In recent times, across virtually all manufacturing sectors, the cost of regulatory compliance has been a cause célèbre. The volume of the hubbub has risen naturally as the regulatory environment has become more demanding, in part because of the rise of globalization; but the pitch of the argument has always focused on direct compliance costs. The fact is that the indirect costs of regulation may be the most taxing on business.
At the outset of this decade, the Swedish Agency for Growth Policy Analysis conducted a study of the impact of regulation on companies that makes this patently clear. Four kinds of costs associated with “regulatory failures” were distinguished:
- Regulations that protect companies from competition
- Regulations that protect companies from growing and exploiting new markets
- Regulations that generate excessively high compliance costs for both companies and government
- Regulations that contribute to companies becoming less capable of responding to technological change or consumers’ needs
“Items 1, 2, and 4 gave rise to indirect dynamic effects that negatively effect companies’ entrance, investment, and production dynamics, which leads to poorer economic growth,” notes the study. The overall conclusion of the analysis is that the indirect economic costs that ensue from a heavy regulatory burden on a country’s enterprises are considerable, and probably more important than those related to the direct costs of compliance (item 3).
Among the evidence accrued in the study:
- A heavy regulatory burden negatively impacts the entry of new companies into the market, thereby reducing competitive pressure and driving down entrepreneurship.
- Significant negative effects on production dynamics arise in connection with regulations impacting a business’ ability to adapt, causing friction that drives down a company’s market agility, which in turn leads to allocation losses.
- Yield requirements increase as the regulatory burden increases, the result of which has a negative impact on investment.
- Production dynamics are lower and yield requirements higher in countries that have a relatively heavy regulatory burden.
- Countries with a light regulatory burden show more rapid economic growth in GDP per capita.
Because these indirect effects are so significant, any new regulations should be considered carefully, and must be considered effective and appropriate.
The study notes several reasons why ineffective rules are introduced, and the insidious effect of such introduction:
According to the so-called “public choice” theory, the political process is extensively influenced by special interests and shortsightedness, which leads to ineffective rules and overregulation. Similarly, these well-organized groups block changes in the rules that disadvantage them, often in alliance with the public officials who administer the rules. Another reason may be that each regulation is well intended and motivated, but the intervention in the market creates distortions, which in turn motivates new intervention.
The circle of regulation can indeed be vicious, and much more dear than the cost of compliance alone.