The U.S. Regulatory Regime and the Global Economy

By Dr. Nancy Bord The President of the United States, accompanied by executives of major corporations, travelled to Asia in January seeking trade concessions to improve America's competitive position. Ile Presi- dent and his entourage were looking in the wrong p l ace for the cure to America's declining global competitiveness. A major source of the problem is not to be found in Tokyo or Brussels, but rather right here in Washington and, to a somewhat lesser degree in places such as Sacramento, Albany, Austin, and H a rrisburg. For it is from the nation's capital and state capitals that regulation hamper- ing the efficient and effective functioning of our market economy emanates. How can American corporations be competitive in the emerging global economy while struggli n g under the most elaborate and oppressive regulatory regime of any developed market economy in the world? Government regulation operates as an "invisible foot"planted firmly on the back of American business and impeding its global competitiveness. In addi t ion, consumers, whom regulation pur- ports to benefit, pay higher prices as the costs of regulation to business am passed along to them. Fi- nally, overall economic growth has slowed as resources are diverted to regulatory compliance rather than to invest m ent, innovation, and productivity. My purpose today is to describe how government regulations, often well meant but usually ill- conceived and erratically administered, have burdened American business to such an extent that our economic status in key glob a l markets has been seriously impaired. This is not to imply that regula- tion affecting business activities is the only source of our economy's global problems, but that it is a significant and often overlooked causal factor in America's current economic m alaise. In my talk I will discuss the perverse economic effects of regulation in general, then focus on spe- cific regulatory regimes, and finally provide some possible prescriptions. Costs of Regulation. Regulatory regimes comprise a body of laws, execut i ng rules and adminis- trative practices, and judicial decisions accompanying them. They have effects which impose costs on the enterprises regulated. A dozen years ago, in his book The Future offtsiness Regulation, Murray Weidenbaum, who served as chairma n of President Reagan's Council of Economic Advi- sors, outlined an analytical paradigm for assessing regulatory effects. He defmed three types of ef- fects of regulation: * Direct effects; * Indirect effects; and

* Induced effects.

He concluded that any analysis of regulatory costs and burdens on business enterprises should consider all thtee. Direct effects are those related to or mandated by a piece of legislation and its implementation rules that immediately and obviously have an impact on production and operational costs. The Cen- ter for the Study of American Business at Washington University in St. Louis regularly estimates

Dr. Nancy Bord is a Bradley Resident Scholar at The Heritage Foundation. She spoke at IU Heritage Foundation on January 16, IM. ISSN 0272-1155. 01992 by 7be Heritage Foundation.

the costs of such regulation on individual manufactured items and the aggre gate costs which are then passed on to consumers. One of the Center's studies shows that the retail price of an American automobile has been increased by over $3,000 due to direct costs associated with federal require- ments. In light of this is there a m y stery about why our autos are not competitive? Other direct costs associated with regulation include the activities of the federal regulatory agen- cies which have been established to enforce and monitor regulatory compliance. In a detailed analy- sis of t he 1992 budget, the Center found that federal spending on regulation will cost an estimated $13 billion for 1992 and employ 122,400 regulators at the federal level alone. More disturbing is the fact that despite a dramatic reduction-in-forct during the fi r st Reagan Administration, the num- ber of federal regulators is greater today than in 1980. These costs, of course, are borne by us as taxpayers, and the assets thus allocated to regulation are diverted from odw potential, more productive uses. Recent stu d ies reported in the Journal ofRegu- lation and Social Costs and in The Heritage Foundation's Policy Review estimate the direct costs of regulation at $400 billion per year. The measures and cost categories may differ, but the overall conclusion is that th e direct costs of regulation are formidable. They fall primarily on business en- tm-prises who then pass them on to consumers. In the electric utility industry, for example, environmental regulations imposed over the past de- cade have been largely respons i ble for the dramatic increases in utility rates during this period. Sim- ilarly, regulations such as the Jones Act, requiring shipping in American bottoms, add substantially to the direct cost of exporting our products. The list goes on and on. It is diff i cult to identify a sin- gle product or production process that escapes regulation's direct effects. Ironically at the same time the U.S. is held to be the model free market economy. Indirect effects of regulation further contribute to the regulatory burde n and am less visible. Compliance costs, particularly those involving paperwork and administrative activities necessary to demonstrate to regulators that an enterprise is properly carrying out regulatory requirements, re- sponding to date requests, prepari n g filings and applications or requesting waivers are chief among these types of effects. Conservative estimates an that 150,000 man-years of effort which might be otherwise productively employed is spent by American firms each year simply responding to re g ulators' information requests. Regulation also introduces delays and impediments in day-to-day business operations as regulatory agencies must process and approve applications for permits, re- quired filings, and licensing requests. The time required for n ow products and processes to pass through the regulatory maze is truly alarming and harmful to innovation. Overall. loss of productivity is the most telling indirect result of the American regulatory regime. The productivity advantage the United States on c e enjoyed has long since disappeared into the regu- latory morass as more and more resources are diverted to regulatory compliance. Induced effects of regulation are the third am of impact. These effects of business regulation are probably the most insidi o us because they are largely hidden. These types of effects take the form of opportunities lost or forgone in investment, innovation and activities which stimulate eco- nomic growth over the long-term. There is no question that the capital formation proces s in this country has been brought nearly to a halt over the past twenty years and particularly after the 1986 tax reform act, which actually penalizes capital formation. This fact would not be so bad so long as the United States was perceived as a favorab l e environment for foreign direct investment. But, largely because of the onerous burden of regulation, at both state and local levels, this is no longer the case. The data show a marked decline in foreign direct investment in the United States over the pa s t year as the regulatory burden on business has increased. Thus, the negative consequences of the -three types of regulatory effects reinforce each other in un- dermining America's competitive position. Inamuod costs of production and distribution from re g- ulatory requirements, diminished productivity, the diversion of resources to regulatory compliance,

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and a mom hostile environment for innovation, investment, and growth taken together represent a nearly insurmountable burden for American business. Further they have the most serious impact on small and moderate size enterprises, the driving force of economic growth. Chart I shows our assessment of the proportion of those regulatory costs attributable to each cate- gory. (See Appendix.) Types of Regu l ation. In the major project I am completing during my tenure as Bradley Resi- dent Scholar here at The Heritage Foundation, I show how and why economic regulatory regimes in the United States have taken the form and direction they have and compare and con t rast these re- gimes with regulation purportedly governing similar phenomena in Europe and industrialized Asia. I have chosen to focus on three specific areas of economic regulation for particular scrutiny. They deal respectively with regulation of 1) cor p orate dynamics, how business and commercial enter- prises form, change and grow; 2) financial institutions and markets, how business enterprises ob- tain and maintain financial viability and the institutions such as banks and securities markets which are i nstrumental in these processes; 3) taxation, which many regard as a form of regulation, particu- larly in the United States, where taxation is used as a national economic policy surrogate. Just as regulation in general burdens business enterprises and int r oduces a drag on economic ac- tivity and global competitiveness, so these three specific areas of economic regulation have particu- lar dysfunctional effects for business. As if these areas of economic regulation were not enough, the last twenty years hav e witnessed a tremendous fixuase in social and environmental regulation, particularly targeted to business. These types of regulation are not directly related to the functioning of economic enterprises. Rather they are motivated by political and social con c erns. While many of these social objectives may have merit, one may question whether goverment regulation focusing on business activities is the best way to achieve diem. Regulation of corporate organization occurs at the state level in the United States. Regulation of corporate combinations through mergers, acquisitions, and joint ventures occurs at both state and na- tional levels. This type of regulation not only hinders ftee market operations but can also preclude corporate formations and strategic all i ances which can enhance global competitiveness. The United States regulatory regime in this area as it presently exists reflects an anti-market bias and limited perspectives -on both market definition and time horizon. Our principal global trading partner s , outside the Western Hemisphere, in contrast, specifically encourage the development of business entities which are designed to be effective global competi- tors. Increasingly, competitive markets are being defined more broadly. Japan, as a small country oriented toward exports, has always defined its markets globally. Europe, as its regional economy has evolved under the European Community's institutions, defines its markets regionally for assess- ing competitiveness. Only in the United States of all maj o r industrial nations is competitiveness do- fined locally. Of course this is not surprising ff one examines the policy process from which regulatory regimes emanate. The American policy process is essentially local politics acted out in Washington, reinfo r ced institutionally by the frequent election of House members, who tend to be locally oriented. Financial MarketL A second area of economic regulation whose impacts serve to impede the competitiveness of American business enterprises in the global marketp l ace involves financial insti- tutions and markets. The regulatory regimes governing commercial banks and other financial inter- mediaries such as securities markets virtually assure that American institutions will be at a disadvantage in the international marketplace. The existing regulatory regime perpetuates a system which has penalized expansion and innova- tion and artificially supported an illogical superfluity of banking institutions. Is there any evidence

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that consumers and corporations in Can ada with barely a dozen full service banking institutions are less well served than those in the United States with more than fifteen thousand banidng institutions with limited specialized functions? Shifting Management Concerns. American businesses also h ave moTe onerous, short-term ori- ented reporting requirements imposed by government agencies. This tends to shift management's concerns from longer term strategic considerations to short-term financial results. Such a focus gen- erally results in more fr e quent financings which are more sensitive to near-term market fluctuations and a higher weighted average cost of capital for American businesses. This is particularly true for smaller and medium sized enterprises which am most dependent on traditional dom e stic financing sources. As for the American corporate tax structure, we know there is absolutely no economic rationale behind it (even Keynesian economists agree on that). It has long since ceased to be merely a means of revenue production and has become t he principal economic policy tool of the federal govern- ment. Its pernicious effects on corporate behavior both domestically and internationally have been amply documented. On the one hand, the tax code is so broad and sweeping in scope and its excep- ti o ns so narrowly drawn that small and medium-sized businesses, the real engines of economic growth, are penalized. On the other hand, the code as presently interpreted also deters large corpo- rate entities from undertaking new ventures, advanced research a n d development and capital invest- ment. The double taxation of dividends and inherent debt-bias of the U.S. tax code provide incentives and disincentives for corporate strategic decisions which are often not in the best interest of share- holders, consume r s, other corporate constituencies or of the corporation itself. A corporate tax code which inhibits growth and innovation is not likely to lead to the type of business and investment de- cisions which would be made in a market less distorted by such a cod e . In addition, given the corn- plexity and internal contradictions with which the U.S. corporate tax code is replete, the level of uncertainty on the tax implications of a corporate decision is very high even for businessmen with a low risk threshold. Tak e n together the implications of just these dim regulatory regimes can be seen to have a seri- ous and substantial negative effect on the ability of American companies' products and services to be internationally competitive. When the added burdens of healt h , safety, "social," and environmen- tal regulation (now accounting for more than half of all regulatory costs) are included, the red im- pact of regulatory drag on both productivity and cornpetitiveness is truly formidable. Woving Counter-Productive. Soci a l and environmental regulations have no rationale in eco- nomic theory. They have been enacted in the interests of attaining what legislatures. believe is a so- cial good enhancing the general welfare. Granted that the objectives of clean air and water an d equal opportunity are noble goals. However, the heavy-handed, non cost-beneficial manner in which U.S. policy makers have sought to fulfill therri are already proving counterproductive to both domestic economic growth and global competitiveness. As an ex a mple, the Center for the Study of American Business estimates that the 1990 Clean Air Act will add costs of $25 billion to $35 billion per year to the $100 billion already being spent on pollution control. This legislation represented a compromise of the c oncerns of special interests and has resulted in elaborate, confusing, and often conflicting compliance rules. Even the attempt to in- troduce economic incentives to the regulatory process through the mechanism of "tradable emission permits" was greatly d i luted by congressional action. Legislation such as the Occupational Safety and Health Act (OSHA) and the Nfine Safety and Health Act (MSHA) have been perverted fimn their initial worthy purpose to become principally revenue generating devices for the fede ral treasury. An elaborate set of mandated fines covering even the most insignificant and trivial "offenses" has been established. Naturally, compliance is

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most onerous and sometimes disastrously destructive to small and medium-sized businesses. IMese businesses, in many instances unintentionally in violation of complicated and obscure rules, are often operating on slim profit margins. They are unable to insure against heavy fines and penalties as larger enterprises can. New legislation such as the Am e ricans With Disabilities Act and the most recent Civil Rights Act further burden businesses of all sizes but again are especially onerous for small and medium-sized enterprises. One may wonder whether these health, social, and environmental regulatory reg i mes represent a concerted, deliberate effort to make the private sector pay for policies which policy makers would like to endarse but that government simply cannot afford. One may also question the form and sub- stance of these regulatory regimes. My exp e rience has shown that whenever government has in- truded unnecessarily into day-to-day operations of business enterprises the results are usually unproductive for the enterprises themselves, for their customers and for the overall economy. Now added to th e unfortunate results of our onerous regulatory regimes is the added factor of diminished global competitiveness. In Chart 2, major categories of regulation have been rated according to their relative impact on U.S. economic growth and global competitivene s s. (See Appendix.) Direct and indirect monetary costs were considered in these ratings as well as the substantial, less easily measurable induced costs of regulation. What Is to be Done. For the past sixty years, exponents of interventionist economic theo r ies have dominated the economics profession in both academia and government. They have legiti- mized expansion of regulatory regimes. In the past thirty years they have been joined by lawyers who draft and then implement and administer regulations. Thus, t wo key professions (in which I claim membership) have had a vested interest in stimulating and perpetuating regulatory regimes which seriously disadvantage American businesses, particularly in the global marketplace. This is a situation which makes me bot h sad and angry. Sad because I see an economy with unique advan- tages and outstanding resources squandering them, losing productivity and world-wide market sta- tus, in short heading in the direction of overall ewnomic decline. Angry because this is happe n ing unnecessarily. Except for a few zealots who really do wish to punish "big bad business" no matter what, most policy makers really seem to believe regulation is in the best interests if not of some- thing amorphous called "the public," at least of a sp e cial interest group purporting to speak for a larger social good. I spent the first half of my professional career in the corporate world. I have great faith in free markets and private enterprise. It is a pity my faith is not shared by more policy makers , lawyers, and government officials in the United States. But, one may protest, markets are not always fair. Of course not, markets any more complicated than Marlborogh Fair am by defini- tion inherently unfair. However, aside from the barest minimum healt h and safety standards subject to genuine, rigorous cost/benefit analysis and broad-gauged assessment, intervening in market pro- cesses through regulation improves neither equity nor efficiency. Although sad and angry about the regulatory morass which has already dampened economic growth and investment and reduced our global competitiveness, I cannot end on a totally negative note. Ile first glimmer of hope is of course that you are all here listening to me and mostly I ex- pect agreeing with me. Some of y o u are directly or indirectly involved in the policy process. Sec- ondly, there will in due course be a book dealing with all of the points I have made, in greater detail with mom substantiation. I hope the book will be read and discussed by policy makers, their profes- sional advisors, and members of the business community. Perhaps it can increase their understand- ing of the relationships, between three key economic policy areas: regulation, trade, and investment.

Thirdly, this is an election year, an d regulation and trade policy are already emerging as import- ant issues. Now is the time for us to play a role in framing the debate and in tying together the re- lated strands of regulation, competitiveness, and trade. The fourth and final factor which g ives some cause for hope comes from the newly liberated economics of Central and Eastern Europe, who are seeking to emulate our high standards of mate- rial well being. They are embracing free market processes and abandoning, albeit somewhat more slowly t h an they might wish, totally regulated and totally uncornpetitive economies. If they are to flourish, however, they should not seek to emulate our regulatory regimes. A favorite story of my youth was Gulliver's Travels. The edition I owned showed an illust r ation of Gulliver completely immobile on the. ground, swathed in ropes and chains. This image might have some relevance to an economic giant so emersed in regulation he can barely move. We have not yet rewhed this sorry state, so there is still time to ac t . Ample Scope for Action. The direct approach of repealing regulation is most difficult for there are now vested interests in the bureaucracy and the economic and social structure supporting vari- ous types of regulations. Less direct approaches such as t h ose employed during the Reagan Admin- istration concentrate on shrinking goverment enforcement budgets. Since more than fifty agencies of the federal goverment and countless state and local agencies are charged with some aspects of regulatory enforcement, there is ample scope for action here. Beleaguered, resource-constrained, state and local governments could realize substantial cost savings from these measures. A third approach, which I am loath to advocate except in very special circumstances, is to inv o ke the judicial process to challenge the most flagrant interference in business operations. There is some evidence that federal courts are rediscovering the contract, takings, and commerce clauses of the, Constitution. Perhaps these can be utilized to rel i eve some of the, regulatory burden from Ameri- can business and consumers and permit free market forces to function with fewer regulatory im- pediments. However, even ff all existing regulation were to disappear tomorrow, Congress and state legislatures a m still producing legislation requiring new regulation and greater goverment interfer- ence on business and economic operations. Legislators say they are only responding to public con- cerns. But if the American voters, who are also consumers and taxpayers , fully realized the hidden taxes and higher prices they pay because of unnecessary and inefficient regulatory regimes, fully recognized the degree to which special interests and entrenched regulatory constituencies influ- enced the shape and scope of regu l ation, fully understood the burdens on economic growth and global competitiveness inflicted on the economy by regulation, the alleged consensus favoring more regulation would be revealed as a lawmaker's fantasy. This does not necessarily imply that the Un i ted States will automatically capture a greater share of the Japanese automobile market, of course, ff regulation disappeared tomorrow. But to the extent forces of free enterprise in the United States are not artificially constrained by government eco- no r nic and social regulation, they will, at least, be better able to realize their potential through inno- vation, new product development, enhanced investment opportunities, fewer tax penalties, and less uncertainty. Election Year Oportunity. The key to rea l izing a less burdensome regulatory regime must be to go to the root of new regulation, and that is legislation. Merely declaring a moratorium on regula- tion writing and review of existing regulation is not enough ff new legislation requiring more regula- tion is being generated by law makers. In this election year we have an opportunity to elect legislators pledged to regulatory relief for our beleaguered economy. Let us do so in order that we may keep our rightful place as an effective global competitor.

Appendix

Induced Costs

50%

Indirect Costs Direct Costs 20% 30%

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Chad 2 Impact of Regulation on Economic Development and Global Competiveness

Level of Impact Type of Regulation Moderate

Economic Taxation

Financial Institutions and Markets X

Corporate Formation

Antitrust X

Social Regulation/Health& Safety X

Environmental Regulation F. . . . .. . . . . . . ........ . . . . . .. . . . . . .

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