Saturday, November 3, 2012

Regulation as a structure for creating economic micro-climates

I have been looking at the way regulation in industry stimulates corporate behaviour. 

I find it interesting that the addition of regulation stimulates employment opportunities and "work activity" around the regulation. 

* Oversight and enforcement behaviour from "regulators"
* Avoidance and complicance behaviour from those being "regulated"

This is fine and obvious.  The interesting this to me is how every regulation creates niches that small operators can use to enter the market.  Exactly like the idea of micro-climates within an eccosystem.

Take for instance a large open grassland.  Large herds of herbivors roam as they wish and grow to huge proportions.  This is the effect of companies in an un-regulated space. They are not differentiated and are generally circular-ish in shape.  Their members are randomly distributed throughout their mass and there are no threats.

Now introduce some small number of predators. (Regulators) who start to pick at the edges of the herd.  The herd either quickly adapts or is quickly obliterated.  The herd adapts its behaviour simply by becoming more cohesive and starting to fight as a group.  The herd still moves as (roughly) a circle across an open landscape.  The preditors have no opportunity.

Now introduce some sort of obstacle within the environment.  A line of cliffs, a fence... whatever.  This is effectivly a "rule" that governs where the herd can move and what it can do.  The herd, being a self-organising system, adapts by avoiding the obstacle ( or suffers a fairly catastropic injury) 

The interesting thing is that the larger the herd, the more efficiently it moves when it stays clear of the obstacles.  So there is a little fringe of ground near the obstacles that is not grazed.  It now presents a resource opportunity for a small herd or something else to exploit.  Thus we have a micro-climate around the obstacle, that is formed by the lack of exploitation by the larger groups who cannot effectivly use their scale to exploit the small niches.

So these micro-climates become "nurseries" for nurturing the next generation, similar to mangrove swamps which shelter small fish from the large predators.

In practical terms, if you look at the American banking and financial industry, you an see the effect of the removal of regulation.  The big groups have grown without constraint.  They have absorbed everything from share trading, to financial managment, to banking, to insurance, to mortgages, small business financing etc.  There is no way small entrants into the market could compete with that size company unless they are in a sheltered area that the large company does not want to compete in.  This is exactly what has been happening.  Take a look at all the small entrants in the industry and you will find them in little "niche" areas servicing(exploiting) populations that do not have enough "margin" to be of interest to the large groups (very poor people and small small businesses.  but they have even figured out that by grouping them together and selling them as derivatives, they can use scale to exploit this niche too), or those that the large group do not want to be associated with ( used to be criminals, migrants, socially un-populare industries, but since they are no longer concerned with repuation as it cant hurt them... is virtually no one)

So, simply by removing all the obstacles, the groups in the finance industry have grown and consolidated into a number of mega-herds that roam around and decimate the landscape by over-grazing and trampling whatever remains... tada! Global financial crisis.  (I know this is a simplification...)

The other intersting thing is that the lack of regulation has expanded the space in which the herds can move.  This has occured by the "removal" of partitioning regulation between the financial "spaces".  So industries that were previously seperate, such as insurance and banking, have merged together into a seamless amalgum.

This amalgumation of the financial industries/spaces into a single "whole" has also amalgamated the effect of a "change in the weather", which previously may have effected each different eccosystem differently, now effects the whole space in the same way.  This makes for a frgile system that is prone to extreems of boom and bust... tada!  GFC again.

Looking at the European environment, there are still a lot of structural obstacles in place within the financial space.  They have a lot of debri from the geopolitical amalgamation of the Euro-zone.  This is to do with the cultural remanants, the language barriers, the different local regulation models and historical artifacts that are still shaping their individual banking and financial systems.  Its interesting to note how resiliant they have been, even thought some of the countries that were carrying large debit levels have crashed... others survived.  While the US, that is one cohesive system, took a fairly massive blow that was distributed across the whole system.  The only reason it survived was scale.  The size of the herd allowed it to survive the storm.

The Europeans are currently busy trying to pick each other up and playing a game of pass the parcle with debit generated by some historical habits.  The interesting thing about the Euro-zone is just how rich a set of micro-climates exist.  There is a massive pile of different banking and finacial systems still bouncing around in that space.  Lots of small players who can potentially grow as the big ones fail. 

This is all simply statement of fact.  It's not particularly a judgement about the success or failure of these systems.  Any large system is essentially "unique". There is no "correct" way to structure such a system.  In any given environment, there are variables that allow some individuals, groups and populations to thrive while others fail.  The only point I am making is that by understanding the effects of these structures and the environmental variables that they create... it becomes easier to predict the effect of manipulating these artifacts.

I think that the biggest problem all the political regulators have is that they think they have something different to all the other environmental manipulators, farmers, hunters, fishermen. But in reality they need to learn the lessons of the past and be very careful when cultivating and exploiting a monoculture. It can all go very wrong if that one crop fails.

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