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Free market defenders need to find their voice
by Roger Bootle
31 Marzo 2008
"The ideas of economists and political philosophers, both when they are
right and when they are wrong, are more powerful than is commonly
understood. Indeed the world is ruled by little else. Practical men,
who believe themselves to be quite exempt from any intellectual
influences, are usually the slaves of some defunct economist. Madmen in
authority, who hear voices in the air, are distilling their frenzy from
some academic scribbler of a few years back."
The author of those words was himself both academic scribbler and
practical man - John Maynard Keynes. And how right he was. For the past
30 years, the dominant intellectual tide in politics and economics has
been the view that the role of governments in the economy needs to be
kept to a minimum. Free markets work best. They are certainly not
perfect but they are much less imperfect than the alternative.
This belief underpinned the sharp change of direction in this country
under Baroness Thatcher, and more widely, the collapse of communism and
the recent embrace of markets and involvement in trade across the
developing world. But now the intellectual tide is turning. If we are
not careful it could swamp us.
As the shenanigans connected with mortgage lending and its repackaging
and redistribution around the system have become apparent, it has
emerged that this particular bit of our economic system is very far
from perfect. It looks as though banks have landed themselves, and the
rest of us, in a pretty pickle.
One response would be to let them take the consequences, even if that
means letting some go bust. That is the pure free market position. But
it was not what the authorities here and elsewhere have done. In this
country, Northern Rock was nationalised and all deposits of the banking
system were guaranteed by the British government. In America, the
investment bank Bear Stearns has been bailed out by the Fed.
And in just about all monetary areas, central banks have altered not
only their monetary policies, but also the way in which they provide
support to the markets, in order to save banks from the consequences of
their own folly.
But the acceptance of a legitimate role for the state in forestalling a
systemic crisis carries an important corollary: the banking system
cannot be allowed to do whatever it might like without interference. It
cannot have it both ways - complete freedom of action in pursuit of
profits - and taxpayer support to cushion losses.
At a minimum, banks will soon, rightly in my view, be required to have
more capital and to hold more liquid assets. Both of these measures
will reduce their return on capital employed.
Pressure emanating from this factor, combined with lower activity in
financial markets, might put downward pressure on the level of typical
remuneration in banks. This, plus the experiences of the last year,
might persuade banks to reform the ludicrous structure of remuneration
packages, which encourages the taking of risks with massive rewards for
success but little personal downside if the bets go wrong. I hope so.
The alternative of public regulation of banks' remuneration structures
is not a happy prospect.
But I am worried. There is a danger that we rush in regulations that
restrict the activities of banks at just the time that, frightened by
recent events and belatedly under pressure from shareholders, they are
restricting their own activities. This could create a worse crunch and
greatly increase the cost of financial operations.
It was both fully predictable and yet also deeply depressing that the
FSA's response to its own failure in the Northern Rock episode was to
demand more staff. This prompted a wicked thought in my mind: could the
FSA also have had a hand in the Terminal 5 fiasco?
Before we rush into new regulations controlling banks, as though they
alone were responsible for what has gone wrong, we should not forget
the role of public policy. In both the US and the UK, rampant lending
was not an accident. It was the direct result of a deliberate policy of
boosting domestic demand via low interest rates. This was bound to lead
to a surge in lending and associated financial activities. How else did
policymakers think they would boost demand? By osmosis?
From the very beginning, critics argued that this policy risked
creating massive financial distortions which would have real economic
costs. In the extreme, it would inflate bubbles whose subsequent
deflation, as in the Japanese case, would prove to be extremely
damaging.
The response on both sides of the Atlantic was that bubbles were so
difficult to spot in advance that the best policy was just to let the
private sector get on with it. If it turned out that a bubble had been
created and it burst, the authorities would then simply have to clear
up the mess afterwards.
As it becomes plain just how extensive the mess is, and how expensive
it will be to clear up, that line is looking far less credible. So one
of the consequences of these events will probably be a shift in policy
regimes that will make a recurrence of these events much less likely.
What makes the change in the intellectual climate with regard to the
financial system more worrying is that it coincides with growing
acceptance of the case for public action to restrict or even forbid
individuals and companies from a wide range of activities in order to
prevent global warming.
Add to this, widespread misconceptions about the role of international
trade in causing poverty in the third world and you have a strong
intellectual tide running against free markets and in favour of
increased state action.
The history of the past 50 years has made it abundantly clear that
markets provide the basis of our prosperity and hopes for advancement.
Admittedly, the tendency towards herd behaviour, the prevalence of
extremely short time horizons even when dealing with assets whose life
stretches many years into the future, and the ubiquity of overwhelming
uncertainty, mean that financial markets are prone to behave in ways
that can pose grave dangers. Accordingly, financial markets and
financial institutions need regulation. But they need better regulation
- not necessarily more of it. After all, it wasn't as though Northern
Rock was unregulated. It was just badly regulated.
What we must not allow to happen is for disgust at the activities of
bankers and their absurd rewards to prompt disillusion with the market
system in general. That would take us on an extremely dangerous
journey. The next stop would be the embrace of protectionist trade
policies. And the final destination would be impoverishment.
by Roger Bootle
Roger Bootle is managing director of Capital Economics and economic adviser to Deloitte.
Source > Telegraph
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