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The regulatory dilemma

Recent events aren’t an indictment of democratic capitalism

Written by Vikram S Mehta |
June 2, 2009 2:25:13 am

Self-regulation is an implicit but important tenet of liberal democratic capitalism. Sure,there are rules and constraints but more to define the framework of economic and political competition than to direct individual behaviour.  The underlying belief is that regulation should be applied lightly and that it should not circumscribe man’s ‘animal spirits’.   Common sense is an intrinsic attribute of human nature and the collective outcome of individual ‘sense’ will ultimately lead to the ‘common’ good.  

This belief has been resoundingly upended in recent months. I am writing this piece from my hotel room in London. Two issues dominate the UK newspapers. The first is of course the financial crisis; the second the shenanigans of the British MPs. Both have had the effect of undermining people’s faith in the ‘soft power’ of self-regulation.

With hindsight it is clear that it was wrong,indeed perhaps delusional to expect bankers to arrest the momentum of their ‘irrational exuberance’. The belief that the market would self-regulate and that rational and clever people would recognise and then preempt the onset of unsustainable ‘bubbles’ did not clearly take into account the power of greed and complacency and the individual and collective stupidity that this generates.

Equally the case with the British Parliamentarians. The people’s trust in the integrity of their representatives to steer clear of the line that divides the bending of rules from the breaking of them was misplaced. Every day,drip-by-drip,the newspapers reveal the names of those in Parliament that have misused their allowances. The amounts involved are by any standards of corruption (if indeed corruption should be quantitatively compared) trivial.  The reasons for the transgressions are however uniquely British. One MP for instance claimed Rs. 20 lakhs towards the reimbursement of the shrubbery he had planted to protect his trees from pestilence; another claimed Rs. 2 lakhs for the cost of building an island duck house to protect his ducks from marauding foxes; a third an undisclosed sum to rebuild the moat around his country home etc.  Many of course did what so many other non-Britishers do. They exaggerated their petrol bills,housing allowances and other petty expenses. The public taxpayer is furious and heads have started to roll. The speaker of the House of Common has been compelled to resign — the first time in 200 years; several MPs have been heckled into political retirement and there is talk of reducing the number of MPs in Parliament (currently there are over 650 in the House of Commons as against our 543 in the Lok Sabha) and constitutionalists and political theorists have reopened the debate on whether Britain should codify its rules of governance in a written constitution.

Underlying the discussions on the financial crisis or British politics is a basic question. Should the light touch of self-regulation be replaced by a heavier hand? The question does not of course lend itself to a generic answer. It has to be responded to on a case-by-case basis. But it does raise a generic concern.

The current problems have not been created by the absence of regulation. The financial institutions have always been bound by rules and procedures and politics by convention and precedent. The problems have arisen because of systemic weakness and in the case of the financial sector by the inability of the regulators to understand the technical complexity of the products that they had been empowered to regulate. The concern now is that in responding to these problems the authorities will blur the distinction between regulations that determine the relations between the market and the state and regulations that address the technical issues.  The latter will require a precise definition of what is to be regulated; it will need technically qualified people and the rules of the game will have to be unambiguously clear. The former on the other hand does not need such precision. For it will be about the allocation of the balance of power between the market and the government. It will be about who,what and how resources are allocated.

The pendulum has over the past decade or so swung decisively towards the market. A cottage industry of one-liners has been generated to affirm this fact — ‘the end of history’; ‘geography is history’; ‘the communications revolution’,etc.  The concern is that the pendulum might now be pushed to the other extreme. Already trade protectionism is part of the vocabulary of many governments. Were this to happen and were the creativity,entrepreneurialism and of course the arrogance and greed of the typical Wall Street banker to be shackled as a result,it is likely that future Bill Gates or Steve Jobs may not find it easy to bring their new ideas and products to fruition. It is worth pondering the reaction of a grey-suited middle-aged,congenial high street banker to a financing proposal from a Harvard drop out.  Would he consider it or would he politely show the young person the door with a few unsolicited homilies on the virtues of a completed degree.?The fact is that most of the recent revolutions in business (viz. Microsoft,Google,Bharti,Dhirubhai Ambani,etc) have been facilitated by bankers that stretched their support beyond simply those companies with legacy assets and conventional leadership (viz. IBM,AT&T,the ‘license raj’ Indian industries).  There is a lot that can be said about the positives of personalised banking. But no one can claim that it was the stimulus behind innovation and entrepreneurship.

Regulation of people and markets has to be tightened. It is important however that the baby of democratic capitalism is not thrown out with the dirty bathwater with which it has been recently scrubbed.   The cure must not be worse than the disease.  Economic and political history shows that individualism and markets are necessary prerequisites for economic progress. The contemporary crisis shows that these are not sufficient. The state has to be in the mix. The issue is to strike the right balance. It is not to redefine the tenets of liberalism or capitalism.

The writer is chairman,Shell group of companies in India. Views expressed are personal.

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