3 Define the problem and assess its magnitude
RIA requires a problem to be identified. Having described the status quo, the next task is to assess the nature and size of the problem associated with the expected outcomes in the absence of any further government action. A good problem definition will explain the gap between the current situation (what officials expect to be the status quo projected over the period of analysis) and the outcome that the agency is aiming for (as described in the objectives). Problems should be couched in terms of public interest, broadly considered.
A problem definition will be the prima facie case for regulatory intervention and the reason for discussing options. The problem should be able to be summarised in a pithy sentence.
3.1 Size of the problem
The problem definition needs to do more than identify the gap between status quo and objectives: it should discuss its size and importance. This involves identifying the costs and benefits of the current arrangements, including:
- the nature and probability of the adverse outcome/s that will arise in the absence of further government intervention (in addition to the interventions already in place), and
- who is likely to be affected by the adverse outcome, including how widespread it is likely to be (ie, how many individuals, groups, firms etc. are affected), what harm or injury is likely to occur, and the magnitude of these impacts.
Not everything can or should be valued in monetary terms, but quantification should occur to the extent possible. For example, if the problem is related to economic efficiency, how much is at stake? If equity-related, what is the current distribution of costs and benefits? If an environmental problem, what is the potential effect of not acting and what are the overall costs? This quantification should include aggregate figures (totals) to help put the issue in a wider perspective.
3.2 Distinguish between causes and symptoms of problems
The next step is to identify the root cause of the problem (not just the symptoms), for example market failure, regulatory failure, unacceptable hazard or risks, social goals/equity issues. Detail should be provided as to the nature of the problem - for example, if the market failure is a result of information asymmetries, the problem definition needs to identify who is unable to access what information and how their behaviour results in evidence of a problem.
The reason why the problem will not be addressed within existing arrangements or by private arrangements (such as individual contracts, market forces etc.) should be explained. If the problem relates to existing legislation or regulation, it should be made clear whether the problem is in relation to its design or its implementation, or both.
In practice, the status quo and problem may be inter-related and considered or discussed together. For instance, the problem may be best expressed by describing how policy objectives are not being met. However, the key elements of both should be addressed.
Identifying and diagnosing problems
Voluntary arrangements between parties are often the best way to promote the long-term interests of consumers, employees, entrepreneurs, investors, government and wider society. However, there are circumstances when voluntary transacting can fail. Good problem definition requires an understanding of the failures that can arise from voluntary transacting, and self- or co-regulatory initiatives, and government regulatory arrangements:
- Imperfect competition - where one or more party is able to control a market for their own benefit at the expense of consumers or other firms.
- Information problems - where one party to a transaction does not have the information needed to act in their best interests. In extreme circumstances this can lead to significant costs to many parties and the market being under-developed because of a lack of trust.
- Externalities (spill-overs) - where costs or benefits fall on people other than those who consume the good or service. This can lead to the over- or under-provision of the good or service, and
- Public and mixed goods - where a good or service is:
- under-supplied, because it cannot be charged for
- under-consumed, because consumers are being directly charged but their consumption is not incurring extra costs, (ie, it non-rivalrous), or
- over-consumed, because there is free access to the resource but consumption still imposes costs.
- Lack of clear property rights - unclear, ill-defined, or poorly designed property rights can mean that parties do not bear the consequences or receive the rewards that result from their actions.
Self- or co-regulatory arrangements can go some way to correcting these failures, but there are risks that other problems are created. The regulatory body might be captured to promote the interests of its members at the expense of the public (rent-seeking), in particular where members have strong market power. Such arrangements may lack legitimacy and credibility (thereby undermining effectiveness), or lack the capability and capacity to deal effectively with new or emerging problems.
The problem may relate to current regulation and previous attempts to manage risks. The government can fail where it lacks the capability or information, or has poor incentives to do a better job than voluntary and self- or co-regulatory arrangements. As well as each of the above problems, direct regulation can risk leading to further problems with:
- Unintended consequences - by inducing behaviour or providing incentives that do not improve welfare
- Inefficient regulatory enforcement - in the absence of market pressures, there may be a risk of institutional failure. For example, regulatory activity might not reflect the current preferences or risk-tolerances of the public
- Moral hazard - making the market less responsive to competitive pressure by giving an implicit guarantee of government support or protecting incumbents from competition
- Crowding-out - a reduction in private economic activity due to complying with regulation
- Rent seeking behaviour - government involvement can open the door to political lobbying to be given a share of wealth that has already been created. As with crowding-out, this activity distracts from creating new wealth.
