Self-Governance in the Emergence of Financial Markets

The common perception is that complicated financial instruments require state sanction to emerge. It is argued that in the absence of state regulation of financial markets, cheating will be common. We argue that the evidence does not support this pessimistic view. In fact, markets are capable of generating endogenously the rules that govern their operation and these rules discipline cheating severely. Finally, if we can persuasively argue that self-governance in financial markets is effective - with the complicated nature of transactions that take place - then the argument for self-governance in economic life, we contend, is much stronger than even economic liberalism has led us to believe. As a foil for this study we will critically examine the work of Timothy Frye (2000) on the financial exchanges in the Russian transition economy. Frye’s work represents a significant step forward in the literature on financial markets in transition economies. Many studies prior to Frye insisted that institutions of corporate governance needed to exist prior to the introduction of privatization and that the rules which defined these institutions of corporate governance were the appropriate domain of the state (Frydman and Rapaczynski, 1994). Without an activist state establishing the framework, and regulating the practices, corporate governance will be ineffective and the market economy will be littered with opportunism and inefficient organizations. Frye does much to dispel this argument. But, despite Frye’s advances over the previous literature, we will argue that his introduction of political actors into the discussion of the mechanics of self-governance ultimately confuses the issue