Regulations can come at a cost.
Overregulation is a bane of business, but unfettered capitalism also has its problems. So how can regulators achieve what’s needed for both the public good and private enterprise?
Governments love to tweak rules and regulations as they seek to impose political ideologies or drive social and economic outcomes.
From taxes targeting climate change to workplace health and safety, and rules around financial services, there’s usually some form of legislative change in the wind.
But such reforms can come at a cost. Business leaders often complain that constant regulatory change creates confusion and weighs down their operations.
Governments try to promote the benefits of their regulatory changes through cost-benefit analyses, but many business leaders remain sceptical.
While it is hard to put an exact figure on regulatory costs, in the US the Small Business Administration’s Office of Advocacy has at least tried, declaring that the total annual cost of federal regulations to the US economy alone is about US$1.75 trillion.
To assess the burden of changing government regulation and ways to better manage the implementation of rules, INTHEBLACK canvasses the views of three experts.
Financial Services Policy Leader
International Organization of Securities Commissions
A labyrinth of rules and regulations around the world imposes a high cost on many businesses, according to David Wright, the secretary-general of the International Organization of Securities Commissions (IOSCO).
The respected financial services policy expert, who urges a more uniform approach to regulation, says business deserves as much clarity and consistency as possible.
“I don’t think it is fair or right that business should face unnecessary multiple different rules around the world,” Wright says.
“That to me is regulatory deadweight loss.”
What it also does is potentially stifle competition and favour bigger firms and companies with the human resources scale to offset such a regulatory burden.
“They can manage their way around that,” Wright says.
“The big firms have got the resources to buy the best lawyers and the best accountants and auditors and so forth. The small ones can’t. They give up because it’s just too complex.”
Not that Wright is anti-regulation. In his role at IOSCO, he oversees an institution that brings together the world’s securities regulators and works intensively to improve the global regulatory reform agenda. The key, he suggests, is to have transparent, considered regulation.
“Regulation should not be there for regulation’s sake, but it should be there to regulate activity on the basis of a clear definition of what the problem is, a clear definition of what the public interest is, where there’s a market failure, and it should respond adequately to all of that.”
"I don’t think it is fair or right that business should face unnecessary multiple different rules around the world."
Although he agrees that cost-benefit analysis of regulation is a necessary discipline, Wright warns that such forecasting is “not an exact science”.
But measures can be taken to improve the design of regulation and its impact – taking a consultative approach in the design phase; checking implementation processes; carrying out rigorous impact analysis; and allowing sufficient time to implement laws.
“The quicker you want to make changes in the law or regulation, in general the costlier it will be because for firms it’s very expensive to change quickly in the short term,” Wright says. “But sometimes, for systemic reasons, it is necessary.”
He also contends that it would be beneficial for countries to agree on a common timetable for bringing in capital markets regulation around the world, arguing that business simply moves to the jurisdiction where the regulation is “lightest” if different rules apply. This can, in turn, distort markets.
A fan of institutions such as the World Trade Organization, Wright says financial markets could benefit from a global body, established by international treaty, with enforcement authority and powers to apply sanctions and settle disputes.
While he supports a lighter regulatory touch where possible, he says that seven years on from the global financial crisis there is still work to be done to create confidence in financial markets. Banks and businesses, he says, can often be their own worst enemy.
“Every time that we see these Libor [interest rate fraud] scandals or mis-selling scandals, this just ramps up the pressure on regulators to get tougher and tougher.”
When it comes to regulation, Wright is an advocate of the Japanese philosophy of kaizen, or continuous improvement.
“You never make a perfect law,” he says. “Markets change, so you need to continually adapt your laws and regulations – but not too often either.”
David Wright is the secretary-general of the International Organization of Securities Commissions, the global standard setter for the securities sector. He was a member of the European Commission’s Task Force on Greece.
Federal Reserve Bank of Dallas
As a former naval academy midshipman, Richard Fisher understands the need for rules and markers to keep things on the right course. However, he argues that “hyper-regulation” in American states such as California is stalling business at a time when most central banks around the world have made money abundantly available for private and publicly held corporations to use.
“They have just been unwilling to step on the accelerator to engage that gas and pump it into the engine and move the economy forward,” Fisher says.
Although frustrated by Congress’s inability to make tough decisions on the economy, he says “the other inhibitor has been the growth in regulation”.
The US has been on a regulatory binge, says Fisher, using the ever-burgeoning Federal Register as his exhibit A. This daily federal government digest has been published since 1936 and lists government agency rules, proposed rules and public notices. First published with a total of 2620 pages, today it has about 80,000.
“There’s an amazing amount of regulation that business has to pay attention to, and some members of Congress will say that we are talking about over a million and maybe millions of [work] hours a year just to comply with regulation.”
The rest of the US could learn from Texas, says Fisher. He describes his home state as a huge jobs machine – with business-friendly policies and fewer local and state regulations – that has attracted enterprises from California and other “over-regulated” states such as New York, Michigan and Illinois.
Despite having the same monetary policy, interest rates and banking regulations, Texas is outperforming other states, with Fisher quipping that a “Texified economy rather than a Californicated economy does a lot better”.
"The rest of the US could learn from Texas."
Yet smart rules and regulations still have their place. Take the law that the government of Texas passed almost 20 years ago preventing people from borrowing more than 80 per cent of the fair market value of a home.
Other states did not follow suit, and they paid a hefty price during the subprime mortgage crisis.
“We didn’t have a housing crisis in Texas, but the rest of the nation went under the tank,” Fisher observes.
“So there is room for positive regulation.”
An MBA graduate from Stanford University, Fisher says that business students are taught from day one that good business is about strong decision-making that seeks to reduce uncertainty.
“But there is increasing uncertainty about rules and regulations that have been passed.”
So what is the cost of all this red tape and regulation?
“I don’t know what the number is,” says Fisher.
“We have almost a US$15 trillion economy in the US and all I can say is that whatever the number is, it’s large and it’s a deterrent.”
Richard Fisher is president and CEO of the Federal Reserve Bank of Dallas, and was assistant to the Secretary of the Treasury during the Carter Administration.
Governance and Change Management Expert
Evans & Peck
Rules and regulations are valuable tools that can deliver significant benefits to business and society, according to Peter Achterstraat, a former New South Wales auditor-general.
But like any tools, they may impose burdens and costs, especially when they are changed or modified in an unplanned way.
Achterstraat says the first thing that must be considered in any regulation is its goal. If it is meant to force a certain response or behaviour – for example, stopping the public from illegally disposing of rubbish – it’s a good idea to work out if there may be a better way of managing the issue.
“Could incentives for recycling be better than imposing fines?” he asks.
“Would a carrot be better than a stick?”
While it is relatively easy for public servants to change laws and regulations at the behest of government, not exploring other possible actions that could achieve the same result can come at a cost to an administration and its taxpayers, says Achterstraat.
Government should recognise that changes to business rules will inevitably lead to more paperwork, downtime and a need for additional training.
What is essential with any regulation is providing certainty so that business leaders know what to expect from new rules or legislation and how they should respond, says Achterstraat. He notes that the lead-up to state and federal elections often creates a window of regulatory uncertainty that stalls economic activity – hurting government, business and the community.
“When there’s uncertainty, people don’t invest. And if we keep changing the regulations too often – just to tinker at the edges – it’s counter-productive.”
To help achieve desired outcomes, Achterstraat suggests involving relevant government, institutional, business and public representatives in crafting regulations. That increases the prospects of designing good rules and getting greater compliance.
“So we need ownership of the new regulation and a good way to get that is to get as many appropriate people as possible designing the regulation,” he says.
"There needs to be a lot more analysis after the event."
As part of a broad cost-benefit analysis of regulation, Achterstraat also advises having a mandatory post-implementation appraisal to find out if the changes have hit the mark.
Which rules had a positive impact? Which ones drew the most complaints and a high rate of non-compliance? Was such dissent because of ignorance? Or did people make a conscious decision that a fine would be cheaper than the cost of compliance?
“This analysis would help government then design better regulation that might achieve the desired end,” Achterstraat says.
“There needs to be a lot more analysis after the event. People tend to do a lot of work at the theoretical stage, up front, but there’s not as much follow-up later when empirical evidence can be found.”
He believes achieving the right regulatory balance can make or break entities, especially smaller businesses with fewer resources.
“If we have regulation that is too stringent, then we’re going to lose our competitiveness and our productivity against other countries.”
He also warns that the cost of poor regulation goes beyond monetary outcomes.
“Excessive regulation not only has a financial effect – it also has a motivational detriment if people think it’s going to cost too much, and also if they can’t see a purpose with it.”
Peter Achterstraat is a principal in the Sydney office of Evans & Peck and an adjunct professor at the University of Sydney’s Graduate School of Government.
Smart regulation can deliver business and social benefits
Business wants clear and consistent regulation
Consultation with all affected parties is essential for good regulation
An analysis of the effect of regulatory changes after their implementation – to assess if they worked – can feed into better regulation in the future
Agree or disagree? Post your comments below.
This article is from the September 2014 issue of INTHEBLACK magazine.