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The Economic Impact of Regulatory Accumulation on your Firm’s Growth

Regulatory overreach is a constant bone of contention for CEOs.

Regulatory overreach is a constant bone of contention for CEOs.

However, while everyone knows that regulatory red tape can hinder business growth, it’s the <em>cumulative</em> impact of federal regulation on the economy that could be most problematic, because the multiplicity of regulatory constraints complicates and distorts business leaders’ decision-making processes.

In addition, buildup of regulations over time leads to duplicative, obsolete, conflicting and even contradictory rules.

When regulators add more rules to the pile, analysts often consider the likely benefits and compliance costs of the additional rules. But regulations have a greater effect on the economy than analysis of a single rule in isolation can convey.

A recent study for the Mercatus Center at George Mason University proves this theory. Using a 22-industry dataset from 1977 through 2012, the study found that by distorting the investment choices that lead to innovation, regulations have created a considerable drag on the economy, amounting to an average reduction in the annual growth rate of the U.S. gross domestic product of 0.8 percent.

Scholars determined that the cost of these regulations is $4 trillion in lost economic growth since 1980.

“By distorting the investment choices that lead to innovation, regulations have created a considerable drag on the economy, amounting to an average reduction in the annual growth rate of the U.S. gross domestic product of 0.8 percent.

Companies respond to regulatory accumulation by altering their plans for research and development, for expansion, and for updating equipment and processes, and by hiring fewer workers. This has consequences for the economy in the long run.

Gary Cohn, Goldman’s top executive, told the Financial Times that if regulation continued to constrict activities of the major banks, that hedge funds and unregulated businesses would be more apt to undertake risky business maneuvers. He argued that new rules should not just be given to banks, but that they should be applied across all markets.

Last year, GE’s Jeff Immelt remarked that heavy regulation and government interference is hurting the company’s ability to grow and expand overseas. “We are a pathetic exporter,” he told the FT. “We have to become an industrial powerhouse again, but you don’t do this when government and entrepreneurs are not in synch.”

Even small business has endured the burden. “The culture of Washington has been unfriendly to small business as long as I can remember,” Merle Thorpe, principal of Thorpe Architects told the Washington Business Journal. “The economy is simply not managed for long-term stability.”

Bottom line: The effect of government intervention on economic growth is not simply the sum of static costs associated with individual interventions—there are dynamic implications. In fact, 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.

The study develops a multisector endogenous growth model that permits a counterfactual experiment: What would have happened if federal regulation had been “frozen” at the levels observed in 1980? The model accommodates 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.

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 and detrimental effect on economic growth—and, over time, have a real impact on American businesses and their workers and families.

About J.P. Donlon

J.P. Donlon
JP Donlon is the Editor-in-Chief of Chief Executive magazine.