Yesterday’s communiqué from the leaders of the G20 – a motley collection of democracies and dictatorships – has some good points, but in general it represents a new version of what economist Friedrich Hayek called “the fatal conceit.” It believes that government has all the answers, and demonstrates that the world’s leading governments recognize few boundaries. As such, not only does the communiqué promise far more than it can deliver – something the voters in G20 democracies should remember – but it may also impede global economic recovery.
The communiqué holds that, “We start from the belief that prosperity is indivisible; that growth, to be sustained, has to be shared” and to “do whatever is necessary.” In clause after clause, this pro-government rather than pro-prosperity declaration embraces new burdens on a limping financial sector in the form of expanded global regulation, and effectively requires that all look toward government before acting in the future. At no point does the communiqué recognize that government action can and does distort market action to the point of significant harm.
The only “growth” being sustained in today’s political environment – and further embraced here – is the open-ended stimulus culture that has already led to an orgy of “sharing” of citizens’ wealth; in a world increasingly at ease with the word “trillion,” we are not suffering from a lack of sharing. The “unprecedented fiscal expansion” is not, as British Prime Minister Gordon Brown said, an injection of new money (except for some sales of gold reserves) but mostly a redistribution of existing taxpayer money to politically-favored recipients.
An effective communiqué would have acknowledged that wealth is not automatic, that it must be created before it can grow and expand – or be shared. Individuals acting together in voluntary enterprise form the foundation of wealth creation and job growth, but that is nowhere articulated here. Leadership would require the G20 representatives to explain precisely how they plan to unravel tax and regulatory barriers to the creation of new wealth, infrastructure, jobs and new financial innovations. Instead, the document stands as yet another open-ended promise for redistribution of a shrinking pie, and aggressive new political dominance of economic life.
This is not to say that the communiqué is wholly bad. Even as they seek to increase the reach of government by a massive expansion of the International Monetary Fund (by its own figures, the IMF budget is now greater than the GDP of all but 16 countries), the G20 leaders had no choice but to recognize the harmful effects of protectionism. The sections lauding free trade are welcome, and stand as a rebuke to Congressional leaders who have introduced protectionist language in recent bills. If there is one glimmer of hope in the G20 communiqué, it is that the vitality of trade may counteract the dead hand of government control.
British Prime Minister Gordon Brown has been talking with President Obama this morning, and high on the agenda was the PM’s call for international banking regulation. The interesting thing is that both Obama and Brown have blamed lack of regulation for the banking crisis, when there is clear evidence on both sides of the Atlantic that it was bad and inept regulation that drove the crisis. For an example from the US, here’s John Carney on how bad regulations helped destroy AIG. Over in the UK, the Taxpayers’ Alliance has an excellent study that outlines numerous ways in which regulations and regulators contributed to the UK’s own crisis. Here are its conclusions:
A poor response from regulators
* Unclear and restrictive EU Directives limited the Bank of England’s response to the crisis at Northern Rock. In particular, the Takeover Code and the Market Abuses Directive were felt to preclude an inter-bank rescue operation and covert lender of last resort assistance respectively. Mervyn King, Governor of the Bank of England, argued that these prevented effective support being given to Northern Rock.
* Deposit protection was not sufficient to give bank customers confidence. In particular, the time it takes for the Financial Services Compensation Scheme to pay out and failures to make other government payments promptly may have led depositors to believe their money would effectively be frozen for months in the event of a collapse.
* The tripartite system meant that the Bank of England lacked the information needed to properly assess whether lender of last resort actions were appropriate or not. Despite the ineffectiveness of regulatory oversight, compliance costs rose substantially for banks after the Financial Services Authority took over supervision.
There had been concerns for some time before the crisis about problems at the Financial Services Authority. Prominent voices criticised a lack of quality staff and insufficient focus on systemic risk, but sufficient changes were not made.
How regulations exacerbated the crisis
* Capital adequacy rules in Basel II are based upon borrower default risk – the chance that companies and mortgages will go bust. This means that capital requirements will tend to increase as an economy falls into recession and fall as an economy is expanding. Studies for the US Federal Reserve System confirmed that the rules are procyclical as far back as 2004. It is clear that the rules worsen financial crises.
* Common capital adequacy rules encourage firms to hold similar assets and respond in similar ways in a crisis. This amplifies herd behaviour. At the same time, common international rules mean that booms and busts in individual countries are likely to take place at the same time, increasing the amplitude of global credit cycles.
* Mark to market regulations rely upon the market to provide a price for an asset and cannot function when that market temporarily ceases to exist, as the market for many assets did at the beginning of the financial crisis. Had mark to market regulations been in place in the 1980s every one of the United States’ ten largest banks would have become insolvent.
* Regulations, particularly restrictions on short-selling, did serious damage to hedge funds. This not only damaged the funds themselves but exposed troubled banks to further risks and closed off some means of funding, in particular by preventing banks being able to raise capital through issuing convertible bonds.
In one sense both the PM and President are right. The global system of financial regulation is broken, but what the two leaders are thinking of doing is merely putting red tape over the cracks.
Rasmussen reports that support for the borrow-and-spend plan is falling rapidly:
The latest Rasmussen Reports national telephone survey found that 37% favor the legislation, 43% are opposed, and 20% are not sure.
Two weeks ago, 45% supported the plan. Last week, 42% supported it.
Opposition has grown from 34% two weeks ago to 39% last week and 43% today.
Interestingly, only 27% of independents support the package, indicating that President Obama would have to spend a lot of his political capital to turn them around.
Meanwhile, across the pond, support for British Prime Minister Gordon Brown’s similar stimulus package has also collapsed. In a poll of voters in the important “marginal” constituencies, where British elections are won and lost,
When asked about the stimulus measures adopted by Labour, 29% think they won’t make any difference and a further 35% say the difference made is not justified by the cost.
The Rasmussen poll also reveals that a tax-cuts only “stimulus” plan is more popular than the spending-heavy plan. It is a shame that the pollsters won’t measure support for a liberate-to-stimulate plan focused on reducing government-imposed barriers to economic activity. Cut red tape first, taxes second and you’ll be on your way to a cost-free package that genuinely deserves the label of stimulus.
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