Raghuram Rajan had seen the impact of over-regulation in an underachieving economy. Years later, he also saw the perils of under-regulation as championed during the Alan Greenspan era. The Eric J. Gleacher, Professor of Finance at the Booth School of Business discusses the question of achieving the right mix of free enterprise and sensible regulation
Raghuram Rajan
He is one of the few economists who balked at the inadequacy of regulation in the US financial system in the early 2000s and warned of a potential catastrophe. Former chief economist of the International Monetary Fund and now an honorary economic advisor to Prime Minister Manmohan Singh. Raghuram Rajan’s books include ‘Saving Capitalism from the Capitalists’ and ‘Fault Lines: How Hidden Fractures Still Threaten
the World’.
How do we resolve the dilemma between allowing people the freedom to start businesses and do what they want to, and the need for regulating enterprises? To use your own phrase, there could be a ‘fault line’ in the interface between these two seemingly contradictory objectives.
I don’t think there is a contradiction between regulation and free enterprise. It is really a question of balance. If you have too much regulation, it can kill competition. And often, regulation is driven by the powerful among the regulated to suit their purpose. So that can destroy competition too.
One example I can think of is the rule in India that an airline can’t fly international routes unless it has been flying domestic routes for some minimum number of years. That seems to me to be primarily anti-competitive in intent. Are Indian lives more expendable than foreign lives? Why should airlines be allowed to ‘practice’ within India before flying abroad? One possible explanation is simply that it is a rule supported by existing airlines who want to secure foreign routes for themselves.
On the other hand, doing away with regulation entirely is also problematic. In fact, too little regulation can also kill competition. Suppose there is no airline safety regulation. Then passengers would be primarily flying the large, established carriers. They would be too scared to fly the smaller carriers because they would be worried that they wouldn’t have paid enough attention to safety. If there was a safety regulator who checked that every airline maintained its aircraft to the requisite standard that would give start-ups a chance, because the regulator’s endorsement would give people more trust
in them.
That is the balance we want to achieve. You can go too far and therefore limit competition. Or you can do too little regulation and again limit competition. There is a golden mean. How to find that golden mean to promote entrepreneurship and competition is a difficult task.
For 10 years, microfinance institutions were growing on their own. They got into some problem and now the Reserve Bank of India (RBI) is trying to regulate them. But there is at least one group of people that think that the RBI may be trying to regulate it in a way that favours the banks. How do you make sure that there is a rule-based system in which regulators operate and there are checks and balances against the regulator also?
That’s important. It is difficult to ensure that there are sufficient checks and balances on the regulator so that you don’t get excessively intrusive regulation imposed by the big incumbents. I think this is the danger. Again and again, the incumbents will use things like safety and risk management to argue that they alone should get the bulk of profits. They will argue only the incumbents can keep the system safe. But the danger to a system from having large, inefficient incumbents is far greater than the danger from allowing the entry of vibrant, low-risk enterprises.
The issue of microfinance, unfortunately, is something that has gone through every controversy that India can possibly manufacture, ranging from some cases of terrible private practices like coercion etc. to political fights for power and influences. Clearly, some interests want to see this industry shrunk [in favour of] public sector bank lending.
Now, there are people who genuinely think public sector lending is safer and is less subject to the kind of terrible practices that the private sector sometime indulged in. On the other, there is another group that wants the public sector reinforced because they can influence who the public sector loans are given to, and gain political or pecuniary advantage. They have much less influence on private sector loans. So there are a lot of influences playing into this debate.
I think it is important we have some clean, clear regulation here, but not excess. Let us not kill the innovation that is happening in the sector and the access that is increasing for the poor by over-regulating it. In some sense, the whole reason this industry has come to light is especially because it has been successful and expanding. If it were small, nobody would pay attention to it. The fact is that in Andhra Pradesh it has such a big presence. It is something that has forced people to pay attention. I think we should be very careful about keeping the baby while throwing the bath water. There is a very clear danger that we [may] throw out everything together.
Our private sector was small till recently. Perhaps we did not have the need for multiple regulators earlier. So the talent for regulation — the human capital — is sort of limited. That is perhaps one of the reasons that some regulator might go two steps or three steps too far because he wants to be seen as a conservative regulator.
For instance, the early versions of the Right to Education Act seemed to suggest that putting mandates on the private sector will lead to high quality private education. Instead, that could lead to more bribes and a higher cost to the private sector, with no improvement in the quality of education.
(This story appears in the 03 June, 2011 issue of Forbes India. To visit our Archives, click here.)