Regulation makes an economy more inflexible than it would be in the absence of that regulation.
Ed. Note: Are the President’s extreme left policies destroying jobs and making people who want to work more dependent on government?
There are policy reasons (government policies that increase uncertainty or decrease productivity) why this economic recovery is the weakest since the Great Depression and those reasons need to be exposed and understood.
We need to understand, for example, why so many young folks who were promised they would find good jobs after getting college degrees are still looking. Here is an explanation of why the recovery has been so slow.
Republished from Forbes.com, by Tim Worstall, January 27, 2015.
The political debate over in Washington tends to be arguing, from one side at least, that it was lack of regulation that caused the Great Recession. Further, that we need more regulation in order to make everything better. And that’s certainly a possible explanation. The thing is that it’s also a testable explanation. And fortunately someone has gone and tested it and it’s the wrong explanation. We actually find that reality (you know, that funny stuff that happens out there, beyond the ivory towers and outside of political offices) works the other way around. Light regulation is not greatly associated with a greater risk of economic disaster and lighter regulation is associated with, if disaster should happen, less disaster and a faster recovery from it.
The results suggest that increased economic freedom is only weakly associated with the probability of observing a crisis, and not at all with the duration of economic crises. However, countries that are more economically free when entering a crisis are clearly likely to experience substantially smaller crises, measured by the peak-to-trough GDP ratio, and have shorter recoveries to pre-crisis real GDP. These differences are driven by elements of the IEF related to regulatory activity while government spending, rule of law and market openness in general are not robustly related to crisis characteristics.
The actual mechanism seems to be:
Following a crisis, entrepreneurial opportunities are likely to increase as some firms perish through crises. However, as realized by Baumol, the institutional framework decides the mix of productive and unproductive entrepreneurial effort. In these situations, Kirzner notes that public regulations such as licensing requirements and other entry barriers can prevent entrepreneurs from realizing the new profit opportunities created by firm exit during the crisis. In general, elements of institutions and economic freedom are strongly associated with entrepreneurial activity. In crises, in particular, resources are left unemployed and therefore available at lower cost, creating profit opportunities to grab. However, labour market regulations making it difficult to fire people and licensing requirements barring entry may arguably prevent entrepreneurs from picking up these opportunities.
The real point underlying this is that regulation makes an economy more inflexible than it would be in the absence of that regulation. Sometimes that’s just great: I’m perfectly happy about the inflexibility of society on the ability of someone to shoot me for example. I think it’s just great that we’ve got regulations that reduce that possibility. However, economic regulations do remove some of that economic flexibility. And at times of full employment that’s not all that great a problem. But a recession is, by definition, when we’ve got unused resources lying around. And it’s the job of the entrepreneur to sort through those resources, ponder what might be done with them and then try to recombine them into producing something that someone, somewhere, wants. The more regulations there are about who may do what and in which manner the harder that entrepreneurial task becomes. And thus the longer it takes to sort through those unused resources and recombine them into a functioning economic unit.
To think about this in a trivial sense. Say that a newly laid off carpet maker notes that there’s a growing fashion for women to braid their hair. In some states it is a legal requirement that you have a cosmetology licence in order to engage in hair braiding. In some of those states that’s a 100 or 200 day process. So, this possible move from carpet making to hair braiding: will it take a longer period of time or a shorter period of time given the existence or non-existence of this regulation about a cosmetology licence?
Well, quite, to ask the question is to answer it, isn’t it? And currently some 30 % of all jobs in the United States are subject to such licensure. It’s really not all that surprising that this recent recovery has been a little slower than the ones before, is it? Because that 30% number is very much higher than it was only a generation ago.
To call this all and everything would be to go too far. But do read this paper. It’s an interesting and convincing proof that the regulatory state increases the depth of recessions and slows the recovery from them.
Republished from Forbes.com. CLICK HERE to read the original.
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