Regulation: finding the right balance

The typical governmental response to any public crisis was best summed up by Sir Humphrey Appleby when he said: "Something must be done; this is something; therefore this must be done."

Government legislates because it can, because the public demands it and because it satisfies the need for action. The question as to whether the legislation concerned will actually benefit consumers or the public is not always uppermost.

The formal programme by which government seeks to control these tendencies in itself is known as the 'better regulation' initiative - now an executive and part of the Department for Business, Enterprise & Regulatory Reform. Its aims are to hold new regulation to a few basic standards: regulation should only intervene when necessary; it should be appropriate to the risk posed; it should not impose disproportionate costs; it should be focused on the problem; and it should be structured so as to minimise side effects.

There is no doubt that these principles set out a gold standard for legislators. However, they are relatively easy to apply when developing technical regulation out of the public gaze, but considerably harder to stick to in the glare of publicity. In such cases the desire to act decisively overturns the idea of evaluating likely impact or outcomes. The result is the class of legislation collectively referred to as 'dangerous dogs acts', named after an act that became a byword for ineffective, media-driven activism.

The primary argument against dangerous dogs acts is, of course, not their stated aims, but their collateral costs. The problem with regulation is that its costs are spread thinly over a wide area and are therefore not easily perceived, such that even a small benefit to a few individuals may appear to justify relatively significant regulatory intervention.

Basic economics confirms that regulation harms consumers in aggregate. The benefits of regulation, however, tend to be focused more narrowly. For example, the gothic nature of UK consumer credit regulation imposes a high compliance cost on consumer credit businesses, but the benefits of the legislation are generally experienced only by those who are either in, or near, default.

Another example is food hygiene legislation. Consumers would be financially better off if food-handling standards were lower (and less expensive to operate), but a few would be worse off by reason of being ill or dead. One way of looking at regulation, therefore, is as a sort of government-mandated insurance policy, where everyone pays in but only a few benefit. Once this is understood the issue can be evaluated on ordinary cost-benefit grounds.

It is important to be clear that the evaluation of 'benefit' in this context is far more than just an economic evaluation. The benefits that regulation provides are more likely to be social than economic. Indeed, if a particular arrangement produced a net economic benefit, it is highly likely that it would be provided by the market and would not need to be mandated by government action.

The determination of whether a particular social benefit is desirable, and if so how desirable it is, is a matter for government. Indeed, the making of such determinations is arguably the very thing that a democratic government exists for. However, the function of government is not to decide in the abstract that a particular thing is desirable, but to decide whether its social value is worth the price to be paid to obtain it.

It is this last proposition - the fact that regulation always has a cost and that the cost is never negligible - that is sometimes in danger of being lost sight of in the rush to legislate.

It is to be hoped that the better regulation principles remain sufficiently near the forefront of the minds of the latter-day Sir Humphreys to avoid a 'Dangerous Bonds Act'.

Simon Gleeson, partner, Clifford Chance