August 2001

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Direct and indirect costs of regulation

By the early 1990s, Canadians had become very concerned about their governments' fiscal policies. The reasons were not hard to find: the federal government had not balanced its budget in over 20 years and all of the provinces were also running deficits. Furthermore, government spending as a percentage of gross domestic product (GDP) had risen to a postwar high of 52.6%¹ and Canadian tax burdens were deemed high even by international standards. Public concern over federal and provincial deficit spending, increasing government debt, and high taxes provided part of the stimulus needed to balance budgets, pay down debt, and cut taxes. Today, just one decade later, the federal government and seven of the provinces have balanced their budgets, debt reduction has become a priority, and pressure to cut taxes is strong. Indeed, some provinces and the federal government have cut taxes, although by less than many Canadians had hoped.

Although deficit spending is no longer fashionable, there is another form of government intrusion into our pocketbooks that is largely hidden and, as a result, has not been subjected to the same scrutiny: government regulation. Direct spending, financed by taxing or borrowing, is only one tool that governments can use to achieve their goals. Regulation is another. There are important differences between spending and regulating. Federal and provincial budgeting processes ensure some degree of accountability to the public--media and policy analysts report on and critique budgets when finance ministers announce them and detailed information on government spending is available from the public accounts. There is no such accountability where governments' regulatory activity is concerned.

When governments regulate, they require others to spend for them to achieve public-policy objectives. Only a small fraction of regulatory costs, the administrative costs, actually appear in governments' budgets. The lion's share of the cost of regulation, the cost of compliance, is passed on to businesses, to lower levels of government, and to consumers as higher prices (see box 1). Governments are not required to estimate and report these compliance costs. This is why some analysts call regulation "hidden taxation" and claim that deficit spending lives on in the form of regulatory compliance costs that go largely unacknowledged (Crews, 2000: 1-7).

Although most of us spend little time thinking about regulation, we live in a highly regulated society. Regulation affects almost every aspect of our lives, including what we listen to on the radio, the price and quality of the food we eat, the safety features in our cars, who is allowed to deliver our mail, where we are permitted to smoke and drink, and how we are restricted in the use our property (see boxes 2 and 3). The total cost of all this regulation is considerable. The direct cost of regulation includes the costs that governments incur to administer regulatory activities and the costs that individuals and businesses incur to comply with government regulation. But, only the costs that governments incur to administer regulation appear in their budgets and these costs are small compared to compliance costs, which have been estimated to be 20 times as high. The Fraser Institute's study, The Cost of Regulation in Canada (Mihlar, 1998), estimated that complying with regulation in Canada in 1996 exceeded $83 billion or just over $11,000 per family of four (Mihlar, 1998: 3). Canada's Regulatory Burden, using more recent data, finds that the private sector spent $103 billion or $13,700 per family of four to comply with regulation in fiscal year 1997/1998.

Indirect Costs

Direct costs are not the end of the story. Regulation also imposes indirect costs ² on individuals and businesses, costs that are often significant but much harder to measure. One of the consequences of regulation not captured by measuring its direct cost is the severe limits it imposes on people's freedom to make their own choices. For example, Health Canada only approves drugs that it believes are safe. Before a drug is approved (or if it is never approved), it is not available for general consumption. Yet some people would gladly accept higher risks than those that Health Canada tolerates. Many products are simply unavailable because regulators have decided that they are not safe enough. In these cases, regulations restrict people's freedom to make their own choices based on their own individual circumstances and tolerance for risk. Assigning a dollar value to this loss of liberty is virtually impossible.

Government regulation also dampens innovation, delays development of products, stifles entrepreneurship, and slows growth of productivity. Dr. Murray Weidenbaum describes some of these consequences of regulation in the United States:

A number of individual companies report that they devote large and growing shares of their scientific resources to meeting regulatory requirements or avoiding running afoul of regulatory restrictions. One hidden cost of government regulation is a reduced rate of introduction of new products. The longer it takes for a new product to be approved by a government agency--or the more costly the approval process--the less likely that the new product will be created. (Weidenbaum, 1979: 38)

Regulated firms no longer produce only goods and services; they also "produce" regulatory compliance (Chinloy, 1989: 127). Resources devoted to regulatory compliance are no longer available to invest in new plant and equipment. The corresponding slowdown in productivity growth translates directly into lower standards of living than could otherwise be achieved. Again, these costs are difficult to measure but one study cited by the OECD (Weinart, 1997, citing Gray, 1987) attributes the 31% slowdown in productivity in American manufacturing in the 1970s to regulation by the Occupational Safety and Health Administration and the Environmental Protection Agency.

Regulation can impose still other indirect costs on consumers by restricting competition and making prices of goods and services higher than they might otherwise be. Competition can be restricted in two ways. First, regulation can put smaller firms at a competitive disadvantage when they are forced to comply with the same regulations as larger firms because smaller firms lack larger firms' financial and managerial resources. As a result, there can be increased concentration in an industry. Second, regulation can directly reduce competition. Government controls sometimes restrict price competition and prevent would-be competitors from entering the industry. For example, the federal government does not allow any firm except Canada Post Corporation to deliver first-class mail.

The benefits of regulation

Does regulation provide Canadian with any benefits? There is no question that regulation creates benefits as well as costs and that some degree of regulation can help markets function (Mitchell and Simmons, 1994: 5). Such regulation includes law enforcement, defining rights to private property, adjudicating disputes, and enforcing contracts (Friedman, 1962/1982: 34). Competition policy, company law, bankruptcy law, and intellectual property rights help markets work (Economic Council of Canada, 1979: 10). Nevertheless, it is beyond the scope of this study to measure the benefits of regulation. In much the same way that fiscal budgets detail what government programs cost without addressing what benefits they provide, this study focuses on what regulation costs without discussing what benefits it provides.

In this study

The purpose of this study is to provide Canadians with more information about the burden of government regulation. Government regulation hits our pocketbooks as surely as taxes do but there is shockingly little information available about its cost. At a time when deficit spending is out of favour and there is little appetite for tax increases, this lack of accountability could make regulation a tempting way for governments to achieve their goals without substantially increasing their spending. Increasing regulatory activity could easily erase any gains from fiscal restraint. It is therefore important that Canadians understand the cost of regulation so they can have a better sense of the full cost of government.

Section 2 of this study discusses the definition of regulation and describes the different types of regulation. Section 3 looks at trends in the volume of regulation enacted by federal, provincial, and territorial governments in Canada, including information about the number of regulations enacted each year, the number of pages of regulations enacted each year, and the total number of regulations in force. These data give some sense of the regulatory burden faced by Canadians. Section 4 provides more information on the regulatory burden endured by Canadians by calculating regulation's direct costs. Finally, the conclusion contains some policy recommendations.

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