Regulatory Competition

REGULATORY COMPETITION

AND INTERNATIONAL HARMONISATION

Konstantine Gatsios* and Peter Holmes**

* Athens University of Economics and Business, 76 Patission St, Athens 104-34, Greece; and CEPR.

** School of European Studies, University of Sussex, Brighton, BN1 9QN, UK.

Tel : (01273) 678832, email p.holmes@sussex.ac.uk

Abstract

In recent years more attention has been paid to the extent to which various form of domestic regulatory policies could, deliberately or inadvertently, constitute barriers to trade.

Producer interests often demand trade measures to force harmonisation on trading partners. Economists on the other hand argue that differences in national rules and regulations are just one factor which determine comparative advantage and many writers have argued that "regulatory competition" is positively beneficial as a way of selecting the best norms, and cite the writings of Tiebout in support of this claim.

Regulatory competition can be defined as the process where regulators deliberately set out to provide a more favourable regulatory environment, in order either to promote the competitiveness of domestic industries or to attract more business activity from abroad. The setting of national regulations in response to the actual or expected impact on internationally mobile goods, services or factors on national economic activity may lead to a form of arbitrage by economic actors across the various market opportunities.

Critics claim that it can lead to a "race to the bottom" in national standards. Here we argue that the "Tiebout Theorem" is in fact wholly inapplicable to regulatory competition and we conclude that regulatory competition is neither as beneficial as its advocates say nor as harmful as critics maintain.

Acknowledgements

The authors are grateful for advice to the editors of the 'New Palgrave Dictionary of Law and Economics' where this essay is scheduled to appear. Peter Holmes is grateful to the ESRC's Global Institutions Programme for financial support for work on the International Regulation of Competition and Competition Policy.

Keywords : International Harmonisation; Regulation; Fiscal Federalism

JEL Classifications : F2,H1,K2,L5,

Regulatory Competition

By Konstantine Gatsios and Peter Holmes

As formal tariff and non-tariff barriers are reduced across the world, more attention has been paid to the extent to which various form of domestic regulatory policies could, deliberately or inadvertently, constitute barriers to trade. A debate has opened up in which producer interests regularly highlight differences in regulatory conditions in particular foreign markets and argue that this gives exporting firms an unfair advantage. The implication is that trade measures should be taken against countries who do not agree to amend their legislation to conform to that of the complaining country. The United States has been very active in this area, but the EU has in its own way pursued this goal by promising totally free access to goods from its neighbours in Central and Eastern Europe only when they harmonise their internal economic rules along EU lines.

Economists have been extremely sceptical of demands for a "level playing field" of this kind, arguing that differences in national rules which modify relative prices are no like any other distinctive factors determining national comparative advantage. The concept of "regulatory competition" has been developed to suggest that it is in fact desirable that countries should differentiate their rules and standards so that market forces may assist in the selection of the best rÐ"©gimes in some sense. It is widely held that the work of Tiebout (1956) provides a theoretical case for this kind of approach. The recent research project reported on in Bhagwati and Hudec (1996) makes it clear that the issue does not lend itself to simple conclusions.

In this paper we explore one aspect of the larger debate, namely the extent to which regulatory competition threatens to provoke a "race to the bottom" in regulatory standards, or whether it, on the other hand, provides a basis for resisting unnecessary demands for harmonisation. We argue it does neither.

Regulatory competition can be defined as the process where regulators deliberately set out to provide a more favourable regulatory environment, in order either to promote the competitiveness of domestic industries or to attract more business activity from abroad (see Woolcock 1994). The setting of national regulations in response to the actual or expected impact on internationally mobile goods, services or factors on national economic activity may lead to a form of arbitrage by economic actors across the various market opportunities (see Sun and Pelkmans 1995).

In other words, regulatory competition occurs when we observe different geographical areas between which goods, services and factors move easily, if not totally freely, and in which rules and regulations are selected with a mind to the relative attractiveness for investors and residents. It is just one way in which states compete in creating a comparative advantage for themselves, as they always have.

The concept is traditionally credited to Tiebout (1956) who put forward a model of local governments in which different levels of service and taxation co-existed with residents "voting with their feet" to choose the pattern they individually preferred. Tiebout aimed to show that local public goods were an exception to the observation by Samuelson (1954) and others that no mechanism existed to force consumers to express their true preferences for public goods. If consumer-voters could "vote with their feet" by moving to another locality if they did not like the mix of public services and taxes on offer in any one place, local governments would tend to allocate resources in a Pareto efficient way.

For many years, a discussion of the concept was mainly confined to urban economics (see, for instance, Mills and Hamilton 1994), but it then resurfaced in debates over harmonisation in the European Union (EU). In the late 1970s and early 1980s, the European Court of Justice