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The Costly Effects of Regulatory Burdens

Analysts Johan Eklund.png around the Björn Falkenhall.png world are realizing the considerable economic costs that regulations impose. While the national budget makes public expenditures transparent, the burden that regulations impose can be hard to discern. In many countries outside the US and Canada, regulators are not even required to calculate and report the compliance and other costs that their regulations will impose on companies, consumers and citizens.

Economic theory indicates that the regulatory burden is considerable. Beyond just the direct costs that businesses incur in coming into compliance with rules, the indirect costs of regulations include raising barriers to entry into markets, harming competition and entrepreneurship, affecting production dynamics, skewing resource allocations, and reducing yields on investments. These indirect effects can hinder economic growth.
In a recent empirical analysis, we found support for many of the indirect effects predicted by economic theory. For instance, in countries that impose heavy regulatory burdens, production dynamics are poorer and the yield requirements are higher. These effects are manifested in the form of enterprises that adapt to external changes less quickly. The effects on entrepreneurship, though, are, as of yet, less clear. In addition, we found that countries that impose only light regulatory burdens exhibit more rapid growth in GDP per capita.
Cost-Benefit.jpg As there are considerable indirect economic costs of imposing a high regulatory burden, it is important for governments to scrutinize their regulations to ensure they are worthwhile. That is, the economic advantages of regulations must be shown to exceed their costs.
To determine the method for ensuring that regulatory benefits outweigh their costs, it is necessary to understand why regulations often impose higher costs than benefits in the first place.  According to the public choice school’s analysis of so-called political failures, special interests and short-term thinking hold sway over the political process, blocking effective regulations and causing over-regulation.  According to the Austrian school, while each regulation is in itself well-intended and possibly well-justified, these interventions in the market and civil society inadvertently create distortions and problems that, in turn, justify new interventions. These new interventions then justify even more new interventions, leading to a self-reinforcing spiral of additional regulation.
Left to their own devices, then, governments will seldom impose only a low regulatory burden on the economy. Governments are also not particularly likely to abolish existing regulations.
Therefore, governments should follow the lead of the US and Canada in establishing an institutional framework for designing and introducing of new regulations. Governments should require regulators to provide impact statements showing the costs and benefits of their intended regulations. They should also establish an independent body or public authority to examine critically these intended regulations and impact statements to ensure that only effective and economically profitable regulations are introduced.

Dr. Johan Eklund is a Research Fellow at the Ratio Institute in Stockholm, Sweden.  Dr. Björn Falkenhall is a Senior Analyst at the Swedish Agency for Growth Policy Analysis in Stockholm. This post draws from the authors’ report entitled “The Economic Effects of the Regulatory Burden.”

 


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