Bank Distress and Manufacturing: Evidence from the Great Depression

Using newly-digitized, city-industry-year level records from the 1923-1937 US Censuses of Manufactures, we examine the influence of the financial sector on the real economy. We do so in the context of the Great Depression, a period in which many banks were suspended and the manufacturing sector, which comprised 30 percent of the US economy, declined significantly. In our research design, we measure whether industries with high levels of pre-Depression external finance dependence declined in employment, output, and establishment growth by more than industries with low levels of pre-Depression external finance dependence from 1929-1933, in cities with higher 1929-1933 bank suspension rates. We control for city-time shocks, industry-time shocks, and other, non-financial industry characteristics interacted with bank suspension rates. We find that high external finance dependence industries contracted by 21 to 27 percent more than low external finance dependence industries following bank suspensions. For robustness, we instrument for bank suspensions with a measure of trust-religious fragmentation-and a measure of real estate price growth. Given the pre-Depression share of high external finance industries and the magnitude of the 1929-1933 bank suspensions, we estimate that approximately 22 percent of the total decline in manufacturing employment from 1929-1933 was due to the banking crisis. We conclude with evidence that the negative effects of the banking shock persisted into the late 1930s on the establishment outcome.