[VIEWPOINT]Red flags are killing our economy

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[VIEWPOINT]Red flags are killing our economy

There was horror and opposition when steam-powered automobiles began to take to the roads in Great Britain, including one that allegedly could travel 40 kilometers per hour. So in 1865, British officials began to regulate the new machines under what became called the "red flag act." Speeds were limited to 3.2 kilometers per hour in urban areas and 6.4 kilometers per hour in the country. Three persons were required to operate an automobile; a driver, a stoker to keep the steam up and a flagman who had to precede the horseless carriage with a red flag to warn oncoming horse carriages and help control horses that were spooked by the new contraption.

The government cited safety concerns, but there was also a desire to keep horse-drawn carriages from becoming an endangered species. Heavy taxes were levied on automobiles as well.

Limiting car speeds and adding the "red flag" rule on top took its toll in Britain. Although the automobile was invented there, England began to lag in developing it. The "red flag" rule was rescinded in 1878, but by then Germany and France began to pull ahead in the development of the automobile industry. Not only did England lose its upper hand in the automobile industry, but failed to protect its horse-drawn transportation industry. Thereafter, the term "red flag act" became synonymous with regulations that undercut industrial productivity.

But the red flag still flies high all over the world. Regulations come in all shapes and sizes under the pretext of nurturing industries to increase their competitiveness. With logic such as "excessive competition must be managed," governments regulate emerging firms. Labor mobility is throttled under the guise of stable employment. But do these rules work? Or do the protected industries wither anyway?

The OECD recently released a study concluding that regulations do indeed sap industrial productivity. It compared statistics from the United States and nine Euro-pean economies and showed that the "red flag" factor was the main reason for lower productivity in Europe compared to the United States between 1987 and 1997. New companies contribute more to productivity than competition between existing industries. Even the leaders in cutting-edge industries were more likely to be new firms than existing ones. According to the report, lagging European productivity can be traced directly to the fact that entrepreneurs face disproportionately greater hurdles in complying with rules regarding protected labor markets and industrial regulations.

The contrast between the United States and Europe becomes increasingly stark when comparing the time consumed in starting a new firm. In America, the wait is only about a week. In France, however, the same feat requires 66 days, and in Germany, a whopping 90 days.

On both sides of the Atlantic, the proportion of companies that failed to make it past their first two years was the same, about 35 percent. The biggest difference was in the rate of the companies' growth. The American companies doubled the size of their work force every two years on average, but their cross-Atlantic competitors only managed to add an additional 10-20 percent to their staffs in the same period. The difference lay in the greater mobility in the labor market and fewer regulations in the United States.

This study demonstrates that the high productivity and low unemployment in the United States are linked to labor market mobility and an administrative atmosphere that does not shut out emerging firms. It also explains the double-digit unemployment rate in Europe, where governments make stronger efforts to protect their labor markets. The same logic explains why productivity is more than 20 percent higher in the United States than in Europe. The study is more proof that lowering the threshold for newcomers paves the way for greater efficiency in industrial markets.

And what about us? How can we compete with a country that welcomes a new business in a week when we are tied down by "red flags" everywhere we look? Instead of debating limited special economic zones, perhaps it is time to reshape the entire nation into an area free of regulations. It would be wiser to lower the "red flag" now, before we fritter away our competitiveness.


The writer is a professor of economics at Yonsei University.

by Jeong Kap-young

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