H. D. Macleod and the Origins of the Theory of Finance in Economic Development

The last thirty years have witnessed an explosion of research on what had previously been a largely ignored topic: how financial development affects economic development.¹ Ross Levine's (1997) survey of the area lists 167 works in its bibliography, 145 of which were published in or after 1973. Maxwell Fry (1995, 23) noted the dearth of work on finance and development "for 60 years from the onset of World War I,"² while Lionel Robbins (1968) reached much the same conclusion for the period before 1870.³ With few (but important) exceptions the period between 1870 and 1914 was no different.

The modern literature on the relationship between financial development and economic growth and development is rooted in research conducted during the 1950s and 1960s. Much of this work was applied analysis done by policy advisers employed by international agencies (e.g., the study of the Colombian economy directed by Lauchlin Currie [1950]). Some research by academic economists specializing in problems of economic development touched on financial issues (e.g., Gerschenkron 1962), and Raymond Goldsmith's collections of empirical data on financial variables (e.g., 1955, 1969) provided fodder for theorizing. However, the modern academic literature stems largely from the work of such monetary economists as Edward S. Shaw and his student John G. Gurley (e.g., Gurley and Shaw 1955; Shaw 1964). Shaw (1908–1994) was drawn to analyze the monetary problems of developing economies both by his personal approach to monetary theory and, later, by his dissatisfaction with the orthodox Keynesian and monetarist views that dominated the field.⁴ Having failed to obtain acceptance of his ideas as applied to the monetary systems of developed economies, Shaw turned to the analysis of developing economies. Shaw's work influenced several other economists of the era (among them, Robert Bennett [1963], Hugh Patrick [1966], and Ronald McKinnon [1973]), and his 1973 book, Financial Deepening in Economic Development, became, along with McKinnon's Money and Capital in Economic Development, one of the most-cited studies in the field.

Shaw's approach to the financial dimensions of economic development not only influenced later research; it also bore a strong affinity to the approach taken nearly a century earlier by the Scottish political economist Henry Dunning Macleod.⁵ Arguing from similar perspectives, Shaw and Macleod each concluded that money and finance matter for the long-run growth prospects of economies. Unlike Shaw's theory, however, Macleod's theory of finance and development was ignored during his lifetime and virtually forgotten thereafter.⁶ The eventual success enjoyed by Shaw's approach⁷ thus suggests an interesting question: Why did Macleod's theory of finance and economic development have so little impact on the profession?

In the following section, I review the intellectual background against which Macleod presented his views. In subsequent sections, I describe Macleod's system, examine its application to Scottish economic history, briefly discuss its numerous commonalities with Shaw's approach, and then consider why Macleod's theory of finance and development failed to influence mainstream economic thought.

Money and Economic Development: Preclassical and Classical Thought

From Smith onward, British classical economists focused much of their attention on economic development, which, they argued, depended primarily upon the accumulation of real capital. Their preclassical forebears thought in monetary terms to a much greater extent. Yet neither the monetary thinkers of the preclassical period nor the real theorists of the classical period made significant contributions to the theory of money and credit in economic development. Such contributions as they made were of modest importance, either being elaborations of long-accepted truths or marginal adjustments to an orthodox theory that, by construction, ignores the possibility that growth might depend on monetary or financial policy.

As an example of the first sort, thinkers going back to Aristotle, as Robbins (1968, 120–24) notes, recognized...