The two extremes in approaches to delivering the objectives of economic development, however that is defined, are either the free market system or state control. However, following one or the other is not an automatic guarantee of success as each is prone to its own shortcomings or failures. It is in particular acknowledging the existence of these failures in the free market system that regulation has sought to find a role. In this context then, regulation is about creating institutional capabilities for dealing with the economic system’s potential failures, while ensuring economic benefits. Specifically, regulation is established with three objectives in mind. Firstly to mitigate against market [and government] failures, secondly to take cognisance of social burdens of economic activities, such as pollution – and address them – and finally, seek to improve the production efficiency of the economy.
But there are challenges to the practice of regulation. One of the major challenges is information asymmetry. Regulators need information of good quality to be effective in their roles. However, the regulated entities that own the information that the regulator needs are more than reluctant to pass on this information. The regulator on the other hand seeks to coax information out of the regulated entities through different incentives and mechanisms. It is debatable whether the regulator succeeds effectively in this bid, which has prompted some to argue that due to information asymmetry, both the regulator and the regulated should be part of government.
Regulation is also subject to failure. Regulatory failure is as a result of political or regulatory capture, with consequences for lack of accountability, transparency and consistency. Indeed, not everybody sees regulation as beneficial. Some argue that regulation overall leads to socially sub-optimal outcomes. Others argue that the outcomes of regulation remain second best to those of free market competition. It has also been argued that regulation is implemented not with the sole purpose of improving economic efficiency, but such that economic activities can be subject to political interference.
Given these challenges, what impact do they have on the effectiveness of regulation? Does setting up regulatory institutions necessarily guarantee efficiencies in economies? One approach that has been taken to answer these questions is the use proxies of effectiveness and regulatory quality to measure the impact of regulation on economic growth (also a proxy for performance). It was found that for the combination of the two proxies, a unit change in the quality and effectiveness of regulation was associated with just under 1% increase in economic growth. It was found that the impact of regulation on economic growth is determined by the efficiency of regulatory policies and instruments, and the quality of the governance process practised. But a number of caveats were also given, among them the fact that regulation as attempted to be measured here, using proxies, was divorced from the broader prevailing context in which it is practised, that regulation is in practice applied at different levels and differently in different sectors, that the direction of causality is not completely settled, and finally, that the question of the counterfactual remains unanswered. Given such caveats, the theory of the relationship between regulation and economic performance continues to be elusive.
But whatever the shortcomings of regulation may be, there are enough cases in recent global history, for example in financial and energy sectors, where it is readily acknowledged that had regulation, or its implementation, been more effective the failures encountered in these sectors could have been averted. It is therefore important that impact assessments of regulation need to become ‘a new governance’. In other words, it is not a question of whether to have regulation or not, but that of ensuring that regulation remains relevant and effective.
By undertaking impact assessments of regulation, it is being acknowledged that both before and after regulation and regulatory instruments are put in place, their effectiveness cannot be taken for granted. Furthermore, there are so many changes that continuously happen in the regulated sectors, in the regulatory bodies and institutions, in the economic system, and in the whole environment for that matter, that it only makes sense to regularly gauge how effective regulation is being. Assessing the impact of regulation, however that is done, would go a long way to ensuring that regulation remains relevant and effective, that failures do not happen unexpectedly, and that by indentifying the risks of failure before hand, mitigating measures can be put in place a prior.