Regulation Tangled; The rich world needs to cut red tape to encourage business

Regulation Tangled; The rich world needs to cut red tape to encourage business

Feb 22nd 2014 | From the print edition

THE WORLD ECONOMIC FORUM, which held its annual gathering of the great and the good in Davos last month, takes advantage of its privileged mailing list to quiz its members on a whole range of issues, including the burden of government regulation. Singapore has come out on top as the least burdensome for the past eight years (see chart 3), whereas many EU countries are bumping along near the bottom. Of the 148 countries surveyed in 2013, Spain was ranked 125th, France 130th, Portugal 132nd, Greece 144th and Italy 146th.

Americans who complain about the Obama administration’s unhelpfulness towards business will also note ruefully that over the past seven years their country has slipped from 23rd to 80th place. In a separate survey conducted by America’s National Federation of Independent Business, the proportion of those who thought regulation was their biggest problem rose from under 10% in 2009 to 20% late last year.

Broadly speaking, in recent years emerging markets seem to have been cutting their red tape whereas the rich world has been strengthening its regulatory regime. This is problematic at a time when developed countries are struggling to generate growth and when prominent economists are talking about “secular stagnation”, a long-term slowdown in the growth rate.

Martin Baily of the Brookings Institution conducted a series of studies to find out why productivity in specific industries was higher in some countries than in others. He found that regulation was an important factor, often holding back competition so that inefficient companies survived for longer than they deserved.

BusinessEurope, a lobby group, calculates that the administrative burden on business in Europe amounts to 3.5% of GDP. Around half of this is due to individual member states implementing EU regulations too zealously, a peculiar habit known as gold-plating.

The EU Commission has come up with a list of the ten most burdensome regulations for business, ranging from the working-time directive to waste-disposal rules, and has trumpeted a plan to reduce the number of existing regulations by 25%. But Patrick Gibbels of the European Small Business Alliance points out that the European Commission and member states are drawing up new regulations all the time. The political will for reform varies from country to country, he says: Britain, the Netherlands and Germany are all quite good at tackling regulation, Belgium, Romania and Bulgaria not good at all. What is needed across the EU is a net reduction in the rules. One way of moving towards that, suggests Markus Beyrer of BusinessEurope, is to scrap an old regulation each time a new one is introduced.

The problem for politicians is that voters who have seen their real wages squeezed by the financial crisis are unenthusiastic about the kind of deregulation that might benefit companies. In finance there has been a wave of new regulation—understandable after the excesses of the credit boom, but veering towards overkill. Elsewhere, politicians have been putting forward populist measures such as price freezes and windfall taxes that will do nothing to encourage investment.

“There has been a significant increase in regulatory uncertainty,” says Robin Cohen of Deloitte, an accountancy firm. “For business, the worry is that the rules may change and a big investment you make now may not be profitable in 10-15 years’ time. If you are making high returns, or your product appears to be high-cost, the tide will eventually turn against you.”

Governments have many reasons to regulate companies. One is to deal with externalities; for example, if a chemical company pumps effluent into a river, there is no obvious market mechanism for dealing with the problem, so rules are needed. Another is to even out asymmetric power. Workers may be so desperate for jobs that they will take on badly paid or unsafe work and perhaps even send their children to toil in the same factory. Few would argue against laws on pollution, workplace safety or child labour.

Too much of a good thing

But not all labour laws are equally useful. In much of Europe the problem is that regulations designed to protect existing workers from unfair dismissal often make employers reluctant to take on new ones. One international executive recounts the tale of a French worker who had been with his employer for just three years but was entitled to five years’ compensation for dismissal. “We wouldn’t put anyone in France if we can possibly avoid it,” the executive said.

Such rules create an employment market divided into insiders and outsiders. One group of workers, with secure tenure, will hold on to their jobs at all costs, whereas another group (often young people) will be able to get only precarious jobs or none at all.

Naturally enough, trade unions tend to resist flexible labour contracts; they represent the insiders who are benefiting from job security, not the unemployed. But, says Mr Beyrer, “flexible labour contracts can be a stepping stone into the workforce for vulnerable groups such as the long-term unemployed and young people.” Employers will be more willing to take the risk of employing such groups if the penalty for failure is small.

The recession has led to some increase in flexibility, in part because some countries have agreed to reform in return for bail-out funding. Spain was one of the countries that needed it most, with the unemployment rate hitting more than 25%. In 2012 the government pushed through a package that discouraged collective bargaining and made it easier to hire and fire workers; by December last year an OECD report estimated that the reforms had created 25,000 new jobs every month, although that barely makes a dent in Spain’s 5.8m jobless.

France has also introduced reforms. The consultation process prescribed for employers who wanted to shed workers could sometimes take years, according to Jeremy Juanola of Eversheds, the law firm; now the limit is one to four months. And the period within which employees can sue for unfair dismissal has been cut from five years to two.

In Britain, where the labour market is fairly flexible, some rules have been loosened but others tightened. Employees now have to be in a job for two years instead of just one before they qualify for protection against unfair dismissal, and employment tribunals’ fees have been raised to reduce frivolous claims. But the government has also introduced shared parental leave of up to 50 weeks that can be split between mothers and fathers.

The danger is that, once European companies come to expand capacity again, they may do so outside the euro zone, where employment contracts are more flexible and wages and social costs are lower. Figures from the European Commission show that the social “wedge” (labour taxes and other social-security contributions) makes up more than 40% of total labour costs in nine EU countries and more than 50% in Belgium. In America and Japan, reckons BusinessEurope, the wedge amounts to only 27%. Angela Merkel, Germany’s chancellor, is fond of saying that Europe has 7% of the world’s population, 25% of its GDP and 50% of its social costs.

The EU not only has inflexible labour markets and high costs; it has slower growth prospects than most emerging markets. That will tempt many businesses to move elsewhere. “Western Europe is at a severe disadvantage because of the costs when you have to restructure your operations,” says Martin Sorrell, the boss of WPP. By contrast, Singapore has a low tax rate, a light regulatory regime and an enviable location at the heart of Asia. Sir Martin thinks some multinationals will eventually move their headquarters to the city-state.

There is another area, loosely defined as market failure, where governments are inclined to intervene. For example, they might decide that prices in a particular sector are being kept artificially high by a cartel; or they might want to provide a subsidy for a service which private companies would otherwise be unwilling to offer. Such measures can be controversial. “Where governments intervene to correct market failure, what is the evidence that they are effective?” asks Cliff Winston of the Brookings Institution. “They either miss the problem or make things worse.” Mr Winston thinks that civil servants are poorly equipped to assess the business climate. “People self-select to go into government,” he says. “Those who do are risk-averse; they are intelligent but want to keep the status quo.”

Perhaps the biggest problem with government intervention is a lack of strategic thinking. Governments do not always seem to realise that they live in a competitive world, and that companies can go elsewhere if the regulatory climate is too harsh. Some countries appear to have taken that message on board, but too many are still drawing up rules that seem designed to hobble business.

From the print edition: Special report