REACH REGULATION IN THE LIGHT OF THE ECONOMIC THEORY OF REGULATION

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REACH REGULATION IN THE LIGHT OF THE ECONOMIC

THEORY OF REGULATION

NAŘÍZENÍ REACH VE SVĚTLE EKONOMICKÉ TEORIE REGULACE

Šimon Buryan

Abstract

REACH represents a significant legislation regulating chemicals in the markets of member

countries of the European Union (EU). According to the regulation, since 2007

all the chemicals in the production of more than 1 ton per year must be gradually registered,

evaluated and authorized. This article assesses the theoretical impact of REACH

on chemical companies using the economic theory of regulation. Evaluation of the effect of

REACH is analysed by using an economic model of regulation theory by S. Peltzman.

Key words: REACH regulation, theory of regulation, chemical industry, EU, Peltzman’s

model

Abstrakt

Nařízení REACH představuje významnou legislativu regulující chemikálie na trzích

členských zemí Evropské unie (EU). Dle toho nařízení od roku 2007 všechny chemikálie

v produkci větší než 1 tuna ročně musí být postupně registrovány, evaluovány a autorizovány.

Tento článek teoreticky posuzuje dopad nařízení REACH na chemické podniky pomocí

ekonomické teorie regulace. Vyhodnocení efektu nařízení REACH je posuzováno pomocí

ekonomického modelu teorie regulace S. Peltzmana.

Klíčová slova: nařízení REACH, teorie regulace, chemický průmysl, EU, Peltzmanův model

1 INTRODUCTION TO THE REACH REGULATION

Regulation (EC) No. 1907/2006 REACH is the Regulation on Registration, Evaluation,

Authorisation and Restriction of Chemicals. This regulation entered into force on 1st June

2007. It belongs to the most sophisticated legislative acts related to chemical globally. Every

chemical (if its annual production is higher than 1 ton) which is offered on the markets in the

EU, must be registered, evaluated and authorized according to the regulation. This is an

obligation for both EU producers and importers of chemicals. [Bergkamp 2013]

The main focus of REACH is to ensure a high level of protection of human health and the

environment from the potential risks from chemicals; the free circulation of chemicals on the

internal market; and enhancing innovation and competitiveness. REACH puts the pressure of

assessing and managing the risks posed by chemicals on the industry itself. Companies are

required to register their agents with the European Chemicals Agency (ECHA). Then they

have to provide safety information to their customers. The regulation has several terms, for

cost lowering and costs sharing. The companies can form consortia and share the price among

its members. Companies can sell the test results to others. [European Commision 2007]



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2 INFLUENCE OF REACH ON COMPANIES

The REACH regulation imposes significant costs to chemical companies. They are required

to provide detail information on features of their agents. The regulation requires that

companies provide data on 54 characteristics of their products. These characteristic are

composed from physical (15), toxicological (18) and eco–toxicity (21) features. [Feuerborn

2011] All required characteristics can be seen in figure 1.

Figure 1: Overview on Required Information of Chemicals by the REACH Regulation

Source: Feurborn 2011

Regarding the registration of a single agent, Eacott [2012] estimated expected costs to 57 700

– 184 500 Euros per agent. The biggest variable by far is the charge for Letter of Access,

which is about 70 to 90 % of the total fees.

The European Commission estimated the direct total industry costs before the regulation went

into force at 2,3 billion Euros over 11 years (2007 – 2018). According to Commission

estimated costs to downstream users of chemicals were estimated at 2,8 – 3,6 billion Euros

over a period of 11 and 15 years. [European Commission 2003]

In a case, when market withdraws 12 % of substances from continued production because

chemicals would not be profitable due to REACH, costs could rise to 4,0 to 5,2 billion Euros

if industry faced higher supply chain adaptation costs. These estimates included the direct

costs passed on from the chemicals sector to downstream users. [European Commission 2003]

However the original total REACH costs from October 2003 were underestimated. The

overall (direct) cost estimates of turned out to be an underestimate by nearly one half. By

2018 might have gone up even more than that. [Directorate general for Internal Policies 2013]

2.1 Chemical industry dynamic

The impact of the regulation on the EU chemical industry has to be evaluated in the light of

economic situation after the global economic crisis of 2008 and current economic trends. As it



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can be seen in figure 2, the chemical industry production fell significantly after 2008. But the

production grew back to its 2008 pre–crisis in the year 2011. [CEFIC 2013]

Figure 2: Chemical Production in EU

Source: CEFIC 2013

According to CEFIC [2015], the European Chemical Industry Council, the total EU chemicals

production slowed down after 2011 from 549 billion Euros to 527 billion Euros in 2013. Then

EU companies have to face increased competition from Chinese producers. The EU share on

2003 world chemicals production was 31 %, but it decreased to 17 % in 2013. In the same

time period share of China increased from 9 to 33 %. [CEFIC 2015]

It is reasonable to suspect that REACH regulation if nothing else is holding companies back

in a highly competitive world. On the other hand according to the CEFIC [2015] data most of

the chemicals sold by the EU companies are shipped to the EU member states 55,4 %,

production of EU’s domestic for domestic market mount 18,2 %. So of EU companies were

faced with increased competition of their main markets (in the EU), their competitors have to

comply with the REACH regulation as well.

2.2 Cost to production operations

Before REACH went into force chemical companies largely rejected the regulation. In their

eyes REACH would put high costs on companies and the regulation would put plenty of legal

constraints on companies’ operations. Many industry executives and REACH analysts

claimed that REACH will cause adverse effects across the chemical industry, from base

materials manufacturers to end users. The bigger concern for executives were then the indirect

costs of the regulation, which range from legal costs, capacity used for management and

administration, new software implementation, safety data gathering and laboratory testing

work. [Scott 2007]

Regarding the direct costs, the picture is not than bleak. As it was said in chapter 2 of this

paper, the expected regulation direct costs were estimated to 2,3 billion Euro over 11 years.



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As it shows up, this figure is an underestimate by a half. In this respect we can revaluate the

expected costs that the EU companies would have to annual costs of 418 million Euro (lower

estimate in further text). In case that industry faced higher supply chain adaptation costs, if we

double again the original figure, we would get a higher estimate of 945 million Euro (higher

estimate in further text).

If we compare these annual estimates to data in Structural Business Statistics database

(in table 1), we would found out that the annual costs estimates compared to annual

production would reach 0,25 % (in 2009) at most in case of the higher estimate. The average

for the higher estimate is 0,21 %. The lower estimate is won’t we more than 0,12 % of annual

production. The average for the lower estimate is 0,09 %.

Comparing the regulation’s cost just with production volume would produce a loose result,

since companies have to bear significant variable and fixed costs already. A better analysis

would be to compare the regulation costs compared to Gross operating surplus, which gives

us a picture, what are capacities of EU companies to bear additional costs.

Gross operating surplus represents a surplus generated by operating activities after the labour

factor input has been recompensed. It can be measured from the value added at factor cost less

the personnel costs. It is a balance available to the unit which allows it to recompense the

providers of own funds and debt, to pay taxes to the authorities and eventually to finance all

or a part of its investment. [OECD 2005]

Again if we compare the expected REACH annual costs to Gross operating surplus the

average share of annual expected REACH costs are on average 0,95 % for the low estimate

and 2,15 % for the higher estimate. From this point of view, it is fair to say that REACH

regulation costs on don’t seem to threaten the industry performance in any high measure.

Table 1: Chemical Industry Operation Statistics – Total Sum for EU28 [millions Euro]

Year 2008 2009 2010 2011 2012

Gross Operating Surplus 44 987 33 559 51 017 50 882 44 444

Production Value 437 422 373 370 445 954 486 231 483 789

Source: Eurostat 2015

In light of this discovery one has to ask, why the industry representatives were so against the

introduction of the regulation in the first place. The industry also put plenty of resources to

the task of counteract the regulation. In the words of Margot Wallström a former European

Commissioner (1999 – 2009):

“REACH saw the heaviest industry lobbying known so far for any new

EU legislation”. [Fuchs 2009]

The lobbying campaign against REACH was led by CEFIC, presenting itself as European

trade association for the chemical industry. But the dominant voice in the organisation

belongs mainly to big corporations rather than small and medium sized companies. First

CEFIC organization pretended to care by supporting the proposal. But then CEFIC’s lobbying

strategies became confrontational after European Parliament voted in favour of the proposal

for a new chemicals policy. CEFIC publicly spoke about chances of relocating the industry

and de-industrialisation of Europe. The organisation often referenced to the international

competitiveness tenet of the Lisbon Agenda as standard parts of the campaign. [Wengler et al.

2014]



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It is necessary to add an important note that the above stated analysis is working with data on

the whole production of all the producers in the EU. For certain companies REACH might

turn to be a hard burden. This seems to be the case for the small and medium sized

companies, which deal with low volumes of production and as a result of this have a harder

position to comply with the regulation. [Eacott 2012] But the European Commissions

proposed a decrease of costs for SMEs registering their chemicals. [Davis 2013]

The regulation might have imbedded terms disadvantaging small and medium sized

companies since. There was very little contribution of small and medium industries as well as

of downstream users before the Commission introduced a proposal of the regulation in 2003.

[Fuchs 2009]

3 THEORY OF REGULATION

The theory of regulation would be most suiting for the analysis of REACH impact to the

regulation. This theory studies the regulation in economic terms from the point of regulations’

proposal introduction up to the final influence of regulations on the economy.

There are two main branches of theory of regulation: public interest theory and private

interest theory.

According to the Joskow and Noll [1981] from the point of view of public interest theory,

regulatory intervention occurs in the interest of the public at large. The regulation is a result

of public demand for protection against monopoly power of producers as well as demand for

greater health and environment safety.

The private interest theory then stresses that regulatory intervention is the result of individual

powerful interest groups exerting pressure on politicians and regulators to capture rents at the

expense of more dispersed groups. Stigler is a well-known proponent of this theory. Stigler

argued that firms are lobbying legislators for regulation when such regulation provides: direct

monetary subsidies, constraints on substitute products or subsidies on complementary

products, easier price-fixing or collusive atmosphere, and incumbent firms with the ability to

control entry by potential new rivals. [Stigler 1971]

3.1 Capture theory

Stigler earmarked a capture theory, which belongs to the private interest theory. According to

the capture theory company capture the regulatory process because each firm has a lot at

stake. While the public as a whole has a lot at stake, any one person has only a very small

stake and so has little incentive to invest resources in affecting the regulatory process. There

are few firms relative to the overall public decreasing costs of organizing. General public

from this point of view faces higher transaction costs than the companies. Firms have the

incentive and the opportunity to successfully invest resources in lobbying for favourable

regulation. [Stigler 1971]

We can find evidence supporting the capture theory of regulation in “revolving door deals”.

High-level regulators and other officials leave their positions in the industry and find high-

level jobs in the administration body regulating the same industry, from which they originally

came from. After a certain period of time they might switch positions from the administration

back to position within the industry again. This motion in between administration and

industry creates an illusion of “revolving doors”. [Wengler et al. 2014]



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Although this concept does not implicate any individual wrongdoing, it identifies direct

causal links between new employment and outcome. It points out that individuals might tend

to stay loyal to their previous peers. In case of REACH the interconnectedness of some

individuals involved in campaigning against REACH does demonstrate a revolving door

paradigm. In several cases EU officials became lobbyists for the chemical industry. Then

there were cases, when lobbyist for CEFIC moved to the REACH Unit of Directorate-General

Enterprise & Industry between 2002 and 2004 and other similar cases in other EU’s institutors

were recorded as well. [Wengler et al. 2014]

According to Wengler et al. [2014] the current version of REACH is weakened compared to

original proposals. Corporates pursue aggressive lobbying efforts in order to manage

regulation. Chemicals producers and their associations have adopted diverse tactics,

encompasses intimidation of job threats, exaggeration of costs, hiring former regulators and

other.

3.2 Peltzman Model

Samuel Peltzman attempted to extend and improve upon Stigler’s capture theory of

regulation. The basic hypothesis is that a regulation is one means by which state power can be

exercised to the benefit of specific groups. Regulation is supplied by utility–maximizing

politicians and regulators in response to the demand for regulation by interest groups. Key

assumption of the model is that those who control regulatory policy do so to maximize

political support. Political support comes in the form of votes or campaign contributions.

[Peltzman 1989]

Various groups (e.g., consumers and regulated firms) compete against each other in the

political arena to increase their income and wealth, or to achieve other objectives (such as

environmental cleanliness). Groups shape regulatory initiatives in a way that will serve their

own (sometimes narrowly-defined) interests. These agents are rational in choosing actions

that are utility-maximizing. [Peltzman 1989]

The model operates with two functions: political support function (M) and industry profit

function (π).

Let the political support function (M) be described by equation 1:

M=M(R, π) (1)

Where R is rates established for the regulated service by the regulatory authority. Companies

make a profit by providing products and services. Notice that M is inversely related to R,

ceteris paribus, and directly related to, ceteris paribus. [Peltzman 1989] That is:

∂M/∂R< 0 and ∂M/∂π>0 (2)

Note that profits are explained as a function of price rates, as can be seen in equation 3:

π = π(R) (3)

In other words, regulators or politicians prefer to set low rates, other things being equal, since

this strategy will garner political support from the costumers of regulated firms. On the other

hand this allows the regulated firm to earn high profits. [Peltzman 1989]

There are two interest groups with conflicting agendas. Consumers want low rates; whereas

regulated firms want high profits. The politicians and regulators face a trade-off. They might



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allow higher profits, then they would gain political support from firms they regulate. On the

other hand this would lead to loose of support from consumers. The reverse is also true. This

trade–off is illustrated by the iso–political support function. [Peltzman 1989]

The iso–political support function shows all combinations of R’s and π’s that yield equal

political support. The iso–political support curves can be seen in figure 3. The convex shape

of these curves faced by regulators. Moving from point from point α to point β along the

curve M1, regulators enjoy increased support from regulated industry. But they suffer a losing

support of consumers. But the overall political support remains stable. Regulators trade off

support from consumers to support from the industry. Moving from point α to point λ is better

from regulators point of view, since it produces more support from regulated firms without an

offsetting a loss of support by costumers. Note then that the curve M3 is preferred to M2,

because it yields more political support. M2 is then preferred to M1.



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Figure 3: The iso–political support function

Source: Author’s ilustration

The goal for regulators is to reach to the highest iso–political support function, in order to

maximize their utility. This iso–political support function is tangent to the profit function. As

we can see in the figure 4 the level of total support indicated by the M2 curve is the best

option for the regulators.

M3 is not attainable for them. Note also that the best rate for the consumers would be the rate

RC, this is the competitive rate. On the other hand the rate for the regulated companies most

preferred rate would be RM

, this rate would maximize companies’ profits. So at the tangency

given point α neither side get all that they want, but they get part of what they are demanding.

Figure 4: The Peltzman model



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The extreme solution of the given situation can be seen in figure 5. The rate RM

and β indicate

a Stigler solution; in this case regulators are “captured” by regulated industry. The rate RC

and α indicate a solution in which regulators are “captured” by consumers. We never see these

extreme cases in practice. Rates established always fall between RC

and RM

. In units with

powerful consumer advocacy groups rates generally are closer to RC than in units with weak

consumer advocacy. [Peltzman 1989]

Figure 5: The Extreme Solutions of the Peltzman model




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4 ASSESSMENT OF REACH IMPACT ON THE EU’S INDUSTRY

According to the basic analysis in chapter 2.2 of this paper, REACH regulation would pose

just marginal costs to the industry as a whole. On the other hand the situation for small

and medium sized companies is expected to be very different and the European Commission

introduced lower fees for these companies.

Industry high effort trying to lobby preferred terms of the regulation was significant in the

case of the REACH regulation. According to the remarks from a Commissioner before

REACH there wasn’t recorded so massive effort of industry to steer the regulation at the EU

level.

According to industry experts big companies are in good shape and REACH did not affect

them negatively. Than big corporations might on the sale of documentation even earn

additional profit and thus cover their own registration expenses. On balance REACH cost

them either nothing or they might even be in a profit due to sell of test results. This is the case

of chemicals whose testing requires special procedures or equipment that is not widely

available. [Stuchlík 2013]

As it was discussed in chapter 2.2 there was a great lobbying effort by the industry in order to

steer or even avoid the regulation. This was accompanied by suspicious cases of presence of

former industry representatives in the administration first introducing and then overseeing the

regulation, which was discussed in chapter 3.1 of this paper. All of these moves led to current

state of the regulation, which is considered by some as a weak version of the original

proposal.

If we should use the Peltzman model and evaluate the impact of REACH to the industry, we

might conclude that the regulators might be influenced more by the corporations then by the

consumers.

The regulation is and will be in force, it serves its original purpose and aim. On the other

hands signs indicate that current impact of the regulation indicate a solution, which is rather

according to the Peltzman model near to the Stigler solution than to the solution most

favoured by the consumers.

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Acknowledgement:

The results of this article were obtained thanks to research grant of University of economics:

VŠE Praha F2/7/2014 New ways of governance in the light of financial and debt crisis

Contact information

Ing. Šimon Buryan

The University of Economics, Prague;

The Faculty of International Relations;

Department of World Economics

W. Churchill Sq. 4; 130 67 Prague 3

The Czech Republic

Email: [email protected]

Phone: +420 224 09 5230

REACH REGULATION IN THE LIGHT OF THE ECONOMIC THEORY OF REGULATION

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