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Assessing Regulatory Alternatives

Introduction

How you categorize regulation depends on whether you take an economic, legal, or political science approach. This guide uses the following structure to review forms of regulation:

1. Direct Product Controls
2. Supplier Entry and Exit Controls
3. Production Process Controls
4. Information Controls
5. Marketable Rights

These categories provide a practical framework for identifying and assessing alternative methods of accomplishing a regulatory policy objective. They link directly with the analytical framework outlined in Part I of this guide.

The categories also reflect prevailing views about the comparative advantages and disadvantages of each form of regulation. However, the effects of any particular regulatory approach will be determined by a variety of factors and will vary from case to case. There is no such thing as inherently good or bad regulation.

There is no single, universally accepted definition of regulation. Regulatory requirements, like other types of law, establish rights and duties for individuals. What distinguishes regulation?

The definition most commonly used in Canada was developed for the Economic Council of Canada's Regulation Reference (1979):

Regulation, in the generic sense, is defined as the imposition of rules backed by the threat of government sanctions, with the intention of modifying or controlling private behaviour. These rules can be established in statutes, subordinate legislation (regulations), administrative procedures, orders, directives, manuals, and, implicitly, in administrative and quasi-judicial decisions.

The House of Commons Sub-Committee on Regulations and Competitiveness has proposed the following definition:

In the simplest terms, regulation can be defined as a set of rules,made and enforced by the state, restricting or specifying the natureof social and economic activity.

Command-and-Control Regulation

1. Direct Product Controls

Controls over the price of goods and services are commonly used in markets where there is a “natural monopoly” (e.g., public utilities). Firms in these markets have significant market power and can shift wealth away from consumers. Price controls can be used to control how much profit these firms make. They are typically used in conjunction with entry controls such as licensing.

There are a variety of approaches to price regulation. Rate-of-return regulation, which sets prices so that the firm will earn no more than a competitive return on equity, is the most common form used for public utilities. Alternatives to the more traditional forms are price caps and social contracts.

Examples

The following are examples of products that have been subject to regulatory price controls:

• telephone services
• transportation services
• electric power
• natural gas
• water and
• cable TV service

Advantages

Price controls may offer the following advantage:

• they protect against abusive use of market power by monopolistic firms, indirectly controlling profitability.

Disadvantages

Price controls can generate the following problems; they:

• can impede market competition and detract from economic efficiency in competitive markets;
• can hinder innovation and development of lower-cost substitutes for regulated products;
• may result in significant shifts of income from consumers to producers (regulated firms enjoy a comparative advantage in dealing with regulatory systems); and
• can result in high administrative costs for both regulatees and the Government.

Factors Favouring Use

The following condition favours using price controls:

• the relevant market is characterized by natural monopoly.

Contraindicators

The following condition works against using price controls:

• the relevant market is characterized by workable competition.

Program Delivery Implications

If you are considering price controls as a form of regulation, you will want to consider the following points:

• it will likely mean that an independent tribunal with significant infrastructure requirements (including analytical and legal capability) will have to be established; and

• it will require detailed procedures for receiving, processing, and adjudicating applications for price adjustments.

Direct product controls may also set limits on the quantity of a product that can be produced. These limits are usually implemented through quota systems. They provide an indirect method of maintaining price levels and of ensuring the profitability of firms in markets where entry is controlled through regulation.

Examples

The following are examples of where direct regulatory controls have been used to limit quantiy.

Advantages

Product quantity controls may offer the following advantages:

• in markets characterized by a natural monopoly, they can help ensure a supply of product to all customers; and

• they protect against abusive use of market power by monopolistic firms, indirectly controlling pricing and profitability.

Disadvantages

Product quantity controls can create the following problems; they:

• can impede market competition and detract from economic efficiency in competitive markets;
• can hinder innovation and development of lower-cost substitutes for regulated products;
• may result in significant shifts of income from consumers to producers (regulated firms enjoy a comparative advantage in dealing with regulatory systems); and
• can result in high administrative costs for both regulatees and the government.

Factors Favouring Use

The following condition favours using product quantity controls:

• the relevant market is characterized by a natural monopoly.

Contraindicators

The following condition works against using product quantity controls:

• the relevant market is characterized by workable competition.

Program Delivery Implications

If you are considering using product quantity controls as a method of influencing behaviour, you will want to keep the following points in mind:

• it will likely mean that an independent tribunal with significant infrastructure requirements (including analytical and legal capability) will have to be established; and

• it will require detailed procedures for receiving, processing, and adjudicating applications for changes in production limits.

This type of control is a common form of command-and-control regulation. Product attributes (e.g., size, appearance, content, quality, durability, safety, purity) are controlled through standards. These standards may be very general (often stated as general prohibitions in regulatory statutes or performance standards in regulations), or they may be highly detailed ( technical standards).

From an economic point of view, standards can do both good and bad things.Standards control the product, but they also provide information about the quality of a product or its compatibility with that of complementary goods or processes.They can increase productivity and competitiveness by reducing costs or increasing the rationalization, interchangeability and compatibility of products. Competitive markets work best when both suppliers and consumers have sufficient information to make informed choices. When suppliers or consumers do not have the information they need, the market may fail. Because standards provide information, they can play an important role in correcting such market failures. These redeeming features of standards will become even more important in a global marketplace where production becomes more interconnected.

It is important to distinguish between technical standards and performance standards.

Technical, or design, standards specify exactly how to comply with specifications for product attributes. This type of command-and-control standard is generally considered to be undesirable from an economic point of view. It locks intechnology, reduces consumer choice, and can create a barrier to innovation and to entry by new suppliers. On the other hand, such standards do provide highly specific information about what a supplier must do to comply with them. Knowing exactly what the law requires is important to businesses.

Examples

Technical standards that specify exact means of compliance for product attributes have been used in the following areas:

• consumer packaging and labeling
• drug safety
• medical devices
• quality of seeds and
• consumer product safety.

Advantages

Technical standards for product attributes may offer the following advantages:

• they lower the cost to purchasers of obtaining and evaluating information about competing products;

• they provide exact information about the behaviours necessary for compliance;

• they diminish uncertainty about what constitutes compliance for regulatees, other players involved and regulatory authorities;

• they may lessen the cost of monitoring compliance (inspection can focus on verifying whether specific equipment or a particular design is present);

• producing products that are interchangeable and compatible can increase the number of sources of supply, promote competition, reduce risk, cut down the size and cost of inventories, raise worker productivity, and enhance the economies of large-scale operations;

• rationalizing products may lead to greater efficiency thorough economies of scale in production, inventories and consumption;

• they may cut costs and increase economic efficiency by improving the rationalization, interchangeability and compatibility of products, and may correct market failure due to production or consumption externalities, and the lack of mechanisms for shifting and reducing risk; and

• they may make it harder for firms to differentiate their products, and may increase competition based on price.

Disadvantages

Technical standards for product attributes may have the following problems:

• they can impede innovation by locking in technology;

• they reduce consumer choice by diminishing product differentiation;

• they can hinder innovation and entry of new suppliers into the marketplace;

• they may create barriers to trade;

• they may be unfair -- standards may lower costs more for small firms than for larger firms;

• inspectors may require more training and expertise to assess compliance with highly detailed technical requirements.

Factors Favouring Use

The following conditions favour using technical standards as a method of controlling product attributes:

• products or services are complex, relatively costly and infrequently purchased by consumers; prospective purchasers are not able to easily detect attributes (information asymmetry);

• regulatees want or need more detailed information and certainty about what behaviours conform;

• market or products are not subject to rapid technological change; and

• independent third-party monitoring and certification programs are available to support the specifications (e.g., CSA, CGSB, UL or ISO 9000).

Contraindicators

The following conditions work against using technical standards as a method of controlling product attributes:

• market or products are subject to rapid technological change;

• imported products account for a substantial portion of the market (it is unlikely that foreign producers will adhere to Canadian specifications);

• economies of scale in production are coupled with significant export potential and there are no international standards or comparable standards in trading partner jurisdictions, putting Canadian producers at a competitive disadvantage;

• prospective purchasers can easily detect and evaluate product attributes (less information asymmetry means less justification for product standards); and

• consumers purchase affected products frequently and repeatedly and can therefore vote with their dollars.

Program Delivery Implications

If you are considering using technical standards as a method of controlling product attributes, you will want to keep the following points in mind:

• it may require significant resources and program infrastructure to support promotion, monitoring, and enforcement functions;

• inspectors may require more training and expertise to assess compliance with highly detailed technical requirements;

• it may require special powers and procedures for Customs to interdict non-conforming imported products.

Performance standards set out the results or objectives to be achieved. They do not specify exactly what a supplier must do to comply with the standards, e.g., what technology must be used. The supplier must still meet a target, but can choose what method to use.

The standard, for example, may set a test of strength or some other objective performance feature for the product. The government may also set a design standard that requires a specific technology to be used but, at the same time, allows an equivalent means to be used. This permits the regulated firm to propose an alternative technology. The standard may also propose choices of technologies or approaches to compliance that are deemed to be equivalent. In each of these cases, the regulated firm has a choice about how it will comply, and may use or invent the least costly means of complying.

Examples

The following are examples of performance standards that specify product attributes:

• energy efficiency standards
• building fire-safety standards
• fuel economy standards
• food safety standards
• consumer product safety standards
• automobile safety standards
• packaging standards and
• package design standards for transporting radioactive material.

Advantages

Performance standards may offer the following advantages as a method of controlling product attributes:

• they may lower the risk of product failure;

• users may perceive a lower risk of product failure;

• they may foster the entry of new products into the marketplace, expand demand, and facilitate international trade;

• they may substantially reduce the amount of information and evaluation required in making a purchase decision, compensating for inequality in the information available to buyers and sellers;

• they are less intrusive and more flexible (regulatees are free to choose -- or invent -- the least costly method of achieving regulatory requirements;

• they minimize obstacles to competition;

• they can produce more flexible, results-oriented policy than design standards;

• the flexibility and choice offered by performance standards can produce significant cost savings for business; and

• they provide continuing incentives for innovation (regulatees benefit from finding less expensive methods of achieving compliance).

Disadvantages

Performance standards may have the following problem as a method of controlling product attributes:

• they may impede innovation and entry of new products into the marketplace;

• they may hinder the dvelopment and application of new technologies;

• they may create barriers to trade;

• they may be unfair -- standards may lower costs more for small firms than for larger firms;

• they may not communicate as much information about what must be done to comply and may raise the cost of compliance;

• they may create uncertainty, which may be a concern for both regulatees and beneficiaries;

• monitoring compliance may be more difficult and more costly.

Factors Favouring Use

The following conditions favour using performance standards:

• products or services are complex, relatively costly and infrequently purchased by consumers; prospective purchasers are not easily able to detect attributes (information asymmetry);

• independent third-party monitoring and certification programs are available to support the specifications (e.g., CSA, CGSB, UL or ISO 9000);

• at least one method of meeting the performance objectives is known and is feasible;

• the industry or products are characterized by rapid technological change.

• quality standards are particularly useful in markets with:
• greater sensitivity to variations in quality;
• little elasticity of demand;
• low marginal cost of providing quality; and
• not much value placed on poor quality service.

Contraindicators

The following conditions work against using performance standards:

• imported products account for a substantial portion of the market (it is unlikely that foreign producers will adhere to Canadian specifications);

• economies of scale in production are coupled with significant export potential and there are no international standards or comparable standards in trading partner jurisdictions, putting Canadian producers at a competitive disadvantage;

• prospective purchasers can easily detect and evaluate product attributes (less information asymmetry means less justification for product standards);

• consumers purchase affected products frequently and repeatedly and can therefore vote with their dollars;

• abstract conceptualization or speculation about new technology is required to identify and describe performance objectives; and

• the regulatory goal has a highly subjective element (e.g., being “aesthetically pleasing” or not producing a “bad smell”.

Program Delivery Implications

If you are considering using performance standards as a method of influencing behaviour, you will want to keep the following points in mind:

• when it is difficult to measure performance objectively, it will be harder to write the standards;

• inspection and enforcement in particular may be harder to administer;

• it may appear to give competitive advantages to larger or more sophisticated firms; and

• it may require special powers and procedures for Customs to interdict non-conforming imported products.

If you determine who is allowed to supply a product, you are in a good position to control other matters such as price and product attributes, as well as production activities. Typically, licensing is used to control entry to, and exit from, a market. It has been used to restrict the number of people using a common property resource (fisheries, broadcasting); to limit entry to natural monopolies (local telecommunications); and to facilitate control and monitoring of supplier activities in competitive markets (air transport, truck transport).

Permits are a variant of supplier control. While they are seldom used to restrict entry, they provide a handy mechanism for exerting detailed control over production-related activities (e.g., use of pesticides).

Self-regulation is type of supplier control. Self-regulation regimes usually have several options: entry control through licensing, standards for services, controls on production activities and, when they can get away with it, price controls.

Entry controls are essential to protecting common property resources and true natural monopolies. In other situations, it is better to look for other alternatives. If entry controls really are necessary, there are “benign” variants that interfere less with the competitive processes -- auctioning the licences, using marketable rights, or certifying instead of licensing.

Examples

The following are examples of areas in which entry and exit controls have been applied:

• commercial and recreational fisheries
• local telecommunications
• long distance communications
• cellular telephone service
• broadcasting facilities
• cable TV service
• transportation services
• professional services and
• agricultural production

Advantages

Entry and exit controls may offer the following advantages:

• they make it easier to monitor compliance and to impose detailed behavioural controls (including information requirements); and

• they facilitate control over consumption or use of common property resources (e.g., fisheries, air, water).

Disadvantages

Entry and exit controls may have the following problems:

• they can seriously distort competitive markets, protecting entrenched interests, impeding innovation, and blunting the pressure for cost reduction and productivity enhancement;

• they may result in significant shifts of income from consumers to producers;

• they can result in high administrative costs for both regulatees and government.

Factors Favouring Use

The following conditions favour using entry and exit controls:

• a common property resource; and

• a market characterized by natural monopoly.

Contraindicators

The following condition work against using entry and exit controls:

• workable competition in the relevant market.

Program Delivery Implications

If you are considering using entry and exit controls as a method of influencing behaviour, you will want to keep the following points in mind:

• it will likely mean an independent tribunal with significant infrastructure requirements (including analytical and legal capability) will have to be established; and

• it may require extensive decentralized monitoring to identify unauthorized suppliers (e.g., unlicensed truckers).

In the third category of command-and-control regulation, the focus is on controlling the inputs used in the production process or the attributes of the processes themselves.

In the latter case, for example, effluent controls are designed to stop companies from consuming too much clean water. Workplace safety controls are designed to make employers and employees take action to reduce the risk of injuries.

In some cases, the objective in controlling aspects of production is to control the product itself (e.g., sanitation standards). In other cases, the objective is to control both the production process and the product (e.g., controls on the use of pesticides).

Like product controls, production controls use both technical and performance standards. In these cases, however, the requirements provide only marginal informational benefits. For more information on how to decide when control of production process attributes may be appropriate, see the discussion under Direct Product Controls: Product Attributes.

Technical, or design, standards can be used to spell out exactly how to comply with specifications for the production process. This type of standard is generally considered to be undesirable from an economic point of view. It locks in technology, and can create a barrier to innovation and to entry by new suppliers. On the other hand, the standards do provide highly specific information about what a supplier must do to comply with them.

Examples

Technical standards that spell out exactly how to comply with specifications for the production process have been used in the following areas:

• occupational safety and health
• Workplace Hazardous Materials Information System (WHMIS)
• marine safety
• air transport safety
• highway transport safety and
• transportation of dangerous goods

Advantages

Technical standards for the production process may offer the following advantages:

• they provide exact information about the behaviours necessary for compliance, reducing uncertainty among regulatees, other involved players and regulatory authorities;

• they may lessen the cost of monitoring compliance (inspection can focus on verifying whether specific equipment or a particular design is present);

• where process standards are intended as an indirect control over product attributes, they may lower costs and increase economic efficiency by improving the rationalization, interchangeability and compatibility of products, and may correct market failure due to production or consumption externalities, and the lack of mechanisms for shifting and reducing risk; and

• where process standards are intended as an indirect control over product attributes, they may make it harder for firms to differentiate their products and lead to increased competition based on price.

Disadvantages

Technical standards for production processes may have the following problems:

• they can impede innovation by locking in technology;

• where process standards are intended as an indirect control over product attributes, they may reduce consumer choice by diminishing product differentiation;

• they can hinder innovation and entry of new suppliers into the marketplace;

• they may create barriers to trade; and

• inspectors may require more training and expertise to assess compliance with highly detailed technical requirements.

Factors Favouring Use

The following conditions favour using technical standards as a method of controlling production processes:

• when process standards are intended as an indirect control over product attributes: products or services are complex, relatively costly and infrequently purchased by consumers, and prospective purchasers are not easily able to detect attributes (information asymmetry);

• regulatees need or want more detailed information and certainty about what behaviours conform;

• production processes are not subject to rapid technological change; and

• independent third-party monitoring and certification programs are available to support the specifications (e.g., CSA, CGSB, UL or ISO 9000).

Contraindicators

The following conditions work against using technical standards as a method of controlling production processes:

• production processes are subject to rapid technological change;

• where process standards are intended as an indirect control over product attributes: imported products account for a substantial portion of the market; and

• economies of scale in production are coupled with significant export potential and there are no international standards or comparable standards in trading partner jurisdictions, putting Canadian producers at a competitive disadvantage.

Program Delivery Implications

If you are considering using technical standards as a method of controlling production processes, you will want to keep the following points in mind:

• it may require significant resources and program infrastructure to support promotion, monitoring, and enforcement functions; and

• inspectors may require more training and expertise to assess compliance with highly detailed technical requirements.

Performance standards for production processes set out the general attributes of the process. They do not specify exactly what a supplier must do to comply with the standards, e.g., what technology must be used. This permits the regulated firm to propose an alternative method of compliance. The standard may also propose choices of technologies or approaches to compliance that are deemed to be equivalent. In each of these cases, the regulated firm has a choice about how it will comply, and may use or invent the least costly means of complying.

For example, a performance standard for a production process may state that the maximum allowable limit of asbestos fibres that can be ingested by workers is x per hour. The standard does not specify whether this is to be achieved by removing the source, installing air filters in circulation systems, increasing fresh air circulation, limiting the workers' exposure, or having employees wear protective devices or breathing equipment.

Examples

The following are examples of production process standards using performance standards:

• occupational safety and health standards (e.g., walkways and hazards that may cause falls); and

• air and water pollution controls (e.g., plant-wide bubble policy).

Advantages

Performance standards may offer the following advantages as a method of controlling production processes:

• they are less intrusive and more flexible (regulatees are free to choose -- or invent -- the least costly methods of achieving regulatory requirements);

• they can produce more flexible, results-oriented policy than design standards;

• the flexibility and choice offered by performance standards can produce significant cost savings for business by making it possible to use a more cost-effective method to achieve compliance; and

• it provides continuing incentives for innovation (regulatees can benefit from finding less expensive methods of achieving compliance).

Disadvantages

Performance standards for production processes may have the following problems:

• they may not communicate as much information about what must be done to comply, and may therefore raise the cost of compliance;

• it may create uncertainty for both regulatees and beneficiaries;

• it may be more difficult and more costly to monitor compliance with performance standards since inspection can no longer focus on simply verifying whether specific equipment or a particular design is present (and inspectors may require more training and expertise).

Factors Favouring Use

The following conditions favour using production process performance standards:

• where process standards are intended as an indirect control over product attributes: products or services are complex, relatively costly and infrequently purchased by consumers, and prospective purchasers are not easily able to detect attributes (information asymmetry);

• independent third-party monitoring and certification programs are available to support the specifications (e.g., CSA, CGSB, UL or ISO 9000);

• at least one method of meeting the performance objectives is known and is feasible; and

• the production process is characterized by rapid technological change.

Contraindicators

The following conditions work against using production process performance standards:

• imports accounts for a substantial portion of the market; this may place Canadian producers at a competitive disadvantage;

• economies of scale in production are coupled with significant export potential and there are no international standards or comparable standards in trading partner jurisdictions; this may place Canadian producers at a competitive disadvantage;

• abstract conceptualization or speculation about new technology is required to identify and describe performance objectives.

Program Delivery Implications

If you are considering using performance standards as a method of controlling production processes, you will want to keep the following points in mind:

• when it is difficult to measure performance objectively, it will be harder to write the standard;

• inspection and enforcement, in particular, may be harder to administer; and

• it may appear to give competitive advantages to larger or more sophisticated firms.

4. Information Controls

This form of regulation requires that information about the attributes of a product, process, or situation (e.g., dangerous working conditions) be disclosed. The information usually appears in a standardized format, a result of labeling requirements, advertising controls, or disclosure statements. A disclosure scheme can either substitute for, or supplement, other forms of regulation. Because it does not regulate by setting a standard for the product, production processes, inputs, prices, or allocation of goods, it is a more desirable alternative to command-and-control regulation. While the requirements will state what matters are to be covered in the disclosure, the content of the disclosure depends on the actual circumstances where the good or service is produced.

Examples

The following are examples of pure information disclosure as a form of regulation:

• automobile gas consumption ratings
• tobacco tar and nicotine ratings
• requirements for securities prospectuses
• warnings on cigarette packages
• Workplace Hazardous Materials Information System (WHMIS)
• grading and labeling of tires
• energy efficiency labels for appliances
• food grading
• food product labeling and
• information disclosure requirements for drugs

Advantages

Using pure information disclosure requirements may offer the following advantages:

• it is less paternalistic than traditional command-and-control regulation;

• it can enhance competition and promote economic efficiency;

• it preserves incentives for innovation;

• it may promote high quality goods, services and practices;

• it is less intrusive;

• it facilitates the buyer's choice by reducing the cost of gathering and evaluating information (e.g., informed buyers can better compare products, assess substituting one for another, and select those having the desired characteristics at a given price);

• it makes certain products available that otherwise might not be safe for distribution to the public;

• compliance costs may be lower (cost of providing information is generally outweighed by such factors as the flexibility permitted in production processes and design choices); and

• it minimizes the cost to the Government of developing behavioural specifications, and promoting, monitoring, and enforcing them

Disadvantages

Pure information disclosure may have the following problems:

• the public may consider that this indirect method of attacking the problem is not responsive enough;

• it may not result in sufficient change in behaviour;

• it may take longer to achieve the desired change in behaviour; and

• it may be difficult to determine the information that will be useful to, and used by, prospective buyers.

Factors Favouring Use

The following conditions favour using pure information disclosure:

• lack of information about the risks or attributes of a product has been identified as a key factor influencing behaviour of users (e.g., consumers or workers);

• products or services are complex, relatively costly and infrequently purchased by consumers; users are not easily able to detect attributes (information asymmetry);

• products or processes are subject to rapid technological change;

• risk levels are moderate or lower;

• effects of poor choices are ambiguous or hidden; and

• no firm has a sufficient incentive to disclose information.

Contraindicators

The following conditions work against using pure information disclosure:

• risks to health or safety are high;

• relevant attributes of products or processes are easily detected and evaluated (less information asymmetry means less justification for mandatory disclosure);

• effects of poor choices are visible and unambiguous;

• changes in behaviour resulting from the provision of improved information would be too slow to meet expectations;

• imported products account for a substantial portion of the market (it is unlikely that foreign producers will adhere to Canadian disclosure specifications); and

• consumers use affected products or are exposed to the processes frequently or repeatedly, allowing them to vote with their dollars.

Program Delivery Implications

If you are considering using pure information disclosure requirements as a method of influencing behaviour, you will want to keep the following points in mind:

• the regulator should have a sophisticated understanding of the regulated businesses' processes;

• you must identify the target audience accurately;

• you must determine the amount and type of information that would be useful and would actually be used by those receiving it, and must consider problems such as incomplete or imbalanced comparative information, overly technical details, and use of jargon;

• you must consider the appropriate form of the disclosure (information must be easily available to the target audience);

• you must consider the potential unintended consequences of information disclosure (e.g., incomplete or overly technical information about the risks of a drug's side effects);

• you will have to be capable of monitoring and enforcement (including decentralized monitoring in the marketplace or workplaces);

• it may require you to communicate how significant the information is and how to use it; and

• it may require special powers and procedures for Customs to interdict non-conforming imported products.

Some forms of information control regulation are hybrids, incorporating restrictions on products and processes. For example, standards may require that products be graded, and that the grade be disclosed; they may also prohibit products from being sold if they do not fall within the specified categories. Food standards may prohibit a product from being sold under a particular name if it has not been produced according to a specified process.

These types of regulatory requirements are primarily informational in nature. They are intended to simplify and control product information and to ensure that it is provided to the purchasers. However, such controls accomplish this objective, in part, by placing restrictions on the products themselves. To this extent, restrictive information controls share some of the advantages and disadvantages of standards.

Examples

The following are examples of restrictive information controls as a form of regulation:

• grading standards
• composition standards and
• some forms of labeling

Advantages

Restrictive information controls may offer the following advantages:

• they are somewhat less paternalistic than traditional command-and-control regulation;

• they can enhance competition and promote economic efficiency;

• they are less intrusive;

• they facilitate choice for the target audience by reducing the cost of gathering and evaluating information about competing products;

• product rationalization may lead to increased efficiency through economies of scale in production, inventories, and consumption; and

• they may make it harder for firms to differentiate their products and may increase competition based on price.

Disadvantages

Restrictive information controls may have the following problems:

• they may reduce consumer choice and product differentiation;

• they may impede innovation by locking in the technology necessary to meet inherent product restrictions;

• they can hinder innovation and the entry of new suppliers into the marketplace;

• they may create barriers to trade; and

• inspectors may require more training and expertise to assess compliancem with highly detailed technical requirements relating to product characteristics.

Factors Favouring Use

The following conditions favour using restrictive information controls:

• products or services are complex, relatively costly and infrequently purchased by consumers; users are not easily able to detect attributes (information asymmetry);

• the market or products are not subject to rapid technological change; and

• independent third-party monitoring and certification programs are available to support the specifications (e.g., CSA, CGSB, UL or ISO 9000).

Contraindicators

The following conditions work against using restrictive information controls:

• the market or products are subject to rapid technological change;

• imported products account for a substantial portion of the market (it is unlikely that foreign producers will adhere to Canadian specifications);

• economies of scale in production are coupled with significant export potential and there are no international standards or comparable standards in trading partner jurisdictions, putting Canadian producers at a competitive disadvantage;

• users can easily detect and evaluate product attributes (less information asymmetry means less justification for product standards); and

• consumers purchase affected products frequently and repeatedly, allowing them to vote with their dollars.

Program Delivery Implications

If you are considering using restrictive information controls as a method of influencing behaviour, you will want to keep the following points in mind:

• it may require substantial program resources for developing and updating regulatory requirements;

• it may require special powers and procedures for Customs to interdict non-conforming imported products;

• the regulator should have a sophisticated understanding of the regulated businesses' processes;

• you must identify the target audience accurately;

• you must determine the amount and type of information that would be useful and would actually be used by those receiving it, and must consider problems such as incomplete or imbalanced comparative information, overly technical details, and use of jargon;

• you must consider the appropriate form of the disclosure (information must be easily available to the target audience);

• you must consider potential unintended consequences of information disclosure (e.g., incomplete or overly technical information about the risks of a drug's side effects);

• you will have to be capable of monitoring and enforcement (including decentralized monitoring in the marketplace or workplaces); and

• you may need to communicate how significant the information is and how to use it.

One form of “market-friendly” regulation is the marketable rights regime. Marketable rights to engage in a restricted activity or to use a scarce resource are created by the government and can be bought and sold. Once the rights are distributed, market forces control the activity or use. The size of allocation might be based on a natural scarcity or limitation (e.g., the radio spectrum) or might be imposed by government (e.g., the total population density in a downtown core).The original allocation of the rights can be handled by the government in various ways: through a lottery or auction, or on an historical or first-come, first-served basis. Once the market is created, the government may act as a broker or trading may be almost totally private. The newly created market identifies which users place the highest value on the right.

These regimes typically employ a mixture of command-and-control measures (including entry controls and production control standards) and mini-infrastructure regulations. They are by no means non-regulatory. They are designed, however, to use market forces. Harnessing them successfully achieves economic efficiencies and provides innovative, lower-cost methods of complying with regulatory requirements.

Examples

The following are examples of situations in which marketable rights could be used:

• air pollution controls
• water pollution controls
• allocation of air wave frequencies
• urban development (building permits)
• water rights
• fishing quotas
• export controls and
• import controls.

Advantages

A marketable rights regime may offer the following advantages:

• it can reduce administrative costs to government by relying on the marketplace to make decisions (e.g., regulators might need less information about abatement technology options);

• it may lower compliance costs for regulatees by removing the need for certifying production processes and technologies);

• it provides flexibility for the Government to adjust the use of a resource (e.g., by creating more rights, or by purchasing rights and then removing them from the market);

• it can remove the Government from difficult, contentious, and lengthy decisions about who can best use scarce resources;

• it is less intrusive -- it allows firms the flexibility to decide how to achieve a regulatory objective, provided they meet the goals and targets established by governments;

• promotes economic efficiency and innovation -- it creates incentives for developing innovative and cost-effective methods of meeting requirements (a firm that becomes especially efficient in its use of a scarce resource or level of restricted activity can sell surplus rights);

• greater flexibility allows regulatory objectives to be achieved at a lower aggregate compliance cost (e.g., allows regulatees with the lowest abatement costs to reduce discharges even more instead of requiring all sources to meet the same pollution standard);

• provides a continuing economic incentive for firms to engage in the desired behaviours and therefore to develop and implement new technologies and processes;

• makes it feasible to set more ambitious regulatory goals, or encourage faster achievement of objectives, than is possible through other forms of regulation;

• can be used to achieve multiple environmental objectives more easily than would be possible with other forms of regulation (the approach is based on recognition that the company involved, not the regulator, is in the best position to make a judgment as to the least-cost method of achieving compliance);

• can more easily accommodate entry of new firms into, and growth within, an industry, without generating an increase in the use of a resource (new firms can be allowed to enter an industry provided they acquire the necessary permits from existing participants). Under a command-and-control regulatory system without entry controls, consumption of the scare resource would increase. Imposing entry controls would have adverse economic efficiency consequences;

• improved cost-effectiveness can result in faster and more extensive behavioural change; and

• may generate greater support for adopting more stringent behavioural requirements if economic instruments are available (allows firms more flexibility in adapting their operations to meet requirements).

Disadvantages

Marketable rights may have the following problems:

• some players may object to the idea of the Government's granting and allowing the sale of rights to pollute;

• market failures may prevent the system from operating as planned (requires constant monitoring by regulatory authorities); and

• they may require entry controls and more extensive support of the monitoring and enforcement functions.

Factors Favouring Use

The following conditions favour using marketable rights:

• a permit system is suitable for controlling the problem (i.e., the problem is related to over-use of a resource, the need for allocation to potential users, or insufficient compensation for consumption of a resource);

• it makes no difference who the user of the controlled rights is;

• the market itself must be free of major structural defects and have enough potential traders to allow the rights to be traded efficiently.

Contraindicators

The following conditions work against using marketable rights regimes:

• the relevant market has few participants;

• the target market is characterized by significant information deficiencies, hindering exchange transactions;

• the identity of the users is important (e.g., Aboriginal fishing quotas); and

• there is a significant imbalance in the wealth of market participants, possibly resulting in unfair redistribution of rights through the market process.

Program Delivery Implications

If you are considering using a marketable rights regime as a method of influencing behaviour, you will want to keep the following points in mind:

• the regulator must be able to determine the overall number or level of rights;

• the regulator must be capable of keeping track of who holds the rights;

• it may take several years to develop healthy markets and trading systems for rights;

• the Government will have to determine the features of the permit (is it permanent or temporary, based on units or stratified by priority or class of ownership?);

• the Government will have to determine the initial allocation scheme (auction, lottery, distribution based on “grandfather” provisions or a hybrid scheme);

• the Government will have to expend resources on designing establishing, and operating such features as public education, brokers, and “gatekeeping” functions;

• the Government will have to establish or maintain a supporting regulatory system, including rule-making, monitoring, and enforcement functions;

• market defects, including uncertainty perceived by participants, concentration of permit ownership, and market thinness can complicate the establishment and operation of the system;

• institutional barriers (e.g., disputes over initial allocation, interest in maintaining the status quo, and controversy over the “correct” number of permits) may complicate establishment of the system;

• changes in the value of property rights may result in tax liabilities (you must determine tax treatment); and

• it may require entry controls and setting eligibility requirements for firms that want to enter the target markets.

Notes

¹ The Business Impact Test is a tool you should consider using to determine the impacts of a proposal on the private sector. It allows you to collect and analyze specific insights directly from stakeholders. Contact Regulatory Affairs, TBS, for more information.

Funding for the original guide was provided by the Department of Agriculture and Agri-Food, Solicitor General Canada, Transport Canada, and Treasury Board of Canada Secretariat.