Andy Haldane, Chief Economist at the Bank of England has pointed out, in 1980 there was one UK regulator for every 11,000 people employed in finance and, by 2011, there was one for every 300 people employed in finance. At that rate of growth, the number of regulators would overtake the number of people employed in finance by about 2070. And that does not include compliance officers working in the private sector. The growth in regulators certainly did not stop in 2011. On April Fools’ Day 2013, the Financial Services Authority was split in two. Today, just one of the two bodies produced in this re-organisation (the Financial Conduct Authority) employs as many people as the old combined authority. In some years, the volume of new regulations, guidance and consultations has been around five times the length of the King James’ Bible.
And yet, the only complaints we get are that we need more government regulations, regulators and enforcers. Many MPs seem to believe that regulators should have stopped the Woodford debacle in which redemptions from a mutual fund have been suspended. Does all responsibility within financial markets being and end with a state bureaucracy or should people be allowed to take responsibility? Rarely, it seems, does a Treasury Select Committee meeting go by without MPs – both Labour and Conservative – calling for more government regulation as if this is the solution to all problems.
Financial regulation has become rather like many other areas of public policy: there is nothing between the individual and the state. We have forgotten about the institutions that can develop within civil society and within the market itself which can help regulate economic life in a more effective and humane way than state bureaucracies.
In part this is because of the way in which economists analyse problems in markets. They have a dry, abstract model of perfect competition built on unrealistic assumptions. If those assumptions do not hold, they tend to assume (with an equal absence of realism) that the government can pull regulatory levers and bring things to perfection. Unfortunately, once regulators are established, they regard it as their job to spend their time writing rules and creating ever-more levers.
George Akerlof won the Nobel Prize in economics, in part for his paper “The Market for Lemons” in which he showed how markets with imperfect information could lead to serious problems. However, though it sometimes seems that his co-prize-winner Joseph Stiglitz can never see a problem without believing that government regulation is the solution, Akerlof pointed out in “Lemons” that market institutions could develop to deal with so-called market failures.
It should be the role of the economists to try to understand the conditions under which such institutions might be superior or inferior to government regulation. There may be some surprising answers.
Even in financial markets, despite the best efforts of government to regulate every nook and cranny of activity, private regulatory institutions still do exist. The International Swaps and Derivatives Association has evolved to foster safe and efficient derivatives markets and oversees dispute resolution mechanisms. It performed very well during the financial crisis. The Alternative Investment Market provides a (lightly) regulated environment for the placing and trading of securities. And the Baltic Exchange regulates those who do business on it. Outside the field of finance, the Uber platform is, in effect, a private regulatory system for both cab drivers and customers. Its regulatory system (which allows market variations in pricing to ensure increases in supply at times of high demand) should be allowed to compete with the alternative TfL and local authority regulatory system for taxis. We should have competition between regulatory systems and not seek a level playing field.
For centuries, financial markets were regulated effectively by market institutions such as exchanges and professions. We cannot go back to that era in one step. However, we can change direction.
We could, for example, make state financial regulation optional whilst requiring market participants to make clear whether or not they were regulated by government bodies. The experience of the pre-1986 regime would suggest that regulation would be the chosen norm, but, allowing that option might attenuate the behaviour of regulators and encourage market and civil society alternatives to government regulation.
Governments regulate to prevent monopolies, but governments do not seem to mind government monopoly regulators. So, a further reform would be to allow the Competition and Markets Authority to investigate both whether state regulators inhibit competition and whether state regulation is itself monopolistic. TfL, for example, should not be able to establish a regulator monopoly by prohibiting Uber.
Regulation is too important to be provided by statutory monopolies. A knowledge of history and a sophisticated understanding of the economics of regulatory institutions also shows that it is not necessary or desirable.
This subject is examined in more depth in Regulation without the State by Philip Booth.
This blog post is based on an article published in City AM.