Friday, July 1, 2016

Regulations Kill Innovation and Growth

Regulations Kill Innovation and Growth

Herbert Grubel
Professor of Economics (Emeritus)
Simon Fraser University

Published in the Financial Post, April 5, 2016

A group of innovators in British Columbia uses organic waste from the many hothouses in the province to feed insect larvae, which they then compress into bricks and sell as feed to fish farms — a more sustainable food source than the fish pellets widely used now. Sales are growing in the U.S., but they can’t sell their product in Canada. After four years in the federal regulatory process, they still have no licence.

A B.C. physician developed a cream that reduces chronic aches and pains. It uses a mixture of natural ingredients readily and legally available, and all considered safe by Health Canada. She’s done rigorous trials showing the effectiveness of the cream in one application, the results of which have been published in a peer-reviewed journal. She has had good results in relieving other types of pain but is not allowed to sell the cream for these applications until she has carried out further expensive and time-consuming trials that satisfy the regulators.

Anyone who has watched CBC’s Dragon Den knows that many innovators struggle financially.  Meeting the demands of the regulatory agencies adds to this struggle and kills many projects. The continual growth in regulations may be one reason why economic growth in Canada is stagnating. Canadian governments use subsidies and tax breaks to encourage innovation because it increases employment, incomes and tax revenues. At the same time, these governments discourage innovation through extensive regulation, as illustrated by the above examples. 

How big are the economic costs of regulation? We have a good idea of the cost of regulations that affect existing economic activities. A recent study based on surveys of firms by the Canadian Federation of Independent Business estimates the annual cost of regulatory compliance at about $31 billion. For small businesses that’s an average cost of $5,942 per employee every year. These estimates provide some insights into the likely cost due to the reduction or prevention of innovative activities, which has not been calculated because there are no records of innovations that never came to market.

There is no doubt that many regulations bring economic and social benefits, like those that order us to drive on the right side of the road, ensure scales record a pound correctly and incarcerate counterfeiters. Less certain are the economic gains from so many regulations that govern the safety and effectiveness of consumer products rather than leaving this determination to consumers and private firms. Even more uncertain are the gains from regulations aimed at reducing financial market crises, which have a very poor record. Regulations to prevent global warming are of questionable value given the uncertainty that it is caused by humans.

In principle, governments should pass regulations only if benefits exceed costs. Yet all estimates of costs and benefits are uncertain and civil servants have to rely on personal judgments in the design and approval of regulations. This would not matter if these individuals could be counted on to be unbiased in their judgements.

Unfortunately, civil servants as well as their political bosses are subject to incentives that bias their decision in favour of overregulation. If the sale of a given product they have approved causes consumers harm, they will be blamed and their careers paths suffer. If they unnecessarily regulate a product, their incomes and careers are safe. Making matters worse is that regulatory agencies tend to be staffed by individuals who believe consumers must be protected from greedy capitalists who put profits ahead of public safety. As a result, it is very likely that the regulation of innovative products has costs greater than benefits.

There are no simple or obvious solutions to eliminate the biases leading to over-regulation. Past efforts by many governments around the world have ultimately failed because these biases cannot be avoided, though public opinion mobilized by knowledge of the cost of regulation can encourage governments to at least slow the growth of new regulations and demand the abandonment of those that have outlived their usefulness.

However, there is also the idea that the level and growth in regulation are proper. Government regulations provide insurance against risks of unemployment, sickness, defective or ineffective products, pollution, global warming and terrorism. The public demands these regulations and believes it can afford them. It can be argued that Canada has reached the age of “insurance,” equivalent to the earlier ages of agriculture, manufacturing and services. That idea is worth considering in discussions about the costs and benefits of regulation.



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