Jeffrey Gordon has posted a paper arguing that applying cost-benefit analysis to financial regulation is a “serious category mistake.” He makes the arresting claim that CBA works best for the real economy, which is governed by the laws of chemistry and physics, but not for the financial economy, which is a “constructed system.” The bulk of the paper is devoted to showing the law of unintended consequences in action. Rules developed in the 1970s to permit money market mutual funds ended up harming S&Ls, which could not compete for funds, with the result that they were deregulated, whereupon they self-destructed. Etc.
Gordon is strongest in showing the sheer unpredictability of financial regulation. But is this problem worse than in other areas of regulation? Perhaps. Possibly connected to the idea that the financial economy is a “constructed system,” arbitrage seems to be a great deal easier in the financial world–limited only by imagination and computer power–than in the real world, where it can be hard to retool factories and move power plants. Still, I remain optimistic. Gordon’s is a nice companion piece to Coates’ paper, which I discussed here.