NEW REPORT: Regulation Restrains Entrepreneurship

By at 24 October, 2019, 11:29 am

For many would-be entrepreneurs the answer is unfortunately “No,” as regulation serves as a key barrier to starting a business.

by Raymond J. Keating-

The costs of government regulation are formidable, and these costs come in a variety of forms. That’s made clear by a recent study by two professors from New York University.

On the matter of regulatory costs, SBE Council’s “Small Business Policy Index 2019: Ranking the States on Policy Measures and Costs Impacting Entrepreneurship and Small Business Growth highlights a variety of studies examining such costs. Consider a few findings that were noted:

● “A study from the Mercatus Institute at George Mason University (‘The Cumulate Cost of Regulation,’ April 2016) examines the impact of federal regulation on the nation’s GDP over an extended period of time. As summed up in the study’s abstract: ‘We estimate the effects of federal regulation on value added to GDP for a panel of 22 industries in the United States over a period of 35 years (1977–2012)… Our results show that economic growth has been dampened by approximately 0.8 percent per annum since 1980. Had regulation been held constant at levels observed in 1980, our model predicts that the economy would have been nearly 25 percent larger by 2012 (i.e., regulatory growth since 1980 cost GDP $4 trillion in 2012, or about $13,000 per capita).’”

● “Another recent study found a clear and substantial negative impact of federal regulation on the economy. Economists John Dawson at Appalachian State University and John Seater at North Carolina State University looked at the impact of federal regulation on economic growth. Their findings are sobering, to say the least: ‘Regulation’s overall effect on output’s growth rate is negative and substantial. Federal regulations added over the past fifty years have reduced real output growth by about two percentage points on average over the period 1949-2005. That reduction in the growth rate has led to an accumulated reduction in GDP of about $38.8 trillion as of the end of 2011. That is, GDP at the end of 2011 would have been $53.9 trillion instead of $15.1 trillion if regulation had remained at its 1949 level.’”

● “In a September 2015 study titled ‘Regulating Away Competition: The Effect of Regulation on Entrepreneurship and Employment,’ economists James Bailey and Diana Thomas found that ‘more-regulated industries experienced fewer new firm births and slower employment growth in the period 1998 to 2011. Large firms may even successfully lobby government officials to increase regulations to raise their smaller rivals’ costs’ and that ‘regulations inhibit employment growth in small firms more than in large firms.’ Specifically, they concluded, ‘We find that a 10 percent increase in regulation leads to a 0.5 percent reduction in new firm births and a 0.9 percent reduction in hiring. Over the period 1998 to 2011 that we study, RegData shows that the overall level of federal regulation increased by 24 percent. Thus, our results suggest that from 1998 to 2011, increased federal regulation reduced the entry of new firms by 1.2 percent and reduced hiring by 2.2 percent.’”

The recent study (June 2019) from NYU’s Germán Gutiérrez and Thomas Philippon touch on a similar topic as the “Regulating Away Competition” study highlighted above. In “The Failure of Free Entry,” Gutiérrez and Philippon look at “the entry and exit of firms across U.S. industries over the past 40 years.”

The authors explain: “The efficiency of a market economy requires free entry. Free entry plays a critical role for allocative efficiency and incentives. As industries adapt to various economic shocks, economic efficiency requires exit from less profitable industries and entry into more profitable ones.”

Unfortunately, the authors find that this free entry has diminished over the past 20 years. That is, we see far less entry of new firms that enhance efficiency. The authors point out that rising entry costs, such as technological costs, and rising returns to scale would be typically looked at to explain a phenomenon like this. But they didn’t find either to be the case here.

Instead, Gutiérrez and Philippon found a link of declining entry to government-related activity, specifically, to regulations and lobbying. The authors noted that “we find that regulations and lobbying explain rather well the decline in the allocation of entry.”

As summarized by the report: “We reconcile conflicting results in the literature and show that regulations drive down the entry and growth of small firms relative to large ones, particularly in industries with high lobbying expenditures. We conclude that lobbying and regulations have caused free entry to fail.”

This is not a surprising finding. Indeed, it lines up with what economics tells us about the interplay between and effect of government regulation and business. Namely, regulatory costs fall hardest on small businesses, including discouraging startup activity. In addition, the regulatory system can be used by large, established businesses to raise costs in such a way as to eliminate or restrict small business and startup activity.

Levels of entrepreneurship have suffered in recent times, and the impact of regulation is clearly in the mix of causes. If policymakers are serious about the importance of economic growth, then they need to recognize the central role that entrepreneurship plays in growth, and in turn, the negative effects of government burdens, such as regulation, on entrepreneurial activity.

Raymond J. Keating is chief economist for the Small Business & Entrepreneurship Council.



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