Australian Lefty on Politics, Governance, Science and Info Management

Red tape good for economics: The Economist

Posted by Dave Bath on 2008-03-14

After my "Deregulation == Unregulated == Uncontrolled" (2008-03-10), it’s worth reading a couple of 2008-03-13 articles in The Economist that support the idea that the rule of law and improved governance (a.k.a. good regulations with enforcing oversight) are good for economies: "Economics and the rule of law: Order in the jungle" and "One rule for the rich" which shows that rules make people rich (usually).

In the following sections, I’ll discuss the implications for Australia, and how this data raises deep concerns about what central bank bailouts of irresponsible (I’d say negligent) financial markets actually means.

THE rule of law is generally held to be not only a political good but also a cause of other good things, notably economic ones.  Daniel Kaufmann, head of the World Bank’s World Governance Institute, has looked at the results of three separate studies (one he co-wrote) which consider measures of GDP per person and the rule of law.  After putting them on a comparable basis, the causal link is clear.  The better a government upholds the rule of law, the more likely its people are to be richer.

Acknowledging the argy-bargy of how to measure governance (e.g. rules and/or outcomes), the correlation is massive, not marginal.

Mr Kaufmann and his colleague Aart Kraay worked out the “300% dividend”: in the long run, a country’s income per head rises by roughly 300% if it improves its governance by one standard deviation. One standard deviation is roughly the gap between India’s and Chile’s rule-of-law scores, measured by the bank.  … Economists have repeatedly found that the better the rule of law, the richer the nation.

As noted elsewhere in my blog, The Economist (and other commentators) argue that decreasing corporate and financial governance over the last couple of decades have been the major root cause of current financial and economic woes, with increased use of off-market and overly convoluted "securities" and derivatives being merely a more proximal cause.

I’ll also note that governance is pretty darn good in mainland Europe, which is under Civil Law rather than the precedent-dominated (and therefore past-dominated) Common Law of countries like the UK, Australia and the US.

I’d argue that Civil Law impedes good governance because it gives greater opportunity for well-paid lawyers to dig up obscure precedents that allow rich clients (e.g. big corporations) to use loopholes and get away with things.

The Economist mentions arguments (albeit by critics of regulation) that…

In a stream of papers they have found strong evidence that civil-law countries encourage government ownership of the media and banks, a higher burden of entry into business, more labour-market regulation and greater formalism of court procedures.

So, accepting the positive correlation (acknowledged by deregulation advocates) between civil law, formal (rather than cowboy) court procedures, tighter regulations, government ownership in economic sectors (that in Oz are considered the domain of purely private enterprise) and the "rule of law", then factoring in the huge positive correlation between the rule of law and economic activity per capita, we can easily say the following:

Civil law, public ownership of infrastructure and financial institutions and a strong regulatory regime creates economic health.

Note the direction of Australia under Howard and the Liberal Party, or abuse and croneyism (especially PPPs, "Public Private Partnerships) in Victoria under the Labor Party and Premiers Bracks and Bumby.  Our trends have been in the opposite direction: decreased scrutiny, decreased public ownership, and decreasing per-capita economic health.

These perspectives also influence how one can view the actions of the US Federal Reserve, which (along with other central banks) is bailing out the privateers and speculators who caused economic turmoil.  Instead of demanding better governance, the US Fed is essentially letting the guilty get away with their crimes.  While markets have given the big thumbs-up to this acceptance of, indeed reward for, poor governance, economists without a vested interest are more circumspect, such as Central bank interventions: Bonding session, in which The Economist describes the actions of the Fed as "daring", recalling Sir Humphrey’s use of the term "courageous":

The scale of the TSLF raises concerns that the Fed, in its attempt to reduce liquidity risk, is taking on too much credit risk." After all, swapping pristine government bonds for dodgier assets lowers the quality of the Fed’s balance sheet and $200 billion represents around a quarter of the Fed’s asset base.

OK, reward shysters, put the US government and citizenry at risk.  This $200 billion happens to be the same figure as the current level of declared writedowns.  As the amount of "missing" money climbs, pehaps hitting $3 trillion (nearly four times the Fed’s asset base), will central banks continue this dodgy behaviour.

Unless governments regulate markets more diligently, and punish, rather than reward the shysters and creative financial engineers, the health of the world’s economies, from the perspective of the citizenry, will be ruined.


One Response to “Red tape good for economics: The Economist”

  1. krissnp said

    the amout of missing money is staggering.

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