Sunday, 18 December 2016

Banks: Liberty or Regulation

Gordon Brown has just said that he made a big mistake about financial regulation. His remarks are in line with many politicians on the financial crisis: regulation failed therefore we need more regulation. But do we?
Frideswide Square is a notorious traffic junction in Oxford, and it’s a nightmare. It has about 20 sets of traffic lights and small problems here lead to long tailbacks in many directions, tripling journey times for many otherwise short trips. So you can imagine how awful it was when the traffic lights all broke down recently.
Except it wasn’t.

For the two blessed days the lights were out of action the traffic ran more smoothly through the junction than ever it usually does, and the improvement was especially evident during rush hour. In fact this shouldn’t have been a surprise: the taxi drivers had said years ago that the introduction of the lights in Frideswide Square had made the whole thing much worse, but their comments were not much heard. You will perhaps not be surprised to hear that the response of the council was to fix the lights.
In Frideswide Square we see writ small typical government failure and the typical response of government to government failure: implement regulation without any evidence that it will improve anything,  suppress the people who know it didn’t work (want your taxi licence renewed, huh?), see regulation fail, ignore better functioning in the absence of regulation, increase regulation.
The last government announced when it first came in 1997 that henceforth it was going to do evidence based policy. One could hardly object, although naturally one felt the same pang of terror as when hearing the medical profession announce that henceforth medicine was to be evidence based. Now plainly, evidence based policy would be policy that was based on knowledge of what is effective at achieving the aim of the policy, followed up with examining whether the policy implemented resulted in an outcome closer to or further from the aim.
Clearly evidence based policy never got through to Oxford Council. To be fair, it never got far in the last government either. After the fine words comes the return to business as usual, and business as usual for politicians is the retention of power. The promises you make get you into power but there is no incentive to implement evidence based policy in pursuit of those promises, since on the whole no one knows how to achieve the promises that are made. After all, following up the effects of the Law to Make Everyone Healthy, Wealthy and Wise will show that it didn’t work.
No,  it is more effective instead to appeal to the peculiar popular prejudice that nothing should be going on without prior approval. The prejudice is insinuated into the promise, dressed up in the rhetoric of democratic accountability: it turns out the aim will be achieved provided only the people submit to a proper and necessary regulation, whereby every failure is that of the people rather than of the government, and is itself proof that we haven’t got all the right rubber stamps in place yet. After all, if once people find out the traffic is better without the traffic lights, why, they might do anything!
What’s this got to do with banks and regulation? Well, the banking industry is the most regulated part of the economy and we have an historical example of no traffic lights being better in banking: Scottish banking 1716-1845. During that time banks were almost entirely unregulated, essentially bound only by the laws of free contract. Scotland’s economy grew faster than England’s and the banks were more stable. So it is at least possible, and indeed has been argued by eminent economists, that regulation causes rather than cures financial crises. Furthermore, politicians have all the wrong incentives to ever acknowledge that if it is true, since a regulatory regime on banks that fails just gives them more ammunition to keep them in power. And that may be why you won’t ever hear Gordon Brown or any other politician say that what he got wrong was too much bank regulation.

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