Scholes on financial regulation

economics ▪ policy ▪

From Myron Scholes's opening statement on The Economist's debate on financial regulation with Joseph Stiglitz:

Economic theory suggests that financial innovation must lead to failures. And, in particular, since successful innovations are hard to predict, the infrastructure necessary to support innovation needs to lag the innovations themselves, which increases the probability that controls will be insufficient at times to prevent breakdowns in governance mechanisms. Failures, however, do not lead to the conclusion that re-regulation will succeed in stemming future failures. Or that society will be better off with fewer freedoms. Although governments are able to regulate organisational forms, they are unable to regulate the services provided by competing entities, many yet to be born. Organisational forms change with financial innovations. Although functions of finance remain static and are similar in Africa, Asia, Europe and the United States, their provision is dynamic as entities attempt to profit by providing services at lower cost and greater benefit than competing alternatives.

Thanks to Puspa Amri for the pointer.

On a side note: Rodrik put up a challenge in his blog for anyone to come up with financial innovations that have made us better off, and Steve Wadman took it up. HT: Dani Rodrik.

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Clive Crook on the crisis and innovation

economics ▪ policy ▪

Growth economists will tell you that the key to long term growth is productivity improvement, driven by technical changes and innovations. Economic history suggests that technical changes create boom-and-bust cycles as people adapt to the new technology. One can say that the crisis is a consequence of technical changes and innovations.

So, what of the present crisis? Does it suggest the utter failure of market forces, hence a need for an overall greater regulation in the financial market -- and not just those related to the specific problems at hand? FT's Clive Crook on the crisis' impact on the regulatory regime:

There is a broader point. The financial crisis was indeed a failure of regulation. The system was overwhelmed by innovation. Regulators are going to have to catch up and, you could say, try to hold innovation back. But finance is not a normal industry. The question to ponder is this: in which other industries will curbing innovation - also known as market forces - strike governments or voters, in the US or anywhere else, as a good idea?

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