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Economic analysis from the European Commission’s Directorate-General for Economic and Financial Affairs
Volume III, Issue 7
29.06.2006
ECFIN COUNTRY FOCUS
Highlights in
this issue:
• Good
regulation
enhances
market
flexibility.
Poor
regulation
undermines
productivity
• The UK's
regulatory
burden is
generally
rather low,
although not in
specific areas
• Other
countries now
appear to be
lightening their
regulatory
burdens faster
than the UK
Regulation in the UK: is it getting too heavy?
John Sheehy*
Summary
Some regulation is needed to enhance growth and economic welfare, but too much
undermines productivity. Generally, the UK seems lightly regulated, especially in its
international transactions, and it has a public enterprise sector small in both size and
scope. Yet British business has become more critical of the regulatory burden it
faces, and work done for the government identifies areas of excessive regulatory
burden. The UK seems to interfere directly in the control of some business
enterprises more than the EU average, seems to "gold plate" EU legislation, and
seems to be obliging SMEs to spend more and more time dealing with regulations.
But perhaps the primary cause of growing British business criticism could be that
regulation in the UK is generally not now so much lighter relative to other Member
States or other developed economies as it used to be. If the lightness of the UK's
regulatory burden was a competitive advantage for British business in the past, in
recent years other countries appear to have been lightening their regulatory burdens
faster than the UK, significantly eroding that advantage; this could also perhaps
partially explain why the UK is no longer closing its productivity gap on other
advanced countries.
What risk does heavy regulation pose?
Regulations are rules which government bodies use to implement specific laws and
general objectives; they consist of specific standards or instructions concerning what
can or cannot be done by individuals, businesses, and other organisations.
Regulations establish the rules governing all aspects of economic activity, notably
market competition, business conduct, the labour market, consumer protection,
public health and safety, and the environment.
According to the OECD (2005), regulations are "perhaps the most pervasive form of
state intervention in economic activity" but are "essential for the good working of
market economies". Unhindered markets can suffer from problems of monopoly or
externalities, problems which governments may be able to correct by regulating.
For example, government can set regulations to maintain health and safety
standards or, in an industry subject to increasing returns, to prevent the resulting
natural monopoly from exploiting its market power. A sound regulatory regime that
reduces risk and bolsters market credibility may be essential to the attraction of
investment and business. Regulating property rights and competition and natural
monopolies can boost efficient economic activity, enhancing economic growth and
welfare.
* Directorate for the Economies of the Member States.
The views expressed in the ECFIN Country Focus belong to the authors only and do not necessarily correspond to those of
the Directorate-General for Economic and Financial Affairs or the European Commission.
If regulation is not
done well, it can
be very damaging
However, too much regulation can undermine productivity performance. Even
regulations introduced for sound economic reasons may be excessive and entail
compliance costs that exceed any possible benefits; alternatively, regulations may
be badly designed. In either case, the regulatory outcome will be inefficient. And
when regulations are introduced as a result of regulatory capture, they are almost
inevitably costly. Regulations which curb competition and private governance are
likely to have a negative effect on productivity by slowing down technological catchup to best-practice technologies or impact negatively on employment creation.
The UK government recognise the challenge posed by regulation. They consider
regulatory reform a key source of product, capital and, especially, labour market
flexibility. Market flexibility is one of the five economic tests the UK Treasury applies
to determine whether the UK should adopt the euro. In 2003, they concluded that
markets in the UK and the rest of the EU were insufficiently flexible.
British business is very critical of the UK's regulatory burden
British business is
very critical of
growing "red tape"
Analysis for the
government has
identified
regulatory
burdens
British business has become noticeably more vocal in criticising the degree of
regulation in the UK. As the UK Parliament's Select Committee on Trade and
Industry remarked in the introduction to their March 2005 report (House of
Commons, 2005), business organisations have undertaken constant public
campaigns against what they see as the increasing tide of regulation which is
constraining their ability to deploy their workforce in a flexible manner. According to
Ambler et al (2006), the cumulative cost (net of benefits to business) of regulations
to UK business introduced since 1998 has grown by £50bn (approximately 5% of
GDP), of which 86% in 2004/05 stemmed from EU legislation. However, business
believes that much of the transposition of EU law into UK law is unnecessarily "gold
plated" – i.e., more regulation being used to implement an EU directive than
required (e.g., to widen the scope or add to the substantive requirement). Deloitte &
Touche (2005), surveying British business opinion about the attractiveness of the
UK as a location to do business, found that the balance of opinion on the evolution
of regulation over the past five years was significantly negative. A separate survey
of SMEs in 2005 by the Federation of Small Businesses (2006) revealed that 56% of
respondents had had to increase the time they spent dealing with legislative
requirements.
Work for the government has tended to corroborate businesses' view. The 2005
Hampton Review (Hampton, 2005), set up by the Chancellor of the Exchequer,
concluded that the regulatory system … as a whole is uncoordinated and good
practice is not uniform. There are overlaps in regulators’ responsibilities and
enforcement activities. There are too many forms, and too many duplicated
information requests (p.1). Meanwhile, the 2005 Arculus Report (Arculus, 2005),
delivered at the Prime Minister's request, concluded that the total annual cost of
regulation to the UK economy in 2005 was over £100 billion (or between 10% and
12% of GDP), approximately equivalent to the UK Treasury's annual income tax
receipts, and that the UK could "considerably reduce the regulatory burden on
business".
Yet the evidence suggests that, overall, UK levels of regulation
are actually relatively light
Yet, compared to
many countries in
the OECD and the
EU, the UK is
relatively lightly
regulated
ECFIN Country Focus
At first sight, the complaints by British business about increasing regulatory burdens
in the UK seem puzzling. According to the OECD (2005) indicators of Product
Market Regulation (PMR), the degree of product market regulation in the UK in 2003
was significantly lighter than the EU (and the OECD) average. According to the
OECD database, overall, the UK was the second lightest regulated economy in the
OECD, and the lightest EU Member State. Chart 1 shows that the UK's regulation
of its UK trade and foreign investment relations with the rest of the world is
especially light (the OECD's index of restrictiveness ranges from 0 - no regulation to 6 - maximum restrictiveness), lighter than its regulation of its domestic economy.
Nonetheless, the UK regulates its domestic economy significantly more lightly than
do other EU Member States.
Volume III, Issue 7
Page 2
Chart 1: Intensity of competition-reducing regulation
2.0
Index of restrictiveness
1.8
1.6
1.4
1.2
1.0
0.8
0.6
0.4
0.2
0.0
Product market
regulation
Inw ard-oriented
policies
UK
Outw ard-oriented
policies
EU
Source: OECD (2005)
The UK regulates
entrepreneurship
particularly lightly
The OECD divides its high level indicator of regulatory activity in the domestic
economy into two: (1) the degree of state control and (2) barriers to entrepreneurial
activity. Chart 2 shows that entrepreneurial activity, in particular, is very lightly
regulated in the UK compared to the rest of the EU.
Chart 2: State control and barriers to entrepreneurship, 2003
Index of restrictiveness
2.5
2.0
1.5
1.0
0.5
0.0
State control
Barriers to entrepreneurship
UK
EU
Source: OECD (2005)
Box: OECD database
The OECD's indicators of Product Market Regulation (PMR) were first developed in
1998 (OECD, 2000) to measure the extent to which regulations in individual OECD
countries reduced the potential intensity of competition in areas of the product
market where competition is viable. The indicators summarise a large set of formal
rules and regulations affecting competition in OECD countries. Answers to a
questionnaire sent to OECD Member governments are the principal source of
regulatory data used by the indicators. The PMR indicators summarise information
on 139 economy-wide or industry-specific regulatory provisions, the bulk of the
information coming from country responses to the questionnaire. Nevertheless, the
database, good as it is, is still limited. For example, it excludes environmental and
health and safety regulations.
The indicators are divided into three levels: low, medium and high. First, 16 low
level indicators are calculated from the responses generated by the questionnaire by
appropriately assigning responses with a numerical value over a scale of zero to six
and weighting them for aggregation purposes. The low level indicators are then
further aggregated using another weighting scheme to produce fewer, more general
"medium-level" indicators.
Finally, further aggregation of the medium level
indicators produces an even smaller set of "higher level" indicators. The supreme
high level indicator attempts to summarise all the information gleaned from the
questionnaires into a single overall indicator of product market regulation.
ECFIN Country Focus
Volume III, Issue 7
Page 3
And the government is very active about regulatory reform
The British
government takes
regulatory reform
very seriously
The government puts great store by regulatory simplification and deregulation. To
that end, it introduced to Parliament in January 2006, the Legislative and Regulatory
Reform Bill. The Bill aims to make it quicker and easier to tackle unnecessary or
over-complicated regulation and help bring about a risk-based approach to
regulation. Should it become law, the Bill will deliver a number of wide-scale
reforms announced in the May 2005 Better Regulation Action Plan, which itself
follows a number of Action Plans for Regulatory Reform. The government's
regulatory reform commitment can be seen in its institutional arrangements; at the
heart of government, in the Cabinet Office, is the Better Regulation Executive which
works to reduce and remove unnecessary regulation right across government.
There is a Better Regulation Commission which conducts in-depth reviews of
different aspects of regulation in order to find ways to lessen regulatory burdens.
Inside government Departments, there are trained Better Regulation Units to advise
policy-makers. Departments have to carry out regulatory Impact Assessments
(RIAs) on all policy changes and these RIAs are then, themselves, regularly
scrutinised by the Better Regulation Commission and the National Audit Office.
There have also been a number of important in-depth reports on regulation in the
UK under the current government: two notable examples mentioned already are the
Hampton Review and the Arculus Report.
Nevertheless, in specific areas of regulation, the UK is not always
the most lightly regulated country
In some specific
areas, the UK
regulates
relatively heavily
and may also
unnecessarily
"gold plate" EU
legislation
The UK government, according to the OECD, seems to interfere relatively heavily in
business enterprises, more apparently than other EU governments (see Chart 3).
Apparently, the UK's public authorities possess special voting rights over businesses
in which they have shares that are more generous than in other countries. Similarly,
in some sectors of the economy, the UK's regulatory touch is not the lightest.
According to a study done for the Commission services by Copenhagen Economics,
in 2004 the UK's regulation of its retail sector was heavier than in at least five other
Member States. The OECD comes up with a similar finding, estimating that in 2003
the UK was the fourth ranked Member State in the EU for the intensity of its
regulation covering road transport and retail distribution. The OECD also finds the
UK's regulation of fixed and mobile telecommunications to be relatively heavier than
a number of other Member States. As for European legislation, Ambler et al (2004)
find that when the UK transposes an EU directive, on average it will "gold plate" the
directive by more than tripling the amount of words used compared to the English
language version of the original EU directive.
Chart 3: Specific levers of state control
Index of restrictiveness (2003)
3.5
3.0
2.5
2.0
1.5
1.0
0.5
0.0
Scope of public
enterprise sector
Size of public
enterprise sector
Direct control over Use of command &
business
control regulation
enterprise
UK
Price controls
EU
Source: OECD (2005)
ECFIN Country Focus
Volume III, Issue 7
Page 4
And the UK is generally not as lightly regulated relative to other
advanced industrial countries as it used to be
In recent years,
other countries
appear to have
reduced the
burden of their
regulatory regimes
faster than the UK
While the UK continues to try to lighten the restrictiveness of its regulatory burdens,
other Member States have also been busy. Chart 4 shows how Member States'
degree of product market regulation has changed between 1998 and 2003.
Countries to the right of the dotted line have reduced the burden of their product
market regulation over that period. All Member States are to the right of the dotted
line, which means that all Member States covered by the OECD, including the UK,
have reduced their levels of product market regulation. However, most Member
States are further away from the dotted line than the UK meaning that not only have
the UK's EU partners generally reduced the restrictiveness of their overall product
market regulation faster than the UK, some - notably Denmark, Sweden and Finland
- have very nearly caught it up. This could be a factor behind the UK's recent
disappointing productivity growth slowdown and inability to close its productivity
gaps with other advanced economies.
Chart 4: Restrictiveness of economy-wide product market regulation
4.0
2003
EU15 average
3.5
3.0
PL
2.5
HU
2.0
EU15 average
1.5
IE
DK
1.0
NL
AT
FR
PT
DE
SE
BE
FIN
IT
EL
CZ
ES
UK
0.5
1998
0.0
0.0
0.5
1.0
1.5
2.0
2.5
3.0
3.5
4.0
Source: OECD (2006)
However, the best
available evidence
on regulatory
burdens may not
do justice to
current UK
regulatory reform
However, the OECD's PMR database may not do justice to the UK government's
ongoing regulatory activities. First, the PMR database does not assess the overall
quality of regulations; in the case of the UK, where the emphasis in regulatory
reform has shifted away from the radical deregulation of the 1980s to a concern with
better regulation, this may mean the database does not adequately reflect the value
of today's regulatory efforts by the government. Secondly, the database, whilst
being the best available, is still incomplete, and that may bias its results. The
indicators do not, for example, take account of issues of implementation and
enforcement. Finally, as remarked at the beginning of this Country Focus, because
a certain amount of regulation enhances economic growth and welfare, therefore an
optimally regulated country would not have PMR indicators registering zero. That
means that the UK's potential by 1998 to reduce its regulatory burden further may
already have been limited by comparison with the potential in other countries.
Conclusion
British business has become more vocal in criticising the UK's regulatory burden.
Puzzlingly, the best available evidence suggests that the UK's overall levels of
regulation are actually relatively light, if not in some specific areas of regulation.
Furthermore, the government pursues regulatory reform energetically. Nonetheless,
summary data indicates that other countries, including many of the UK's EU
partners, appear in recent years to have been deregulating faster than the UK. The
primary cause of British business criticism could reflect these signs that, in a
globalising world, regulation in the UK is now not significantly lighter than in some
other Member States, or in other developed economies. Whereas in earlier years,
when the UK's regulatory burden was much lighter than in other countries, British
business enjoyed the competitive advantage of lower regulatory compliance costs
and, therefore, operating costs than their external competitors. Today, however, as
regulatory regimes outside the UK have apparently gained ground on the UK, the
competitive advantage may have shrunk. That, in turn, may be a factor behind the
ECFIN Country Focus
Volume III, Issue 7
Page 5
UK's recent inability to further close its productivity gap with other advanced
countries.
References
Ambler, T. et al (2004), How Much Regulation is Gold Plate? A Study of UK
Elaboration of EU Directives, London, the British Chambers of Commerce, available
from: http://www.chamberonline.co.uk/policy/pdf/goldplate.pdf
Ambler, T. et al (2006), Regulators: Box Tickers or Burdens Busters? UK
Regulatory Impact Assessments in 2004/05, London, the British Chambers of
Commerce, available from: http://www.chamberonline.co.uk/policy/pdf/RIA_2006.pdf
Arculus, D. (2005), Regulation - Less is More: Reducing Burdens, Improving
Outcomes, London, BRTF, available from:
http://www.brc.gov.uk/downloads/pdf/lessismore.pdf
Copenhagen Economics (2005), Economic Assessment of the Barriers to the
Internal Market for Services – Final Report, Copenhagen, available from:
http://ec.europa.eu/internal_market/services/services-dir/studies_en.htm
Deloitte & Touche (2005), Trading Places: How Globalisation will Drive Future UK
Competitiveness, London, available from:
http://www.deloitte.com/dtt/article/0,1002,sid%253D43550%2526cid%253D101639,00.html
Federation of Small Businesses (2006), Lifting the Barriers to Growth in UK Small
Businesses: The FSB Biennial Membership Survey, 2006, London, available from:
http://www.fsb.org.uk/data/default.asp?id=381&loc=policy
Hampton, P. (2005), Reducing administrative burdens: effective inspection and
enforcement, London, HM Treasury, available from:
http://www.dti.gov.uk/files/file22988.pdf
House of Commons (2005), Trade and Industry – seventh report, Select Committee
on Trade and Industry, London, available from:
http://www.publications.parliament.uk/pa/cm200405/cmselect/cmtrdind/90/9002.htm
OECD (2000), Summary indicators of product market regulation with an extension to
employment protection legislation, Economics Department Working Paper No.226,
Paris, OECD Publications, available from:
http://puck.sourceoecd.org/vl=4111140/cl=17/nw=1/rpsv/cgi-bin/wppdf?file=5lgsjhvj846b.pdf
OECD (2005), Product market regulation in OECD countries: 1998 to 2003,
Economics Department Working Paper No.419, OECD Publications, available from:
http://puck.sourceoecd.org/vl=4111140/cl=17/nw=1/rpsv/cgi-bin/wppdf?file=5lgsjhvj755k.pdf
OECD (2006), Economic Policy Reforms: Going for Growth 2006, Paris, OECD
Publications, available from:
http://www.oecd.org/document/7/0,2340,en_2649_201185_35995079_1_1_1_1,00.html
The ECFIN Country Focus provides concise analysis of a policy-relevant economic question for
one or more of the EU Member States. It appears fortnightly.
Chief Editor: Marco Buti, Director of the Directorate for the Economies of the Member States.
Coordinating Committee: Zdeněk Čech, Heinz Jansen, Martin Larch
Layout: Vittorio Gargaro, Johannes Kattevilder
E-mail: [email protected]
Website: http://europa.eu.int/comm/economy_finance/publications/countryfocus_en.htm
ECFIN Country Focus
Volume III, Issue 7
Page 6