Reforming regulations for competition

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BRIEFING NOTE

Reforming regulations

 

Source:

Ennis, S. and Ghosal, V.. (2010) "Initiatives in Reforming Rules and Regulations", in Reforming Rules and Regulations: Laws, Institutions and Implementation, in Vivek Ghosal (Ed.). MIT Press: Cambridge, Chapter 1, 2010.

 

 

Executive Summary:

This briefing document examines the crucial role of rules and regulations in the economy, highlighting that while intended for benefit, they often carry significant costs . It explores various sectors like innovation, environmental, and financial markets through case studies of both successful and unsuccessful reforms, emphasizing the importance of carefully designing regulations and considering alternative structures. Ultimately, the text discusses methodologies for assessing the impact of regulations to identify areas where reform is needed to promote competition and efficiency.

 

Key words

Regulatory reform

Costs of regulations

Market-based instruments

Case studies

Assessing impact

Reforming Rules and Regulations

 

I. Main Themes:

The central theme of the provided text is the critical role of rules and regulations in governing economic activity and the significant impact that their design, implementation, and reform have on competition, innovation, economic efficiency, and consumer welfare. The document highlights the potential for regulations to impose substantial costs, despite being often developed with a focus on alleged benefits. It explores various examples of regulatory reform across different sectors, including innovation markets (patents), environmental markets, telecommunications markets, and financial markets, illustrating both successes and failures. A recurring theme is the importance of considering alternative policy structures and institutional setups to maximize benefits and minimize unintended consequences. Finally, the text discusses methodologies for assessing the impact of regulations on competition to identify areas ripe for reform.

 

II. Most Important Ideas and Facts:

 

Regulations as Governance Structures: Rules and regulations serve as fundamental governance structures for diverse economic activities, developed for purposes ranging from economic benefit and social improvement to environmental risk reduction and fairness. They are formulated and enforced by various institutions, including governmental and privately-endorsed bodies.

 

Costs of Regulations: While regulations aim for benefits, they can impose significant costs. These include:

 

High administrative and compliance costs.

 

Distortion of incentives, leading to less efficient resource utilization.

 

Creation of excess rents when competition is limited, distorting factor prices.

 

Prevention of firms from achieving economies of scale.

 

Reduction in innovation.

 

The text provides specific examples: "Regulations can create costs and inefficiencies in several ways. The first, and most direct, is that the administrative and compliance cost of regulation can be high. Second, they can be distortionary in the sense that they leave firms with less incentive to economize on resources. Third, when regulation limits competition, excess rents may increased to capital or labor, distorting the prices of these factors of production. Fourth, regulations can prevent firms from increasing economies of scale. Fifth, regulations may reduce innovation."

 

Approaches to Regulatory Reform:

When existing regulations or their institutional frameworks are deemed inappropriate, policy responses can include:

 

Changing a rule or regulation without involving a law-making body, utilizing flexibility within existing laws.

 

A law-making body changing or creating a law.

 

Changing the institutional setup for enforcement of regulations.

 

Market-Based Instruments Preferred: The text suggests a preference for market-based instruments over technology-based standards, particularly in environmental regulation, because the latter can restrict innovation. As stated, "...preference should be given to market-based instruments, such as environmental taxes and tradable permits, over technology-based standards because the latter often restrict the domain of possible innovations that can be made or adopted from elsewhere."

 

Case Study: California Electricity Market Reform (Failure): The partial deregulation of the California electricity market in 1996, aiming for lower retail costs, resulted in a significant crisis. Key factors contributing to this failure included:

 

A fixed maximum retail price, limiting consumer incentive to reduce consumption during wholesale price increases.

 

Extensive reliance on day-ahead and real-time balancing markets instead of long-term contracts.

 

Horizontal separation of generation capacity, with incumbent utilities selling off significant power generation assets.

 

External factors like increased natural gas prices and NOx emissions permit costs.

 

A long timetable for regulatory approvals of new generating capacity.

 

Actions by market participants, including the withholding of supply, which led to large price increases.

 

The cost of this poorly designed reform was substantial, leading to significant increases in wholesale electricity prices and ultimately requiring the state to raise retail prices and purchase expensive long-term contracts.

 

Case Study: Ireland Taxi Reform (Success): The reform of the taxi market in Ireland, which removed quantity restrictions on licenses, is presented as a more positive example. Key aspects of this reform included:

 

The initial restrictions were imposed by ministerial order and challenged in court.

 

The High Court ruled that the Minister had exceeded legal powers in restricting licenses for reasons unrelated to vehicle quality standards, voiding the restriction.

 

Subsequent regulations allowed suitably qualified individuals to provide taxi services, leading to a rapid and significant increase in the number of taxi licenses (from 4,218 in 2000 to 14,171 in 2004, a 336% increase).

 

This increase in supply led to shorter wait times for consumers.

 

The government introduced a "taxi hardship fund" and capital allowances to compensate existing license holders for the decline in the value of their licenses, contributing to the acceptance of the reforms. This illustrates how addressing the concerns of those negatively impacted can aid reform implementation.

 

Innovation Markets: Patents and R&D: The design of patent systems and R&D incentives are crucial for fostering innovation and economic growth.

 

Triadic patent counts and R&D intensity vary significantly across countries, indicating different levels of innovative activity.

 

R&D performed by business, public, and foreign sectors are significant determinants of long-term productivity growth.

 

There is a debate on the effectiveness and impact of patents, with some arguing they grant unnecessary monopoly rights and hinder welfare ("IP-inefficiency").

 

R&D tax incentives can stimulate innovation, but their effectiveness and optimal design (level-based vs. incremental) are subject to evaluation and debate.

 

The fragmented European patent system, with centralized examination but national enforcement, is seen as reducing the effectiveness of the system due to high litigation costs and uncertainty. A proposed solution is a centralized jurisdiction.

 

Environmental Markets: Regulations in environmental markets aim to control pollution.

 

Environmental policy can influence technological innovation, with market-based instruments like taxes and tradable permits potentially leading to greater innovation and diffusion of inventions than technology-based standards.

 

The unilateral EU environmental policy raises concerns about competitiveness impacts on energy-intensive sectors, leading to consideration of border tax adjustments or increased use of the Clean Development Mechanism (CDM). The CDM is presented as an attractive market-based alternative to border tax adjustments.

 

Policies to cap CO2 emissions in the US electricity sector could impose significant costs. Alternative allocation allocation methods (free allocation to firms vs. allocation to customers) have different implications for prices and efficiency.

 

Telecommunications Markets: Regulatory reforms have significantly increased competition and improved consumer welfare in telecommunications.

 

Deregulation has led to increased competition, decreased prices, and increased service variety.

 

The Chilean experience shows dramatic improvements in fixed-line and mobile service penetration, quality, and price after opening the sector to competition.

 

Reform approaches in developing countries have varied, with some governments preferring gradual liberalization.

 

The independence of regulatory authorities is important for effective regulation, but its impact on outcomes may vary depending on the extent and nature of the change.

​

Financial Markets: SME Financing: Efficient credit flows are vital for economic growth and innovation, especially for Small and Medium Enterprises (SMEs).

 

SMEs are more likely to face financing constraints due to factors like uncertainty, sunk costs, and informational frictions.

 

Despite perceived institutional differences between countries, SMEs are becoming a strategic and profitable segment for banks due to competition in other sectors.

 

Banks are developing mechanisms to overcome institutional obstacles and compete for SME business, even without significant government program influence. Policy action could still help reduce the cost of financing for SMEs, particularly for long-term lending.

 

Assessing the Impact of Regulations: Methodologies exist to identify regulations that unduly limit competition.

 

Sector monitoring, using statistical criteria, can identify sectors needing reform but requires substantial data.

 

Competition assessment, like the OECD's toolkit, focuses on individual regulations and uses a qualitative methodology with a simple checklist to identify potential restrictions on entry, the ability to compete, and the incentive to compete.

 

The OECD's competition assessment toolkit is being used in various countries to evaluate existing regulations and inform reform proposals.

 

These two methodologies can be complementary, with sector monitoring identifying areas for deeper examination using competition assessment tools.

 

III. Key Quotes:

 

"Generally, rules and regulations are developed with a focus on their alleged benefits. This ignores the fact that, in some cases, rules and regulations can potentially have large costs."

 

"Regulations can create costs and inefficiencies in several ways. The first, and most direct, is that the administrative and compliance cost of regulation can be high. Second, they can be distortionary in the sense that they leave firms with less incentive to economize on resources. Third, when regulation limits competition, excess rents may increase to capital or labor, distorting the prices of these factors of production. Fourth, regulations can prevent firms from increasing economies of scale. Fifth, regulations may reduce innovation."

 

"...preference should be given to market-based instruments, such as environmental taxes and tradable permits, over technology-based standards because the latter often restrict the domain of possible innovations that can be made or adopted from elsewhere."

 

“The cost of poorly designed reform in California’s electricity markets was large.”

 

"Most reform experiences are more positive. Consider the example of taxi reform in Ireland (OECD, 2008). While the reform process did not proceed in the way the government initially envisioned, ultimately the reforms led to major benefits for consumers."

 

"...the overarching result that emerges from the three case studies presented in this chapter is that infrastructure and performance outcomes might not be overly sensitive to independence. That is, small changes might not impact outcomes adversely while, large changes, as seen in the Sri Lankan case, might have a discernible impact."

 

"...while size per se may not be a direct determinant, it is strongly correlated with the primitive factors that do matter. The informational frictions that add to the costs of external finance apply mainly to younger firms, firms with a high degree of idiosyncratic risk, and firms that are not collateralized. These are, on average, smaller firms."

 

"When the regulation is shown to have the possibility to unduly restrict competition, a full competition assessment is required that considers and evaluates alternatives that might have less harm to market operation but still achieve the government's objective."

 

 

Paper Summary Initial Draft By NotebookLM