The 2012 Keith Joseph Memorial Lecture: The limits to the market – lessons from the financial crisis

‘The limits to the market – lessons from the financial crisis’

Roger Bootle, Managing Director of Capital Economics delivered the annual Keith Joseph Memorial Lecture to a large CPS audience. In what CPS Chairman Lord Saatchi called a provocative but highly interesting examination, the leading economist used the lecture to highlight his support for free-market capitalism, but stressed that its supporters must recognise the need for effective Government regulation to cure market failures in financial services.

He concluded: “The dog-eat-dog competitive self-seeking world of the foreign exchange market may be the best way of trading foreign exchange. But it is at one extreme of the market spectrum. Neither its strategy, nor its attitudes, nor its motivations should be duplicated elsewhere in the economy. Indeed, an economy without effective limits to self-seeking behaviour ends up as Upper Volta – without the rockets.”

In the course of the speech, he outlined five key failings of current financial markets which make regulation desirable:

  • Financial markets are prone to bubbles that, when they burst, can endanger the stability of the whole financial system. Only some outside body, acting in the public interest, can fully appreciate these stability risks.
  • Financial markets engage in too much activity that is purely distributive, to the quick, and clever, and money-obsessive.
  • They push up the pay of financial professionals to levels out of all proportion to the value their work contributes to society.
  • Consequently, they have a natural tendency to take up too many resources.
  • The increased cost of this, allied to the over-emphasis on liquidity, leads to economic short-termism and a diminished rate of real investment.

He attributed the failure of the regulatory system in the build-up to the crash as a result of a universal belief in the efficient markets hypothesis, by regulators and financial institutions. This meant that participants.

  • were short-sighted;
  • were over-optimistic about sustainable returns; and
  • displayed herd behaviour.

He was also deeply critical of the current ownership structures of our largest financial corporations, arguing that the high pay currently seen is an example of market inefficiency:

“When this process goes badly wrong, a substantial distortion results. But this should not be of concern only for distributional or “fairness” reasons. It also affects market efficiency. For bad pay practices drive out good. How are we to face down aggressive trade union groups, such as the tube-train drivers, if we do not similarly face down the aggressive rent-seeking behaviour of corporate executives?”

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Roger Bootle - Thursday, 8th March, 2012