There are two things called ‘regulation’, and they’re very different

Whenever people discuss regulation, whether for or against, it’s always treated as basically one type of thing. Opponents might say, “regulation is bad for business,” or, “we need to cut red tape,” while advocates might argue, “regulation makes us safer,” or, less positively, “regulation is a necessary evil.”

Occasionally, someone will distinguish between good and bad regulation, but it’s still talked about as one thing, with one purpose; the debate is whether it achieves that purpose to a better or worse extent.

Visiting India helped crystallise in my mind that there are two very different things, both called “regulation”. They have different aims, and different effects on business. We shouldn’t confuse one for the other. We should also be aware that it’s a deliberate policy of business lobby groups to try to make us do just that.

So what are the two types of regulation?

The first type of regulation seeks to prevent activity. Let’s call this inhibitory regulation.

With inhibitory regulation, a government wants to stop the activity being done at all (prohibition), to restrict how much is done (quotas), and/or to directly decide and control who does it (licensing).

There are sometimes good reasons for inhibitory regulation. We prohibit murder, for example, primarily to discourage it as a leisure activity, but also as a 99% effective inhibitory regulation of the assassination industry. Also, we might be happy to allow the practice of fishing, but limit the industry by quotas so that it doesn’t overfish and wipe out fish populations.

However, inhibitory regulation is often applied for bad reasons, and in counter-productive ways. Prohibition of alcohol was a disastrous policy, thankfully abandoned. Prohibition of drugs and sex work continue to be equally harmful.

Quotas are used in planned economies to try to restrict industries, forcing them to produce only as much of their product as the government thinks should be made, when market forces and pricing would do the job better. Cartels use quotas to artificially suppress supply and raise prices, causing damage to the wider economy.

Licensing policies are often damaging too. In most cases there is no genuine reason for the government to control who is able to participate in an industry, and the licensing system is just a revenue generator, enforced by state power: not much different in principle to a criminal extortion racket. The system is highly prone to abuse and corruption, too, as licences are worth big money and decisions are usually in the hands of unaccountable officials. Many of the “graft” scandals which blight India’s political and business landscape are caused by licensing.

Inhibitory regulation was common in planned economies, especially ones with dogmatic ideas about which industries should or shouldn’t operate. It was also common in the developing world, where newly independent governments saw the exercise of state power over their industries as a crude opportunity for revenue generation, either for the state itself, or, too often, for themselves personally.

Deregulation – removal of inhibitory regulation – is one of the pillars of the Washington Consensus, the set of liberal economic reforms promoted by the IMF and World Bank. Inhibitory regulation is a stranglehold on industry, and a fertile source of corruption in business and government. Sweeping it away is not just desirable, but essential. In this sense, deregulation is a necessary and uncontroversial reform.

The second type of regulation doesn’t seek to prevent activity, but to improve it. Let’s call it constructive regulation. Rather than try to impede an industry, it sets safety and quality standards for the industry to meet, for the benefit of the people working in it, the people buying its outputs, and the wider society which is affected by its activities. In other words, health and safety, consumer protection and environmental rules.

Constructive regulation doesn’t stop anyone participating in an industry. It just makes sure that anyone who does, must do so properly and safely. For example, the food industry is regulated. That doesn’t mean you’re prevented from baking cakes and selling them, as you would be if there were cake quotas and licences. It just means that your cakes must be non-toxic, and your staff must be given oven gloves if you expect them to take hot trays out of the oven – and other sensible rules which mean better cakes and fewer baking injuries.

One of the key effects of constructive regulation is to level the playing field for the good guys. Let’s say there’s a meat processing plant owner who wants to run an ethical business, and not mix horse meat in with the beef. That’s all well and good, but his rival meat processors, who are less scrupulous, will price him out of the market because horse is cheaper than cow. That’s why we have regulation banning such practices. It doesn’t imply that all meat processors would use horse if they could; it just recognises that some would, and they’d be competitive. The good, non-horse-meat-substituting meat processors, should applaud regulation against horse meat substitution: it doesn’t affect them, because they’re not doing it, and it stops their competitors from doing it and under-cutting them.

Or perhaps there’s an entrepreneur who wants to create a company with the USP of making its product with no carbon emissions. Consumers like that sort of thing, so with enough advertising, she might be able to break into the market. But not only will it still be cheaper for the established players to continue making the product in the traditional, high-emission way, it’ll probably still be cheaper to do that AND invest in a marketing strategy to mislead consumers into thinking they’re green too, thus neutralising the start-up’s USP.

The basis of a thriving market economy is supposed to be competition and innovation, which businesses often claim is hindered by regulation. But there’s nothing anti-competitive about constructive regulation. In fact, a lack of constructive regulation favours the big, established companies. If a new law tells companies they must achieve a certain standard (say, reduced carbon emissions) that they haven’t before, it requires them to do things differently. The market will punish complacent companies who can’t innovate, and create opportunities for new players to enter.

Not surprisingly, the opposition to regulation comes from the large corporations who have lobbying budgets and whose CEOs mingle with politicians, not from the SMEs and start-ups, who drive the economy, and can adapt more easily. Of course, as soon as a start-up succeeds in a new regulatory environment and becomes a big player itself, it immediately starts lobbying to maintain that environment in stasis. Constructive regulation doesn’t hinder the market, it makes the market better; it isn’t the enemy of capitalism, but it is the enemy of crony capitalism.

This important distinction, between regulation to restrict activity and regulation to improve it, is usually lost in ideological debates over red tape versus business. The regulation which restricts competition and productivity is largely eradicated in the developed world already: it is the type which generates graft and corruption scandals over coal licences in India, not the type which ensures the products you use are safe and environmentally friendly. That’s a deliberate ploy: lobbyists take the arguments against inhibitory regulation, which are widely accepted, and use them to attack constructive regulation, which is another kind of thing altogether.

So when you hear a business representative saying that regulation is bad for business, that it should be cut for the good of the economy, that industries should be left to set their own voluntary standards, or that the free market and consumer choice will maintain them, remember this:

The regulation that’s bad for the economy is inhibitory regulation.

Most of the regulation in developed economies like the UK is constructive, not inhibitory. We’ve already dispensed with most inhibitory regulation long ago, or never had it.

Constructive regulation improves industry for employees, consumers and the environment. It also promotes competition and innovation in the market.

The only beneficiaries of deregulation are big companies, who are resistant to change, and who profit from providing bad products and services.

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