The NBER Working Paper Series presents "The Great Reversals: The Politics of Financial Development in the 20th Century" by Raghuram G. Rajan and Luigi Zingales. The paper challenges the notion that financial development is a steady, increasing process, arguing instead that financial systems have fluctuated over time. It finds that many countries were more financially developed in 1913 than in 1980, and only recently have they surpassed their 1913 levels. This contradicts theories that attribute financial development differences to time-invariant factors like legal origins. Instead, the authors propose an "interest group" theory, suggesting that incumbents oppose financial development because it fosters competition. The theory predicts that opposition is weaker in economies with open trade and capital flows. The paper also highlights that financial markets declined after 1929, reaching a low in 1980, and then recovered. The authors argue that structural theories are incomplete and that political forces favoring financial development are a key variable. They emphasize that incumbents in industry and finance may oppose financial development due to the threat of competition. The paper also discusses how openness to trade and capital flows can mitigate incumbent opposition, leading to financial development. The authors test these ideas using historical data on financial development, finding that openness to trade and capital flows are correlated with financial development. They conclude that financial development is influenced by political forces and the balance of interests between incumbents and new entrants.The NBER Working Paper Series presents "The Great Reversals: The Politics of Financial Development in the 20th Century" by Raghuram G. Rajan and Luigi Zingales. The paper challenges the notion that financial development is a steady, increasing process, arguing instead that financial systems have fluctuated over time. It finds that many countries were more financially developed in 1913 than in 1980, and only recently have they surpassed their 1913 levels. This contradicts theories that attribute financial development differences to time-invariant factors like legal origins. Instead, the authors propose an "interest group" theory, suggesting that incumbents oppose financial development because it fosters competition. The theory predicts that opposition is weaker in economies with open trade and capital flows. The paper also highlights that financial markets declined after 1929, reaching a low in 1980, and then recovered. The authors argue that structural theories are incomplete and that political forces favoring financial development are a key variable. They emphasize that incumbents in industry and finance may oppose financial development due to the threat of competition. The paper also discusses how openness to trade and capital flows can mitigate incumbent opposition, leading to financial development. The authors test these ideas using historical data on financial development, finding that openness to trade and capital flows are correlated with financial development. They conclude that financial development is influenced by political forces and the balance of interests between incumbents and new entrants.