Regulation from market institutions

The usual way economists and regulators think about regulation and competition policy is in terms of market failure. The problem with that model is that it obscures some of the most important features of real life. The model begins by making unreasonable assumptions about markets which, according to those assumptions, will always ‘fail’. However, governments do not have the knowledge, nor the incentives, to be able to ‘correct’ market failure. This model also fails to recognise that markets themselves can develop regulatory institutions to address some of the so-called failures. One group of those private regulatory institutions is stock exchanges. The fact that the government, in 1986, decided to prohibit a private institution (the Stock Exchange) from regulating equity and gilts markets in many important ways on the grounds that the London Stock Exchange was inhibiting competition and that this act (Big Bang) is generally referred to as an act of ‘radical deregulation’ should perhaps tell us something. In fact, it tells us three things. The first is that governments are not necessary to regulate markets. The second is that private institutions might, in fact, regulate markets more strictly than government regulatory bodies. The third is that the focus of economists should not be on so-called market failures being corrected by government bodies but on analysing the relative advantages of private and government regulation. I will illustrate this by five examples, though not all relate to specific market institutions.