Question

To regulate or not to regulate: what are the economic benefits and costs of public policy regulation versus private sector self-regulation?

Answer 1

Regulatory requirements to protect the environment, workers, and consumers often lead to innovation, increased productivity, and new businesses and jobs. Although an argument is sometimes made that the cost of complying with regulations is too high, that the societal benefits do not justify the investment, or that job losses will result, a review of past regulations reveals just the opposite. Historically, compliance costs have been less and benefits greater than industry predictions, and regulation typically poses little challenge to economic competitiveness.

Recent rule-making, including regulations that curb carbon emissions and foster clean energy investments, are facing opposition from utilities. As public comments on these proposed rules are reviewed, it is instructive to look back at industry projections and compare them to the documented impacts and benefits of previous regulatory measures.

Regulation can also benefit an economy by enabling competition. This seems counter-intuitive, and indeed some forms of regulation serve to enable rent-seeking behavior. Businesses in oligopolistic sectors often complain about the burden of compliance; but they clearly rely on regulation as a barrier to market entry by new competitors. The cost of their regulatory burden is a fee they pay for market power.

The regulation of some of these sectors, like finance, is an example of what not to do. Officials imagine that consumer protection requires another regulation whenever something goes wrong, resulting in thickets of rules that protect incumbents and lead to all kinds of unintended consequences and complexities. As the new regulations prove ineffective (not surprising, given the overabundance of scams and mis-selling in finance), a vicious circle is set in motion, with additional regulation resulting in further failure – and more regulation

In new sectors, or those with a real possibility of new entrants with new technologies, regulation actually helps to create a market. For example, by removing information asymmetries about innovative products – asymmetries that are larger the more technologically advanced the products – regulation facilitates a level playing field between large incumbents and new entrants, enabling innovation to take root. And by providing assurances about the safety or effectiveness of new products and services, and setting minimum mandated standards, regulation gives consumers the confidence to try something new.

The third way in which regulation is good for an economy is precisely in its protection of consumers. If this means businesses earn a lower short-term profit, so be it. A society’s welfare is not identical with the profitability of its businesses, or with the growth rate of GDP. In the CBI’s conversations about post-Brexit regulation, the sectors most interested in regulatory divergence were waste and environmental services and water. Tough EU environmental standards impose high costs on these businesses, which might mean they grow more slowly than they otherwise would. But it is well known that GDP growth does not account for environmental externalities.