Author: Colin Scott

Proposals by the British coalition government to abolish a quarter of the list of eight hundred public bodies have garnered considerable attention. The full list of public bodies and their proposed destiny can by found here. In some instances functions are being transferred into government departments and in other cases privatized. Curiously the casualty list includes some rather effective value for money regulators, notably the Audit Commission. Their local government audit functions are to be transferred to private audit firms. The Australian state of Victoria made a similar move some years ago, turning the Auditor-General into a purchasing authority in the 1990s. The policy was soon reversed as both political and capacity concerns about audit in Victoria became apparent.

The coalition government is retaining public bodies chiefly on grounds that they perform technical functions, that impartiality is required or that transparency in factual determinations is required (as with central statistical functions). There is a valuable discussion by Ian Magee of the Institute for Government here. Magee notes that value for money was not properly considered in the proposed institutional reforms.  Even if the principles are correct it is not clear they are applied correctly when the Human Fertlization Embryology Authority is on the list for abolition – it has had both an important technical role and removed significant controversial decisions from the partial realm of politics over a number of years. In this instance it is said the functions are to be transferred to other regulators and this is part of broader theme in the proposals of rationalization of regulatory bodies. In Ireland the Cowen government has already commenced a programme of abolition of state agencies leading to the first significant reductions in numbers of agencies, following on from the report of An Bord Snip Nua. Data on this trend will be discussed at next month’s launch of the Irish State Administration Database, produced by a team working under the leadership of Dr Niamh Hardiman in the UCD Geary Institute.

This guest blog is by Mick Moran, WJM MacKenzie Professor  of Government, University of Manchester and is an edited text of the keynote address to the Biennial Conference of the European Consortium for Political Research Standing Group on Regulatory Governance,  and was presented at University College Dublin, 18 June 2010.

Regulation and the Financial Crisis

The mess we are in.

Four quotations aptly summarise the mess we are in, and the way we got there.

‘Complex financial instruments have been especial contributors, particularly over the past couple of stressful years, to the development of a far more flexible, efficient, and resilient financial system than existed just a quarter-century ago.’ (Alan Greenspan 2002)

‘In addressing the challenges and risks that financial innovation may create, we should also always keep in view the enormous economic benefits that flow from a healthy and innovative financial sector. The increasing sophistication and depth of financial markets promote economic growth by allocating capital where it is most productive. And the dispersion of risk more broadly across the financial system has, thus far, increased the resilience of the system and the economy to shocks’ (Ben Bernanke May 2007)

‘the current economic situation is better than what we have experienced in years. Our central forecast remains quite benign: In line with recent trends, sustained growth in OECD economies would be underpinned by strong job creation and falling unemployment.’ (OECD Economic Outlook 2007)

These first three quotations sum up ‘the Great Complacency’ –  the delusion that led so many economists and economic policy makers to announce that the last bubble was ‘the Great Moderation’ – a new utopian age when all the fundamental problems of a market economy had been solved.

And the fourth quotation sums up the sort of intellectual mess that the financial crash left behind.  Buiter puts it with characteristic Dutch bluntness:

‘The Bank of England in 2007 faced the onset of the credit crunch with too much Robert Lucas, Michael Woodford and Robert Merton in its intellectual cupboard.  A drastic but chaotic re-education took place and is continuing.’ (Wilhem Buiter 2009).

What went wrong with economic understanding? 

 The problems with the discipline of economics are surely threefold:

·        It became corporatised: both as to education (especially in the Business Schools) and in practice (economists in financial institutions).  The economist in the study was transformed into the economist broadcasting from the dealing room, laying down the law about what markets would and would not tolerate.

·        It became organised into a conventional academic hierarchy.  What we can learn from the recent fate of economics is that the worst thing that can happen to a social science discipline is that it gets  access to a Nobel Prize

·        It became professionalized: it developed a recursive world of professional economics that heightened the danger of succumbing to groupthink.  Algebra is not substitute for observation.

 

But while economists were cheerleaders during the ‘Great Complacency’ they were not the only culprits. Hardly anybody – not policy makers, not academic students of regulation – foresaw what was coming.  We all have lessons to learn.  Here are three that we must urgently take on board.

Democracy matters: the end of the ‘Great Moderation’ was also the end of  a ‘Great Experiment’ lasting more than 30 years: the experiment was designed to insulate regulation from democratic  politics.  Hence  the rise of central bank independence and the spread of independent regulatory agencies.  We saw the realisation of Majone’s theory of the regulatory state: a theory that asserted that majoritarian democracy could not cope with the complexity of modern market management.  The Great Experiment proved to be a disaster.  It led us to the catastrophe of 2008; and rescuing the financial system was only possible by turning to those despised figures, elected politicians, who it turned out were the only ones able to mobilise the cash and legitimacy to put the financial system on something like an even keel.

Ideology matters: the core of the crisis was due to the naturalisation of markets: an exercise in ideological hegemony that pictured them as subject to quasi-scientific determined laws.  They need to be denaturalised both to understand the crisis and to avert future disaster. Markets are social institutions to be understood by observation not algebra.

Interests matter: Many of our standard notions in explaining regulatory catastrophe – Groupthink, coordination problems – work contingently to explain things – see my opening three quotes.  But why was something like groupthink so prevalent?  It was linked to three developments

1.     The astonishing rise of a new Anglo-American plutocracy in the markets: the era of the Great Moderation was also the greatest era of plutocratic enrichment since the age of the Robber Barons.  But unlike the Robber Barons these new plutocrats did not practice the engineering of steel of railways; they practised the smoke and mirrors of financial engineering.

2.     The fantastic wealth of the financial sector on both sides of the Atlantic bought an equally fantastic amount of lobbying muscle.

3.     This converted into the kind of hegemony that lay behind my opening quotes: the stories of regulation before the crisis – in the UK, in the US, even in a smaller case like Ireland –are of timidity and subordination on the part of public regulators.

We have to fashion a new ideology of public interest regulation, and a new confidence in that regulation: it existed when the American  New Deal institutions found their feet; it must be rediscovered.  And, as the forces of financial power might regroup, it must be rediscovered in the face of the lobbying machines of the financial markets.