Political Institutions and Financial Systems: Theory and History—A Precis Stephen Haber, Douglass C. North, Barry R. Weingast Draft: February 3, 2003 1. Introduction Economists and political scientists have established a positive correlation between political systems that limit the discretion of rulers and levels and rates of economic growth. In this literature, “constraints on the executive” are usually measured by Gurr’s Polity IV data set, which codes executive constraint on a one to seven ordinal scale (see, e.g., Acemoglu, Johnson, and Robinson, forthcoming). Missing from the literature, however, is an understanding of the mechanisms that underlie these observations. Indeed, “constraints on the executive” can take any number of institutional forms (federalism, separation of powers, an independent judiciary, a professionalized civil service, electoral suffrage). Moreover, these interact with the economy through any number of economic institutions (rules and regulations that govern firms, markets, and individuals). What is therefore missing in the literature to date is an analysis of the political micro-foundations of economic performance. We offer a contribution to this literature by focusing on the relationship between political institutions and the development of financial systems. By financial system we mean both the interconnected set of banks, brokers, and markets that create and trade financial contracts; and the governmental institutions of public finance that include a central bank and a treasury (Sylla 2000). We focus on the political economy of financial system development for the following reasons. ã First, as recent events in Argentina make clear, the functioning of modern economies is directly linked to the efficiency of their financial systems. ã Second, financial systems are highly sensitive to changes in the rules and regulations that govern them. Indeed, financial systems cannot exist without a series of rules, regulations, and enforcement provisions, all created within the political system. Financial systems allow claims on real—and often relatively immobile and illiquid—assets to be represented by relatively liquid contracts. Rules laid down by the government determine the enforceability of those contracts and how easily they may be traded or transferred.