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May 30, 2014

The Macdonald-Laurier Institute has issued a new paper on government regulation (authored by Philip Cross) together with a companion Globe article (Regulation a ‘quaint relic’ with a firm grip on Canada’s economy) that caught my eye, which argues that the historic rationales for regulation in many sectors no longer hold true: Estimating the True Size of Government: Adjusting for Regulation.

Given the current debates over Uber (rider sharing apps), Tesla (direct auto sales in the U.S.) and a number of local regulation issues regularly in the media, such as liquor retailing in Ontario, I thought this paper quite interesting and timely.

Abstract:

“Knowing the extent of regulation in the economy is important because regulation has been found to stymie innovation, depress productivity, raise prices, and lower living standards. However, several studies have measured the cost of complying with the regulatory burden, there has been no attempt to measure the extent of the Canadian economy subject to regulation.

What’s more, there is little appreciation in this country of the overall size of government, which should be fundamental to almost any informed debate on public policy. The traditional measure, government spending as a portion of GDP, ignores the significant impact of two other vital determinants of the true size of government: regulation, to be discussed in this paper, and tax expenditures, which were examined in an earlier Macdonald-Laurier Institute study authored by former StatsCan Chief Statistician Munir Sheikh. The results are eye opening.

Combining all three measures of how government exerts direct control over the components of GDP yields an estimate of the full extent of government control of spending in the Canadian economy. The results challenge the traditional view of the size of government in Canadian society. The standard measure is that government accounts for about 44 percent of the economy, based on its share of spending in GDP. Accounting for tax expenditures, which have grown to at least 10.1 percent of GDP, raises the share that government controls to 54 percent. Adding the 10.5 percent of the economy where government regulates either prices or output boosts government control of all spending to over 64 percent.

In a broad sense, all sectors of the economy are subject to regulations covering health, occupational safety, and the environment. The focus of this paper is on regulations that are intended to control the price or output of a specific industry. Examples of such regulatory control are utilities that require government approval of prices, supply management boards that control entry into farming, or restrictions on foreign investment in telecommunications or banks.

The results show that 10.5 percent of the Canadian economy was subject to regulatory control in 2010. Almost 80 percent of this control was concentrated in utilities, agriculture, finance, and communications.

Regulation in these four industries goes back decades, often rooted in the original motivations for regulation – the problem of natural monopolies in utilities, the preservation of a sound banking system, and protection of Canada’s culture industries.

That the rationales for regulation in key industries are long-standing is a major problem for the future of regulation. Justifications that were valid decades ago may no longer apply, particularly given the pace of technological change. What is the usefulness of regulating media for Canadian content after the arrival of the Internet? Similarly, firms and households can buy financial services anywhere in the world, skirting the efforts of regulators in Canada to control risk.

Regulation is concentrated in the consumer sector, although it now rarely takes the form of direct control of prices for energy, air travel, and rental units that proliferated in earlier decades. Instead, regulation is implemented through the granting of monopolies in industries such as utilities or the post office, or insulating domestic firms from foreign competition.

Regulations are far less common outside of the consumer sector. In particular, governments usually avoid regulating export industries because they have to compete in the global marketplace. This is an implicit recognition that regulations lead to inefficient producers and higher prices. Regulation thrives in domestic industries sheltered from foreign competition, such as banking and culture. The transportation industry demonstrates this dichotomy, with little regulation in areas which face foreign competition (such as air travel, rail, and truck transport), while urban transit and taxis are regulated because they do not have competition from imports.

Globalization and the Internet are already undermining the monopoly of traditional domestic sup- pliers. Similarly, technological change threatens the traditional monopolies of utilities, while efforts to liberalize trade are intensifying the pressure to end the tariff walls that protect marketing boards. In the early 21st century, where adaptability to rapid change is paramount, regulation increasingly seems a quaint relic of the 20th century.”

For a copy of the full paper see: Estimating the True Size of Government: Adjusting for Regulation

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