The Theory of Regulation and Finance

The objective of this chapter is to provide a general view of the theories of regulation followed by a final section on the role of finance in promoting efficiency and growth. The two main approaches are the public interest view, with emphasis on the need of government intervention to attain welfare improvements, and the private interest view, raising doubts about the effectiveness of regulation. The general theory of second best raises doubts as to the feasibility of determining welfare improving policies once the assumptions of the first best are violated. Applied welfare economics provides an engine for searching concrete information that could be useful in guiding policy. Property rights, transaction costs, and the new institutional economics (NIE) have changed the view of government intervention in markets. Asymmetry of information is an extremely important friction of the first best in financial markets. The capture theory has been modified by the analysis of the principal/ agent problem and the assumption of imperfect information. The final section considers finance, efficiency, and growth. There is a summary of the main themes in the chapter.