Regulatory Impact Analysis Meets Economic Analysis of Law: Differences and Commonalities
Regulatory Impact Assessment is a tool for law-making, which makes use of economic criteria and techniques, such as Pareto-efficiency and cost-benefit analysis. It has been developed from the mid-seventies of the twentieth century and until now is in use worldwide, mainly pushed by OECD and the European Union. RIA reflects pragmatism.
The economic analysis of law, although having early roots in Europe at the age of enlightenment, has become a worldwide renown scientific approach and a vast field of interdisciplinary research at the intersection of economics and the law. It meets highest standards of sophisticated research and at the same time serves as methodology for policy recommendations.
For decades the two fields developed without explicit reference to each other. So the question emerges, what they have in common and what are the differences. This is shown and complementary use is advocated.
In this entry it is shown what “Regulatory Impact Assessment” has in common with the economic approach to the law or “law and economics.” Intuitively, “regulation” and “laws” have a common scope. Moreover, they can be treated with the same tool: economics. But what makes them differ? For one it is the history of origins; this is remarkable inasmuch most of the time, there are no mutual references! Secondly it is in the purpose and thirdly in the range. While laws form the molecules of the judicial framework of every society, regulation is seen to form an essential part of economic policy making. However, in the influential view of the Organization for Economic Cooperation and Development (OECD) regulatory impact assessment – RIA for short – takes a much wider stance than the law inasmuch it is a tool, which meanwhile even by scholars of the doctrine of law-making (Gesetzgebungslehre) is acknowledged as the most comprehensive among the tools for the accomplishment of their task (Schäffer 2007)! But how does this fit into the observation that with respect to economics RIA seems essentially to rest on cost-benefit-analysis and little else, while the economic analysis of law makes use of the full range of microeconomic theory. Still there is a bracket around these which is welfare economics and a more comprehensive approach named new institutional economics, to be outlined later.
In order to elaborate on the commonalities and differences of RIA and Law and Economics, in the entry I proceed as follows: section “The Notion of “Regulation” and the Focus of “Regulatory Impact Assessment”” deals with the notions of “regulation” as well as “regulatory impact assessment” (RIA for short), a brief history of RIA and distinct properties. It follows a refresher of the approach of the economic analysis of law (EAL) in section “A Bird’s Eye View of the Economic Analysis of Law,” the core- chapter on the comparison (section “The Overlap”), followed by a brief outlook (section “Outlook”).
The Notion of “Regulation” and the Focus of “Regulatory Impact Assessment”
It is important to note that the term “regulation” here is not meant in the narrow sense of imposing government constraints on private undertakings alone!
In fact, regulation is understood as a particular kind of incentive mechanism, namely, a set of incentives established either by the legislature, government, or public administration that mandates or prohibits actions of citizens and enterprises. Regulations are supported by the explicit threat of punishment for noncompliance (ideas on which scholars of EAL definitely will perfectly agree).
Finally, regulation here includes the full range of legal instruments and decisions – constitutions, parliamentary laws, subordinate legislation, decrees, orders, norms, licenses, plans, codes, and often even “grey” regulations such as guidance and instructions. Note that this view of regulation contrasts to the usual and somewhat narrower understanding of regulation as, for example, in Ogus (2004).
And when President Barack Obama made Cass Sunstein of Harvard head of the Office of Information and Regulatory Affairs (OIRA), even “nudging” became part of the regulatory arsenal. Here, nudging refers to means, by which people are gently induced to make appropriate decisions or act in a specific way. No explicit constraints are used and no particular enforcement mechanisms.
Monopolies and natural monopolies
Continuity and availability of services
Anticompetitive behavior and predatory pricing
Moral hazard in the presence of public goods
Unequal bargaining power
Scarcity and rationing
Distributional justice and social policy
Rationalization and coordination
One important observation regarding the use of regulation must be stressed here: Public policies can be classified as “resource” – intensive and as “regulation” – intensive. To illustrate: A government may intend to cut carbon-dioxide-emissions by the reduction of exhaust-fume of cars. This can readily be pursued by an order, stating that car-owners are obliged to prove installation of the most advanced catalytic converter in the car by the end of the year. This would be at the cost of the owners and just leave enforcement costs with the government. However, we could imagine that government wants to make sure that the task is accomplished with minimum delay and allocate a certain amount out of the budget for the installation of the devices. This truly would be a resource-intensive undertaking. So with respect to public policy, spending and regulation are substitutes here!
However, since spending programs by the rule of law must rest on a law, the view put forward above requires some “metatheory of regulation,” which conveys the rationale for an initial framework of some order. As will be pointed out a little later, “new institutional economics” could serve as such metatheory.
Having investigated the notion of regulation, it is now time to turn to.
Regulatory Impact Assessment
A RIA is simply a way of gathering and organizing information about the expected impacts of a law or regulation and its major feasible alternatives. (Morrall 1994, p. 3, see also this Encyclopedia, Lanneau, R., “Regulatory Impact Analysis”)
“The purpose of RIA is to improve the quality of government interventions. It operates on familiar principles and seeks first to ensure that the impacts both intended and unintended of proposed legislation and regulations are assessed in advance, and form an input into decision-making. RIA begins by answering the questions: Will the proposed intervention actually cause welfare to increase? What are the economic effects, i.e., how do the benefits stack up against the costs?” “Next, RIA highlights the strictly redistributive impact of proposed government intervention and establishes precisely who wins, who pays and how much” (Quotations from manuals on RIA by OECD 1997a).
Is the problem correctly defined?
Is government action justified?
Is regulation the best form of government action?
Is there a legal basis for regulation?
What is the appropriate level (or levels) of government for this action?
Do the benefits of regulation justify the costs?
Is the distribution of effects across society transparent?
Is the regulation clear, consistent, comprehensible, and accessible to users?
Have all interested parties had the opportunity to present their views?
How will compliance be achieved?
This list obviously requires typical considerations rooted in economic analysis, such as looking for alternatives and their consideration, as well as cost benefit analysis (see this Encyclopedia, Torriti, J., “Cost-Benefit-Analysis”). Moreover, it stresses procedural rules (cf. point 9) as well as typical issues of compliance and enforcement, respectively (cf. point 10) (which are, almost needless to say, considerations most familiar to the scholar of the economic analysis of law).
Ultimately, each of these questions requires treatment of the following steps: An analysis of the status quo as well as the need of intervention, an analysis of alternative ways to come to grips with a problem, including consultations and the collection of information. From this the most preferred action should emerge, depicted in adequate measures, which then allow drafting (Renda 2010).
The generality of the procedures conveys a hint as to why in the doctrine of law-making RIA has such a prominent stance.
From First Oil-Crisis to Smart Regulation: A Very Brief Look on the History
After the oil-price-shock of 1974, the Ford-administration initiated measures to stabilize the economy with primary concern about inflation and employment. To this end, all regulations had to be checked for their effectiveness and subsequently reconciled with the “office of management and budget.” So in the very beginning it was a device to check macropolicies. However, it were the frictions in the implementation of the policies, which were the primary focus of said checks! The respective attempts appear to have been quite promising. Consequently the first executive order regarding the systematic use of RIA was enacted by President Reagan 1981, (Order 12291). There one could read: “Regulatory action should not be undertaken unless the potential benefits to society for the regulation outweigh the potential costs to society … Regulatory objectives shall be chosen to maximize the net benefits to society.”
While RIA enjoyed changing popularity in subsequent years, it received stimulation from a study by Hopkins (1996), who shows that the aggregate compliance cost from federal regulation borne by the private sector and territorial authorities amounted to US $ 668 billion or approximately 10% of GDP in 1995. This was, when the struggle against frictions in the economy due to flaws in regulation started, aptly illustrated by the upswing of the “office of information and regulatory affairs,” founded by President Clinton through executive order 12866, which quickly reached 40 permanent staff.
Whereas several countries outside the USA fairly early adopted RIA, the boost came from an initiative of (OECD 1997b) regarding “transition economies,” culminating in the program SIGMA (Support for Improvement in Governance and Management in Central and Eastern European Countries) and PUMA (Public Management Service). Via OECD it entered the EU, where it first was adopted under the label “less and better regulation” which has muted to “smart regulation” meanwhile, being widely used, as can be seen from an ever increasing number of studies on http://ria-studies.net/en (cf Renda 2010).
Where Hope Lies There Is Also Disappointment
RIA for sure corresponds to the claim of a comprehensive approach. It meets several demands to a tool of law-making, the most prominent being lucidity and traceability, flexibility, and consistency. Moreover, it meets technical standards of lawmaking such as terminology and the allocation of competences, but also standards of implementation, such as practicality, feasibility, enforceability, but also acceptance.
The most prominent features are however those of economic efficiency as well as effectiveness, where the former is enhanced by cost-benefit analysis as the economic core of the tool. In a nutshell, the basic structure of every CBA is to secure that B(x) − C(x) ≥ 0, where B are the (aggregated social) benefits (appropriately measured) of an act such as lowering/increasing the degree of regulation to some desired level x and C are the (social) costs. In the case of a continuous variation of x the criterion requires that ∂B/∂x = ∂C/∂x, constraints and contingencies notwithstanding.
The benefits B, accruing from some project (level of regulation) x, are captured by the (consumer) surplus brought about at prevailing (imputed) price of some regulations.
The basic structure of CBA is structurally equivalent to the Kaldor–Hicks test, which means that ostensibly there is a rigorous criterion for the selection of solutions to a regulatory agenda. However, one has to be cautious here for at least two reasons.
Leaving the tool itself unquestioned, the Kaldor–Hicks test itself has a serious weakness in its distributional ambiguity: To illustrate, assume that the benefits from some environmental measures go to a densely populated area, while the (opportunity) costs are borne by taxpayers. Then the aggregated individual benefits may be equally distributed among the beneficiaries. But assume now that the beneficiary is a single entrepreneur owning the large parcel of land, which will increase in value to the level B. Such effect makes the beneficiary in a sense privileged, although the criterion for potential compensation still holds.
But there is a still harder objection: CBA carried out lege artis follows a couple of strict assumptions rooted in neoclassical microeconomics. And it is held that in many cases these could – or should – not be applied, which can easily be seen from the increasing number of deviations from neoclassical results brought about by “behavioral” and “experimental” economics, respectively (Camerer et al. 2011)
It is worth mentioning here that in the EU a “better regulation package” was released in May 2015, which partly took account of the methodological weaknesses just pointed out.
With respect to the relatedness to the “economic analysis of law,” the following features of RIA should be recalled:
RIA is definitely rooted in Paretian welfare economics (see the citation from President Reagan’s executive order, supra)
Closely related to the latter is “methodological individualism”
RIA takes a weak “consequentialist” view. This can be inferred from the OECD-checklist (supra), which implicitly at least asks for ethical or moral justifications. Moreover, the questions regarding distributive issues as well as the comprehension of affected groups underline this view inasmuch they point to certain underpinnings regarding standard perceptions of a society.
Before some commonalities and differences are pointed out, a view on the “economic analysis of law” (EAL) is due.
A Bird’s Eye View of the Economic Analysis of Law
Given the broad understanding of RIA in the view of OECD (which is shared by the EU), one may ask, if in law and economics the notion of a “law” might have a different meaning here than in the concept of RIA. Well, upon inspection of some definitions of a law, one does not get a clear idea. Here are just two tasters:
“A rule of conduct or procedure established by custom, agreement, or authority” or “A statute, ordinance, or other rule enacted by a legislature.”
Both give rise to similar implications: it is not the “nature” of the legal rule which is at stake, but the way of formation through a distinct procedure.
This is, why the law eventually is contrasted to “norms” and “standards,” as, for instance, in a well known article by Michael Adams (2002). The latter are seen as outcomes of voluntary agreements (within an industry, say) or collective action of some kind, as in the exceptional book on “social institutions” by Schotter (1981).
This notwithstanding, the legislature might have some discretion in choosing the rule, which is established, provided it is backed by the superordinate legislature.
Unfortunately, the domain of the economic analysis of law appears to be slightly broader than that (in the meantime). Recall that sometimes – and especially with respect to international law – it is referred to “soft law” (Gersen and Posner 2008).
So summarizing “law” and “regulation” do overlap to a considerable extent with respect to the domain.
What about the scope of analysis?
In contrast, look at this: “Economic analysis of law seeks to answer two basic questions about legal rules. Namely, what are the effects of legal rules on the behavior of relevant actors? And are these effects of legal rules socially desirable?” (Kaplow and Shavell 2002, p. 1661), and one must add: how can they be improved so as to meet the measures of social efficiency?
Since the law guides the legislature, the executive branch, as well as the judiciary, the domain of the approach is all-encompassing.
Paretian welfare economics
In particular a methodological individualism
Most of the time assuming rationally deciding people (“homo oeconomicus”)
And a consequentialist view.
However, the quickly emerging psychology-prone contributions appear to lead to an erosion of both, the rationality-assumption and consequentialism, since the patterns guiding judgement as well as decision are more and more coming to the fore.
Before looking at the commonalities, one remarkable detail in the history of RIA is worth stressing: Looking at the publications dealing with RIA and as mentioned in the introduction most of the time, there is no reference whatsoever to the economic approach to law (and vice- versa!). To assure oneself, one might consult the OECD’s website on this issue, but this would be in vain! One thus gets the impression that the approach neglects the many valuable insights from an economic analysis of law regarding incentives of people in any social role, consumers, entrepreneurs, politicians, bureaucrats, judges, mothers, thieves, whatever, despite the fact that regulation is considered an “incentive mechanism” (supra, at section “Regulation”).
However, while after first inspection, the main tool of RIA is identical with the main tool of EAL, evidently there are considerable differences which come to mind immediately. The most important of these differences seems to be that in the course of a RIA typically no analysis is undertaken, of how a single representative individual would react to a norm; that is to say, how this person would calculate expected benefits and expected cost, so as to make the inherent incentives and likely transaction costs (broadly defined) of some regulation more visible. Instead, an aggregate measure is sought right away.
Now it is beyond the scope of this note to treat the steps of a RIA in detail. However, some of the requirements, as laid down in several guidelines as well as the Clinton Directive (Executive order 12866), deserve mention:
One such requirement is the “statement of need,” which is supposed to justify government intervention (a list of reasons for regulation has been given above).
Moreover, the possibility of “over-regulation” due to preceding rent-seeking must be stressed here, which, in terms of economic analysis of law, can be seen as a treatment of malfunctions of a law, thus fitting into the list of purposes according to Kaplow and Shavell (supra).
But from time to time RIA appears to be even a kind of extension of the domain of the economic analysis of law (EAL). The importance and the relevance of EAL lies in the general and robust theoretical results, e.g., regarding incentives of all kinds (e.g., regarding liability rules vs. property rights or different kinds of punishment and so on). In contrast and taking a normative stance, the aforementioned directives point out that different standards of safety and quality of commodities are legitimate according to specific demands; even the legitimacy of barriers to entry for distinct professions is stressed, one example being pilots.
Consequently, what scholars of EAL would discuss under the label of “alienability” of property rights is addressed. Property rights here are understood as “sanctioned behavioural relations among men that arise from the existence of goods and pertain to their use” (Furubotn and Pejovich 1974, p. 3).
From such considerations to the emphasis to analyze alternative structures of property rights (institutions), it is just a fairly small step. To illustrate: the Clinton directive requires to take into account lawsuits and taxation as alternatives to regulatory measures.
One advantage of EAL over RIA definitely is the explicit consideration of transaction costs (on the notion: this Encyclopedia, Vereeck, L. et al., Transaction Costs). Recall that these costs are seen as the obstacles to the internalization of externalities. Therefore, they cannot be grasped as indirect cost or stemming cost within the typical classification of a cost-benefit analysis. They are, on the contrary, instrumental to such costs: To illustrate: Where clarification of property rights will not work, transaction costs suggest clear guidelines, which then allow for bargaining in the shadow of the law.
Moreover, RIA seems to abstract entirely from the role of courts, an issue, on which EAL has a lot to say. Bearing in mind that RIA is embedded in the broader concept of regulatory reform, which in turn is summarized by the guidelines stated in section “Regulatory Impact Assessment” above. Upon inspection, one learns that in some respect, these guidelines advocate a partial approach: while it is recommended to ask, whether regulation was the appropriate form of government intervention, it is not explicitly recommended to consider alternative institutional settings (as first suggested by Ronald Coase in his seminal 1960-article).
Now it is definitely true that EAL might be less conclusive on the aggregate level than RIA: This might follow from a typical way of reasoning within the law and economics framework: Frequently, the generalized consequences for resource allocation emerging from the way in which a judge handled a particular case are at stake. The famous “Learned Hand” formula may serve as an illustrative example (forming part of the set of robust results pointed out above). Here, the problem at hand – the liability of the “cheapest cost avoider” – is worked off by induction, that is to say by the generalization of considerations in the course of handling the case United States v.Carroll Towing Co (159 F.2d 169 [2d Cir. 1947], excellent description of the case in Cooter and Ulen 1988, p. 360 passim). RIA, with its flavor of pragmatism, takes a different approach. However, given the broad definition and the subtle claim of the more recent development of RIA (see section “Regulatory Impact Assessment,” supra), one wonders why there is so little mentioning of, e.g., incentives and the presence of obstacles to action (i.e., transaction costs).
Maybe that the evasion of such subtleties is the price one has to pay for the explicit intention of OECD to provide a tool for a standardized treatment of a very broad range of issues.
Such observations open out into the question, whether RIA and EAL are not so much two fields with a common overlap, but rather closely related branches of a common approach, which might be labeled “new institutional economics” (see this Encyclopedia, Randla, R., “Institutional Economics”). As an underpining of the institutionalist view of the economy, one may recall George Stigler here. In his Presidential Address at the occasion of the 1964(!) meeting of the American Economic Association he stated: The competence of economists “...consists in understanding how an economic system works under alternative institutional frameworks,” and one is tempted to say: consequently: “The basic role of the scientist in public policy, therefore, is that of establishing the costs and benefits of alternative institutional arrangements.”
Although it is not an easy task to give a definition of such a broad term as “institution,” it ought to be outlined at least. An Institution is a system of formal and/or informal rules, which by consent guides human actions in a particular way and contains remedies for enforcement. Furubotn and Richter (1997) offer a comprehensive view on this approach. So very briefly, what is (new) institutionalism about? Economics traditionally deals with decisions over scarce resources. Thus, the constraints caused by scarcity are at the core of economic research. But there is a second set of constraints, which deserves attention: these are norms of all kinds, which govern human behavior in society. Such norms can take the form of laws, but – as has already be stated – they also comprise informal rules, customs, and traditions. They can be the result of explicit collective decision making, but they may also emerge tacitly. They are subject to change or they may be violated. The by now well established New Institutional Economics concentrates on the analysis of the emergence and change of such norms, their effect on human conduct as well as conditions for and consequences of violation. The work on both RIA and EAL may be comprised as subsets of that broader approach, which serves as the “meta-theory” here for reasoning about the emergence of norms in general.
At first sight RIA has a strong flavor of pragmatism, much stronger than the more academically prone Economic Analysis of Law: the image of EAL meanwhile might be to be primarily an academic approach, a playground for quibblers, whereas RIA, despite the efforts to broaden its scope and to deepen the theoretical underpinnings, has conquered the marketplace for ideas as a tool designed to be applied for the practitioner. But EAL has not been developed just as a toy for contemplation of theoretical curiosity. The contrary is true: In the USA at least, it grew out of a down-to-earth request for reform (compulsory accident insurance for car-owners). And its advocates in Europe and other parts of the world always had the aspiration of reforming or at least complementing the orthodox approach to the law by a strictly analytical approach. In some sense, RIA does much the same as EAL does in some distinct areas of application. But the approach of RIA is pushed by the EU, OECD, and various member-states and has been strongly advocated and applied earlier in the USA, whereas EAL does not enjoy such almost continuous promotion; rather it is there to be discovered.
In this contribution the commonalities and differences in the two approaches have been investigated and the conclusion is that RIA and EAL not only do meet, meaning that they have much in common. Definitely they cannot merge. Rather they can be grasped as parts of a broader approach: that of new institutional economics. There they should meet, for the benefit of our society.
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