The Market, Regulation’s Best Friend

By Max Molden.

"Regulation hinders progress. But if regulation stays moderate, the market process can overcome detrimental regulation and ensure overall progress. And with this the market process quietly supports the popularity of regulation because it makes it seem as if regulation led to more wealth and progress.

In a recent comment here on EconLog, user Mactoul made an interesting observation: “With so much socialism and ever increasing regulations, the world continues to grow ever richer”. This points to a conundrum which has already puzzled Sam Peltzman of the Chicago School. Economics tells us that regulation will make us poorer. But we do have lots of regulation and we’re getting richer, overall. So, perhaps economics is false? Does regulation, in fact, make us richer?

Not so, argues Peltzman in his paper “Regulation and the Wealth of Nations: The Connection between Government Regulation and Economic Progress,” with an explanation that also goes a long way toward explaining the continuing popularity of regulation and the mixed economy. To Peltzman, government regulation indeed has little chance to do good. It distorts market prices, or at least makes it more difficult to respond to them. Consequently, regulation makes us poorer.

But while regulation has this effect, it can stay on a quite moderate level. If this is the case, the free market’s entrepreneurial forces are to a sufficient degree left in play. Clever entrepreneurs engaged in competition will continue to find ways to make profits and thereby continuously satisfy the shifting wants of consumers and with this increase wealth and ensure progress.

When we have lots of regulation and things overall get better, people will usually conclude that regulation was fine and remains desirable for the future. Peltzman succinctly summarizes: “The fact is there was regulation; there was progress, so why change anything?” (p. 199).

And this is just what Mactoul was pointing at. People usually follow the logic post hoc ergo propter hoc. Since the regulation of the economy, in the Western world at least, is moderate, there is enough scope for beneficial entrepreneurial action and the market process. It is the ongoing competition within markets which makes us better off. And since it is strong enough to overcome damaging regulation, it bolsters this moderate regulation which permeates our economies. The superficial observer will think that regulation, and not the competitive market, is responsible for much of the progress we make. Housing, she may be led to think, got more comfortable and cheaper not because of competitors who incessantly innovated and improved their product to win out against their rivals, but because of regulation that stopped greedy real estate sharks from exploiting poor tenants.

The market process, it turns out, may then be regulation’s best friend, covering up the pernicious effects it has. This notwithstanding, it is sobering to look at some examinations of the consequences of regulation for progress. For instance, John W. Dawson and John J. Seater in their 2013 paper “Federal regulation and aggregate economic growth” find that the new regulation which was implemented in the US since 1949 reduced the average growth rate by about 2 percent. Their estimates indicate that the 2005 annual output is roughly 28 percent of that level it would have reached had it not been for additional regulation since 1949. These figures are colossal. They may of course overestimate the effects of regulation. And regulation can of course protect things valuable to us, e.g., the beautiful scenery in a conservation area. But the figures strongly indicate that while regulation is usually insufficiently strong to kill growth, it does hamper growth very much – to such a degree that we should be skeptical as to its desirability. The market process and regulation form a one-sided friendship.

 

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Max Molden is a PhD student at the University of Hamburg. He has worked with European Students for Liberty and Prometheus – Das Freiheitsinstitut. He regularly publishes at Der Freydenker."