Bad regulatory diagnosis leads to wrong legislative cure

The Judiciary Committee press release unveiling the Regulatory Accountability Act paints an alarming picture about the relationship between jobs and the economy. House Judiciary Committee Chairman Lamar Smith (R-Texas) states: “The current regulatory system has become a barrier to economic growth and job creation. Federal regulations cost our economy $1.75 trillion each year. Employers are rightly concerned about the costs these regulations will impose on their businesses. So they stop hiring, stop spending and start saving for a bill from Big Brother.”

If this picture were accurate, one might appropriately support legislation that a just-released Coalition on Sensible Safeguards study found would “grind to a halt the rulemaking process.” But it is not.

The chairman’s statement incorporates two oft-repeated but fundamentally inaccurate claims. The first is the cost of regulation finding from a study by Crain and Crain conducted for the Small Business Administration. Their $1.75 trillion estimate is a gross exaggeration. It has been debunked by the Congressional Research Service, Obama administration officials, and the Center for Progressive Reform.

A study by EPI’s John Irons and Andrew Green is especially telling. It examines Crain and Crain’s estimate of the costs of economic regulation, which accounts for 70 percent of the overall estimate. The economic regression model used to determine these costs contains a series of fundamental flaws, including reliance on an international data set rife with holes (spotty data typically produces spotty findings), as well as a misspecified regression that confuses regulatory stringency with regulatory quality. The Crain and Crain regression also produces the counterintuitive finding that increased education in a country leads to less economic growth, reason alone to be skeptical of the overall estimate.

Irons and Green correct for just one of the problems with the regression – they fill in the spotty data set – and find no statistically significant relationship between Crain and Crain’s measure of regulation and economic outcomes. This implies that the economic costs of regulation cannot be distinguished from zero, an unsurprising result since certain regulations, such as financial regulations that stabilize the economy, promote economic growth.

The second inaccurate claim of Smith’s is that the specter of additional regulation is what’s causing companies to hold back on additional hiring. EPI has released a series of reports on the relationship between regulations and jobs; one of the clearest findings is that it is a huge shortfall in demand, not regulatory uncertainty, which ails the economy.

In this report, EPI President Larry Mishel finds that data suggesting a significant role for regulatory uncertainty is altogether absent. In fact, investment in equipment and software has grown faster than during the previous three recoveries, and private sector employment has grown much faster than during the last recovery. There are no mysterious lags that might be explained by regulatory uncertainty.

In fact, Labor Department data show that in 2011, just 0.2 percent of mass layoffs have been due to regulation, while 29.7 percent have reflected the lack of demand. (This data is summarized by Bruce Bartlett.)

Of further interest, companies are not using a substantial amount of resources they already have at their fingertips; presumably, they would use these resources more fully before they would increase investment or hiring. The capacity utilization rate (the degree to which current factories and equipment are being used) is still well below its average from 1979 to 2007. Similarly, the average number of hours employed individuals are working each week is still below the pre-recession level. Substantial unused capacity is another indicator that lack of demand, not regulatory uncertainty, explains why economic trends have not been stronger.

Turning to what businesses themselves are saying, Mishel found that the percent of small businesses reporting that regulations are the single most important problem they face has not been out of its historical range during the Obama administration. For instance, the proportion reporting this concern is lower than it was during the Clinton years, when employment growth was rapid. What is unusual now is that the most common problem cited by far is “poor sales (an indicator of the lack of demand);” during the Obama administration, the average share of small businesses citing “poor sales” as the most important problem they face is more than double the average cited in the eight other presidential terms examined.

This Congress has seen many examples of unwarranted economic concerns about regulations driving legislation likely to prove damaging to the regulatory process, thereby undermining essential health, safety, and economic safeguards. The thinking behind the Regulatory Accounting Act is a case in point; bad diagnoses tend to lead to the wrong cures.