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

Some economic consequences of the GDPR

With Darcy Allen, Alastair Berg and Jason Potts.

At the end of May 2018, the most far reaching data protection and privacy regime ever seen will come into effect. Although the General Data Protection Regulation (GDPR) is a European law, it will have a global impact. There are likely to be some unintended consequences of the GDPR.

As we outline in a recent working paper, the implementation of the GDPR opens the potential for new data markets in tradable (possibly securitised) financial instruments. The protection of people’s data is better protected through self-governance solutions, including the application of blockchain technology.

The GDPR is in effect a global regulation. It applies to any company which has a European customer, no matter where that company is based. Even offering the use of a European currency on your website, or having information in a European language may be considered offering goods and services to an EU data subject for the purposes of the GDPR.

The remit of the regulation is as broad as its territorial scope. The rights of data subjects include that of data access, rectification, the right to withdraw consent, erasure and portability. Organisations using personal data in the course of business must abide by strict technical and organisational requirements. These restrictions include gaining explicit consent and justifying the collection of each individual piece of personal data. Organisations must also employ a Data Protection Officer (DPO) to monitor compliance with the 261-page document.

Organisations collect data from customers for a range of reasons, both commercial and regulatory — organisations need to know who they are dealing with. Banks will not lend money to someone they don’t know; they need to have a level of assurance over their customer’s willingness and ability to repay. Similarly, many organisations are forced to collect increasingly large amounts of personal data about their customers. Anti-money laundering and counter-terrorism financing legislation (AML/CTF) requires many institutions to monitor their customers activity on an ongoing basis. In addition, many organisations derive significant value from personal data. Consumers and organisations exchange data for services, much off which is voluntary and to their mutual benefit.

One of the most discussed aspects of the GDPR is the right to erasure — often referred to as the right to be forgotten. This allows data subjects to use the government to compel companies who hold their personal data to delete it.

We propose that the right to erasure creates uncertainty over the value of data held by organisations. This creates an option on that data.

The right to erasure creates uncertainty over the value of the data to the data collector. At any point in time, the data subject may withdraw consent. During a transaction, or perhaps in return for some free service, a data subject may consent to have their personal data sold to a third party such as an advertiser or market researcher. Up until an (unknown) point in time — when the data subject may or may not withdraw consent to their data being used — that personal data holds positive value. This is in effect a put option on that data — the option to sell that data to a third party.

The value of such an option is derived from the value of the underlying asset — the data — which in turn depends on the continued consent by the data subject.

Rational economic actors will respond in predictable ways to manage such risk. Data-Backed Securities (DBS) might allow organisations to convert unpredictable future revenue streams into one single payment. Collateralised Data Obligations (CDO) might allow data collectors to package personal data into tranches of varying risk of consent withdrawal. A secondary data derivative market is thus created — one that we have very little idea of how it will operate, and what any secondary effects may be.

Such responses to regulatory intervention are not new. The Global Financial Crisis (GFC) was at least in part caused by complex and rarely understood financial instruments like Mortgage-Backed Securities (MBS) and Collateralised Debt Obligations (CBS). These were developed in response to poorly designed capital requirements.

Similarly, global AML/CTF requirements faced by financial institutions have caused many firms to simply stop offering their products to certain individuals and even whole regions of the world. The unbanked and underbanked are all the poorer as a result.

What these two examples have in common is that they both have good intentions. Adequate capital requirements and preventing money from being cleaned by money launderers are good things, but good intentions are not enough. Secondary consequences should always be considered and discussed.

Self-governance alternatives, including the application of blockchain technology, should be considered. These alternatives use technology to allow individuals greater control over the personal data they share with the world.

Innovators developing self-sovereign identity solutions are attempting to provide a market based way for individuals to gain greater control over — and derive value from — their personal data. These solutions allow users to share just enough data for a transaction to go ahead. A bartender doesn’t need to know your name or address when you want a drink, they just need to know you are of legal age.

Past instances of regulatory intervention should make us cautious that even well-meaning regulation will achieve its stated objectives with no negative effects. Self-sovereign identity, and the use of blockchain technology is a promising solution to the challenges of data privacy.

Tradetech and the problem of international coordination

With Darcy Allen, Sinclair Davidson, Mikayla Novak, and Jason Potts. Originally a Medium post.

International trade is an information problem.

As goods move between firms and across borders, information about the provenance, characteristics, and compliance liabilities (whether they are subject to taxes or tariffs) of those goods move alongside them.

Handling companies need to know which goods are going where.

Regulators and trade authorities need to know whether the goods crossing a national border are compliant with domestic regulations.

(Does a good need an import permit? Does it require any special documentation? In Australia the Minimum documentary and import declaration requirements policy is a 27 page document.)

And end-users increasingly demand information about where their goods came from and how they were produced.

(Consumers want to know where their food is grown, whether it was grown to organic standards, or was manufactured gluten-free or nut-free. Advanced manufacturing firms want assurances that components — such as aircraft or wind turbine parts — are of high quality. And everyone wants assurances that their goods have been looked after while in transit.)

The result is piles of documentation shipped alongside internationally traded goods.

And the demand for documentation is growing. Supply chains are getting more complex. Regulatory requirements are increasing. End-users want more information about what they’re buying.

Introducing TradeTech

FinTech is the application of new technology — particularly developments in computer science — to the financial services industry. RegTech does the same for regulatory compliance.

Now we have TradeTech — the application of information technology to reduce the information costs of international trade.

TradeTech can reduce transaction costs, increase transparency for firms, regulators, and consumers, facilitate trade finance, and significantly lower regulatory and tariff compliance burdens.

Tackling border costs

One TradeTech application, blockchains used to manage supply chains, have the potential to provide a new digital services infrastructure for international trade in goods.

Blockchains use a combination of cryptography and economic incentives to allow people to come to a consensus on a shared digital ledger without the need for a trusted third party. Blockchains are a technology for secure non-hierarchical information governance.

Blockchains can store information about the provenance and distribution of tradable goods through the entire supply chain in circumstances where firms (and regulators) through the supply chain do not necessarily trust each other.

The invention of the shipping container in the 1950s radically transformed international trade by tackling the high cost — and unreliability — of getting goods on and off ships intact.

But in the 2010s, it isn’t the cost of transport that is the biggest burden on international trade. According to IBM and Maerskthe costs of bringing goods across borders are higher than the costs of transport costs.

In 2018 and 2019 we expect blockchains used in supply chains and to facilitate global trade will be one of the breakthrough blockchain use cases.

The impact of this sort of TradeTech will provide an enormous boost to the potential for global trade.

Facilitating trade flows

The information flows that facilitiate international trade are still to a remarkable degree governed and organised on a one-to-one basis and using paper. Each firm in a global supply chain passes off information relating to a tradeable good to each other one step at a time, vouchsafing that information until it can be passed to the next firm on the chain.

Furthermore, despite two decades of the digitisation of global commerce, it is still the case that international trade is a significantly paper-based process — which is slow, error-prone and raises fraud risks.

The growth of the regulatory state over the last thirty years has significantly increased the compliance costs of trade. While regulatory harmonisation and tariff reductions have encouraged larger volumes of trade, these have been matched by greater demands for information those goods travelling across borders.

New regulatory concerns about labour, environmental, chemical, and biosecurity standards are being reflected in international trade agreements and are translating into more regulatory requirements at the border.

Longer and more complex supply chains as a result of globalisation has multiplied these compliance burdens.

Blockchains can provide a ‘rail’ on which all this information travels.

Blockchains are uniquely suited for an era of advanced globalisation, the regulatory state, and demand for information about product origins and quality.

But TradeTech needs multilateral coordination

Private industry is developing the technology for blockchain-enhanced supply chains.

But there is the need for an international coordination to ensure that industry is able to exploit the opportunities this technology presents.

For example: information rmanaged on blockchains needs to be accepted as valid and compliant by domestic regulators.

One risk is that industry-developed blockchains might not be not treated as compliant with existing regulations. Goods could then remain subject to existing paper-based processes, necessitating double-handling of compliance and reducing the benefits of blockchain-enhanced trade.

Another risk is that individual trading countries adopt their own standards, which would also necessitate double-handling.

A further risk is that standards are developed by early market leaders in the blockchain-facilitated trade space, are adopted by regulators and trade authorities on an ad-hoc basis, and through regulatory lock-in limit the contestability of this trade infrastructure.

The benefits of TradeTech will be realised in a world of open-standards, rather than closed ones.

Multilateral bodies like APEC (Asia-Pacific Economic Cooperation) should be considering these questions now.

We don’t think governments should try to regulate the development of blockchain technology, or compel its introduction. The blockchain is an experimental technology that needs space to evolve. But there is a clear role for multilateral bodies to set standards for information managed through blockchains.

TradeTech doesn’t need government regulation or direction. But it does need government cooperation.

Subjective Political Economy

With Darcy Allen. Published in New Perspectives in Political Economy (2017), Vol 13, no. 1-2, pp. 19-40.

Abstract: We extend the Institutional Possibility Frontier (IPF) – a theoretical framework depicting the institutional trade-offs between the dual costs of dictatorship and disorder – by incorporating the notion of subjective costs. The costs of institutional choice are not objectively determined or chosen by a society; rather, they are subjective to the political actor that perceives them. Our methodologically individualist approach provides a new, highly adaptable extension of the IPF enabling examination of the political bargaining process between dispersed actors, the bounds and evolution of institutional innovation and discovery, and follower-leader dynamics in long-run institutional changes. Our new Subjective Institutional Possibility Frontier (SIPF) helps to integrate ideas into the economics of political systems, creating the foundations for a more subjective political economy.

Available in PDF here.

Opening statement to Commonwealth Senate Select Committee on Red Tape inquiry into the effect of red tape on the sale, supply and taxation of alcohol

With Darcy Allen

The Institute of Public Affairs welcome the opportunity to appear before this inquiry. Red tape is one of the most pressing challenges facing Australia. A recent IPA estimate calculated that red tape costs us $176 billion in forgone economic output every single year. That $176 billion is more than we pay in income tax and it is the equivalent of Australia’s largest industry. Cutting red tape is one of the keys to ensuring our future prosperity; therefore the present inquiry into red tape is welcome. Liquor licensing in particular is a significant burden on Australian businesses. This is a red-tape problem not only for late-night venues but for thousands of cafes and restaurants across this country.

If we look to South Australia as an example, there are more liquor licences for restaurants than under any other category. Business owners spend millions of dollars in compliance costs each year and these pieces of red tape generate economic distortions that hold our country back. The central contribution of our submission is a broad, cross-jurisdictional analysis of liquor-licensing regulations. We have two main findings. First, that across various states there are multiple different types of liquor licences, sometimes over 10; and, second, many jurisdictions exhibit complex and tiered fee structures ranging into the tens of thousands of dollars. Based on these findings, we make three recommendations. First, Australian states and territories should seek to streamline the number of licence types to the minimum viable level. A wide range of different licence types acts to increase business uncertainty and thereby compliance costs. We see no logical reason that some states would require 13 different licences, for instance.

Our second recommendation stems from the fact that many jurisdictions are characterised by excessive and complex liquor licence fee structures. The fees for application and renewal of liquor licences are progressively tiered from the cheapest to the most expensive licence, based on factors such as venue capacity and patron numbers. Some states even apply complex multipliers based on these factors. We recommend the structure of the licence fee system across Australia be flattened. By ‘flattened’, we mean: to reduce the difference between the lowest and the highest licence fee. There is no clear reason why the current fee structure is tiered, apart from the chance to raise more government revenue.

Our final recommendations concern licensing more broadly. We recommend that all Australian jurisdictions shift their regulatory resources away from licensing, first towards enforcing the basic principles of the regulation of liquor on operating businesses. That is to say, we should proceed by enforcing defections from agreed, simple laws, rather than increasing the red tape and compliance burden, which collectively impacts all businesses. Indeed, this broad principle, if applied to many Australian industries, would help ameliorate Australia’s growing red tape problem. Thank you for your time. We welcome any questions you may have.

Opening statement to Victorian Standing Committee on the Economy and Infrastructure Subcommittee inquiry into ride sourcing services

With Darcy Allen and Aaron Lane

Regulatory decisions surrounding the ridesharing industry are of critical importance to the Victorian economy, because they will set a precedent for the disruption and the potential disruption of the sharing economy more broadly.

The most general principle underpinning our submission today is the idea of permissionless innovation — that is, we believe, a quality regulatory system, one that deals well with disruptive technologies and business models and one that enables innovation by default. In contrast, a permissioned system is one where unnecessary red tape is applied that stifles the potential for entrepreneurs to bring benefits to consumers. Further, we must remain wary of erecting any regulatory barriers today that will prevent the emergence of new business models tomorrow.

It should be a guiding principle that any definitions and new regulations, if they are enacted, should be broad enough so that they do not exclude new organisational and technological forms which may later emerge in the future. A second issue permeating the debates on ride sourcing are the concerns over consumer safety and protection. These legitimate concerns are best examined by asking a deeper question: why do we regulate point-to-point transport in the first place?

The main rationale for regulation of point-to-point transport is to protect and maintain the safety of the public. Government intervention to achieve this goal is largely justified on the basis of asymmetric information — problems between drivers and passengers, where riders lack information about the characteristics of the drivers. Traditional solutions to this market failure are through government regulation. However, enabled by new technologies such as the smart phone and the GPS, these are changing necessary scope of government intervention. They are developing new ways to achieve the safety and consumer protection that Victorians desire and deserve.

Self-regulation of ridesharing has proved remarkably efficient and remarkably effective. For instance, the growth of the reputational mechanisms where drivers and riders rate each other, just as an example, the use of cashless payment systems through ridesharing platforms and the removal of anonymity issues. The implication of this technological progress is that governments must reassess the extent to which imposing state-based regulation is necessary.

A further contentious issue for this committee is the matter of industry transition and the question of compensation. Licences are licences to drive and operate a taxi. They were not invented to be financial instruments. They are not government guarantees of return or guarantees of a certain level of income. The risk of regulatory changes are and should be borne by the licence-holders themselves. Disruption and change is natural. It is a natural state of a vibrant, technologically innovative market economy. Furthermore, compensation hinders the competitive and evolutionary adjustment of a market-based economy.

We at the IPA are concerned about the precedent that compensation sets for future disruption, as taxpayers and consumers might be expected to pay for barriers to economic progress that have been erected in the past. Allowing incumbent industries to seek compensation for technological change is a dangerous door that Parliament should not open.

The IPA believes that new business models which uproot traditional markets, break down industry categories and maximise the use of scarce resources should be welcomed by this committee. Overregulation, however, could suppress this potential economic revolution. Victoria must adopt a deregulatory approach to ridesharing, one that brings down existing barriers without erecting new ones. Such a permissionless innovation approach will make Victoria an attractive jurisdiction to future entrepreneurial endeavours. We thank you very much for the opportunity and welcome the committee’s questions.

The sharing economy: How over-regulation could destroy an economic revolution

With Darcy Allen

Executive Summary: The sharing economy describes a rise of new business models (‘platforms’) that uproot traditional markets, break down industry categories, and maximise the use of scarce resources. The best known services are the ridesharing system Uber and the accommodation service Airbnb. However, the sharing economy extends much further into finance, home tools, investment, and everyday tasks.

The ‘sharing economy’ emerged from dramatically falling transaction costs that had prevented certain markets from developing. The sharing economy coordinates exchanges between individuals in much the same way as a traditional market, but does so in a flexible, self-governing, and potentially revolutionary way.

These burgeoning benefits are profound: more sustainable use of idle and underutilised resources; flexible employment options for contractors; bottom-up self-regulating mechanisms; lower overheads leading to lower prices for consumers; and more closely tailored and customised products for users.

These sharing economy platforms are only in their embryonic stage of development. The benefits to the Australian economy as the market becomes more efficient are likely to expand. This expansion will only occur if Australia’s entrepreneurs are left to experiment and innovate.

The real threat to the sharing economy is government regulation driven by the incumbent industries that are challenged. The danger of excessive legislation and regulation will absorb the gains yielded by technology improvements, preventing mutually beneficial trade and stifling economic growth.

This paper recommends new approaches to regulatory design that would encourage the growth of the sharing economy:

  • regulators should encourage bottom-up, organic, self-regulating institutions prior to introducing top-down government control;
  • occupational licensing needs to be reduced to allow private certification schemes and reputation mechanisms to evolve;
  • industry specific regulatory frameworks need to be avoided;
  • regulations making it harder for start-ups to compete for labour need to be reduced; and
  • the status of individual contractors needs to remain separate from highly restrictive employment law

Available in PDF here.