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Capital Controls Again

 February 19, 2010 10:11 AM


By Simon Johnson

Adair Turner, head of the UK's Financial Supervisory Authority, has developed a flair for pushing the official conversation on banking forward.

He spoke in favor of a tax on financial services, long before that was fashionable.  This idea has been picked by both the UK and US governments – and in some amended form is likely to emerge from the G20 intergovernmental summit process later this year.

Turner also pointed out that much of financial innovation is not actually socially useful – and may, in some instances, be profoundly dangerous.  For a while, it seemed that his voice on this point might be lost in the wilderness.  But then President Obama launched the Volcker Rules, which essentially attempt to rein in certain forms of risk-taking (and arguably innovation) by very big banks.

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Now Adair Turner is at it again, this time in the 14th Chintaman Deshmukh Memorial Lecture, delivered at the Reserve Bank of India in Mumbai earlier this week.

Turner lays out a more integrated – and skeptical – view of modern finance than we have heard from him before.  He also delves into new issues, of obvious interest to his hosts and – if we are thinking straight – to the rest of us: What do our recent financial crises imply for emerging markets?

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He points out that the so-called Asian financial crisis of 1997-98 and the more global crisis of 2008-09 had much in common.

"… both were rooted in, or at least followed after, sustained increases in the relative importance of financial activity relative to real non-financial economic activity, an increasing "financialisation" of the economy."

The big point here is that the standard thinking about finance is wrong.  More financial development (e.g., an increase in the size of bank deposits or credit relative to GDP) is not necessarily a good thing.  To be sure, "financial repression" in the traditional poorer country fashion – with interest rates held low, often below inflation – was never appealing as it discourages savings, and should not now be a goal.

But allowing finance to become as big as it wants, from usual market processes, is asking for trouble.  The corollary is that "financial liberalization" – just get out of the way, as Alan Greenspan used to argue, and let markets do their thing – can become very dangerous.

This is true for the United States – at one level the last 30 years have been a series of misguided and excessive financial liberalizations.  But it is also true for other countries, presumably at all income levels.


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