Making banks a 'normal' industry
- By Raghuram Rajan
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E-mail Shanghai Daily, November 27, 2012
Many economists are advocating regulation that would make banking "boring" and uncompetitive once again.
After a crisis, it is not uncommon to hear calls to limit competition.
During the Great Depression, the head of the United States National Recovery Administration argued that employers were being forced to lay off workers as a result of "the murderous doctrine of savage and wolfish competition, of dog-eat-dog and devil take the hindmost."
He appealed for a more collusive business environment, with the profits made from consumers to be shared between employers and workers.
Concerns about the deleterious effects of competition have always existed, even among those who are not persuaded that government diktat can replace markets, or that intrinsic human goodness is a more powerful motivator than monetary reward and punishment.
Where the debate has been most heated, however, concerns the effects of competition on incentives to innovate.
The great Austrian economist Joseph Schumpeter believed that innovation was a much more powerful force for human betterment than was ordinary price competition between firms. As a young man, Schumpeter seemed to believe that monopolies deaden the incentive to innovate.
As an older man, Schumpeter qualified his views to argue that some degree of monopoly might be preferable to competition in creating stronger incentives for companies to innovate.
The rationale is simple: If patent protection were limited, or if it were easy for competitors to innovate around intellectual property, a firm in a competitive market would have little incentive to invest in path-breaking research and development.
After all, the firm would gain only a temporary advantage at best. If, instead, it withheld spending, and simply copied or worked around others' R&D, it could survive perfectly well - and might be better off.
But if the firm enjoyed a monopoly, it would have the incentive to undertake innovations that improved its profitability, because it would be able to capture the resulting profits, rather than see them be competed away.
A "boring" bank, shielded from competition and knowing that it "owns" its customers, would want to go the extra mile to help them, because it would get its pound of flesh from their future business. Customers can be happy even when faced by a monopoly, though they would grumble far more if they knew how much they were paying for good service!
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