Critique by Leon Louw, Executive Director, Free Market Foundation of Southern Africa
THE CHOICE: PROSPERITY OR POVERTY
Countries have a simple choice: their governments decide whether they will be rich or poor. If the South African government adopts legislation such as the Financial Advisers Bill it will, in effect, be deciding to make or keep South Africa poor – to have inhumane levels of unemployment, declining per capita incomes, negligible domestic or foreign investment, and so on.
The world’s experience leaves no room for informed debate on why some countries prosper and others don’t. The simple fact is that prosperous countries, in order to prosper, had only one policy paradigm at their disposal; to reduce government intervention of this kind.
The evidence is now as conclusive as it gets in the social sciences. Definitive studies during the past twenty years show that, no matter how one defines it, more “economic freedom” results in rapidly achieved prosperity and social justice. Curtailed economic freedom, of the kind that informs this bill, always and everywhere leads to poverty.
There is a long debate about why this is so – why economic freedom and only economic freedom coincides with the prosperity of nations. That it does so is no longer seriously debatable. My conclusion is that it is due to the fact that market processes result “spontaneously” in the rapid harnessing and utilisation of information dispersed throughout society, the more efficient allocation of scarce resources, positive incentives for economically active people, and the co-ordination of millions of decisions made continually and independently by participants in the economy. In other words, personal liberty, freedom of contract, the price mechanism, and respect for private property rights work.
Whatever the case might be, the record is clear, and the Financial Advisers Bill, if adopted, will be a needless nail in the economy’s coffin.
THE EVIDENCE: THE WORLD’S EXPERIENCE
In the 1970s economists like John Greenwood in Hong Kong developed early and, by later standards, crude definitions of economic freedom. Greenwood found that freer economies became more prosperous. As more studies became available, it became clear that economic freedom is usually a pre-condition for other elements of “the good society”, such as civil liberty, high literacy rates, low infant mortality, a sound environment, and low inflation.
Similar work was, done by Frank Vorhies, who found that economic freedom usually coincides with more prosperity and more democracy. The first seminal study was by the World Bank (Marsden), which found that during the 1970s countries with lower government participation rates – measured by aggregate tax collections – enjoyed dramatically higher growth rates. The average per capita growth rate for low-tax countries was 7% compared to 1% for high-tax countries. At 7%, wealth doubles every 10 years. Had South Africa grown at this rate since its transition to democracy started in 1990, the average South African would be twice as rich as they were then. Perhaps more significantly, all income groups would be richer, with the rich getting richer and the poor getting richer faster.
Sadly, since South Africa, followed a high tax path, instead of South Africans being twice as rich, we are now on average, poorer. GDP growth over the period has been lower than population growth which means that per capita incomes have declined.
Why? Because well-intentioned laws of this kind have unintended negative effects in excess of real or anticipated benefits. Whilst I will show why, it must be remembered that the onus rests with those who propose a measure to justify it. They have made no bona fide attempt to do so. There have been no more than bald unquantified assertions that there are problems and that the proposed act would redress them.
The most recent and definitive studies have been undertaken by two alliances: the Wall Street Journal with the Heritage Foundation, and the International Freedom Network lead by the Fraser Institute in Canada. The studies used leading experts, including Nobel economists, to compile indices of “economic freedom”. Once compiled, numerous correlation’s can be tracked. The evidence is overwhelming; societies with freer economies, that is economies without this sort of law, out-perform societies with less-free economies in almost every indicator of human well-being. (Further information is available on request from the Free Market Foundation in Johannesburg, or from the web sites of any of the organisations mentioned).
THE ONUS OF PROOF: PROBLEMS, SOLUTIONS AND UNINTENDED CONSEQUENCES
For a legitimate case to be made for a law of this kind, there are a number of preconditions that must be satisfied. None of these have been satisfied in respect of the Financial Advisers Bill.
1. Problem Analysis
Typically, all policy proposals are accompanied by exaggerated assertions of both problems and anticipated benefits. The benefits appear to be achievable at no cost, and there are no uncertainties about whether they will materialise. The motivation for new policies is that supposedly proven problems will be overcome by the mere implementation of the new law.
This is usually the end of the matter. No attempt is made to identify precisely what the problem is, how extensive or widespread it might be, how serious it is, for whom it is a problem.
The architects of this bill at the Financial Services Board (FSB) are particularly guilty of this. Under their influence, the FSB seems to be suffering from legislative diarrhoea. It currently has 13 published laws in the pipeline, maybe more. In the army they say: “If it moves salute it, if it doesn’t, paint or polish it.” The bureaucratic equivalent is: “If is moves, regulate it, if it doesn’t, subsidise it.”
Once problems have been identified and quantified, and those for whom they are a problem identified, then, and only then, might a new law be warranted. But, even then, what caused the problem should be established first. More often than not real and imagined problems are the unintended consequence of earlier policies that were equally ill-considered, and were supposed to have solved earlier problems, if not the same problem. Thus, solutions beget problems, which beget solutions, and so on, in a never-ending spiral of over-regulation that suffocates productive economic activity.
Whilst new laws seldom solve targeted problems, most problems can be solved by the simplest cost-saving expedient of discontinuing the cause. The cause is partially in this case, financial market regulation that inhibits effective competition. More of the same thing will result in more, not less, of the problem.
2. Benefit Analysis
There is seldom any concern for the extent, to which the policy is likely to achieve envisaged benefits. Policies are propagated as if we live in a deterministic world where desired results are inevitable and consummate – have problem, will legislate. In truth, real benefits usually fall far short of promised benefits. Sometimes there are no benefits only consequences.
Before a bill such as the Financial Advisers Bill reaches the stage of being propagated seriously, it should be accompanies by a bona fide and detailed description and quantification of desired benefits.
Additionally, there should be an estimate of the degree to which desired benefits van expected to materialise in the real world.
There are many reasons why benefits fall short of expectations. One is the realities of markets. In the real world officials, politicians and the regulated public usually have their own diverse and contrarian objectives and agendas. They find ways of “doing their own thing”, which is known as “goal substitution”.
After all, the reason why regulation is desired in the first place is that, left free, people do not act the way legislators want them to. All controls are people controls. Governments do not control finance, transport or agriculture. They control people. They do not control only identified people, such as financial advisors. They also control those who employ them or use their services, and, indirectly, many others around them.
The most profound reason for failed legislation is the nature of the “market process”. Markets are dynamic and, as Minister of Finance, Trevor Manuel, observed, amorphous. His mistake was to assume that being amorphous means that markets have no power. He learnt a bitter lesson when the “invisible hand” of the market hit back and drove the Stock Exchange down. The market, is powerful and dynamic. Because it is so complex, those who try to regulate it fall into the trap of legal positivism or determinism. They stick resolutely to the notion that they can direct it much as a puppeteer controls puppets, or a conductor leads an orchestra. But what they have is a chess board where each piece has a will and a response of its own to whatever move the players make.
3. Cost Analysis
An analysis of potential disadvantages – of unintended negative consequences – should precede any serious policy proposal. A bona fide cost analysis is almost unheard of in South Africa, or for that matter in any country. One of the rare exceptions is legislation introduced last year by the Clinton Administration according to which new legislation has to be accompanied by a small-business impact assessment. If it is not, or if the assessment is not thorough and sincere, the legislation can be set aside by the courts.
The tradition in South Africa is for most national draft legislation, to be accompanied by an Explanatory memorandum. Sometimes there is a Green or White Paper, or a Report that precedes legislation. Reports range from superficial departmental Reports to substantial Reports, perhaps by a Commission of Enquiry. They can run into hundreds of pages. Such Reports may contain a substantial Problem Analysis. Most also have a Benefit Analysis, although I have never seen one with an analysis of the extent to which real benefits are likely to fall short of desired benefits because of goal substitution and this market process. There may be examples, but I am unaware of them, and I assume therefore that they are rare. I have never seen an attempt at a comprehensive cost analysis, not even in the most bulky Reports.
Explanatory Memoranda usually provide a brief motivation. Apart from being, in most cases, brief and superficial, they tend to be predictable, consisting largely of popular platitudes, clichés, and unsubstantial claims, rather than a scientific analysis of problems and intended benefits. Some do not even provide for administrative budgets.
Self-evidently, before they can decide whether new legislation is likely to have benefits that exceed costs, politicians would have to be provided by those who lobby them with realistic and comprehensive cost estimates. These would have to include obvious costs, such as the administrative costs which are often, but not always, mentioned. In particular, the compliance costs for people affected by the legislation would have to be articulated. These include direct compliance (financial and staffing) costs and the indirect costs of the diversion of human resources from other productive activities towards compliance (opportunity costs). To these should be added hidden costs, such as cross subsidies for capital and office space, the tax-free nature of government operations, and so on.
Further costs such as the costs that might be incurred by consumers and employees should also be quantified. More importantly and less obviously there are economic impact costs. All policies distort or, at best, change prior market structures. Economic activity and resources are necessarily shifted or relocated from some activities and uses to others. For instance, the Financial Advisers Bill would have the effect of measuring the cost of financial services, the range of people providing financial services declining or shifting, the institutions providing financial services gaining or losing market share, et al.
There will be more serious fundamental consequences such as less financial advice, and thus, potentially, more of the problems the law was suppose to alleviate. Resources will be redirected in ways that will probably be sub-optimal, into different forms of investment and saving than the market would have preferred.
In other words, before it could be said that this bill is likely to have net benefits there would have to be a bona fide economic impact assessment indicating what the primary and secondary economic and social consequences are likely to be: for whose benefit and at whose expense, and why it is thought that these impacts are a desirable trade-off.
In short since no such research has been undertaken, and virtually none of the necessary information is available, we know with absolute certainty that the Financial Advisers Bill should be abandoned until a proper cost-benefit analysis or economic impact assessment has been done.
It is presently not possible for policy makers to know whether the Bill, if enacted, will achieve a net improvement, since they have no information before them – not even an estimate – of what the benefits might be, at what cost they will be achieved, who the beneficiaries and losers are likely to be, and to what extent.
EFFICACY MONITORING
If they proceed with the Bill, which seems likely, since it has been said that the implementation of a Bill along these lines is a fait accompli, second prize would be the addition of a mechanism for monitoring whether the intended benefits materialise. Equally, unintended negative effects should be monitored so that an informed decision can be made within a year or two as to whether the Bill should be retained or abandoned. Experience elsewhere predicts that the Bill will backfire and, if its effect are monitored, will have to be repealed or amended substantially for damage control purposes.
Predictably, advocates of the Bill will protest that a cost benefit analysis is not possible because the costs and benefits cannot be quantified, at least not in Rands and Cents – or so they will say.
WHAT COST-BENEFIT ANALYSIS CAN TELL US
The flaw in this view is that it reflects a misunderstanding of the nature of cost-benefit analysis. A cost-benefit analysis is or should be an holistic assessment of likely costs and benefits in both cash and kind. Contrary to the erroneous view, non-cash benefits can usually be quantified. For example, the effect of a new crime policy might be an identifiable and quantifiable increase or reduction in the number of burglaries. The effect of a paediatric programme might be an infant mortality rate that rises or falls by a precisely quantifiable number.
Costs and benefits that do not lend themselves to numerical quantification can also be assessed. The prohibition of newspapers would reduce the amount of litter and pollution attributable to newspapers thereby providing an aesthetic gain to society. Almost everyone, even radical greens, will agree that that this benefit, even if not quantified numerically, falls far short of the cost to society of having no newspapers.
However, non-financial and non-numerical cost-benefit analysis is not even required in this case. All the costs and benefits based on what has been said in support of the measure can be reduced more easily than in respect of most legislation to simple, accessible and coherent quantities. Financial services, after all, have to do with finance. Finance is, if anything, a matter of numbers, specifically Rands and Cents. If there is anything quantifiable at all in the world, it must surely be the financial benefits of a financial policy. A case could be made against a purely financial cost-benefit analysis (albeit not a comprehensive cost-benefit analysis) in respect of most other legislation, such as a Broadcasting Control Act. But it would be manifestly absurd to maintain that financial benefits cannot be quantified.
A very rough provisional estimate, based on the experience of such legislation in Britain and Australia, is that there will be no identifiable financial benefits resulting from this measure – except, of course, to a few concentrated vested interests and “rent seekers” – and that the policy will cost South Africa more than R2 billion per annum. It is likely that a few consumers will indeed be better off financially than they would have been without the Bill, but their gains will be offset by the far greater losses of those who will be worse off. And the losers are likely to be more numerous.
The perverse beneficiaries will be those protected from effective competition, officials with new empires and powers, private sector employees responsible for compiling absurdly comprehensive records and submissions, and the like. All at the expense of consumers.
It should be emphasised that the onus of showing that a measure will have counter-productive net effects is not the responsibility of critics. It is the obligation of someone who propose the measure to show that its benefits will exceed its costs. Only once that obligation has been discharged does it become the responsibility of critics to challenge the motivation.
The FSB and the government should refuse to consider this Bill unless and until it is provided with a financial and social quantification of intended benefits and possible costs. The questions are essentially quite simple and the answers can be provided with a relatively painless and affordable amount of effort on the part of the Bill’s protagonists. What policy makers should demand before considering this Bill includes:
1. What improvement in their financial position are consumers likely to achieve after the Bill is implemented? Will they receive 10% higher returns, or 10% lower losses?
2. What proportion of consumers will benefit; to what extent?
3. How much will it cost the government to implement the measure ab initio, and how much thereafter? The narrow financial and staffing implication assessment that normally accompanies such a Bill is inadequate. The government’s compliance cost includes costs imposed indirectly on other government employees, departments and agencies such as the police, courts, the revenue service and the registrar of banks.
4. What compliance cost will be imposed on the private sector? The narrowly defined and more obvious compliance costs are those that individuals and enterprises will incur by having to qualify, register, pay registration fees, administer the system, and so on. Beyond this there is the cost that people will incur by giving and receiving financial advice they would not otherwise have provided or wanted. Valuable time will be spent soliciting ad providing mandatory information and filling in forms. There will be administrative costs in collating and storing this information. Costs will be incurred by people who have to gain qualifications, they will spend additional money and time during which they might otherwise have been producing wealth for the country.
5. What changes will the policy bring about in the structure of the economy? How many less financial advisers are there likely to be? the most elementary insight into economics is that costs reduce consumption, in other words, if it is more difficult or costly to become a financial adviser, there must be fewer financial advisers. Presumably, therefore, those who are permitted by the law will be doing more work and charging more.
6. What are the numbers? Consumers will pay more. How much? They will pay directly and indirectly. Indirect costs to consumers are the reduced quantity of financial services and products for them, increased taxes to cover government compliance, reduced government services elsewhere because of the required diversion of resources, and reduced returns from financial products because of the unavoidable added cost of private sector compliance.
7. How do these costs compare with anticipated benefits?
8. Experience elsewhere shows that the Bill will result in a shift in financial advice from existing financial advisers to others. Who will the losers be? To what extent? Is this desirable?
CONCLUSION
The conclusion any objective analyst has to reach is that the Bill is ill-conceived, inadequately motivated, and likely to do far more harm than good. It should be abandoned, or, at the very least, shelved, pending the necessary information to enable policy makers to make an informed decision.
