Why Finance Lags for Good Reason...Small Government Begins with Financial Regulatory Reform

There is an old saying in Korean: “A quack kills people.” Milton Friedman, the winner of the 1976 Nobel Prize in Economics, illustrated this idea through the parable of “the fool in the shower.” Through this parable, Friedman criticized government incompetence and clumsy economic policymaking. The story goes like this.

A fool steps into a shower and turns on the faucet for cold and hot water. As we all know, even if the cold-to-hot ratio is set properly, the water that first comes out is usually cold, and only after a short wait does it become warm. But when cold water comes out, this person hastily turns the faucet toward hot. Then water that is far too hot comes out. Startled, he quickly turns the faucet back toward cold. This time it is too cold again, so he turns it back toward hot, then again toward cold, and so on.

The behavior currently being displayed by the financial authorities is almost a textbook case of this parable. Early last year, in an effort to prop up the weakened real estate market, the financial authorities pushed down mortgage rates. They also rolled out low-interest policy loan products such as Didimdol and Buteimmok, claiming they were for ordinary people. It was as if they had yanked the faucet hard in the direction of hot water because cold water was coming out. As a result, household lending increased and real estate prices began to rise. On top of that, when implementation of the second-stage stressed Debt Service Ratio (DSR) regulation was delayed by two months, people flocked to bank counters under pressure to catch what was called the “last train” for loans. Before long, talk of a “surge in real estate prices” and an “explosion in household debt” began to spread, and now the financial authorities have abruptly shifted course toward sharply shrinking lending. They have turned the faucet hard in the direction of cold water. As banks flounder trying to follow the financial authorities’ instructions, people who need loans are searching for lenders and borrowing methods less affected by regulatory oversight and control.

What the financial authorities and the banking sector have shown recently seems to lay bare the naked face of state-directed finance. When the financial authorities called for a reduction in household lending, banks raised lending rates. When criticism emerged that this would only increase the interest burden on end users, the financial authorities responded by saying that “raising lending rates was not what we wanted,” and called for measures other than rate hikes. In response, banks hurriedly poured out measures such as cutting the maximum maturity on mortgage loans to 30 years and suspending mortgage loans and jeonse loans for single-home owners. In just 2 to 3 weeks, the five major banks announced around 10 different measures to restrict and reduce lending. This time, criticism arose that even end users were being shut out of borrowing, so the financial authorities began emphasizing the protection of end users. Yet in reality, there is neither a clear basis nor a standard for defining who exactly counts as an end user and which borrowers qualify as such. All this does is intensify regulation, control, and confusion in the financial market.

It is often said that the most underdeveloped sector in Korea is the financial sector, and there is good reason for that. As seen above, finance is one of the sectors where state control is most severe. The heavier the regulation and control in a sector, the more the market is distorted, the more competition is restricted, and the slower development inevitably becomes.

In *Free to Choose*, the famous book in which Friedman presented the “fool in the shower” parable—a book President Yoon Suk Yeol has reportedly read several times and found deeply moving—he says this: voluntary exchange in the market is a necessary condition for freedom and prosperity. Yet when government power controls and regulates the market, freedom is infringed and the economy falls into stagnation. Therefore, to enjoy freedom and prosperity, we must restore market functions distorted by government control and reduce the excessively expanded power of government, moving toward “small government, limited government.”

The government, in fact, has also announced that it will begin earnestly pursuing “small government.” Saying it will seriously aim for a government that is small but efficient, it has also finalized 10 key regulatory reform tasks to be promoted as priorities. The idea is to slim down the government and remove regulations so that a dynamic economy led by the private sector can take shape. That is the right direction. Unfortunately, however, news reports show no explicit mention of regulatory reform in the financial sector. Shouldn’t sweeping regulatory reform in the financial sector—the most underdeveloped sector of all—come first?

Hyukchul Kwon, Director, Free Market Institute

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Original title: 이유 있는 금융 부문 낙후...작은 정부 구현은 금융 규제 개혁부터

Author: Hyeok-cheol Kwon

Date: 2024-09-11

Source: https://www.cfe.org/bbs/bbsDetail.php?cid=column&pn=2&idx=26860