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If You Build It, Will They Come?

Despite declarations that geography no longer matters, finance centers are vying for supremacy.

As transportation improved and new types of securities developed, other financial centers emerged. In a new study on the evolution of financial centers, Michelle Fratianni, of Indiana University’s Kelley School of Business, marks the 1688 “Glorious Revolution” in England as the beginning of London’s emergence as a financial center. A new Parliament made property rights a priority and the Bank of England was formed, selling government debt as securities. As the East India Company and the South Sea Company went public, shares became more “marketable and liquid.” Good institutions, an ideal harbor, and a central location put London on pace to become the center of the financial world.

The handoff from London to New York began around 1815, explains Charles Kindleberger in his landmark book The Formation of Financial Centers: A Study in Comparative Economic History. When the War of 1812 ended, the British dumped their supplies in New York. Once they had left, merchants from around the United States flocked to New York to bid in auctions for the leftover goods. When one of the merchants started a liner service to ship goods to Liverpool, New York became a major hub for cotton traders. Financial institutions and corporations followed.

Face Time Matters

Abroad, Paris, Berlin, and Zurich all had their moments as Europe’s financial capital. In 1842, Hong Kong began to emerge as an Asian financial center when China ceded control of the island to Britain under the Treaty of Nanking.

New York’s importance became especially clear during World War I, when J.P. Morgan and other U.S. banks provided credit and loans to the French government. By 1914, with Europe engulfed in war, most English bankers agreed that New York needed to “carry the load for financing the world’s commerce,” says Kindleberger.

Ideas still develop best in close quarters, and the complexity of financial innovation magnifies this effect. When Kindleberger wrote in the 1970s, the place-shifting power of the Internet was decades away. But his argument for the importance of face time still holds true: “Clustering develops when the high risks of an activity can be reduced by continuous interchange of information. Many financial functions involving uncertainty are better performed face to face.”

Finance has never been riskier than it is today, and companies pay high prices for proximity. Many argue that London is retaking its position as the world’s financial center. Perhaps Shanghai or the desert emirate will follow. Although the vast improvements in the speed and cost of transportation have depleted manufacturing cities and back offices, such innovation helps financial capitals thrive. “Once backroom operations can be separated from the front roomÂÂÂ…the attractions of London, New York, and Tokyo are no longer diluted by the expense of office space for clerical activities,” wrote Nicholas Crafts and Anthony Venables, economists at the University of Warwick and Oxford, in their 2001 paper on economic geography.

So finance centers keep rising, popping up in new time zones like glittering trophies of financial nationalism. However, the substance behind such developments remains unclear. Kindleberger called the history of financial centers a “Darwinian evolution” in which banks lacking either caution or prime location were wiped out. Shanghai and Dubai will surely be tested by future newcomers. But soothsayers preparing the obituary of the financial center should not bank on it.

Alan Rappeport is a reporter for CFO.com.

The Emergence of Financial Centers

Mid-1200s: Florence

1493–1520: Antwerp

Mid-1500s: Genoa

Late-1580s: Amsterdam

1587: Venice

1694: London

1801: Paris

1815: New York

1850: Zurich

1871: Berlin

Sources: “The Evolutionary Chain of Financial Centers,” by Michelle Fratianni, Kelley School of Business, Indiana University. The Formation of Financial Centers: A Study in Comparative Economic History, by Charles Kindleberger.

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