Japanese history from about 1990 to 2005 also illustrates the importance of banks in using a nation’s savings effectively. During this period, the Japanese continued to save, but Japanese economic growth was zero or negative for most of these years. How can this have been? Many Japanese banks were bankrupt or propped up by the government. They were not allocating funds efficiently. Other banks were pressured to lend money to well connected political allies, rather than to the most efficient new businesses. During this period, Japanese banks acted as storehouses for wealth, but they were not effective financial intermediaries. Japanese business innovation, and the Japanese standard of living, suffered accordingly.

In Japan, as in the United States, banks are privately owned so politicized lending, even when it occurs, is limited. But in many other countries, most large banks are owned by the government. Government-owned banks are useful to authoritarian regimes that use the banks to direct capital to political supporters. While it might be politically wise for the ruler to support his uncle’s firm, that uncle is probably not a superior entrepreneur. One important study by economists Rafael La Porta, Florencio Lopez-de-Silanes, and Andrei Shleifer found that the larger the fraction of government-owned banks a country had in 1970, the slower the growth in per capita GDP and productivity over the next several decades.6

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