Regulatory Red Tape and Private Firm Performance: a review by Marcos Fernández-Gutiérrez

Review by Marcos Fernández-Gutiérrez

Regulation is increasingly consolidating as a main tool for policy-making in most countries across the world, including the EU countries. This has led to the rise of the notion of the “regulatory state”, which following Levi-Faur (2014) is, defined by its instruments, an state whose action is based on the application and extension of rule making, rule monitoring and rule enforcement, directly or indirectly. From an economic point of view, the legitimate basis for regulation is that it may serve as a mean by which governments can achieve social benefits or social objectives that are not directly provided by private firms (as protecting employee’s health and safety, stimulating competition or guaranteeing access to public goods).

However, regulation may have both positive effects, as serving to these objectives, and negative effects, as the costs imposed to different stakeholders. A case in point is that of private companies, where the negative effects may prevail. The possible positive effects of regulation on private companies are increased action capability and organizational efficiency, as well as protection of certain enterprises in some markets and access to other markets which were previously open only to other organizations. But the negative effects on private companies may be dominant, implying compliance with rules that are frequently changed and that require inside and outside legal expertise, and thus may obstruct dynamic adaptation, innovative power and entrepreneurial activity. For this reason, regulation frequently concentrates complains of firms. A key issue on this regard is the so-called regulatory red tape, which following the definition by Bozeman (2000) is referred to “rules, regulations and procedures that remain in force and entail a compliance burden but do not serve the legitimate purposes the rules were intended to serve”. Costs of regulation have been estimated by the literature as 3-4% of GDP, on average, for European countries, although significant differences exist between sectors and countries. This includes the costs for developing, administering and enforcing regulations by the public sector (administrative costs), the costs of complying with regulation for the private companies, capital costs (time and money spent on meeting regulations) and psychological costs (frustration generated). As a response to these concerns, a variety of instruments, such as regulatory impact assessments and cost-benefit or cost-effectiveness analyses, are increasingly used to assess the effects of regulation. In addition, the reduction or rationalization of regulation is a key issue in the policy agenda of most of the EU countries and international organization, as reflected in the “better regulation programmes”.

The academic literature has analysed mostly the effects of regulation in the country-level or the industry-level, as those on GDP per capita or on investment. The paper by De Jong and Van Witteloostuijn, however, focuses on analysing the impact of regulatory red tape on the performance of private companies, using a survey from 530 Dutch companies. Thus, this paper complement the existent evidence on regulatory red tape with a firm-level analysis. Also, it incorporates a multi-dimensional conception of regulation on performance, differentiating between regulation cost, regulation inconsistency and regulation change, using separate measures of these dimensions. Regulation cost is referred to the time and costs entailed in complying with regulation, which may be associated with crowding out effects and opportunity costs, creating disincentives for investment. Regulation consistency, based on Radaelli (2010), is referred to an efficient, effective, coherent and simple regulation, considering that low regulation consistency may be a source of lower performance for companies. Finally, regulation change, referred to the changes that tend to transform rule systems incrementally, is related to more needs for the companies to adapt to the new circumstances, and thus may be associated to more costs, less flexibility and more managerial attention to them. An additional interesting point of the paper is that the empirical analysis is based on perceptual measures from private managers, an approach which permits a very rich analysis, justified by the results of the literature who find a relation between perceived information and events and firms’ strategic decisions, organizational commitment, job satisfaction, motivation and performance.

After the first section of the paper, which introduces all these issues, the second section describes the state of the question, based on theory and literature on the topic. The section reviews insights from studies of red tape in public administration (focused on government organizations) and on public policy (focused on private companies). As described in the paper, research on red tape started in the 1970s, gained importance in the 1980s and made substantial progresses in the 1990s and 2000s. These developments led to refine Bozeman’s (2000) definition of red tape, in order to make the concept applicable in empirical research. In particular, Pandey and Kingsley (2000) defined red tape as “impressions on the part of managers that formalization (in the form of burdensome rules and regulations) is detrimental to the organization”, thus putting perceptions of respondents at the centre of the analysis. Next, the paper describes the approach to red tape in business impact studies, focused on compliance costs and measuring the costs that regulation may bring to the companies, as well as the various approaches for measuring them. At the end of the section, the paper describes its three hypotheses: first, that regulation cost is negatively associated with private firm performance; second, that low regulation consistency is negatively associated with private firm performance; and third, that regulation change is negatively associated with private firm performance.

The next section of the paper describes the methodology, beginning with the explanation of the research context, design and sample. The paper is focused on the case of the Netherlands, which is justified for being one of the most regulated economies and also a leading country in the application of better-regulation programmes, including: explicit policy targets (as a 25% of reduction in administrative costs for firms in 2012), methods to measure administrative costs and an institutional infrastructure including interdepartmental taskforce and an independent advisory board. The empirical approach is based on a survey addressed to a random sample of 1,800 small and medium-sized companies (with 100 or fewer employees) in the Northern provinces of the Netherlands, covering all relevant economic activities in the region. The survey consists on a questionnaire focused on managerial perceptions of different dimensions of regulation, as well as organizational characteristics, context, performance and strategies. It takes the form of a mail survey, in order to improve the response rate.

The indicators used are based on subjective perceptions. As regards firm performance, two indicators are used: firm’s growth in sales turnover in the past two years and firm’s performance vis-à-vis its more important competitor, using a 7 and a 5 point scale, respectively. Regulation cost is measured through the respondent’s assessment of the firm’s administrative burden, defined as all the time and costs that compliance with laws and regulations involve to companies. Regulation inconsistency is measured through two questions: “the legislation of the government contains many inconsistencies” and “the legislation of the government implies much unnecessary paperwork”, each of them measured on a 7-point scale and both combined into an overall index of regulation inconsistency. Finally, regulation change is measured asking the respondents to “Assess the change in regulation compared to a year ago”. Control variables are included, referred to the context of the firms (branch or sector, geographical situation, etc.), firm characteristics (size, age and strategy), and the human capital of the respondents (work experience, formal education and age).

Results are estimated by a two-step hierarchical regression: a first model including control variables only, and a second model adding the three dimensions of regulation considered. A significant increase in model fit, as occurred, indicates the importance of the main variables. This also permits determine the extra explanatory power of the independent variables. The results reflect significant support to most of the hypotheses. In particular, regulation cost has a negative and significant effect on sales turnover growth, although not on market competition performance. The same is observed as regards regulation inconsistency. Finally, regulation change significantly hampers both sales turnover growth and market competition performance.

After describing the results, the final section of the paper remarks in detail the contributions and implications of the analysis as conclusions. In spite of the results obtained and the negative effects that it may have for individual firms, the conclusions of the paper do not forget the key point that regulation is an intrinsic part of democratic societies, which can benefit large parts of society, as protecting the economic position of citizens or preventing collusion between companies that may have negative effects on economy. As a result, an evaluation of all the benefits and costs of the rules is encouraged, in order to estimate the overall net effect of regulation for society. Thus, the paper evaluates the impact of different dimensions of regulation on private firm performance from a perception-based perspective, although analysis of the impact of regulation in other dimensions and stakeholders should be considered as a complement.

From the results obtained, the paper underlines the importance of avoiding poorly designed or outdated regulation, due for example to inadequate understanding of its aim by regulation-makers or misapplication in the implementation phase. This would be key for avoiding unnecessary costs for organizations, because it affects competitive capabilities of companies as raising costs and reducing flexibility, and diverting management attention from strategic issues. These problems are particularly severe for small and medium-sized enterprises, in which this paper focuses.

The paper ends describing some opportunities for future research. First, it proposes analyses based on cross-country firm-level panel data set, in order to avoid endogeneity and permit causal attributions. Second, it contemplates a multi-respondent replication of the study, with more questions concerning regulation and firm performance, to allow for cross-validation of the findings. Also, it proposes to test the model in other countries, to determine whether the role of regulation is similar. Finally, an additional future research line would be to analyse the interaction effects between particular characteristics of entrepreneurs of firms, which may moderate the negative effect of regulation on firm performance, thus helping to design firm-level strategies that dampen this negative relationship.

Summing up, this paper provides a very interesting analysis of the costs of regulation for private-firms, which should be complemented with other analyses on other dimensions of regulation including broader social perspectives, in order to evaluate and improve regulations taking into account all their social benefits and their social costs.

marcos_fernandez_gutierrez

MARCOS FERNÁNDEZ-GUTIÉRREZ

Universidad de Cantabria. Santander, España

Personal page on academia.eu

 

 

References

  • Bozeman, B. (2000): Bureaucracy and Red Tape. Upper Saddle River, NJ: Prentice Hall.
  • Levi-Faur, D. (2014): “The Welfare State: A Regulatory Perspective”, Public Administration, 92, 3, 599-614.
  • Pandey, S.K. and Kingsley, G.A. (2000): “Examining Red Tape in Public and Private Organizations: Alternative Explanations from a Social Psychological Model”, Journal of Public Administration Research and Theory, 10, 4, 779-99.
  • Radaelli, C.M. (2010): “Getting to Grips with Quality in the Diffusion of Regulatory Impact Assessment in Europe”, Public Money and Management, 24, 5, 271-76.