The growth of federal regulations over the past six decades has cut U.S. economic growth by an average of 2 percentage points per year, according to a new study in the Journal of Economic Growth. As a result, the average American household receives about $277,000 less annually than it would have gotten in the absence of six decades of accumulated regulations—a median household income of $330,000 instead of the $53,000 we get now.
The researchers, economists John Dawson of Appalachian State University and John Seater of North Carolina State, constructed an index of federal regulations by tracking the growth in the number of pages in the Code of Federal Regulations since 1949. The number of pages, they note, has increased six-fold from 19,335 in 1949 to 134,261 in 2005. (As of 2011, the number of pages had risen to 169,301.) They devise a pretty standard endogenous growth theory model and then insert their regulatory burden index to calculate how federal regulations have affected economic growth. (Sometimes deregulation extends rather than shortens the number of pages in the register; they adjust their figures to take this into account.)
Annual output in 2005, they conclude, "is 28 percent of what it would have been had regulation remained at its 1949 level." The proliferation of federal regulations especially affects the rate of improvement in total factor productivity, a measure of technological dynamism and increasing efficiency. Regulations also affect the allocation of labor and capital—by, say, raising the costs of new hires or encouraging investment in favored technologies. Overall, they calculate, if regulation had remained at the same level as in 1949, current GDP would have been $53.9 trillion instead of $15.1 in 2011. In other words, current U.S. GDP in 2011 was $38.8 trillion less than it might have been.
Let's use those results as the starting point for some rough calculations. The Bureau of Economic Affairs estimates that real GDP in 1947 was $1.8 trillion in 2005 dollars. The real GDP growth rate between 1949 and 2011 averaged 3.2 percent per year. Compounded over the period, that would yield a total real GDP of about $13.3 trillion in 2011; that's the same figure the bureau gives for that year. If regulation had remained fixed at 1949 levels, GDP growth would have averaged 2 percent higher annually, yielding a rate of about 5.2 percent over the period between 1949 and 2011. Compounded, that yields a total GDP in 2005 dollars of approximately $43 trillion, or $49 trillion in 2011 dollars, which is in the same ballpark as the $53.9 trillion figure calculated by Dawson and Seater.
But let’s say that the two economists have grossly overestimated how fast the economy could have grown in the absence of proliferating regulations. So instead let’s take the real average GDP growth rate between 1870 and 1900, before the Progressives jumpstarted the regulatory state. Economic growth in the last decades of the 19th century averaged 4.5 percent per year. Compounding that growth rate from the real 1949 GDP of $1.8 trillion to now would have yielded a total GDP in 2013 of around $31 trillion. Considerably lower than the $54 trillion estimated by Dawson and Seater, but nevertheless about double the size of our current GDP.
All this means that the opportunity costs of regulation—that is, the benefits that could have been gained if an alternative course of action had been pursued—are much higher than the costs of compliance. For example, the Competitive Enterprise Institute's report Ten Thousand Commandments 2013 estimates that it costs consumers and businesses approximately $1.8 trillion—about 11 percent of current GDP—to comply with current federal regulations. That's bad enough, but it pales in comparison to the loss of tens of trillions in overall wealth calculated by Dawson and Seater.
Defenders of regulation will argue that regulations also provide benefits to Americans: lower levels of air pollution, higher minimum wages, and so forth. But the measure devised by Dawson and Seater accounts for both the aggregate benefits and the costs of the regulations. The two researchers note their results "indicate that whatever positive effects regulation may have on measured output are outweighed by negative effects." There may be some unmeasured positive outputs that result from regulation. But the benefits would have to be hugely substantial to offset the loss of $39 trillion in output in 2011 alone. Is that plausible?
Dawson and Seater explicitly do not attempt to separately measure the benefits of regulation in their study, only its overall effects on output. But the Office of Management and Budget does claim to measure the costs and benefits of federal regulation. In the most recent Office of Information and Regulatory Affairs (OIRA) report, the highest estimates for costs and benefits for regulations adopted from 2002 to 2012 are $84 billion and $800 billion respectively. Let's be extremely generous in calculating regulation's benefits and assume that they provide not just $800 billion in total benefits over 10 years, but that much in just one year. Then, just to be sure that we haven't overlooked any non-monetized benefits unaccounted for the OIRA, and to take into account of the fact that number of pages in the CFR have risen six-fold, let's multiply that by 6, yielding an estimated annual regulatory benefit of $4.8 trillion.
That's just a bit more than a quarter of the current GDP. Recall that Dawson and Seater have calculated that if the regulatory burden had remained the same as it was in 1949, the U.S. economy would be about $38 trillion bigger than it currently is. So the upshot of this wildly optimistic set of assumptions regarding the benefits of regulation is that Americans have foregone $33 trillion in income that we otherwise would have had. Or in the alternative case, where a lower rate of growth results in a GDP of only $31 trillion, that would mean that Americans have foregone about $10 trillion in income due to overregulation.
Whatever the benefits of regulation, an average household income of $330,000 per year would buy a lot in the way of health care, schooling, art, housing, environmental protection, and other amenities.
Since GDP growth rates in other industrialized countries more or less track U.S. growth rates over the period, I asked both Dawson and Seater via email if it would be fair to conclude that those countries had also adopted a similar suite of regulations that also slowed their potential GDP gains. Being careful not to go beyond the data in the study, Dawson replied, "Similarity of growth rates really doesn't tell us anything about the growth effects of regulations in the different countries. However, it would be fair to say that many studies (cited in our paper) examine the effects of regulation in many European countries and find large negative effects on employment, investment, rates of new business start-up, and so on."
For example, a 2004 World Bank study of the effects of regulation in a large sample of industrial and developing countries constructed an index of severity of regulation. It revealed that increasing a country's index of regulation by one standard deviation (34 percent) reduces its per capita GDP growth by 0.4 percent. Dawson and Seater's article, in comparison, finds that "an increase in total regulation of 600 percent reduces growth by just 2 percentage points. Relatively speaking, our effect is smaller." With appropriate caveats about differences in various studies, Seater told me via email, "The uniform message that comes through from all the studies I have seen is that regulation has strong negative effects on economic growth."
So if the effects of regulation are so deleterious to economic growth and the prosperity of citizens, why do countries enact so much of it? Dawson and Seater's paper mentions three theories: Arthur Pigou's notion that governments enact regulations to improve social welfare by correcting market failures, George Stigler's more cynical view that industries capture regulatory agencies in order exclude competitors and increase their profits, and Fred McChesney's argument that regulations are chiefly aimed at benefiting politicians and regulators. I asked if their results fit most closely with McChesney's. Dawson replied: "This could be the conclusion that one reaches based on our empirical results (since they show a net cost of regulation over time), but again we did not set out to prove or disprove any particular theory." Seater added that their research does not address the question of "why society allows excessive regulation....It's an important [issue], but it is one for the public choice people to study, not for macroeconomists like me and my coauthor."
One such public choice theorist, Mancur Olson, argued in The Rise and Decline of Nations (1982) that economic stagnation and even decline set in when powerful special-interest lobbies—crony capitalists if you will—capture a country's regulatory system and use it to block competitors, making the economy ever less efficient. The growing burden of regulation could some day turn economic growth negative, but in a note Dawson and Seater suggest that in the long run that will "not be tolerated by society." Let's hope that they are right.