Regulation hinders progress. But if regulation stays moderate, the market process can overcome detrimental regulation and ensure overall progress. And with this the market process quietly supports the popularity of regulation because it makes it seem as if regulation led to more wealth and progress.
In a recent comment here on EconLog, user Mactoul made an interesting observation: “With so much socialism and ever increasing regulations, the world continues to grow ever richer”. This points to a conundrum which has already puzzled Sam Peltzman of the Chicago School. Economics tells us that regulation will make us poorer. But we do have lots of regulation and we’re getting richer, overall. So, perhaps economics is false? Does regulation, in fact, make us richer?
Not so, argues Peltzman in his paper “Regulation and the Wealth of Nations: The Connection between Government Regulation and Economic Progress,” with an explanation that also goes a long way toward explaining the continuing popularity of regulation and the mixed economy. To Peltzman, government regulation indeed has little chance to do good. It distorts market prices, or at least makes it more difficult to respond to them. Consequently, regulation makes us poorer.
But while regulation has this effect, it can stay on a quite moderate level. If this is the case, the free market’s entrepreneurial forces are to a sufficient degree left in play. Clever entrepreneurs engaged in competition will continue to find ways to make profits and thereby continuously satisfy the shifting wants of consumers and with this increase wealth and ensure progress.
When we have lots of regulation and things overall get better, people will usually conclude that regulation was fine and remains desirable for the future. Peltzman succinctly summarizes: “The fact is there was regulation; there was progress, so why change anything?” (p. 199).
And this is just what Mactoul was pointing at. People usually follow the logic post hoc ergo propter hoc. Since the regulation of the economy, in the Western world at least, is moderate, there is enough scope for beneficial entrepreneurial action and the market process. It is the ongoing competition within markets which makes us better off. And since it is strong enough to overcome damaging regulation, it bolsters this moderate regulation which permeates our economies. The superficial observer will think that regulation, and not the competitive market, is responsible for much of the progress we make. Housing, she may be led to think, got more comfortable and cheaper not because of competitors who incessantly innovated and improved their product to win out against their rivals, but because of regulation that stopped greedy real estate sharks from exploiting poor tenants.
The market process, it turns out, may then be regulation’s best friend, covering up the pernicious effects it has. This notwithstanding, it is sobering to look at some examinations of the consequences of regulation for progress. For instance, John W. Dawson and John J. Seater in their 2013 paper “Federal regulation and aggregate economic growth” find that the new regulation which was implemented in the US since 1949 reduced the average growth rate by about 2 percent. Their estimates indicate that the 2005 annual output is roughly 28 percent of that level it would have reached had it not been for additional regulation since 1949. These figures are colossal. They may of course overestimate the effects of regulation. And regulation can of course protect things valuable to us, e.g., the beautiful scenery in a conservation area. But the figures strongly indicate that while regulation is usually insufficiently strong to kill growth, it does hamper growth very much – to such a degree that we should be skeptical as to its desirability. The market process and regulation form a one-sided friendship.
Max Molden is a PhD student at the University of Hamburg. He has worked with European Students for Liberty and Prometheus – Das Freiheitsinstitut. He regularly publishes at Der Freydenker.
READER COMMENTS
David Seltzer
Feb 16 2023 at 12:42pm
Max: As I read your article, I wondered how much greater output would have been with less regulation. Then I read “find that the new regulation which was implemented in the US since 1949 reduced the average growth rate by about 2 percent. Their estimates indicate that the 2005 annual output is roughly 28 percent of that level it would have reached had it not been for additional regulation since 1949.”
By analogy; if I’m a NASCAR driver, how much more power would the engine produce with out a restrictor plate?
Max Molden
Feb 18 2023 at 6:59am
I’ve actually been shocked when I first read that number! More awareness of the costs of the government-imposed “restrictor plates” is needed.
There’s also some research on regulation leading to more poverty which you might find interesting, see here.
Richard W Fulmer
Feb 17 2023 at 10:51am
There is no such thing as an unregulated free market. Companies are regulated by their customers, who can choose to do business with someone else; their competitors, who can offer better products and services at lower prices; and by their employees, who can choose to quit and work for someone else or start their own businesses.
Knut P. Heen
Feb 20 2023 at 8:09am
Correct. Private property is a regulation that works. Most “regulations” are an attack on private property.
Richard W Fulmer
Feb 17 2023 at 11:15am
This is a good reply to anyone who argues that regulations save lives. How many lives would have been saved had we become three or four times wealthier than we are today?
Also, I suspect that this underestimates the cost of regulation simply because we cannot imagine what innovations would have occurred had they not been regulated out of existence. Take, for example, the catalytic converter whose use was mandated on all cars sold in the U.S. after 1975. Had the Clean Air Act simply specified the goal (i.e., allowable emission levels) rather than the means, who knows what might have been invented?
We do know that other effective technology is possible because Honda engines were capable of meeting clean air standards at the time even without converters. Once converters became required by law, though, incentives to devise alternatives were greatly reduced if not eliminated. Changing existing laws is very difficult especially when wealthy supporters of the status quo (e.g., catalytic converter manufacturers) fight tooth and nail to keep the laws in place. Multiply that loss of innovation countless times, and the costs are staggering.
Max Molden
Feb 19 2023 at 12:46pm
Richard, strongly agree with you! We simply do not know what it is that we miss out on due to government interventions. Leads back to Bastiat’s famous dictum “What is Seen and What is Not Seen”. It is difficult to make visible to people that innovations didn’t occur, and strictly speaking we cannot even make it visible, for, as you said, we do not know what would have been invented.
Concerning your other comment: I think this is a terminological issue. You’re right that customers discipline producers. I used the term “regulation” to mean governmental interference with producers’ decisions, like quality standards.
Terri
Feb 19 2023 at 9:28am
Where would we be without regulation? Patients who receive pacemakers don’t work in a marketplace. Doctors do, but without regulation patients would have no way of evaluating their doctors. The same goes for nearly every consumer product. I like my brakes but I certainly have no expertise in determining whether they work properly.
Economics is a system and systems work on feedback. Regulations are the formalization of informed feedback (quality testing, engineering standards, ethical standards).
Max Molden
Feb 20 2023 at 1:52pm
Terri, the significant distinction, which I did not work out as clearly as I should have, is the one between governmental regulation and private “regulation” (if you want to call it regulation at all). I much agree with you that we need quality standards and the like. The main point is simply whether government should regulate or the free market be allowed to work that out and develop its own quality standards, processes to ensure them, and firms that test for these standards etc.
The research I quoted focused on governmental regulation. In general, there are good reasons to be sceptical of the quality of governmental regulation, see knowledge problems and public-choice problems (‘regulatory capture’).
Thomas Lee Hutcheson
Feb 19 2023 at 9:06pm
_Bad_ regulation hinders progress. Regulation (although a tax would be better) that reduces pollution to an optimum level increases real income. That’s progress. Of course this apply only to regulating that passes cost benefit analysis and much does not and some that might have passed under one set of circumstances may not under another. That why regulation neeeds to ve constantly reviewed and renewed
Max Molden
Feb 20 2023 at 2:01pm
Much agreed that regulation can be helpful. I tried to hint at that when I wrote that “regulation can of course protect things valuable to us, e.g., the beautiful scenery in a conservation area”. It is just that there are costs to regulation, as you point out. And we need to be aware of them. (I conjecture that much of the regulation governments have implemented would not pass a cost-benefit analysis.)
Perhaps you find this work interesting: the authors propose a Regulatory Reform Commission to improve regulation.
Anders
Feb 24 2023 at 9:05pm
One of the things that works well in the US is spread of good ideas at the local or state level. That might matter more. In addition, digitising and servitising the economy will leave large tracts outside its reach. Google et al is a case in point. Fearing the end of search, they created alphabet and invested rents into risky ideas. At the same time, any reasonable or politically attractive option for reigning in big tech is fraught with unintended side effects, including as always raising barriers to entry and thus shielding the incumbent, in addition to the network externalities and access to big data already do.
The idea of agile governance is pretty simple. We regulate, either by grafually increasing taxes, investment into alternatives where the risk is too high for the private sector (someone please invent an airconditioner that is not still as power hungry as half a century ago), or by stating, with some range what we want to achieve. Then let companies experiment. If they fail to meet standards on a few measurements, they can do better on others, often along the way making production more efficient.
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