Unfreeze: How to create a high growth economy after the pandemic

With Darcy WE Allen, Sinclair Davidson, Aaron M Lane and Jason Potts. American Institute for Economic Research, 2020

During March and early April 2020, much of the world economy was deliberately shut-down and frozen to combat the COVID-19 pandemic. Modern economies are complex systems that are not easily frozen and unfrozen. Governments now face the challenge of unfreezing their economies. The social and economic cost of the pandemic will be enormous and long-lasting. This book develops an analytic and policy framework—cryoeconomics—for understanding what needs to happen next and how to restore our standard of living. We spell out the policy settings necessary for the rapid adaptation and market re-coordination that is required to resuscitate the economy. We explain why a return to business as usual is simply not enough to get everyone working again. A period of high growth prosperity will be imperative to deal with the costs of the freeze. This book tackles the tough questions and fills some of the current void of ideas and thinking about economic recovery. We develop a framework and principles for an institutional re-build, presenting a path to recovery based on the ideas of private governance, permissionless innovation, and entrepreneurial dynamism.

Available at Amazon in print and Kindle and Amazon Australia in Kindle edition.

This silent deregulation must become a pillar of recovery

The COVID-19 pandemic has seen a massive expansion of the power of the state – heavy-handed police action and huge increases in government spending are just the most obvious.

But at the same time, the crisis has also seen a major retreat of state power in other areas – a wave of deregulation across the economy that has almost no historical parallel. And these regulatory reforms offer us a path back to prosperity.

The most obvious regulatory reductions have been on the medical frontline. Some controls over the production and use of medical face masks, ventilators, virus testing and pathology have been relaxed. Supervision requirements have been reduced for nurses re-entering the workforce. Regulations have been eased to allow distilleries to produce alcohol-based hand sanitiser.

But the most consequential deregulations have been intended to keep the economy afloat. Night-time curfews on delivery trucks have been lifted to ensure supermarkets can be more easily restocked, and trading and operating hours restrictions for essential retail have been eliminated. Liquor licensing has been relaxed to allow restaurants and bars to do home-delivered alcohol. Construction work can now be done on weekends and public holidays to make up for productivity losses that might come from trying to build while social distancing.

Other reforms have involved the government relaxing its most burdensome regulations. The Australian Prudential Regulatory Authority has eased capital requirements on banks. The Australian Competition and Consumer Commission is reducing its enforcement and surveillance program, announcing that it would now “carefully consider the impact on businesses already under pressure” (this is great, but at the same time reveals a lot about their attitude before the pandemic).

The Australian Securities and Investment Commission has even put a hold on the program that embeds bureaucrats in private companies. This is the program introduced after the financial services royal commission that has government-appointed psychologists observing the ethical standards of senior management. It was widely derided as “shrinks in the boardroom” – and it is no longer active because of COVID-19.

The rules we didn’t need

Even more astonishingly, the communications regulator has suspended Australian content requirements on commercial television and pay TV. It would be hard to nominate a more heavily defended and politically sensitive bunch of regulations. And they have now been shelved with almost no comment.

For the past two decades Australian governments have repeatedly announced red tape reduction programs. Regulatory reform has been a major plank of the Coalition government’s agenda. It was a major plank of the Labor government before it. But none of those heavily promoted programs have had as much scope and scale as the COVID-19 deregulations.

Those earlier red tape reduction programs focused on the sorts of regulations that nobody was interested in defending. They tended to eliminate lots of minor rules rather than significant ones. The guiding principle has been quantity not quality. Ultimately they were less major economic reform and more tidying up the statute books.

But this time is different. The regulations that have been suspended are precisely those that are most burdensome. They are the rules that are most costly to comply with but also least essential to support a functioning economy.

In other words, they are the rules that governments worried about the effect of over-regulation on productivity and economic growth should be very reluctant to reinstate.

This is the conversation to have now. The pandemic is moving from urgent crisis stage to risk-management stage. The Reserve Bank governor warns that we are looking at the greatest hit to the economy since the Great Depression. We need to start thinking about what policy settings will be able to revive the relative prosperity we enjoyed at the end of 2019 – and pay for all the spending that the government has committed to.

Deregulations must stay

Making these temporary deregulations permanent should be one of the pillars of recovery. We cannot assume that the economy will happily bounce back once social distancing controls are lifted. The damage inflicted by the shutdown on business models and supply chains has made this naïve hope impossible. The economy needs to adapt to the post-pandemic world – quickly. Regulations that prevent this rapid adaptation or prevent firms from establishing new sustainable business models need to be culled.

In a 2016 paper published in the European Journal of Political Economy, the economist Christian Bjørnskov looked at how economic freedom (that is, low taxes and minimal regulation) affected how different countries performed during an economic crisis. He found that how heavily a country was regulated predicted how quickly it recovered from crisis – the less regulation, the quicker the recovery.

A lot of the growth in government is likely to survive after the COVID-19 pandemic. It will be politically hard to abolish free childcare or to return Newstart payments to where they were. But we’re going to need a much more productive and prosperous economy to pay for it all. So the deregulations done during the crisis should be locked in too. And the principles that have been established during this crisis – that many politically popular regulations make it hard for businesses to adapt to unexpected circumstances and keep people employed – will be needed to guide our policymakers when they return.

As Scott Morrison has said, all workers are essential. But not all regulations are.

Cryoeconomics: how to unfreeze the economy

With Darcy Allen, Sinclair Davidson, Aaron Lane and Jason Potts. Originally a Medium post.

The Australian government, like many governments around the world, wants to freeze the economy while it tackles the coronavirus pandemic. This is what the Commonwealth’s JobKeeper payments and bailout packages are supposed to do: hold workers in place and keep employment relationships together until mandatory social distancing ends.

Easier said than done. We are in completely uncharted territory. We’ve never tried to freeze an economy before, let alone tried to thaw it out a few weeks or months later. That’s why our new project, cryoeconomics, looks at the economics of unfreezing an economy.

To understand why this will be so hard, think of an economy as a remarkably complex pattern of relationships. Those relationships are not only between employees and employers, but also between borrowers and lenders, between shareholders and companies, between landlords and tenants, between producers tied together on supply chains, and between brands and tastemakers and their fans.

The patterns that make up our economy weren’t designed from above. They evolved from the distributed decisions of consumers and producers, and are shaped by the complex interaction between the supply of goods and services and their demand.

The problem is that the patterns the government plans to freeze are not the patterns we will need when they finally let us thaw.

When the government decides to pull the economy out of hibernation, the world will look very different. As a simple example, it’s quite possible that many Australians, forced to stay home rather than eat out, discover they love to cook. This will influence the demand for restaurants at the end of the crisis. On the other hand, our pent-up desire for active social lives might get us out into the hospitality sector with some enthusiasm. There will be drastic changes because of global supply chain disruptions and government policies. These changes will be exacerbated by the fact that not all countries will be unfrozen at the same time.

The upshot is that the economy which the government is trying to hibernate is an economy designed for the needs and preferences of a society that has not suffered through a destructive pandemic.

Unfreezing the economy is going to be extremely disruptive. New patterns will have to be discovered. As soon as the JobKeeper payments end, many of the jobs that they have frozen in place will disappear. And despite the government’s efforts, many economic relationships will have been destroyed.

Yet there will also be new economic opportunities — new demands from consumers, and new expectations. Digital services and home delivery will no doubt be more popular than they were before.

These disruptions will be unpredictable — particularly if, as we expect, the return to work is gradual and staggered (perhaps according to health and age considerations or access to testing).

As we unfreeze, the problem facing the economy won’t primarily be how to stimulate an amorphous ‘demand’ (as many economists argue government should respond to a normal economic recession) but how to rapidly discover new economic patterns.

It is here that over-regulation is a major problem. So much of the laws and regulations imposed by the government assume the existence of particular economic patterns — particular ways of doing things. Those regulations can inhibit our ability to adjust to new circumstances.

In the global response to the crisis there has already been a lot of covert deregulations. The most obvious are around medical devices and testing. A number of regulatory agencies have stood down some rules temporarily to allow companies to respond to the crisis more flexibly. The Australian Prudential Regulatory Authority is now willing to let banks hold less capital. The Australian Securities and Investment Commission has dropped some of its most intrusive corporate surveillance programs.

The deregulatory responses we’ve seen so far relate to how we can freeze the economy. A flexible regulatory environment is even more critical as we unfreeze. Anything that prevents businesses from adapting and rehiring staff according to the needs of the new economic pattern will keep us poorer, longer.

Today the government is focused on fighting the public health crisis. But having now turned a health crisis into an economic crisis, it must quickly put in place an adaptive regulatory environment to enable people and businesses to discover what a post-freeze economy looks like.

Automating the big state will need more than computers

Robodebt – the automated Centrelink debt issuance program that was found invalid by a federal court last month – is not just an embarrassment for the government. It is the first truly twenty-first century administrative policy debacle.

Australian governments and regulators increasingly want to automate public administrative processes and regulatory compliance, taking advantage of new generations of technologies like artificial intelligence and blockchain to provide better services and controls with lower bureaucratic costs. There are good reasons for this. But our would-be reformers will need to study how robodebt went wrong if they want to get automation right.

The robodebt program (officially described as a new online compliance intervention system) was established in 2016 to automate the monitoring and enforcement of welfare fraud. Robodebt compared an individual’s historical Centrelink payments with their averaged historical income (according to tax returns held by the Australian Taxation Office). If the Centrelink recipient had earned more money than they were entitled to under Centrelink rules, then the system automatically issued a debt notice.

That was how it was supposed to work. In practice robodebt was poorly designed, sending out notices when no debt actually existed. Around 20 per cent of debts issued were eventually waived or reduced. The fact that those who bore the brunt of these errors had limited financial resources to contest their debts contributed to robodebt’s cruelty. In November, the federal court declared that debts calculated using the income average approach had not been validly made, and the government has now abandoned the approach.

Automation in government has a lot of promise, and a lot of advocates. Urban planners are increasingly using AI to predict and affect transport flows. The Australian Senate is inquiring into the use of technology for regulatory compliance (‘regtech’) particularly in the finance sector. Some regulatory frameworks are so byzantine that regulated firms have to use frontier technologies just to meet bare compliance rules: Australia’s adoption of the Basel II capital accords led to major changes in IT systems. And the open banking standards being developed by CSIRO’s Data61 promise deeper technological integration between private and public sectors.

Regulatory compliance costs can be incredibly high. The Institute of Public Affairs has estimated that red tape costs the economy around 11 per cent of GDP in foregone output. The cost of public administration to the taxpayer is considerably more. Anything that lowers these costs is desirable.

But robodebt shows us how attempts to reduce the cost of administration and regulatory compliance can be harmful when done incompetently. The reason is built into the modern philosophy of government.

Economists distinguish between administrative regimes governed by discretion and those governed by rules. The prototypical example here is monetary policy. Rules-based monetary policies, where central banks are required to meet targets fixed in advance, are less flexible (as the RBA, which has consistently failed to meet its inflation target is keenly aware) but at the same time provide a lot more certainty to the economy. And while discretionary regimes are flexible, they also vest a lot of power in unelected bureaucrats and regulators, which comes at the cost of democratic legitimacy.

Automation in government is possible when we have clear rules that can be automated. If we are going to build administrative and compliance processes into code, we need to be very specific about what those processes actually are. But since the sharp growth of the regulatory state in the 1980s governments have increasingly relied less on rules and more on discretion. ASIC’s shrinks-in-the-boardroom approach to corporate governance is almost a parody of the discretionary style.

The program of automating public administration is therefore a massive task of converting – or at least adapting – decades of built up discretionary systems into rules-based ones. This was where robodebt fell over. Before robodebt, individual human bureaucrats had to manually process welfare compliance, which gave them some discretion to second-guess whether debt notices should be sent. Automating the process removed that discretion.

The move from discretion to rules is, to be clear, a task very much worth doing. Discretionary administration feeds economic uncertainty, and ultimately lowers economic growth. We have a historically unique opportunity to reduce the regulatory burden and reassert democratic control over the non-democratic regulatory empires that have been building up.

Of course, public administration-by-algorithm is only as effective (or fair, or just, or efficient) as those who write the algorithm build it to be. There’s a lot of discussion at the moment in technology circles about AI bias. But biased or counterproductive administrative systems are not a new problem. Even the best-intentioned regulations can be harmful if poorly designed, or if bureaucrats decide to use discretion in their interest rather than the public interest.

Robodebt failed because of an incompetent attempt to change a discretionary system to a rules-based system, which was then compounded by political disregard for the effect of policy on welfare recipients. But robodebt is also a warning for the rest of government. The benefits of technology for public administration won’t be quickly or easily realised.

Because when we talk about public sector automation, we’re not just talking about a technical upgrade. We’re talking about an overhaul of the regulatory state itself.

Towards Crypto-friendly Public Policy

With Sinclair Davidson and Jason Potts. Published in Melanie Swan, Jason Potts, Soichiro Takagi, Frank Witte and Paolo Tasca, 2019. Blockchain Economics: Implications of Distributed Ledgers, World Scientific Publishing, Singapore, pp. 215-232.

Abstract: Distributed ledgers are institutional technologies that pose complex challenges regarding regulation and inter-jurisdictional competition. This chapter introduces ‘crypto-friendly’ public policy as a way to understand these challenges. Blockchains are relevant to public policy in at least three ways. First, they can be adopted by governments for the provision of public services. Second, many blockchain applications interact with existing regulatory frameworks and may provide new regulatory challenges. Third, they present the possibility of ‘crypto-secession’ as a form of privately provided public goods provision. The chapter applies an institutional theory of regulation to assess how blockchains effect relative institutional costs and guide public policy choices. Blockchain applications such as property rights and identity management are also considered. Finally the chapter considers the possibility of crypto-friendliness as a dimension for international regulatory competition.

Available at World Scientific.

Opportunities for crypto-havens to capture business

With Sinclair Davidson and Jason Potts.

Blockchain technology is set to drive a new era of global public policy competition. In May 2018, the premier of Bermuda, David Burt, announced to the 8,500 attendees of the Consensus blockchain and cryptocurrency conference his country’s new Digital Asset Business Act and Initial Coin Offering Act. This legislation is intended to establish Bermuda as a premier destination for blockchain business by providing regulatory certainty around new business models.

But Bermuda is hardly the only jurisdiction seeking to attract blockchain firms. Singapore, Switzerland, Dubai, Estonia, subnational jurisdictions and dependencies like Illinois, Zug, the Isle of Man and Gibraltar are all positioning themselves to capture blockchain services. In October 2017, the then prime minister of Slovenia, Miro Cera, declared the country was “setting itself up as a blockchain-friendly destination.”

What we are seeing right now is an aggressive policy-driven grab to become a world leader in blockchain technology, and to capture some of the enormous value that this can unlock. Where once we saw global tax competition – as small nations attracted investment with business-friendly tax and regulation policy – now we are able to watch the green shoots of global blockchain competition. Blockchains are a unique technology, and that uniqueness presents some unusual public policy challenges. They offer us a new platform to organize economic activity: to make trades, to arrange production processes, to store information about assets and property ownership. Blockchains provide an economic infrastructure on which parallel technological developments, such as artificial intelligence and machine learning, the Internet of Things, 5G, and automation, can be built.

We expect to see a great deal of economic activity that currently takes place in firms, in markets, even in government, to be displaced by distributed ledger technology. Blockchains will tie organizations together that have currently cooperated only through market exchange, or by the force of regulation. It will lead to demergers, as large firms realize that a decentralized ledger is an alternative to complex multidivisional corporate structures.

But we have spent hundreds of years building complex taxation and regulatory systems around these institutions. The dominance of large firms has led governments to impose anti-trust laws. Principal-agent problems between owners and firm managers has led to the introduction of complex schemes of directors duties and manager controls. Securities law is built around the dominance of the public offering, taxation law around a sharp distinction between currency and other assets, and labor law around the employer-employee divide.

As a new technology of governing economic activity, blockchain applications pull at the threads of all these traditional regulatory frameworks. Globally, there are still deep uncertainties over the most basic questions around cryptocurrencies, such as when they are taxed, and as what: currency or security? The initial coin offerings that have brought so much money into the industry exist in a legal gray area almost everywhere in the world.

Blockchains are an incredibly young technology – just ten years old. Distributed autonomous organizations, decentralized labor markets, blockchain-secured intellectual property assets and blockchain-enhanced international trade will raise complex issues about fundamental regulatory structures, like labor, competition, and companies law – structures which have been reasonably fixed for the better part of a century. As more applications around economic problems, such as identity management, charities, healthcare, finance and global trade, are developed and introduced into the real world, they will face a spiraling number of regulatory and policy barriers that will need to be overcome. We face decades of regulatory uncertainty and demand for reform.

This is where crypto-friendliness matters. Crypto-friendliness does not mean the government needs to subsidize, plan or control blockchain technology. The sector is awash with funds: a happy by-product of the enormous speculative investment in cryptocurrencies that has occurred over the last eighteen months. No government planner could predict how this technology is going to develop, and given its global nature, no regulator has a hope of controlling it.

But blockchains do require governments to facilitate adoption. Because of the many ways blockchain use cases interact with existing regulatory frameworks they will need the help – or at least the acquiescence – of public policymakers to reform those frameworks to suit. The biggest regulatory risk in the blockchain space is uncertainty. Right now, those uncertainties are about how crypto-assets will be taxed, how and when they will be treated as securities, and the levels of disclosure around anti-money laundering and know-your-customer rules.

Governments that want to attract blockchain firms to their jurisdictions need to be resolving those uncertainties as soon as possible.

A crypto-friendly government is one which is not only focused on resolving current uncertainties but is able to credibly commit to facilitating the sorts of regulatory reforms needed in the future. Technological change is unpredictable. We do not know what blockchain applications are going to be the most successful and disruptive. Consumer demand is unpredictable. Governments should ensure, as far as possible, that regulation is both predictable and adaptive, that shape-changes in regulatory regimes do not occur, and that yet there is adequate space for entrepreneurial experimentation.

Which governments are likely to be the most crypto-friendly? At the first instance, the governments which have already demonstrated themselves as business-friendly environments are obvious candidates for blockchain friendliness. The ingredients of long-run economic growth – liberal, responsive institutions, the rule of law, limited government, regulatory modesty, and low taxes – are as important for blockchain firms as they are for other industries. The Isle of Man, for instance, has long been an established global leader in gambling and e-gaming, thanks to a deliberate effort on its part to establish welcoming and certain public policy. The Isle of Man is now a thriving site of blockchain innovation. As this suggests, blockchain technology presents a historically significant opportunity for the Cayman Islands, and any other jurisdiction which has a reputation for business-friendly policy. The last few decades of global tax competition have shown that smart policy can shape the geography of global capitalism just as strongly as labor or natural resources. Blockchains are a decentralized network but their developers, entrepreneurs and users exist in a real world, subject to real laws. Crypto-havens can capture that business.

Regulation and Technological Change

With Darcy Allen. Published in Darcy WE Allen and Chris Berg (eds.),Australia’s Red Tape Crisis: The causes and costs of over-regulation, Connor Court Publishing, Brisbane, 2018

Abstract: This chapter explores the relationship between technological change and regulation in both directions. New technologies such as artificial intelligence, machine learning, and distributed ledgers are likely to drive structural changes in decades to come, not least in the way firms comply with regulation and how regulators enforce regulation. Regulatory technology, or ‘RegTech’, presents opportunities to reduce the regulatory burden on firms and make regulation more efficient and less harmful. On the other side, regulators need to come to terms with new technologies that may challenge existing business models or regulatory constructs, and we propose policymakers adopt a ‘permissionless innovation’ principle in response, ultimately allowing experimentation with new technologies by default unless direct harms can be demonstrated.

Available at SSRN

Regulation and Red Tape in a Small Open Economy: An Australian Overview

Published in Darcy WE Allen and Chris Berg (eds.), Australia’s Red Tape Crisis: The causes and costs of over-regulation, Connor Court Publishing, Brisbane, 2018

Abstract: It is widely acknowledged in political circles that Australia has a high red tape and regulatory burden. However little scholarly attention has been directed towards understanding the extent and significance of that burden. This paper describes why red tape and regulatory reform should be treated as a particularly significant priority for a small, open economy such as Australia’s. Australia faces a number of economic and fiscal challenges and is likely to become more exposed to macroeconomic fluctuations in coming decades. Red tape and regulation slow adjustment to changes in that environment among individuals and firms. The red tape and regulation reform program should be seen as a central element in making Australia more resilient to local and global economic shifts.

Available at SSRN.

Australia’s Red Tape Crisis: The Causes and Costs of Over-regulation

Edited with Darcy Allen. Connor Court Publishing, 2018

Red tape costs the Australian economy as much as $176 billion a year. Governments create and enforce thousands of regulations on our workplaces and our communities. These rules slow and prevent businesses forming, people from flourishing, new technologies from being adopted, and hold back Australia’s global competitiveness.

Australia’s Red Tape Crisis is an exploration into the economics, politics and culture of over-regulation. How should we structure our federation to achieve reform? Why should political responsibility sit with the elected? Does Australia have a deep desire for a federal bureaucracy? What is the future of red tape reduction policies?

Together, the contributions of economists, philosophers, politicians and lawyers help define a path for overcoming Australia’s red tape crisis.

Available from Connor Court Publishing

A Genuine Commercial Justification for Interchange Fees

With Sinclair Davidson and Jason Potts

Abstract: Ronald Coase famously argued that “if an economist finds something – a business practice of one sort or other – that he does not understand, he looks for a monopoly explanation”. So it is with credit card interchange fees. Intellectual confusion has led to the phenomenon of interchange fees being misdiagnosed as being a monopoly problem leading to inappropriate policy intervention. Following George Stigler’s path breaking analysis of the US Security and Exchange Commission he claimed that financial regulation was “founded upon prejudice and … reforms are directed by wishfulness”. In our opinion, Australian regulatory attitudes towards interchange fees should be placed into the same category: reforms initiated by ignorance and anti-bank prejudice.

Working paper available on SSRN