Principles work better than rules

reprinted with permission
NEIL REYNOLDS

Rembrant_HarmenszOTTAWA — Once you decide that 10 Commandments aren’t enough, where do you stop? You don’t. In excruciating detail, you legislate more and more. You pile rules on rules, 100,000 Commandments, and they’re not enough. You still have criminal conduct. So, you must prosecute and punish everyone.

In its 2005 annual report, FedEx observed that it needed 1,200 staff members, working 100,000 hours, to meet the requirements of a single section of a single law — in this instance, the famous Section 404 of the Sarbanes-Oxley Act. It’s merely one regulatory requirement among thousands imposed by the U.S. government on public corporations. Like most of the rest, it’s unnecessary.

Section 404 requires that chief executive officers list the methods they use to keep their financial officers from stealing shareholder assets and falsifying records to hide the crimes — and then find accountants and lawyers to swear that the list is accurate. (Make sure you name the people who have keys to the executive washrooms.) It’s not obvious why the Eighth Commandment and Ninth Commandments aren’t enough. Alas, for some reason, they are not.

Section 404 may or may not have stopped anyone from stealing. Yet it has certainly stopped people from doing honest work — which itself, when you think about it, should be illegal, shouldn’t it? With 1,200 people for 100,000 hours, FedEx could have moved a lot of packages to people and places other than to regulators at the SEC.

Criminal conduct isn’t an argument for massive regulation. You have criminal conduct with regulation and you have criminal conduct without regulation. The Chinese government is now prosecuting the former head of the Bank of China for spending $652,000 (U.S.) of the bank’s money on plastic surgery to make his mistress look more like his high-school sweetheart. So you therefore need to interrogate all other executives to prevent this particular offence? In principle, this is the entire justification for most regulatory excesses. The problem with it is the high cost it imposes on companies that have done nothing wrong.

In a report published earlier this year, the Competitive Enterprise Institute, a Washington-based think tank, calculated that federal rules and regulations now impose a hidden cost of $1.13-trillion a year on American businesses — a levy roughly equal to 50 per cent of the federal government’s budgetary spending ($2.3-trillion). This cost exceeds the pretax profits of all U.S. corporations combined ($900-billion) and equals four times the country’s corporate income taxes ($225-billion).

In 2005, the U.S. Federal Registry, the depository that keeps a record of all federal rules and regulations, contained 73,870 pages. During the year, led by the U.S. Treasury and Commerce Department — not, as you might think by Homeland Security — an additional 3,943 “final rules” were added.

American corporations are irrepressibly productive. (U.S. productivity has increased 3 per cent a year for five straight years.) They could otherwise scarcely have survived.

U.S. Treasury Secretary Henry Paulson commented on these matters the other day, observing that “the time, energy and expense” imposed by Section 404 would have been better used in the creation of jobs. In this instance, the government knows that it should rescind it — but it won’t bother to try, not in a Democratic-controlled Congress. The corporate regulators will simply interpret the section differently and stop enforcing it. This is a fine example of the way in which regulation corrupts, replacing rule by law with rule by regulation. For this reason, the Competitive Enterprise Institute advocates that no regulation take effect without a congressional vote on it in its final form. No regulation, as they say, without representation.

“We cannot legislate our way to ethical behaviour, whether it be in the business world or in any other endeavour,” Mr. Paulson said. “We must rise above a rules-based mindset that asks, Is this legal? and adopt a more principles-based approach that asks, Is this right?”

If Mr. Paulson is correct in this assessment, as he is, what purpose do most of these rules and regulations serve? Pull back this particular curtain and you find yourself in Oz, in conversation with the great and powerful and beneficent Wizard himself. (In L. Frank Baum’s allegorical adventures, published in 1900, the Emerald City was indeed Washington and the Wizard was no help at all.) Mr. Paulson noted that U.S. corporations must pay other extraneous and punitive costs. American civil courts are an industry by themselves. Sue and be damned? Absolutely. U.S. tort costs exceed $250-billion a year. At 2.2 per cent of GDP, civil litigation takes a larger share of the American economy than the advertising industry, more than three times as big a share as farming and agriculture. Only 42 cents on the dollar go to plaintiffs, the rest to lawyers.

Mr. Paulson advocates “principles-based” regulation instead of “rules-based” regulation. This is wise, because you need fewer principles than you need rules. Thou shalt not steal, for example. Thou shalt not lie to hide it. Put that in Sarbanes-Oxley and delete the rest.

Neil Reynolds (nreynolds@xplornet.com) writes a column on Canadian economic issues for The Globe and Mail.

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