Should Governments Consider the Re-Regulation of Financial Markets - Case Study Example

Should governments consider the re-regulation of financial markets? Introduction: In political science there are many roles that governments are supposed to play. Regardless of this fact governments are supposed to provide the greatest happiness to the largest number of the population. As a result governments should try to make sure that the majority of the people are satisfied. It is however necessary to consider the perspective with which the evaluation is made. This is due to the fact that the Smithsonian perspective offers a different perspective to that of Keynesian and Marxian perspectives. Governments and industries have different policies of their own. Thus interaction between the private and public sectors needs to be investigated with a lot of caution. Over the years we have seen that countries that are over protective lose trade to more open countries. Since all countries do not have equal resource endowment trade is necessary and so there is always need to have some little protection for infant domestic industries that are emerging to the global village. It is however important to note that financial markets in any country facilitate the following; international trade, transfer of risk mainly in the derivatives markets as well as the raising of capital for trade. It is also obvious that people have different productive capacities and so communal production would be a draw back to more productive people since the share of the final cake would favour the less active in society. This would cause the Marxist approach to turn violent and become more individualistic (capitalistic) Analysis: Smith’s view: Adam smith’s work and influence on modern day economics mainly started after the publication of his book ‘The Wealth of nations published in the year 1776.This book which was compiled for a period of around ten years has come to be one of the most influential books in the field of modern economics. He appraised the idea of a free market system where he argued against government intervention in economic affairs. This is what came o be called as the laissez-faire economics. According to smith regulation would lead to high prices unequal distribution of goods and services as well as reduced profitability. According to Adam smith the role of the government was to complement the market and assist it to be more effective. One of the main points of The Wealth of Nations is that the free market, while appearing chaotic and unrestrained, is actually guided to produce the right amount and variety of goods by a so-called "invisible hand" (an image that Smith had previously employed in Theory of Moral Sentiments, but which has its original use in his essay, "The History of Astronomy"). Smith believed that while human motives are often selfishness and greed, the competition in the free market would tend to benefit society as a whole by keeping prices low, while still building in an incentive for a wide variety of goods and services. Smith was categorically opposed to government restrictions which he thought were hindering industrial expansion. One government policies that he was objected to was the use of tariffs to limit trade especially in the context of comparative advantage. He argued that these caused much inefficiency and also led to unjustifiable high prices. However Smith advocated for a Government that was active in sectors other than the economy: he advocated public education of poor adults; institutional systems that were not profitable for private industries; a judiciary; and a standing army. These he claimed were justifiable involvements by the central government in economic affairs. A favourite quote, usually recited by economists from The Wealth of Nations is: People of the same trade seldom meet together, even for merriment and diversion, but the conversation ends in a conspiracy against the public, or in some contrivance to raise prices. It is impossible indeed to prevent such meetings, by any law which either could be executed, or would be consistent with liberty and justice. But though the law cannot hinder people of the same trade from sometimes assembling together, it ought to do nothing to facilitate such assemblies; much less to render them necessary. Keynes view Keynesian economists advocate for a mixed economy. In this view they consider an equally important role to be played by both the private sector and the government. . Thus Keynes believed that the government was responsible for not only helping the economy rise out of a depression by increasing aggregate spending but also it could increase general levels of investments by pumping more money into the economy, then the citizens are encouraged to spend more because more money is in circulation. Once this is done then People will start to invest more, and the economy will react by increasing productive ventures. Thus Keynes argued that government investment in public goods that will not be provided for by the market will encourage the private sector's growth. This would include government spending on such things as basic research, public health, education, and infrastructure. Although Keynes and Adams perspectives have a clear view on the governments’ role in the economy Marx’s perspective is not very clear on the issue. This is because Marx does not view a state as an external factor to the economy but instead as representation of a certain class within the state. Karl Marx’s view: Karl Marx believed the state to be a manifestation of the ruling class, in many instances he claimed that the ruling class was the bourgeoisie (owners of the means of production) whose aim was self-enrichment under such a state developments of either the infrastructure or education would be done if it was to their benefit and not to the benefit of the workers (Proletariat). Thus in order to have a state where developments were made to the betterment of everyone then the proletariat was to take power either forcefully or peacefully. He believed that were the proletariat to seize the means of production, they would encourage social relations that would benefit everyone equally, and a system of production less vulnerable to periodic crises would emerge. On the case of financial markets regulation: In economics financial markets are defined as mechanisms or processes that facilitate the easy transfer (buying and selling) of securities, commodities and other goods at low costs internationally. Securities may include bonds, stocks and other bills. Commodities usually include precious metals like diamonds, agricultural goods etc. Financial markets have been in existence for many years although they are constantly improved in order to make trade easier as well as to increase liquidity. Financial markets are usually of two kinds. These are the specialized markets and the general markets. The two kinds are not very different in nature only that the specialized markets deal with the selling and buying of one commodity while on the other side the general markets deal with a variety of commodities. Depending on the nature of the economy financial markets can either be vibrant or not. History has however shown us that market economies have more vibrant financial markets while command economies have less vibrant or developed financial markets. Financial markets usually have lenders and borrowers. It is not all the time that lenders and borrowers meet. Due to this we also have financial intermediaries and the market system itself. The lenders include companies and private individuals. On the other hand the borrowers may include central governments, companies, private individuals, public corporations or enterprises as well as local government authorities. The intermediaries (those who facilitate the transactions) include; banks, mutual funds, insurance companies and pension funds. Financial markets can be divided into the following sub-categories; foreign exchange markets, derivatives markets, capital markets, insurance markets, commodity markets and money markets. Capital markets are comprised of stock and bond markets. Bond markets provide money through the issue of bonds and their subsequent sale. The stock markets raise money through the sale of shares. The derivatives markets are concerned with the avoidance of transactional risks of losses and thus provide standardadized contracts especially in the futures market. Re-regulation of the financial markets may have both positive and negative impacts depending on the degree of regulation. Negative impacts: Budget deficits: As we have seen some of the borrowers in financial markets are public corporations, central governments and municipalities. These are all government agents. When the financial markets are increasingly regulated there might result into budget deficits. Budget deficits are not uncommon to modern day economics. Budget deficits arise when the public expenditure exceeds the government receipts and there is no means to access capital from the financial markets. Sustainable budget deficits can be sometimes good to increase the productivity of any economy. However to have a sustainable deficit in a global economy is very challenging and a harmonious correlation between the fiscal and monetary policies needs to exist. In addition the private sector behaviour needs to be regulated since it can be and is usually a cause of unsustainable budget deficit. Depreciation of currency: The private sector is very critical in maintaining a stable currency. If the private sector is not confident with the monetary policy they may export their capital causing a depreciation of the currency. A stable currency is usually of great importance when it comes to trade between two or more countries. This is due to the fact that the currency can be relied upon when making predictions for the futures market. Incise this is not so then the there can result great losses for business people in the countries involved in the transactions. The depreciation of a currency generally means that the value of that currency declines with respect to its major trading partners. For example if one British pound exchanges for 1.5 U.S dollars then when one British pound exchanges for 2 dollars then we conclude that the dollar has depreciated against the British pound. In the case of America the dollar has been declining against other major currencies for a long time now. Many scholars and researchers have come up with many suggestions as to why the U.S dollar has been depreciating. Among these reasons put forward include the following: The rate of inflation within the economy Interest rate levels within the economy as compared to other major economies International payment balances within the economy Rate of return on investment within the economy. Prices of major imports like oil. The above factors have been found by scholars to affect the financial markets of any country. Positive effects: Improvement of transparency and price efficiency: Well regulated financial markets especially in developing countries are essential to provide for transparency. In addition they make sure that prices are economically efficient to facilitate better outflow of capital as well as inflows. This also enables government agents to detect and prevent fraudulent transactions or activities. Prevention of high risk taking: Well regulated financial markets usually require for there to be collateral and capital requirements. With these requirements the system exhibits a buffer for market vicissitudes as well as preventing market players to be over-competitive and in the process creating higher risks in the market. Control of inflation: Economically we can define inflation as the rate at which the general price levels of goods and services within an economy rises, while at the same time the purchasing power of the currency falls. This means that if a unit of one currency can by a certain basket of goods, as the prices of goods goes up the same unit of the currency will buy less of the basket of goods. In most cases central banks try to maintain an inflation of not more than 3%. Well regulated financial markets can help to contain the rise of inflation since they determine the level of capital or money that can leave the local economy. This usually prevents central governments from adjusting the monetary policy as well as the fiscal policy. CONCLUSION: Financial markets are more successful when operated in a free market economy. Regardless of this it is usually very important to have a well formulated and controlled regulatory framework. This ensures that the transactions taking place within the market are well coordinated. It is also important to note that financial markets provide a substantial share of both gross domestic product as well as net foreign assets. For this reason it is important for government authorities to provide incentives for people to invest through the financial markets. References: Smith Adam.1776. An inquiry into the nature and causes of the wealth of nations. Online version, available at: www.wiki/An_Inquiry_into_the_Nature_and_Causes_of_the_Wealth_of_Nations Mankiw, N. G. 2004. Principles of economics (3rd Ed.). Thomson South-Western Chicago, ILLIOIS: Philip Hardwick .1982. An Introduction to Modern Economics. Longman, U.K Weatherford, Jack. 1997. The History of Money. Three Rivers Press. Read More