November 29, 2008

Diseconomies of scale

An interesting essay on one of the causes of the diseconomies of scale that you find as any organisation grows. He is mainly concentrating on why small companies are so much more nimble and responsive than large ones, but the same arguments apply to why small states are better than large ones.

Such things happen constantly to the biggest organizations of all, governments. But checks instituted by governments can cause much worse problems than merely overpaying. Checks instituted by governments can cripple a country's whole economy. Up till about 1400, China was richer and more technologically advanced than Europe. One reason Europe pulled ahead was that the Chinese government restricted long trading voyages. So it was left to the Europeans to explore and eventually to dominate the rest of the world, including China.

In more recent times, Sarbanes-Oxley has practically destroyed the US IPO market. That wasn't the intention of the legislators who wrote it. They just wanted to add a few more checks on public companies. But they forgot to consider the cost. They forgot that companies about to go public are usually rather stretched, and that the weight of a few extra checks that might be easy for General Electric to bear are enough to prevent younger companies from being public at all.

The thing is that goverments never know the costs of their actions, they can't because they are never costs to them. With a company too much red tape will eventually hit the bottom line as they become slower to react to changes. Eventually a company will get strangled by their own red tape if they let it get out of control. For a government on the other hand there is no cost to producing more checks on action because it is always somebody else that pays the price for them because it is other people who are having their actions curtailed.

In other words regulation is an externality, and we all know the correct response to an externality. You place a tax on it to internalise it.

But how to tax the government? And whom to give the tax to? Well a tax reduces your income so perhaps we should force the government to send out rebates on the taxes that we pay it based on the amount of regulation there is. Regulation goes up and the rebate goes up. Regulation goes down and so does the rebate. The government could just keep on putting up taxes to cover the cost of the rebate, but then there would finally be a political cost to them since no government gets elected on a promise of putting up taxes (hence Labour's current scorched earth economic policy). It might make them think whether yet more regulation really was the answer.


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