The Economic Costs of the Regulatory State: ‘a little hole in the dike can be as damaging as a big one. Just give it time.’

The troubling antics of the remaining three contenders for each party’s Presidential nomination have forced me to detour from postings on Ecomentary.com far too long. Governance issues have been capturing my full attention. Let’s direct some comments to their economic policy recommendations.

Each candidate speaks of doing something for those who feel underserved or even left out of the economic benefits our economy creates. Their substantive proposals amount to two sorts of “cures.” One is to blame someone or a class of “someones” for poor economic outcomes and the other is a continuing advocacy of ‘once size fits all’ remedies—more government intervention. Actually, all three wish to use the government to “do something,” with little or no recognition that government interference is not costless to economic growth. On the contrary, increased regulation has undoubtedly contributed significantly to lower economic growth. A smaller pie, even if redistributed, is not a winning economic strategy.

The two Democrats, Clinton andSanders both argue for more government intervention, more regulation and heavier taxation (albeit more “progressive”).   Trump also argues for government intervention. He wants to punish the Chinese and other “foreigners” for American job losses. He even wants to punish American firms who relocate production overseas. Traditional Republican support for free trade has been eviscerated,  free traders have little to choose between the two parties. Restricting trade is a sure fire method to reduce growth.

One expects Democrats to try slicing up the economic pie and redistributing it to pay off the various political minorities and interest groups that Democrats depend upon to win public office. By assigning much of the blame for the 2007-2008 financial meltdown to greedy bankers, evil mortgage companies and mortgage brokers and other profit seeking financial intermediaries, Democrats don’t look deeply, if at all, into the role played by much faulted government housing policies. They continually advocate more regulation, not less. Meanwhile, instead of attacking the increased interference and regulation that deters the formation of new business enterprises, the Trump response is that voters need to pick a Winner instead of sticking with Democratic losers. Is that a policy prescription or a denial of how the economy actually works?

Neither side seems to understand that government intervention and regulation does not offer a free lunch.   They seem totally unaware that the already well-laden Regulatory State costs the US substantial economic growth. Obama always argued that the US needed to become more like Europe. He succeeded beyond all measure. The US has more regulation and lower growth. Welcome to Europe, voters!

Of course, if you think that the economic pie has been distributed “unfairly,” you probably don’t focus on how to bake a larger pie. You might not even think that regulation can affect how fast the economy grows. Former President Reagan’s remark that “Government is not the solution; Government is the problem,” has long since been forgotten, even by some claiming to be market- oriented Republicans.

In recent years, however, a number of economists have been focusing on the costs of regulation and how regulation can slow and undoubtedly has slowed U.S. economic growth. When the question is, How much does a reduction in annual growth of say 1% per year actually cost the US, when that reduction continues over say a thirty five year period, the cost is staggering. A bigger pie was available, but increased regulation destroyed a much better outcome.

A recent study published on the Mercatus.org web site (“The Cumulative Cost of Regulations,” by economists Bentley Coffey, Patrick McLaughlin, and Pietro Peretto) provides some insight. They estimate US economic growth was lowered by 0.8% per annum as a result increased regulation. Putting it more graphically, they find our economy would be 25% larger today than it actually is —-even if the costs per annum were as small as 0.8% per year. We conjecture that the annual costs might well exceed 1%.

There are many studies that show that the current level of reporting now required under environmental, health care and labor regulations pose a heavy cost burden for new, small businesses. New business formation lags in spite of very low interest rates.  Yet, it is widely understood that real economic growth comes from precisely this segment of the economy. It is also well noted, but yet unexplained, that business investment in plant and equipment has been unpredictably sluggish.   Perhaps, our declining productivity trends are not just accidents due to “slower innovation.”

These are subtle arguments but none of the candidates care or perhaps are even aware of them. They have missed the truism that a little hole in the dike can be as bad as a large one, given sufficient time. Time makes water a very powerful cumulative force. Similarly, even small decreases in annual economic growth can cumulate to a very large reduction in actual output. Increasing regulation works the same way and the US economy is badly under achieving.

It will be hard to punish the “foreigner” for our own failings. Punishing our own business sector can only worsen the problem of inadequate growth. The first step in getting well must be a proper diagnosis of our growth disease.   We become our own worst enemy when we listen to the Siren calls  for more regulation by the current candidates.