november5,1996.docVIP

November 5, 1996 FINANCIAL REGULATION IN THE GLOBAL ECONOMY AS PROPERTY RIGHTS Randall Morck* and Bernard Yeung** All changes are in bold marked with a “*”, but I left typo-corrections unmarked *Jarislowsky Professor of Finance, Faculty of Business, University of Alberta, Edmonton, Canada T6G 2R6. **Associate Professor of International Business, Graduate School of Business, University of Michigan, Ann Arbor MI, USA. This paper was completed while Bernard Yeung was visiting the Milken Institute for Job and Capital Formation. FINANCIAL REGULATION IN THE GLOBAL ECONOMY AS PROPERTY RIGHTS Randall Morck and Bernard Yeung As pants the deer for cooling streams, so do I for regulation. Alfred Krupp, 19th century German Industrialist I. Government and the Innocence of Economics People who spend their lives studying economics often develop odd attitudes towards government. Economists with a rightward perspective can become infatuated with the beauty of an untarnished free market economy - how its perfect symmetries create an astonishingly efficient information processing and action coordinating machine. To them, government is a nuisance that gums up this perfection and thereby destroys wealth, stunts progress, and harms people. Economists of a leftward persuasion see the free market economy as a soulless juggernaut, devoid of ethics or morality, that tramples human beings. They see government as a lash for taming the free market economy. By moving a supply curve left and a demand curve up, by raising a wage level here and lowering an interest rate there, government can infuse an ethical quality into what would otherwise be a soulless monster. These two views are quite similar: for both, government is something outside the economy. From the right, it is sand in the wheels; from the left, it is a guiding hand. But in neither case is government “inside” the economy or, in economists’ jargon, “endogenous”. Our basic premi