Dani Rodrik's weblog

The market confidence bugaboo

A specter is haunting Europe – the spectre of “market confidence.”

It may have been fear of communism that agitated governments when Karl Marx penned the opening line of his famous manifesto in 1848, but today it is the dread that market sentiment will turn against them and drive up the spreads on their bonds. Governments all over are being forced into premature fiscal retrenchment, even though unemployment remains very high and private demand shows few signs of life. Many are driven to undertake structural reforms that they don’t really believe in – just because it would look bad to markets to do otherwise.

Read the rest here.

A debate on industrial policy

In which Josh Lerner and I pretend to disagree.

The next big debate in financial reform

Now that we know the shape that regulatory reform is likely to take on both sides of the Atlantic, it is time to focus on the next big question: how do we deal with the differences in the European versus U.S. approaches to reform? 

You cannot ignore these since financial transactions will have a tendency to migrate to the least-regulated jurisdictions, leading to all kinds of hue and cry about losing financial competitiveness. This is the familiar problem of regulatory arbitrage.    

The choice is clear here.  Either we put our faith in some Basel or other international process that will deliver global convergence on standards and on how to deal with systemic risk issues. Or else we go the national route, and ensure that national financial systems are ring-fenced and protected against regulatory arbitrage and contagion.

The first approach remains the conventional wisdom among the financial technocracy.  It receives support in a new report authored by Stijn Claessens, Richard J. Herring, and Dirk Schoenmaker.  Meanwhile, Simon Johnson seems to support the second approach.  Even though Simon is not very explicit in this latest piece, he has been quite clear in the past that if the U.S. faces the prospect of foot-dragging or weaker regulations on the part of the Europeans, the U.S. should just go it alone and make sure everyone that does financial business in the U.S., regardless of nationality, abides by U.S. rules.

I am with Simon Johnson on this one, for reasons explained here.

Yes, global financial integration will suffer, but frankly should we care if that is the price for better regulation, more in line with national preferences and realities?