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Krugman has a point

March 8, 2010

Looking at the crash in the Irish economy and the US economy he find four similarities

As a new research paper by the Irish economists Gregory Connor, Thomas Flavin and Brian O’Kelly points out, “Almost all the apparent causal factors of the U.S. crisis are missing in the Irish case,” and vice versa. Yet the shape of Ireland’s crisis was very similar: a huge real estate bubble — prices rose more in Dublin than in Los Angeles or Miami — followed by a severe banking bust that was contained only via an expensive bailout.


So what did we have in common? The authors of the new study suggest four “ ‘deep’ causal factors.”


But the most striking similarity between Ireland and America was “regulatory imprudence”: the people charged with keeping banks safe didn’t do their jobs. In Ireland, regulators looked the other way in part because the country was trying to attract foreign business, in part because of cronyism: bankers and property developers had close ties to the ruling party.

What really mattered was free-market fundamentalism. This is what led Ronald Reagan to declare that deregulation would solve the problems of thrift institutions — the actual result was huge losses, followed by a gigantic taxpayer bailout — and Alan Greenspan to insist that the proliferation of derivatives had actually strengthened the financial system. It was largely thanks to this ideology that regulators ignored the mounting risks.

In a perfect market regulators wouldn’t be needed. Unfortunately there is no such thing as a perfect market, even Adam Smith recognized the need for some limits of the market –

In the classical economics of such figures as Adam Smith and David Ricardo, “free markets” meant “free of unnecessary charges”[17] and a “market free from monopoly power, business fraud, political insider dealing and special privileges for vested interests”.[18] A “free market” particularly meant one free of foreign debt;[19] as discussed in The Wealth of Nations.[20]


Hayek also accepted the reality of some government regulation –

Even Hayek, however, viewed the regulation of economic activity as the product of legislation or human design. He observed that “a free system does not exclude on principle” regulation of economic activity, including regulation of production techniques and ‘factory legislation’” (Hayek [1960] 1972: 224–25). He advocated a
cost-benefit approach to evaluating government regulations. While he was dubious about all such activity, he did not believe that it could be excluded on principle.


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