The Economics of ZPG

With Jason Potts

In the dystopian 2013 film Elysium, written and directed by Neill Blomkamp, the earth is badly overpopulated. The society that results is deeply unequal. The haves flee to a luxurious space station orbiting the earth. The have-nots remain on an increasingly polluted and decaying planet, subject to the robotic oppression of the haves in space above them.

The dangers of runaway population growth, and the dangerous society that such growth would create, have been an enduring Hollywood obsession for half a century. Elysium nostalgically recalls a spate of films in the 1970s that predicted overpopulation—and increasingly totalitarian measures of controlling population—from the famous, Soylent Green and Logan’s Run, to the forgettable, ZPG and The Last Child.

Yet in the early twenty-first century it is increasingly clear that if humanity faces a population crisis, it is a crisis not of overpopulation, but underpopulation. Neill Blomkamp derived a sort of crude Marxist vision of capitalism from the overpopulation crisis, depicting workers toiling under oppression to feed the demands of the comfortable and distant rich.

While the economic analysis shown in Hollywood films might be questionable, the idea that dramatic changes in population will have significant economic consequences is not. Today, fertility rates are below replacement level in developed countries like Australia. They are heading in the same direction in the developing world. Nearly fifty years after the American biologist Paul Ehrlich published his book The Population Bomb, sparking off the modern overpopulation panic, it seems more urgent to consider the costs of population stagnation than population explosion.

A society’s demography is shaped by three factors: fertility, ageing and migration. Australian fertility rates were as high as 3.5 in 1961, giving us the baby boom generation. But they sharply declined from those heights, so that by 1980, the fertility rate was 1.9. It has remained there ever since, and the Commonwealth Treasury assumes the fertility rate will remain at 1.9 for some time to come. But this is below replacement rate: that is, the couples of Australia are not reproducing enough to replace themselves.

The second factor is ageing. The Commonwealth government’s Intergenerational Report suggests that life expectancy at birth will increase from its 2015 state of 91.5 years for men and 93.6 years for women, to 95.1 and 96.6 years respectively by 2055. When Joe Hockey said that it was possible that a child born today might live to 150 it was widely seen as a political gaffe but, with the rapid changes in molecular biology, living to 150 is not at all absurd. The sequencing of the human genome, completed in 2003, has been described as the biological equivalent of the development of the table of elements in the nineteenth century, a breakthrough which led to a revolution in chemistry. Placing genetics at the centre of medical practice is almost certain to dramatically change our expectations about longevity and health. Whether Hockey is right or not, the consequence of these trends skews the age distribution so that the Australian population is older.
The countervailing demographic pressure against increased longevity and fertility decline is migration. Simply put, what we no longer produce ourselves we can import. However, our migration intake selects against the highest-fertility population. Policy favours skilled migrants over unskilled migrants, and highly educated migrants over migrants with less education. These are the same populations that are going to be both older and less fertile. The obvious exception to that approach is our refugee intake, but refugee numbers are a tiny subset of the immigration total. Migration expands the population, because while Australia’s fertility is under the replacement rate, the global fertility rate is 2.4. Global fertility was around 5 in 1960. But where Australian fertility has plateaued, global fertility is still on its trajectory of long-term decline. And migrant populations quickly adopt the fertility rates of their new homes.

However, while the mathematics of population decline are fairly straightforward, history shows that untangling the economic consequences of population stagnation or decline is not. Between 1347 and 1351 the Black Death killed between a quarter and a half of Europe’s population, even more in some major centres. Three quarters of the population in Florence may have died in 1348. The plague sparked a century-long population decline across the continent. Where England had a population of 2.8 million people in the 1370s, it had only around 2.3 million in the 1520s.

The plague and the subsequent demographic decline cut short a relative economic boom in the high Middle Ages, which had seen the buds of capitalist exchange, expanding markets, technological development and population expansion. The first economic consequence of the Black Death that historians have long pointed to was its role in rewriting the structure of the labour market. The sudden scarcity of labour pushed the price of wages up dramatically, to the extent that the English parliament attempted to place a maximum ceiling on wages.

This smaller number of workers changed the economic and political leverage of the survivors. Contemporary elites complained about the newly demanding workers, who would refuse to work—or would work poorly—if they were not rewarded the market wage. “So the world goes from bad to worse,” wrote John Gower, a poet and friend of Geoffrey Chaucer, “when they who guard the sheep or the herdsmen in their places, demand to be rewarded more for their labour than the master-bailiff used to be.” Labour scarcity broke the traditional peasant–lord relationship, as workers went on the road looking for the best wages and short-term contracts. “Servants are now masters and masters are servants,” complained Gower. Economic power tends to become political power. A sense of the political consequences of this population shift is offered by the Peasants’ Revolt in 1381, when rural workers reacted to the introduction of a series of poll taxes by forming an army and ransacking government buildings in London. This was a proletarian parallel to the rebellion of the elites that had given England Magna Carta a century and a half earlier, but one which ended unhappily for the rebels.

The long-term consequences of the Black Death were more subtle. Demographic change allowed for rapid institutional innovation as the bonds that maintained the old order were weakened. It has been too common for popular historians to strip the medieval world of agency of its own and imply that only an outside shock—in the form of the bacillus Yersinia pestis—could alter fixed political and economic dynamics. The humans of the medieval world adapted to their new demographic environment in complex ways. The fact that the plague was less severe in some parts of Europe has allowed economic historians to show that even where the population continued to rise, as it did in Holland, wage rates increased in this period. The supply-and-demand relationship between population decline and labour costs does not necessarily mean that in all regions affected by the plague wages increased at a higher rate than in those which avoided the plague. And while Holland fared well in the long run from its relative avoidance of the Black Death, other places which also avoided the plague—such as Prague or Bohemia—did not experience the same sort of economic prosperity as the Low Countries.

This non-linear relationship between demographic change and economic change is not surprising. How societies responded to the consequences of the Black Death depended on their institutional environment: the legal and regulatory framework, the capacity of classes enfranchised and disenfranchised by change to prevent or exploit those changes through the political system, the capital structure of the economy, resource endowments, the depth of market exchange for goods and labour and so on. The Black Death wrought institutional changes that gave us the modern world—institutional changes that were unpredictable to those who lived through the crisis and which historians are still trying to trace. Higher wages moved economic activity towards capital-intensive agriculture and proto-industrialisation, sparking changes in urbanisation and the organisation of guilds and communities. Rather than the short-term effects on the supply and demand for labour, it will be in institutions that we see the long-run significance of modern population change.

This captures one of the essential errors in much of the popular debate about the consequences of population change. A strictly mathematical approach to population analysis—fertility plus migration equals population—transposed onto the current political order does not capture the institutional evolution that would result from the trends. In the January 1977 edition of Quadrant, the Liberal gadfly W.C. Wentworth derived the consequences of population change from such an accounting of fertility rates, concluding, “There may be serious doubts as to how many can really live well on the limited surface of the globe.” Decades on, in the wake of the digital and agricultural revolution, it is clear that such negativity was unjustified.

The direct economic consequences of a declining population could be a slow increase in the price of labour, as occurred suddenly in the years after the Black Death. As the scarcity will be concentrated in the younger population, these price increases will be particularly for work which has traditionally been performed by the young, including service jobs and unskilled manual labour. Technology allows for some substitution, and higher labour costs encourage development in further innovation. Existing tendencies towards automation of labour—encouraged by the demands of consumption and the prohibitive strictures of industrial relations laws—will be accelerated. Every Australian suburb now has a vision of the future in the McDonald’s automated ordering system, and it is easy to imagine further automation of service industries that were once believed to be immune.

More diffuse economic consequences of population stagnation will be delivered through the political system. All else being equal, an older population means that the interests of older citizens will be better reflected in public policy. We are already seeing some of the direct political economy consequences of an ageing population. Much current public policy tends to favour older rather than younger people. One of the most harmful is the restrictions on land use that benefit established home-owners over possible new entrants to the housing market. Both controls on urban development and limits on land release raise the price of housing by creating artificial scarcity. This works out very well for home-owners but terribly for those who want to enter the housing market for the first time. These sorts of policy-induced housing shortages ultimately divert capital away from more productive investments—Australians end up using more of their wealth for what could otherwise be much cheaper—with long-term consequences for living standards.

Other political economy consequences could be less harmful—even beneficial. High rates of population growth distort the political system towards the interest of its younger members. For instance, while the overwhelming benefit of education accrues to the person who is being educated, governments have long paid the bulk of education expenses out of taxpayer funds. This over-subsidisation of education may be reduced as the population skews older. Wasteful or unnecessary family payments are less likely to be tolerated by an older population that does not feel it receives direct benefits from these funds. On the flip side, that older population will be much more protective of generous pension schemes and health subsidies. A rebalancing between older and younger generations is likely to lead to more social spending rather than less. Pensions are a far larger drain on the Commonwealth budget than family payments, and the cause of market-oriented reform in healthcare provision is much less advanced than in education. While the shape of social spending will change, population stagnation is more likely to increase that spending rather than decrease it.

We have already hinted at some of the causes for optimism. One approach might be to use policy to reverse negative trends. In the overpopulation dystopias of the 1970s, Big Brother governments took it upon themselves to limit breeding or eliminate the elderly. Governments have long been aware of the declining fertility rate and, particularly under the Howard government, sought to align policy incentives to encourage people to have more children through baby bonuses and tax benefits. However, the downsides of using the political and legal system to influence the demographic profile of the population are substantial. Obviously those dystopias imposed huge costs of the rights of the citizenry, and the one-child policy in China has had enormous human costs. The modest family payments designed to boost fertility in Australia are subject to the same inefficiencies, churn, opportunities for rent-seeking and politically motivated subsidisation as any other part of the welfare system.

We see more reasons for optimism in the development of healthcare technologies that might both lower the cost of providing healthcare services to an ageing population, and also allow an ageing population to work more productively. The net effect is that an ageing population becomes less of an economic burden on the rest of society, requiring fewer resource transfers.

There are multiple sources of such technologies. At the biomedical level, enormous improvements in new biotechnologies such as personalised genomics may significantly improve the effectiveness of targeted medicines. The breakthrough gene-editing technology CRISPR may dramatically reduce the incidence of chronic genetic diseases and improve our ability to repair diseases of senescence. Very large falls in the cost of wearable personal monitoring technology and the internet-of-things may greatly improve access to healthcare and increase the incidence of low-cost early interventions. Personal robotics may facilitate greater ability for the ageing to continue to live independently, both as providing services that range from robot vacuum cleaners and quadcopter drones for delivery, which already affordably exist, to robotic assistants (imagine the Artificial Intelligence platform Siri on Apple’s iPhone coupled with industrial robots), to driverless cars (which already exist), to personal exoskeletons, which are in use in the US military. This list can go on and on, and while there are certainly high development costs, the economics of mass adoption and market competition will drive these costs down.

Such benefits do not depend on a special class of technologies for the ageing and elderly, but are adaptations of general-purpose technologies (for instance gene-editing techniques, big-data, industrial robotics, and so forth) that are subsequently applied to particular and growing market segments. We can rely on the market mechanism and profit-seeking entrepreneurs to figure out how to adapt new general-purpose technologies to create value by improving the lives of an ageing population. Many such benefits can be expected to maintain health, well-being and independent functionality to enable continuing participation in society and contribution to the economy.

Of course, a longer working life is not just a joy for the federal Treasurer; it is also a very good thing for each individual person because it means a higher level of income and freedom, which in turn means greater independence and ability to consume. Working longer is a good thing not because work is a good thing—although there are surely benefits from increased social and community engagement that come from gainful employment. Working longer is good because more production means more consumption. These higher levels of income and consumption may be spent on travel and experiences, higher quality of living, on family, or on greater levels of healthcare or even enhancement.

These causes for optimism are dependent on current trends in innovation holding true. It is equally obvious to observe that an ageing society will experience second-order effects that can reasonably be expected to dampen the rate of innovation and technological change. These are effects that go directly to the underlying incentives to develop the new general-purpose technologies mentioned above, rather than the specific adaptations of these innovations to the needs of the elderly.

The first is that an ageing population has a different overall risk-reward profile than a younger population, particularly among males. The young of all species (and not just humans) have a higher risk-taking propensity because they are engaged in mate competition. We’re wired this way. This increased risk-taking propensity can be destructive when it is channelled into fighting, raiding and warfare. But a great benefit of a free-market society, as economists from Adam Smith to Joseph Schumpeter to Deirdre McCloskey have pointed out, is that there are substantial pay-offs to society when this competitive instinct is harnessed towards entrepreneurial action to create and develop new ideas—whether great artworks, new technologies or new products.

Entrepreneurship and innovation are risky. But when they succeed they furnish substantial benefits for many, and possibly a great many. The US economist William Nordhaus estimated that entrepreneurs only capture (as Schumpeterian profits) about 2 per cent of the social value of their innovations. That means that 98 per cent spills over to society as consumer surplus. But other economists such as Edmond Phelps have pointed out that the net private return to innovation is actually pretty close to zero. This should not be surprising. Most entrepreneurial endeavours to develop new technologies, companies and innovations fail. The few that succeed in effect balance the many that fail, such that there is a Pareto distribution of returns. But because most of the value of an innovation spills over as consumer surplus, the social returns to innovation are everywhere substantially higher than the private returns. (Another way of saying this is that innovation has public good qualities, or can be subject to market failure.) One of the great benefits a society with a young population experiences is its high natural propensity toward risk-taking entrepreneurship, and the associated social benefits that brings. Equivalently, one of the great although often hidden costs of an ageing population is the loss of entrepreneurial dynamism. Along with this comes an increased tendency to seek political solutions rather than market solutions to social problems, which further drives an economy towards rent-seeking.

A second and related point that further constrains innovation in an ageing society is that the basic economics of investment returns to innovation are different. Specifically, in respect of the costs of adopting new technologies the discount rate for a younger population is lower than an ageing population. This is for the simple demographic expedient that an older population has less time to amortise the costs of developing and adopting a new technology and also less time to receive and accumulate the benefits. In short, because the costs to innovation are upfront while the benefits accrue through time, innovation is simply more expensive when you have less expected life in front of you. Now the elderly might actually care not just about themselves, but also about the future welfare of their children and grandchildren and so on, creating what economists call an infinite overlapping generation model. But without such an assumption, or some attempt to engineer it through the tax system, an ageing population will rationally invest less in innovation.

A third observation follows from these two and connects the types of economic institutions that a democratic society will choose when the population is relatively younger and growing or older and stable or shrinking. One of us has written recently about why the mass leisure society that John Maynard Keynes famously envisaged in his 1930 essay “Economic Possibilities for Our Grandchildren” has never come to pass, by emphasising that the sorts of economic institutions of a wealthy prosperous society are those that encourage entrepreneurship and innovation and not just consumption. But this same argument also runs the other way. As we have noted above, the sorts of economic institutions that a zero population growth society chooses are likely to be geared towards political redistribution of economic resources. These institutions require higher taxes, which penalise entrepreneurial action and therefore blunt the rewards to innovation.

An ageing society tending towards zero population growth also risks tending towards zero economic growth because of the harmful consequences on the supply of entrepreneurship and innovation, because of its effect on risk preferences and on investment, and also on the way such a demographic transition will likely distort economic institutions away from a liberal market ideal. In the long run, it is hard to say whether these headwinds on general-purpose entrepreneurship, innovation and new technology are likely to dominate the more optimistic tailwind scenarios on the specific application to the problems and opportunities of an ageing population.

An obvious class of solution is to recognise that an ageing zero-growth population will create increased pressure on political solutions to economic problems, and therefore to seek to constitutionally head that off by constraining and limiting the powers of politicians to offer political solutions. Privatising more of the healthcare system would be a start. Our institutions need to be capable of adapting to the consequences of ageing and population stagnation—consequences which are now unpredictable. Allowing for greater market control of social services will provide such adaptability. The fragility of medieval society to the Black Death and its demographic aftermath was not only technological and medical: medieval markets were shallow, meaning that resources could only slowly reallocate to new uses, if at all.

Another class of solution follows from the diagnosis of the intergenerational nature of the innovation problem. Innovation requires both an entrepreneurial risk appetite and liquid resources. A young population has much of the former, and an older population has more of the latter. If pension funds were able to function more effectively as venture capital funds, that would be a step in the right direction. For instance, financial regulations designed to protect investors by constraining pension fund investments to say ASX30 listed companies stand in the way of such reform.

But the most important factor is the importance of maintaining an open economy with free and easy movement of people, resources, capital and ideas. If risk preference and investment in creating new ideas and innovations will decline in a zero population growth economy, then it becomes critical to be able to import new ideas from elsewhere. This will also be true of gaining access not just to technologies but also to services offered in other countries. Perhaps certain types of regenerative therapies or surgeries will be developed in Singapore or the Philippines. It may not matter much if they are not invented, produced or delivered in Australia, provided Australians have access to them, through having produced things of value that we can exchange for them. This is where the importance of continued participation in the labour force matters.

A zero population growth economy will impose substantial challenges on Australia in the future. It is not the ecological utopia that some imagine, but nor is it likely to be a Marxist dystopia. It will make us all poorer. And it will do so in significant part because of its effect on entrepreneurship and innovation. But these consequences can be mitigated by sensible and far-sighted commitment not to allow the harms to happen. Maintaining an open economy, constraining government growth with commitment to free-market institutions, will go a long way towards allowing us to live well as population growth slows.

The Undone Tasks of Deregulation

Back in 2007, Kevin Rudd thought he could make a big political statement by outflanking John Howard as a free marketeer. He claimed to be the true “economic conservative”, and attacked the Howard government’s “reckless spending”. But that was just half of Rudd’s pitch. A headline in the Australian Financial Review in October that year screamed, “Labor blasts PM over red tape burden”. Readers learned that Rudd had “savaged” the Coalition for the regulation that was “strangling” business. “Stand by for the Regulation Revolution,” said theSydney Morning Herald; “cutting back the maze of business regulation and red tape” would be one of Rudd’s “top policy priorities”.

They say the past is another country. Campaigns are another planet. Once handed power by the Australian voters, the practice of the Rudd government was light years away from its soaring campaign rhetoric. Yes, true to Rudd’s promise, Lindsay Tanner was appointed Australia’s Minister for Finance and Deregulation. Yet one of Tanner’s first acts as minister was to preside over a vast increase in regulatory control over the finance sector, adopting new federal anti-money-laundering and counter-terrorism-financing laws that had been prepared by the Howard government.

This was just a taste of things to come. Tanner was our first deregulation minister and the experiment was a failure. Just as he was unable, as Minister for Finance, to prevent the massive splurge of government spending instigated by Rudd, Wayne Swan and Treasury Secretary Ken Henry, he was unable to hold back the tidal wave of new regulation that came with an interventionist government. By the twilight of the Labor government, this wave of regulatory interventionism had become a flood. Rudd’s professed disdain for the red tape burden strangling business was forgotten. Vast new regulatory frameworks were being imposed on labour markets, financial markets, employment conditions, child care, hospitals and health, aged care, competition law, health and safety laws, higher education, charities, coastal shipping, and of course the environment.

These increased the regulatory burden on individual sectors, but also the economy in general. For instance, the cost of regulation imposed on the mining and energy sectors flow through to raise the costs of downstream products. Just as taxes—like the carbon and mining taxes—reduce economic growth and living standards, so can regulation imposed on these vital sectors.

Some of the most egregious new regulations were not successfully implemented. Communications Minister Stephen Conroy was unable to pass his large-scale attempt to regulate fairness in the press. Attorney-General Nicola Roxon was unable to pass her attempt to create a right not to be offended on everything from race to politics in the workplace. Roxon did however manage to pass that manifestly absurd and deeply symbolic instance of regulatory over-reach—plain packaging on tobacco products.

These new regulations became a source of pride for the Labor government. Trying to combat the sense that parliament under Julia Gillard’s minority government was chaotic, Anthony Albanese used to brag about just how many pages of legislation Gillard had ushered through parliament. As the months ticked by the number grew ever larger. In six years, Labor passed a whopping 975 acts, adding up to 38,874 pages of legislation.

It’s true that the volume of legislation is an imperfect measure of the growth in regulation, for a number of important reasons. It is indicative rather than demonstrative. It does not take into account the effect that each new piece of legislation will have, nor does it take into account the fact that some legislation might repeal existing law, thereby reducing the regulatory burden. On the other side of the ledger these figures do not include subordinate legislation nor any state laws and council bylaws. But it is extremely suggestive. And constant legislative change imposes its own costs, as we shall discuss below. In 2012 the Institute of Public Affairs calculated that there were 103,908 pages of Commonwealth legislation on the books.

Rudd’s deregulation push may have been brazen, but every government comes to power promising to cut red tape. The Howard government had its own promise to reduce the regulation which was “enveloping small business” but the fruits of that labour are hard to see. Australia was more regulated after the Howard years rather than less, as I pointed out in the 2009 book The Howard Era. For all the stability and good governance that the Coalition offered between 1996 and 2007 it did little to stem the growing tide of regulation. Rudd wasn’t wrong when he diagnosed the red tape problem in 2007. It’s just that he wasn’t the person—and his party wasn’t game—to fix it.

So how does the Abbott government shape up? There are positive early signs. On the headline figure of legislative activity, 2014 was a good year. There were just 135 acts constituting 4607 pages of legislation passed through the Commonwealth parliament last year. This is a drop from the more than 5000 pages passed in 2013, and happily well below the 8150 passed in 2012. No doubt this is in part due to the trouble that the government has had passing its bills through a hostile, unpredictable Senate. But it is also due to the efforts of the Coalition’s own deregulation minister, Josh Frydenberg, and the emphasis that the Abbott government has placed on its deregulation agenda. Abbott and Frydenberg made deregulation one of the central features of its economic message in the Gillard years, leaning heavily on reducing the regulatory burden as part of its plan to revive the economy after years of sluggishness.

And yet. While the Abbott government repealed 57,000 pages of legislation in 2014—and claims to have saved the economy a whopping $2.1 billion a year—much of that which was repealed was already defunct. The real work of deregulation, if it is to occur, hasn’t started.

Indeed, the Abbott government’s deregulation experience shows why this agenda is so hard to pursue. In 2013, the much-publicised “Repeal Days”—a single parliamentary day every six months dedicated solely to repealing law rather than introducing it—were important but, as they came around, their agenda items kept disappearing. For instance, the proposal to eliminate the entirely unnecessary gender-equality reporting requirements imposed on businesses with more than 100 employees had to be dropped, apparently for political reasons. The reforms to the Labor government’s Future of Financial Advice program, which would have taken the edge off some of the most extreme regulatory controls but nevertheless left the previous government’s regulatory framework largely in place, were implemented by regulation. In a surprise upset the Future of Financial Advice reforms were reversed by the Senate at the end of the year. Other deregulatory proposals—such as the deregulation of higher education—have floundered as well.

Every regulation, even the most absurd, has a unique justification, and its own constituency. Gender-equality reporting is “not an issue of red tape”, according to Claire Braund, the head of an organisation called Women on Boards Australia. But it is the epitome of red tape—it imposes no other compliance requirements on firms except paperwork, and paperwork that has no other purpose except informing government. It should be the low-hanging fruit of regulatory reduction. There is not a single person in the country, except perhaps the bureaucrats that administer the program, who would be materially worse off if this requirement was abandoned. Yet gender reporting could not be repealed.

In some areas the government seems intent on going backwards. The Abbott government started 2015 with a stalled budget and by talking up a range of regulatory increases. It’s clamping down on foreign ownership in property. It’s introducing new country-of-origin labels to food products. It’s talking about lowering the GST threshold on imports and digital products, which would require enormous new regulatory infrastructure for retailers and importers alike. It has passed legislation to impose new controls on social media websites to clamp down on cyberbullying and to require internet service providers to keep vast amounts of information on every Australian’s online activities just in case they are in the future suspected of a crime or regulatory violation.

We can bat the pros and cons of these proposals around. They ought to be debated earnestly. But they illustrate that even a government as apparently dedicated to deregulation as the Coalition under Tony Abbott is nevertheless unable to resist the steady creep of new economic controls. There’s something much deeper going on here than traditional party ideology. While it is clear that Labor’s approach to regulation was worse than what we saw under the Howard government and what we have seen so far under Abbott, we’re talking about differences in degree, not kind. There is a deep and seemingly inexorable logic of modern democratic government that pushes it towards regulatory excess. Recognising we have a problem is the first step to solving it.

And it is a problem. Each year the World Econ­omic Forum publishes a Global Competitiveness Report which rates world economies according to a large range of indicators that would help facilitate business. Australia does relatively well overall. We rate well on things like education, the soundness of our banks, the health of our population, the depth of our financial markets, the professionalism of management and so on. But we are catastrophically bad when it comes to “burden of government regulation”—a terrible 124th in the world, sharing a spot with such economic powerhouses as Iran, Spain and Zimbabwe. Our competitors rate much higher. The United States is at eighty-second, while Canada is twenty-ninth.

The Australian Industry Group surveyed 241 CEOs in Australian businesses. The number of executives who nominated government regulation as one of their top three impediments to growth has grown from 9 per cent in 2011 to 11 per cent in 2014. This figure may seem relatively small in isolation, but given that it competes against other factors like the global economic and investment climate, it is strikingly high. Fully 83 per cent of CEOs believe they face a medium to high level of regulatory burden—particularly in the areas of industrial relations and health and safety.

The Minerals Council of Australia commissioned a review of legislative controls on the mining industry. It found that the number of primary pieces of legislation overseeing project approvals nation-wide increased from ninety-four to 144 between 2006 and 2013. Subordinate legislation increased even more: from sixty-six in 2006 to 119 in 2013. As they told the Productivity Commission’s 2013 review into mineral and energy resource exploration, the largest mining states, Western Australia and Queensland, have some of the most onerous regulatory burdens. Hancock Prospecting’s Roy Hill iron ore project in the Pilbara has required a staggering 4000 licences, approvals and permits—much of them imposed by the state government.

The cost burden of regulation is well known. But more important—and harder to test—is how regulations shape and constrain the economy itself. A modern economy is subject to constant shocks. Technologies change. Preferences change. New business models supplant old business models. Political events in distant countries can have unpredictable ricochet effects for Australian firms. Foreign price changes suddenly render existing ways of work unprofitable, or open up new opportunities. Firms have to constantly shift their operations, their ways of doing things, even their entire business models sometimes just to stay afloat. Economic change does not just occur in boom-bust cycles, nor in the long-term technological revolutions that have characterised the last two centuries. Tiny changes to supply lines, seemingly minor legislative changes in distant countries, and modest but constant adjustments to consumer goods mean that the economic ground is constantly shifting under the feet of the business sector.

Contrast this unstable economic dynamism with the political system that proposes to regulate it. Statutes reflect the nature of the world only at the moment of their passage through parliament. Legislation is static—black words in leather books that can only be altered through fraught and complex political negotiation. Even minor, uncontroversial legislative amendments can take months. Serious change can take years, from green papers to white papers to exposure drafts to committee inquiries to law of the land. Each of those legislative changes that the Gillard government was so pleased to have overseen was a long time in the making—the fruit of months and years of bureaucratic busywork. As a consequence the economic environment depicted in statute is almost always long out of date. Embedded in each statute are assumptions—about the shape of industry, technological ability, the force of competition—which do not last.

In other words, no matter how active the government is, the law is a static instrument. The economy it governs is dynamic. This creates serious problems. As rock beats scissors, law trumps business needs. Firms facing economic headwinds find that their ability to adjust is limited by the legislative environment they operate in: legal constraints are constraints on business flexibility. In an Institute of Public Affairs paper published in December 2014, Dom Talimanidis demonstrated the perilous decline in entrepreneurism in Australia. Where new businesses constituted 17 per cent of total businesses in 2003-04, in 2012-13 new businesses were just 11 per cent of total businesses. Unsurprisingly, the relative decline in business entry is greatest in those states that are the least economically free.

The burden of regulation is most obvious when we look at individual firms—the time spent on paperwork, the business opportunities not pursued. But all these little disincentives and distractions add up. Regulatory excess can have serious macro-economic consequences. In an important paper published by the Swedish think-tank Research Institute of Industrial Economics in January 2015, the economist Christian Bjørnskov looked at the relationship between standard measures of economic freedom and economic crises. As Bjørnskov finds, a high degree of economic freedom does little to prevent countries from suffering an economic crisis. But the degree to which an economy is free is a very important factor in how quickly a country recovers from a crisis. The things that matter here are not whether taxes are low, government spending is modest, or whether the rule of law is strong, but how efficient the regulatory environment is.

Economic crises necessitate a large-scale reallocation of resources, away from troubled sectors and into more stable ones. At the individual level, a person who has lost a job in an economic crisis needs to move rapidly into new employment—perhaps even new employment in a new industry—before the harm of unemployment becomes too manifest. Regulations like occupational licensing and industrial relations laws that raise the cost of employment act as a handbrake on the necessary economic adjustment. All regulation in some way prevents resources from being used alternatively—even if it is just the opportunity cost of time spent filling out gender-reporting forms. Even when regulation is desirable, we have to recognise that all regulation makes for a less flexible economy, and one less able to adapt to change.

One possible answer to the problem of legislative immobility is for parliament to grant a certain amount of discretion to adjust and interpret regulations according to changing circumstances. This is what we do when we hand decision-making power over to regulatory agencies. Yet vesting unelected regulators with discretionary power does more harm than good. It exacerbates regulatory uncertainty, with serious consequences for the private plans of individuals and firms. It facilitates regulatory “capture”. And of course it has a democratic legitimacy problem—under whose authority do regulators make what are effectively public-policy decisions?

Nevertheless, policy-makers today lean heavily on delegation to regulatory agencies, handing them quasi-legislative power. In an important book, Is Administrative Law Unlawful? (2014), the Columbia Law School professor Philip Hamburger traces the origins of such delegated legislative power back past the creation of regulatory agencies at the beginning of the twentieth century—where most scholars’ history stops—all the way to the pronouncements of medieval kings. Hamburger draws a distinction between administrative pronouncements by executive governments that are intended to bind officers of the executive and those that are intended to bind society more generally. The former form of pronouncement is obviously necessary for government to function. Bosses need some way of instructing their employees. But pronouncements that affect the public more generally ought to be the purview of the legislature, not the executive. These are more akin to the exercise of the royal prerogative than democratic law.

We often imagine that our modern concerns are distinct from those of the past. But how much legislative power the executive could exercise without parliamentary approval was one of the great contests in the lead-up to the English Civil War. The seventeenth-century English historian Roger Twysden declared that “the basis or ground of all the liberty and franchise of the subject” was “this maxim, that the king cannot alone alter the law”. Yet through executive pronouncement and delegation governments have vested vast legislative power in what scholars call “non-majoritarian” regulatory and bureaucratic agencies.

We are yet to work out the long-term democratic significance of this approach to governance. But the economic consequences are dire. Friedrich Hayek argued that the rule of law had three requirements. Laws had to be general, that is, they applied not to specific circumstances and individuals but to society as a whole. They had to be equal—they had to apply to all people in society equally, without discrimination. And finally they had to be certain. Certainty is a strange word to be used in connection with economic life, of course: there is nothing certain about the future. But the challenge of economic uncertainty is exacerbated by political uncertainty. Hayek wrote:

I doubt whether the significance which the certainty of the law has for the smooth and efficient working of economic life can be exaggerated, and there is probably no single factor which has contributed more to the greater prosperity of the Western World, compared with the Orient, than the relative certainty of the law which in the West had early been achieved.

So laws ought to be clearly spelled out. They need to be “known”. Their consequences and significance ought to be discernible to all those who are expected to follow them. We ought to limit the discretion that administrators and bureaucrats have in applying the law.

But does this black-letter approach to law really create certainty? What is certain about black-letter law that is subject to constant revision? Or black-letter law that is constantly being supplemented, complemented and expanded? The volume of legislation currently being pushed through parliaments, state and Commonwealth, Labor or Coalition, and invented by regulatory agencies, is itself a challenge to the certainty of the law. As Bruno Leoni wrote in his classic study Freedom and the Law:

The more intense and accelerated is the process of law-making, the more uncertain will it be that present legislation will last for any length of time. Moreover, there is nothing to prevent a law, certain in the above-mentioned sense, from being unpredictably changed by another law no less “certain” than the previous one.

Thus, the certainty of the law, in this sense, could be called the short-run certainty of the law.

For anybody who had a time horizon longer than that short run, the law was anything but certain. Leoni’s book was published in 1961. His lifetime (Leoni was born in 1913) had seen enormous economic and technological change, but the scale of those changes pales in comparison to the shifts in technology and business that we are seeing today. In just a few years entire industries have shifted out of the terrestrial world into online. Ubiquitous communications have made older traditions of work obsolete. It is absurd that we have shop trading-hour regulations, as still exist in Western Australia, co-existing alongside always-on mobile internet shopping. While firms like Uber and Airbnb are revolutionising transport and accommodation respectively, they present a competitive threat to the taxi and hotel industries that have been lumbered with long-standing and costly regulation. Stretching our view slightly further into the future, today’s regulatory assumptions are going to be challenged by new technologies like 3D printers, consumer drones and digital cryptocurrencies like Bitcoin. No matter how manic is the legislative activity that characterises our political system, it is nevertheless unable to keep up with social and technological change.

Despite the small but important successes of the Abbott government in reducing some regulation and clearing the statute books of anachronisms, it is obvious that the deregulation movement has stalled. Deregulation is now more a political slogan than a serious public-policy project. Politicians have ceased trying to justify the purposes of deregulation and now treat deregulation as a good in-and-of-itself. This is a testament to the intellectual success of the deregulators of the past—who made the case for lower regulation a virtual self-evident proposition—but it has left the political class with little appetite to actually argue the case for needed reform. When each side has committed itself to deregulation, all that remains is a rule-in, rule-out game. Unfortunately, in the nature of politics, rule-outs are more common than rule-ins. The populist pressure for new law is far greater than the intellectual pressure for less.

Thus the deregulation stalemate, a stalemate more pernicious as we move towards an unpredictable economic future and hyper-innovations in technology. The issue is not how many “repeal days” are scheduled in a year. The issue is how the government sees its relationship with the economy. We do not lack alternatives to the over-regulation path we have taken. Leoni was an advocate of the common law—the system of private, particular and iterative law-making vastly superior to the statutory law which now dominates our legal systems. Rather than expecting politicians to play constant catch-up with economic and technological changes, the common law would allow legal issues to be solved when they arise. Law can be discovered, rather than imposed.

Hayek spoke of “generality” as an ideal of the rule of law. In modern regulatory parlance this is akin to “neutrality”. Four decades ago the Fraser government’s Campbell Committee into financial regulation spoke of “competitive neutrality”, just as the Rudd government’s Convergence Review into media and communications regulation spoke of “technological neutrality”. The idea is that products or services that compete with each other should face the same regulatory burden. Deposits in building societies should be regulated the same way as those in banks. Video broadcast over television channels should be regulated the same way as video served over the internet.

Neutrality has proven to be more of a catchphrase than a policy program. This is because genuine regulatory neutrality undermines some of the most fundamental assumptions of government economic management. To regulate is to control. Every advocate of new regulation has an idea of the world that their proposal would create. Regulation is always purposeful—it has a goal, a vision of a fixed future. For all the valuable discussion of technological neutrality, Labor’s Convergence Review collapsed into absurdity when it was unable to shed a fundamental belief in the ability of governments and regulators to shape the world around them. Rather than reducing the burden on highly regulated television services, it proposed to expand those regulations onto the ungovernable internet. Neutral, yes. But also absurd.

The Convergence Review offers a microcosm of the broader regulation problem. Regulatory excess is the result of governments trying to impose their values on the economy—using law to shape the economy according to their own preferences rather than allowing the economy to flow unpredictably according to consumer demand and entrepreneurial experimentation. In that sense, it is a reflection of the political system from which it emanates. If the Abbott government wants to go down in Australian history as a significant reform-driven government, then the “deregulation agenda” is not enough. It needs to start a serious rethink of the relationship between the dynamic, entrepreneurial economy and the static but over-energetic regulatory state.

Regulation And The Regulatory Burden

 

IN MANY AREAS of government policy, the fingerprints of the prime minister are clearly visible. When we consider the highest-profile issues of the John Howard years-foreign policy, immigration, federalism and the culture wars, just to name a few-the influence of senior Coalition ministers on the government’s policies are obvious.

However, this is not necessarily the case when we look at regulation, changes in the regulatory burden, or developments in the structure of economic management. Certainly, individual regulatory reforms can be identified and attributed to individual policy actors. The Howard government oversaw a vast array of regulatory changes, as well as the extensive inquiries and reports which accompany them.

But it is less interesting to debate who initiated what regulatory inquiry than to step back from the policy minutiae and consider how the federal government interacts with the economy, and how it has changed over the last decade.

This approach allows us to properly attribute blame or credit where it is due. After all, assessing the Howard government’s record in the field of regulation poses slightly counter-intuitive challenges. For instance, we have to decide how much influence we are willing to grant the government over the operation of its own bureaucracy. We have to ask how inevitable regulatory increases are and how much the pattern of regulatory growth is a function of the historical circumstances faced by individual governments.

LIBERALISATION and privatisation have been a feature of almost all Western democracies since the early 1980s. Australia’s reform movement had been one of the more ambitious projects around the world, joining the United Kingdom and New Zealand as the most extensive. By 1996, the Australian state which John Howard inherited had undergone more than a decade of nearly continuous economic reform.

The contemporary Australian state is a radically different beast from Australia’s mid-century welfare state. W.K. Hancock’s “vast public utility” is no more, having shed its own vast state enterprises. State and Commonwealth governments have systematically privatised a list of small and large scale enterprises traditionally operated by government – banks, airports, telecommunications and energy utilities, laboratories, even radio stations. Labour market reform, in a general direction of liberalisation, has been a recurrent feature of the last two decades.

In Australia, to the extent that this ambitious program of liberalisation and privatisation has been carried out, it has been largely successful in reversing the slow economic decline of the second half of the twentieth century. But contrary to the belief held by many on both the left and right of the political spectrum, this dramatic change in systems of political economy has not been as didactic as a shift from the welfare state to a liberal – or “neo-liberal” – model of the political economy. Leviathan has certainly not faded away-instead, amongst the reforms, liberalisations and privatisations of the last few decades, government has increased its expenditure and taxation.

But for our purposes, the most striking attribute of the last few decades is how Australian governments have matched privatisations and liberalisations with regulatory expansion, rather than retreat. Governments have shifted away from the direct provision of services, to the regulation of those services.

When public utilities have been sold to the private sector, they have been placed under the jurisdiction of specialised statutory authorities whose role it is to direct and regulate those industries for public, rather than private, purposes. Often these measures have been matched by the development of regulatory mechanisms designed to introduce competition into industries where the cost of entry is seen to be prohibitively high – the mandatory third-party access provisions of the Trade Practices Act and allied legislation allow firms to access the infrastructure of their competitor. Part of the reason that newly privatised enterprises have been highly regulated is the political controversy which accompanies privatisations. When supporters of public ownership complain that the “social benefits” of public ownership are not possible in the private sector, governments respond by forcing those benefits by regulatory design. Retail price controls in telecommunications, which have limited pricing flexibility, are an example of how this occurs.

The old protectionist or “infant industry” legal structures which applied to specific sectors of the economy, such as monopoly marketing boards and government cartelisation, have now yielded to economy-wide competition regulation. Indeed, competition regulation has developed into its modem form parallel to the reform period.

A great deal of the growth in regulation under the modern regulatory state is social, rather than economic. Environmental regulation has a long history – Solon the Great proposed in the sixth century that Greek agriculture be banned from steep slopes to prevent soil erosion – but its marked rise from the early 1970s was encouraged by the 1972 Stockholm Conference on the Human Environment. This resulted in the establishment of national environmental agencies in many developed nations, including Australia. During the Howard years, environmental regulation was an area of particular growth, despite the solemn pronouncements of the Coalition’s green critics. The Natural Heritage Trust, the Australian Greenhouse Office and the Environmental Protection and Biodiversity Conservation Act all represent significant increases in government intervention for environmental purposes. Consumer product safety, particularly in the transport sector, and occupational health and safety regulations have also seen significant increases.

Financial regulation has followed an uneven path, but here too recent decades have seen significant regulatory expansion. The “four revolutions” of financial deregulation in the early I980s-the end of official control of the exchange rate, and of exchange control over capital flows, the entry of foreign banks, and interest rate deregulation-precipitated the broader reform movement in Australia, and resulted in far greater Australian participation in global financial markets. Certainly, these reforms rapidly changed Australia’s banking sector from one of the most regulated in the world to one of the least. But this deregulation was closely followed by an increase in financial and securities regulation after a number of corporate failures, loans crises and much public criticism of the perceived excesses of the “corporate cowboys” of the time.

In the late 1990s, the Wallis Inquiry into the financial system increased the regulatory burden across many sectors, and a number of prominent corporate collapses in the first years of the twenty-first century provided the impetus for more again. Furthermore, participation in global financial markets has been accompanied by participation in global regulatory regimes, such as the GIO’s Basel II Framework.

It is perhaps not too much of a stretch to say that, at least for those industries which before the reform period were relatively free of government intervention, many of the developments under the aegis of the regulatory state consist of an encroachment of government into the private sphere, rather than the other way around. Writing about the parallel developments in the United Kingdom in regulation and privatisation, the regulatory analyst Michael Moran has characterised the last two decades as a period of “hyper-innovation”. This characterisation is just as apt for Australia. The institutional certainty of Australia’s mid-twentieth-century political economy has been replaced by a continuous process of regulatory and legislative reform.

As we could expect, this remarkable increase in government regulation has had a significant impact on the efficiency of the Australian economy and general levels of prosperity. However, the focus on the economic and social impact of regulation masks its full significance: there has been a fundamental shift in the relationship between government and society; in the mechanisms by which policy is conducted; and the institutions where political power resides. As we shall see, during the Howard era regulatory agencies expanded and consolidated to match this enormous regulatory growth. The power these independent agencies have over the Australian economy warrants their considerable scrutiny; and to a large degree their growth is attributable to economic reforms under the Howard government.

Indeed, this is the central story of regulation under the Coalition.

THE COALITION GOVERNMENT may not have initiated the growth of the regulatory state, but the period in which it governed saw the largest regulatory expansion in history. For our purposes, regulation is the attempt to define the boundaries of economic activity for economic, social or environmental reasons. Regulation is designed to modify or limit economic behaviour, but not to outlaw it. It can be produced by explicit legislation, by subordinate legislation, by a wide variety of class orders, instruments, codes of conduct or guidelines. Where the government restricts economic or social activity, regulation can be found.

Legislation is wider in scope and content than regulation, but it can serve as a useful proxy. The growth in Commonwealth legislation since Federation, measured by the number of pages of Acts of Parliament passed per year, clearly illustrates a dramatic increase in legislative activity over the past few decades. For instance, if we mark the year 1980 as the beginning of the reform period in Australia, through to 2006, there was more than five times the number of pages of legislation passed than there had been in the eight decades before this period.

It is striking how little legislative activity was required at the time of Federation to unify the country – 358 pages, spread over two years – compared with how much it took to manage the Commonwealth in 2006 – a massive 6786 pages. Certainly, the changing nature of Australia’s federal structure has expanded the jurisdiction of the Commonwealth legislature, but there have been similar increases in state legislative activity – not decreases, as would be expected if there had simply been a shift in responsibility from the states to the federal government. Indeed, state legislation has been marked by significant growth.

And what data is available indicates that subordinate legislation-which is commonly described as “regulation”-is growing at a similar pace as legislation. Subordinate legislation in the Commonwealth and the states parallels the increase in total legislation over the last four decades. Changes in government have little effect on the relative increase in legislative activity. As a consequence, John Howard’s government was the highest legislating government in Australia’s history. Based on his performance so far, it is not hard to guess that Kevin Rudd’s government might be even more active.

A similar analysis is possible by looking at the data on regulation: the Howard government oversaw the largest regulatory expansion since Federation. Certainly, simply counting the pages of regulation and legislation is a highly imperfect method of assessing total regulatory burden, but in the absence of a superior alternative it has been widely recognised as the most effective. Other factors can increase the number of pages without increasing the regulatory burden. For instance, one potential cause of the increase in pages of legislation is the move during the 1980s to plain English drafting-as opposed to the traditional legislative language inherited from England in the nineteenth century-as well as the use of double-spacing. Formatting changes can also alter the words-to-page ratio.

Nevertheless, there is little to suggest that the plain English drafting reform or formatting changes are the sole, or even primary, cause of increasing pages of legislation – page increases both preceded these changes and continued after they had filtered through the various tiers of government. Technical changes in the manner in which legislation is drafted cannot explain modem legislative and regulatory excess.

For the firms and individuals affected by regulatory and legislative increases, the impact is cumulative. Individuals not only have to act in accordance with the legislation and subordinate legislation passed in any given year-they also have to contend with the entire body of law as amended. Some of this legislation and regulation replaces existent law; but it is clear that it is growing – if not at the same heady pace that legislation and regulation in general is being passed.

And anecdotal evidence supports the empirical evidence for the growth in regulation. The 2006 taskforce on Reducing the Regulatory Burden on Business noted that a particularly striking example of the level of regulation was the 24,000 different types of licences administered by three levels of government. Telstra notes that the amount of regulatory instruments applicable to its business has grown since 1997 from twenty to 348, and that the number of reports required by the Australian Competition and Consumer Commission has been increasing by two or three per year. This is particularly striking because the regulatory framework governing telecommunications has been relatively stable during that time.

MUCH OF THE INCREASED regulatory burden is not sector-specific, but is related to workplace law. The Australian Construction Industry Forum has argued that the Howard government’s changes to industrial relations and changes to state and federal occupational health and safety law are a significant addition to the regulation facing their industry, as well as taxation changes. Indeed, the Income Tax Assessment Act, often used as a barometer of legislative and regulatory growth, has grown from 120 pages in 1936 to a bookshelf-crushing 7000 pages.

The Insurance Council of Australia attempted to describe the level of regulation affecting its industry by noting its effects on business structure and practice. Regulatory compliance now compromises between 10 and 25 per cent of board and senior management workload. One large insurer estimated a much higher work load, at least 40 per cent of senior executive time, and up to 60 per cent of board time. One small insurer estimated that this had grown five times above the amount five years ago, and ten times over the last decade. Another insurer estimated that compliance expenses as a percentage of operating income had more than doubled in the last five years. Another estimated that the staff numbers in regulatory compliance committees had grown 20 to 30 per cent in the two years up to 2005. A PricewaterhouseCoopers analyst has noted that for the insurance industry over the last five years the cost of complying with the prudential regulatory framework has increased significantly.

The Credit Union Industry Association notes that the burden on both their credit union membership and other banks and building societies has increased since the Wallis Inquiry in 1997, and attributes this to the mandatory implementation of Basel II, recent financial services reforms, changes to prudential standards, and the adoption of international accounting standards. A practical example of this increase is provided by the Business Council of Australia: a total of 227 pages of documentation needs to be given to a customer before they can open a simple cheque account with an overdraft limit and a home loan, roughly five times the amount in 1985. The Australian Bankers Association reports that one bank has doubled its annual compliance expenditure levels every five years since 1994-95, with a similar growth in staff dedicated to regulatory compliance.

There has been little quantification of the extent of local government regulatory activity, but, there are indications that it is increasing. The Australian Chamber of Commerce and Industry writes that there was a marked upswing of local government regulation as a constraint to investment between 2003 and 2005.

MANY ANECDOTAL IMPRESSIONS of the regulatory burden understate the economic impact of regulation by focusing inordinately on-the paper-burden cost rather than the total regulatory cost. The paper-burden cost includes the cost of employees dedicated to regulatory compliance, and external legal, economic and financial consultants, and they typically constitute one-third of the total cost of regulation.

Thus, the contemporary political focus on “red tape” presents the problem of over-regulation in a narrow light. The structure of regulation is so central to the business models and profitability of some’ firms that regulatory governance and compliance is an “all-of-firm” question. For these firms, it is not necessarily possible to separate regulatory compliance costs from business costs. The anecdotal estimates above, which focus predominantly on easily measured paper-burden costs, are, for many industries, likely to be dramatic underestimations.

The full cost of regulation is much greater than the visible cost of compliance. Certainly, the distribution of costs caused by regulation varies by industry. In the food sector, the primary cost of regulation is a paperburden cost. But for much of the economy, the paperburden cost is dwarfed by the restrictions imposed by the regulations. For instance, the “chilling’ effect” of access regulation dwarfs the paper-burden cost of those regulations by holding back infrastructure investment.

As Gary Banks has argued, “regulations not only create paperwork, they can distort decisions about inputs, stifle entrepreneurship and innovation, divert managers from their core business, prolong decisionmaking and reduce flexibility”. These effects are, on average, far more significant than the red tape which is required by regulators to assess compliance. Focusing only on paper-burden costs is like focusing on the time spent filling out a tax return rather than the amount of tax paid. Political platitudes to lower the red-tape burden offer little promise if they are not part of a general push to decrease overall regulatory intervention in the economy. And like its predecessor, this is a point that seems unfortunately lost on the new Labor government.

Firms now operate in a much more uncertain regulatory environment than before the reform period. This is particularly concerning because investment decisions are contingent not only on the regulatory environment in which they are made, but also on an estimate of the regulatory environment of the future. If that future environment is plagued by uncertainty – investors do not know what “reform” their industry can look forward to in the future – it will be factored into the decision to invest or not.

Firms can delay investments and, through political activity, try to influence future regulatory frameworks in which that investment might be more profitable. Where investments are irreversible, investors face two options: invest now, or defer investment until the uncertainty is resolved.

This is not merely a consequence of uncertainty about what actions legislators may take in the future – it can also be because of uncertainty about the actions of regulators. For instance, ambiguous statements about the manner in which, or extent to which, regulations will be applied can exacerbate this uncertainty.

A 2001 study into the relationship between American anti-trust law and investment found strong links between levels of regulatory uncertainty and lower levels of investment-the much-cited measures of “business confidence” may be partly proxies for regulatory certainty. A local example was recently given by the CEO of Pipe Networks, a telecommunications backhaul provider, when he argued in April 2007 that regulatory uncertainty in the telecommunications industry meant that investment in backhaul had been, at least for the moment, effectively shut down. Indeed, many submissions to the Howard government’s Taskforce on Reducing the Regulatory Burden on Business cited uncertainty about future regulations-and uncertainty about how recently-imposed laws and regulations would be interpreted by the judiciary as a major impediment to business operation.

Political regimes which have broad uncertainty about potential government intervention across the economy experience concrete effects. And uncertainty scales with dramatic effect. The historian Robert Higgs has found that “regime uncertainty” – of which uncertainty about possible future regulatory decisions was a key part – was the major factor in prolonging the Great Depression in the USA. The anti-business rhetoric of President Roosevelt and his supporters concerned investors enough to withhold investment, even when the actual investment climate was not particularly punitive.

Regulatory hyper-innovation, regardless of the character or nature of the regulatory change, can, in and of itself, discourage productive activity. Recognition of this effect should compel caution before pursuing continuous rapid economic reform-particularly if the economic reform in question is of a reregulatory rather than deregulatory nature. Regulatory uncertainty in economy-wide areas like corporate governance has the potential to massively disrupt economic growth. The effect of uncertainty on economic activity is even more concerning when the nature of what is considered proper compliance to those regulations is vague.

THE HOWARD YEARS also saw major expansion in regulatory agencies. This trend is a reflection of the regulatory increase, but it is also a significant change in the structure of government and economic management, indicative of a rise of a sector of government that is both independent and non-democratic. One of the biggest, and yet least appreciated changes to government under the Coalition has been the elevation of regulatory agencies to the centre of the political and economic system. With their new-found role, they have found themselves in possession of a significant amount of political power relative to the executive and legislative branches of government. If we are to understand the Howard government’s performance in the regulatory sphere, we have to look at how institutional and legislative reforms have changed the power structure and activities of these regulatory agencies.

There are approximately sixty Commonwealth regulators and national standard-setting bodies. There are a further forty federal ministerial councils setting and administering regulations. While hard to estimate, the federal regulatory agencies employ over 34,000 people, with a combined budget of well over $4.5 billion.

The Victorian Competition and Efficiency Commission identified sixty-nine regulatory bodies in that state, with a combined budget (excluding the Metropolitan Fire Brigade, Country Fire Authority and Parks Victoria) of over one billion, and a staff of 6895. The Productivity Commission extrapolates these figures to come up with an estimation of 600 regulatory agencies across the country. Taking into account government departments with regulatory functions, ministerial councils, inter-governmental bodies, and the range of quasi-official agencies and boards, it is easy to imagine that at the end of the Howard years, at least $10 billion was spent annually on regulating the Australian economy.

Using numbers of staff as a proxy of agency size, many agencies have seen significant recent growth: For instance, the Australian Fisheries Management Authority has nearly doubled in size in the last decade, from a staff of 100 to 186. Food Standards Australia New Zealand has increased from 100 in June 2000 to 146 in 2006. The Australian Pesticides and Veterinary Medicines Authority has increased in that same period from 113 to 133. There is a large variety of regulatory agencies dedicated to regulating specific industries, like the federal Civil Aviation and Safety Authority or the Australian Fisheries Management Authority.

But occupying a central role in Australia’s regulatory system are a few key economic regulators with economy-wide scope. Rather than being confined to narrow jurisdictions, these agencies typically do not only regulate a wide variety of industries, but are also multi-dimensional in scope. That is, Australia’s major economic regulators regulate for both economic and social outcomes, as well as technical regulation like standards-setting.

These regulators are not built around the institutions that they administer, but are rather built around “functional’ lines. The Australian Securities and Investment Commission (ASIC) is responsible for consumer and investor protection, the Australian Prudential Regulatory Authority (APRA) is responsible for prudential regulation, that is, market failure associated with information asymmetries in financial contracts; and the Australian Competition and Consumer Commission (ACCC) is responsible for policing anti-competitive behaviour economy-wide. The financial services sector powerfully illustrates how reform to regulatory institutions under the Howard government has led to significant increases in the regulatory burden.

The 1997 Financial System Inquiry (the Wallis Inquiry) was only the third major inquiry into the Australian financial system since Federation, after the 1936 Royal Commission and the Campbell Inquiry in 1981. After the “four revolutions” which followed the Campbell Inquiry, the financial market and its structure went through a dramatic overhaul, with the introduction of new institutions such as foreign exchange firms, recognised bond dealers and new types of trusts and management funds, as well as entrance into foreign exchange markets and new secondary mortgage markets. In the decade between 1985 and 1995, the number of commercial banks in Australia increased from thirteen to forty-nine.

THE PURPOSE of the Wallis Inquiry was to assess the appropriateness of the regulatory framework which had been constructed during the period of financial deregulation in the light of these changes. The “modest trend” towards agency consolidation internationally was noted in the inquiry’s discussion paper – the inquiry predated the now prototypical example of an “all-in-one” regulator, or “mega-regulator”, the United Kingdom’s Financial Services Authority (FSA).

Governance and power concentration were factors for the participants of the inquiry when recommending the ideal regulatory structure. The inquiry rejected an FSA-style mega-regulator due to the need for efficiency and specialisation. And the inquiry was concerned with regulatory governance, noting that the single regulator may become “excessively powerful”.

But nevertheless, the Wallis Inquiry’s final recommendations as adopted by the government consisted of major agency consolidation into two main organisations, the Australian Prudential Regulatory Authority (APRA) and the Australian Securities and Investment Commission {ASIC). This model was popularly known as the “twin peaks” model, from a 1995 article which recommended delineating financial regulation according to function-prudential (APRA) and disclosure (ASIC). Advocating this agency consolidation, Treasurer Peter Costello said before the Wallis Inquiry:

The regulatory framework is hopelessly out of date. You have superannuation funds that are now in home lending and are essentially running banks and you have banks coming into superannuation – you have got different institutions offering the same product, different regulators regulating the same product because they are offered by different institutions. Why do not we cut all that away and say whatever the nature of the financial institution we will have a regulator covering prudential and a regulator covering consumer protection and we can sweep a whole lot of that away?

While the “twin peaks” model amalgamates regulatory functions in a less extreme manner “than the United Kingdom’s FSA, it was nevertheless a significant consolidation. By drawing the vast bulk of regulatory functions away from the Reserve Bank of Australia (the bank did gain some roles of the Australian Payments System Council), the new model eclipsed the international consolidations described in the inquiry’s discussion paper. It is not inaccurate to refer to the new tri-regulator model as a system of “mega-regulators”, even if the FSA provides a more “pure” example of such an institution. In both the Australian and international context, the result of the Wallis Inquiry’ was the creation of two functionally-structured mega-regulators with economy-wide jurisdiction.

APRA, as a functional regulatory agency, has assumed prudential regulation of finance-based industries. It required eleven pieces of legislation, which constituted over 4000 pages, including four new acts and two omnibus acts. In total, APRA’s foundation amended and repealed more than seventy existing acts. APRA absorbed the entire Insurance and Superannuation Commission (ISC), as well as roughly seventy staff from the RBA who had bank regulation roles. The prudential regulator has since experienced rapid growth, from a staff of roughly 400 at the time of transition to 570 in 2006. The annual federal appropriation for APRA has grown 55 per cent in that time. On top of the legislation which founded APRA, the prudential regulator has overseen more than sixty-six major regulatory changes since 2000.

For the insurance industry, the creation of APRA represented a significant increase in regulatory activity covering the sector. Under the ISC, the insurance industry had been regulated relatively lightly. In the view of the new consolidated regulator, this light-handed regulation was unsatisfactory. APRA’s Executive General Manager of Policy, Chris Littrell, argued: “Until 2001 the Australian general insurance industry was characterised by an unsatisfactory culture of reluctant regulatory
compliance by some entities, even among our largest companies.”

Indeed, following the HIH insurance collapse, Littrell argued that eliminating this cultural clash was one of the early tasks that the regulator faced:

As an integrated supervisor, APRA is in a position to observe the managerial differences between our regulated sectors. Banks in general are run by people who are or have been risk managers, and by people who understand that regulation has its good points. In Australia at any rate, many insurance companies have been dominated by salesmen, who ‘often viewed regulation as something to be avoided. Having come up the career ladder by dealing with actuarial restrictions, they tended to treat regulatory requirements as another annoyance to overcome, rather than a guide to good practice.

While HIH’s collapse and the subsequent royal commission heralded the beginning of a major wave of regulatory increases in the insurance industry, its genesis was the foundation of APRA itself, which coupled the insurance industry with the much more highly regulated banking industry. Indeed, plans to increase regulation of the general insurance industry preceded the 2001 collapse of HIH. The Financial Services Reform Act 2001 classified most insurance as a “financial service” – with the notable exceptions of reinsurance, health insurance and government insurance-and therefore required an Australian financial services licence. Financial product advice, dispensed by intermediaries not directly providing insurance, also required licences under the 2001 Act to do so. The Act also imposed significantly increased product disclosure requirements, and capital and corporate governance requirements.

The Association of Superannuation Funds of Australia, in its submission to the Reducing Regulation Taskforce, stated that since the establishment of ASIC and APRA, supervisory levies paid by superannuation funds had increased dramatically. Indeed, APRA’s expenses relating to superannuation have grown, even though the number of superannuation funds has decreased significantly.

For the banking sector, a great deal of the regulatory change after the foundation of APRA was concerned with the transfer of regulatory authority from the still-existent RBA towards the new prudential regulator. But the most significant regulatory change has been adopting the Basel II Capital accords.

The implementation of Basel II under the auspices of a mega prudential regulator has, for many organisations, had the effect of a dramatic increase in regulatory burdens. Basel II constructs an internationally consistent framework for banking capital requirements and accounting standards. For large, internationally active banks, implementing Basel II has much important significance. However, for smaller domestically-based authorised deposit-taking institutions, Basel II provides little benefit. For credit unions, whose involvement in international markets is low, the cost of implementing the framework is precipitously high. Similarly questionable benefits have accompanied APRA’s uniform adoption of the International Financial Reporting Standards, which affects major, internationally active Australian banks and small domestic co-operatives like the St Mary’s Swan Hill Co-operative Credit Society alike.

APRA’s activities illustrate clearly the perils of uniformly applying regulations that are designed for a specific class of institution.

UNDER THE TWIN PEAKS model of financial regulation, ASIC regulates company and financial services law for consumer, investor and creditor protection. Where APRA regulates for the viability of financial institutions, ASIC’s many briefs include regulating conduct and disclosure, administering corporations law and consumer protection. To do so, it administers eight separate laws, including the
Corporations Act 2001, Australian Securities and Investments Commission Act 2001, and the Insurance Contracts Act 1984.

ASIC was drawn from the Australian Securities Commission, and in 1998 absorbed the consumer protection responsibilities in insurance and superannuation of the ISC. It also drew consumer protection responsibilities in finance from the Australian Competition and Consumer Commission, replicating Section 52 of the Trade Practices Act in the ASIC Act. Further, ASIC absorbed the consumer protection responsibilities of the Australian Payments Systems Council and financial sector industry codes of conduct. In 2005-06, ASIC had regulatory responsibility for 1.5 million corporations and 4415 financial services businesses.

ASIC’s growth has been the most marked of the economic regulators. Since 1999, the regulator’s annual real appropriations have increased by 76 per cent. Its staff has grown from 1221 to 1471.

ASIC has overseen a rapid and comprehensive overhaul of corporate governance law under the Corporate Law Economic Reform Program (CLERP). The rapid, comprehensive change in corporate law under the continuous process of CLERP, as well as the Wallis Inquiry-era reforms which inaugurated ASIC, have been matched by the regulators use of legal instruments to modify the Corporations Act 2001. Since 2002, ASIC has issued more than 380 class orders, which materially alter the terrain of corporate law. Indeed, the Association of Superannuation Funds of Australia argues that ASIC’s reliance on instruments like class orders has been a major cause of the increased complexity of corporate regulation in the last decade.

The gains from the expanding reach of regulatory intervention in the structure of the firm are uncertain. Prominent corporate collapses have been a regular feature of Australian economic history since before Federation. There is, however, little evidence to suggest that the dramatic increase in corporate, securities, financial and banking regulation that followed the wave of corporate collapses in the late 1980s has had any significant impact on subsequent collapses.

There is a very real likelihood that the excessive restraints placed upon corporate form and function, particularly at the executive and upper management level, can have a detrimental effect on entrepreneurial activity. Regulatory micromanagement places a significant burden upon innovative practices and structures. It also induces substantial costs upon firms. For instance, regulatory measures which attempt to foster “compliance culture” by imposing personal legal liability for business decisions upon executives reduce the incentive to take up those senior management positions, and raise the salaries of those who do.

As with all tax and regulatory burdens, firms try as far as possible to pass these costs on to the consumer. It is indicative that an August 2006 CPA Australia survey found a strong perception that the overwhelming beneficiaries of CLERP 9 auditing processes reforms were regulators and auditors.

The other major federal economic regulator is the Australian Competition and Consumer Commission, which has also seen significant growth in staff and resources. However, compared to ASIC and APRA, the ACCC’s regulatory regime was relatively stable during the period of the Howard government, further reinforcing the view that regulatory agencies and bureaucracies grow regardless of any obvious “need’ to do so. Telecommunications and media regulation saw a major change in 2003 when the Australian Communications Authority and the Australian Broadcasting Authority merged to form the Australian Communications and Media Authority. Furthermore, the Reserve Bank, the Australian Taxation Office, and the Australian Customs Service all exit the Howard decade with substantial regulatory powers.

HOW MUCH of the blame for this remarkable increase in the regulatory burden and high levels of regulatory uncertainty can be laid at the door of the prime minister’s office? The phenomenon described above is, unlike some other ways we can measure government activity, diffuse. It is not a phenomenon that is subject to system-wide review by the senior ministry, unlike, for instance, government spending, which is constantly subject to the scrutiny of the budget process. For this reason, one of the perennial tasks of regulatory watchdogs like the Productivity Commission and VCEC is simply to estimate the size of the regulatory state. Given the paucity of published information, these agencies can only guess at how many regulatory agencies there are across the country, let alone determine how much we spend on them.

The origins of regulation vary significantly. Some do, unquestionably, originate in cabinet-level policy decisions. Populist regulations which cover issues like pornography on the internet or teen drinking are just as much political strategy as regulating, and are consequently of interest to senior government ministers. But these regulations are only a small portion of the total regulatory burden-internet filtering may be a high profile regulation, but is ultimately a drop in the pool compared to the gigantic array of rules which the government administers.

Furthermore, the prime minister’s office is not directly responsible for minor changes to the finer points of financial service regulation, consumer product regulation, or occupational health and safety laws. Indeed, even those regulatory frameworks which are high-profile are ultimately defined by individuals well down the chain of government delegation from the cabinet. For example, while the WorkChoices reform program may have had its origins in the senior ministry, the complexity of its regulatory and legislative framework is largely attributable to thousands of minor decisions made by a diverse array of lawyers, regulators and advisers who actually drafted the nearly 2000 pages of regulation and legislation. The government may have signed off on the final WorkChoices bill, but they did so because their more informed and technocratic subordinates convinced them that deregulation meant re-regulation.

Similarly, it is not fair to blame the Howard government for the substantial regulatory burden emanating from the states, or for the petty regulations imposed by local government, both of which constitute a substantial part of the regulatory landscape. The federal government can exert a degree of pressure on the other levels of government to reduce regulation, as it did under periodically during the Howard era, but doing so rarely does more than continue to erode our crippled federalism.

If we are to discover a major source of much of the regulatory increase over the past few decades, it is also necessary to cast our eye over the regulatory agencies themselves. Regulators are delegated substantial amounts of discretionary power to make decisions regarding the structure of their jurisdiction’s regulatory framework, which gives them significant political power. These regulators are systematically biased towards an ever more expansive interpretation of their proper role in the economy and, compounding this, the “cat-and-mouse” nature of regulatory negotiation and compliance leads regulators to lobby for legislative enhancements to their coercive powers. The powers and independence with which regulators have been vested means that they operate in a substantially separate sphere to the executive branch of government. To a surprising degree, regulatory agencies are autonomous actors in Australia’s political system. The capacity for the government to restrain their decisions, and therefore the degree to which we should consider the government responsible for their excesses, is limited.

Nevertheless, it would be easy to conclude, on the basis of the growth of regulation and the extremely modest efforts made to reduce the regulatory burden, that the Howard government’s performance in this field was a failure. But we cannot measure governments against our ideal visions of free market economies-the economic study of politics which has developed over the last half-century has repeatedly emphasised the structural barriers to free market reform, and it is an all-too-common intellectual failure of right-of-centre politics to ignore these in debate. As Adam Smith noted in The Theory of Moral Sentiments, perfection is rarely the correct yardstick:

When a critic examines the work of any of the great masters in poetry or painting, he may sometimes examine it by an idea of perfection, in his own mind, which neither that nor any other human work will ever come up to; and as long as he compares it with this standard, he can see nothing in it but faults and imperfections. But when he comes to consider the rank which it ought to hold among other works of the same kind, he necessarily compares it with a very different standard, the common degree of excellence which is usually attained in this particular art; and when he judges of it by this new measure, it may often appear to deserve the highest applause, upon account of its approaching much nearer to perfection than the greater part of those works which can be brought into competition with it.

Following Smith, if we acknowledge the structural impediments to regulatory reform, we must ask how successful the Howard government was relative to other governments. It is easier to be sympathetic to the Coalition when we recognise that no Australian government has ever passed less legislation than its predecessor- regulation appears inevitably to escalate over time.

But that does not mean regulation cannot be restrained. One of the great successes of the Reagan administration was to slow the rate of legislative and regulatory expansion significantly, particularly after the excesses of the Carter years. Data from the Federal Register – which records rules, proposed rules and notices of the federal government – shows clearly that unlike in Australia, during the 1980s the United States saw a notable slowdown in the rate of regulatory growth.

Certainly, slower regulatory growth is not deregulation. There were more pages in the Federal Register at the end of the Reagan administration than at the start. But the US experience does seem to indicate that growth can be restrained, if not entirely resisted.

So what are the lessons of the Howard era? John Howard was always a passionate supporter of the reform agenda, if not always a passionate reformer. But there is little to suggest that his government was aware of the significance of regulation as a restraint on economic growth, at least until its last few years, when its deregulatory rhetoric became louder. When the Prime Minister’s Taskforce on Reducing the Regulatory Burden reported its findings, the government provided in-principle support for its recommendations but little action.

It is easy for a government to profess its distaste for over-regulation – after all, is there anybody who actually likes “red tape”? – but it is much harder for governments to nominate specific regulations which they have the political will to cull. The regulatory burden is more than the sum of its parts. Individual regulations still have to be removed individually. And when governments try, they come up against the institutional and political interests which have formed around those regulations. For this reason, a program for economy-wide deregulation has to be piecemeal, but systematic.

So if our wishes for deregulation are ever to be indulged, advocates of a free economy and free society have to hope for a political movement that shares our goals. Ronald Reagan may be our closest contemporary who worked to slow, if not reduce, regulation, but history does provide one example of a grand regulatory purge. The English Whigs and early Liberals are one of those rare examples in history that conducted a wide scale regulatory and legislative purge. The English had a long history of mercantilism and state power to recant. It has been estimated that, of the 18,110 Acts which had been passed between Henry III and 1873, four out of five were fully or partly repealed. Both the Reagan administration and the great English liberalisation shows us that deregulation is possible, but doing so requires a formidable dedication to reducing the power and size of government.

This was a dedication the Howard government lacked. In its absence, there was no institutional or philosophical bulwark against regulatory growth, whatever the origins of those regulations. The eleven years of Coalition rule merely illustrates the enormous challenge of reducing the regulatory burden.