Financial Regulation Does Not Hinder Growth

David Wessel of the Wall Street Journal wrote a column today in which he proposes that the US has to choose between economic stability and economic growth. I am usually on board with Wessel, who does not follow the Journal’s usual slash and burn libertarianism, but in this case I think he’s wrong. His dichotomy is false.

The regulation that Wessel is discussing is financial regulation to curb the boom and bust cycle that we have just lived through. He asks whether “wise government rule to prevent market excesses” would also prevent the dynamic innovation that fuels economic growth. I answer emphatically NO.

As I noted yesterday, financial innovation is unrelated to business innovation. In yesterday’s post, I pointed out that the companies driving recent growth – the Googles of the world – have not depending on the innovations coming out of Wall Street. But today I will go even further. Between World War II and the S&L crisis, we had a long period of mostly financial stability, without the crises we’ve seen since then, and with a regulatory regime that had general consensus on Wall Street and in Washington. That long period of stability didn’t hinder economic growth; in fact, as the graph below shows it was one of the greatest growth periods in our nation.  Notice how much higher the growth is (the red lines) before the S&L crisis in the mid-1980’s.

Growth in GDP after WWII

I would argue that not only did financial stability and economic growth coexist during this period, but that the stability was actually helping the growth. After all, it’s a lot easier for companies to plan and budget if the financial markets are not booming and busting. And potential entrepreneurs are more likely to take the leap and start a new business if they aren’t worried about their retirement savings disappearing in a Wall Street flame-out.

So let’s not worry about financial regulation slowing down growth. Let’s focus on smart regulation that will spur growth.