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13
THE RULES OF THE GAME AND THE DEVELOPMENT OF
SECURITY MARKETS
Franco Modigliani and Enrico Perotti
Introduction
Rationales for economic legislation
An important contribution of economic theory has been the elaboration of a normative
theory of economic policy. While positive economic theory explores the
implications of individually rational behavior, normative economic analysis concerns
desirable allocations from a social point of view, with the purpose of defining
principles to guide economic policy. 1
A well-recognized purpose of economic legislation is to limit market failure,
or at least to attenuate its consequences. Macroeconomic policy and microeconomic
regulation are instruments to correct circumstances in which uncoordinated
private agents fail to achieve efficient outcomes through market transactions.
Examples are the containment of monopoly power and the regulation of externalities;
the residual risk function of certain institutions, such as the lender of last
resort; or finally, macroeconomic stabilization policy in the face of monetary disturbances
or excessive wage rigidity.
Equally important, the legal rule absolves also the primary purpose of facilitating
private arrangements by offering an impartial enforcement mechanism.
This ensures that individuals can bind themselves contractually to efficient
actions, so that all potential gains from trade are realized.
The former function has been dubbed the Hobbes Principle, referring to
Hobbes’ mistrust of the capacity of individuals to behave cooperatively in the
absence of coercion; and the latter the Coase Principle, concerning the opposite
belief that private bargaining, in the absence of transaction costs, can achieve efficient
allocations (Cootner and Ulen, 1988). 2
Reprinted from Pacific-Basin Capital Markets Research 2 (1991), 49–63, with permission from
Elsevier Science.