On regulation and the invisible hand

A very interesting article has appeared on Transitions Online over the last few days looking at the role of western banks in lending to central and eastern Europe in the run up to the financial crash – which has ended up hitting several countries in the region (chiefly Hungary, Romania and Latvia) particularly hard.

The article points out a couple of interesting things:

– that the net cumulative capital inflows into central and eastern Europe between 2003 and 2007 were, according to the IMF, three times greater than those flowing into Asia before the 1997 crisis there. Annualised capital inflows were running at 15% of GDP and, in Bulgaria, doubled in this period to reach a cumulative total of 192% of GDP

– most lending was to consumers, in the form of mortgages, rather than corporate lending which could have stimulated economic growth and employment. Some part of the corporate lending that did exist was for property developments (which may well have been targeted at (far) western Europeans)

– the consumer boom thus generated sucked in imports, which destabilised the structures of central and east European economies

– and, crucially, the debt offered was denominated in foreign currencies, leaving domestic borrowers absolutely exposed not only on the grounds of the global downturn and to the credit crunch, but also as a result of the ultimately destabilising impact which the nature of these loans had on local economies.

Consequently, average growth between 2003 and 2008 was higher in countries that did not have an economic boom before the crash – i.e. that the foreign bank-led lending boom actually made these countries poorer than they would have been with a more moderate lending policy.

Clearly, Someone Must Be To Blame For All This. The author resists apportioning blame – while giving space to the views of a board member of an Austrian bank within the Raiffeisen group to the effect that regulators and politicians must take a share of the blame.

I disagree.

What is ultimately to blame is unfettered free markets (thank you, Adam Smith). Where there’s demand in a capitalist economy, organisations will fill it – that’s the nature of the beast and it’s exactly what a free market would predict would happen. To a very major extent, banks can’t be blamed for fulfilling the role expected of them. They can’t help it – the natural trend of capitalism is towards supply, in the sure knowledge that a market correction will take place where over-supply takes place. It’s not the fault of politicians, who have other concerns, nor of regulators – it’s not their role, either. And neither is is the role of market-based organisations to be concerned with the impact of the activities.

What is to be done about it, is the key question. Regulation exists to fetter monopoly organisational powers created in this post-modern privatised world in the interests of liberalisation and removing the role of the state. It exists to protect consumers against the abuse of power by organisations that, in other times, would be a state monopoly. It’s not actually there to protect consumers against the red-blooded teeth and claws of capitalism in full flight – but it is clearly a very easy target when things go wrong. A failure of regulation is monopoly profits – not people (or organisations) suffering as a result of capitalism doing its thing. It’s not the job of regulation to stop private sector banks from lending so much money, and in the wrong areas of the economy – not in this system, anyway.

If we want a different future, one based on a more dirigiste approach, in which individual banks offering micro-solutions can be controlled in favour of macro- level interests, and forms of lending both directed appropriately and not over-concentrated beyond a country’s economic capability, it’s not regulation we want – and, I would suggest, neither is it a capitalist free market.

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