Why regulations are important

When the standard is set by regulation in a large market like the EU, the United States, or China, economies of scale kick in quickly. The virtuous circle of falling prices, quality improvements, and growing demand is thereby established. This is a powerful dynamic. It explains why British businesses are increasingly appalled by the prospect that the UK government will not deliver continuing post-Brexit regulatory alignment with the EU.

The scale of the accessible market is immensely important to growth prospects. 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.

The FCA is proposing to make its regulatory sandbox method global. Moreover, there is some safeguard against complex regulatory thickets if new rules need to undergo a cost-benefit analysis. But such assessments are only incremental, whereas what is needed is a periodic assessment of the regulatory framework as a whole.

Major disasters are often the result of a failure to think in such terms, as evidenced , tragically, by the fatal Grenfell Tower fire in the UK. When they work well, democratic governments make laws to protect people from harmful things that they cannot prevent on their own. This is the basic role of good government, yet the American public hears a constant drumbeat of anti-regulatory messages from conservative politicians and think tanks and influential business organizations like the U.

Chamber of Commerce. But the arguments against sensible regulations are not valid empirically or in principle. Much evidence shows that the benefits of regulations vastly outweigh the costs. Furthermore, anti-regulatory claims rest on faulty ideas about the economy and democratic governance. For many years, the U. Office of Management and Budget has systematically studied the costs of regulation.

Looking at more than major regulations over the ten-year period ending in , it found that benefits were three to ten times greater than costs. For every regulatory agency considered, benefits exceeded costs. As the Office reported to Congress in June , the economic benefits of federal regulations totaled in the hundreds of millions of dollars over the previous decade, while the costs were a mere fraction of that total. Many other studies have also shown that regulations have little impact on employment — or else a slight positive effect on balance.

Both types of programs may claim dramatic benefits from eliminating disease, or crime, or pollution, but such claims often lack credibility and accountability. We would never allow the spending agencies to collect their own taxes from the public, in whatever amounts they feel they need. Yet regulatory agencies effectively do just that. While many regulatory costs initially fall on regulated businesses, those costs are necessarily passed on—to consumers in the form of higher prices, to employees in the form of lower wages, and to investors in the form of lower returns on investment.

For this reason, regulation can produce not only large social benefits but also large negative effects on prices, wages, business investment, and job opportunities.

As mentioned earlier, regulation functions essentially as stealth taxation. The regulatory dilemma is this: On the one hand, regulation can be critically important to our welfare. Federal and state regulatory agencies have contributed to great improvements in air and water quality, highway safety, public health, honest commerce, racial and gender equality, and many other central aspects of American life.

On the other hand, regulatory actions often have come at a cost that exceeds their benefits and sometimes actually have been counterproductive. These failures are abetted by the structure of the regulatory process: regulation operates outside our usual system of checks and balances, where policies are enacted directly by our elected representatives and disciplined by taxing and budgeting.

Regulatory agencies have too often fallen short of public expectations and disappointed public trust. Precisely because of its importance, regulation deserves constructive criticism and earnest efforts at improvement.

In the following pages, we attempt to show how regulation can be reformed to achieve its valuable goals more thoroughly, more effectively, and at lower cost.

In thinking about the real effects of regulation, it is important to understand that the special resource of the government—which private entities do not possess—is the power to coerce. Interest groups that can convince the government to use its coercive power to their benefit can profit at the expense of others.

The motivation for each of these activities is to maximize economic returns, but the unintended consequences of profit-seeking and rent-seeking differ dramatically. Ultimately, consumers receive the gains in the form of lower prices and better products. Such rent-seeking to achieve favorable regulatory treatment is a rational response to the opportunity presented by regulation, and generates concentrated gains for the successful rent seekers at the expense of everyone else.

But rather than creating new opportunities and value for consumers, such behavior leads to socially wasteful uses of resources. When regulations can provide competitive advantage, it is often in the self-interest of regulated parties to support them, 17 often hiding behind public interest arguments 18 even while other interests oppose them.

Thus, talent and energy get channeled into lobbying for favorable government treatment a zero sum game at best , rather than into entrepreneurial experimentation and innovation that leads to growth and prosperity. This leads to regulatory agencies advancing the commercial or political concerns of the most well-organized special interests which may be, but are not necessarily, regulated parties. And even where regulations are well intended, they can produce unintended negative consequences.

For example, drug regulation may delay the introduction of new, life-saving pharmaceuticals. The well-connected—those who can hire lobbyists and know the right people in Washington—can gain at the expense of ordinary citizens.

For example, large, established interest groups, such as large companies and trade associations, environmental groups, trial lawyers, unions, and state, local, and tribal governments, generally have much better access to legislators and regulatory officials, and can influence how regulations are designed and enforced. They often have Washington offices dedicated to ensuring their interests are reflected in regulations. This can disadvantage everyone else—ordinary consumers, taxpayers, workers, small businesses, the middle class, and the poor.

Businesses who ignore Washington, and just concentrate on competing for customers in the marketplace, can quickly find themselves on the losing side of trade policy, or tax policy, or some other regulatory tilt of the playing field. Large businesses also have advantages over smaller entities in that they have systems in place to handle the burdens of regulatory compliance, and can spread those costs over more employees and products.

In heavily regulated industries like medical care or consumer finance, it becomes difficult, if not impossible to be successful by attending only to the needs of consumers. Catering to the whims of the regulators can dominate other considerations. The real costs of regulation are passed on to all Americans, who are generally unaware of these costs because they are hidden in lower wages, higher prices for consumer goods and services, and fewer products and opportunities made available.

Often, those least able to represent themselves shoulder the greatest burdens. For example, many regulations lead to higher energy and transportation costs, raising product prices on almost everything we buy. These regulations may lead to some benefits, but is it really fair to ask low-income families to pay a larger share of their income for these benefits than wealthier families?

Products standards that may make sense for many may also price low income consumers out of the market entirely. Higher prices for new cars to incorporate backup cameras, for example, make them less affordable to lower income consumers who end up driving older, less safe cars longer.

Regulations in the workplace may keep the workplace safer, but they limit worker flexibility, and can dampen wages, or discourage employers from hiring less-experienced or lower-skilled workers. Lengthy drug approval processes not only increase the cost of new drugs but discourage investment in potentially life-improving products.

Consumers may face absurdly high drug prices, not because the drug is new or expensive to produce, but because it enjoys a monopoly protected by regulatory barriers. And, patients are prevented from getting access to promising products during the bureaucratic delay, even those with terminal illnesses.

Small, pioneering companies cannot afford the costs and time required to get approval of innovative new products, and often sell out to larger companies with the expertise and resources to obtain government approvals.

It is then up to the larger company whether to market the new product or crush it. This reduces competition and innovation, and ultimately increases prices. There is a growing concern that the U. Like pebbles tossed in a stream, each individual regulation may not have a significant impact, but cumulatively, they can hinder the flow of innovation and economic growth. Thus, regulators typically proceed from one regulation to the next without focusing on understanding the results of their work.

Insofar as regulators are concerned about results, the yardstick tends to be whether they are criticized by elected officials, interest groups, or judges. This is a weak feedback loop since, when citizens experience good or bad outcomes in their daily lives such as safer products or higher prices , they rarely know whether those outcomes relate to regulation or other causes.

Regulation is an essential tool for achieving broad public goals, but as we have shown, poorly designed regulations can do more harm than good. Recognizing that regulations can impose costs on entrepreneurs, workers, and consumers, the U.

As a result, they have done little to constrain regulations or ensure they are serving broad public goals. These recommendations continue the spirit of our recommendations. Unlike our recommendations in , however, we now put less emphasis on Congress doing the heavy lifting.

We also conclude that no matter who is in charge of developing and maintaining regulations, the regulations will be more supportive of the economy and the public interest—as well as more sustainable over time—if based on broadly defined, commonly agreed-upon economic principles rather than narrowly defined technical rules.

If we are to improve the regulatory policymaking process and the ultimate quality and effectiveness of the regulations themselves, we will need to determine which entities are best able to consider, construct, administer, and review regulations in ways that help businesses, the economy, and our society.

See a more detailed discussion of issues of stakeholder involvement in Appendix 4. Reorienting our approach to regulation in this way will help to achieve our goal of regulations that are better justified and regularly monitored, reevaluated, and scrutinized to be economically smarter, not just administratively simpler. Following are some valuable contributions from the recent literature.

Frantz and Instefjord 72 present an academic, theoretical paper on rules- versus principles-based financial regulation. We study the relative strengths and weaknesses of principles based and rules based systems of regulation. In the principles based systems there is clarity about the regulatory objectives but the process of reverse-engineer[ing] these objectives into meaningful compliance at the firm level is ambiguous, whereas in the rules based systems there is clarity about the compliance process but the process of forward-engineer this into regulatory objectives is also ambiguous.

The ambiguity leads to social costs, the level of which is influenced by regulatory competition. Regulatory competition leads to a race to the bottom effect which is more harmful under the principles based systems. Regulators applying principles based systems make dramatic changes in the way they regulate faced with regulatory competition, whereas regulators applying rules based systems make less dramatic changes, making principles based regulation less robust than rules based regulation.

Firms prefer a rules based system where the cost of ambiguity is borne by society rather than the firms, however, when faced with regulatory competition they are better off in principles based systems if the direct costs to firms is sufficiently small.

We discuss these effects in the light of recent observations. When we think of regulation, we think of specific rules that spell out the boundaries between what is approved and what is forbidden. I call this bright-line regulation BLR.

What I want to propose is an alternative approach, called principles-based regulation PBR. With PBR, legislation would lay out broad but well-defined principles that businesses are expected to follow. Administrative agencies would audit businesses to identify strengths and weaknesses in their systems for applying those principles, and they would punish weaknesses by imposing fines. Finally, the Department of Justice would prosecute corporate leaders who flagrantly violate principles or who are negligent in ensuring compliance with those principles.

The banks will always be savvier than the consumers and nimbler than the regulators, so bright-line regulation is bound to fail. As with any regulatory approach, principles-based regulation must be well executed in order to work.

A key element is that the principles should have clear meaning. They are just glittering generalities that offer no concrete guidance to a firm.

Businesses often use internal mission statements and lists of principles as a tool to align employees with the goals of top management. However, in many instances, the statements are so general that they have no implications for any particular way of conducting business. The truly meaningful statements of corporate philosophy are those that provide strong signals of what type of business directions the firm will and will not take.

Similarly, for PBR to work, the principles have to clarify rather than obfuscate. Legislative commentary should include specific examples of conduct that falls outside of the principles, in order to provide further guidance Principles-based regulation is not a cure-all.

There are many regulatory problems that are better addressed with bright-line regulation. For example, the algorithm for calculating the Annual Percentage Rate of interest should be standardized and clearly specified by regulators. And any regulatory system will have gaps and flaws. After all, those who design and implement regulations are as human as the people who run the businesses that they regulate. But in an increasingly complex and fast-paced market environment, there are likely to be many regulatory issues where principles-based regulation will prove to be more robust.

Burgemeestre et al. There is an ongoing debate in law and accounting about the relative merits of principle-based versus rule-based regulatory systems.

In this paper we characterize what kind of reasoning underlies the two styles of regulation. We adapt an original account of Verheij et al. The model is validated by a comparison between EU and US customs regulations intended to enhance safety and security in international trade. Black et al. It is proposing a significant shift towards reliance on broadly stated Principles rather than more detailed rules. The implications of a more Principles-based approach for regulators, those regulated by the FSA and those whose interests the regulatory regime is designed to protect are the subject of ongoing dialogue The potential benefits claimed of using Principles are that they provide flexibility, are more likely to produce behavior which fulfils the regulatory objectives, and are easier to comply with.

Detailed rules, it is often claimed, provide certainty, a clear standard of behavior and are easier to apply consistently and without retrospectivity. They explain:. Because most global companies concentrate on making their systems operate as efficiently and functional as possible, they can lack the agility and appropriate mindset to navigate and manage reputational risk and its underlying drivers with alacrity.

Compounding the challenge can be corporate dependence on rules-based compliance systems to manage risk. These are situations in which agents are motivated by incentives that reflect legal, regulatory and political constraints rather than and frequently at the expense of moral and ethical imperatives. Professor Caroline Kaeb at the University Connecticut Business School concludes that rules-based compliance systems possess far greater hidden costs that prevent maximum compliance at a level of economic efficiency.

In addition, rules-based systems often pose design challenges. Their rules are over- or under-inclusive. Therefore, they are unsustainable since global risk has become fragmented and increasingly qualitative, simultaneously Many regulatory policy experts across the political spectrum call for better review of regulations after they are put in place to get rid of stale, outdated, and inefficient regulations. The findings from ex-post, retrospective reviews could also serve to validate ex-ante assessments.

Multiple presidents from both parties and with increasing emphasis over time have pushed for greater retrospective review of regulations via executive orders. He mentions a detailed reappraisal a quintessential retrospective review of the cost and effectiveness of the rule mandating center high-mounted stop lamps on cars and light trucks, and the original prospective study that had randomly assigned vehicles to have the special stop lamps under consideration.

Orrin Hatch, Republican from Utah would establish a Retrospective Regulatory Review Commission to review and make recommendations to repeal rules or sets of rules that have been in effect more than 15 years.

Congress would approve the full package of recommendations via joint resolution. These proposals are explicitly supported by former OIRA Administrator Susan Dudley and implicitly achieve policy goals laid out by many other regulatory policy experts. Their conception is that:. The [Regulatory Improvement] [C]ommission would consist of eight members appointed by the President and Congress who, after a formal regulatory review, would submit a list of regulatory changes to Congress for an up or down vote.

Congressional approval would be required for the changes to take effect, but Congress would only be able to vote on the package as a whole without making any adjustments.

This is illustrated in Figure 6. The GAO report identified the major strategies and barriers that affect agency implementation of retrospective analyses:. Strategies: i establish a centrally coordinated review process to develop review plans; ii leverage existing regulatory activities to identify needed changes; iii use existing feedback mechanisms to identify and evaluate regulatory reforms; and iv facilitate tracking of reviews and interagency discussion and collaboration on best practices.

Agencies need to be forced to or more strongly encouraged to analyze data at regular intervals and in an impartial manner;. The regulatory system needs to better provide and align resources and incentives to undertake and enforce retrospective review. Who is responsible for designing and implementing regulations, and can that person or entity be trusted to pursue and enforce economically beneficial regulatory policy? Role clarity: An effective regulator must have clear objectives, with clear and linked functions and the mechanisms to coordinate with other relevant bodies to achieve the desired regulatory outcomes;.

Preventing undue influence and maintaining trust: It is important that regulatory decisions and functions are conducted with the upmost integrity to ensure that there is confidence in the regulatory regime.

This is even more important for ensuring the rule of law, encouraging investment and having an enabling environment for inclusive growth built on trust;. Decision making and governing body structure for independent regulators: Regulators require governance arrangements that ensure their effective functioning, preserve its regulatory integrity and deliver the regulatory objectives of its mandate;.

Accountability and transparency: Businesses and citizens expect the delivery of regulatory outcomes from government and regulatory agencies, and the proper use of public authority and resources to achieve them. Regulators are generally accountable to three groups of stakeholders: i ministers and the legislature; ii regulated entities; and iii the public;.

Engagement: Good regulators have established mechanisms for engagement with stakeholders as part of achieving their objectives.

The knowledge of regulated sectors and the businesses and citizens affected by regulatory schemes assists to regulate effectively;. Funding: The amount and source of funding for a regulator will determine its organization and operations. It should not influence the regulatory decisions and the regulator should be enabled to be impartial and efficient to achieve its objectives;. Performance evaluation: It is important that regulators are aware of the impacts of their regulatory actions and decisions.

This helps d rive improvements and enhance systems and processes internally. It also demonstrates the effectiveness of the regulator to whom it is accountable and helps to build confidence in the regulatory system. Stakeholder engagement is an important ingredient in the good governance of regulators. Steven J. Balla and Susan E.

Through this site, you can find, read, and comment on regulatory issues that are important to you. Balla and Dudley also describe how advances in internet technology and access have inspired some non-profit and academic institutions to develop their own innovative approaches to interfacing with stakeholders and the general public regarding regulatory policy. But despite the recent progress, Balla and Dudley conclude that the current state of stakeholder participation in rulemaking is mostly a one-way street.

Descriptions of regulatory policies in the pipeline are provided to the public and comments are solicited, but there is little evidence that feedback collected via public comment is systematically accounted for in actual decision making:.

Our review demonstrates that there are extensive opportunities for stakeholder participation at all stages of the regulatory process. These opportunities, however, are typically oriented toward facilitating the provision of information on the part of stakeholders.

Susan E. Edward Aiden, Bernard L.