Impact of Financial Systems on the Economic Success of a Country - Essay Example

Is it Free Market or Regulated Financial Systems that Underpin Long-Term Economic Success and Effective Corporate Governance? Insert (s) Instructor’s name Course Code Date of Submission Is it Free Market or Regulated Financial Systems that Underpin Long-Term Economic Success and Effective Corporate Governance? Introduction The question as to whether it is the free market or regulated financial systems that can underpin long-term economic success and effective corporate governance has always been one of the major reoccurring and central issues in the contemporary economic policy debates discussions. Generally, a free market financial system is a situation whereby the financial market is largely run by the forces of supply and demand with no governmental policy intervention. On the other hand, a regulated financial system refers to a system in which the government controls the financial system through restrictions, laws, requirements and guidelines aimed at influencing the economic outcome, protecting the consumers or environment as well as maintaining the integrity or stability of the financial system. The major problem is that any occurrence of financial crises has been perceived as a failure of the governments or other relevant institutions to apply the necessary regulatory control measures to avert such financial crises (Bernanke, 2000, p.21). On the other hand, the increased government involvement in matters of both market and financial systems regulation has been perceived as highhandedness on the part of the government, and thus criticized on the basis of stifling the free operation of the markets. Thus, either way, the law of unintended consequences always applies. The issue of the operation of the economy and the markets is a tricky one, due to the fact that a complete lack of control of the economic operations by the government makes economic crises more likely and severe in the future (Doepke and Schneider, 2010, p.72). Generally, government or formal regulation that is too heavy may stifle future financial efficiency, while at the same time hindering innovation (Meltzer, 2004, p.163). However, although free market is necessary for economic growth, many critics argue that it may not be sufficient condition for economic success and effective corporate governance. This paper seeks to critically compare the free market and the regulated market systems with a view to evaluating whether it is free market or regulated financial systems that underpin long-term economic success and effective corporate governance using the five major economies namely the USA, UK, Japan, Germany and China as case studies. Relevant Theories There are a number of theories that have sought to explain the potential impacts of different financial systems on the overall long term economic success of a country and effective corporate governance. For example, the Theory of Market Failure is fundamentally concerned with evaluating the conditions that makes the competitive market environment less efficient. Thus, according to this theory, the production of goods and services in the competitive markets under a condition where the market agents are pursuing their own self-interest results in an allocation of goods and services that is socially inefficient (Aikins, 2009, p.25). This can simply be interpreted to mean that some form of regulatory control is necessary in the competitive market economy. For example, under a situation where the companies have either the opportunity to limit competition or fix prices, the consumers are always at a disadvantage, since the consumers will lack the information to make the relevant product choices, the industrial structure creates barriers to entry, while the market systems results in the inequitable distribution of incomes and wealth (Aikins, 2009, p.26). This assertion of the Theory of Market Failure is backed up by the Public Interest Theory, which offers that regulation is necessary both in the product market and the financial markets, since regulations are instituted for the protection and also benefit of the public, or at least a larger subclass of the society (Aikins, 2009, p.26). Thus, according to this theory, regulations are a response to the free markets operational failure, and are thus instituted for the benefit of the society, for example to stimulate competition, where the free market system is unable to promote competition in the markets (Aikins, 2009, p.26). However, the assertions of these two theories are opposed by the Private Interest Theory which holds that the exercise of the government regulations of the market is nothing more than the exercise of private interests, which entails the application of the government machineries to redistribute wealth from one economic group in the society to the other (Aikins, 2009, p.26). For example, a company that is earning less than optimal profits in the competitive free market can lobby for the government institutions to institute regulations that may stifle the free operation of the markets, and in this way secure an opportunity to increase its profitability. The tag of war between the theories above can continue until the end of time. Nevertheless, the fundamental aspect about the theories is that each is arguing for or against the free market or the regulated market systems. In this respect, it becomes necessary to investigate the strengths and weaknesses associated with each of the economic structure. Generally, the Theory of Market Failure and the Public Interest Theory provides that the regulation of the economy by the government is a necessary condition for economic success and also effective corporate governance. However, this is disputed by the Private Interest Theory, which holds that government involvement in the regulation of the economy results in unfavorable business environment that does not promote economic success. In summary, while the two theories stands for the opposite arguments in support for or against either free market or regulated financial system, the discussion above has managed to show that a free market condition is a necessary, though not sufficient condition for economic success. Further, due to the high competitiveness associated with a free market economy, effective corporate governance is also promoted under the free market structure. However, this conclusion does not eliminate the possibility of moderate government regulation of the economy as a necessary condition for both economic success and effective corporate governance. The appropriateness of the intermediate state that entails the combination of both free market structure and moderately regulated financial systems, as the basis of achieving economic success and effective governance of corporations, needs to be investigated further. Free Market Financial System vs. Regulated Financial Systems: Case of China, USA, Germany, UK and Japan The differences between China’s financial system and the current free market financial system used in the United States is one of the best case studies that can effectively be used to highlight the diverse impacts of the two main financial systems on both long-term economic success and effective corporate governance. For example, China’s financial system is highly regulated and controlled by the government.The economic structure of China represents a regulated financial system structure, which is also characteristic of moderately free product market structure. China is a country that adopted the socialism economic system from its early inception, which was based on the communist ideology, but is gradually transforming into a mixed capitalist-socialist economy (Guriev & Tsyvinski, 2012, p.60). However, while some of the changes that are transforming the economy of China into a capitalist market structure can be identified in the product and services markets, the financial market system in China has remained under the tight grip of the government control (Guriev and Tsyvinski, 2012, p.61). According to many experts, China’s economy also operates on a regulated system that is founded on political directives. Basically, the country is far from being a free state, and its financial system is pegged on Communist Party Committees secretly holding sway over virtually all executives in leading company. Citizens have however denied the idea that the country’s economic success was driven by the authoritarian political system therein. This is reported to have bread challenges like ownership issues alongside weak legal systems. Nevertheless, there is a widespread belief that government accountability is the best way to make sure that China is not governed or dictated by the interest of few elites. This is sharply contrasted with a free market economy that is characteristic of the USA, where both the product and the financial system markets operate under minimal government intervention, by only limiting the government involvement to the bare necessity (ALTA News, 2010, p.7). Generally, the U.S economy features a free market financial system as the more dominant system (Gasper, 2006). In most cases buyers and sellers pursue their business duties without government regulation, though there are debates from economists and politicians as to the extent to which the government should intervene. The consequence is that the USA has developed a robust financial market system, where both the stock and the credit/bond market in the USA have become the prime example of how effective financial markets can operate globally. Nonetheless, the free market system has brought about some pitfalls like unequal distribution of wealth, instability in productivity level (typically recess and peaks) in addition to a survival for the fittest environment that makes numerous enterprises to neglect the safety associated with the general public. A regulated system is a trade system that allows direct and indirect intervention of the government as pertains to the business-related decisions such as through restrictions, laws, requirements and guidelines aimed at influencing the economic outcome, protecting the consumers or environment as well as maintaining the integrity or stability of the financial system. Thus, the U.S will be better placed using a regulated system to prioritize consumer safety, safeguard the safety and health of the general public and to attain stability. Despite the fact that both the USA and China have high economic potentials, the financial markets in China are not as robust or as prime as those in the USA. The argument can be put forward that the political systems in the two countries have played the role of determining which nation succeeds more economically than the other. However, while the economy is in dire need of investment, the households and the firms in the economy are directing their investments outwardly, meaning that the Chinese economy is hindered from exploiting its full potential. Additionally, the Chinese government, which has been responsible for crippling the financial sector in the country through exercising a tight control on the financial sector, has also turned into investing in foreign financial assets, such as purchasing the sovereign government bonds of the United States (Guriev & Tsyvinski, 2012:61). Similarly, the Japanese economy has never had any better encounter with the regulated system in the post-war era. Typically, the economy was insulated against foreign financial markets plus institutions, fixed bond issues, loans and benefits, permitting a limited scope of financial instruments, a restricted count of financial institutions with new entrants virtually barred (Baker, 2005). Finally, there was great segmentation in the financial market and every enterprise was expected to remain in an area of expertise that is unique to its objectives. In response to these weaknesses, Japan shifted to a free market-oriented system as an approach to allocating funds and pricing. To this far, the move has brought about great transformations in terms of the roles of financial institutions, manner of operation in addition to extension of the kind of financial liabilities and assets(Vogel, 2011, p.122). Besides, the shift in bank deposits to other financial assets capable of yielding better revenue has afflicted the big banks. In response to this trend, the banks have ended up increasing loans for small and medium enterprises (SME) to attain a competitive edge. On the other hand, the German government has been at the forefront introducing capital market reforms for over 15 years. However, the endeavor has left the populace believing that capital markets are not only risky, but also underdeveloped. So, what has brought about this? It is the strict regulatory practices that inclusive of the indirect plus the cutting-edge soft regulations thus pointing to the idea that regulated financial system is never the best solution if a long term economic success is anything to go by (Vogel, 2011, p.134). Finally, UK features a regulated financial system requiring directors to put more weight on shareholder value. As pertains to his condition, boards are to see to it that business entities remain sustainable and considerate of the long-standing impacts in defining enterprise models plus strategies. This manner of governance allows boards to long term success in addition to remaining accountable to the shareholders. Better still, the boards are often informed of the need to perceive governance as a tool for performance improvement and not a routinely compliance requirement. Furthermore, this approach considers shareholders as the legitimate people to evaluate whether the governance practices prevailing in a business context are leading to the sustainable success associated with a company. In the financial sector, the regulated system has seen the UK government use to central banks to extend great liquidity levels to the banking sector. However, the central banks bear minimal amounts of government debts and they take up larger claims from the private sector thus impairing long term goals of financial success of the citizens there at an individual level. Based on the analysis of the different financial systems currently being used in the USA, UK, China, Germany and Japan, it is evident that the free-market system is the tool to drive nations towards long-term financial goals and effective corporate governance. Despite its few limitations such as market failures and the dangers attributed to profit motives, it is currently the best financial system that can underpin long term economic growth and sustainable corporate governance. This is because free market financial systems such as the one adopted in the United States and the United Kingdom usually creates a highly competitive environment thereby driving innovation based on customer driven choices, and ultimately long term economic growth. However, it is worth noting that the economic structure of a country is tied to the political system, such that a democratic and freer political system will create a more conducive environment for free trade, economic operations and overall product and financial markets prosperity (Doepke, M. & Schneider, 2006, p.1085). Therefore, it can be rightly argued that due to the tight government control of the financial markets, which does not offer either the households or the firms any sustainable long-term or short-term financial assets to invest in, it has emerged that foreign investments have become a popular means of investment for Chinese insurance and other commercial firms. Conclusion In conclusion, a free market economy is more productive than a regulated financial economy, and thus free market structure is a factor leading to economic success. Despite a few limitations of free market financial systems such as market failures and the dangers of profit motives, it is widely considered to be the best financial system for long term economic growth and sustainable corporate governance owing to its creation of a highly competitive environment thereby driving innovation based on customer driven choices. Finally, unlike a regulated financial system like the case of China, a free market system normally encourages efficient use of resources as the profit motive tend to drive firms into producing goods more efficiently and at lower costs. As a result, it is the free market financial systems that most underpin long term economic success as well as effective corporate governance. References Aikins, S. K. 2009. Global Financial Crisis and Government Intervention: A Case for Effective Regulatory Governance. International Public Management Review 10(2), 23-43. ALTA News. 2010. Free Market vs. Regulation You Decide. Title News, 1-21. Baker, R. W. 2005. Capitalisms Achilles heel dirty money and how to renew the free-market system. Hoboken, N.J., John Wiley & Sons. Bernanke, S. 2000. Essays on the Great Depression. New York: nPrinceton University Press. Doepke, M. & Schneider, M. (2006). Inflation and the Redistribution of Nominal Wealth. Journal of Political Economy, 114(6), 1069-1097. Gaspar, J. E. 2006. Introduction to business. Boston, MA: Houghton Mifflin Company publishers. Meltzer, A. (2004). Monetarism Revisited. World Economics Journal, 5 (2), 161-164. Vogel, S.K.2011. The Crisis of German and Japanese Capitalism Stalled on the Road to the Liberal Market Model? Comparative Political Studies, 34 (10): pp.1103-1133. Read More