The economic growth-regulation trade-off

How much regulation is too much? 

Works in Progress has a very good article that highlights the trade-off between regulation and economic growth in the context of developed economies in infrastructure construction. The case in point is environmental and other safeguards-related permissions required for infrastructure projects in developed countries. 

Consider this on the prohibitive costs of environmental and other safeguards documentation required to obtain permissions for large infrastructure projects in the US,

1,961. That’s the number of documents contained within a single planning application for a wind farm off the northeast coast of England – capable of powering around 1.5 million homes. The environmental impact assessment and environmental scoping documents alone totalled 13,275 pages. To put that into context, that’s 144 pages longer than the complete works of Tolstoy combined with Proust’s seven volume opus In Search of Lost Time... EDF Energy had to produce 44,260 pages of environmental documentation for Sizewell C, a new nuclear power station to be built on the same site as two existing nuclear power stations in Suffolk, England.... a Freedom of Information request from New Civil Engineer magazine recently revealed that the UK’s National Highways agency spent £267 million preparing a planning application to build a 23-kilometer road. The planning application, which featured 30,000-plus pages of environmental documentation, was the longest ever prepared... 

It takes, on average, ten years for an electricity transmission project to be completed. But before you get to that point, it can take as long as 13 years just to get approval for the project. For example, Harvard’s Belfer Center cites the case of the 732-mile Transwest Express high-voltage transmission line. It applied for its permit in 2007, but did not receive full approval for construction to begin until 2020. It’ll come online in 2026, 19 years after that first permit application was filed... Using the average environmental page count from a sample of 18 projects (11,756) gives us an average per-project cost of £98 million. And that’s before the projects have put a single spade in the ground and before any spending on environmental mitigations has taken place. Think what could be achieved with even half of that nearly £100 million cost per project.

In stark contrast, sample this from history

France responded to the oil shock of 1973 with the beautiful slogan: ‘In France, we do not have oil, but we have ideas’. Over the next 15 years, the French built 56 nuclear reactors. To this day, France gets more than two thirds of its electricity from nuclear power... consider the construction of Britain’s national electricity grid in the 1920s–1930s. In the space of three years, Britain devised a plan to connect over 100 of the UK’s most efficient power stations into seven local grids across the country, and passed legislation needed to enable the plan and begin work on it. It took five more years for the project to be completed, with 4,000 miles of cables running across 26,000 pylons around the country. A year after the seven local grids were built, a group of impatient and rebellious engineers decided it was easier to ask for forgiveness than permission, and switched on the connections between the seven grid areas themselves to form a single national system. That national system remains to this day. It is hard to imagine projects of similar scale taking place today at similar speeds.

This debate has important relevance in the context of developing countries. In many areas, developing countries tend to adopt state-of-art regulations from their developed counterparts - labour standards, environmental protection, corporate and financial markets regulation, etc. In fact, they are actively encouraged to do so by multilateral lending agencies. But this has consequences that adversely impact their growth. 

Regulation is an incremental cost that gets added to the cost of production. It manifests in the form of additional equipment or building or infrastructure, slack or redundancies, increased construction times, etc on the grounds of safety, pollution abatement, employee welfare and working conditions, community welfare, social inclusiveness etc. This is a simple model of how regulation increases costs, lowers demand, and reduces economic competitiveness. 

Therefore, historically, the scope of these regulations has expanded progressively with the country's development. In fact, the historical trajectories of economic growth of today's developed economies point to a Maslowian hierarchy of values. The values associated with a subsistence economy are very different from that of an aspirational middle-income economy or a rich post-modern economy. 

The early development pathway of all today's developed countries, including that of China recently, have been characterized by large-scale externalisation of costs by all economic agents. The industrial revolution happened in a very loosely regulated world. In fact, it could not have happened with the modern world regulations. 

While gains are privatised, environmental and social costs are externalised on the society. Looser regulations and their enforcement, corruption, crony capitalism, etc are inevitable accompaniments to rapid economic growth from a low baseline. Once countries reach a certain income level and command adequate tax revenues, they venture into the higher levels of the values hierarchy. This is a messy reality of development. Nothing has changed to warrant a revisit of this theory of change.

Many developing countries, or regions there, continue to remain in the pre-industrial stage of economic development. Forget the fourth, they are still to fully realise the benefits of the second industrial revolution. In this debate, the irony of developed countries that have enjoyed lighter regulations during their growth phases now turning around and forcing developing countries to adopt tighter regulations should not be missed. 

Further, the commentators and opinion makers in developing countries, who inhabit the post-modern world, too tend to foist the social and economic values they share with the developed countries on the collective choices of their nations. Politicians and policymakers in developing countries should keep this in mind while making policy decisions on regulations.

The problem with this is that once we accept lower regulation, there is a slippery slope of exploitation by all kinds of economic interests. The markets are not known for restraint and social responsibility. So the challenge is to get regulation right. This has to be borne in mind as policymakers in developing countries adopt progressive regulations. 

These aspects should also inform global policy formulation on such issues. The energy transition debate where developing countries are being asked to sharply cut their carbon footprints at a very early stage in their economic growth is a case in point. Steep cuts and rapid changes by developing countries will erode their global competitiveness, besides also raising questions of affordability and market demand (see this and this). It's also an existential issue for people in many developing countries - poverty will get you before climate change can. I'll write about this in the coming days.