Commercial banks varied between extreme specialization – as in Britain, where merchant banks, colonial banks, clearing banks, issuing banks, trustee banks, discounters, jobbers, stockbrokers, and savings banks each engaged in distinct financial activities – and universality – as in Germany, where all these activities were indifferently handled by large banks. More generally, a universal banking system is defined as a system in which banks engage in both lending and the underwriting of securities. In contrast, a specialized banking system keeps the two activities under separate roofs. Before 1913, universal banking is commonly held to have existed in Belgium, Germany, Austria, and Italy, whereas specialized banking was mostly encountered in France and the Anglo-Saxon countries.

Gerschenkron argued that universal banking reflected a median intensity in firms' capital needs – higher than in England, but lower than in Russia. From the perspective of the information asymmetry literature, universal banking is the most advanced form of delegated monitoring in conditions of acute information asymmetry.

The present account stresses the effect of capital spatial concentration.

The key variables of financial viability for any major project are costs (investment, financing, operations and maintenance) and revenues (mainly tolls in the case of transport projects). For each variable, forecast values may be different from actual values as documented above. Ar isk therefore exists that actual project viability may be substantially different from forecast viability.

The difference between forecast and actual viability may be so large that if the actual viability had been known for a given project, decision makers might have resolved:

1. (i) not to implement the project;

2. (ii) to implement the project in another form; or

3. (iii) implement another project.

In other words, non-viable projects, or projects that are less viable than forgone projects, may be implemented not because they are viable but because their viability was inaccurately predicted. The result would clearly be an inefficient use of resources.

Channel tunnel, Great Belt and Øresund

For the Channel tunnel, original estimates of viability have been rendered irrelevant by actual developments which have taken the project on a rollercoaster ride from expected high profitability to several near-bankruptcies. Most observers today consider the commercial viability of the Channel tunnel unproved and the prospect uncertain for original investors making a satisfactory profit.

After being issued at £3.50 per share on 9 December 1987, by mid-1989 initial optimism had spiralled Eurotunnel share prices to more than three times this value, above £11.00. Then delays and cost overruns hit the project, resulting in capital shortage and crisis.

With the necessary instruments for enforcing accountability elaborated in Chapter 10, we see two main alternatives for developing and reaching accountable decisions on whether or not to go ahead with a mega infrastructure project. The first alternative is based on the assumption that a project, if built, would be regulated by a concession, that is this alternative is based on the build-operate-transfer (BOT) approach, or a similar set-up. In the second alternative, a possible project, if built, would be constructed and operated by a state-owned enterprise (SOE). We assume in both alternatives that at least one third of the required capital will not be secured with government guarantees. We furthermore assume that the same taxation regime would apply to both alternatives.

The two main alternatives are set out in Tables XI.i and XI.ii, and should be compared to the conventional approach as summarised in Table VIII.i in Chapter 8. The first part of the process is similar for the two alternatives but differs towards the end, once all the public interest issues have been settled through the identification of performance criteria and regulatory provisions, and once it has been decided whether project implementation should be publicly or privately led. The steps involved in the development process would not necessarily follow each other in a simple consecutive order. Several of the steps would, most likely, be carried out simultaneously and with possible interactions and iterations.

This book is about moving money within and across countries. It raises the following question: are the few percentage points of my income that I save each month lent to a firm in my neighborhood or do they end up refinancing the short-term debt of the Republic of Mali instead? The answer to this question does not depend on technology, for, since the telegraph was invented, money has had the capacity to move to almost any urban area in the world at the speed of electromagnetic waves. Nor is the answer more likely to be found in economic reasoning. The local firm and the foreign government, holding risk constant, will pay the same interest on the sums they borrow. The answer, instead, is political. My savings are more likely to help fund production in my local industrial district if I live in Germany, Italy, Canada, or the United States, but to end up in Timbuktu if I live in Britain or France. Mobility of capital reflects the degree of centralization of the state. It is the structure of the state that determines the outreach of the “great go-between,” Bagehot's phrase for Britain's financial system, to which he ascribed the responsibility for moving money.

The second half of the nineteenth century saw the advent of modern finance. This is when the first joint-stock banks, financed by deposits rather than equity alone, opened their vast and sumptuous offices in London, Paris, New York, and other financial centers (chapter 3). This is when the first true international market for capital, backed by the most stable fixed-exchange-rate system ever to exist – the gold standard – emerged (chapter 4). This is when corporate stock markets opened their doors to the masses of individual investors (chapter 5), and when financial sectors across the industrializing world began to feel the need for product specialization (chapter 6). Except for automated tellers and internet connections, what we know of the financial sector today was already in place by the beginning of the twentieth century.

The previous chapter established that centralized countries registered relatively high levels of financial agglomeration. Without regulatory and legislative power, local governments in centralized countries could not – nor did they want to – stop center banks from opening a branch on every local “Main Street.” The reasoning, however, rested on an autarkic model – one without an international dimension. This chapter brings the international dimension into the picture, asking whether it ran parallel to or mitigated the process of agglomeration at work in the domestic economy. Theory and historical evidence both suggest that internationalization happened simultaneously with agglomeration, and more markedly in centralized than in decentralized countries.

Consider a country with two regions – the basic model of chapter 2. Graft onto it another country with a similar structure. Allow capital to flow freely between regions of a same country but not across countries. Burden the exchange of financial products with information asymmetry so that the losses incurred are lower between two financial cores than between a given core and a foreign periphery. The rationale for this differential in asymmetric information is that nineteenth-century foreign investors had an overwhelming preference for large, central, visible assets in foreign countries – mostly government bonds – over small, peripheral, and unfamiliar ones. It is reasonable to expect from such a model that the core–periphery pattern within a country and the degree of internationalization of the financial sector in that country would be mutually reinforcing.

In this and the following chapters we review the experience from a large number of megaprojects, including the Channel tunnel and the links across Great Belt and Øresund, all three multibillion-dollar projects. Although we subject these projects to critical scrutiny, our objective is not to criticise them, even where they have underperformed, but to learn constructively from experience by identifying lessons that may prove useful in improving future decisions regarding megaprojects. Given the large amounts of money spent on major transport infrastructure projects, it is remarkable how little data and research are available that would help answer the two basic questions: (i) whether such projects have the intended effects; and (ii) how the actual viability of such projects compares to projected viability. Therefore, in addition to transport projects, we have found it pertinent to review data and research from other types of infrastructure project and to compare experience from these projects with experience from the transport sector. In this manner, we will review data from several hundred large projects. In this chapter we focus on the costs of megaprojects. In Chapters 3 and 4 we consider the demand for, and viability of, such project.

The problem of cost overrun

Cost overruns in major transport infrastructure projects are widespread.

Finance is a rich field of study, pooling contributions from historians, political scientists, and economists. My goal is not to draw up an exhaustive inventory of the existing literature, but merely to situate the approach adopted in this book. I successively look at (1) the historical debate on capital scarcity, on which I offer a new perspective; (2) the use by political economists of the notion of capital mobility, which I try to clarify; and (3) the economic literature on information asymmetry, on which I build my argument.

Capital scarcity

In an article published in 1952, Gerschenkron provided the most ambitious explanation yet offered of why financial structures differ across nations. The more capital was needed in a short amount of time, he argued, the less equity markets could cope with the task of allocating long-term financial capital; instead, banks and state had to step in. Hence the “orderly system of graduated deviations from [the first] industrialization”: British industrialization was self- and market-financed, manufacturers ploughing back profits into their own factories; French industrialization (the 1850–70 spurt) was financed by investment bankers, who raised long-term capital and lent it to factories; German industrialization was financed by universal bankers, intermediating between depositors and factories; and Russian industrialization was financed by the state, raising capital from taxpayers and foreign lenders to distribute it to banks and factories. The need for banks or state intervention reflected economies of scale.

The argument of this book is that a freely functioning financial sector can split an economy's financial geography into a center and a periphery, redistributing income from location-specific factors in the periphery to those in the core. It may thereby modify the fiscal apportionment between local and central governments, and thus the very makeup of the state. Consequently, and in anticipation of this occurrence, the financial market elicits political resistance and incurs regulatory curbs in countries that are not fully centralized.

Consider an economy featuring a financial sector distinct from non-financial sectors. The financial sector raises capital (the factor) to make finance (the product). Capital is an input that is specific to the financial sector, but it is not location-specific, at least not to the same extent as labor, machinery, or skills are, but instead easily moves around. A financial product, in contrast, is the output of the financial sector. This output is used as input by non-financial firms (in the form of loans and underwriting) and financial firms – banks are the largest consumers of day-to-day loans, bond issues, and derivatives. The output is also consumed by final consumers in the form of mortgages and credit for consumption.

Unlike capital, financial products are not necessarily free to move around, but see their geographic mobility hampered by information asymmetry – the fact that investors cannot trust borrowers to tell them the truth about the profitability of their investment.

Banking became international for the first time in the nineteenth century when the international money market grew large enough to enable banks to refinance themselves on that market. Until World War I, the international money market rested on bankers' international acceptances – trade bills endorsed by reputable London merchant banks. The banking crisis of the 1930s put an end to that era. In the immediate postwar years, cross-border flows took the form of direct investment (FDI) by multinational firms; this was an instrument of marginal financial importance, for it was neither mediated by banks nor traded on markets. International banking took off again with the emergence of the Euromarkets, initially a London-based offshore interbank market in short-term dollar-denominated deposits. The Euromarkets made possible a rapid expansion of international banking. Banks lent or borrowed liquidity on the Euromarkets at rates that were more advantageous than those obtained on regulated domestic markets.

Banking internationalization was at first hindered by the Keynesian–Phillips synthesis that dominated macroeconomic policy. It was generally believed that wages were sticky and full employment unreachable without government managing consumers' demand for goods. Governments, seeking the right mix of price stability and employment, viewed cross-border flows as an irritant. Inflation led most OECD countries to restore capital controls in the 1960s and 1970s. Euromarkets developed on an offshore basis, in breach of acceptable economic practice. It is only in the 1980s that internationalization became a deliberate policy, which governments pursued to improve the efficiency of their financial system.

Definition

Financial regulation has evolved along two dimensions: center/periphery and for-profit/non-profit. Their intersection generates four banking sectors (see table 2.2, p.30).

The center bank category includes all commercial banks headquartered in the financial center(s), whether joint stock or partnership, whether nationalized by the central government or in private ownership. The central bank is not included. Joint-stock banks, with the central bank as primus inter pares, were created by private bankers, usually in the second half of the nineteenth century, with central government approval in the form of a charter. Many of these banks were nationalized after World War II and privatized in the last two decades of the twentieth century. Strictly speaking, it is incorrect to label these banks “for-profit” during the period when they were owned by the state, since they were not distributing dividends. But I kept this notation for convenience, because state ownership had little or no implication for the way the banks were run. Their directors enjoyed enough autonomy to pursue market-oriented strategies. Nationalization merely aimed at redistributing bank profits, not at reallocating bank credit. The private banks (a residual category, since most of them were incorporated as joint-stock banks in the nineteenth century) are also included in this category.

The local non-profit bank category includes savings banks, mortgage banks, credit cooperatives, and two categories of credit banks operated by local governments – the German Landesbanken and Swiss Kantonal banks.

Description and sources

Universal banking is measured by the ratio of own resources (capital, reserves) against individual deposits and savings. The numerator includes capital, reserves, and notes whenever appropriate. The denominator includes individual deposits and savings accounts. Unless otherwise noted, it excludes creditor current accounts, which exist for transaction purposes and are usually unremunerated. Interbank deposits (which usually constitute a relatively insignificant proportion of total liabilities) are excluded whenever possible. Data are for 1913 unless stated otherwise.

For the United Kingdom, 43 joint-stock banks of England and Wales, Sheppard 1971, p. 118. The numerator is “Paid-up capital and reserves.” The denominator is “Deposits and other accounts”; it was not possible to separate current accounts from deposits. As a result, the ratio overstates the liquidity of UK banks.

For the United States, 7467 national banks, Historical Statistics of the United States 1975, Series X 634–55, p. 1025. The numerator is “Capital accounts”; the denominator is “Deposits” excluding “US government.” It was not possible to separate current accounts from deposits. Consequently, the ratio overstates the liquidity of US banks, a bias that is further reinforced by the large number of banks included in the sample.

For Canada, all chartered banks, Urquhart and Buckley 1965, Series H 226–245, pp. 240–42. The numerator is “Capital and rest fund.” The denominator includes “Notes in circulation,” “Personal savings deposits,” “Public notice deposits,” and “Public demand deposits.”

For Australia, 21 Australian trading banks, Butlin et al. 1971, pp. 114, 120, and 131. The numerator is “Shareholders' equity.”

In this chapter we will review experience with private financing of infrastructure, in particular the experience of private-sector involvement in the implementation and operations of large transport infrastructure projects. The focus will be on whether private-sector involvement may help to deal with the institutional shortcomings of the conventional approach identified in Chapter 8, and thus to improve accountability, including enhancing risk management and overall project performance.

Private megaproject financing

During the nineteenth century, private capital played an important role in the development of infrastructure, in particular for investments in railways. Then, in the twentieth century, public financing became much more common, including financing with private capital secured with a government guarantee. The latter type of financing has been particularly common in developing countries, where the international development financing institutions have played a major role in the financing of infrastructure investments. Such institutions normally lend against a sovereign guarantee.

During the last ten to fifteen years, there has been a resurgence of interest in private financing and also increased mobilisation of private capital for infrastructure. One reason is increased fiscal pressures on most governments with a resulting shortage of public funds. Other reasons relate to the types of problem described in Chapters 2-4, for instance the large cost overruns typical for many major infrastructure projects, leading to a desire to: (i) shift the risks of projects from taxpayers to capital markets; and (ii) promote private and entrepreneurial initiative in infrastructure projects, including in the design and development of projects.