Of red tape and recessions
Sep 6th 2011, 15:29 by G.I. | WASHINGTON
HOW much of our economic malaise can be blamed on regulatory uncertainty? Conservatives argue that a wave of Obama administration regulations and the threat of more to come are the primary hindrance to business confidence and hiring. Liberals say that the weak economy is far more important and that any regulations being enacted more than pay for themselves in economic terms.
I’ve been struggling with this question for months and have found the debate frustrating: the terminology is wrong and the subject poorly framed, the evidence fragmentary and unhelpful, and generalisations are rampant. So what follows are a few thoughts that I think clarify the debate, though without necessarily resolving it.
First, it is not “uncertainty” per se that bothers business. Whether uncertainty is unwelcome depends entirely on what’s at stake. What would you prefer: 100% probability of dying next year, or 50%? Most of us would choose the latter. Similarly, business would prefer zero probability of a burdensome new rule, but if that’s not possible, would certainly take 50% probability over 100%. The administration’s decision to delay implementation of a new ozone standard perpetuates uncertainty. Business welcomed it nonetheless because now they do not have to spend money to meet it for at least two years, and perhaps forever if in the interim a new president chooses never to implement it. Does the Federal Reserve create some uncertainty when it undertakes quantitative easing? Probably, but in the process it makes the stability of inflation around 2% much more certain, and that, most businesses would say, is a reasonable trade-off.
Second, “regulation” doesn’t capture the breadth of government activity that affects business confidence, investment and hiring. The threat that America might default must surely have been one of the most toxic sources of uncertainty America’s political classes have yet inflicted on the economy, something you’ll see mentioned in the Federal Reserve’s latest beige book. This speaks to a more deep-rooted alienation between business and Washington. As shown by the chart in this article, based on data compiled by Daniel Kaufmann of the Brookings Institution, American business’ confidence in Congress has been declining for a decade. Business attitudes in Germany and Britain with regard to their respective legislatures have been relatively stable, by contrast. Polarised views about growth in government arose after 9/11 and continued under Democratic and Republican administrations and Congresses.
Third, most critical attention concerns new laws such as the Affordable Care Act or Dodd-Frank. But potentially more important is the way in which existing rules are interpreted, enforced and litigated. Here are a few examples. The Interior Department has canceled offshore leases that Exxon claims may yield billions of barrels of oil. Exxon is suing, claiming that Interior deviated from longstanding practice which was to extend such leases as a matter of course. Immigration and Customs Enforcement since 2009 has been auditing employers and forcing them to fire workers they can’t prove are legal. This represents a shift from its traditional approach of deporting workers but leaving firms alone. The Food and Drug Administration has become stricter and more capricious about approving medical devices. Michael Mandel highlights the trend with a terrific case study here. Finally, there’s the practice by Fannie Mae and Freddie Mac to force banks to take back mortgages they originated during the boom and which have since gone bad. Fannie and Freddie have always had the right to do this but have only exercised it since the bust, I am told. There is merit to the government’s position in each case but surely the effect of each is, on balance, to deter investment, hiring and lending. By how much, I don’t know. Update: The Washington Post has an interesting editorial today pointing out that the Davis-Bacon Act, which requires prevailing wages be paid on federal contract work, has been applied in a new more sweeping way to a $700m development in the District of Columbia. End of update.
A fourth issue concerns the rigorous measurement (or lack thereof) of the impact of regulation and uncertainty on growth and employment; I know of no such gauge. Members of the National Federation of Independent Business say the weak economy is their biggest problem, followed by taxes and regulation. This tells nothing, however, about the actual impact on growth and hiring. We can measure uncertainty in the financial markets with Vix, credit spreads and the like, but those figures reflect macroeconomic, rather than microeconomic, uncertainty.
Both sides of the debate erroneously seek support in the macroeconomic data. Gary Burtless of Brookings tells Mark Thoma that the highest profit margins and lowest corporate taxes (as shares of GDP) in 60 years are not consistent with the argument that regulatory uncertainty is an undue burden: firms should clearly be hiring and investing now to make money before those feared rules become reality. I’m not sure I agree with this logic. Today’s profits reflect returns on yesterday’s investments. Regulations and taxes affect the perceived return on tomorrow’s investments. One could equally argue that businesses’ failure to invest despite such high profits show they are demanding new investment meet a much higher expected return rate because of regulatory uncertainty. Conservatives, in fact, make just that argument. But that, too, is faulty. Corporate balance sheets are flush with cash in countries such as Britain that do not share America’s more activist approach to regulation. The simpler explanation for the hesitancy to invest in all countries is the pervasive weakness of overall economic growth.
Fifth, it is impossible to generalise about the impacts of regulation because they vary depending on the implementation period, type of rule and type of firm. If a cash strapped municipally-owned utility lays off workers in order to buy foreign-made pollution equipment, that’s bad for jobs. But if a cash-rich private utility buys American-made equipment, perhaps jobs, on net, are created. A federal tail-pipe greenhouse gas emissions standard may be costly to business, but cheaper than 50 state standards. Timing matters, too. It is hard to imagine new CAFE standards taking effect in 2016 materially hurting the car industry since the changes can be accommodated through one to two model changeovers. On the other hand, forcing banks to hold additional capital and liquidity now, pay higher deposit insurance fees and subject credit card and mortgage borrowers to higher underwriting standards impairs the supply of credit at a time when the economy badly needs it to be loosened. Far better to do this when credit conditions are easy again.
Sixth, all regulations have trade-offs. An intriguing question is whether those trade-offs are worse when the economy is weak; Mr Mandel makes this case in advocating countercyclical regulatory policy. In other words, he argues that regulators be more sparing with new rules when the economy is weak. Do we want workers to have an easier time forming unions? Is net neutrality essential to competition on the Internet? George Bush said no, Barack Obama says yes. But even if the answer is yes, couldn’t these decisions wait? If business confidence is particularly fragile, won’t such policies be costlier now than later? I see the case for countercyclical fiscal and monetary policy; the former is less likely to crowd out private investment and the latter to generate inflation when the economy is below potential. Is there a similar argument for countercyclical regulatory policy? Does the discount rate vary over the cycle in such a way to make a regulation more costly at some times than others? If so, then it may be harder to justify a rule that costs jobs today but saves a life tomorrow when fear, anxiety and discount rates are high, as they arguably are now. I’d like to see more analysis of this issue.
Seventh, even when government action creates costly uncertainty, that may not be reason to delay. Invading Afghanistan raised fears of further terrorist attacks in America but that was judged a necessary price for long-term security. (The same argument was made, tragically, for the invasion of Iraq.) Delaying the implementation of a carbon cap-and-trade plan may be good for business in the short run but very bad for the planet in the long run. Very little about the discussion of the impact of regulation on the economy lends itself to the sweeping conclusions so commonly drawn.