Regulation Worldview

I’ve been spending a lot of time the past two weeks looking through the current financial services regulations and the proposals for additional regulations. All these rules we have created are designed to provide safety nets, guarantees, and a legal structure aimed at maintaining confidence. This is important because confidence is part of what drives speculation, which helps create wealth. So the question I keep coming back to is a base level one, could we operate without any stability geared oversight, save the prosecution of fraud? I think the answer is yes, we could, but it would be a more expensive world, with more worry from investors about the stability and reliability of firms and products. Rules create a framework that gives everyone common knowledge for how the system works—or least that is the idea—and that knowledge decreases transaction costs and risk adjusted prices.

But too many rules will stifle innovation and hinder the growth creation process. We could have the banking standards of Canada, but then we’d have the economic impotence of Canada. Thus, there is a trade-off between rules that provide stability, and those same rules disincentivizing the growth creation process. And the trade-off appears to be largely unknowable. Which is the point. We can’t know (and neither can the government) what will be a winning or losing idea in the marketplace, amongst the general population. That is why discovery, testing, creative destruction, and price signals are so important for allocating resources. Centralized authority can’t know intuitively what will be the most efficient balance of rules and freedom.

None of this is a new idea, but laid out it provides a framework for understanding how different actors in the regulation overhaul process are thinking. There is a trade-off line that each individual falls on. It is important to see this and recognize that where we stand on the trade-off spectrum may not be the right place to stand. My default is to not trust government decisions on what will be most efficient. I do not believe lawmakers have the right incentive alignment to make those choices well. But study of history can help us in finding a place on the trade-off line, and it appears from my study that limited government regulation is more beneficial to the wealth and prosperity of all.