From the TUC

Debunking the deregulation myth

22 Nov 2011, by Guest in Economics

Three years after the financial sector triggered a global recession, not much has changed in world of bank regulation. The financial liberalisation introduced since the 1980s remains defiantly in place, discussion of regulation is still dominated by a ‘hands-off’ approach, and the international institutions are still promoting financial liberalisation and market-friendly regulation as the correct policies.

But new research has just been published which shows very clearly that these policies are wrong – and that they are in fact highly damaging. Remarkably, this evidence comes in a research paper published by the IMF.

The paper reports the results of a study of 102 countries and how their system of regulation affected their economic performance in the recession.

The research looked at the effect of “the quality of the public sector regulation…as measured by the corresponding sub-component of the Worldwide Governance Index—quality of regulation— computed by the World Bank, calculated for 1996–2006”. They found that countries which scored well on this index of market-friendly regulation did worse than others: “This variable is negative and highly significant…”.

They got the same results with banking sector liberalisation:

“the significantly negative coefficients indicate that the countries that liberalized their financial systems the most, were most affected by the banking and economic crisis.”

The paper re-iterates that these policies did not simply fail- they actually made things much worse:

“the countries with the best ratings in terms of public sector regulatory framework, as well as those countries with the most far reaching financial deregulation, were hit the hardest economically”.

The results confirm the findings of a study carried out last year by ECB economists and others, who also found that countries did better on economic growth, and less badly in the crisis, if they scored badly on ‘market friendliness’ – especially in the financial sector. It also confirms research carried out in Latin America in the 1980s, which also showed that financial liberalisation damages growth.

The IMF and the authors deserve one cheer for publishing results which so contradict their basic policies. But only one cheer: although the paper includes these results, they are not mentioned in the abstract, and the policy recommendations and conclusions include nothing except a strangled acknowledgement that the impact of regulation “is deeply intertwined” with these two factors. Instead, the paper prefers to spend pages discussing other results about the apparent uselessness of merging regulatory agencies.

The paper gloomily refers to its results as ‘this major defeat’.  But a belated victory could be snatched if the IMF, World Bank, EU and national governments use the evidence to reformulate their policies. And at least we now know that the World Bank governance index is indeed useful- the worse you score, the better your policies.

GUEST POST: David Hall is the Director of the Public Services International Research Unit of the University of Greenwich, UK. His research is centered on the issues of water, energy and healthcare, and he is a former coordinator of the Watertime project, funded by the European Commission. Before joining PSIRU he worked at the Public Services Privatisation Research Unit, which developed a database on privatisation for the UK trade unions. He has been a lecturer at the World Bank water division, and has been an invited speaker on water and related issues to the UN, OECD, ILO, UNCTAD, Economic and Social Committee of the EU and at meetings organised by unions and civil society organisations in over 30 countries.

One Response to Debunking the deregulation myth

  1. Per Kurowski
    Nov 24th 2011, 8:31 pm

    I accuse the bank regulators… they caused the crisis!

    If risk models, credit ratings and market intuitions were perfect, then a bank would really not need any capital at all, since all risk considerations would have been correctly priced, in the interest rates, in the amounts and in the duration of the loans. But, since risk-models, credit ratings and market intuitions are often not perfect, the regulators needs to require the banks to hold some capital, to make sure that there is an adequate cushion provided by the shareholders who are profiting from the bank activity, before creditors and tax payers are called upon to help out.

    Unfortunately the current generation of bank regulators, stupidly, did not base their capital requirements for banks on the possibility of mistakes, but on precisely the same risk models, credit ratings and market intuitions… requiring for instance minimal equity when the perceived risk of default of a borrower seemed minimal.

    And it is precisely there, where the perceived risks of default seem minimal, where the risks for a systemic bank crisis resides, as what is ex-ante perceived as “risky” does never grow into a dangerously sized exposure.

    And so, instead of helping to cushion for the mistakes of the banks, the regulators, with their distortions, increased the probabilities of the mistakes being made, and their negative financial consequences.

    And that is why we got those monstrous large bank exposures to what was ex-ante officially perceived as not risky, like triple-A rated securities and sovereigns, and that have ex-post exploded in the whole Western World.

    And that is why the “risky” job creating small businesses and entrepreneurs find access to bank lending so curtailed and expensive.

    The bank regulators need to be held fully accountable for what they did, because if we do not get to the bottom of this sad affair, neither won’t we get out of it.

    It was the bank regulators who did Europe in! Occupy Basel!

    Per Kurowski
    A former Executive Director at the World Bank (2002-2004)