Dodd-frank, competitiveness and the cost of financial regulation

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Dodd-Frank is down there somewhere

Dodd-Frank is down there somewhere

This month a group called the American Action Forum (AAF) published a document entitled “The Growth Consequences of Dodd-Frank,” looking at the U.S. Dodd-Frank legislation introduced to curb financial excesses in the wake of the global financial crisis that first emerged in 2007.

Reflecting the complexity and — how shall we put this delicately? — dodginess of large parts of the financial sector, Dodd-Frank is a huge and unwieldy creature. It’s also been set upon by sharks: read this stunning (though out of date) Matt Taibbi article about how it’s done. As he put it:

“Dodd-Frank is groaning on its deathbed. The giant reform bill turned out to be like the fish reeled in by Hemingway’s Old Man – no sooner caught than set upon by sharks that strip it to nothing long before it ever reaches the shore.”

Yet despite the savagery and success of the efforts to gut Dodd Frank (including this latest initiative) there is still life in the old beast – hence the ongoing efforts to keep attacking it. For all its shortcomings, Dodd-Frank has seriously crimped the ability of financial sector players to carry on business as usual.

But a key question is: has Dodd-Frank been worth all that regulatory effort?  Well, on AAF’s evidence, the answer is a resounding no:

“The consequences [of Dodd-Frank] are significant – roughly $895 billion in reduced Gross Domestic Product (GDP) over the 2016-2025 period, or $3,346 per working-age person. Clearly, such a computation is subject to large uncertainties, but the order of magnitude is instructive.”

AAF tax rates

From the AAF report: garbage in, garbage out

That is a serious charge. Clearly, the AAF is arguing, all this regulation is harming the U.S. economy and making it less ‘competitive.’

Fortunately the AAF’s report has not gone without challenge. Let’s turn to one of the few expert organisations on the other side of the fence: Americans for Financial Reform (AFR). As they note:

“The study has multiple significant flaws.  These include:

  • A failure to incorporate any of the benefits of improved financial sector regulation. Extensive economic research shows that the benefits of greater financial sector stability alone will exceed the costs claimed by the AAF. As explained below, if Dodd-Frank cuts the annual probability of a financial crisis in half, it will create $2.9 trillion in economic benefits over the next decade. This figure alone is more than triple the costs claimed in the AAF study, and does not even count the substantial benefits that will accrue from improvements in consumer protection and economic fairness.

  • Exaggerating the growth impacts of regulation. The AAF study exaggerates the cost of regulation in several ways. The study assumes that all regulatory costs will be subtracted from capital investment, even though some regulatory costs themselves involve capital investment and some compliance costs will be funded by spending reductions (e.g. cuts in top executive compensation) at financial institutions. The study also appears to assume that temporary transitional regulatory costs extend permanently. Finally, the study assumes that increases in bank capital (higher equity vs. debt in bank funding) are identical to a tax on investment, which is highly questionable.”

We point to this because although neither of these two reports mention the c-word, we see this basic lobbyists’ formula again and again in debates about ‘competitiveness.’  The formula goes like this:

“exaggerate the benefits, then air-brush out the costs.”

It’s really that simple.

This same basic equation can be wheeled out in almost any area of the economy one might choose to consider.

So when talking about ‘competitive’ corporate tax cuts, for instance, emphasise all those potential benefits (such as the purported boost to investment, which is generally inferior to what one might hope or expect, and often negative) then simply ignore the costs in terms of lost tax revenues. Similarly, higher labour standards are portrayed as a cost to business – but the costs to business are often far less than supposed, and the benefits to workers and society is ignored.

None of this is new: we’re just highlighting how this simple formula lies right at the heart of the competitiveness agenda – and how broadly-based this agenda can be.

Endnote 1: grounds for caution. Before we push for ‘proper cost-benefit analysis,’ as this blog might seem to suggest, consider this intervention from another Washington, D.C.-based group, the Center for Capital Markets Competitiveness, supported by the U.S. Chamber of Commerce.  It published a long document in 2013 entitled The Importance of Cost-Benefit Analysis in Financial Regulation, in which it envisages placing a series of additional hurdles in the way of financial regulation, in the name of cost-benefit analysis.

A cost-benefit analysis is as a very general principle a good idea, but the outcome so often depends on the lobbying firepower of those pushing the costs, versus the firepower of those pushing the benefits. It all depends on who is doing the asking. A truly independent, nonpartisan civil service body, or academic institution, free of the prevailing prejudices of the day, can in some cases do a decent job. But the more complex the issue, the greater the potential for obfuscation, and for raw lobbying muscle to win the day.  It can be the same with “evidence-based policy” or “dynamic scoring” (described on p23 as “a ruse to make tax cuts look good.”)

Given the enormous mismatch here, a cost-benefit analysis always risks becoming a legitimation exercise for the biggest, most powerful players. At the end of the day, politicians have to take difficult political decisions about what to do, and take these studies with a large fistful of salt.

Endnote 2: the finance curse. We will soon be writing about the “Finance Curse” thesis, which states that economies overly dependent on finance display many characteristics of economies overly dependent on natural resources.  (See also Martin Wolf’s article in the Financial Times today, which very much supports the Finance Curse thesis. The Finance Curse thesis depends on a cost-benefit analysis, and has been described as a possible “new grand narrative” for finance. It recognises that you will never get a definitive answer as to the balance of costs and benefits – because some things, such as ‘political capture’, or ‘criminlisation’, simply can’t be measured in a way that can be offset against benefits (such as tax revenues.)




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