Kunal and Gaurav are right. In this post, I was talking of the trade-off between rules and principles in policy enforcement. Actually, when you think of it, rules vs. principles is not a simple dichotomy, but a spectrum of choices.
Imagine that these choices are spread from left to right. At the left end of the spectrum is automation. Rules are enforced automatically, without anyone having the responsibility of enforcing them. The best example of automation in my stories was actually the turnstile – it automated the task of checking for tickets, leaving very little scope for discretion.
Another example is the jugad “automation” that the Hyderabad police enforced. Blocking off the right turn doesn’t seem like an example of automation, but for our purposes, it is, because it enforced the rules without the police having to intervene.
To the right of automation come rules – clear and transparent rules that leave no scope of discretion to the enforcers. But then, whether to follow the rule or not is still a choice – and ensuring that officials enforce the rule depends on the existence of procedural mechanisms.
As you move further to the right, you find that the rules have more and more discretion embedded in them. For example, consider the difference between enforcing a red light and ticketing someone for rash driving. The former is easier to enforce fairly than the latter.
At the extreme right of the spectrum is the idea of “principles-based regulation”. This distinction between rule-based regulation and principles-based regulation is used most often in the financial sector, so let me use an example from Banking to illustrate.
“Yes, you can lend money as many times as you wish, but what interest do you charge for the money?” The cabbie asked.
“Well, I charge whatever I can get. ”
“In the beginning, it was quite high. There had been no development in the village for years. I checked out the first entrepreneur’s business proposal and saw that his factory, because it would be the first factory to produce whatever it was producing, would make obscene profits. So I adjusted my cut accordingly.”
“What happened then?”
Long long ago, nestled among the mountains, there was a village perfectly isolated from the rest of civilization. Its inhabitants led a hand to mouth existence. Because this village always behaved according to our macroeconomic models, it was called “The Model”.
Now, in The Model, villagers used gold coins, and only gold coins for trading. They used gold for nothing else. The total number of gold coins in The Model was fixed.
But gold coins were cumbersome to lug around and exchange with each other. So one day, a wise villager named Arjun Banker (or AB for short) made them an offer. He told them to deposit all their gold coins with him. He would maintain their titles to the gold coins. Whenever they wished to make a transaction, they could inform him and he would transfer the titles to the gold as needed.
I am writing a series of posts that will tell you everything you need about the banking system and about how money works. It will be simple to understand because I am not a real economist. First post will be up on Monday morning.
Anonymous Coward wants to know what exactly is wrong with the logic in the paragraph I linked to below. Let me explain:
Rothbard claims that when I open a current or savings account with the bank (“checking account” or “demand deposit” for you Americans) the bank is implicitly promising to keep the money locked up in its vault, which means that lending it out constitutes fraud. I don’t see how that makes sense. The bank is only promising to pay me my money on demand. How it manages to do it is the bank’s business.
A demand has arisen in some quarters that I explain what exactly I find objectionable in Rothbard’s article criticising Fractional Reserve Banking. I don’t want to spoonfeed my readers, so I will point out the paragraph where all his errors are concentrated. Readers are invited to point out specific errors: