Saturday, August 16, 2014

The book by Calomiris and Haber, "Fragile by Design"

This is an excellent book by two decent conservative economists. Decent because they make explicit their absolute support for democracy, although they distinguish between liberal democracy and populist democracy. And decent because as opposed to other right-wing economists, they do not have any problem in qualifying governments such as Pinochet's in Chile as a "brutal dictatorship" (and not only a military government). They combine economic theory, history and political science to give a political economy account of the evolution of banking systems and financial regulation in several countries. Unfortunately, none of their examples include continental Europe. They explain the political nature of the web of contracts that make banking possible. Depositors must trust bankers, and bankers must trust debtors, and the relationships among all of them are possible because there is some government that enforces property rights and the rule of law. They explain very well the trade-off between deposit insurance and competitive incentives. The idea of unregulated laissez-faire banking is non-sense. Besides, states need banks to finance their increasing needs when the democratic franchise expands, and because they need to maintain expensive armies. States need banks and banks need states. It is impossible to understand the evolution of banking without understanding the political underlying forces behind banking structures. In some countries, history has been such that the political equilibrium has been a banking industry too much inclined towards risk, such as the United States, whereas in other countries history has been such as to make possible stable banking, such as it happened in Canada. The authors rightly argue that what matters is this basic structure, and that individual regulators or regulatory agencies are just responsive to these underlying forces, and therefore we should not have too much faith in these regulatory solutions. Calomiris and Haber emphasize the relationship between increasing risk taking by politicized financial institutions and redistributive pressures. If the latter are not addressed through the appropriate instruments of transparent tax and transfers, distortions such as reckless risk taking may have very costly consequences in the long run. They spend considerable space explaining this argument, but they seem to be left without arguments on the relationship between the Thatcher revolution in the UK, which they very much admire, and the financial crisis there, about which they merely spend a couple of pages. Perhaps the question marks they leave open will be answered by my next reading, the book by Atif Mian and Amir Sufi, "House of Debt."

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