Colonial Legacy and Informal Finance

Abstract

An influential line of research emphasizes that colonial legacy plays a key role in formal financial development. Can colonial legacy also shape informal finance? We investigate the impact of colonial legacy on informal financial development using a manually georeferenced data set within a credible empirical framework. In the 19th century, Europeans arbitrarily designed colonial borders that partitioned many ethnicities across multiple countries in Africa. Leveraging several spatial regression discontinuity designs across national borders and within British-French–partitioned Cameroon and a unique natural experiment where the same former British colony is compared with two otherwise similar areas with different exposures to French colonization, we discover that former British colonies today have better informal financial development than former French colonies. Exploring the channels, we find that places with a British colonial legacy maintain a style of social control that facilitates information flow, supports private enforcement and market interactions, and promotes strong legal cultures. This paper was accepted by Kay Giesecke, finance. Funding: C. Lin acknowledges the Research Grants Council of Hong Kong for financial support [Grant AoE/B-704/22-R]. J. An acknowledges the general financial support from The University of Hong Kong Start-up Fund for New Professoriate Staff. M. Tai acknowledges the Research Grants Council of Hong Kong for financial support [General Research Fund No. 17500722]. Supplemental Material: The online appendix and data files are available at https://doi.org/10.1287/mnsc.2023.01856 .