Can better regulation boost growth?

It has been called the “war of words”. The disagreements over the Volcker rule between bankers and regulators have been well documented. It is one of the most recent and visible clashes between business and regulators. It is by no means the first or the last time the two groups will struggle to find common ground.

While it can sometimes seem that business and regulators are at odds, they can agree on one thing: the need for smooth functioning markets that allow business to invest in people and innovation thereby creating economic growth. Smarter regulation can help to achieve this.

Unfortunately, today’s regulatory environment is characterized by a patchwork of complex, overlapping and often inconsistent rules. The US alone finalizes between 2,500 and 4,500 rules each year, according to the Congressional Research Service. The complexity is magnified for any business that operates across borders.

Governments need to work with the private sector to find the right balance between managing risk and allowing innovation to drive growth and employment.

Reducing regulatory burdens can have a real impact. The recent Bali agreement, which cuts red tape in relation to customs procedures and was brokered by the World Trade Organization, will, by some estimates, raise global output by more than US$ 400 billion a year.

However, the answer is not only to reduce the burden but also to ensure that regulations are well designed. During my career I’ve worked in both the private and public sectors. The experience of sitting on both sides of the table has given me an appreciation of the benefits of good regulation as well as a keen understanding of what an ideal regulatory framework should look like.

Well-designed regulation plays an important role in helping the markets function. Take for example US Corporate Average Fuel Economy (CAFE) standards. It helps to provide regulatory certainty to the US car industry and allows companies to invest in technologies that save an estimated 3 million gallons of oil a day.

The government negotiated with 13 carmakers that initially opposed the standards to win their support. This is a critical point: the regulatory process should invite, encourage and consider the input of all interested parties. And the dialogue should continue once regulations are in place. There should be a process of ensuring that the effectiveness is continually evaluated.

Open communication between the business community and policy-makers is key. Businesses need to be open and responsive with policy-makers, and not just react. They need to not only answer the questions that have been asked but also to raise – and answer – new questions.

When thinking about regulations we should remember the challenges connected to their implementation and continued effectiveness. The implementation of Basel III has shown us that overlooked details can lead to unintended consequences. There is often the risk that regulations impose significant costs or alter behaviour in unintended ways. This is particularly true if regulators lack strong technical knowledge. In the absence of knowledge, regulations may focus on the wrong areas or fail to evolve to take account of industry or market changes. This underscores the importance of reasonable flexibility.

Flexibility is necessary in both implementation and enforcement. Enforcement must be effective and focused on the right priorities. After all, regulation is only as good as the enforcement behind it.

In today’s globally connected world enforcement is even trickier given the complexities that arise when businesses operate across borders. To be effective, governments must work together in all stages of the regulatory process from development to enforcement. The financial sector in particular needs both a globally consistent framework and a desire among countries to work together to create one. Institutions such as the Financial Stability Board, the Basel Committee and the International Organization of Security Commissions have an important role to play.

I’m looking forward to taking part in a panel discussion, “Getting Back to Natural Growth”, on Wednesday morning of this year’s Annual Meeting where we’ll be talking about regulation among other topics. It’s a good follow-up to a really interesting discussion we had regarding regulatory frameworks at last September’s World Economic Forum Annual Meeting of the New Champions.

Mark Weinberger is Global Chairman & CEO, EY and is participating at the World Economic Forum’s Annual Meeting 2014 in Davos.

Image: A delegate waits for the opening of a session of the Trade Negotiation Committee at the World Trade Organization (WTO) in Geneva. REUTERS/Denis Balibouse