Governments cannot ignore the indirect effects of regulations to reap their full benefits.
Regulatory simplification has become a major policy priority for governments around the world. Throughout the Organization for Economic Co-operation and Development, governments have refocused “better regulation” initiatives on streamlining administrative processes, reducing burdens, and improving the clarity of legal frameworks. Initiatives include fast-tracked procedures and, in some instances, explicit de-regulation. There is a common rationale, reiterated in a recent communication by the European Commission: “Simplicity-by-design” will create a more positive business environment, stimulating competitiveness.
Periodic and multi-stakeholder rationalization of the regulatory stock to keep it fit-for-purpose is a necessary feature of all well-designed better regulation strategies. But the current simplification wave is unlikely to be sufficient, on its own, to restore competitiveness. Like a treasure hunter scanning only the surface, current approaches risk overlooking the deeper, more consequential dynamics that determine whether regulation truly delivers value to society and the economy. Policymakers must dig further.
Regulation remains a cornerstone of modern governance. When well designed, it enables governments to achieve social and economic objectives effectively, proportionately, and with legitimacy. It is an integral part of the framework conditions under which markets operate, influencing investment decisions, innovation trajectories, and the allocation of capital. In this sense, regulation is not a constraint but a structural determinant of prosperity and societal well-being.
Over the past decades, better regulation agendas have made important progress. Governments have strengthened processes governing the production of regulation through ex ante impact assessments and legislative planning. They have also sought to improve the “stock” of regulation via offsetting mechanisms and ex-post evaluations. By and large, however, efforts to identify and quantify regulatory impacts have remained relatively modest, focusing primarily on direct compliance costs and administrative burdens calculated through the standard cost model assessment method. which examines statistically representative business units and assigns standardized values to the unitary costs of complying with regulatory requirements. Besides the relative simplicity of the calculations, reducing administrative burdens allows for a tangible, measurable and easy-to-communicate narrative. It gets political traction.
However, this comes with important drawbacks. This approach neglects to assess the benefits of regulations. Moreover, whereas assessing the costs of compliance is useful because they can pose particular problems for small and medium enterprises, many of which lack the human and financial capital to absorb these requirements without affecting their competitiveness, simple cost-focused methodologies do not capture the full range of regulatory impacts. As a result, governments fail to secure the real treasure from review and simplification programs.
To understand whether regulation works, policymakers must go beyond static cost assessments and embrace a dynamic perspective. They must examine how regulated entities respond to interventions—what we term the “impact-response paradigm”—and how these responses reshape incentives and decisions by businesses in the private sector to allocate capital and to invest in innovation, operating efficiency, and structural change over time. This also entails identifying unintended consequences that may undermine the original policy objectives.
Evaluations should consider, for example, how regulatory interventions affect investment cycles and the utilization of scarce resources. Poor-quality regulations banning goods, for example, may lead to longer time-to-market for goods and increased capitalized development costs, discouraging investment in research and development (R&D)These regulations may also divert resources away from productive innovation—so-called defensive R&D—to sustain efficacy and functionality. This not only affects firm-level performance but can also weaken the overall innovation ecosystem. Regulations may also induce behavioral changes among consumers, creating ancillary unintended risks, a phenomenon known as risk-risk trade-offs.
Take, for instance, fragrance encapsulation, the technology used to preserve aromatic molecules. Research indicates that a potential restriction on the continued use of this technology in laundry products is likely to lead to 2 to 3 percent more rewashing because of the loss of perceived long-lasting freshness. In the European Union, this would equate to around 1 billion additional washes per year, causing a significant increase in water and electricity consumption and contributing to higher carbon emissions and greater release of micro-fibers.
In the case of biopharmaceuticals, Europe’s historic lead in that industry eroded in the 1990s due to poorly designed regulations. From investing 50 percent more than the United States early in that decade, Europe’s share of global pharma innovation fell to 18 percent by 2004 while the United States’ rose to 62 percent. The United States recorded a nearly double R&D growth rate between 1990 and 2017 compared to Europe’s. By then, nearly half of all new therapies originated in the US versus only one-quarter in Europe. Although national price controls in Europe played a part, the major factor driving innovation away from the EU was precautionary regulatory choices, based upon technology stigmatization rather than likelihood of harm, that extended the time needed to bring products to market, increased capitalized development costs, weakened intellectual property rights, and hampered companies’ scaling. For patients, this has meant delayed access to breakthrough drugs, fewer clinical trials, and fewer treatment options, including for cancer, rare diseases, and complex chronic conditions. The European Commission’s recently proposed European Biotech Act is, in part, an attempt to overcome these structural regulatory failures in the health biotech sector.
The agricultural machinery sector provides a further illustrative case. EU emission standards have been imposed on the sector that were equivalent to those required for passenger vehicles, despite evident differences in the risk posed by the two types of vehicles. This forced manufacturers to divert 70 to 80 percent of R&D to develop compliant engine technologies. Overall expenditure on defensive R&D to achieve those targets exceeded €10 billion. This not only increased the cost of new vehicles by 25 percent but also diverted capital from productive investment in new agronomic technologies. The industry got restructured, with many European small manufacturers forced to close down. Additional risks were also created as older, more polluting vehicles were retained for longer, leading to higher rather than lower emissions.
In the financial services sector, the anti-money laundering global regulatory model imposes primary responsibility for monitoring and detecting crime on financial institutions. Compliance with obligations is enforced by bank supervisors, levying fines on individual banks of more than $1 billion for process failings. Poorly designed, extensive obligations trigger major compliance costs: over $180 billion per year globally. Therefore, financial institutions focus on reducing compliance costs and managing the reputational risks and costs of process failings rather than combatting crime. Unintended consequences include de-banking, reduced competitiveness, misallocation of capital, and risk-risk outcomes, including the emergence of new forms of crime, notably extortion.
Poorly designed regulatory frameworks can also create systemic uncertainty, creating strategic risk and diverting capital into other jurisdictions and investments, notably for start-ups and scale-ups. This reallocation has long-term implications for economic growth and prosperity.
Identifying and understanding such dynamic life-cycle impacts is critically important for evaluating regulatory effectiveness. These steps underscore the need to view regulation not only as a set of rules but as a signal, shaping expectations and decisions across the economy that are rarely captured in traditional ex ante or ex post review programmes.
Simplification programmes should aim to make the investigation of dynamic life cycle impacts the most important factor in the economic analysis of regulations. Businesses can and should contribute to this by making available their expertise with different regulatory frameworks internationally, and first-hand data and studies on the full range of impacts.
Ultimately, the promise of better regulation lies not in doing less but in understanding more. The simplification wave we are experiencing is a necessary starting point, but it is only the beginning. Policymakers, by favoring dynamic impact analyses, would unlock the full potential of regulatory policy. They could better assess whether particular regulatory interventions are effective, proportionate, and relevant. The approach would also provide a stronger evidence base for redesigning policies when outcomes fall short of expectations. The better regulation debate would then move from one about the sheer quantity of regulation and surface-level, quick simplifications to a deeper understanding of how regulation shapes real-world outcomes. To truly deliver on the objectives of efficiency, competitiveness, and societal well-being, policymakers must dig deeper to uncover the simplification treasure.
