In the wake of the financial upheaval in East Asia in 1997 and 1998, much was said about a need for a new global "financial architecture."
What this was all about was vision of significant reforms to the institutions, structures, and policies that govern international financial flows.
And now the chief executive of the Hong Kong Monetary Authority, Joseph Yam Chi-kwong, recently called for more cooperation in the reform of global financial markets to avoid future financial turmoil. Although he indicated the probability of another financial crisis in the region is low, he insists that there is too little regional and international cooperation in the reform effort.
However self-assured Yam might appear when he speaks with his characteristic rhetorical flourish, the debate over how best to prevent future financial upheaval is far from settled.
Yam's enthusiasm for these simple and appealing economic policies masks the amount of predictable damage that this approach might bring about. Indeed, his premise that outside forces such as hedge funds or inherent market instability was to blame for Asia's financial turmoil in 1997 to 1998 is just flat wrong.
At issue here is the notion of the role of governments and their ability to stabilize markets. A crucial concept in this context is the notion of "market failure" that has served as the basis for policy interventions designed to improve the efficiency of economic outcomes.
There are solid intellectual foundations for the concept of market failure.
Economic theory reflects upon the tendency for actions taken by one group to have "spillover" that affect others. Under these conditions, an outcome in a free market will be less than optimal.
Similarly, markets are seen to fail when there are too few competitors or when some individuals have different access to information or when there are "free riders" that enjoy uncompensated benefits from the efforts of others.
However, this application of economic theory sets the level of perfection at a very high standard. Consequently, that markets can always be seen to "fail" when compared to such an unrealistic benchmark.
In turn, politicians and bureaucrats find that they are blessed with an infinite scope to interfere with markets to improve on their operation. Thus, the market failure argument does not provide sufficient grounds to warrant government action.
In the benign case, policymakers seem all too eager to presume that their prescience will insure improvements in the way markets operate. In the less benign scenario, such theory-based explanations for expanded government reach can provide convenient rationalization to justify the abuse of power.
In all events, before undertaking the prescribed corrective actions, the potential costs of the policy must be weighed against the anticipated benefits.
Ironically, critics that focus upon short-term capital flows (the proximate cause or perhaps the effect of financial turmoil) tend to believe in the widespread existence of market failures and so concoct constraints to apply against them. In turn, there are demands for policy restraints on capital flows or new international financial architecture. Yet all of these proposals rely upon the implausible presumption that political decisions are ultimately based upon equity and fairness while self-interest of the policymaker is assumed away.
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