The Hindu Business Line : G-20 meet: Tighter regulation in store

Adam Smith certainly didn’t visualise the turn that free markets have taken. His was simple and straightforward economics — each man working for his self interest would magically deliver maximum wealth creation and full employment of land, capital and labour. And, in his time, it was mostly about the seeding, growing and harvesting of food crops and rudimentary industry — the production of real goods.

It’s a telling commentary of the importance accorded to economics in the 19th and early 20th centuries that no Government thought the economy was anything to worry about. Business cycles were supposed to be self-correcting; the only thing to be done was to protect the value of the currency through a fixed gold link. In any case, the colonies were an inexhaustible source of wealth transfer. It is no coincidence that after the industrial revolution, practically every major technological discovery and innovation came from America. Europe had become secure and smug in its colonial possessions. The Depression of the 1920s and 1930s was a rude awakening for everyone, America included. For the first time — and indeed far from the last — it seemed capitalism could not necessarily overcome business cycles on its own. Enter John Maynard Keynes with the proposition that Governments and central banks can and must fine tune (ease) monetary and fiscal policies in downturns.

What Keynes could not have foreseen was the rapidity of growth of banks and financial markets, whose function was originally only to intermediate the flow of savings to companies and businesses. It was perhaps inevitable that sooner or later they would put their hands in the till. After all, who would want to merely watch hundreds of billions of dollars passing through without a juicy cut.

So the gigantic game of churning gigantic funds began. Markets sprung up to enable institutions and individuals to trade stocks, currencies, bonds, commodities, loans, mortgages, et al, and their derivatives. Volumes soared year after year. The results are there for all to see. Warren Buffett pointed out some years ago that the humongous turnover in financial markets was deceptive; the increase in production of tangible goods and services was nowhere near. Lord Turner of the UK’s Financial Services Authority has come to the same conclusion; most of ‘financial innovation’ adds no real value.

So top of the agenda at the G-20 meet this week should be how to rein-in the financial beast. The US has put its cards on the table. It is proposing more capital requirements and tighter regulation of the systemically important and large institutions in financial markets to prevent the recurrence of catastrophes like the present one.

Europe is likely to agree as will the developing world. Neither, barring the UK, was too keen on the financial sector anyway.

Obama’s opponents are more likely to be at home — the captains of Wall Street and elements of the Republican Party.

But given the weak (intellectual) case for less regulation, the US President will probably have his way.

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