Saturday, May 23, 2009

Finance and its negative externalities...

... deserves to be taxed! So writes Martin Wolf (via David Leonhardt),

The UK has a strategic nightmare: it has a strong comparative advantage in the world’s most irresponsible industry. So now, in the wake of the biggest financial crisis since the 1930s, the UK must ask itself a painful question: how should the country manage the cuckoo sitting in its nest?...

... The fiscal costs of this crisis will be comparable to those of a big war... Loss of jobs and incomes will also scar the lives of hundreds of millions of people around the world. All this occurred, in part, because institutions replete with highly qualified and highly rewarded people were unable or unwilling to manage risk responsibly.

[W]hat framework is needed to ensure that the operation of the financial sector is compatible with the long-run health of the UK and world economies? Quite simply, the sector imposes massive negative externalities (or costs) on bystanders... So how should one manage a sector that produces such 'bads'? The answer is: in the same way as any polluting activity. One taxes it.

And about the way ahead for Britain (and this applies for other economies), he has five recommendations - global regulation to prevent regulatory arbitrage; ensure that owners and managers of financial institutions internalise most of the costs of their actions; reject egregious special pleading (on the pretext of maximizing innovation) from the industry; diversify the economy away from finance; and ensure that the risks run by institutions they guarantee fall within the financial and regulatory capacity of the British state.

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