Brexit Reveals Generational Rift


IT IS too easy to be pessimistic about the future of Europe and the UK these days. The recent decision by UK voters to leave the EU will have far-reaching and devastating consequences on both sides of the channel.

The consequences are already being felt in the UK, with the pound losing value at a speed usually reserved for the rand on a sunny December morning.

The ill-begotten decision will haunt the UK for generations. It has been Europe’s financial powerhouse mainly because it benefited from the so-called passport system, which allowed London-based banks to conduct business in all EU member states. With this privilege gone after the UK is no longer a European country, many international banks will move jobs from London to Frankfurt, Paris, and Amsterdam.

British banks face substantially increased costs of doing business in the rest of Europe and it is not clear whether all of them will survive. The Royal Bank of Scotland was hammered in the hours following the decision to leave and its stock price dropped almost 30%.

Some might ask who needs bankers anyway. But the UK, home of the industrial revolution, now hinges crucially on its financial sector and is almost devoid of any real industrial base. Services account for almost 80% of GDP.

On the other side of the channel, the economic consequences will be less severe. A number of countries will painfully lose some of their exports to the UK, but the much bigger challenge is a political — and almost existential — problem for the EU.

The success of the Brexiteers is a boost to populists across Europe.

Right-wing xenophobic movements from France, the Netherlands and Hungary will carefully take notes on how to use the fears of the economically excluded and those left behind by globalisation for their short-term political gains.

The sovereign debt crisis has already highlighted the fundamental differences between northern countries — such as Germany, France and the Netherlands — and southern countries such as Greece, Italy and Spain. These fundamental differences in opinion about economic policies have not been resolved and the differences have intensified due to the refugee crisis.

Europe has always been united when there is a cake to be divided. It remains to be seen how strong it is when there is a burden to be shared.

AS PAINFUL as it is to observe Brexit from an economist’s perspective, it is almost insufferable from the perspective of a millennial born between 1980 and 2000. Ours is the generation that is most directly and most strongly affected by the UK vote.

Millennials are the generation that most emphatically voted for the UK to remain in Europe. And why wouldn’t they? They have adapted to globalisation, study and work across Europe and have friends from Europe who study and work in the UK.

The millennials will be most directly affected by the economic downturn to come. Their jobs can easily move to Europe, while they won’t be able to follow freely.

Who, then, voted to leave? The baby boomers, the generation now aged 50 and above, tilted the referendum in their favour. They will also suffer from the economic downturn, but have a different time horizon from the millennials. The full wrath of the downturn will unfold in the long run and when many baby boomers are retired.

Naturally, the baby boomers care less about education and labour mobility, and more about security and health. This is why the Brexiteers campaigned with the promise to funnel £350m a week to the chronically cash-strapped National Health Service. And why they promised to “keep Britain’s borders secure” — openly pandering to xenophobic resentments towards immigrants from eastern Europe and refugees.

The Brexit vote unveiled a deep rift between millennials and baby boomers. The two generations have fundamentally different interests, which were bound to clash eventually. What makes the Brexit vote different from other policy decisions where the two generations have opposing interests is that the clash has become evident to all.

There is at least something positive for SA in all the European gloominess: our demography is radically different from Europe. Millennials make up the bulk of the population, which provides us with a great opportunity to enforce policies that will benefit future generations. The recent protests about free education are but a small glimpse of things to come.

The big opposition parties have understood these dynamics. The DA has a relatively young leader in Mmusi Maimane and recently started a youth tour to woo younger voters. The EFF follows a much more populist approach but also targets the young as its main source of votes.

The only party that seems to not have got the memo is the ANC. Its local election posters carrying the image of a geriatric President Jacob Zuma with the slogan “Power to the People” must ring hollow in the ears of millions of young people without a job and without prospects for the future.

ZUMA has proved, time and time again, that he cares more about being secure in comfort than he cares about the future of the country.

Brexit also provides a great opportunity for SA. We should make it as easy as possible for well-educated young Europeans to come to SA. The recent decision by the Department of Home Affairs to open up a path to permanent residency for all graduates of South African universities is only a first step.

Getting a visa is still a prohibitively painstaking process. Despite SA’s rampant youth unemployment, many jobs that require a higher education cannot be filled, due to a lack of qualified applicants. More immigration from Europe and the UK will benefit the economy.

If there is something to be learnt by the dire situation in Europe it is this: young people must organise to make their voices heard and to enforce policies that benefit their generation. The South African demography will greatly help in this.

We should tell this to our friends in Britain and Europe. Perhaps they will remember it when they leave the UK and Europe in search for a better future for themselves and their children.

First appeared in Business Day Live on 29 July 2016.


Why Julius Malema’s EFF doesn’t offer South Africans a way out of poverty

In “Why Nations Fail: The Origins of Power, Prosperity, and Poverty”, economist Daron Acemoglu and political scientist James A Robinson argue compellingly that the key to economic growth and prosperity lies in strong and inclusive institutions.

Inclusive economic institutions, such as those in South Korea and the United States, are those that allow and encourage participation by the great mass of people in economic activities that make best use of their talents and skills and enable individuals to make the choices they wish. To be inclusive economic institutions must feature secure private property, an unbiased system of law, and a provision of public services that provides a level playing field in which people can exchange and contract; it must also permit the entry of new businesses and allow people to choose their careers.

The authors go on to say: “Secure property rights are central, since only those with such rights will be willing to invest and increase productivity.”

In the same way that inclusive institutions spur economic growth and prosperity, extractive institutions that “are structured to extract resources from the many by the few and that fail to protect property rights or provide incentives for economic activity” doom a country to perpetual poverty.

Understandable anger about the excessive inequality in South Africa lies at the heart of the rise of Economic Freedom Fighters (EFF). The party is the most successful of the three splinters from the governing African National Congress (ANC) since 1994. The others are the United Democratic Movement and the Congress of the People. The EFF made headway by engaging in aggressive rhetoric and proclaiming an African socialist revolution.

The problem is not that the EFF’s analysis of South Africa’s problems is completely inaccurate – the party has a valid point about the necessity of free education, for example. The problem is how the EFF wants to address these issues and where it gets its economic policies from.

The manifesto

In its founding manifesto the party outlines seven “nonnegotiable cardinal pillars”, which include building state capacity, the nationalisation of strategic sectors of the economy and the expropriation of land without compensation.

The EFF’s local government election manifesto spells out this vision in more detail. Its manifesto is a combination of lavish promises and magical thinking with regard to basic economic concepts.

But first and foremost, the party’s manifesto is a continued attack on South Africa’s economic institutions. Among other things, the EFF wants to abolish the tender system that is used, for example, to determine who can build a road at the lowest cost.

Doing so would diminish competition among businesses. Rather, the EFF wants to directly employ residents to do the same job, thus creating the same patronage network it criticises in the ANC. How this should lead to less corruption remains a mystery.

Another aspect of the election manifesto is even more worrying. The EFF writes that

A minimum of 50% of basic food items and goods would have to be produced within a municipality. A minimum of 40% of all investments in its jurisdictions should be owned and controlled by community trusts or invest a minimum of 40% of their profits in the municipality.

The party envisions nothing less than a society where municipalities are organised in chiefdoms rather than being part of a modern nation state.

The Venezuela option

In a eulogy after the death of former Venezuelan president and fellow commander-in-chief, Hugo Chavez in 2013, Malema praises the comrade following his visit to Venezuela in 2010 where he studied the country’s nationalisation programme:

Chavez was able to lead Venezuela into an era where the wealth of Venezuela, particularly oil was returned to the ownership of the people as a whole.

Venezuela has some of the world’s largest proven oil reserves that, in conjunction with a tenfold increase in crude oil prices between 1998 and 2008, enabled Chavez to enact a series of populist socialist policies.

But when the oil price started to fall in 2014, the party in Venezuela was, quite literally, over.

On April 29 Empresas Polar, the country’s largest producer of beer, stopped producing because it ran out of barley. This is only the latest in a long list of shortages that includes basic necessities, such as baby food and toilet paper. Things have turned so badly that three meals a day have become a luxury many people can no longer afford.

The reason for this shortage is that many international firms suffered billion-dollar losses and abandoned their operations.

Russ Dallen, head of investment bank Latinvest, summarised the situation in Venezuela in grim words:

The worst shortage is of medicine and medical equipment. To be sick in Venezuela right now is a death sentence.

The EFF is trying to follow the Venezuelan model by heavily promotingthe nationalisation of “minerals, metals, banks, energy production and telecommunications” as its core economic agenda.

Even if nationalisation along the lines of the EFF document were legally possible – and it is not – the numbers simply do not add up. Primary mineral exports contribute about 30% of South Africa’s total merchandise exports. This is well below the 95% oil contributes to Venezuela’s exports. And it is less than clear that any state-owned entity will turn profits. Take power utility Eskom, for example, which would be insolvent without government bailouts, or national carrier SAA, which is currently in need of yet another guarantee from the National Treasury. Nationalisation will not be enough to finance the EFF’s lavish promises.

Reservoir of resentment

What the EFF is trying to do is tap into a reservoir of accumulated apartheid injustice. Freelance journalist Louise Ferreira summarisedaptly:

White prosperity was built on the oppression and dehumanisation of black bodies.

The scars of the apartheid regime’s crimes, in particular of the forced resettlement of millions of people, are still visible today. In 1994 the ANC set out to redistribute 30% of farmland to black farmers by the end of 2014, but only 5% of land has actually been transferred.

This lack of transformation is what makes the EFF attractive to so many. Early on, Malema picked up on the discontent South Africans had begun to feel towards democracy.

He was recently quoted saying that “white monopoly capital has stolen our land,” and one of the EFF’s key promises is that, similar to Zimbabwe, it will expropriate land without compensation.

Malema has never made a secret of his man-crush on Zimbabwe’s ruthless dictator Robert Mugabe:

There’s no system that has worked successfully for Africans, except the Zimbabwean system. The Zimbabweans today can be hungry and poor, but at least they own property.

What he fails to understand, however, is that without capital, and in particular foreign capital, the only thing people can do with their land is subsistence farming that will offer neither them, nor their children, a way out of poverty.

The EFF’s entire economic policy, it seems, consists of weakening the very institutions that economists have identified as key drivers of economic growth.

But without inclusive institutions, South Africa will be turned into a kleptocracy akin to countries like Venezuela and Zimbabwe.

Time for the youth to plot their future


(Appeared first in Business Day on 11 February 2016. Available on BDLive)

SA’s millennials, the roughly 20-million young people born between 1980 and 2000, are the largest cohort in the population pyramid and the most underrepresented in Parliament.

It is the cohort that suffers most from unemployment, that will be most affected by climate change and depleted natural resources, and that will be handed the highest debt burden in South African history.

If the past is any indicator, this week’s state of the nation address will be another sorry performance by a political class that is more engaged with plundering the state’s resources than with fixing the elementary problems of education and infrastructure.

Last year was economically devastating and things will get worse before they get better. Even if we manage to avoid a recession, the abysmal growth rates most economists forecast will not be sufficient to generate the jobs a desperate young generation needs.

Youth unemployment is a cancer we allow to fester within our society and it is only a matter of time before the cancer will turn metastatic and kill the patient.

Some of our problems have historic roots. Others, such as low commodity prices and slowing demand from China, are global in origin. But many problems we are facing today are domestic — and it is these ones we should tackle first. The big question is how.

EDUCATION is arguably the most pressing structural issue for the economy. Dissatisfaction with the god-awful state of affairs finally broke out last year during the #FeesMustFall protests.

Despite the victory for the students, too many gifted and determined young people are still excluded from tertiary education because of their parents’ income. Our economy cannot afford to lose this talent. There still is a critical skills shortage that curtails meaningful economic growth.

Students! Do not wither. Insist on free tertiary education for all. Not in a distant future, but now. This year.

Since rich households will benefit disproportionately from free tertiary education, we should increase taxes for the richest South Africans, plain and simple. Whether a VAT increase should be in the finance mix, or a higher education tax should be introduced, can be debated, but fixing the education system must be our number one priority.

And it is not only tertiary education that needs an urgent update. When teachers miss more days in school than their pupils, something is deeply wrong. We can no longer afford to allow the South African Democratic Teachers Union’s blind opposition to meaningful reform to endanger the future of this country.

Teachers should be compensated according to their performance. A base salary at or below the current average level should provide the necessary security for teachers.

This base salary should then be augmented with a performance-based bonus, where performance can include very basic things such as actually showing up for class, or documenting an effort to improve literacy and numeracy where necessary.

Such a system can be implemented without additional funding, and a number of political parties have tabled proposals to improve our education system.

The second big issue that affects future generations is infrastructure. Eskom and other parastatals are under miserable management. When a single party holds absolute power for more than 20 years, cronyism becomes entrenched, favours need to be repaid and loyalty triumphs over capability.

GENERALLY, infrastructure can be funded through debt, because future savings outweigh the cost of credit. But SA faces an external debt limit and the government cannot just borrow as much as it wants.

Higher spending on infrastructure means less money for government pet projects such as increasing public sector wages to secure a majority in the next election. Just look at the increase in the government debt-to-gross domestic product ratio, which soared from 27.8% in 2008 to 39% in 2014.

Most of this additional debt was squandered on short-term policies and will never generate any future savings. The young generation is left with the bill and will have to repay it with their future taxes.

Instead of paying for an election, we should borrow for things that generate future savings, such as high-speed internet and new ports, railroads, highways, dams, and sources of power generation.

The good news, fellow millennials, is that there is a remedy for our problems.

The born-frees are starting to vote and with every election, the African National Congress (ANC) comes closer to losing its absolute majority.

Other countries experience the same dynamics: whenever there is a crisis, new parties challenge the rule of the old. It is the political circle of life and sooner rather than later, we will have to discuss coalitions.

So far, the only new party that has successfully established itself is the Economic Freedom Fighters (EFF). It portrays itself as the voice of the oppressed and it certainly has kept the ANC on its toes on Marikana and Nkandla.

Unfortunately, the EFF is a party that preys on the hopes of the poor and desperate. Its policies have been tried, for example in South America, and failed miserably. Hence the EFF’s strategy is to lure South Africans into voting for it with promises it can never keep.

This is no party for future generations since, after all, spending money you don’t have on lavish promises is precisely what screwed us in the first place.

WHAT is most scary about the EFF, though, is that it satisfies a frightening number of the criteria that Umberto Eco and others use to characterise a fascist party.

Fixing the education system and resolving the infrastructure backlog requires significant transfers from the top end of the income distribution curve. Therefore, future generations cannot rely on the Democratic Alliance (DA) either. Too many of its potential voters have too much to lose for the DA to be a reliable agent of true change.

What SA needs is a new party that targets the youth. A party that unequivocally supports free education and infrastructure investment instead of short-term consumerism. That supports cost-efficient green energy instead of costly nuclear waste.

A party that believes in the ingenuity of people rather than the infallibility of the state. And a party that empowers women in a largely patriarchal society.

Impossible, you say? Consider this. Such a party will not need to win an election. All it needs is 7%-10% of the votes to make a difference and ensure that no stable government can be formed against it.

Simply the threat of having such a party will move policy in the right direction. And winning 7% when first competing in a South African election is not impossible. Look at what the Congress of the People achieved in 2009 and the EFF in 2014.

The student protests are a fertile ground for political discussion among the next generation. What we now need is the determination to seize this moment. Rather than having our future handed to us by previous generations, we must take it in our own hands and make sure the future we get is the future we want.

There has been an awakening. Have you felt it?

Zuma Shows Himself the Door

Mayhem is the only word that can describe Sunday’s shock reversal of the appointment of almost-minister of finance Desmond van Rooyen. Markets will undoubtedly welcome the move to a well-known and trusted minister of finance and the Rand already jumped for joy in the minutes following President Zuma’s announcement. As much as the nomination of Pravin Gordhan is to be welcomed, it poses a number of serious questions about President Zuma’s fitness for office.


In his statement the President writes that he has “received many representations to reconsider my decision. As a democratic government, we emphasise the importance of listening to the people and to respond to their views”, and without doubt the President will have had many representations to reconsider his decision. All he had to do was open any given South African newspaper, or read a random story on South Africa in any international newspaper. The voices were loud, clear, and unison: the dismissal of finance minister Nene was a colossal mistake. But if the President indeed cared about public opinion, as he declares in his statement, he would reverse a number of other positions as well, starting with the luxury upgrades to his private home in Nkandla or his fancy VIP jet.

The next couple of days might unveil the deeper reasons and power shifts within the ANC that lead to this shocking plot twist. But even at this early stage four points can safely be concluded.

First, and foremost, the President has lost control of his administration. Either he was ill advised before his announcement, assuming he asked anyone for advise at all. In this case he chose his advisers miserably. Or he simply ignored the advise of those around him, in which case he holds them in so low esteem that he would go against their advise on a key issue like the Treasury. Or he is easily swayed by public opinion and rectified his mistake as soon as the public outcry reached the Union Buildings. Any of the three cases is bad and shows a lack of leadership.

Second, the President has lost control of his party and will be a lame duck from now on. Usually the term “lame duck” refers to a President in the last year of his presidency. Some commentators said US President Barack Obama was a lame duck, at least until he managed to engineer a path-breaking nuclear deal with Iran and helped put together the historic Paris Agreement on climate change last week. And while President Obama shows that not all outgoing presidents need to be lame ducks, President Zuma shows that you can become a lame duck even with plenty of time on your presidential watch. The back and forth on the key Cabinet position leaves Zuma a toothless tiger. His second-sharpest weapon as President, the nomination and redeployment of Cabinet members was taken away, leaving him with only his sharpest weapon: helping his cronies to gain positions of power within government and at parastatals such as SAA and Eskom. But if his sharpest weapon were enough to keep his party in check, Desmond van Rooyen would still be the minister of finance on Monday.

Third, the Government put the South African economy in a most vulnerable position. With our glaring current account deficit, we strongly depend on the goodwill of international investors. Without their capital flows our currency plummets, the price of imports, including oil, goes up, the risk of inflation increases, and the Reserve Bank is forced to raise interest rates, curtailing lackluster economic growth even further. We have seen all this in the past couple of months already. The other side of the coin is the fiscal side. With the increase in government debt, South Africa depends on favorable ratings and benevolent investors. Neither the current account deficit nor the increasing public debt levels are necessarily bad. But if debt levels are growing because of wasteful government spending, including subsidizing incompetent management of state-owned entities and using social grants as an easy way to buy votes in rural areas, investors start getting very cautious. And this, sadly, is the path our economy is currently on.

Fourth, the removal of finance minister Nhlanhla Nene was an attack on one of South Africa’s foremost institutions. It is unlikely that Sunday’s reversal means the attack has been stopped. The ludicrous ‘project spiderweb’ documents circulating the Internet, the farce that was Hlaudi Motsoeneng’s disciplinary hearing, and the many small and large attacks on the public protector, Thuli Madonsela, speak a very clear and nasty language.

The #ZumaMustFall movement is now gathering momentum and the first marches are already organized. An online petition quickly gathered more than 100,000 votes and it is very unlikely that the re-installment of Pravin Gordhan will put the minds of South Africans at ease.

Neither should it, because it is nothing but a red herring. What this week has shown is that President Jacob Zuma is no longer fit for office. He has shown that he lacks a number of important ingredients a President needs to have in order lead a country: Good judgment, foresight, and economic finesse. Many of these shortcomings were known for years. What this week has added, however, is another key ingredient a President needs: Power.

President Zuma has shown himself to the door. Now he is standing there, unsure what to do next. It is time for South Africans to come together and give an old man a helping hand to safely make it across.

Zuma’s Haphazard Move Sign of Deeper Malaise

(Appeared on BDLive on 10 December 2015) The sacking of finance minister Nhlanhla Nene less than a week after the Treasury’s refusal to rubber-stamp the controversial restructuring of a deal between SAA and European aircraft manufacturer Airbus not only sent the Rand plummeting. It shows how little the President regards formerly sacrosanct South African institutions like the Treasury, and how little he understands of the economy. If there is one thing that international investors dislike, it is policy uncertainty. The Treasury has a reputation for being amongst South Africa’s finest institutions. It needs this reputation in order to manage market expectations credibly and to steer the South African economy successfully.

With his decision to oust finance minister Nene, President Zuma put the Treasury’s hard-earned reputation at risk.

Not because the new finance minister David VanRooyen has by no means the same experience that his predecessor had. But because it is apparent that Nene’s removal was driven by petty politics and nothing else.

Under normal circumstances a power struggle between the minister of finance and the chairperson of a government owned parastatal would be a fairly dull affair resulting in a new chairperson for the parastatal. Not so in South Africa. Here, an incompetent but politically well connected chairperson can welcome a new minister of finance into office.

Unfortunately, the haphazard move to replace the minister is no isolated incident, but part of a pattern. It is the pattern of a President who puts himself and a select group of cronies over his people and his country. It is the pattern of a President who builds himself a 247 million Rand home when so many have to live in shacks and who wants to buy a 2 billion Rand VIP jet when the countries’ students take to the streets because government has been starving the universities and students cannot pick the bill up any longer. When President Zuma says “ANC first” what he really means is “My ANC first”.

The Airbus deal SAA chairperson Dudu Myeni proposes would put SAA at an acute risk of default. And, thanks to the generous government guarantees, put taxpayers at an acute risk of having to bail them out. Such a risk might be worth taking and in an open and transparent process taxpayers could form an opinion about whether they really want to shoulder this risk. But the Airbus deal is by no means open and transparent. Much of the details that are known are only known because of the tireless efforts of investigative journalists. The whole deal smells. And smells really bad. It smells as if someone would privately benefit from an agreement that puts taxpayers at risk.

But SAA is not the only thing that stinks up the presidential rose bushes. Of even greater concern is South Africa’s nuclear bid. The President pushes South Africa silently and in secret towards a massive nuclear program with unforeseeable consequences for our environment and our economy. The details about whether or not nuclear is the cheapest options are rather gory, but there are excellent reasons to believe that a country drenched in sunshine but with an outdated power grid will be much better off with decentralized energy from solar power. However, the real worry about the nuclear program is the secrecy it is shrouded in. Where is the public consultation process? Where is the debate within our society whether we really want to produce toxic waste that will pollute the earth for Millennia? Where are the scientific studies that would inform such a debate? Minister Nene reportedly “dragged his feet” with regards to the nuclear program which might well have exacerbated President Zuma’s decision to replace him.

South Africa is in a precarious situation. Political capture of key state institutions including Treasury, the Reserve Bank, and the judical system, are arguably amongst the biggest risks looming on the horizon. The good thing about this situation is that there are remedies. Governments need checks and balances, and the most powerful of these is the risk of losing power, either to the opposition as part of a coalition. Markets would certainly be grateful if South Africans remember this lesson during the next elections.

Complexity of Regulation Limits its Effectiveness

(Appeared in Business Day on 28 October 2015) The American economist Robert L. Heilbronner, in his marvellous book “The Worldly Philosophers”, notes on the rise of socialism in the late 19th century that “capitalism has become so complex that it needed direction, but capitalists insisted on a ruinous freedom”. By regulating every aspect of economic life, including the prices of basic food, fuel, clothing, and many other products, socialism tried to provide such direction–and failed miserably. Seeing the disastrous failure of socialism everywhere and anywhere it has been tried, one cannot help but wonder just how much direction capitalism needs in order to remain manageable and ultimately yield an inclusive, fair, and equitable society.

This is the formidable challenge regulators and policy makers face nowadays. Luckily, academia can provide some input. In a stream of recent papers, economists study various aspects of complexity in financial markets.

First, and foremost, a better understanding of the term complexity is needed. What is complexity and what does it mean that capitalism has become complex? The American economist and complexity scientist W. Brian Arthur defines complexity as “the study of the consequences of interactions”. The key insight from the word study is that complexity is related to our understanding of the consequences of interactions, for example the interactions among workers competing for a scarce job, or the interactions among firms in selling a product. These interactions can be manifold and their consequences are not always straightforward. If we want to understand them, we need a certain set of cognitive skills and, in many cases, computing power.

Thus, when Heilbronner writes that capitalism has become complex, he describes a situation in which nobody has the cognitive skills or computing power required to perfectly understand the economy, including all the intricacies of markets and the production process. As Princeton economist Markus Brunnermeier, and Martin Oehmke from Columbia University point out, complexity is another word for bounded rationality, where bounded rationality describes individuals who act on insufficient information or with a cognitive bias.

Unfortunately, there are many situations in which customers have insufficient information or are biased. Buying a financial product, for example, is one such situation. When the proverbial man on the street buys a financial product, he is typically concerned with three things: how much bang he will get for his buck, how long it will take him to get this bang, and what the risk is of not getting it at all. But what if the risks were obscured in a mountain of legal Mumbo Jumbo? What if a financial product was so complex that not even a university degree in finance and law would be sufficient to fully understand it?

It turns out that banks, particularly banks in the United States, love such products. Boris Vallee from Harvard Business School and Claire Celerier from the University of Zurich study the complexity of financial retail products in an innovative new working paper. Using text analysis of the actual product description, they show that indeed the complexity of financial products has increased over the past couple of years. But not only that. They also show that this increase in complexity is more prevalent at banks with a less sophisticated investor base. Overall, their finding is consistent with banks using complexity as a way to alleviate competitive pressure. Clearly, such a behaviour is detrimental to investors. But investors are boundedly rational, they do not have the resources to fully read or understand a highly complex financial product.

From an economic perspective the banks’ behaviour constitutes an externality: consumers bear the costs of reduced competition but will not receive the best possible product.

A similar externality lay at the heart of the financial crisis of 2007/2008. Former Goldman Sachs trader Fabrice Tourre was found guilty by a Manhattan Federal District Court of defrauding investors in a scheme involving some of these highly complex financial products. He became infamous due to an email in which he wrote he would sell mortgage backed securities, a particularly complex type of financial product, to “widows and orphans”.

Externalities need to be regulated. So, as a natural reaction to the crisis, regulators have reacted in the only way they know how: by enacting more regulation. Most of these new regulations help to make the financial system more stable and resilient. But the new regulation in itself is rather complex.

In a widely acclaimed article titled “The Dog and the Frisbee”, the Bank of England’s Chief Economist Andy Haldane explores “why the type of complex regulation developed over recent decades might not just be costly and cumbersome but sub-optimal for crisis control. In financial regulation, less may be more”. Haldane points out that the sheer amount of of new regulation is mind-boggling. The first global bank regulation standard in 1988, called the Basel I accord, after the city where it was agreed upon, had about 30 pages of regulation. The successor agreement Basel II, agreed upon in 2004, already had 347 pages of regulation. The new and revised Basel III accord, which was enacted as a reaction to the financial crisis, comes in at 616 pages already.

And this complexity of the international agreements is dwarfed by the complexity of their national implementations. Conservative estimates put the national implementations of Basel III, including the Dodd-Frank Act in the United States, at tens of thousands of pages of new regulation.

From a complexity perspective, this is madness.

Banks, and in particular large international banks, can hire the army of lawyers necessary to survive in a business environment where the player with the most expertise at interpreting–and circumventing–existing regulation has a competitive edge. But think about smaller banks in emerging countries. They will clearly be at a disadvantage. It is no wonder that colleagues who were part of the Basel III negotiations later report that the new agreement was reached to no small part due to pressure from the United States. Their banks will fare particularly well in such a complex regulatory environment.

And it is not only financial regulation. What could be called “regulatory exuberance” can be found in every aspect of the economy, from environmental law to consumer protection and antitrust law. This is not to say that regulation does not serve a purpose or that every piece of regulation adds unnecessary complexity. But often more regulation means more complexity. The problem with regulatory exuberance is that it does not make regulation more effective. If anything, the opposite is the case.

In his book “The Great Degeneration: How Institutions Decay and Economies Die”, the conservative Harvard historian Niall Ferguson argues that excessively complex regulation is one of the main impediments to economic growth and one of the contributing factors of the decay of Western institutions. The lesson South Africa can learn is that we should place less emphasis on the amount of regulation and more emphasis on its effectiveness. It should be a goal of every government to reduce the amount of regulation inherited from previous governments by 10%.

Sometimes less is more. But almost always simpler is better.