Systemic Stability and Competitive Neutrality - Assignment Example

Advocates of market regulation often appraise in such a way to metaphorically portray it as equivalent to the placement of a stop sign at a busy intersection—meant to prevent individuals from behaving dishonestly. Although this is correct in the sense that regulation is a limiting force on the behaviours of actors in the marketplace, it is wrong to suggest that without this regulation, or this stop sign, that the intersection, or this marketplace, would break down into chaos (Anderson 2004). In fact, there is no better time than now to see large-scale condemnation of capitalism from all sides of the political spectrum. Such condemnations seem to all have in mind that the American economic system is one of laissez-faire, and that laissez-faire is the culprit for the financial crisis which has gripped the world. For instance, a recent article in The New York Times declares, “The United States has a culture that celebrates laissez-faire capitalism as the economic ideal...” (Lohr 2008). However, this historical dishonesty displays nothing more than a crass ignorance of what defines laissez-faire and the fact that true capitalism—an economic system free of coercion—has never existed because no government has ever allowed it. In this examination, cases for regulation in two pieces of industry—the financial sector and the public education sector—shall be scrutinized and evaluated for merit. In the end, however, it shall be found that although the financial sector seems to be more deserving of government intervention, the case for doing so is not strong enough to warrant such action to control and hinder freedom in the marketplace. Although there is always discussion amongst politicians regarding which industry should be regulated more or less, some certainly are the focus of discussion more than others. In particular, two industries—the financial/banking sector and the public education sector—are common targets for those advocating increased intervention in the marketplace. Is there a reason to support regulation on either of these industries as opposed to the other? There are certainly convincing cases for regulating them to a greater extent than they are already, and said arguments will be addressed in turn. However, it may first be instructive to examine what differentiates the banking sector from other pieces of the financial sector—non-banking financial services such as insurance, life assurance, and pensions. The rationale and form of regulation, no doubt, must be different when directed at either of these two categories, “especially when long-term contracts are involved” (Goodhart 1998, 10). To be sure, there are systemic issues which are much more significant in the regulation of bans than for non-baking financial services (Benink and Llewellyn 1995). In particular, consumer protection issues form the bulk of what goes into rationalizing regulation for these non-banking financial services. With this distinction in mind, it has been proposed that there are primarily four considerations which go into regulating the banking industry. First is the importance place which banks have in the entire financial market, including but not limited to clearing and payments systems. Secondly, there are the latent systemic dangers which are inherent in bank runs. Thirdly, the nature of bank contracts; fourthly, undesirable choice and moral problems connected to the “lender-of-last-resort role” and other safety net arrangements that apply to banks (Goodhart 1998, 10). These are taken to be the primary justifications in regulating banks; all of these reasons bear some relationship to the central role that banking plays in the entire structure of the financial sector, and thus help prevent the latent systemic dangers involved with bank failures. When one speaks of bank runs, one refers to a problem wherein depositors demand their deposits back at the same time, and the consequent problems the bank has “in meeting its obligations vis-à-vis its deposits” (Biggar and Heimler 2005, 6). But bank runs form only a small portion of potential problems for banks in the event of financial meltdowns. Rather, the primary purpose of regulating banks is to avoid “the highly negative consequences for the economy of widespread bank failures” (Biggar and Heimler 2005, 7). Another reason is the systemic dangers of a bank failure, which refers to the probability that a failure in one institution could conceivably lead to immediate and complete failures in others. As one economist puts it, “Systemic risks to the banking system are risks for the nation as a whole... Banks left to themselves will accept more risk than is optimal from a systemic point of view” (Feldstein 1991, 15). One might distinguish between two types of such failures: a “consequent failure” and a “contagion failure” (Schwartz 1998). The former category of failure refers to one bank failing, which leads consequently to the decline in value of assets—inducing failure in another bank. The latter category refers to the failure of one bank leading to another’s through a so-called “contagion mechanism” (Chen and Zhang 2003). Another rationale for regulation in the banking industry is the payments system and its stability. Two economists summarize the problem as follows: An efficient payments system, in which transferability of claims is effected in full and on time, is a prerequisite for an efficient macroeconomy. Disruptions in the payments system carry the risk of resulting in significant disruptions in aggregate economic activity” (Kaufman and Benston 1995, 37). The problem is if the expected payment to the bank extending credit does not materialize in full and on a timely basis, previous payments may need to be reversed or unwound, which “may be complex and time-consuming and cause ‘gridlock’ in the payments system that interrupts the smooth flow of trade. Moreover, if the losses to the paying bank from customer defaults were large enough to drive it into insolvency, the receiving banks would experience losses, which might be sufficient to drive them to insolvency if these losses exceed their capital” (Kaufman and Benston 1995, 37). Thus, we have the primary reasons for regulating the banking industry of the financial sector: to ensure the long-term self-interest of the nation as a whole. We turn now to look at the case for regulation in the public education sector. Nicholas Barr describes the best situation as one in which there is “an efficient and equitable package whereby the state regulates education and subsidies it wholly or in part, but where production takes place in the private sector”, and thus operating in much the same way as many universities do today (Barr 1998, 312). Barr describes government subsidies of education as necessary in the sense that they are justified dually by “efficiency” and “equity”. By “efficiency”, Barr means that “allocation of scarce resources [is conducted] in such a way that no reallocation can make any individual better-off without making at least one individual worse-off” (Barr 1998, 427). By “equity”, he means, essentially, “social justice”, or, normatively speaking, “a goal relating to the way in which resources should be distributed or shared between individuals” (emphasis mine) (Barr 1998, 427). “Should” here represents a claim about the way things ought to be, and thus must be contrasted to objective, factual statements relating to efficiency. Barr suggests that some regulations are necessary for achieving the best education sector possible. He proposes, to name a few, regular inspection of schools, minimum qualifications for teachers, and certification for schools. Barr believes that the libertarian premise of subsidies in public education is insufficient on the grounds that paying for the private benefits received from education might be deficient—that individuals from lower brackets of society might “have poorer information about the benefits of education and/or be reluctant to incur large debts” (Barr 1998, 312). Barr bases this claim of a lack of information on the fact that private consumption decisions are most likely to be efficient and equitable if paired with sufficient information and real concern for the best interests of the child. Thus, it seems that arguments from those who favour “choice” in education come from those who belong to higher socio-economic brackets (Barr 1998, 313). The case, then, can be made from equity that welfare statist principles applied to public education work, and regulation should be applied fairly. We should now evaluate the premises utilized in arguments for regulations both in banking and in education. The claim for regulation in banking rests upon four independent reasons, each directed at the same end: bank failures are central to the economic stability of any given nation. In fact, the first rationale was explicitly that, but pertained explicitly to the structure of payment systems. The first premise, having to deal with payment structures, is thus very similar to the second, which describes the effects of bank runs. Answering both is a matter of looking at a gold standard. Without a gold standard (a standard of value which no country currently uses), governments can print as much money as they wish to, and destroy wealth through inflation (Nell 1984). In the United States and the United Kingdom, “bank runs” and collapses in payments systems are possible only because of unbacked paper currency. Thus, regulation in terms of the issuing of this paper money which, in the past, undermined the gold standard, served as the primary culprit in many of history’s great financial crises and depressions (Simpson 2008). The other two premises, the nature of bank contracts and the coercive nature of “lender-of-last-resort” scenarios, are questionable in terms of their effectiveness in arguments for government intervention into the banking sector. The problem with bank contracts is that banks offer contracts for liquid deposits, and the potential hazard for banks is that they may be forced to sell assets at a lost. Distress in this area may entail panic, driving down prices and inducing a general fall in asset values (Goodhart 1998, 11). However, this entailment is not necessary, for there are plenty of steps preventing the asymmetry of bank contracts from leading to the types of situations feared by those in favour of such regulation. The fourth premise deals with normative ethical theory, and should consequently be dealt with by ethicists; this is because the premise deals primarily with such normative notions as “moral”, “coercive”, and “undesirable” that are contingent upon values and has no place in positive economics (McConnell and Brue 2004, 10). Barr’s arguments for regulation in education too are particularly weak when examined under a microscope. His claims focus upon three premises: perfect information, perfect competition, and market failures (Barr 1998, 301-03). In the first, Barr argues that in the free market, sometimes, families will act against their own self-interest due to a lack of information, and this leads to inefficiency. However, this ignores the fact that acquiring this requisite information is itself constitutive of a self-interested action, and thus, a failure in the action which is more elemental means that the family is responsible for an inability to act on sufficient information. In the second claim, Barr worries that such as a rural school, without competitors, could potentially form a monopoly, which has efficiency implications. However, a fundamental principle of a free market is that monopolies can occur only with government interventions. Another school will inevitably challenge the monopoly with lower prices for equivalent services, and thus create competition (Powell and Skarbek 2004). In the third, Barr claims that if education is unregulated, its social benefit would be contingent upon market conditions. Nevertheless, this proposition must answer the objection that if education is such a value to a society, then its demand will remain consistent throughout fluctuations in the market. Whether or not education is indeed an individual or communal benefit would be left entirely for self-interested actors to decide. Hence, both sides of the aisle make apparently strong cases for regulation in both the banking and education sectors. These claims are made primarily on the bases of social advantage and principles of efficiency. Although I have attempted to avoid questions of normativity, Barr’s discussion of equity has been referenced in order to explicate his arguments. But however persuasive either case is for government intervention, my own objections to these claims leaves me to conclude that neither type of regulation is completely necessary, nor even desirable (to use normative language). It seems to me, nonetheless, that Barr’s arguments with respect to education are weaker than interventionists’ with respect to banking, so it seems that regulation in banking is, in some sense, needed more. This is not to suggest that a government should, in fact, regulate its banking sector, but only that the arguments considered here in the foregoing discussion are stronger for that case. Works Cited Anderson, William L. "A Primer on Regulation." The Free Market, Vol. 24, No. 5, 2004. Barr, Nicholas A. The Economics of the Welfare State. 3rd Edition. Palo Alto, CA: Stanford University Press, 1998. Benink, Harald A., and David T. Llewellyn. "Systemic stability and competitive neutrality issues in the international regulation of banking and securities." Journal of Financial Services Research, Vol. 9, No. 3, 1995: 393-407. Biggar, Darryl, and Alberto Heimler. An Increasing Role for Competition in the Regulation of Banks. Bonn, Germany: International Competition Network, 2005. Chen, Weihua, and Rui Zhang. "Study on the Impulse-Contagion Mechanism of Financial Crisis." The Sixth Wuhan International Conference on E-Business - International Finance Track. Wuhan, CN, 2003. 1754-1760. Feldstein, Martin. "The Risk of Economic Crisis: Introduction." In The Risk of Economic Crisis, by Martin Feldstein, 1-18. Chicago: University of Chicago Press, 1991. Goodhart, Charle. Financial Regulation: Why, How and Where Now? New York: Routledge, 1998. Kaufman, George, and George Benston. "Is the Banking and Payments System Fragile?" Journal of Financial Services Research, Vol. 4, 1995: 209-240. Lohr, Steve. "Intervention is Bold, but Has a Basis in History." The New York Times, October 14, 2008: A14. McConnell, Campbell R., and Stanley L. Brue. Economics: Principles, Problems, and Policies. 16th Edition. New York: Irwin/McGraw-Hill, 2004. Nell, Edward J. Free Market Conservatism: A Critique of Theory and Practice. Sydney: Allen & Unwin Australia, 1984. Powell, Benjamin, and David Skarbek. "Monopoly: Parker Brothers Gets It Wrong." The Free Market, Vol. 24, No. 6, 2004. Schwartz, Anna. "International Financial Crises: Myths and Realities." The Cato Journal, Vol. 17, No. 3, 1998: 9-15. Simpson, Brian. Gold and a Free Market: The Solutions to Our Financial Crisis. October 31, 2008. http://www.capmag.com/article.asp?ID=5339 (accessed December 1, 2008). Read More