial systems. Data on net sources of finance for the non-financial corporate sector show that internally generated funds (i.e., internal finance) dominated funding of all physical investment by NFCs. The evidence shows that market-based finance is always small, and when external sources of finance are relatively large, it is banks rather than markets that dominate NFC funding. The central issue in national financial systems is not whether they are bank-based or capital-markets based varieties but how interdependent and dynamic processes among structures, institutions and agents affect the nature of bank behaviour, financial system stability and economic growth.