Government should not regulate the banks!

It is widely believed that government intervention in industry can and does benefit consumers. But does regulation in practice have these desirable
effects?

Adam Smith certainly doubted its efficiency. To restrain people from entering into voluntary transactions ‘Is a manifest violation of that natural liberty which it is the proper business of law not to infringe but to support’. Nevertheless, he argued, ‘those exertions of the natural liberty of a few individuals which might endanger the security of the whole society, are, and ought to be, restrained by the laws of all governments . . . ’

He defended regulation in such cases in principle. But he objected to the practice. The legislature, he argued, is directed not by a view of the common good, but ‘the clamorous importunity of special interests’. His view was that whatever regulation could do in theory, in practice it usually benefits those regulated.

What does the evidence say?

A pioneer in this area is George Stigler. In a study of the electricity industry in the US, he found that regulation affected neither rates charged to customers nor profi ts earned for shareholders. In a study of the securities industry, he found that regulation governing the listing of new securities, presumably intended to protect the investor, had no significant effect on the returns to new shares as compared to ones already in the market.

A current UK example which should lead one to wonder about the benefits of regulation is food. When it was feared that eggs were likely to be harmful, and sales dropped, egg farmers were offered compensation – which was paid of course by a levy on consumers, who had just very plainly indicated in the market that they did not wish to support egg farmers!

In contrast, how was a different group, one not close or important to the regulators, treated?

Producers of non-pasteurised cheeses – a tiny group of farmers – and foreign cheese makers, were both threatened with having their products banned on health grounds before consumers had a chance to show if they were concerned!

Regulation has two vices. It restricts competition – all producers are compelled to behave in a similar way. And it restricts information – information has to go to the regulator, but not to the consumers who buy the product. Informed choice is not possible without information; and restricting competition means that there is less pressure to raise quality and lower cost.

For these reasons, regulation by government generally harms the consumer.

The best regulation is by competition combined with provision of information.