Wednesday, November 16, 2016

WHY WAGES AND INCOMES HAVE BEEN STAGNATING


WHY WAGES AND INCOMES HAVE BEEN STAGNATING
According to Nobel laureate and influential public intellectual Joseph Stiglitz, “In the US, the bottom 90% has endured income stagnation for a third of a century. Median income for full-time male workers is actually lower in real (inflation-adjusted) terms than it was 42 years ago. At the bottom, real wages are comparable to their level 60 years ago.”
These statistics drive much of the current political debate in the United States, Canada and most other Western democracies. The trouble is that they measure the wrong thing. Wages and incomes determine the amount of market goods and services consumers can buy. But through time public demand has shifted increasingly to the provision of non-market goods that determine well being and are supplied by governments: the stability and predictability of income, the quality of the environment and characteristics of national culture.
Politicians have responded to these demands with a vengeance. There now are public insurance programs that make incomes more stable and predictable: government-run insurance against the results of personal ill health, accidents, unemployment and retirement. For the entire economy there are regulations for the prevention of financial instability, global warming and harm to the safety of consumers and workers.
The public has also demanded policies that affect its sense of well being by making it feel good: policies to clean the environment; make the distributions of incomes and wealth more equal; create racial and gender equality; accept large numbers of immigrants and refugees and create a multi-cultural society.
There are several aspects of these government policies, which bear directly on the problem of low wages and incomes discussed by Stiglitz. First, the benefits from social insurance programs involve the redistribution of incomes. The value of the programs to society is assumed to be equal to the governments’ cost of operating them, which means that these programs can never increase the productivity of labour and capital and lead to higher average incomes and wages.
Second, policies aimed at the delivery of other non-market goods result in ephemeral, non-measurable benefits at an uncertain time in the future that cannot be recorded in wage-increasing current income, as is the case with policies preventing of global warming or financial crises.
Third, while these non-market benefits are not recorded in national income, their creation results in the use of labour and capital that is withdrawn from the production of market goods. The value of resources used by regulatory agencies and by private firms complying with regulations has been estimated to be worth $1.8 trillion in the United States in 2015.
In addition, some regulations reduce economic growth by imposing costs and delays on entrepreneurship and innovation. Some regulations actually lower growth, as will happen if the efficient use of fossil fuel is replaced by the less efficient use of renewable sources of energy to create electricity. (The US Supreme Court has in fact stopped this replacement on the grounds that the costs are too large.)
In effect, these economic consequences of regulations show again that there is no such thing as a free lunch. The more the public wants greater security in all aspects of their lives and more feel-good policies, the smaller will be incomes and wages that can be used to buy market goods.
These public preferences can also explain the vexing puzzle why since 2008 interest rates near zero have not generated economic growth. The reason is that reduced incomes and wages of the public have lowered the demand for private goods and the need for growth-generating investments by so much that even the very low interest rates are insufficient to induce private sector investment and cause cash-rich companies to buy back shares or their competitors.
The shift of the public demand from market to non-market goods has profound implications for economic policies. Expansionary monetary and fiscal policies to stimulate the production of market goods must fail because the stock of labour and capital are finite and already utilized fully in the production of market and public goods. In addition, expansionary monetary policy will create inflation and expansionary fiscal deficits will eventually become unsustainable. Both pathologies can be cured only by recessions and fiscal austerity.
The preceding analysis does not imply that the growth in the production of non-market goods has failed to increase the well being of the public. However, it does suggest that the public needs to be aware that it is impossible to have both, more market and non-market goods and that asking politicians to ignore this fact will lead to inflation and austerity in the future and possibly much more instability and lower levels of income and wages.

Published in the Financial Post on November 9, 2016, page FP7.


Sunday, November 13, 2016

Why Trump won: Two different explanations

Why Trump Won:
The limited shelf life of governments and Obama’s ideological overreach

Herbert Grubel
Professor of Economics (Emeritus)
Simon Fraser University

If you are not fed up with the repetitive and self-reinforcing flood of pundits’ explanations on why Trump won, you may want to read my own two explanations that are different from the ones in the main media.
            My first explanation involves a powerful law of politics: Governments have a limited shelf-life because their appeal to the public inevitably deteriorates with time, much like that of food on grocery shelves. In politics this deterioration is driven by the fact that every policy a government adopts makes some voters unhappy whiles another set of voters becomes unhappy because the government did not pass policies they had wanted.
            Through time these two sets of disgruntled voters grow inexorably and after eight years typically their numbers have become so large that they determine the outcome of elections. This explains why since 1981, every eight years Americans switched between the election of Republican and Democratic Presidents. The only exception occurred when in 1989 Republican President George Bush Senior followed the Republican President Ronald Reagan, which might be considered evidence of the working of the law of limited shelf-life.  
            The existence of large pools of disgruntled voters every eight years suggests that the optimum strategy of candidates for election is to have their campaign platforms dominated by the promise of change, which captures the support of voters disgruntled by policies adopted by the past president and of voters who expect to see their preferred policies enacted by the next. This strategy was successfully used by candidates Barack Obama’s with his slogan “hope and change” and Donald Trump’s with his slogan “complete change”. To her disadvantage, presidential candidate Hillary Clinton could not use this strategy because she had to support the Obama policies she had helped to create as an administration insider.
            The second reason for Trump’s win involves what Charles Krauthammer considered to be “the most overlooked factor in the election”: the historic and never ending battle between the political right and left in which “Obama overreached ideologically”. The American system of governance has prevented presidents from moving the lines of battle too much, even as it has moved through time in small incremental steps to the ideological left.
            Obama’s overreach involved the pursuit of policies in the tradition of the political left, which sees a large role for governments in the fields of national health care, climate change, foreign policy, income redistribution, immigration and strengthening the rights of minorities. The evidence that these policies represented an ideological overreach is found in the fact that starting in 2012, four years after Obama took office, every election brought to Washington more Republicans who had campaigned on the promise that they would stop these policies, which ultimately led to Republican majorities in both Houses of Congress.
            Obama disregarded the signal these election results had sent and pressed ahead with his legislative agenda with few changes or compromises, forcing Congress to prevent the passage of most of his legislation and producing the infamous Washington stalemate. Obama responded by using executive orders to advance his agenda.
            The American public became increasingly more angered by Washington’s left politics that they believed caused unemployment, kept down wages, worsened domestic and foreign security and interfered with their traditional cultural and religious practices. Shortly before the election, the loss of employment in coal-producing industries and regions and increases in medical insurance premiums effectively reminded voters of this problem while large numbers of voters dealt daily with the annoying and costly regulations affecting their work on farms, as fishermen, in financial institutions, doctors’ offices, hospitals, schools, accounting offices, manufacturing and many other forms of employment.  
            Trump’s appeal to voters was due to his promise to end the Obama’s ideological overreach by dealing harshly with the Washington establishment, which had failed to respond to the message the voters had sent through the election of a Republican majority of Congress. Clinton lost because she had no choice but to promise continuation of the hated Obama policies. She was part of the establishment that had created them, as Obama reminded voters throughout the campaign.

            In sum, Clinton lost in spite of Trump’s confrontational and politically incorrect campaign and style resented by many voters simply because she could not overcome the law of limited shelf-life of governments and the widespread resentment caused by Obama’s ideological overreach. 

Wednesday, November 2, 2016

100 MILLION IN 2100 AND CANADA’S INFLUENCE ON THE WORLD

Recently Terry Corcoran, Dominic Barton and Andrew Coyne have advocated that Canada raise the number of immigrants to 450,000 a year and a population of 100 million in 2100 on the grounds, in Coyne’s words, “it would add to our clout in the world...our ability to project our interests and values on the world stage.”
     The advocates of the higher immigration levels called the Century Initiative believe that Canada is the shining model of a tolerant, caring, egalitarian, democratic, open and economically successful society, the projection of which to the world will be leveraged by the country’s increased size. Canadians will be proud to be citizens of a country able by its example to create a better world. The public intellectuals behind the idea already bask in the praise of their ideological peers everywhere.
     The ability to gain enough clout to engage in such a projection requires a reality check. According to the latest UN Projections, in 2100 the world’s most populous nations will be (in millions): India (1,660), China (1,004), Nigeria (752), USA (450), Republic of Congo (389), Pakistan (364) and Indonesia (314). If the proposed immigration policy will be enacted, Canada’s population in 2100 will be to .97 percent of the world’s total population, double the present .48 and what it would be without the larger annual number of immigrants. 
     Will such a projection take place and be successful? If history is a guide to the future, the outlook is not promising.  In 2100 all countries will continue to have serious problems of their own. The need to combat income inequalities, religious, racial, regional and international tensions will continue to exist. These political realities plaguing countries like India, China and Nigeria are too well known to need elaboration.  They also afflict all the middle sized countries of Europe, Asia and South America as well as the small countries in all parts of the world. For politicians in these countries studies of Canada’s shining success are likely to be very low on their list of priorities.
     It is also possible that by 2100 Canada itself will cease to be the model for the world. The 100 million citizens will have required housing and economic and social infrastructure, the provision of which will be costly and divisive and will be in conflict with policies to combat global warming, preserve the environment and finance the governments of the First Nations. It remains to be seen whether dealing with these problems will be possible without changes in Canada’s ability to be the tolerant, caring, democratic, open and economically successful society it now is.
     These problems will be aggravated if Canada changes from a first-past-the post to a proportional system for the election of its politicians.  Under this system groups Canadians united by common national origins and cultures will form political parties dedicated to fight for their interests. Elected politicians in Ottawa will no longer spend most of their time on the design of the best policies for increasing national output but will instead engage in fights over the distribution of national output among the groups of Canadians represented by their parochial political parties.
     Even in the absence of the proportional system for elections, the very size of Canada’s population resulting from the proposed 450,000 immigrants is likely to create ethnic enclaves where alien languages and cultural institutions dominate life and where, like in Richmond, BC, it is virtually possible to be born, educated, entertained, work, retire and die without knowing a word of English. These enclaves will gain increasing influence on government policies that advance their interests at the expense of the broader public interest. Perhaps public policies can prevent the development of enclaves and their exercise of political power, but it is by no means certain that they can.

    All of the above observations are made before even considering that most of the economic gains expected from the 100 million in 2100 are unlikely to be realized. The discussion of these issues will have to wait for another article.

This article was published in the Vancouver Sun on Saturday, November 12, 2016, page E5 under the title "Canada a beacon at 100 million? That's doubtful. History doesn't paint a rosy picture"

Tuesday, October 4, 2016

TOO MUCH MATHEMATIC IN ECONOMICS?


The excessive use of mathematics in economics has long been discussed by professional economists. The topic has now reached the general public when recently John Robson and Stephen Gordon debated the topic in the National Post, one of Canada’s two national newspapers.[i]

According to Robson “Mathematical technique has severe limits, including that you cannot model the economy. There are too many variables, whose interactions are too uncertain and whose feedbacks are too complex. In short, it is transcomputable. (sic)”

Gordon argues “Robson’s assessment of the complexities involved in economic analysis is depressingly accurate, but these complexities strengthen, rather than weaken, the case for using models and mathematics as tools for understanding economics.”

 Both authors are right and the real issue is whether the use of mathematics in economics is at an optimal level. Larry Boland and I published a peer reviewed article on this subject in 1986.[ii] In it we documented a rapid growth in mathematical economics in publications and teaching, which we considered to be an important problem since it attracted increasing amounts of resources away from research and university teaching needed for students‘understanding of the real world, the design of government policies and political agendas.

The failure of mathematical economists to provide students with this understanding of the real world is due to the fact that most of them are poorly prepared to do so. Many come to economics trained in mathematics and took few if any courses in which they would have learned about economic institutions, real world practices and history.
A second problem arises from the fact that some mathematical economists believe that their abstract reasoning has important policy implications, which often are reported uncritically by media that like the findings for political and ideological reasons. In fact, mathematical models never result in valid policy implications since they use many simplifying assumptions, which logically pre-determine the conclusions and often can be changed at will.

However, mathematical modelling also brings some benefits to the profession and the world claimed by Gordon. It has brought rigor to the formulation of some fundamental ideas in economics, such as the way in which Adam Smith’s “invisible hand” guided by competition leads to a welfare maximizing allocation of resources.[iii] It also is fundamental to the design of computer models that are used with limited success for economic forecasting and the study of the effects of government policies.

Assuming that mathematical modelling produces some useful results and that it is achieved by diverting resources away from more traditional approaches to economic analysis, the question becomes how many resources should be devoted to each of the two disciplines.

Our 1986 study argues that the optimum level has been exceeded because economists specializing in mathematic modelling have formed a cartel. They have much more time than economists analyzing the real world to devote to the promoting and praising their work among the public. They scheme and take over hiring and tenure decisions in economic departments. They become editors of journals and find referees sympathetic to studies heavy on mathematical modelling. The resultant publications lead to tenure and ever more of their friends in university positions. They also are very influential in the committee that chooses winners of the Nobel Prize in Economics awarded annually by the Swedish Central Bank.[iv]

Nobel laureate George Stigler has argued that competition among universities and the success of their economics graduates in finding jobs in the real world limits the ability of mathematical economists to create such a cartel and that at any time the use of mathematical economics is at the optimum level.

Surveys of economists undertaken for our 1986 study showed that most disagree with Stigler and that research and teaching mathematical models has been much above optimal. It would be interesting to know what Gordon and other economists think about this issue in 2016.



http://news.nationalpost.com/full-comment/stephen-gordon-the-case-for-mathematical-models-in-economics. The references show the titles of the articles, which in turn summarize the views expressed by the two authors.

[ii] Herbert G. Grubel and Lawrence A. Boland, “On the Efficient Use of Mathematics in Economics: Some Theory, Facts and Results of an Opinion Survey”, Kyklos, August 2986, found at http://onlinelibrary.wiley.com/doi/10.1111/j.1467-6435.1986.tb00779.x/abstract

[iii] This work has been done by Nobel laureates Kenneth Arrow and Gerard Debreu.  In 1988 I presented a seminar on trade in services at a research institute in New Dehli, India, which demonstrated to me the misuse and misunderstanding that can arise from a faulty interpretation of mathematical modelling. During the discussion a young economist with a PhD from the Massachusetts Institute of Technology challenged me with the proposition that the mathematical model by Arrow and Debreu had proven that capitalism did not work since some of the assumptions they made in their analysis did not hold in the real world. Fortunately, the discussion of this issue ended after the director of the institute reminded his colleague that the theme of the seminar was trade in services, not the merit of capitalism versus socialism.
[iv] In the 1970s Peter Lloyd and I published a number of papers and the book “Intra-Industry Trade: Theory and Measurement of Trade in Differentiated Products” (MacMillan, 1976), which contain very nearly the same models and conclusions reached by Paul Krugman in his papers on the subject. Krugman received the Nobel Prize in 2008 for his work, all of which was published several years after the appearance of the Grubel and Lloyd studies. While we used words and diagrams to develop our theories, Krugman used mathematical models to explain his. However, we are pleased to know that the Nobel committee acknowledged our work as having been the most important inspiration for Krugman who used the empirical evidence we had provided.   



Wednesday, September 28, 2016

CANADA’S OLYMPIC SUCCESS: 10TH OR 62ND BEST IN THE WORLD? HOW TO IMPROVE FUTURE SUCCESS.

Now that the excitement brought on by the Rio Olympics has died down, it is time to have a sober second look on how well Canada’s athletes have done and consider this record in planning for the Tokyo Olympics in four years.

The 4 gold, 3 silver and 15 bronze medals won by our athletes add up to a total of 22, which puts Canada into 10th place.[i] This rank has received the bulk of media attention and is remarkably good, given that 207 teams had been in the competition and 86 of them had won at least one medal.

One problem with using the sum of medals as a metric of success in the minds of many is that it counts equally medals of all colours. For this reason, some prefer ranking on the basis of gold medals won. By this standard, Canada has achieved a very respectable rank of 21st.

Another method is used widely to take account of the fact that medals are of different colour. It assigns 4 points for gold, 2 for silver and 1 for bronze. Canada’s medal count weighted in this way comes to 37, which puts Canada in an excellent 17th  place.

However, these rankings fail to account of differences in the size of countries that sent teams to Rio. Canada is in 33rd place on a list of all countries ranked by the number of medals won for every million of people.

Canada is in 62nd place according to the count of medals won per billion dollars of national income, which reflects the availability countries’ financial resources used for training and selecting athletes.




Team Size and Medals

There is one final and important metric used for ranking countries. It is based on data shown in the table below: the weighted number of medals won and the size of the team, which allows calculation of the percent of team members who have won a medal (the ratio of team size over the number of medals).

The table shows that 53 percent of the US team members won a medal, which ranks that country in second place. Of Canada’s team, only 11 percent won a medal and the country ranks 53rd.[ii]

Rank
Country
Weighted
Size of Team
Ratio of
Medals Won
Team Size/Medals
2
United States
296
554
53
6
Jamaica
32
68
47
7
Great Britain
171
366
46
8
North Korea
16
35
45
9
Kenya
37
89
41
10
China
166
413
40
35
New Zealand
39
199
19
44
Australia
64
421
15
53
Canada
37
314
11

The countries shown in the table were selected for this analysis because their programs for the preparation and selection of athletes are of interest to Canada’s efforts to send successful teams to the Olympics.

Relevant for this quest is the success of the US team. It is due mainly to the competitive sports programs of its colleges and universities, which train and identify talented athletes for the Olympics.

The successes of the teams from North Korea and China are the result of their governments’ sponsorship of expensive training facilities and coercive methods which have little to teach democratic countries like Canada.

Of greatest relevance to the evaluation of Canada’s program is the success of countries like Jamaica and Kenya, ranked in 6th and 9th place, respectively. Both countries sent relatively small teams of athletes who competed in a small number of sports. Jamaicans dominated the sprint events. Kenyans were prominent in endurance races. Their success appears to be based mainly on their focus on a limited range of sports in which they competed.

Great Britain’s medal haul was its largest in 100 years and was based on rich financial support from the National Lottery arranged by the government.[iii] This support for the team in Rio was a record level. But the country’s success is also due to the same policy used by Jamaica and Kenya. A limited number of sports with past success received most of the financial support. To the dismay of many in Britain, some very popular sports like basketball ended up without representation in Rio. 

Canada, New Zealand and Australia have very similar histories, cultures and per capita incomes. New Zealand’s population is 4.5 million, Australia’s 24 million and Canada’s 36 million. These figures suggest that Canada should have outperformed the other two countries. In fact, it ranks the lowest in 53rd place while New Zealand and Australia are in 35th and 44th place, respectively.

The data on the relative performance of Canada’s athletes in the Rio Olympics suggests that its methods for preparing and selection them could be improved. One approach for doing so would encourage more competition among students of the country’s colleges and universities and participation in US academic leagues.

More financial support from governments and the public sector would help, but within any level of such resources, the largest improvement in the success of future Canadian teams in the Olympics is likely to come from limiting the range of sports that receive financial support and the attention of trainers.

Canada has engaged in this policy in the past and it is possible that the low ranking in the Rio Olympics is the result of the focus on the support of competition in the Winter Olympics, but an evaluation of this proposition requires more resources than are available to me.



Political Correctness and the Rio Games

A final note on the Rio Olympics is that they have not been criticized by activists and politicians concerned with fairness, gender balance, human rights, climate change and other efforts to create a better world. There is much to criticize.

·       Out of 207 countries 121 won no medals at all.
·       Out of 22 medals, 16 were won by Canadian women and only 6 by men.
·       Nearly all of the sprints and foot-races were won by black men and women.

Some aspects of the Games would be subject to much political protest if they were found elsewhere.

·       The money spent on the Olympics could have been used to help the needy in the world.
·       Canadian athletes competed against athletes from countries known for the human right violations, creating legitimacy for the often tyrannical governments of these countries. 
·       The Games encouraged nationalist sentiments as medals were awarded while national flags were raised and anthems were played, undermining efforts to create a peaceful world of cooperation and sharing.
·       The games glorified the use of weapons such fire-arms, bows and arrows, sabres and swords, undermining efforts to use dialogue and compromise to settle conflicts. 
·       Horses were confined to small boxes in the holds of airplanes while on their flights to and from Rio, which led to inhumane physical and emotional suffering.
·       The travel of athletes and officials resulted in huge emissions of green-house gases, contributing to catastrophic global warming.

Fortunately, activists and politicians concerned with these conditions stayed away from criticizing the Rio Olympics on these grounds. Let us hope that they will do so in the future. 




[i] All of the data are found in the publication “Medals Per Capita: Olympic Glory in Proportion” found at the website http://www.medalspercapita.com/#medals-by-team-size:2016.

[ii] This calculation disregards the fact that some athletes won more than one medal. It also disregards the fact that all members of a medal winning team receive a medal.  The metric includes only the medal won by the team.
[iii] The analysis of the success of Great Britain’s athletes in Rio draws on:
Ahmed, Murad, Joe Leahy and Samantha Pearson (2016), “Rio Olympics 2016: Britain emerges as sporting superpower”, Financial Times, August 22, found at http://www.ft.com/cms/s/0/e91184a4-67fa-11e6-a0b1-d87a9fea034f.html and

Gibson, Owen, (2016), “Team GB’s Olympic success: five factors behind their Rio medal rush” Rio 2016 Sports Blog The Guardian, August 15, found at https://www.theguardian.com/sport/blog/2016/aug/15/five-factors-team-gb-olympic-success-medal-rush

 


Friday, July 1, 2016

Regulation and Economic Growth










Regulation and Economic Growth



Herbert Grubel
Professor of Economics (Emeritus)
Simon Fraser University





Draft of July 1, 2016

Abstract

At the initial stages of economic development regulations increase productivity and create a positive relationship between the stock of regulation and economic growth but this relationship is subject to diminishing and ultimately negative returns  At later stages of development regulations are increasingly used to satisfy income-elastic demand for government-supplied social benefits and public goods, which reduce growth in the market sector but increase the growth of income defined to include these ephemeral benefits. This model describes conditions existing in the advanced economies of the world.
            The study also discusses the difficulties inherent in the estimation of costs and benefits of regulation, especially in the case of social benefits and public goods. Public choice theory suggests that modern economies are over-regulated.
            The study implies that traditional policies to stimulate growth are bound to fail because of the public’s demand for social benefits and public goods. More political oversight and transparency is recommended to deal with public choice issues around regulations.

JEL Classification: D61, D62, D63, D73, H10, H21, H41, L51, O40



The secular decline in rates of economic growth in the world’s developed countries since the 1970s has been analyzed widely, especially after the unusually poor record of growth after the Great Recession of 2008. Economists have suggested a number of causes such as income inequality, fiscal austerity, excessive levels of private debt and the absence of scientific and technological breakthroughs.

One cause mentioned by all studies of the slow growth phenomenon mention excessive government regulations. This paper focuses on this relationship because of its importance. According to Gordon and Katz (2015) ...regulatory excess increasingly inhibits economic growth. Unless constrained, the regulatory state will overwhelm America’s entrepreneurial spirit...”[1]

In the first part of this paper I argue that for many years in the past the relationship between regulations and economic growth has been positive because regulations during that time tended to enhance economic efficiency and productivity. However, in recent years regulations have reduced growth rates because high average incomes resulted in a public demand for regulations designed to produce social benefits and public goods, which decrease economic growth measured in conventional national income accounts but increases growth in non-measured dimensions of income

Part two considers the implications of the change in the dominant goal of regulations from increasing efficiency to creating social benefits and public goods. My model suggests that a marginal increase in regulations can reduce conventionally measured growth rates but increases rates of growth in income that includes social benefits and public goods. This result is consistent with recently observed conditions in developed countries.

The third part of this study discusses the problems associated with the valuation of the costs and benefits of regulations, which make unreliable all estimates but especially those providing social benefits and public goods.

In part four, public choice theory and the theory of bureaucracy are used to establish a strong presumption that the incentives facing politicians and regulators lead to excessive amount of regulation for the creation of social and public goods.

The concluding section considers the policy implications of the preceding analysis and reviews policies that can and have been used to curtail over-regulation.
The Optimum Level of Regulation

Consider a primitive economy that initially is without a government in which economic growth is determined solely by increases in population and the accumulation of capital in a fixed amount per person. The absence of regulations protecting property rights prevents productivity-enhancing innovations and increases in the stock of capital.

In Figure 1 the annual rate of economic growth and the existing level of regulation are measured along the vertical and horizontal axes, respectively. Under the preceding assumptions, the level of regulation is zero and the annual rate of growth is assumed to be equal to OA.

Figure 1

Now assume that the residents of this economy form a government and give it the authority to establish regulations to protect property, create a police force to enforce them and collect taxes to cover the costs of these policies. The protection of property encourages the accumulation of capital and entrepreneurs to develop new productivity-enhancing technologies and products. The resultant gains in productivity and output are greater than the government and private costs of the regulation. This development is reflected in the upward slope of the curve in Figures 1.

The growth in the size and complexity of the economy following the protection of property is assumed to lead to the adoption of ever more comprehensive productivity-enhancing regulations like those that govern road traffic, standardize units of measurement and money, protect intellectual property and increase education.

This positive relationship is assumed to continue until diminishing returns to regulations set in. This development is reflected in the levelling of the curve in Figure 1 in line with the higher levels of regulation. At the level of OQ regulations the marginal costs and benefits are equal and the optimum level of regulation is reached at the OB rate of economic growth.  Further regulations generate costs greater than benefits and lower the growth rate until it becomes zero at OR regulations.[2]

The growth depressing regulations are especially severe when they reduce the innovative activities of entrepreneurs[3] and the high costs of compliance on established private businesses makes some non-profitable so that the labour and capital they used are redeployed in uses where they are less productive.[4]

New Goals of Regulation

The negative effect of regulations on economic growth is increased as average incomes rise and the people demand social benefits that are not sold in private markets such as protection from the loss of income due to ill health, unemployment, retirement and disabling accidents. The people also demand that the government supply public goods such as human rights for minorities, a more equal distribution of income and wealth, the creation of desirable industries and the protection of consumers, the environment and culture.

The value of these social benefits and public goods are not included in national income estimates based on existing accounting conventions but their production requires labour, capital and generates losses in the efficiency of the private sector and thus reduces conventionally measured economic growth. 


A Different Optimum Level

In Figure 2 the horizontal axis measures the stock of regulations. The vertical axis on the left side represents growth rates for GDP measured according to present accounting conventions. The right vertical axis measures growth rates for GDP including the value of the currently non-measured benefits from the consumption of social and public goods.

In Figure 2 the solid line AR replicates that shown in Figure 1.  The broken line AT shows the relationship between regulation and the new index of national income that includes social and public goods as well as the traditionally measured income. The two lines coincide until regulations are at OX.  Thereafter, the two curves diverge and the curve reflecting additional value of social and collective benefits is a broken line.

I hypothesize that conditions existing in the real world are described in Figure 2 when the level of regulations is at OS, the growth rate of conventionally measured income is OD and the expanded measure of income is at SC. These conditions are the result of the public’s demand for income-elastic social and public goods, which use resources that cause conventionally measured growth to be low.

The preceding analysis has important policy implications. The low levels of economic growth of recent times that has attracted so much attention cannot be cured by the traditional policies stimulating investment and innovation. The slow rates of growth are the cost of creating social and public goods, which absorbs the capital and innovative efforts that otherwise would be used to increase the output of conventional goods and services.

Unfortunately, the data needed to test the validity of the model presented here do not exist. The costs of regulations bringing both efficiency-enhancing and social and public goods have been measured but the measurement of the benefits is elusive, especially those involving the ephemeral nature of the social and public goods. However, for reasons discussed in the next section, there exists a strong presumption that these benefits are over-estimated and have led to inefficiently high levels of consumption and regulation.

Figure 2



Estimating the Costs and Benefits of Regulations

In a number of studies the level and cost of regulation is assumed to be proportional to the number of regulations in effect. A variant of this approach counts the number of pages required to list existing regulations in the document published by regulatory agencies.

The indices created by this basic methodology suffer from the fact that regulations are very heterogeneous. For example, a regulation restricting the use of a small area of farm land to protect an endangered species costing $1 million annually counts as much as another one-page regulation prohibiting the use of an herbicide affecting millions of farmers and costing billions.

For this reason, the proper measurement of the level of regulation should weight each by the costs it causes. These costs consist of spending on the creation, enforcement and policing of regulations by the government agencies plus the cost of compliance by regulated enterprises and the economic cost resulting from the shift of resources out of their most efficient use in the private sector.

The basic problem with this methodology is that estimates of the costs of regulation encounter a well-known accounting problem. Government agencies and private firms have large fixed costs and no objective and universally acceptable principle exist for allocating proportions of this fixed cost to specific regulations. This fact is important because it can lead to systematic biases in the estimates of costs made by civil servants with ideologically driven policy agendas.

Additional problems with the measurement of the costs of regulation arise from the fact that some require the use of sophisticated mathematical models that employ many assumptions about future developments, which makes the estimates highly uncertain and subject to the introduction of ideologically driven bias.

Economic costs resulting from the effect of regulations on entrepreneurial activities and innovation are especially difficult to measure since statistical surveys cannot obtain information about the extent to which the regulations prevent entrepreneurs from bringing their innovations to market or are completely discouraged from even starting their work.

In spite of these problems with estimates of the costs of regulation, a number of studies have calculated them.  A recent study is by Clyde Crews (2015) who found that for the US economy in 2014 the costs came to $1.88 trillion, or about one half of federal government spending that year. 

The Benefits of Regulation

The benefits of regulations are even more difficult to quantify than the costs. For example, the regulation forcing the installment and use of seatbelts in automobiles reduces injuries and deaths. Savings in medical costs and the preservation of incomes of accident victims from the use of seatbelts can be estimated, but what is the value of the avoided pain and suffering?

Estimates are even more difficult in the case of regulations producing social benefits. For example, what is the value to individuals and society from knowing that their incomes are made more secure through the public provision of health care and pensions?

The value of the benefits from regulations producing collective goods is also impossible to estimate. For example, the value to individuals and society resulting from regulations that reduce the discrimination minorities and women encounter in economic and cultural activities is ephemeral and cannot be measured. Another example is the value of the benefits from the prevention of global warming. The forecasts of temperatures with and without regulations are very uncertain as are their effects on extreme weather incidents, crop yields and property damage.

It is highly unlikely that the problems of producing reliable estimates of costs and benefits of regulations will ever be overcome and the existing, imperfect measure will be used to provide at least some useful information for analysts. However, the next section presents theoretical considerations, which imply that the cost/benefit calculations made by the regulatory agencies are biased in favor coming up with net benefits for specific projects, which lead to the adoption of regulations that objective evaluations would have prevented.

Biased Estimates of Costs and Benefits of Regulation

In democracies politicians are expected to pass legislation only if it improves the well-being of society after due consideration of the resulting costs. Civil servants in ministries and regulatory agencies design regulations needed to put into effect such legislation, with each regulation implemented only if its benefits exceed its costs.[5]

It has long been assumed that politicians and civil servants make these cost/benefit calculations motivated only by the desire to maximize the well-being of society. However, this assumption has been challenged not so long ago by the theory of public choice developed by James Buchanan and Gordon Tullock (1962) and the theory of bureaucracy by William Niskanen (1971) (1975). Buchanan and Tullock argued that politicians are motivated not just to improve the welfare of society but also by the desire to be elected or to stay in office and government. Niskanen argued that the motives of civil servants in the evaluation of regulations are influenced by their desire to enjoy a successful career, high pay, good reputation and important influence on events.
 The work of politicians involves a difficult calculus. On the one hand, they are constantly besieged by groups of citizens and organized businesses with demands for specific laws and regulations allegedly improving the well-being of all citizens. On the other hand, they face the risk that the vast majority of citizens who have to pay the cost of the benefits to the interest may oppose the legislation. While the interest group guarantees the politicians votes and financial support, if only a relatively small proportion of the rest of the population withdraws its electoral support, the politicians’ re-election chances can be doomed.[6]

Buchanan’s analysis suggests that individual voters either do not know about the cost such legislation imposes on them or they believe the cost to be so low that it is rational for them to ignore the issue. As a result, much legislation serving mainly the interest of relatively few citizens is passed even if politicians know that a rational cost/benefit analysis shows it to reduce overall public well-being and a properly informed electorate would vote against it.[7]

Civil servants in charge of designing, implementing and policing regulations are also subject incentives that bias their decisions. On the one hand, if they approve the marketing of a new product that turns out not to be effective or safe, their careers and incomes are threatened. They therefore delay their approval until research indicates that it is effective and safe at a probability much higher than it would they did not face these personal costs. On the other hand, the delay of their approval imposes costs on the owners of the new product and on consumers who would have benefited from buying it. These costs do not enter into the civil servants’ personal calculus determining the conditions for licensing a product. This problem is especially serious in the case of pharmaceuticals, where the delay in the approval of new medications can cause serious, unnecessary suffering by patients with painful and life-threatening diseases.

Finally, it is worth mentioning that over-regulation also takes place because civil servants and politicians are entering these occupations because they believe in the need for governments to deal with the shortcomings of free markets, which they see in producing great inequalities in income and enabling large corporations to exploit consumers and spoil the environment. Given the uncertainty surrounding estimates of costs and benefits of regulations affecting these alleged problems with free markets, their views are likely to under-estimate costs and over-estimate benefits.

Policy Implications

The main policy implication of this study is based on the conceptual framework, which distinguishes between regulations that increase efficiency and economic growth and regulations that bring social benefits and public goods. The shift from the first to the second type of regulation in recent times caused economic growth measured traditionally to slow but has increased growth of income including social benefits and public goods.

This result implies that the existing low rates of economic growth cannot be improved by policies that stimulate capital formation, education and innovation as the increase in these factors of production is likely to be used to meet the public’s demand for more social and collective goods.

It is an open question whether the present mix of investment in the two types of output meets the true preferences of the public because the trade-off between them is not known to the public and politicians and has not been a major issue in election campaigns. The need for such discussion is especially important to counter the populist notion presented by the leading candidates in the 2016 presidential election who argue that economic growth can be returned only by protectionism, isolationism and income redistribution, economic planning and other illiberal policies. These policies will be costly and fail to achieve the desired objective.

The second half of this study implies that the public discussion of the proper mix of regulations aimed at the two types of benefits should take account of the strong presumption that the motives of politicians and civil servants for private gains has resulted in an excessive production of social benefits and public goods.

A broad public discourse on the optimal mix of regulations is important but likely to take a long time to improve political decisions and regulatory practices. In the meantime, governments can adopt policies that ensure that the analysis of costs and benefits is correct and protected from the biases stemming from the selfish motives of politicians and civil servants.

Leading Washington think tanks have done much research, published many studies on regulatory policies and presented proposals for reforms of the regulatory system: The CATO Institute has for more than 25 years been publishing in its periodical Regulation Magazine papers on regulation reform by distinguished researchers; The Competitive Enterprise Institute has been publishing periodic updates focusing on the cost of regulation, the latest of which is by Crews (2016)); and The Heritage Foundation published a volume (Gordon and Katz (2015)) containing recommendations for policy reforms written by a number of experts.

Almost all of the published studies on regulation criticize specific policies on the grounds that the costs exceed the benefits. These studies are valuable and can serve as useful guides for changes in specific policies if and when the people of the United States elect a government willing to consider such changes.

More important are the recommendations found in these studies for fundamental changes in the way the costs and benefits of past and future regulations are determined: The primary responsibility for this task should be returned to the elected members of Congress and away from the unelected the civil servants operating regulatory agencies. To protect the process from politicians attempting to use it for personal gains, the work of Congress should be made transparent and accessible to the media and public scrutiny.

Under these proposed reforms elected officials would face mountains of additional work organizing and attending relevant committee hearings and voting on proposed regulations. Their workload could be eased by restricting the Congressional evaluation of regulations to only those with a likely cost of a certain level, such as $500 million.

Another policy change would be for Congress to invite public petitions for review of specific regulations regardless of the costs estimated by the regulatory agencies. This process should be triggered only if the petitioners exceeded a specific number set high enough to deter frivolous use of the instrument. Such reviews would create an important obstacle to the existence of regulations for which costs exceed benefits and would encourage regulatory agencies to be more diligent in their own research on the costs and benefits they design and consider for adoption.

Strong and effective Congressional oversight of regulations is not much different from that required of military, social and other spending programs. The results of these efforts are unlikely ever to be perfect, but they would almost certainly increase the chances that regulations are efficient and respond to the demand of the general population.

Another approach to reducing the level of regulation in the economy involves using market signals and competition. Chris Edwards (2016) recommends privatization of publicly owned enterprises so that market forces reveal the damage done by regulations and lead to their abandonment rather than rescue by further regulations. Privatization efforts have met with some success but run into powerful opposition from interest groups benefiting from public ownership.

Grubel (1983) suggests the creation of free market zones in which regulations are at a bare minimum and whose commercial success encourages regulated businesses to demand equal treatment. The most successful experiment in this spirit has been the creation of special economic zones in China. The success of the first zones has inspired the creation of many others, led to the reduction in regulations throughout the country and provided the conditions for China’s economic growth. Free market zones have also been created successfully in some developing countries, but few can be found in advanced market economies where political and interest group opposition is pervasive.[8]





References:
Becker, Gary (1976), Toward a More General Theory of Regulation”, The Journal of Law & Economics, Vol. 19, No. 2, pp. 245-248 found at https://www.jstor.org/stable/725165?seq=1#page_scan_tab_contents
Buchanan, James M. and Gordon Tullock (1962), The Calculus of Consent: Logical Foundations of Constitutional Democracy, Ann Arbor: University of Michigan Press, reprint found in June 2016 at http://www.econlib.org/library/Buchanan/buchCv3Cover.html

Chao, Johnny and Herbert Grubel (1998), “Optimal Levels of Spending and Taxation Canada”, pp. 53-68 in Grubel editor, How to Use the Fiscal Surplus: What is the Optimal Size of Government, Vancouver: The Fraser Institute found at https://www.fraserinstitute.org/sites/default/files/HowtoUseFiscalSurplustblContents.pdf

Crews, Clyde Wayne Jr. (2016), Ten Thousand Commandments: An Annual Snapshot of the Federal Regulatory State 2015 Edition, Washington: Competitive Enterprise Institute, accessed June 13, 2015 at https://cei.org/sites/default/files/10%2C000%20Commandments%202015%20-%2005-12-2015.pdf

Edwards, Chris (2016), Privatizing the U.S. Postal Service, Tax and Budget Bulleting No. 75, Washington: CATO Institute found at http://www.cato.org/publications/tax-budget-bulletin/privatizing-us-postal-service

Gordon, Robert and Diane Katz, Editors (2015), Environmental Policy Guide: 167 Recommendations for Environmental Policy Reform. Washington, DC: The Heritage Foundation, accessed June 2016 at http://thf_media.s3.amazonaws.com/2015/pdf/EnvironmentalPolicyGuide.pdf

Grubel, Herbert (1983), Free Market Zones: Deregulating Canadian Enterprise, Vancouver: The Fraser Institute found at https://www.fraserinstitute.org/sites/default/files/free-market-zones.pdf

-------------------- (2016), “Canada’s New Immigration Policies 2016: Good Politics, Bad for the Country”, Optimum Online: Journal of Public Sector Management, 46, 2, summer; found at http://www.journals4free.com/link.jsp?l=29062666

 

Laffer, Arthur (2004), The Laffer Curve: Past, Present, and Future, Backgrounder #1765 on Taxes, Washington: Heritage Foundation, found at http://www.heritage.org/research/reports/2004/06/the-laffer-curve-past-present-and-future

 

Niskanen, William A. (1971), Bureaucracy and Representative Government, Aldine, Atherton

--------------------------- (1975) “Bureaucrats and Politicians”, The Journal of Law & Economics, Vol. 18, No. 3 
Regulation Magazine published quarterly by the CATO Institute, found at http://www.cato.org/regulation/about

Scully,  Gerald (1989), “The Size of the State, Economic Growth and the Efficient Utilization  National Resources”,  Public Choice 63, pp. 139-164



[1] The quote is from Gordon and Katz (2015) page 31.
[2] The shape of the inverted U with the right end of the curve at zero growth rates used here is the same as that found in the study by Laffer (2004), which has tax revenue on the vertical axis and the level of taxation on the horizontal axis and that by Scully (1989), which has economic growth and government spending on the two axis. The study by Chao and Grubel (1998) contains an empirical estimate of the Scully curve for Canada.
[3] The effects of regulation on entrepreneurial innovations, productivity and economic growth are nearly impossible to measure. The legendary entrepreneurs that created computers and other successful products and services in their garage came to the attention of statistical agencies only after they marketed their products successfully, employed workers and capital and paid taxes. There are no records of the entrepreneurs who stopped their work because the regulatory requirements and delays caused them to run out of money or of the entrepreneurs who were discouraged from pursuing their dreams because they knew of the regulatory costs they would face.
[4] The economic costs of regulation caused by the closing of businesses are also nearly impossible to measure because such closures take place all the time for other reasons and in practice it is very difficult to identify the role played by the cost of regulation and other factors affecting profitability.
[5] The study by Gordon and Katz (2015) indicates how policies set by law leads to regulations designed and executed by regulatory agencies. For example the “Clean Air Act” and “Clean Water Act” authorize the Environmental Protection Agency (EPA) of the United States to design, enforce and policy regulations needed to achieve the objectives of these acts.  The Bureau of Land Management, the U.S. Forest Service, the U.S. Fish and Wildlife Service, and the National Park Service pass regulations to achieve the objectives of the “Endangered Species Act” and some provisions of the “Clean Water Act”.
[6] Gary Becker (1976) suggests that the political system leads opposition politicians to make the public aware of the costs of special interest legislation passed by the government. This effort by opposition politicians represents a restraint on the ability of politicians to buy votes and on the size of the costs their legislation imposes on the population.

[7] Current immigration policy in Canada illustrates this proposition. According to the analysis found in Grubel (2016) the government headed by Justin Trudeau elected in 2015 increased the annual admission of immigrants from 270,000 to 300,000. Canada’s large immigrant communities benefit from this new policy as it strengthens their political and economic influence in the country and allows them to grow their cultural traditions and institutions. This legislation brings the Trudeau government many votes from the immigrant communities, which in some electoral districts can decide the outcome of federal elections. 

The government does not risk a significant loss of votes from the rest of Canadians because they do not know that the legislation imposes serious costs on them or because they have been persuaded that immigrants increase economic growth, prevent labour shortages and create a favorable demographic balance need to finance social insurance program.

In fact, however, these benefits are illusory while recent immigrants impose a heavy fiscal burden of $30 billion annually on taxpayers, mainly because recent immigrants pay taxes much below the national average but consume government services equal to the average. Immigrants also aggravate the problem of income inequality as they raise returns on capital and lower the incomes of labour. In addition they increase the cost of housing and the levels of pollution, traffic congestion and shortage of medical services.

[8] When first I published some studies on this subject and it attracted interest from the media and some jurisdictions in Canada, a powerful mandarin in the federal government wrote to me that he and his government opposed the creation of free market zones because eventually they would spread throughout the country.