Returning British Columbia to Prosperity

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Regulatory Policy: The Hidden Tax

The expanding regulation of economic activity, in health and safety, labour markets, and countless other sectors, is increasingly drawing the attention of economists, policymakers, and concerned citizens. The reason for this increasing attention is that regulations represent a cost to both individuals and businesses. Although there are many important areas affected by regulation, including transit, energy, and the operation of Crown Corporations, this study covers two of the more important areas of regulatory activity: labour and natural resources, specifically, forestry.

This chapter presents a general analysis of regulation, including the economics of regulation, an overview of regulation in British Columbia, and some cost estimates. Some general recommendations for regulatory reform follow, along with a specific analysis of labour market regulation in British Columbia. The study also includes a section on natural resource regulation, specifically the regulation of the forestry industry. The chapter concludes with relevant policy recommendations.

I. Regulation in British Columbia

[The main section on regulation relies heavily on previous work completed by Fazil Mihlar, the former Director of Regulatory Studies at The Fraser Institute; most of the recommendations for regulatory reform are taken from policy sections in previous works.]

Regulation as a Hidden Tax

Governments at all levels now regularly compel both businesses and individuals to act in certain ways, or preclude them from undertaking certain activities through regulation, in order to protect the "public interest." Regulation covers myriad economic sectors. For instance, governments in Canada regulate such activities as radio and cable television, packaging and labelling of consumer products, financial institutions, airlines, taxicabs, Canadian content in culture, energy, liquor, minimum wages, and occupational licensing and certification.

Regulation involves both direct costs and indirect costs. The direct costs of regulation are compliance costs, such as administration required of individuals and businesses based on regulation, in addition to monitoring costs incurred by government in the enforcement of regulation.

The indirect costs of regulation are a result of the behaviour-changing effect regulation can have. Like taxes, regulations change the relative price of certain activities, resulting in either more or less economic activity in the regulated areas. Regulations can also impose indirect costs when they stifle innovation and experimentation by individuals and businesses, or where they increase the level of uncertainty as to how businesses will be treated.

Although both direct and indirect costs constitute a hidden tax on individuals, it is the direct cost of regulation, namely compliance and administration, that is readily measurable. Thus, when the cost of regulation is referred to in the rest of this section, the term is referring only to the compliance cost of regulation, or the direct cost of regulatory activities.

As discussed, regulations force businesses and individuals to act in certain ways, or avoid particular behaviours. The idea that the direct cost of regulation is a hidden tax is most easily seen in business regulation. When governments require businesses to undertake certain activities, or preclude them from doing so, the requirements impose subsequent compliance costs, such as monitoring and reporting costs. These costs are inevitably paid by the business's customers through higher prices, by the owners through lower profits, and/or by the employees through lower compensation.

In addition to the costs that businesses and individuals incur, government also incurs costs to monitor and assess regulatory compliance. Economist Murray Wiedenbaum of the Center for the Study of American Business estimated that for each $1 the government spends on regulations, business typically spends roughly $20 in compliance costs (Defina and Wiedenbaum, 1978). For Canada, Mihlar (1996b) estimated that in the fiscal year 1993/94 alone, regulations cost Canadians roughly $85 billion in total compliance costs, including both government costs and business and individual costs.

Economics of Regulation

As with most other economic analyses, the economic evaluation of regulation uses a cost/benefit approach: does the associated benefit of a particular regulation exceed its costs? Unfortunately, all too often the decision to enact regulation ignores this fundamental principle.

Since the early 1970s, Canada has experienced a decline in productivity growth (OECD, 1994; OECD, 1997; Sharpe, 1998; and Law, 2000). This decline in both total factor and labour productivity has resulted in slower real income growth. In fact, after-tax real incomes have actually declined in the last decade. Empirical analyses have concluded that increasing government regulations account for between 12 and 30 percent of the productivity decline (Wienert, 1997). Worse still, other analyses have suggested that in many cases, the cost of regulations have exceeded their benefits (Hahn and Hird, 1991). Not only has the regulatory burden dampened productivity and income growth, but in many cases, the benefits from regulation were outweighed, in some cases significantly, by their costs.

Regulation in British Columbia

British Columbia has experienced a significant expansion in its regulatory burden over the last quarter century. As Regulatory Figure 1 illustrates, between 1975 and 1998 British Columbia passed 12,133 regulations totalling 21,891 pages.⁷ The last decade alone has witnessed the addition of 3,675 regulations, or a little over 30 percent (30.3%) of the total number of regulations added since 1975. Further, 7,788 pages of regulation have been added since 1991, or 35.6 percent of the total number of regulatory pages added since 1975 (Mihlar, 1998; with calculations by author).

The average number of pages per regulation is a proxy for the complexity of the regulations. As Regulatory Figure 2 depicts, the average number of pages per regulation has been increasing since the late 1980s. For example, the average number of pages per regulation for the last 25 years was 1.8, while the average number of pages for regulations passed between 1991 and 1998 was 2.1, an increase of 16.7 percent (Mihlar, 1998; with calculations by author). The trend is evident: not only has the number of regulations been increasing in British Columbia, but so have their complexity.

Cost of Regulation

[For a detailed explanation of the methodology used to calculate compliance costs, please see: Fazil Mihlar (1996). Regulatory Overkill: The Cost of Regulation in Canada.]

Not surprisingly then, the cost of regulatory compliance has also been increasing in British Columbia. Regulatory Table 1 presents the cost of regulatory compliance for British Columbia for selected years between 1973-74 and 1995-96, the latest year for which data is available. The data presented in Regulatory Table 1 and depicted in Regulatory Figure 3 clearly illustrate that British Columbia, far more than either Alberta or Ontario, has experienced a consistent upwards trend in the cost of regulation. In fact, the growth in the total cost of regulation in BC between 1973-74 and 1995-96 (194.9%) far exceeded the cost growth incurred in either Ontario (123.6%) or Alberta (48.4%) (Mihlar, 1998; with calculations by author). In fact, Mihlar (1996b) estimated that the direct cost of administering regulations in British Columbia increased by nearly 800 percent between 1973/74 and 1993/94.

Total regulatory compliance costs⁸ do not illustrate the full extent of the regulatory burden since they do not account for the different sizes of the relative economies or populations. Regulatory Table 1 also includes per capita regulatory costs between 1973-74 and 1995-96. The per capita data show a similar trend to the data for the total regulatory cost. The growth in the total per capita cost of regulation in British Columbia between 1973-74 and 1995-96 (86.4%) exceeded the growth in per capita regulatory costs in either Ontario (65.6%) or Alberta (-6.1%) (Mihlar, 1998; with calculations by author).

BC's Attempt at Reform

The NDP government of British Columbia announced a review of regulations in its 1998/99 budget. The Business Task Force on Regulatory Impact was formed and some areas of regulation are under review. The task force's mandate is to recommend ways to reduce the cost of doing business in British Columbia by streamlining regulations and eliminating red tape as well as devising institutional processes to prevent unnecessary regulation. The streamlining initiative, particularly, indicates that the provincial government has apparently taken the need for regulatory reform seriously.

In addition to creating the task force, the provincial government also passed the Regulatory Impact Statement Act (RISA) in 1999. Under RISA, government ministries and agencies must scrutinize proposed regulation based on an OECD checklist. Over time, RISA should lead to better and more carefully considered regulatory decisions. In addition, spurred by the task force, reviews of several existing areas of provincial regulation are now under way. Unfortunately, recent changes to labour laws indicate a weak commitment to these principles as most were ignored.

Some changes to regulation have already been enacted. For instance, outmoded rules governing the number and size of television screens permitted in licensed establishments serving alcohol have been streamlined. Some changes have also been made to ease the burden of the Forest Practices Code whereby the government has agreed in principle to the need for a simplified results-based code in place of the current process-driven code. The government appears to be increasingly open to some kinds of regulatory reform. However, the status of some extremely costly environmental measures, such as the phase-in of the zero emission standards for pulp mills, is still uncertain. Some isolated progress has been achieved, but British Columbia still lacks a broad, coherent system for managing regulation.

General Regulatory Policy
Recommendations

(1)

Implement a three-year moratorium on all new regulations in conjunction with a review of existing regulations.

The province should place a three-year moratorium on all new regulations, except in special circumstances. It should concurrently complete a thorough review of all existing regulations, emphasizing outcomes and streamlining the regulatory process.

(2)

Apply cost/benefit tests, and make the results public.

British Columbia should require reliable and comprehensive cost/benefit analyses of proposed regulations before they are enacted. Further, the results of such analysis should be made public.

(3)

Prioritize regulations.

Regulatory bodies in British Columbia should prioritize all regulations. Since not all risks are of equal magnitude, emphasis and priority should be given to the most serious risks facing British Columbians.

(4)

Change the regulatory focus to outcomes.

Any new regulations should focus on achieving specific and measurable goals. They should also be written clearly and concisely to ensure that they are readily understood.

(5)

Introduce a regulatory budget along with the annual fiscal budget.

The government should submit a comprehensive budget annually, along with the normal budget, that details the costs of regulation, including costs for both government and those affected by regulations, i.e. business and individuals.

(6)

Enact a sunset clause for all regulations.

Regulatory bodies should include a sunset clause in all new regulations to ensure that they are reviewed regularly. This would assure relevance, accountability, and adaptability for the province's regulatory framework.

Fraser Institute Policy Contact:

Laura Jones, Director of the Centre for Studies in Risk and Regulation
Phone: (604) 714-4547
E-mail: lauraj@fraserinstitute.ca

Recommended Readings

[Note: For complete publication data, please see the list of references.]

Peter L. Bernstein (1996). Against the Gods: The Remarkable Story of Risk.

Laura Jones, ed. (2000). Safe Enough? Managing Risk and Regulation. Fazil Mihlar (1998). The Cost of Regulation in Canada, 1998 edition.

Milloy, Steven and Michael Gough (1999). Silencing Science.

II. Labour Market Policy

The labour market is perhaps the most important example of how regulation can affect markets. Specifically, by implementing regulations, whether they target health and safety, unionization, or mandatory benefits, government changes the way the labour market functions by changing the costs associated with labour.

Economics of Labour Policy

One peculiarity of the labour market is the way in which regulatory costs manifest themselves. The cost of regulation incurred by individuals—and collectively by society—comes in the form of higher than normal unemployment, and lower than normal productivity growth. Mounting research indicates that an inflexible labour market may have been a major contributor to the unemployment and the productivity growth slowdown that most countries experienced during the 1970s and 1980s (Grubel, 1988; Daly and MacCharles, 1986; OECD, 1994b).

These barriers, or rigidities, are the direct and indirect result of legislation. For instance, minimum wage laws or certain mandatory benefits create a regulatory barrier for firms hiring new employees (Stigler, 1946; Gramlich, 1976; Rottemburg, 1981; Linneman, 1981; Neumark and Wascher, 1992). Similarly, labour market rigidities are created when legislation permits some employees to exact higher compensation from their employers than they would otherwise receive by restricting the hiring of others, as in the case of closed-shop union contracts (Hirsch, 1997; Mihlar, 1997). Another labour regulation that can cause rigidity relates to workplace laws limiting employer flexibility, such as workplace jurisdictional rules, seniority, and other practices that prevent an employer from using incentives to promote productivity and innovation (Hirsch, 1997).

How do labour market rigidities caused by regulation translate into higher unemployment and lower productivity growth? The answer is rooted in the costs necessitated by such regulation. For instance, minimum wage laws and mandated benefits increase the cost of labour, at least initially. When labour becomes more expensive without a corresponding rise in productivity, there is an obvious incentive for the employer to reduce, or at least control costs, by substituting capital for labour.

Another example of labour regulations translating into higher unemployment and lower productivity growth relates to workplace rules, particularly those that limit flexibility. By limiting a firm's ability to react to market conditions, experiment with new production models, or introduce new products, labour regulations prevent, or at least impede, the business's ability to remain competitive. The end result of such legislation is often industrial stagnation and a loss of competitiveness which eventually results in less employment.

A final example of this deleterious relationship rests on organized labour's ability to extract higher compensation for its members through closed-shop union contracts. These contracts preclude non-union workers from joining a firm or sector's workforce, depending on the nature of the contract (Mihlar, 1997). Such preferential treatment allows a union to negotiate significant benefits for its members, but in many cases, these higher labour costs and restrictive hiring and workplace practices also reduce employment levels and productivity. For instance, studies show that unionized firms are about 10 to 20 percent less profitable than non-unionized firms (Mihlar, 1997). A study of 510 Canadian firms between 1980 and 1985 found a median growth rate for employment in non-unionized firms of 27 percent, compared with 0 percent for their unionized counterparts (Mihlar, 1997). A series of international studies have also shown that unionization reduces rates of employment growth (Cote and Hostland, 1996; Mihlar and Peacock, 1997).

British Columbia's Labour Policies

Unfortunately for British Columbia, the last decade has seen significant increases in labour market regulation, and subsequently a serious decline in the level of labour market flexibility. For example, 1991 changes to the Industrial Relations Act banned the use of replacement workers during strikes and lockouts, allowed secondary picketing, and eliminated the right of workers to a secret ballot for union certification.

Another example is the Fair Wages Act, introduced in 1992. It imposed a minimum standard of pay and benefits on successful bidders for government contracts (Mihlar, 1996a). Since the standards imposed are above market wages, the taxpayer is, in effect, subsidizing union wages on government projects. Estimated cost increases due to this policy approach 4 percent, with annual costs to the taxpayer totalling nearly $166 million. One study found the act was responsible for the disappearance of almost 10,600 construction jobs alone in the province between 1994 and 1995 (Mihlar, 1996a). The clear intent of the Act is to promote unionization within the private sector by making it more difficult for non-union suppliers to obtain government contracts.

Changes to the Employment Standards Act introduced in 1994 provide yet another example of labour market regulation. The Act attempted to establish minimum working conditions for part-time employees. Issues such as vacations, statutory holidays, termination of employment, and layoffs were all proposed for coverage under the Act. The government effectively denied the covered workers the opportunity to negotiate their own terms of employment with their employers (Mihlar, 1996a) as well as reduced the efficiency of firms employing part-time workers. Also, the Act clearly increased the cost of employment and thus once more raised the cost of doing business in British Columbia.

In spite of clear evidence of the harm associated with increasing minimum wages (Law, 1998), the British Columbia government has continued increasing the minimum wage. In fact, it just recently announced a two-stage increase to bring the minimum wage up to $8.00 per hour. This announcement means British Columbia will have by far the highest minimum wage in the country.

The State of BC's Labour Market: The Cost of Rigidity

[A more expansive assessment of labour market performance is found in the Economic Performance section.]

Given the economic research into the relationship between labour market flexibility and employment, one would expect British Columbia's labour market performance to be relatively muted. Regulation Figure 4 shows the average unemployment rates for British Columbia and Canada as a whole between 1975 and 2000 (see also Economic Figure 8).

Two periods shown in Regulation Figure 4 are striking: 1982-1990 and 1991-1997. First, between 1982 and roughly 1990, British Columbia's unemployment rate was significantly above the national average. Second and more importantly, between roughly 1991 and 1997, British Columbia's unemployment rate was lower than the national average. Unfortunately, since 1997, BC's unemployment record has reverted to its previous trend of being above the Canadian average. For instance, British Columbia's average annual unemployment rate of 7.1 percent for the year 2000 is above the national average for the year of 6.6 percent.

Regulation Figure 5 presents similar data based on relative comparisons to Ontario and Alberta between 1990 and 2000. The lack of a major decline in the unemployment rate in British Columbia is clearly noticeable. Ontario and Alberta both experience a drop in their unemployment rates, while British Columbia maintains a relatively high unemployment rate (see also Economic Figure 8). In fact, for the fiscal year 2000, the unemployment rates in Ontario (5.3%) and Alberta (4.9%) were well below that in British Columbia (7.1%).

As discussed in the Economic Performance section, British Columbia's relatively positive performance in employment during the 1990s must be taken in context. Although the province performed relatively well in generating employment growth between 1990 and 1994, it has done so largely by expanding the public sector. That is, while private sector employment growth has been next to stagnant, the public sector has grown. Specifically, employment in the provincial public sector increased from 319,000 in 1990 to over 345,000 in 2000, an increase of 8.2 percent.

As the Economic Performance section discussed, it is unclear how dramatic the curtailment will be in the public sector once the necessary structural reductions are made to the level of spending and taxes. What is clear, however, is public sector growth cannot continue to offset lacklustre performance in private sector employment.

Equally importantly is the continued negative business and investment climate. Part of this negative environment is driven by anti-business labour legislation enacted over the last decade and partially enumerated above. There is little disagreement that one of the main priorities for reform must be labour market reform aimed at reinstituting labour market flexibility.

Policy Recommendations

[The policy recommendations included in the labour policy section are largely based on those made in the 1998 report by Satinder Chera and Fazil Mihlar, The Government of British Columbia, 1991-1998: An Assessment of Performance and a Blueprint for Economic Recovery.]

(1)

Repeal the amendments made to the Industrial Relations Act, the Employment Standards Act, and the Fair Wage Act over the last decade.

Mounting evidence reveals that amendments made to the first two pieces of legislation have led to a dramatic deterioration in labour-management relations and contributed to a negative business climate in BC. Similarly, the amendments to all three labour bills have increased the cost of doing business in the province by altering the cost of labour. A return to market-determined compensation and greater flexibility must underlie labour market reform. A first step in this process is to undo the damaging labour legislation implemented over the last decade.

(2)

Rescind announced increases to the minimum wage and ensure that minimum wages maintain an appropriate relationship with per capita GDP, assuming they remain at all.

Mounting research indicates that minimum-wage laws have a negative effect on employment, particularly for young and unskilled workers (Law, 1998). In fact, the evidence shows that minimum wage laws may be to blame for high rates of unemployment among young British Columbians (Law, 1998; Mihlar, 1996a). While jobs continue to be created in the rest of the country, employment growth in British Columbia is expected to remain relatively weak (Conference Board of Canada, 2000). Governments in general need to stop interfering in the process of real wage determination in response to changes in labour supply and demand. Assuming the ongoing presence of minimum wages, they should be set at an appropriate level relative to per capita GDP—a proxy for per capita productivity (Arman, Samida, and Walker, 1998).

(3)

Enact Right-to-Work (RTW) legislation.

The government of British Columbia should repeal the existing Labour Relations Code and enact Right-to-Work legislation. Right-to-Work laws preclude closed-shop unions and thus make union membership voluntary. As a result, workers are no longer forced to join unions and have more flexibility to negotiate contracts with employers based on their own particular economic and personal circumstances. Unions, in turn, would be forced to become more responsive to the interests of their members, who have chosen to join. Indeed, a large body of evidence shows that jurisdictions where RTW laws have been implemented successfully have lower rates of unemployment and stronger economic growth (Mihlar, 1995; Holmes, 1995). For instance, in the United States between 1988 and 1993, 77 percent of all new high-paying jobs in manufacturing were created in states with Right-to-Work laws (Mihlar, 1995). Further, a study by Thomas Holmes of the Federal Reserve Bank of Minneapolis found that employment grew by 170 percent in Right-to-Work states between 1947 and 1995, compared with employment growth of just 54 percent in states which authorized union monopoly hiring (Holmes, 1995). RTW legislation would allow British Columbia's labour market to become more competitive, improve labour productivity, and increase employment. This legislation should be modelled on the Employment Contracts Act enacted in New Zealand.

(4)

Implement a more balanced approach to the issue of union certification and de-certification.

Government legislation should neither favour the creation of, nor unduly impede the introduction of a union, assuming the presence of Right-to-Work legislation which prevents closed-shop unions. The question of unionization should be left to the workers affected by such a decision. The province should, therefore, move to reinstitute secret balloting for union certification and decertification and ensure equal access for all employees for certification and decertification.

Fraser Institute Policy Contacts:

Fred McMahon, Director of Social Affairs Centre
Phone: (604) 714-4569
E-mail: fredm@fraserinstitute.ca

Recommended Readings

[Note: For complete publication data, please see the list of references.]

Walter E. Block and Michael A. Walker (1981). Discrimination, Affirmative Action, and Equal Opportunity.

Barry T. Hirsch (1997). Unionization and Economic Performance: Evidence on Productivity, Profits, Investment, and Growth.

Fazil Mihlar, ed. (1997). Unions and Right-to-Work laws: The Global Evidence of their Impact on Employment.

III. Natural Resources: A Sector in Decline?

Natural resource industries have historically been central to the economic development of British Columbia, and they continue to play an important role in determining the economic well-being of the province (Finlayson, 1998). Unfortunately, due to space and resource constraints, a broad analysis of the natural resource sector was not possible for this study. The following analysis of the natural resource sector is limited to forestry, as it remains one of the largest sectors of the BC economy (PriceWaterhouseCoopers, 2000b). This does not, however, in any way diminish the importance of other natural resource industries, such as mining, oil and gas, agriculture, and fishing, or the regulatory problems facing them.

This subsection, like all policy sections, presents the general economics associated with natural resources. It assesses the state of natural resource policy in British Columbia and offers policy recommendations for forestry. Many of the regulatory problems affecting forestry are equally applicable to other natural resource industries. Thus, the policy recommendations offered for forestry can, in many cases, be applied to other industries in the natural resource sector.

Importance of Natural Resources to BC: A Lifeline

Logging and forestry activities represented 2.7 percent of GDP in 1999, with mining accounting for another 2.5 percent of GDP in the same year. The production of paper and allied products represented an additional 1.2 percent of GDP in 1999, the latest year for which industrial GDP statistics are available (Statistics Canada, 2000c).

According to the BC Ministry of Finance and Corporate Relations, (2000b), forestry directly accounted for 1.6 percent of total employment in the province in 1999, roughly 30,200 people (BC Ministry of Finance and Corporate Relations, 2000b). According to a 2000 PriceWaterhouseCoopers' (PWC) study, in 1999, the forestry industry, broadly speaking, employed 90,600 people directly, with another 181,200 people employed indirectly (PWC, 2000b). Further, PWC estimates that the forestry industry in BC alone accounts for 49 percent of manufacturing shipments, 16 percent of GDP, and 14 percent of the provincial workforce (PWC, 2000b). The same study characterized the forestry industry in British Columbia as the "largest industrial and most geographically dispersed employer," upon which "British Columbia's economic prosperity is dependent" (PWC 2000b).

It is clear that BC's economy, whether viewed in terms of GDP or by employment, is still reliant on the natural resource sector, particularly the forestry industry. Public policy within the natural resource sector influences an important aspect of the provincial economy that cannot be neglected.

Economics of Natural Resources

Public policy analysis of natural resources should use cost/benefit techniques. However, the natural resource sector is unique in that governments in Canada own most of the resource. That is, private property rights, and thus functioning markets for vast quantities of natural resources, are either absent or significantly muted by government ownership. For instance, the BC Ministry of Finance and Corporate Relations noted in its 2000 review that the government of British Columbia "has a higher degree of responsibility for forest management than most other jurisdictions in the world because it owns more than 90 percent of the province's land" (BC Ministry of Finance, 2000b, p. 95). In fact, 88.8 percent of all forestry products billed in 1997/98 were from Crown lands (BC Ministry of Forests, 1999).

One of the problems inherent in situations where the state owns the resource is what is referred to as the "tragedy of the commons." This term means that the lack of private property rights results in an incentive to overuse the natural resource. The traditional example of the "tragedy of the commons" is the field designated for grazing. When private property rights do not exist, there is an incentive for those using the field to allow their animals to overgraze on it, since they do not directly incur the cost of doing so. If one farmer stops his animals from overfeeding on the common property, there is no incentive for others to do the same; in fact, his restraint may prompt them to expand their own use of the field. Thus, the incentive is for everyone to overuse the natural resource.

Elizabeth Brubaker, executive director of Environment Probe, has researched the different incentive structures present in governments and markets. She has specifically argued that one of the main reasons governments continue to prove unable to manage natural resources efficiently and effectively is because of defective incentives. Using the case of overfishing, Brubaker identified four problems associated with government and its incentive structure (Brubaker, 1998):

(1)

Short-Termism
Governments are generally unable to implement policies with time horizons that exceed the election cycle. Thus, governments often select public policies that have immediate returns, even if they result in long-term negative consequences.

(2)

Agency
Participants in the political process are required to compromise between vying or competing interests in order to maximize votes. This compromise process often leads to legislation that fails to increase the welfare of the general population; thus, governments are ineffective agents for the general public.

(3)

Special Interests
Special interest groups armed with the ability to influence specific voters can exert enormous pressures, which can force government to implement legislation that may ultimately have negative effects on all except for the particular group exerting pressure.

(4)

Government Accountability
The link between the outcome of specific decisions and the rewards or punishments experienced by government policymakers are extremely weak, if not absent altogether. Most often governments are not held accountable for each specific decision, but rather for their aggregate performance every four or five years.

A final economic consideration is the nature of the products the natural resource sector produces. By and large, this sector's products face internationally-determined prices. Firms must, therefore, focus more intensely on cost control since it is extremely difficult, if not impossible, to create premium-priced products based on marketing, distribution, or product differentiation. Currency exchange rates are also that much more crucial than in other sectors since much of this sector's production is exported.

The natural resource sector poses specific challenges that are not generally present in other areas of public policy, due to the government's ownership position. Also, the government faces specific incentive problems in making decisions, both within natural resource policy and in general. Finally, the general economics of regulation apply equally to the field of natural

resource regulation and, as will be demonstrated, one of the main challenges to the natural resource sector in British Columbia is the heavy hand of regulation.

The State of Forestry in BC

Unfortunately for British Columbia, the forestry industry shows serious signs of decline. The sector's employment is well below levels previously maintained, its rates of return are lagging badly behind those in other jurisdictions, and capital expenditures are well below replacement values.

Before assessing current specific deficiencies in the forestry industry, let us examine some aggregate industrial data. Regulation Figure 6 depicts the real value of forestry and logging activities in British Columbia between 1984 and 1999, in both dollar terms and as a percentage of total GDP. Since peaking in 1987 at $2.6 billion, representing 3.9 percent of GDP, logging and forestry activities have declined in dollar value and as a percent of GDP. In 1998, they totalled $2.1 billion, or 2.4 percent of GDP. Logging and forestry activities recovered slightly in 1999, fuelled by a moderate increase in paper prices, increasing to $2.5 billion, or 2.7 percent of GDP.

The provincial timber harvest remains well below the allowable annual cut (AAC)—the amount of timber available for harvesting each year as determined by the provincial government. Regulation Figure 7 shows the annual provincial timber harvest measured in millions of cubic metres along with the allowable annual cut. Except for 1993, each year's harvest has been below the permitted level. Even with a 26 percent increase in coastal harvesting, and a 13 percent increase in interior harvesting in 1999, the actual timber harvest remained 5.2 percent below the allowable actual cut (PWC, 2000b).

Effect of BC Regulation: Purposeful
Decline of Forestry

The question for policy makers is whether the decline in British Columbia is simply part of a larger global decline in the industry or whether it is due to poor public policies. As discussed previously, British Columbia's forestry industry cannot, and does not, exist in a vacuum. Any deterioration in the international market will affect the provincial industry.

PWC, in its analysis of the BC forestry industry, concluded that over the last decade or so, British Columbia has implemented a number of policies that have impeded the development and operations of the forestry industry. For instance, the government implemented large-scale increases to stumpage fees, withdrew large amounts of timber supply by doubling the acreage of parks and ecological reserves (from 6 to 12 percent of the province's land area), reduced the permitted harvest (annual allowable cut), and imposed a complex, process-based Forest Practices Code. The net result of these various initiatives has been to substantially increase the cost of operating in the forestry industry in BC while stifling the investment climate.

Increasing the Cost of Forestry

The Forest Practices Code, which includes restrictions and requirements aimed at preserving biological diversity and non-timber values, including wildlife and fish habitat, water quality, and even the visual quality of forests (Haley, 1996), is attributed with almost the entire increase in provincial-based logging costs. Between 1989 and 1998, the average provincial logging cost increased from $37 per cubic metre to $57 per cubic metre. Inflation accounted for $8, or 40 percent, of the increase. The entire remaining amount, $12 per cubic metre, is explained by regulation costs associated with the Forest Practices Code (PWC, 2000a). The $12 per cubic metre increase in average provincial logging costs is estimated to be roughly $680 million per year in additional regulatory costs (PWC, 2000a). Another study estimated these additional costs to be roughly $400 million per year with little or no significant social benefit (Van Kooten and Wang, 1998).

An additional cost increase imposed on the forestry industry that has had negative effects is the increase in stumpage fees—a cost charged to loggers by the province to harvest timber on Crown lands. The average stumpage fee increased from $9 in 1991 to $24 in 1998 (PWC, 2000a).

Both the Forest Practices Code and the "super-stumpage" fees were predicated on the government's belief that the lumber market had fundamentally changed. The government believed that a floor had been reached in lumber prices. This meant that the increased costs imposed by government on forestry in British Columbia were deemed affordable, given the new price floor. The subsequent decline in lumber prices, which caught the government by surprise, significantly affected the performance of BC forest companies.

The above-mentioned additional costs (both government-imposed costs and the actual operational costs) have resulted in a significant increase in the average total cost of logging and forestry in BC. The average total cost of logging on Crown lands increased from $45 per cubic metre in 1989 to $81 per cubic metre in 1998, an 80.0 percent increase over 8 years (PWC, 2000a).

Another deleterious initiative undertaken by the government of British Columbia is the reduction of allowable cuts in the province. While forestry companies have invested substantial sums in reforestation and reduced the backlog of unsatisfactorily reforested sites, the government has nonetheless reduced the allowable cut. This effectively reduces the potential supply of timber. It is not surprising, then, that a 1996 analysis incorporating the supply reduction anticipated massive employment reductions, roughly 45,000 jobs over a future 5- to 10-year period (MacCallum, 1996). In fact, in its analysis of the forestry industry in 2000, PWC concluded that total employment (direct and indirect) in the sector would have been 26,000 positions greater had production just met the allowable annual cut (PWC, 2000a).

Unionization and the corresponding increase in wages has also affected the forestry industry. The relatively high concentration of ownership in the sector has permitted large-scale union wage increases. In 1999, the average compensation per forest industry employee in BC, excluding benefits, was $49,633—a premium above the average provincial wage of 52.7 percent (PWC, 2000a).

Much more than reducing stumpage fees must be done to decrease the costs of forestry in British Columbia. The tremendous cost increases, doubling between 1992 and 1997 alone (PWC, 2000a), must be reversed if British Columbia is to return to a position of prominence in the forestry industry. Another example of the decline in BC's cost competitiveness is that ten years ago, British Columbia represented one of the low-cost producers in Canada; now is well below other jurisdictions, such as Ontario and Quebec, in its cost competitiveness.

Investment and Capital Deficiency

Apart from significant cost increases, the BC forestry industry also faces serious investment concerns because of uncertainty arising from the ongoing negotiations with aboriginal groups to settle land claims. The as-yet-unknown results of these negotiations could have serious affects on natural resource rights in the province. This uncertainty is a major barrier to investment in the province (PWC, 2000a; and PWC, 2000b).

Cost increases coupled with investment uncertainty have resulted in a decline in the forestry industry's performance in British Columbia. PWC estimates that a minimum threshold for return on capital to ensure reinvestment in the forest industry is roughly 12 percent. Rates of return on capital employed (ROCE) have lagged in British Columbia relative to rates achieved in the rest of Canada. PWC calculated the 1999 five-year average rate of return on capital employed in British Columbia at 2.9 percent compared with an average rate of return of 8.1 percent in the rest of Canada (PWC, 2000b). The rate of return gap in 1998 for the BC interior relative to the rest of Canada was 12.4 percent while the rate of return gap for the BC coast was 14.4 percent for the same year (PWC, 2000a). Across the board, British Columbia has been unable to compete with its Canadian counterparts, largely due to poor government policy, increasing costs, and constrained supply.

A serious concern for the future of BC's forestry industry is the poor record of capital investments made by forestry companies in recent years. This should not be surprising, given the forestry sector's poor performance in generating positive and competitive rates of return. Gross capital expenditures fell below depreciation values in both 1998 and 1999 by $306 million and $255 million respectively (PWC, 2000b). The deficiency in capital expenditures has led to serious fears of dis-investment, since new capital is not replacing depreciated capital. If this trend continues, the assets, and thus the productive capacity of the forestry industry in British Columbia, will continue to decline.

Attempts at Improvement

There have been a number of recent improvements in government policy aimed at revitalising the forestry industry. For instance, the government has accepted, at least in principle, the need to move from the process-based Forest Practices Code to a simpler, results-based code; it has asked industry to assist in developing new guidelines, and has enacted some pilot projects.

The government has also attempted to mitigate the difficulties it created when it increased stumpage fees. It has introduced modest reductions in stumpage and Forest Practice Code costs since 1998. Average total logging costs on Crown land (including stumpage) were estimated by PWC to have declined to $75 per cubic metre in 1999 from $81 per cubic metre in 1998, a reduction of 7.4 percent. However, average total logging costs are still 66.7 percent higher than they were in 1991 (PWC, 2000a).

Just as this study was going to print, the provincial government announced an agreement with coastal forestry companies to phase out the stumpage fee system and replace it with a market-based stumpage system (Hamilton, 2001). BC Forests Minister Gordon Wilson stated that the ministry could reduce forestry costs by as much as $400 million per year. The Minister specifically stated that a new policy regime would be implemented by March 1st of this year (Hamilton, 2001).

Increasingly, small businesses and community forestry initiatives are joining the forestry sector. In an effort to diversify the industry, the provincial government has been allocating an increasing volume of timber to small businesses, value-added projects, and community forest initiatives (referred to as tenures). Although these initiatives are a step in the right direction, they are piecemeal attempts to compensate for a top-heavy regulatory regime—an inferior approach to pursuing greater private ownership and competitive markets.

Conclusion

The potential for increased employment, greater capital investment, and profitability in the industry remain the purview of government, since most of the difficulties currently facing the industry are government-driven. A responsible and balanced approach to forestry must emerge involving outcome-focused regulation, based on cost-benefit analyses. If British Columbia is to return to a position of economic leadership and prominence, the forestry industry and its rebirth must be a central part of the process.

Policy Recommendations

[The policy recommendations included for the natural resource sector are largely based on those made in the 1998 report by Satinder Chera and Fazil Mihlar, The Government of British Columbia, 1991-1998: An Assessment of Performance and a Blueprint for Economic Recovery.]

Most, if not all of the recommendations listed below, are equally applicable to other natural resource sectors not covered in this study. For instance, mining, which has enormous potential in the province, has been plagued by many of the same problems discussed above and would, therefore, benefit from some of the same types of policy changes recommended below.

(1) Create a pro-development natural resource investment and business climate.

The last decade has been characterized by a generally anti-business climate in BC, which has had disastrous effects on business investment. The government of British Columbia must make real efforts to reverse the business climate and create conditions conducive to investment. Part of these efforts in the natural resource sector will include streamlining regulations with emphasis on outcomes rather than process, and taking a more pro-development stance. It is interesting that the results of The Fraser Institute's most recent Mining Survey corroborate the need for an improved investment climate. For instance, of the nine policy factors examined, British Columbia scored the worst on 8 of any of the 35 jurisdictions (Fredricksen and Jones, 2000). Clearly, British Columbia needs to adopt a more pro-development view of natural resources, and indeed of the economy as a whole.

(2) Privatize forests that are currently owned and managed by the Crown.

Given the evidence presented on the adverse impact government policies have had on forestry in British Columbia, the best solution for managing the industry efficiently would be to privatize Crown-owned forests in British Columbia. One of the biggest problems with state ownership of forests is that neither government nor private companies logging on Crown lands have any incentive to operate efficiently, to replant, or to harvest prudently.

Governments have little incentive to replant since the main beneficiary of this initiative will be some other government in power later, when the trees mature. Since private companies harvest on land that they themselves do not own, they see no direct benefit or economic incentive to invest in costly long-term "forest enhancement." In short, both see short-term benefits in harvesting, but no long-term value in replanting and forest enhancement programs.

Rather, as Lawrence Solomon, executive director of Environment Probe pointed out: "Private owners don't cut at a loss, they don't cut for employment reasons, and they manage their forests not as an undifferentiated commodity but as multi-purpose properties with timber being but one asset" (Solomon, 1989). Since "the long-term value of an asset is the present value of the long-term stream of income from it, a private owner with secure property rights will act to preserve that long-term income stream" (Robson, 1992, p. 39). Hence, private ownership would put an end to lumber disputes between Canada and the United States and provide economic incentives for implementing replanting programs and for harvesting at sustainable yields.

For instance, in 1991, Abitibi Price began cleaning up its half-million acres of land near Thunder Bay, Ontario. Three years later, it turned one section of the land into a money-making park and made plans to lease cottages around some remote lakes. The company stated: "We can market our products—our forest and lakes—better and get more value from them" (Brubaker, 1997). Canadian Pacific made a similar decision with its game reserve near Montebello, Quebec. The company manages the property for forestry and tourism purposes. In the process, it has not only created jobs, but has also succeeded in preserving the natural beauty of the region. Private owners have financial incentives to protect the long-term value of their property because to do otherwise would have an adverse impact upon the long-term profitability of their enterprises.

Serious questions have, however, been raised regarding the possibility of forestry privatization given unresolved aboriginal land claims. This is particularly true in the wake of the Supreme Court of Canada's Delgamuukw decision, which effectively ruled that the province has no capacity to extinguish native rights and that aboriginal title may well hold in many areas of the province. The presence of possible native land claims, although an immediate barrier to privatization, does not negate its long-term efficacy.

(3) Repeal the Forest Practices Code and the Forest Renewal Act.

Both the Forest Practices Code and the Forest Renewal Act have more to do with increasing the regulatory burden on the forest industry than generating positive environmental outcomes. Haley estimated that the Forest Practices Code will cost the provincial economy $1.4 billion per year in lost economic activity, but will fail to reach even its own objective of sustainable forest resources development (Haley, 1996). Like the Forest Practices Code, the Forest Renewal Act is also more oriented towards process than towards outcomes. The government should repeal these bills and rely on common-law remedies and private ownership of the forests to protect the environment. Further, a results- and performance-based forest code that establishes key performance targets and objectives, and provides business operators flexibility to meet the targets in the most efficient manner should be enacted to replace the Forest Practices Code.

(4) Eliminate the minimum stumpage fee and link stumpage fees to world prices.

Since coming to power in 1991, the NDP government has increased stumpage fees by nearly 200 percent. These payments are now part of the cost of production. As a result, British Columbia forest companies have become costly producers of lumber and other forest products, a situation that has led to lower levels of output and reduced employment. Given that world lumber prices fluctuate constantly, the provincial government should put in place a mechanism for linking stumpage fees to the price of lumber in order to allow companies to remain profitable and viable well into the future. As this study went to print, the provincial government had indicated that they were indeed going to move towards a market-determined stumpage fee process (Hamilton, 2001).

(5) Eliminate the British Columbia Environmental Assessment Act.

British Columbia's Environmental Assessment Act results in cumbersome and time-consuming processes that lead to allocative inefficiencies. The government should repeal this act and rely on common-law remedies to ensure protection of the environment. Its one-size-fits-all process of assessing the environmental impact of projects around the province fails to take into account the uniqueness of each project and the possible negative externalities arising from each. The assessment mechanism overestimates the impact of certain projects and so deprives the provincial economy of higher levels of economic activity when these projects are not undertaken.

(6) Subject the setting aside of Crown land for parks and heritage sites to cost/benefit analysis.

The government must immediately stop the practice of turning Crown lands into provincial parks or heritage sites without a cost-benefit analysis. This move would ease the uncertainty over land use in the province and lead to a more stable investment climate and would ensure that land is devoted to its highest-value use.

(7) Co-ordinate land claim settlements with forest privatization.

Future development in the resource sector requires final settlement of native claims and conversion of settlement resource values into marketable private property rights. This will ensure a secure and level playing field is established for all current and future investors.

Fraser Institute Policy Contacts:

Laura Jones, Director of Centre for Studies in Risk and Regulation
Phone: (604) 714-4547
E-mail: lauraj@fraserinstitute.ca

Recommended Readings

[Note: For complete publication data, please see the list of references.]

Elizabeth Brubaker (1997). No Expropriation Without Full Compensation.

Elizabeth Brubaker (1998). Property Rights: Creating Incentives and Tools for Sustainable Fisheries Management.

Harry Nelson (1998). Seeing the Forest as well as the Trees.

PriceWaterhouseCoopers (2000). The B.C. Forest Industry: Unrealized Potential.

PriceWaterhouseCoopers (2000). The Forest Industry in British Columbia, 1999.

PriceWaterhouseCoopers (2000). The Mining Industry in British Columbia, 1999.

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