Regulation and Economic Growth

A recent New York Times article reported on some U.S. businesses that are getting increasing investment in light of the Trump Administration’s deregulatory efforts. Although the claims are broad, the article specifically mentions the rollback of Obama-era regulations on the coal industry as an example.

Economist Paul Krugman—whose own column is carried by the NYT—was aghast. On Twitter, Krugman linked to the article and claimed that “There is no evidence—none—that regulation actually deters investment.” He then went on to argue the exact opposite, namely that climate change regulations in particular would promote business investment (in renewables and conservation projects).

In this post, I’ll refute Krugman’s assertions. His claim that there is “no evidence—none” is simply balderdash; of course there are reputable, peer-reviewed studies that document a negative relationship between excessive regulations and investment/growth. On his more substantive argument, Krugman ignores the reasons that we want pro-growth policies. On both points, Krugman’s response misinforms the public and disguises his support for climate change intervention in neutral garb.

Regulation Doesn’t Deter Investment?

On the face of it, it’s downright funny that Krugman is assuring us that government regulation doesn’t deter investment—at the same time he is warning that we need the government to prevent the construction of more coal-fired power plants. In previous posts, I’ve pointed out this contradiction among many interventionists: On the one hand, they claim we need high carbon taxes, the EPA’s “Clean Power Plan,” and so on, in order to induce massive changes in the power generation and transportation sectors, to save humanity from the ravages of climate change. On the other hand, they claim that high carbon taxes and the EPA’s “Clean Power Plan” won’t pose any significant compliance burden on business, and that the loss of jobs in the coal industry has nothing to do with government policy.

Now in fairness, a defender of Krugman might say, “OK, Murphy, your gotcha is funny and all, but Krugman was writing on Twitter. Obviously he acknowledges that the government has the power to stop investment in more coal-fired power plants. What Krugman meant was that there’s no evidence that government regulation deters good investment.”

Hmm, but if that’s the case, it’s interesting that Paul Krugman himself has argued that “blue states” engage in excessive housing regulations that deter economic growth. Here’s Krugman writing in August 2017 in the NYT: “[A]ll too many blue states end up, in practice, letting zoning be a tool, not of good land use, but of NIMBYism [Not In My BackYard], preventing the construction of new housing. In fact, liberal (in the non-political sense) land use policy is probably the secret behind Texas economic growth” (bold added).

Now to be sure, Krugman wasn’t embracing the religion of laissez-faire; in a 2014 article you can see an elaboration of his views regarding zoning. My modest point in our current discussion is that Krugman himself acknowledges that right now, in the real world, excessive zoning restricts economically beneficial housing investment and that this hampers economic growth in certain states. So he is clearly bluffing when he says there is “no evidence—none” that regulation restricts investment.

The Empirical Literature

In any event, anyone who wanted to actually consult the literature—rather than taking Krugman’s word for it—could find several peer-reviewed articles in reputable outlets, with about 15 minutes of looking.

For example, James Broughel has a new book on the subject that recently came out. Now one might push back and say the book is published by the Mercatus Center, and so this is ideological. I would disagree with that characterization, but fair enough, let’s just look at the references in the back of the book, where we find, for example:

• A 2016 paper by Balázs Égert in the American Economic Review—one of the top-ranked journals—with the following abstract (I’m just grabbing an excerpt):

This paper seeks to understand the drivers of country-level multi-factor productivity (MFP) with a special emphasis on product and labour market policies and the quality of institutions. For a panel of OECD countries, we find that anticompetitive product market regulations reduce MFP levels and that higher innovation intensity and greater openness result in higher MFP.

• Nicoletti and Scarpetta had a similar Working Paper for the World Bank posted in 2003. Here’s part of the abstract:

[R]egulation limiting entry may hinder the adoption of existing technologies, possibly by reducing competitive pressures, technology spillovers, or the entry of new high technology firms. At the same time, both privatization and entry liberalization are estimated to have a positive impact on productivity in all sectors. These results offer an interpretation to the observed recent differences in growth patterns across OECD countries, in particular between large continental European economies and the United States. Strict product market regulations-and lack of regulatory reforms-are likely to underlie the relatively poorer productivity performance of some European countries…

• A 2007 working paper from the OECD Economics Department by Erlandsen and Lundsgaard has the following in its abstract:

The economic crisis in the early 1990s prompted action on reforming the Swedish welfare state and its institutions, including deregulation of a wide range of product markets. In that way, Sweden took early action compared to other OECD countries currently struggling with how to make public finances more robust in an ageing context. The reforms that were implemented during the 1990s are now paying off in terms of productivity and GDP growth. Empirical evidence suggests that deregulation has delivered a considerable “productivity dividend”. 

Don Boudreaux, former chair of the George Mason economics department, also pushed back against the absurd claim (made by Jared Bernstein in this case, rather than Krugman) that deregulation doesn’t lead to faster economic growth. Boudreaux listed the two following papers:

• In a 2003 NBER Working Paper, Harvard’s Alberto Alisina and three co-authors state the following:

One commonly held view about the difference between continental European countries and other OECD economies, especially the United States, is that the heavy regulation of Europe reduces its growth. Using newly assembled data on regulation in several sectors of many OECD countries, we provide substantial and robust evidence that various measures of regulation in the product market, concerning in particular entry barriers, are negatively related to investment. The implications of our analysis are clear: regulatory reforms, especially those that liberalize entry, are very likely to spur investment.

• A 2016 Mercatus Center working paper by Coffey et al. that found:

Using a 22-industry dataset that covers 1977 through 2012, the study finds that regulation—by distorting the investment choices that lead to innovation—has created a considerable drag on the economy, amounting to an average reduction in the annual growth rate of the US gross domestic product (GDP) of 0.8 percent.

I will stop here. I hope that I’ve amply demonstrated that Krugman is simply making stuff up when he claims “there is no evidence—none—that regulation actually deters investment.” At this point, when Krugman emphasizes one of his claims—like saying “none” set off by dashes—this should alert the innocent public that Krugman is now in rhetorical mode, rather than scientist mode. It’s not even that he’s lying; we should interpret Krugman’s claims the same way we would consider a car dealer saying, “My prices can’t be beat!”

Could Climate Change Boost Investment?

Interestingly, not only does Krugman claim that government regulation hasn’t in practice deterred business investment, he then tries to argue the opposite: By tightening emission and renewables standards, Krugman argues that businesses must invest in order to comply. So isn’t this the best of both worlds, where we reduce possible climate change damages and benefit from job creation?

The fallacy here is one that I tackled with co-author Robert Michaels in our study for IER. Yes, in Krugman’s “liquidity trap” model his claim makes sense, but I happen to reject that framework. Regardless of the height of the unemployment rate, you don’t make Americans richer by having the government dictate the flow of resources.

Yes, if the government suddenly mandated that businesses had to use hot pink construction vehicles, that would “promote” a lot of investment. But it would make Americans poorer. The reason for the standard free-market emphasis on “pro-investment” policies is that in the market these investments are directed to serving consumer welfare. It’s not a fetish for investment per se.

It’s ironic that Krugman would cite energy sector regulations to justify his view, since the oil price controls of the 1970s were clearly inefficient and restricted domestic development, as even Nobel laureate (and left-leaning) Kenneth Arrow and Joseph Kalt documented in this study.

Conclusion

In a refreshing move, the NYT ran a story explaining that businesses have increased investment (in part) because of the friendlier regulatory environment under the Trump Administration. Paul Krugman and others pushed back, claiming there was no evidence to support such a linkage.

This is demonstrably false. Several papers—including ones published in prestigious outlets—have purported to show empirical support for the claim that excessive regulation deters investment. Maybe these papers are wrong, but Krugman misleads his readers when he acts as if this is a mere right-wing fantasy.

Furthermore, Krugman tries to turn his liability into an asset by arguing that climate change regulations in particular boost investment. This might be true in the obvious sense that outlawing existing equipment might force businesses to buy new equipment, but in that case we squander the rationale for being “pro-investment” in the first place. If Krugman wants to justify particular government interventions on climate change grounds, we can have that discussion, but it doesn’t make us richer to scrap existing techniques and equipment in order to comply with a new rule from Washington.

The post Regulation and Economic Growth appeared first on IER.