Friday, 28 March 2008

Regulatory Overkill (updated)

Allan H. Meltzer writes in the Wall Street Journal on Regulatory Overkill. He notes,
The first principle of regulation is: Lawyers and politicians write rules; and markets develop ways to circumvent these rules without violating them.
Meltzer also points out
Regulators and most politicians are good at developing rules and restrictions, but poor at thinking about the incentives that the market will face. If the incentives are strong, the market circumvents the regulation.
These are points that regulators should keep in mind. They aren't going to achieve whatever they think they will achieve with their regulations. The law of unintended consequences holds big time with regulation mainly because regulators and politicians don't think about incentives. There is often a naive assumption made by people that regulation will work exactly as the regulator intends but this assumption is almost always wrong and wrong, in many cases, by a wide margin.

Update: Arnold Kling makes the same basic point, see Meltzer on Financial Regulation.

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