After Crises: Assessing Costs and Benefits of Financial Liberalisation
YESTERDAY the Reserve bank of India organised the 14th C.D. Deshmukh Memorial Lecture which was delivered by Lord Adair Turner, Chairman, Financial Services Authority, UK on ‘After the Crises: Assessing the Costs and Benefits of Financial Liberalisation'.
Lord Turner said,
Twice in the last 15 year the world economy has been hit by financial crises which have imposed huge economic harm – first the Asian financial turmoil of 1997 and then the developed world financial crisis of 2007-09. The precise nature of these crises differed, but there were underlying common features which need to be understood if we are to learn lessons and build a safer global financial system for the future.
Both crises were preceded by a rapid growth in the scale of financial activity relative to the real economy. The Asian crisis followed a period of rapidly increasing short-term capital flows and related foreign exchange trading. The crisis of 2007-09 followed an explosion of financial innovation and trading in credit securities and credit derivatives. And across the last three decades throughout the whole world the scale of increased financial activity relative to the real economy has been striking.
A dominant conventional wisdom of economy theory and policy – the Washington Consensus as it was labelled – has assumed and asserted that this increase in the financial intensity of the economy is beneficial, driving a more efficient allocation of capital, imposing discipline on inappropriate policies and enabling investors and users of funds to hedge risk better. But this theory has shown to be severely deficient, failing to take account of the inherent potential of financial markets to be subject to self-reinforcing herd and momentum effects, with periods of irrational exuberance followed by sudden and contagious panics. Short-term capital flows can under some circumstances be harmful: and complex financial innovation in developed countries has produced few demonstrable benefits and resulted in an increased risk of financial instability. John Maynard Keynes's insight that increased market liquidity can bring disadvantages as well as benefits needs to be rediscovered.
In the aftermath of these crises it is therefore essential for economists and policy-makers carefully to assess the benefits and disadvantages of different categories of financial liberalisation, rejecting the over simplistic ideology which asserted that limitless liberalisation in all financial markets is always beneficial. The challenge for policy makers is that a more thoughtful analysis provides no simple and universally applicable answers - liberalisation and increased market liquidity may well be beneficial in some markets but harmful in others.
It is much easier to proceed in life with a clear and simple set of beliefs which provides immediate answers to all specific answers. But we are more likely to achieve good economic results if we live the real world of complex trade-offs and of economic relationships which are true up to a point and in some circumstances but not in others .