The Evolution of the US Financial Industry from 1860 to 2007: Theory and Evidence.∗

The share of finance in U.S. GDP displays large historical variations. I argue, using evidence and theory, that corporate finance is a key factor behind these evolutions. Corporate demand for intermediation depends crucially on the relative investment opportunities of firms with low cash flows (young firms) and firms with high cash flows (incumbents). A simple general equilibrium model is developed in order to separate demand and supply factors in the market for financial intermediation. The demand parameters accord well with historical evidence on the importance of entrants during technological revolutions. The supply parameters suggest financial regress in the 1930s and progress in the 1990s. The model accounts for much of the variation in the income share of the financial sector from 1860 to 2001. Only the period 2002-2007 appears puzzling.