Regulating Finance

In recent years many countries have liberalized their financial markets as a central element of their efforts to reform their economies and increase their economic growth rates. Financial deregulation leads to a fundamental restructuring of a country's economy and polity, as market forces, not state officials, begin to determine who obtains financial resources and at what cost. A critical question is whether countries can undertake a program of liberalization while undergoing democratic transformation. In this study, Arvid John Lukauskas explores why governments tightly regulate their country's financial system and why they choose to liberalize it.

Using a rational choice approach, Lukauskas contends that public officials provide the dynamic behind the evolution of financial regulation as they seek to retain power and generate public revenue. Lukauskas argues that the nature of a country's political institutions shape the incentives facing politicians and influence whether they seek to regulate closely or liberalize financial markets in the pursuit of their goals. Lukauskas then tests his ideas in an in-depth case study of the evolution of financial policy in Spain, a country that transformed its financial system into a mostly market-based system after years of heavy state intervention, while undergoing a transformation from a dictatorship to a democracy. Contrary to the conventional wisdom that leaders will not undertake structural change during periods of democratization, he finds that leaders in Spain undertook financial liberalization despite opposition from powerful groups, because democratization gave Spanish leaders a strong incentive to improve economic performance through financial reform in order to compete for votes.

This book will be of interest to political scientists and economists interested in studying financial markets and the effects of regime change, including democratization, on economic reform.

Arvid John Lukauskas is Assistant Professor of Political Science, Columbia University.