Regulation

Regulation exists everywhere, in every country, in so many places. Even the hardcore capitalist thinkers accept the need for it. Governments simply like it, for it gives them power, and fill its coffers. Businessmen despise it for it cuts their profits and restricts them. But how much of it is actually needed, and where is it needed. For that we need to look at what a market is, how it operates, and why regulation is needed.

A market is where trade occurs. A transaction is a give and take of resources between two parties. Many transactions constitute trade. Involved parties seal a transaction based on its individual benefits to each. They both gain value through it. This is how a free market works in the absence of regulation. The net value of the two-party system always increases during trade. But what the involved parties do not account for is the impact on physical and business environment. Regulation is needed to account for it. Trade also removes uncertainties in future trading and self stabilizes the system. In come cases, speculation plays a major part, and destabilizes the system. Regulation is the only way to bring it back.

The market is mostly in a stable equilibrium, as regards the prices of goods and services, in that, any variation in them tends to bring it back. As demand increases, price increases. It creates new opportunities for production, and methods of production previously unviable, now become profitable. So higher prices, increase supply after a small time lag, and bring down prices. Except for this small lag, the correction phase, the system is in a stable equilibrium. The prices self-correct. This holds not only for the market as a whole, but also for individual consumables. This is a typical competitive market, running in a perfect state, and should not be tinkered with any external levies or regulation.

Regulation is needed to account for the harm done to the natural environment. As individuals and groups evaluate the feasibility (if earnings>investment) of their economic activities, they do not routinely evaluate the effect of their actions on the environment. In order to force them to weigh the environmental harm into their decisions, it is essential to penalize them by the amount of harm. Something like a pollution tax on all polluting units and fuels, in proportion to the pollution they generate.

When a market is controlled by a single player, it is called a monopoly. A single stake holder, being party to all transactions, deviates from the regular behaviour. He may not over supply when demand prices have gone up, and harms the business environment. He may sell lower to undercut competition. Also monopoly feeds monopoly, which in the long run may adversely impact consumers in the market. To control such behaviour, regulation is needed. While regulating to curb monopolies, care should be taken for some markets cannot sustain without one.

Sometimes essential goods are subsidized as part of regulation. In almost all cases, this is harmful to economic health. It encourages wastefulness of the resource. It discourages those pursuing to seek alternatives. For example, by providing for free electricity, it increases consumption. It disadvantages people seeking natural ventilation to avoid or atleast decrease use of lights and fans. It hinders penetration of low power devices. It increases consumption to extents that it becomes costlier to source it. Finally, the governments would be forced to put a variety of conditions on these subsidies, but they still remain harmful. Restricting it to a section of people, like below poverty line, would retain the problem to slightly lower extents, but with additional organizational overheads. Sometimes subsidies come in the form of lower price tag, but restricted supply. It deviates from perfect economy by denying to those who genuinely need it and willing to pay a commensurate price, like students needing light in exam days. All kinds of subsidies meant to make goods more affordable, serve to cut from the overall economic value. The best way to make an essential good available to the people would be to let the market run its free course, and equi-distribute the whole money meant for the subsidy. This serves to make the good affordable, reward those who save, and charge those who over consume. It keeps consumption under check.

Another need for regulation is to ensure that the stable equilibrium achieved by the market is sustainable and not by depleting reserves we inherited from our ancestors. If petrol is dug from the ground, it needs regulation, for even in the ground, it was a natural resource and not of zero value. When mobile telecom companies are operating in an area, they are consuming spectrum of that area, and disturbing the ability of others to operate using the same bandwidth. Whenever such resources are consumed, they must to be accounted for. All natural resources need to be ascribed a value, and their consumption for any kind of economic activity be charged. This ensures that unprofitable economic activity does not go unheeded, by destroying large flora and fauna for small profits.

Stock markets trade stocks, which are not consumables, but extract their worth from the potential to generate value. They are purely investments. They are bought for the potential to generate profits, which would come back to the investors as dividend, or reaped back into the company as further investment to yield higher rewards in future. A stock of 100 value that yields a fixed dividend of 5 each year is a 5% stock. This is an unstable equilibrium, for if the stock suddenly happens to earn a profit of 6%, the price of the stock would drastically change from its initial state, without any converging price. A market that generally yields 5%, will value a stock yielding 6 at 120. A relatively small increase in profits from 5% to 6% has shot the stock from 100 to 120. By trading in this stock, an investor can reap in an extra 20 besides the 6. Again, the 5% market would view this as a golden stock as on the rise having yielded 26% in the last year, and would value it at 520, more than 5 fold increase. Price continues to shoot up, till some sane advice prevails and prices stagnate. The stagnated prices cannot yield the same kind of returns, and the stocks fall, completely a bull cycle. It has potential to similarly lower the prices and go into a bear cycle. The bull and bear phases trigger each other, without letting the price to stabilize, and fluctuating at the mercy of investor mood. It is a perfect case of an unstable market which seeks regulation to control pricing.

To come up: How to regulate speculation, and make trading self-correcting

Destabilizing effect can also be seen in currency markets. Say interest rates in the local Japanese and US markets are 3% & 4% respectively. For markets to be balanced, a given amount of sum, held in different countries, should after a year grow to the same amount. So Yen should increase in value by 1% to the dollar each year. But what actually happens is a falling Japanese Yen due to carry trade. Say initially, the rates of Yen and Dollar were stable. Investors react to the difference in interest rates by selling Yen for Dollar, holding Dollar for a year, and then buying back Yen. As many investors follow the practice, it causes rapid selling of Yen across the globe, and Yen keeps falling, till the slide is curbed by proactive governmental interferences. This is another case calling for regulation. And, the governments do regulate by pegging the currencies. But, they can defend the prices only till it pushes within a price band. This is a case where some regulation is needed, a regulation is in place, but it does what was not intended – pegging the currencies.