Summary: The Great Divergence

The Great Divergence, which most likely began around 1700, and the Industrial Revolution, are striking confirmations of the rise of the west, but the demarcation of western Europe over the rest of the world takes roots far earlier during the middle ages. The importance of financial development for economic growth has been highly debated by economists, some agreeing to this vision, others arguing that the causation goes the other way. Overall, Levine (1997) states, “Although conclusions must be stated hesitantly… theoretical reasoning and empirical evidence suggests a positive, first-order relationship between financial development and economic growth”. Indeed the evolution of financial systems contributed to this dominance, fostering economic

Gains from trade can only be obtained if specialized producers are able to exchange goods and services, and this requires coincidence of wants. There were multiple stages in this change from barter to commodity money to bill of exchange banknotes and finally modern fiat money (Persson 2010, chap.7). This financial tool evolved because international and interregional trade requires more sophisticated means of payment. The bills of exchange, major step toward paper money, were widely used to settle payments related to trade. A bill entailed a promise by the debtor to pay the creditor at some future date. They first appeared in Italy during the 13th and spread through Italian migration along Europe’s Atlantic coast. It soon became a credit instrument and a substitute for money. It slowly became possible to transfer bills from one owner to another and banks would discount them. The use of bills of exchange for all of these various financial purposes generated an enormous volume of transactions. Indeed, as early as the 14th century, most bills of exchange arose out of financial transactions rather than trade (Meir Kohn 1999, p.9). The extensive use of bills of exchange both required and encouraged the development of organized exchange markets. Cities with organized exchange markets were known as “banking places”. Those innovations took place around core cities like Bruges, Antwerp, and later London. The Bank of Amsterdam, sometimes called the Wisselbank, founded in 1609, was very successful in the use of bills. Then, actual paper money developed spontaneously, with the Swedish bank Stockholm and then the Bank of England in 1694, which were granted the right to issue bank notes. Since the control of the parliament over the state managed to increase public trust, more and more people utilized