Home / Opinion / Cost and innovation: The fig leaf argument

Also Read | Monika Halan’s earlier columns

India is moving from a central command economy to free markets. We’re experimenting with a variety of regulatory structures as we go. There are regulators in sectors including telecom, electricity, aviation and drugs, to name a few. The financial sector has five. Regulators for microfinance, real estate and municipal services are on their way. Free markets move towards equilibrium only in textbooks. The real world sees painful and expensive blowouts of free markets gone awry. Effective regulation protects the interests of all the participants in the market—the firm, the consumer and the investor. Writes Rick Bookstaber, the author of A Demon of Our Own Design: Markets, Hedge Funds, and the Perils of Financial Innovation on his blog, “Capitalist regulation forces the producers to recognize all of their costs."

Two popular arguments used in the US against regulation have been around costs and innovation—that regulation raises costs and crushes innovation. Again good in textbooks and big firm funded conferences, but we know that innovation on Wall Street led to products that took a legal and advanced math degree to decipher. Which need not have been bad if the products had worked. We know that the only people they worked for were the bankers and the top management of the Wall Street firms and not the consumers or employees—both paid. Before the innovation argument is used against tighter regulation in India, there needs to be discussion on what this “innovation" means and what its aim is. “Innovation" in life insurance polices in India is mainly in designing products that hide costs and this “innovation" will lead to a blowout, creating deep fissures in trust people have in insurance. We can live without such “innovation".

The second myth is around cost. Tight regulation raises costs so that the poor can’t afford products and services. A top official at the US Financial Industry Regulatory Authority (Finra) told me while arguing against zero commissions in financial products: “Zero commissions will make products and service more expensive for those at the far end of the consumer chain." It is a refrain I am hearing in India as well. The bleeding heart argument for that old retired couple, as it is turned away from the full-regulatory cost bearing financial institution and is snared by unregulated sharks. Maybe we need more work on the unregulated entities than to reduce the regulatory cost for those that anyway act like unregulated sharks.

The Indian experience with regulators has been mixed and we’re muddling along, deciding as we go with each regulator in isolation. There is no shared regulatory philosophy in India so that some micromanage and clear advertisement texts, others look the other way when a blowout happens. Still others complain that the firms they regulate don’t listen. And some are busy fighting among themselves over turf or with their boss, the ministry. The good part is that it is still early days on the free-market road since the socialist overhang has ensured that every two steps forward were followed by a step back. This means that we can still do some core thinking about how India needs to look at regulation as more and more sectors get freedom.

A good place to look for ideas would be in the smallest unit that needs some rules in order to function. The home. Quite surprisingly the micro lessons of a home tend to work well at the macro level as well. As a commentator on Bookstaber’s blog wrote: “Do we scold or praise the mother who restricts her son from eating like there is no tomorrow? Do we scold or praise the father who, when teaching his son/daughter how to drive, admonishes them when they get reckless? Do we scold, or praise the teacher who sets clear rules of discipline in the classroom, so everyone has a chance to begin to learn? The answer is obvious, isn’t it? Therefore, pray tell why this basic common sense logic, shouldn’t apply to Wall Street? I rest my case."

Monika Halan works in the area of financial literacy and financial intermediation policy. She is consulting editor with Mint and can be reached at expenseaccount@livemint.com

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