Politics

The Simple Reason Most Regulations Are Harmful

The Simple Reason Most Regulations Are Harmful by Scott Sumner, Foundation For Economic Education

Interfering with Voluntary Transactions Has Predictable Consequences

One of the most basic ideas in economics is that the vast majority of regulations are harmful. Here’s a simple example. Suppose banks charged $2 to use ATMs. Then suppose the government passed a “pro-consumer’ law banning those sorts of fees. What would happen? Economic theory suggests the law would hurt consumers, and yet I’d guess that 97% of consumers do not know this fact. Here’s why a ban on fees hurts consumers:

Banks will see this as a cost increase, and pass the cost on to consumers in other ways. Can I be sure this will occur? No, but it’s very likely. Suppose I told you that Congress passed a 10-cent increase in the gas tax. What would you expect to happen to gas prices at the pump? Most people would expect a 10-cent increase. In fact, the oil industry is perhaps the industry where taxes are least likely to be passed on to consumers. That’s because the supply of oil is less elastic that the supply of almost any other good, including banking services. So if you think gas taxes are passed on to consumers, then you should be even more certain that I’m right about the elimination of bank fees being passed on to consumers in other ways, such as fees on deposits, or lower interest rates on deposits.

OK, but so far this is a wash. If consumers pay less in one place and more in others, does the regulation actually hurt consumers? Yes it does, because it also hurts bank efficiency. Eliminating ATM fees will reduce the profit maximizing number of ATMs, which will make banks less efficient. Since tellers cost more than ATMs, the cost increase passed on to consumers will be larger than the saving from ATMs.

This logic applies to most other regulations, except those aimed at special market failures, such as monopoly power, externalities, and information asymmetry. None of those market failures apply in the ATM case.

Nor do they apply to the new regulations on overtime, discussed recently by David Henderson. Nor do they apply to the vast majority of regulations aimed at health, safety, worker benefits and 1,000 other aspects of our daily lives. I won’t say they never apply, there are probably a few areas where OSHA understands health risks better than workers and companies, but there is no statistical evidence that OSHA has actually improved worker safety. Nor do externality or information asymmetry arguments justify banning smoking in restaurants.

This used to be a basic idea that was known to all good economists, like the idea that fiscal stimulus is not needed when the central bank is targeting inflation, or that minimum wages are a bad idea, or that free trade with China helps America, or that trade deficits are not bad things, or that fiscal stimulus doesn’t reduce budget deficits by triggering faster growth.

Unfortunately, much of the core of economic theory is rapidly being forgotten. Here is Paul Krugman: “The Obama administration issued new guidelines on overtime pay, which will benefit an estimated 12.5 million workers.”

This is a real head-scratcher. Basic economic theory predicts that this rule will hurt workers, for exactly the same reason that a ban on fees at ATMs would hurt bank consumers. And that’s probably true even if higher minimum wage rates help workers. Overtime rules don’t cap total worker compensation, which is set by the market. Reduce worker efficiency (as this regulation does) and you will reduce total compensation.

I didn’t write this post to bash the overtime rules; others like Don Boudreaux have done that far more effectively. I’m writing this post to remind people that economic theory suggests that the vast majority of regulations are counterproductive, and many actually hurt the people they are intended to help. I’d guess that over 90% are not justified, including almost all occupational barriers to entry, trade restrictions, health and safety regulations, tax rules, employer mandates, landlord mandates, etc., etc.

What regulations are justified? Primarily environmental mandates (or taxes), and perhaps a few anti-trust rules. One can also justify some regulations, like minimum capital requirements for banks, on “second best grounds”, due to deposit insurance.

We’d be better off passing a law sun-setting all regulations and the entire federal tax code in 2025. Then give Congress the next 9 years to set about re-passing all the regs and taxes that actually make sense.

Cross-posted from Econlog.

Government Regulations

Government Regulations