Is America's accumulating pile of regulations slowing down economic growth? According to a new study from the Mercatus Center at George Mason University, the answer is yes: Thanks to regulatory drag, the U.S. economy is $4 trillion smaller than it otherwise would have been.
How do regulations harm economic growth? "For each new regulation added to the existing pile, there is a greater possibility for…inefficient company resource allocation, and for reduced ability to invest in innovation," explain the Progressive Policy Institute economists Michael Mandel and Diana Carew in a 2013 policy memo. "The negative effect on U.S. industry of regulatory accumulation actually compounds on itself for every additional regulation added to the pile."
Mandel and Carew offer three explanations for how that pile slows growth. In the first, regulations act as "pebbles in the stream." Tossing a few small rocks into a stream will have no discernible effect on its flow, but the accumulation of regulatory pebbles eventually dams the river of innovation. (The development of mobile health apps, for example, has arguably been blocked by the accretion of medical privacy rules, Food and Drug Administration approvals, and insurance regulations.) The second explanation rests on how regulations can interact in counterproductive ways—think of how fuel economy standards push automakers toward lighter vehicles even as safety standards favor heavier cars. The third focuses on "behavioral overload." As the web of regulations becomes more complex, confused managers and workers must direct more resources to compliance and away from innovation and company growth.
The proliferation of federal regulations ultimately affects the rate of improvement in total factor productivity, a measure of technological dynamism and efficiency. Regulations also affect the allocation of labor and capital—by, say, raising the costs of new hires or encouraging investment in favored technologies.
The Mercatus Center's new study refines the earlier work of two economists, John Dawson of Appalachian State University and John Seater of North Carolina State. In a 2013 Journal of Economic Growth article, Dawson and Seater constructed a regulatory burden index by tracking the growth in the number of pages in the Code of Federal Regulations since 1949. That number, they note, increased sixfold from 19,335 to 134,261 in 2005. (As of 2014, it had risen to 175,268.) The authors devised a pretty standard endogenous growth theory model and then inserted their regulatory burden index to calculate how federal regulations have affected economic growth.
Their astonishing conclusion: Annual output in 2005 was "28 percent of what it would have been had regulation remained at its 1949 level." If not for the growth in the regulatory burden, gross domestic product would have been $53.9 trillion in 2011 instead of $15.1 trillion—a 2 percent annual reduction in economic growth cumulated over 56 years. Americans are significantly poorer due to federal regulations, without which 2011 U.S. per capita income would have been almost four times higher, at $168,000 instead of $48,000.
The compliance costs alone are enormous. The Competitive Enterprise Institute's report Ten Thousand Commandments 2015 estimated that it costs consumers and businesses almost $1.9 trillion—more than 11 percent of current GDP—to comply with current federal regulations. That exceeds the $1.82 trillion that the IRS is expected to collect in both individual and corporate income taxes for 2015. The report notes, "Federal regulation is a hidden tax that amounts to nearly $15,000 per U.S. household each year."
But as bad as that is, regulatory compliance costs pale in comparison to the loss of tens of trillions in overall wealth, as calculated by Dawson and Seater.
To update those findings, the Mercatus researchers devised a new regulatory database analyzing all federal regulations between 1970 and 2014, seeking to determine the magnitude of the limitations and mandates being imposed on specific industries. The information trove, called RegData 2.2, enables researchers to probe how rules handed down from Washington affect key decisions in particular industries, such as amounts of investment, product and service outputs, and market entries and exits. In the study, three economists focus on 22 major industries, including oil, coal, natural gas, chemicals, machinery, metals, computers, trucking, finance, air transport, health care, and entertainment.
The Mercatus researchers cranked their data through an endogenous growth econometric model to estimate the regulatory effect on entrepreneurs' investment decisions throughout the U.S. economy between 1980 and 2012. "In endogenous growth theory, innovation is not an exogenous gift from the gods but rather the result of costly effort expended by firms to realize gains," they explain. "The growth generated by that entrepreneurship can be thwarted by misguided public policy." Money and brainpower spent on compliance cannot be invested in innovative technologies and processes that boost productivity, create new companies, and speed up economic growth.
So what did they find? "Our results suggest that regulation has been a considerable drag on economic growth in the United States, on the order of 0.8 percentage points per year," the Mercatus economists report. Though their estimate is a bit less than half that found earlier by Dawson and Seater, they believe that "it is still within a reasonable range, especially since their study covers a longer time horizon."
Slowing economic growth by slightly less than 1 percent per year may not sound like much, but it adds up over time. Consider that in 1980, U.S. GDP in 2009 dollars was $6.5 trillion; by 2012, it had multiplied to $15.2 trillion. This implies an annual growth rate of 2.7 percent. If the economy had grown at a rate of 0.8 percentage points more—or 3.5 percent total per year—U.S. GDP in 2012 would have been $19.5 trillion.
"The economy would have been about 25 percent larger than it was in 2012 if regulations had been frozen at levels observed in 1980," the authors say. "The difference between observed and counterfactually simulated GDP in 2012 is about $4 trillion, or $13,000 per capita."
Just for fun, let's apply the Mercatus finding that regulatory drag has been slowing U.S. economic growth by 0.8 percent per year to calculate its cumulative effect since 1949. So instead of growing at 3.2 percent, the economy would have expanded at a rate of 4 percent annually. In that scenario current U.S. GDP would be nearly $28 trillion instead of $16.5 trillion today, and per capita GDP would be $36,000 higher. This suggests that regulatory drag has made Americans 41 percent poorer.
In 1982, the public choice theorist Mancur Olson famously argued in The Rise and Decline of Nations 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 someday turn America's economic growth negative. Dawson and Seater argue that in the long run that will "not be tolerated by society." Let's hope they're right.