The Governmental Regulation vs. Litigation Spectrum

There’s a pretty great ongoing conversation going on below stemming from a comment-turned-post by Jaybird on the unintended costs of governmental regulations. As always, my thoughts on the subject of governmental regulation don’t lean toward “Yay Government Oversight!” or “Boo Government Oversight!” but rather where do we agree that it is needed, and to what extent?

That being said, I want to chime in and say that even those in the blogosphere that discuss the hidden costs of governmental regulations usually ignore the expenses that proportionally rise as regulation falls: the costs associated with liability indemnification.

We have a tendency to think that in industrialized countries governmental intervention either exists and costs go up, or it doesn’t and costs go down. But in a democratic society there are always two competing mechanisms to ensure against corporate malfeasance: government oversight, and litigation. These two mechanisms exist on opposite sides of a seesaw; as the costs associated with one increase, the costs associated with the other decrease.

At my company we might have a client that has manufacturing operations in both the States and in Europe. The costs associated with adhering to governmental regulations – fees, taxes, man-hours, etc. – are significantly higher in Europe. Not only do they have greater oversight, but also in most European countries if you cut corners and produce a food product that killed scores of people, the government has the ability to come down hard on you. Overly negligent actions by a corporation in the United States might lead to someone being fired and the company fined; in Europe it might well mean prosecution and jail time.

However, the overall costs are not as different as you might think. This is because in the States we use another tool to regulate corporate malfeasance: litigation. The amount that you can successfully sue a corporation for is stratospherically higher here than in most other industrial countries, and this creates huge cost differences on the risk transfer side. If you process meat in Fordhall, England your product liability costs are dwarfed by the costs of you doing the same in Provo, Utah.

So if you save money in one country by not having to go through so much red tape, you generally turn around and pay that savings to your insurance company (or, if you are large enough to self-insure, your re-insurance company). Third world countries, of course, usually choose neither oversight nor a litigious system. Instead, by choosing neither they choose to live with corporate malfeasance.

But if you agree that corporate malfeasance should be discouraged, you can have a society of governmental oversight, or you can have society that is very litigious – or you can pick the place on the spectrum between them where you are most comfortable. But the idea that simply reducing governmental oversight directly reduces your costs is not that simple.