Committee Reports > List of Committees > Joint > 2004 > Committee on Enterprise and Small Business > Report No. 04 - Innovation, Competition and Regulation - Achieving the Balance

Tithe an Oireachtais

An Comhchoiste um Fhiontraíocht agus Mionghnóthaí

An Ceathrú Tuarascáil

Nuálaíocht, Iomaíocht agus Rialáil - Comhardú a Bhaint Amach

Aibreán 2005

Houses of the Oireachtas

Joint Committee on Enterprise and Small Business

Fourth Report

Innovation, Competition and Regulation - Achieving the Balance

April 2005

Chairman’s Foreword

The Joint Committee on Enterprise and Small Business agreed, as part of its Work Programme, to examine the increase in the number of regulators and regulatory authorities.

The Joint Committee appointed Mr. Phil Hogan TD, as rapporteur, to undertake the examination and to present a report for consideration. The report entitled ‘Innovation, Competition and Regulation - Achieving the Balance’ was considered by the Joint Committee and it was decided to seek the observations of the relevant Government Departments and that these observations would be furnished within four weeks. The Joint Committee, upon receipt of the observations will follow up the recommendations contained in the report.

The Joint Committee wishes to thank Deputy Hogan for the excellent work that he has carried out in the preparation of the report.

The Joint Committee recommend this report to the Houses of the Oireachtas.

_________________________

Donie Cassidy, T.D.,

Chairman.

13^th April, 2005.

Innovation, Competition & Regulation - Achieving The Balance

A Report Prepared for

The Committee on Enterprise & Small Business

Phil Hogan TD

March 2005

Innovation, Competition & Regulation - Achieving The Balance

Innovation, Competition & Regulation - Achieving The Balance

1. INTRODUCTION

Since the middle of the 1990s, Ireland has witnessed a growth in the number of regulators and regulatory authorities. Regulation was mandatory in some instances as a consequence of EU obligations or deemed a necessity in circumstances where the State had previously been the shareholder and regulator of key aspects of economic activity. Consequently, regulators were appointed for Telecommunications (1997), Energy (1999 & 2000) and Aviation (2001) and Health Insurance (2003). In other instances, regulatory bodies were established in response to concerns about accountability and transparency in key sectors such as financial services (2003). The establishment of the Office of the Director of Corporate Enforcement and the new Irish Accounting and Auditing Standards Authority were in direct response to concerns about standards in general corporate behaviour, while the Competition Authority has a regulatory role to ensure greater competition across all sectors of the economy. A list of the Irish regulatory authorities and the years they were established is set out below.

In some particular sectors there are additional regulatory aspects, ranging from measures designed to ensure safety in the workplace, to measures designed to ensure food safety. Many regulatory measures arise through statutory obligations imposed on businesses and consumers.

While the establishment of new regulatory agencies has been seen as positive and an indication of progress in key areas, the experience is not altogether positive. Some commentators have claimed that overlaying the relatively small Irish economy with such a complex and multifaceted regulatory structure is bound to create additional costs and burdens that will not be matched by obvious benefits. Many of the regulatory structures introduced into Irish business life have been criticised by business groups as burdensome for Irish businesses, without delivering the expected benefits for consumers or the State. In some instances it is clear that regulatory authorities have suffered from the creation and maintenance of unrealistic expectations about their impact. In some cases the appointment of a regulator to a sector has been expected to revolutionise aspects of economic activity that have been under monopoly control for decades. There are signs that the public expectations of the role of regulators may now be more realistic, and some regulators are also moving to more narrowly define their role and responsibilities.

While Government has taken steps through the Better Regulation Programme, to tackle any new or additional regulatory burdens being placed on business, there remains a legacy of legislation and a regulatory structure that is adding to the costs of doing business in Ireland. It is important that these costs are assessed, quantified and measured against any resultant benefits to the economy arising from regulation.

2. THE ROLE OF REGULATION

What is the role of regulation in a modern economy? Regulation has generally been introduced into a sector when the existing market either fails or is not seen to be competitive. Market failure usually occurs when there is evidence of the following:

▪Information and asymmetry problems between buyers and sellers

▪Market concentration and natural monopoly

▪Too few markets or non-competitive behaviour

▪Negative external effects

Regulation is designed to protect competition, not competitors. It is recognised as an imperative where markets need to be liberalised, given the absence of any voluntary competitive dynamic. In an ideal world, once competition is established the Regulator should become redundant, leaving behind a competitive and vibrant market. So far in Ireland, there is no sign of regulatory redundancy — if anything the regulatory agencies seem to be increasing in size and scope.

When operating effectively regulation has the potential to eliminate existing monopolies and reduce uncompetitive behaviour. Regulatory agencies should also be concerned with removing barriers to entry to a market and increasing levels of competition. This should generate greater value for customers and encourage informed decisions by consumers on the options available within that sector. The gain to the national economy from an effective and focused regulatory market can be seen from an attraction of investment and a general enhancement of Ireland’s reputation as a country to do business in worldwide. Regulation also has a role in increasing and encouraging greater accountability in sectors where consumers have limited competitive choice.

3. THE COST OF REGULATION

The levels of regulation in Ireland and in Europe far exceed those of America or the Far East, which in an increasingly global economy can present major problems for national competitiveness. This can contribute to a huge difference in the costs associated with conducting business here than in other parts of the world.

The cost of regulation can also be measured in the efficiency of the regulatory structures in a particular country. For example, it takes an average of four days to set up a new business in the US, compared to 38 days in Europe. In terms of actual monetary significance, it costs approximately 1% of gross national income in the US to start a business, compared with 12.2% in Europe.¹ Establishing a regulatory structure can never be an end in itself and the operation of the regulatory structure must constantly be assessed to ensure that it is focused, effective and targeted. The cost of regulation must also be assessed to ensure that it is delivering benefits that outweigh any regulatory burdens being imposed.

In some EU countries, this process is developing at a pace. In the Netherlands², the newly elected Dutch government decided in 2003 to reduce regulation by a quarter by the end of its term in 2007. The Dutch Bureau for Policy Analysis (CPB) was commissioned to research the macro-economic effects of reducing this administrative burden. They estimate that approximately 40% of legislation affecting the Netherlands stems from the EU. According to the CPB, by reducing red tape by 25%, Dutch GDP will grow by 1.5% and labour productivity will increase by 1.7%. The Ministries of Finance and Economic Affairs are charged with coordinating a national approach on behalf of the Dutch government, and a package of 130 measures were identified late last year and sent to Parliament. This package has since been expanded and agreed upon and is now estimated to have the potential to reduce administrative burdens by €4billion.

In Ireland, it is estimated by the Department of An Taoiseach that the cost to business of compliance with existing legislation is approximately €4 billion per annum. According to the Government White Paper on Regulation 15% of this burden is avoidable. That means that each year, unnecessary regulation costs €600 million to business here. It is important to note that not only does this cost impact negatively on the economy and consumers in monetary terms, it also prevents businesses from expanding or generating new jobs each year.

In addition to monetary costs, there are also indirect impacts on business and consumers from an ineffective or unfocused regulatory regime. For example a failure of proper regulation could delay the effective opening of a market to competition, or deter new entrants from locating in Ireland. These indirect impacts are harder to detect, but have a far greater negative impact for the economy as a whole.

4. THE NEGATIVE ASPECTS OF REGULATION

Criticism of regulatory authorities in Ireland has been levelled on the basis of 5 main headings:

4.1 Over-regulation

A number of business groups have expressed widespread concern that Ireland is rapidly becoming over-regulated, to the point that some claim it is becoming difficult to conduct business here while maintaining a competitive edge. In addition, the appointment of a regulator or the introduction of new regulations is becoming an almost automatic response to many public policy issues, without pausing to consider other alternatives. Many groups, including the Enterprise Strategy Group have voiced the concern that as we adopt more extensive and complex regulatory structures, our capacity to remain competitive dwindles and we move down the scale of competitive globalised countries in the world.

Notwithstanding the fact that Europe is subjected to far greater levels of regulation than the United States, some business representatives in the US have recently expressed their dissatisfaction with the extent of bureaucracy and red tape there.

4.2 Lack of Accountability

Many business and consumer representatives in Ireland have called for a Commission to oversee the work of the various regulators that have been set up in Ireland over the past number of years. There have been suggestions of a ‘ National Commission of Regulators’, which would consolidate all of the existing Regulators into one body, which would co-ordinate the Regulators’ activities and review each individual Regulator on a systematic basis.

It has been suggested that by introducing such a Commission, there would be greater accountability amongst Regulators, reduced levels of operating costs and more consistent decision-making in general.

Increasing accountability of the Regulatory Authorities to the Oireachtas is also of critical importance. The relationship between IFSRA and the Oireachtas Committee on Finance presents a model for the political accountability of regulatory authorities. It is important that the veil is lifted off the regulatory bodies and that their activities are seen as transparent, open and accountable — regular interaction between the Committees and the Oireachtas can play a key role in this regard.

4.3 Poor Quality Regulation

There are instances where, even though regulation may be the preferred way forward of dealing with a market problem, it is poorly developed and so does not work effectively. There are also instances where there is duplication between regulatory agencies or an inconsistency in approach to dealing with issues of critical importance to the national economy. The well-publicised lack of co-ordination between the Competition Authority and some of the sectoral regulators in the early parts of this decade perhaps illustrated this best. The conclusion of co-operation agreements between the agencies has improved the situation, but there is still a sense that the economy would benefit from greater co-ordination from regulatory agencies.

There are also a number of pieces of legislation that enforce regulations that are poorly constructed, according to business representatives. The Companies (Auditing and Accounting) Act 2003 is a particular source of frustration for businesses. It introduces a range of compliance requirements on business that some claim acts as a disincentive for individuals looking to take on the role of non-executive directors within a company. Encouraging enterprise, innovation and responsibility can be mutually compatible objectives and achieved without strangling initiative and vision.

4.4 Costs of Compliance

Presently, small companies with a turnover of €317,000 are required to carry out an annual audit at a cost of several thousand euros. This threshold is due to be increased to €1.5 million but has not yet come into effect. However, even when this new threshold has been introduced, it will be considerably lower than many other EU countries. For example, in the UK, the threshold is £5.6 million sterling.

After labour, energy and insurance costs, many businesses cite compliance costs as an area of major concern to business. Compliance costs rise significantly each year, putting huge strain on big and small businesses alike. For example, the cost of Professional Services incurred by companies increased by 37.2% between 2001 and 2003, while overall business costs increased by 29% over the same period.

4.5 Regulatory Capture

Where a ‘natural monopoly’ exists, a Regulator is often necessary. However, quite often, the Regulator is at the mercy of the regulated in terms of accessing information and figures relating to the business and the Regulator can become ‘captured’ by the regulated firm. Regulatory capture results in the regulator protecting the interests of the regulated firm instead of promoting and furthering competition. The regulated firm sets the agenda for regulation and the Regulator does not have the information available to him to change the situation.

This kind of situation has arisen in other countries in relation to industries such as gas and electricity. In many cases, it was decided that the transmission and distribution networks could be deemed natural monopolies, while competition was possible in every other area. However, this has sometimes resulted in the natural monopolist impeding other companies’ access to transmission and distribution networks, and as a result, the ownership of the networks have been transferred to separate independent companies.

This is not the case in Ireland where Bord Gáis Éireann (BGE) remains vertically integrated and where Eirgrid have been allowed access to operate the national electricity grid but the grid is still owned by the ESB.

4.6 Sectoral Problems

Regulation can also pose greater problems for a number of specific sectors, such as:

•Hospitality & Food

The hospitality and food industry is affected by waste management regulation, health and safety regulation, labour regulation, environmental regulations, food regulations and so on. For example, EU regulations³ relating to food hygiene are extremely complex and detailed. EU legislation relating to food hygiene is currently scattered over 17 complex EU Directives. In April 2004, the EU adopted a ‘hygiene package’, which aims to simplify and merge the detailed Directives. It is expected this law will be applicable by January 2006. However, having to constantly adapt and adhere to such an array of regulations is time-consuming, costly and difficult. It makes it an imperative that any regulatory burden that is imposed on a business must be proportionate and only imposed for as long as is necessary.

•Energy

The energy sector also poses a number of problems in terms of regulation. By its very nature, the energy sector is complex, financially, economically and technically. Wholesale prices in the energy sector change rapidly, as fast as every five minutes in areas of the world such as Australia. Other energy prices change hourly, others annually. Therefore financial and risk assessment is vital. Safety and security of supply have also to be taken into consideration by the regulator, as do environmental considerations. These factors combined make it difficult for regulators to ensure a long-term supply for consumers, of high quality, while also maintaining competitiveness at all times. However it is important that the complexity of the industry in which a regulator operates does not blur constant focus on the important priorities that should govern regulation — competition, reliability and efficiency.

5. EUROPEAN UNION

The Lisbon Agenda was announced in March 2000 as the European Union’s core means of enhancing competition. A key aspect to this Agenda is achieving effective better regulation.

A report issued by the High Level Group on the EU Lisbon Strategy (Kok Report) at the end of 2004 indicated that the quality of regulation and the extent of existing red tape is preventing the Lisbon Agenda from moving forward and is impeding the growth of competition throughout the Union. The Report recommended that in order to improve regulation, costs on business and red tape should be reduced. It also recommends that the quality of regulation should be monitored by carrying out proper and thorough regulatory impact assessments on proposed legislation. The report also recommends that the cost of starting up a business in the EU must be ‘drastically reduced’ and a community patent should be adopted to help improve the regulatory environment.

6. IMPACT ON SMALL BUSINESS

Small businesses bear a disproportionate burden from excessive regulation. Increasingly, levels of bureaucracy and regulatory requirements are resulting in a number of difficulties for smaller enterprises. This ‘strangulation by regulation’ has been highlighted by ISME, the independent business organisation frequently.

Clearly, the main impact regulation has on small business is cost. It is estimated that red tape can add the equivalent of 4% of turnover in costs⁴ to a small business. Small businesses can often be subjected to thousands of euro in regulatory costs, which can have negative consequences for the business. Not only can excessive regulation costs impede a small business’ ability to expand, it can also prevent a business from developing new ideas and adapting to changing economic circumstances.

One of the main regulatory burdens, which affects smaller businesses, is the process required for compliance with employment laws. Employment issues are currently regulated by 25 Acts and 8 separate bodies. According to IBEC there have been almost 50 new pieces of labour legislation introduced during the last five years. As smaller businesses tend by nature to be labour intensive and involve a greater hands on commitment from the owner managers, they are hit hardest by the need to be continually playing catch up with new employment legislation. This can act as a deterrent for new businesses hoping to enter the market or for existing businesses contemplating expansion.

Small businesses also complain that as they spend such a great deal of time and energy complying with regulatory demands, they are unable to spend as much time as necessary on product and business development and sales which would allow their business to grow and prosper.

SME’s have also been highly critical of the regulation of the financial sector, saying banks have imposed an excessive level of hidden charges on small businesses who are regarded as an ‘easy touch’. There seems to be a perception from some small business groups that the high costs for banks of regulatory compliance has been passed onto customers, rather than taken from the bottom line.

7. EXEMPTIONS FOR SMALL BUSINESSES

Small business representatives have repeatedly called for exemptions for SME’s from some aspects of labour regulations and other perceived regulatory burdens. They believe an amalgamation of the 8 employment bodies and the consolidation of 25 Employment Acts and 11 Companies Acts would lessen the burden on SME’s and permit them to grow and expand their businesses instead of spending excess time on completing forms and concentrating on complex rules and regulations. ISME estimate that small business owners have to be aware of and implement almost 1,000⁵ different major legislative issues in order to comply fully with various aspects of regulation, in areas such as taxation, industrial relations, auditing, environmental issues and health and safety.

The question of granting an exemption from any aspect of regulation for a particular class of enterprise raises challenges. Clearly no employee of a small or medium sized company should be at a disadvantage in terms of regulatory protection by virtue of working for a small company. Similarly no customer of an SME should suffer any disadvantage. There is a balance of interests to be secured, but there must be an imperative, in the context of creating and sustaining enterprise, to ensure that the regulatory obligations facing a well resourced and staffed multinational are not identical to those facing a smaller owner operated family business.

8. BETTER REGULATION

There are signs that addressing the regulatory burden on business and enterprise is receiving sufficient political priority. For example, the Government’s White Paper on Better Regulation was published in January 2004 and identified the need for a more focused and strategic approach to be taken to regulation in future. Central to this is the need to ensure that Regulation conforms to key principles including necessity, effectiveness, proportionality, transparency, accountability and consistency. The Government has made it clear that all new legislation will be assessed by reference to new Regulatory Impact Analysis to determine the likely impact on the economy and society. As a priority, the Government has announced its intention to amend the —1922 legislation, through a process of Statute Law Revision.

While this is a welcome development, it does little to address the concerns of business that there has been a legacy of burdensome and unnecessary regulation in recent years. If a programme of Better Regulation is to have any meaning for business, it must focus on the legislative changes which have been introduced in recent years and not start back with pre 1922 statutes. There is an imperative for modern businesses to have an effective and efficient modern regulatory system. Devoting State resources at the outset to target statures enacted before Independence, does little to ensure businesses that the State is serious about regulatory reform.

As a priority, Government should consider a number of measures:

1.An independent review should be carried out of the effectiveness and operations of all the regulatory agencies set up since the 1990s, to determine their performance in the context of the 6 key principles outlined as part of the Governments White Paper on Regulation. This review should not contain representatives of the regulatory bodies, but be based on a broad composition of the stakeholders’ ostensibly benefiting from the new regulatory regime. In particular, the review should consider the need for a multitude of regulatory authorities in such a small economy as Ireland.

2.A process of identifying the operation and impact of recent regulatory legislation on businesses and consumers must be undertaken as part of this review. The review should also examine the extent to which the regulatory agencies observe the 6 key principles of Better Regulation in their consultative and decision making processes. Businesses and representative groupings should be requested to outline their experiences of complying with regulations, to see how any burden can be reduced, without diluting the public policy objectives underpinning the appointment of the regulatory agency in the first place.

3.This review group should report to the Committee on Enterprise and Small Business and carry out its functions over a 4-month period. Any requirements for legislative amendments identified as a consequence of the review should be fast tracked through the legislative process.

4.All of the regulatory authorities should be issued with guidance from Government on the key principles that they should respect and seek to achieve in both their consultative, investigative and decision making processes. In particular the regulatory agencies should be compelled to follow a code of practice on the manner in which they regulate and should ensure that they comply with the 6 tenets of Better Regulation laid down in the Better Regulation White Paper.

5.As a group, the regulators should meet, under the auspices of the National Competitiveness Council, to ensure that their key role in helping to deliver a vibrant and competitive economy is constantly in focus.

6.All of the regulatory bodies should be called to account before a relevant Oireachtas Committee at least once a year on the general issues relating to their operations. This process of parliamentary accountability should be encouraged and prior to their appearance, business and consumer interests should be invited to make submissions on the operation of regulation in that specific sector.

7.A proactive approach at reducing regulation in the economy should be carried out. Some consideration should be given to adopting the same approach as the Dutch and setting specific targets to reduce regulation in the economy by 25% over a 5-year period. The Dutch government applied the ‘Standards Costs Model’ to their regulatory environment, which calculates the time and cost involved for a firm or individual in complying with a specific law or regulation. This model has also been effectively used in other countries such as Norway, Sweden, Denmark and Belgium to calculate the cost of enforcing VAT regulations. Adopting a similar initiative would deliver tangible benefits for consumers and businesses that are measurable and would further assist national competitiveness.

Phil Hogan TD

March 2005

¹ Statement by Maurice Pratt, President of IBEC, 19/04/04

² www.comliancecosts.com

³ www.fsai.ie

⁴ ISME Press Release, 02/01/05

⁵ ISME, 02/01/05