How Regulation Eats the Economy   Leave a comment

I promised myself to be fair about the Trump presidency. I objected to the bombing of Syria, I praised Neil Gorsuch for SCOTUS, I’ve liked some of Trump’s cabinet picks and I’ve disliked others. I am pissed about not getting rid of Obamacare. I think Congress has chickened out and I see it absolutely eating the middle class until there are only poor people and rich and most of us will be poor, which by my definition is that we qualify for government subsidies and have no hope of ever aspiring to better our lives, because the minute we do, we lose our government subsidies and become poor again paying bills that we shouldn’t have to pay.

But Trump has done some truly good things in his few months in office. Most of those good things involve executive orders, which I normally oppose. I’ve been anti-executive order since Carter stole one-third of Alaska, so it’s a stretch for me to like Trump’s executive orders, but they’re different. I like many of Trump’s executive orders because they rollback federal overreach. Since when has a president sought to reduce his power over the states and individuals? Yeah, I got nothing. Even Reagan didn’t call for an investigation of national monuments, though he took office less than three years after Carter stole by proclamation one-third of Alaska.

The impact of regulation on economic growth has been widely studied, but most research has focused on a narrow set of regulations and industries. These studies typically rely on regulatory indexes that measure subsets of all regulation, on country-to-country comparisons, on short time spans, or on surveys in which experts report how regulated they believe their country or industry is. In order to better understand the cumulative cost of regulation, a comprehensive look at all regulations across many industries over a long period of time is imperative.

Remember Hazlitt’s maxim – we have to look at how any particular policy affects a broad range of society for an extended period of time. (Economics in One Lesson)

A recent study for the Mercatus Center at George Mason University used an economic model that examined regulation’s effect on firms’ investment choices. Using a 22-industry dataset that covered 1977 through 2012, the study found that regulation distorts investment choices that would otherwise have lead to innovation and creates a considerable drag on the economy, amounting to an average reduction in the annual growth rate of the US gross domestic product (GDP) of 0.8 percent. With GDP growing in the United States at 1-2% a year, that’s a significant anchor.

The problem is that we tend to focus on just one regulation, or a small set of regulations, as being either good for society or the economy, but we don’t pay attention to the accumulation of regulations over many decades. When regulators add more rules to the already heaping pile, analysts often consider the likely benefits and compliance costs of the additional rules, but ignore how they interact with or exacerbate impacts from previous regulations.

So, for example, the individual mandate of Obamacare seemed like a good idea, but it interacts with previous regulations restricting the purchase of medical insurance across statelines. The near-monopoly of medical insurance at the state level concentrates the cost of coverage into small pools, which drives up risk and premiums.

Regulations have a greater effect on the economy than analysis of a single rule in isolation can convey. The accumulation of regulations over time leads to duplicative, obsolete, conflicting, and even contradictory rules, and the multiplicity of regulatory constraints complicates and distorts the decision-making processes of firms operating in the economy while also confusing government employees tasked with managing those regulations. Firms respond to both individual regulations and regulatory accumulation by altering their plans for research and development, expansion, and updating equipment and processes.  Innovation and productivity suffer and because of the important role these play in an economy, these distortions have consequences for the growth of the economy in the long run.

Economic growth in the United States has, on average, been slowed by 0.8 percent per year since 1980 owing to the cumulative effects of regulation:

  • If regulation had been held constant at levels observed in 1980, the US economy would have been about 25 percent larger than it actually was as of 2012.
  • In 2012, the economy was $4 trillion smaller than it would have been in the absence of regulatory growth since 1980.
  • This loss amounts to approximately $13,000 per capita, a significant amount of money for most American workers. Assuming households with two incomes, that’s about one-third of most people’s household incomes every year … lost to regulation.

The study developed a multi-sector endogenous growth model that allowed a counterfactual experiment: What would have happened if federal regulation had been “frozen” at the levels observed in 1980? The model accommodated industry-specific variation in how regulation affects investment and growth, while specifying the determinants and relationships needed to estimate the long-run cost of the regulation for the economy overall.

The study concluded:

  • Economic growth is dependent on investment. Economic growth in a particular industry is determined by investment in research and development and other forms of knowledge creation. Such investment leads to innovation and increases in productivity. This means that regulatory interventions that affect investment choices have a greater effect on the economy than the simple sum of static costs associated with regulatory compliance.
  • Regulations have cumulative effects. A key insight of endogenous growth models in general is that the effect of government intervention on economic growth is not simply the sum of static costs associated with individual interventions—there are dynamic implications. The accumulation of regulation over time leads to greater and greater distortion of investment choices. Moreover, the investment choices of previous years affect growth in future years because knowledge that is not created cannot be implemented next year and the years after to be more productive.

While static analysis of individual regulations sometimes predicts beneficial effects for society, policymakers should consider the results of this study not only when creating new regulations, but also when considering reform of the regulatory process itself. By altering investment decisions and disrupting the innovation that comes from investment in knowledge creation, regulations have a cumulative detrimental effect on economic growth.

Over time, that has had a real negative impact on American families and workers. Think back on the whole idea that America’s middle class has not seen any real wage growth in the last 30 years. Here’s why. That’s where our prosperity went, middle-class!

So, Trump’s executive orders … while I still think they’re unconstitutional and Congress needs to allow a constitutional amendment to stop executive orders in general from occurring … have been an overall good thing because they haven’t advanced presidential power so much as they have reduced the power of the regulatory state … which, by the way, the president is supposed to have authority over. The “executive branch” is within his purview. Most presidents have acted like that wasn’t their job and I appreciate President Trump for recognizing that it is.

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