Understanding the Impact of Regulatory Burden

We often hear political groups advocate for economic regulations to address an externality or “protect” some group – usually consumers and labor. They only consider the initial and visible outcomes with little or no regard for the secondary and indirect consequences. At the same time, they fear America’s “unregulated capitalism”.

It is often thought that without regulation, corporations MIGHT carry out destructive acts that result in social externalities. Many of these regulations are crafted on the grounds of what MIGHT happen, as opposed to what has happened. Net neutrality is an excellent example.

Regulations are also crafted without consideration for what is ALREADY in place. Economists refer to this problem as regulatory build up. It also results in regulatory inconsistencies where one regulation may directly conflict with another.

Let’s look at how the unrestrained build-up of “regulations” has affected the economy.

A study from the Journal of Economic Growth concluded that regulatory build up between 1949 and 2005 slowed growth by an average of 2% per year. If regulatory levels remained approximate to 1949, it is estimated that 2011 GDP would have been $39 trillion – or 3.5 times – higher. This translates into a cumulative loss of about $129,000 for EVERY person in the United States.

“We find that regulation has statistically and economically significant effects on aggregate output and the factors that produce it—total factor productivity (TFP), physical capital, and labor.”

According to the World Bank , a 10% increase in a country’s regulatory burdens slows the annual growth rate of GDP per capita by half a percentage point. As a result, thousands of dollars in GDP per capita are lost in less than a decade.

In 2010, an empirical study by the Swedish Agency for Growth Policy Analysis found that “the indirect economic costs that ensue from a heavy regulatory burden on a country’s enterprises are considerable and probably more important than the direct costs related to complying with the rules.” In other words, there is strong empirical support that regulatory supply AND demand (usually from the public) are both unjustifiably higher than necessary.

Since regulations come with compliance costs, one unintended consequence can be reduced employment. While those affected will likely find work again, that does NOT mean they have experienced any kind of benefit. In fact, an NBER paper asserts that displaced workers often face permanent losses in lifetime earnings as high as almost three years of the previous annual income. This is largely due to a mismatch of skills between their lost job and newly created jobs elsewhere in the economy.

So what are these compliance costs? The Small Business Administration calculated that, in 2008, the annual cost of federal regulations amounted to $1.75 trillion – or over $15K per household and $8K per employee. Since compliance requires mobilizing resources, larger firms are more adept to meet the requirements. They turn compliance into an investment, whereas small firms do not have those resources. As a result, smaller firms shell out an estimated 36% MORE for compliance than do large firms.

Now that we have looked at the effect regulations have on growth and economic performance, let’s look at the US economy. So is the US economy really “unregulated capitalism”? Hardly.

As you see in the attached graph , the number of regulatory restrictions in the Code of Federal Regulations has increased from just over 800K in 1997 to over 1 million in 2012. From 1975 to 2011, the total number of pages in the CFR has increased from 71K to over 170K. Despite this increase, there has NEVER been a large scale retrospective analysis as to the efficacy of these regulations.

But what are in these regulations? It’s extremely difficult to tell because very few people have actually read it.

The Mercatus Center created a new program called RegData (7) that uses algorithms to scan the CFR and Federal Register. RegData can pinpoint regulatory expansion on a per industry basis as well as the aggregate. By targeting certain words and phrases, they can comprehend the TYPES of regulations crafted – restrictive or otherwise.

It also determines how many new pages are added to the regulatory scope of each agency. For example, there are 26 different federal agencies that regulate our land, air, and sea travel. ALL of them have seen enormous increases in regulatory scope (7).

Furthermore, using this technology, Mercatus determined that the broad increase of regulation has been restrictive on business operations, productivity, and growth while adding considerable costs to both consumers and labor. To be sure, the Mercatus tool is experimental in nature and continuously improving, but it is truly the only available tool to wholly analyze the regulatory state.

What can be done about it? The Progressive Policy Institute has a paper on the issue. They advocate for a Regulatory Improvement Commission to be authorized by Congress. RIC would review federal regulations submitted by the public and present solutions to Congress for a vote. Since it would remain independent, RIC would avoid the burdensome costs and lack of impartiality of regulatory bodies.

I agree with their paper, but would add one thing: RIC should be required to reduce federal regulatory restrictions by X% every year. RIC would result in more economic growth and taxpayer savings, both of which are welcomed.

CONCLUSION: Regulations are important in a functioning economy. As with everything, they are only useful in moderation. In order to remain on top, policy makers need to focus on pro-growth strategies by reducing the regulatory burden. Large amounts of regulation reduce new enterprise and entrepreneurial ventures as well as reduce consumer value and labor demand.

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