Could Stronger Regulations Fuel Faster Economic Growth?

By Markets Fool.com

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It's generally assumed that tighter regulation, and particularly of the financial industry, hinders economic growth. But is this actually true? The data is far less conclusive than one might think.

The following chart plots the economic growth of the United States over 10-year increments. From 1896-1906, for instance, gross domestic output expanded by 61%. In the decade ending in 1933, output contracted by 10%.

What's important to note is that there are two distinct periods of sustained, long-term, economic growth during which output increased by at least 40% over the preceding decade in 10 or more consecutive years.

The first period was during World War II. It was fueled by both America's emergence from the Great Depression and by an increase in domestic fiscal expenditures and heighted demand for supplies from our allies during the war.

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The second period spanned from 1964 to 1974. This was bolstered by the United States' role in financing and supplying Europe and Japan with the means to rebuild. And, importantly, it was also fueled by the fact that very few banks in the United States failed during this period.

This may seem like mere nuance, but it's important. If there was anything that we learned from the Great Depression, it was the importance of minimizing bank failures, or, in the event that banks did fail, to reduce the damage therefrom. This was the impetus for the Glass-Steagall Act as well as the legislation that created the FDIC.

Why did so few banks fail in the years after World War II? The answer is twofold. First, the industry was operating under the heavy regulatory regime implemented in response to the 1930s. Second, many of the bankers in charge of the nation's biggest banks had observed the mistakes of the Great Depression firsthand and were thereby understandably conservative in their approach to banking.

This trend began to change in the 1970s, '80s, and '90s, as a new generation of bankers, unburdened by memories of the Great Depression, took the helm at the nation's biggest banks, and as new legislators, similarly unburdened by the past and salivating over the financial industry's deep pockets, were installed in Washington, D.C.

This deregulatory fervor, championed by politicians in both parties, soon ushered in a return to the instability that characterized the bank industry in the six decades between the Civil War and the Great Depression. Hundreds of banks failed throughout the 1980s and '90s, and the financial crisis of 2008-2009 led to the downfall of more than 500 banks, some of which were among the largest in America.

My point is that there is reason to believe that a stronger regulatory presence in the bank industry and economic growth are not mutually exclusive. In fact, in light of the evidence that a more robust regulatory role seems to have reduced bank failures in the decades after World War II without sacrificing rapid growth, one could even argue that the opposite is true.

The article Could Stronger Regulations Fuel Faster Economic Growth? originally appeared on Fool.com.

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