Introduction
During the 1980s, America's ability to create jobs was the envyof the world. No longer. The American job-generating machine hasground to a halt, and regulation deserves much of the blame. Theregulatory burden on U.S. firms relaxed through most of the 1980s,and private-sector employment grew by 19 million jobs. Most ofthese new jobs were created by small businesses, which are mostsensitive to regulatory costs. Over the last four years, however,the regulatory burden has grown substantially (especially for smalland medium-sized businesses), and the private sector has lostnearly two million jobs since early 1990.
While government red tape is a costly frustration to Americanbusiness, few business owners -- or even government policy makers-- appreciate the full impact of regulation. Among the little-knownfacts:
Government regulation costs at least $8,000 per household, andmay reduce national output by as much as $1.1 trillion peryear.
Unnecessary and inefficient regulation at the federal, state,and local levels is now costing the American people somewherebetween $810 billion and $1.7 trillion per year -- even aftertaking account of the benefits of regulation -- or between $8,400and $17,100 per year per household. (Nancy A. Bord and William G.Laffer III, "George Bush's Hidden Tax: The Explosion inRegulation," Heritage Foundation Backgrounder No. 905, July 10,1992, p. 19. Regulations may be treated as "unnecessary" if (1) thecosts they impose exceed the benefits they produce, or (2) eventhough they produce benefits that may exceed costs, they do so inan unnecessarily costly manner because of an inefficient method orapproach. The basis for the distinction between necessary andunnecessary regulations is discussed further in footnote 15 below.) A major portion of this cost consists of the additional goods andservices that the American economy could have been producing todaybut is not because of over two decades of slower growth due toexcessive and inefficient regulation. The value of this foregoneoutput is somewhere between $450 billion and $1.1 trillion peryear. (Ibid.)
Regulation reduces total U.S. employment by at least threemillion jobs.
Another heavy cost of regulation is reduced employmentopportunities for Americans. This toll is not usually apparent,because in most instances regulation merely leads to a slowergrowth in employment rather than to visible loss in existing jobs.Nonetheless, even by a fairly conservative estimate, there are atleast three million fewer jobs in the American economy today thanwould have existed if the growth of regulation over the last twentyyears had been slower and regulations more efficiently designed.(Footnote 17 below explains how this figure was calculated.)
Many regulations directly increase the cost of employing workersand thereby act like a hidden tax on job creation and employment.Among such regulations are minimum wage laws and federal laborlaws. These regulations place especially heavy burdens on smallbusinesses, the primary engines of job creation. And exemptingsmaller businesses from regulations generally does not solve theproblem. Instead it simply creates a "Catch 22" situation in whichgrowing small firms are penalized by an increase in the number ofregulations they became subject to.
Officials currently face no explicit requirement to consideremployment effects as they develop new rules. Nor do lawmakers.Even when the agencies or congressional committees do consider theemployment effects of proposed rules or regulatory legislation,policy makers often do so in ways that are simplistic or that relyon faulty assumptions and models. The methodologies used vary fromagency to agency, and from regulation to regulation even withinagencies. Moreover, nowhere in the entire federal regulatoryprocess does anyone consider the cumulative effects of existingregulations, or the possible combined effects of new and existingregulations.
To deal with the mounting employment costs of regulation,Congress and the Clinton Administration should institute severalurgent reforms. Among the most important:
Reform #1: President Clinton should issue an executive orderrequiring explicit consideration of the employment effects of allnew regulations.
Reform #2: Congress should extend the same requirement to all"independent" regulatory agencies that are outside the executivebranch.
Reform #3: Congress should establish a federal regulatorybudget. Such a budget means that a maximum total regulatory burdenthat government could impose on the economy -- or regulatory budget-- would be established. Whenever an agency planned to add a newregulation that would exceed the budget, it would be required torepeal or modify some other regulation so that the total burdenimposed on the economy by federal regulation would not beincreased. Alternatively, the government would have to arrange anoffsetting reduction from another agency.
Reform #4: Congress should require the expected employmenteffects of all proposed regulations to be published in the FederalRegister; even before such a requirement is imposed, executive andindependent agencies should voluntarily publish the expectedemployment effects of proposed regulations. This would permit theAmerican people to know the expected magnitude of any job lossesdue to a new rule before it takes effect. Americans then could letofficials and lawmakers know if they felt the benefits of theproposed rule were worth the job losses.
Enactment of these four reforms would reduce substantially thecost that federal regulations impose on the economy, whilepreserving or even increasing the benefits that regulationssometimes can provide. In particular, they would reduce the toll onemployment and wages that the well-meaning pursuit of worthy endsoften takes. A clean environment and safe and discrimination-freeworkplaces can be achieved without depriving three million or moreAmericans of jobs.
How Regulation Kills Jobs
Between January 1, 1983, and March 31, 1990, private-sectoremployment in the U.S. economy grew by some 19 million jobs, risingfrom 72.8 million jobs in December 1982, to 91.8 million jobs inMarch 1990. However, over the next two years the private sectorlost nearly 2.2 million jobs, reaching a low of just over 89.6million jobs in January 1992. The number of private-sector jobs hasrecovered only slightly since then, rising to 90.1 million jobs asof January 1993. (Source: U.S. Department of Labor, Bureau of LaborStatistics (BLS) ("establishment data," based on a monthly surveyof employers, seasonally adjusted). These figures do not includeagricultural employment or employment by federal, state, or localgovernments. Using BLS's figures for total civilian employment("household data," based on household interviews conducted monthlyby the Bureau of the Census, seasonally adjusted), includingagricultural employment and non-military government employment, therelevant employment figures are 99 million jobs in December 1982,118.3 million jobs in May 1990, 116.5 million jobs in August 1991,and 118 million jobs as of January 1993.)
What accounts for the difference between the two periods? Inparticular, what caused employment to start rising in January 1983,and what caused it to begin to fall in April 1990? To be sure,there are many factors that affect employment levels, includingtaxation. Tax rates were reduced significantly in 1983, butincreased somewhat in 1990. (See Daniel J. Mitchell, "An ActionPlan to Create Jobs," Heritage Foundation Memo to President-ElectClinton No. 1, December 14, 1992, pp. 4-5. The tax cuts that wereenacted in 1981 did not take full effect until January 1983.Although the 1990 tax increases were not signed into law untilNovember 1990, President Bush renounced his "no new taxes" pledgeand indicated his willingness to agree to a tax increase in June1990.)But there is considerable evidence to suggest that changes inthe total cost of federal and state regulation also played a majorrole, especially in the downturn that occurred in 1990.
As the graph on the following page indicates, regulatory costsgenerally were declining during the period of private-sectoremployment growth. The period of decline and stagnation, bycontrast, started shortly after regulatory costs started to riseagain. Moreover, as the graph on page 5 shows, there was a veryclose negative correlation between the number of federal regulatorsand private-sector employment. Fewer regulators coincided with anincrease in job growth; an increase in regulators with a decline injob growth and even a decline in jobs.
Policy makers concerned about job creation need to understandthe basic factors that determine the level of wages and employment.Explains economist Arthur B. Laffer:
Firms base their decisions to employworkers . .. .. in part, on the total cost to the firm of employingworkers. . .. .. All else equal, the greater the cost to the firmof employing each worker, the less workers the firm will employ.Conversely, the lower the cost per worker, the more workers thefirm will hire. (Arthur B. Laffer, "Supply-Side Economics,"Financial Analysts Journal, September/October 1981, pp.32-33.)
In a world without taxes or regulations, the cost to employersof hiring an additional hour of labor services and the benefit to aworker of working an additional hour would be the same. Taxes andregulations raise the cost to employers above the reward receivedby the employee. These government-mandated costs include such itemsas unemployment and disability insurance, government paperworkrequirements, and the cost of lawyers to advise firms on how tocomply with the rules. While some of these government-imposed costsdo provide a benefit to the employee, many of them do not.
The difference between what it costs a firm to employ a workerand the net benefit the worker receives is commonly referred to byeconomists as the "regulation and tax wedge." Any increase in thewedge, whether caused by regulations or by taxes, will tend toraise the cost to employers of hiring an additional employee,thereby reducing the demand for labor, and reduce the net wages andbenefits workers receive, thereby reducing the supply of labor aswell. Thus, the basic laws of economics indicate that if regulatoryburdens rise (and tax burdens do not fall by an equal or greateramount), employment and wages will fall.
The Direct and Indirect Effects ofRegulation
Some regulations have a direct and immediate impact on wages oremployment. The minimum wage law and federal labor laws, forexample, tend to increase the cost of employing workers and therebydecrease wages or employment, and sometimes both. Other regulationsaffect wages and employment indirectly, but just as significantly.Banking and environmental regulations, for example, have aconsiderable negative effect on the overall level of economicactivity. And when output slows, employment usually slows withit.
More often than not, the effects of regulation on employment arehidden by other factors, such as tax policy or general economicchanges. But in other instances, the impact on jobs is very clear.Example: The federal government's efforts to protect the northernspotted owl, under the Endangered Species Act and other relatedlaws, means millions of acres of land in Washington, Oregon, andnorthern California have been closed to logging operations. Tens ofthousands of loggers have lost or will lose their jobs because ofthese regulations, and thousands more jobs have been lost incommunities dependent on logging as the principal industry.
Example: California has increased regulation sharply over thelast two years, driving businesses and jobs from the state.California has lost approximately 700,000 jobs since May 1990.(George F. Will, "Can California Compete?" The Washington Post,September 27, 1992, p. C7.) Indeed, for the first time in nearlytwenty years, more people are leaving California than arriving.("Californians leaving state in record numbers," The WashingtonTimes, September 4, 1992, p. A2.) While California's job exodus ofcourse is due to many factors, including higher taxes, severalstudies and surveys have concluded that regulations -- especiallyonerous new environmental regulations -- are the principal factordriving businesses' decisions to leave the state. (The mostimportant of these studies is California's Jobs and Future (April23, 1992), a detailed report prepared by the Council on CaliforniaCompetitiveness, led by Peter Ueberroth, the former baseballcommissioner and organizer of the 1984 Olympic Games in LosAngeles. Another is Mark Baldassare and Associates, "Department ofCommerce Survey of California Manufacturers" (Sacramento:California Department of Commerce, Office of Business Development,December 13, 1989). Two additional surveys are cited in Philip K.Verleger Jr., "Clean Air Regulation and the L.A. Riots," The WallStreet Journal, May 19, 1992, p. A14.)
Why the Regulatory Cost is Usually Hidden
Still, cases in which regulation can be clearly identified asthe culprit for specific job losses are the exception rather thanthe rule. There are several reasons why there is rarely a smokinggun: Businesses usually base their decisions on such matters aswhether or where to build a new plant, and how many people theywill hire, on a variety of considerations. It is rarely clear whichconsideration was decisive.
The result of regulation often is not a cut in wages oremployment levels, but simply slower growth over time. Jobs notcreated are much less visible than layoffs.
Regulation in one part of the economy can have an impact inother areas. For example, a recent study by economists MichaelHazilla of American University and Raymond Kopp of Resources forthe Future, a Washington, D.C.-based research group specializing inenvironmental issues, found that environmental regulations hadreduced employment in the finance, insurance, and real estateindustries by 2.64 percent as of 1990. (Michael Hazilla and RaymondJ. Kopp, "Social Cost of Environmental Quality Regulations: AGeneral Equilibrium Analysis," Journal of Political Economy, Vol.98, No. 4 (1990), p. 869.) This occurred despite the fact thatthese industries produce no pollution themselves and thus did notincur the direct cost of pollution abatement equipment. Hazilla andKopp found that all sectors of the economy are affected byenvironmental regulations, because such regulations cause the costof inputs to the production process such as labor, raw materials,and electricity to rise, and cause savings, investment and capitalformation to fall.
Unfortunately for workers, the indirect causal links whoseeffects Hazilla and Kopp attempted to measure are invisible to mostobservers. Nonetheless, Hazilla and Kopp found the employmenteffects of environmental regulation for the economy as a whole tobe substantial. By their estimates, environmental regulations alonehad by 1990 reduced the overall employment level by 1.18 percent.(Ibid., p. 867.) This would mean between 1.1 million and 1.4million fewer jobs than would have existed without environmentalregulation. (The average number of Americans employed in 1990 wasbetween 91.5 million and 117.9 million, depending on which BLS dataseries one uses. 91.5 million x 1.18% = 1.1 million. 117.9 millionx 1.18% = 1.4 million. Of course, the number of jobs eliminated byenvironmental regulation might be smaller if some of the 1.18percent reduction in labor supply were simply due to people workingfewer hours in existing jobs.) Moreover, environmental regulationsignificantly altered the distribution of labor employment acrossthe economy. Although a few sectors, such as the natural gasindustry and the wholesale and retail trade sectors, experiencedmodest increases in employment, most sectors experiencedreductions.
The Total Cost to the Economy
Most studies analyzing the cost of regulation examine onlydirect compliance expenditures. They do not consider the indirecteffects of regulation on output and employment. But some otherstudies, such as that by Hazilla and Kopp, suggest that theindirect effects may be as large as or even significantly largerthan the direct compliance costs, at least in the case ofenvironmental regulations. (Another such study, with similarresults, was done by economists Dale Jorgenson of HarvardUniversity and Peter Wilcoxen of the University of Texas. See DaleW. Jorgenson and Peter J. Wilcoxen, "Environmental Regulation andU.S. Economic Growth," RAND Journal of Economics, Vol. 21, No. 2(Summer 1990), pp. 314-40.) The reason for this is that reductionsin investment due to regulation have cumulative effects over timeon output and employment.
The most widely cited estimates of the combined cost of allfederal regulations put the figure between $595 billion and $667billion per year for 1992, measured in 1991 dollars. (Thomas D.Hopkins, Cost of Regulation, Rochester Institute of TechnologyPublic Policy Working Paper (December 1991); Robert W. Hahn andJohn A. Hird, "The Costs and Benefits of Regulation: Review andSynthesis," Yale Journal on Regulation, Vol. 8, No. 1 (Winter1991), pp. 233-278. The figures in the text are arrived at bytaking Hopkins's estimate of the total cost of regulation as of1992, substituting Hahn's and Hird's original estimate of the grosscost of economic regulation for the figure Hopkins used (which wasa modified version of Hahn's and Hird's estimate), substitutingHopkins's updated but as yet unpublished figure for the federalpaperwork burden, and converting the new total from 1988 to 1991dollars.) However, these estimates do not take any account of theindirect effects of regulation on output and employment. A recentstudy by Nancy Bord and William Laffer, of The Heritage Foundation,attempted to estimate the indirect effects of all regulations --state as well as federal -- by extrapolating from the results ofother studies, such as that of Hazilla and Kopp. Bord and Laffercalculate that, in the absence of all unnecessary regulatory costs,(Insofar as some types of regulation -- environmental regulation inparticular -- produce benefits as well as costs, one may not simplyassume that all of the costs of regulation can be eliminated.However, even where existing regulations may produce benefits thatexceed costs, it often appears that the same or even greaterbenefits could be obtained at a significantly lower cost by usingbetter-designed, more efficient forms of regulation. Consequently,in calculating the foregoing figures, wherever a regulationappeared to produce net benefits, no cost was counted except thedifference (if any) between the actual cost imposed by theregulation in question and the lower cost that would be incurredunder a more efficient regulatory scheme.) annual gross domesticproduct (GDP) would exceed its current level of $5.672 trillion asof 1991 by at least some $450 billion, and possibly by as much as$1.1 trillion. (Bord and Laffer, op. cit., p. 19. Bord and Lafferused a very wide range of estimates of the ratio of indirect coststo direct costs because of the inherent uncertainty involved inestimating how much output is not produced. That is why their lowerand upper bounds are so far apart. )This additional output wouldmean the existence of several million additional jobs. Even aconservative estimate would put the figure at well over threemillion jobs. (Based on the ratio of 1991 GDP to averageprivate-sector employment in 1991, the production of an additional$450 billion to $1.1 trillion in annual GDP would mean the creationof an additional 7.2 million to 19.2 million jobs, depending onwhich figure is used for private-sector employment. However,because much of the additional GDP would have come from increasedproductivity, rather than increased employment, the actual jobgrowth figures would likely be much smaller. Assuming that half ofany increase in annual GDP came from increased employment, theadditional jobs that would have been created in the absence of allunnecessary regulatory costs would number between 3.6 million and9.6 million.)
Examples of Job-Destroying Regulations
As noted earlier, some regulations directly increase the cost ofemploying workers and thereby act like a tax on job creation andemployment. Three examples show in practical terms how thishappens.
Example #1: Minimum Wage Legislation
It is now almost universally accepted that minimum wage lawsreduce the employment of low-skilled workers whose productivitysimply is not worth what the employers are required by law to pay.(See, e.g., Simon Rottenberg, ed., The Economics of Legal MinimumWages (Washington, D.C.: American Enterprise Institute, 1981).) Theonly major disagreement today is over the degree of employmentreductions caused by the minimum wage requirement. (Some studiesnote, for example, that while the minimum wage law reducesemployment of low-skilled workers, it may increase employment ofmedium-skilled workers who, to some extent, can be used in lieu ofthe low-skilled workers whose labor the minimum wage renders tooexpensive. However, the increase in employment of medium-skilledworkers is never enough to fully offset the decrease in employmentof low-skilled workers.)
For the nine years running from January 1981 through March 1990,the federal minimum wage remained fixed at $3.35 per hour. Becauseof inflation, however, the real value of the minimum wage -- andtherefore the real cost to businesses of employing less-skilledworkers -- declined. Not surprisingly, the percentage of teenagerswith jobs climbed from 41 percent to over 48 percent over the sameperiod. (Alan Reynolds, "Cruel Costs of the 1991 Minimum Wage," TheWall Street Journal, July 7, 1992, p. A14.)
Congress decided in 1989 to increase the federal minimum wage to$3.80 per hour as of April 1, 1990, and to $4.25 per hour as ofApril 1, 1991. Again, not surprisingly, teenage employment fellimmediately after each of these increases. Just four months afterthe 1990 increase, for instance, the percentage of teenagers withjobs had fallen from over 48 percent to less than 43 percent,undoing most of the previous nine years' improvement. (Ibid.)
In total, the federal minimum wage rose by 27 percent, andteenage employment fell by 11 percent. (Ibid.)The 1990 and 1991minimum wage increases made it harder for teenage workers to getsummer and Christmas vacation jobs. The hikes made it harder foryoung adults with little education, skill, or experience to obtaintheir first full-time entry-level jobs. These are the jobs wherethey would acquire the training, experience, and work habits thateventually would make their labor worth more than the legalminimum. And the increases in the minimum wage made it harder forunskilled housewives trying to supplement their family's incomewhile their children are in school to obtain part-time work.
Calculations by economists Lowell Gallaway and Richard Vedder ofOhio University show that the total cost to a business for eachworker hired and for each hour worked rose sharply after each ofthese increases in the minimum wage, but especially after the first-- which was the larger of the two increases in percentage terms.(Lowell Gallaway and Richard Vedder, "Why Johnny Can't Work: TheCauses of Unemployment," Policy Review, Fall 1992, p. 29.)Furthermore, calculations by Gallaway and economist Gary Andersonof the Joint Economic Committee (JEC) of Congress suggest that thetotal cost per worker hired and per hour worked rose particularlysharply for smaller businesses. (Gary Anderson and Lowell Gallaway,"Derailing the Small Business Job Express" (Washington, D.C.: JointEconomic Committee, November 7, 1992), pp. 25-28.) Largercorporations tend to be less affected (at least directly) byincreases in the minimum wage, since they already pay most if notall of their workers wages well above the legal minimum. Bycontrast, the overwhelming majority of businesses that employpeople at the minimum wage are small and medium-sized.Consequently, increases in the minimum wage -- like most otherincreases in the regulatory burden -- tend to have a greater impacton smaller firms, and to exacerbate the disparity that alreadyexists between small and large firms. (For a discussion of thedisparate impact of regulation on small business, and of theimportance of this disparity from the standpoint of job creation,see pages 10-12 below.)
Private-sector employment peaked in March 1990, and starteddeclining sharply in April 1990. It appears likely, therefore, thatthe legally mandated explosion in the cost of employing relativelyunskilled workers was a significant factor contributing to the1990- 1991 recession and the stagnation of the past year. (Seechart below.)
Example #2: Federal Labor Laws
Federal labor laws regulate employers' dealings with theiremployees and with organized labor unions. Under these laws, theflexibility of companies to hire and fire workers is restric-ted,and often they are required to engage in costly negotiations withlabor unions. Far from being balanced, federal labor lawsdeliberately tilt the scales in favor of unions and againstemployers, as well as against employees who do not wish to join aunion. (See, e.g., Richard A. Epstein, "A Common Law for LaborRelations: A Critique of the New Deal Labor Legislation," Yale LawJournal, Vol. 92 (1983), p. 1357; Daniel J. Mitchell, "GovernmentIntervention in Labor Markets: A Property Rights Perspective,"Villanova Law Review, Vol. 33, No. 6 (1988), pp. 1043-1057.)
There is, however, no free lunch. Restrictions imposed onemployers (and employees) by federal labor laws inevitably increasethe cost of employing workers, resulting in fewer jobs and lowerwages, or at least in slower growth in employment and wages overtime. (See, e.g., John T. Addison and Barry T. Hirsch, "UnionEffects on Productivity, Profits, and Growth: Has the Long RunArrived?" Journal of Labor Economics, Vol. 7 (January 1989), pp.72-106. In addition, compulsory union dues reduce the net benefitsworkers receive for working, thereby reducing the supply of laboras well as demand.)
Example #3: Mandated Benefits
Regulations that require employers to provide various benefitsto their employees, such as health insurance, unemploymentinsurance, workers' compensation, retirement benefits, or childcare, all tend to reduce wages and employment. They increase thecost of employing workers, which can lead to a slowdown in thecreation of new jobs or even to layoffs.
In the long run, employers will seek to offset their increasedcosts, either by reducing wage and salary payments or by cuttingback on other benefits that the employer previously might haveprovided voluntarily as a means of attracting workers. As a result,the total value of the employees' compensation eventually may be nohigher than it would have been in the absence of the regulation. Infact, the value to the employee may even end up being less than itwould have been, while the cost to the employer may still begreater. In this case, the regulation will end up reducing thesupply of labor as well as demand. Thus, one way or another, muchof the cost of the regulation will end up being borne by theworkers, whether in the form of fewer jobs, fewer fringe benefits,a reduction in the growth of wages over time, or some combinationof the three. (See, e.g., Richard B. McKenzie, The American JobMachine (New York: Universe Books, 1988), pp. 218-31; Don Bellanteand Philip K. Porter, "A Subjectivist Economic Analysis ofGovernment-Mandated Employee Benefits," Harvard Journal of Law andPublic Policy, Vol. 13, No. 2 (Spring 1990), pp. 657-687.)
Regulation and Small Business
The U.S. economy created some 19 million net new private-sectorjobs during the 1980s. Most of these new jobs were created by newbusinesses, and most of the remainder were created by existingsmall businesses. (Lawrence A. Kudlow, "Small Business Is BigBusiness," Global Spectator, February 28, 1992, reprinted inCongressional Record, March 10, 1992, p. S3153.) By contrast, largeU.S. multinational corporations contributed less than one-tenth ofone percent of the employment growth that occurred between 1982 and1989. (Ibid.) Indeed, employment by Fortune 500 corporationsactually fell by about 4 million jobs during the 1980s. (George F.Will, "A refresher course on what ails us," The ProvidenceJournal-Bulletin, September 14, 1992, p. A6.) Thus, taken as aseparate sector, employment in small and medium-sized businessesactually grew by an astounding 23 million jobs.
Small businesses have always been the engine of job creation inthe U.S. economy. Some 57.2 percent of all net new jobs createdbetween 1976 and 1986 were created by firms with fewer than 500employees, 43.7 percent were created by firms with fewer than 100employees, and 26.2 percent were created by firms with fewer than20 employees. (U.S. Small Business Administration, The State ofSmall Business: A Report of the President (Washington, D.C.: U.S.Government Printing Office, 1989), p. 48.) Today, two out of everythree new jobs in the United States are created by small andmedium- sized businesses. (Kudlow, op. cit.) The vast majority ofAmerican businesses are small, and the majority of American workersare employed by small firms. In the U.S., 93.3 percent of allbusiness establishments employ fewer than 100 employees, and 83.4percent employ fewer than 20 employees. Only 3.4 percent of allfirms employ 500 or more employees, and only 1.5 percent of allfirms employ 5,000 or more employees. (David L. Birch, Job Creationin America: How Our Smallest Companies Put the Most People to Work(New York: The Free Press, 1987), p. 9.)
How Regulation Hurts Small Business
Regulation does not affect all businesses equally. It imposesthe heaviest burdens on small and medium-sized businesses. Thereason is that small and medium-sized firms find it harder tospread the high overhead costs of processing paperwork, attorneyand accountant fees, and the staff time needed to negotiate thefederal regulatory maze. Direct labor regulations, such asincreases in the minimum wage, also represent a comparativelylarger burden for small firms. Consequently, increasing levels ofregulation tend to put small and medium-sized businesses at acompetitive cost disadvantage compared with larger firms. (See,e.g., Ann P. Bartel and Lacy Glenn Thomas, "Direct and IndirectEffects of Regulation: A New Look at OSHA's Impact," Journal of Lawand Economics, Vol. 28, No. 1 (April 1985), pp. 1-25; Ann P. Barteland Lacy Glenn Thomas, "Predation Through Regulation: The Wage andProfit Effects of the Occupational Safety and Health Administrationand the Environmental Protection Agency," Journal of Law andEconomics, Vol. 30, No. 2 (October 1987), pp. 239-264; B. PeterPashigian, "The Effects of Regulation on Optimal Plant Size andFactor Shares," Journal of Law and Economics, Vol. 27, No. 1 (April1984), pp. 1-28; B. Peter Pashigian, "Environmental Regulation:Whose Self Interests Are Being Protected?" Economic Inquiry, Vol.23, No. 4 (October 1985), pp. 551-584.)
Future regulation will compound this problem. For example,although President Clinton has yet to finalize his health careproposals, he has indicated tentative support for proposals torequire firms to shoulder much of the cost of universal coveragefor workers and their families. This would significantly increasethe cost of hiring workers in the small business sector, where manyfirms currently do not provide coverage. While 98 percent of allfirms with 100 or more employees already provide health benefits,only 27 percent of firms with fewer than 10 employees offer healthbenefits at present. (Health Insurance Association of America,Source Book of Health Insurance Data 1991 (Washington, D.C.: HealthInsurance Association of America, 1991), p. 27 (Table 2.5).) Inother words, while 73 percent of firms with fewer than 10 employeeswould see their cost of employing workers rise under either ofthese proposals, only 2 percent of firms with 100 or more employeeswould be significantly affected.
Out of the Frying Pan and into the Fire
To its credit, Congress generally has tried to compensatefor the disproportionate burden of regulation on smaller firms byexempting firms below a certain size -- measured by the number ofemployees -- from various regulations. For example, the WorkerAdjustment and Retraining Notification Act of 1988, which requiresemployers to give employees and local government officials advancenotice before closing a plant or laying off workers, only appliesto firms with 100 or more employees. Likewise, the Americans withDisabilities Act (ADA) of 1990 currently applies only to firms with25 or more employees. After July 26, 1994, however, the ADA willapply to firms with 15 or more employees.
Unfortunately, this well-intentioned approach does not reallysolve the problem; it merely changes the form of the problem. Insome respects it may even make the problem worse, for it givesbusinesses an incentive not to grow beyond a certain size. If afirm stays small enough, it remains exempt from regulations.However, if it hires "too many" workers, it becomes subject tovarious costly regulations. Thus, instead of punishing firms merelyfor being small, federal regulations also punish small firms forgrowing and creating more jobs.
As a result, firms nearing the relevant threshold for a rulehave a powerful incentive to avoid hiring additional employees. Forexample, in a letter to The Washington Times, the president ofSchonstedt Instrument Company of Reston, Virginia, tells how he hasdeliberately kept his company below 50 employees in order to avoidhaving to file certain forms with the federal government, becauseof the cost and time involved. (E.O. Schonstedt, letter to theeditors, The Washington Times, February 16, 1992, p. B5.)
Worse still, the prospect of an exemption from a regulation canmake it profitable for firms actually to reduce their workforces inorder to fall below the relevant threshold. For example, the Familyand Medical Leave Act of 1993, recently signed into law byPresident Clinton, will apply to firms with 50 or more employees.Calculations by the Joint Economic Committee (JEC) of Congresssuggest that under this law, a firm whose optimal size before theregulation was 60 employees might actually find it profitable tocut back to 49 employees. (Anderson and Gallaway, op. cit., pp.21-24.) As the JEC report puts it, "Exemption from governmentregulations and mandates on the basis of the size of a company is aguaranteed recipe for making small businesses smaller." (Ibid., p.24.)
The Myth that Regulation Creates Jobs
Defenders of regulation sometimes argue that while regulationmay cut jobs in some firms, in general it is good for the economyand creates jobs. A number of writers recently have made thisargument in connection with environmental regulation. (E.g.,Timothy E. Wirth, "Easy Being Green... Lighten Up, Loggers --Environmentalism Actually Creates Jobs," The Washington Post,October 4, 1992, p. C3; Michael Silverstein, "Bush's PolluterProtectionism Isn't Pro-Business," The Wall Street Journal, May 28,1992, p. A21; Curtis Moore, "Bush's Nonsense on Jobs and theEnvironment," The New York Times, September 25, 1992, p. A33.) Forexample, it is pointed out that environmental regulations stimulateemployment in industries that manufacture special devices requiredby government, such as scrubbers for smokestacks, and create jobsin environmental clean-up firms. Similarly, it is argued thatsecurities regulations and the Treasury's regulations interpretingthe Internal Revenue Code create employment for lawyers andaccountants.
These arguments almost always rest on a basic economic fallacy:they confuse the creation of jobs in a particular industry with thecreation of jobs for the economy as a whole. Thus while jobs areindeed created in firms that assist in helping companies complywith rules, these rules also cost jobs in the regulated industry.The fallacy that adding costs to firms actually creates jobs in theeconomy is a persistent fallacy that was refuted decades ago.Rather than creating jobs, regulation simply diverts employmentfrom productive to unproductive activities, with a net loss inefficiency and jobs. (See Frederic Bastiat, "What Is Seen and WhatIs Not Seen," in Frederic Bastiat, Selected Essays on PoliticalEcon- omy, trans. Seymour Cain, ed. George B. de Huszar(Irvington-on-Hudson, New York: Foundation for Economic Education,1964); Henry Hazlitt, Economics in One Lesson (Westport,Connecticut: Arlington House, 1979).) .In particular instances, thejobs created may be more or less numerous than those destroyed. Forexample, if a new Medicare regulation increases the cost of doingbrain surgery, a hospital may lay off one $300,000-per-year brainsurgeon and hire three $30,000- per-year administrators to fill inthe relevant Medicare forms. In other instances, however, a firmmay lay off three blue-collar workers and replace them with onehigher-paid engineer. There is no reason to expect the jobs thatare created because of regulation to systematically outnumber -- orpay more than -- the jobs that are destroyed.
How to Avoid Unnecessary Job Losses
Jobs are lost unnecessarily though regulation because currentlythere is no explicit requirement that the employment effects ofregulation be considered, either by Congress when it legislates orby federal regulatory agencies in the rule-making and enforcementprocess.
Executive Order (EO) 12291, issued by President Reagan inFebruary 1981, does require executive branch agencies to inquireinto the overall costs and benefits of proposed regulations.However, EO 12291 does not explicitly require any particular kindof costs or benefits to be counted. Thus, while the negativeeffects of a proposed regulation on wages or employment levels canbe counted as costs, they do not have to be. Likewise, theemployment-enhancing effects (if any) of a proposed regulation canbe counted as benefits, but need not be. An agency thus may computebenefits and costs in dollars without ever counting how many jobswould be gained or lost. Moreover, EO 12291 applies only to newregulations, not regulations that are already on the books. And EO12291 does not apply to any of the "independent" regulatoryagencies that lie outside the executive branch, such as theSecurities and Exchange Commission or the Federal CommunicationsCommission.
This is not merely a problem in theory. A recent study by theNational Commission for Employment Policy examined the regulatoryreview practices of seven federal agencies with majorresponsibility for preparing and enforcing regulation. The studyfound that "federal regulatory agencies . . . do not explicitly orsystematically take potential employment effects into considerationduring the review process, or in enforcement decisions." (Nancy A.Bord, "Addressing Employment Effects in the Regulatory ReviewProcess," draft final report prepared for the National Commissionfor Employment Policy, September 9, 1992, p. 33.) Even whenemployment effects are considered by the agencies, they areconsidered either in a simplistic way, or on the basis of faultyassumptions and models. The methodologies used vary from agency toagency, and even from regulation to regulation within agencies. Thestudy also found that federal regulatory agencies generally fail toconsider the cumulative effects of existing regulations and thepossible effects of new regulations on existing rules.
Because regulation of one part of the economy can affect otherparts, and because regulations often interact with each other insignificant ways, no regulation can properly be judged or measuredin isolation. (An analogous point applies in the area of taxation:Because different taxes often interact with each other in importantways, no individual tax can properly be evaluated in isolation. Infact, strictly speaking, taxes and regulations can only be analyzedin conjunction with each other. Each specific tax must be analyzedin light of every other tax and every regulation, and each specificregulation must be analyzed in light of every other regulation andevery tax. See generally John R. Hicks, Value and Capital, 2nd ed.(Oxford: Oxford University Press, 1946); Arnold C. Harberger,Taxation and Welfare (Chicago: University of Chicago Press, 1974).)In fact, this interaction means the adoption of a new regulationcan increase the cost imposed by existing regulations. Therefore,computing the total costs and benefits of any new regulation wouldrequire determination of the net impact of all regulations takentogether. Generally speaking, the greater the volume of regulationthat already exists when a new regulation is introduced, thegreater will be the incremental, overall cost of adding the newregulation. Failure to take account of this is one of the mostimportant factors contributing to the enormous growth in theoverall regulatory burden. It also helps explain the decline inU.S. labor productivity and wage growth over the past two decades(see chart on following page), and the decline in employment duringthe last two years.
In light of the severe burden imposed by regulation onemployment, President Clinton and Congress should reform theregulatory review process. Among the necessary reforms:
Reform #1: President Clinton should issue an executive orderrequiring explicit consideration of the employment effects of allnew regulations.
Reform #2: Congress should extend the same requirements to allof the "independent" regulatory agencies that lie outside theexecutive branch.
Reform #3: The President and Congress should establish a federalregulatory budget.
Under a regulatory budget, a limit would be placed on the totalestimated cost imposed on the economy each year by all federalregulations. This limit would apply to new and existing regulationstaken together. Thus, if the budget had been reached, an agencywishing to add a new regulation would have to repeal or modify anexisting regulation. If an agency could not find a large enoughoffsetting reduction among the other regulations for which it wasresponsible, the government would have to agree to an offsettingreduction by another agency.
The introduction of a regulatory budget would have severalvirtues. First, it would place a limit on the total cost that canbe imposed on the economy by federal regulation. This total burdenwould have to be a political decision, with ordinary Americans ableto take part in the national discussion.
Second, it would force agencies to debate each other to justifythe merits of proposed regulations, with the Office of Managementand Budget (or any other body designated by the President, such asthe newly created National Economic Council) making the final call.This in turn would compel the agencies, as they are not compelledat present, to think seriously about which regulations are mostimportant to them and yield the greatest benefits.
And third, it would give agencies the incentive to review theirexisting regulations and find those which are not really worthretaining -- or are causing greater job losses than expected -- inorder to make room for new regulations with a higher priority.
Reform #4: Congress should require the expected employmenteffects of all proposed regulations to be published in the FederalRegister before the regulations take effect.
Present law allows but does not require publication of expectedemployment effects in the Federal Register. Congress should makesuch disclosure mandatory. In the meantime, executive andindependent agencies should disclose expected job losses or wagereductions voluntarily.This would permit the public to know theexpected magnitude of any job losses or net wage reductions. ThusAmericans could comment on this aspect of proposed regulationsbefore they take effect. This also would enable the public tocompare actual job losses with what was predicted at the time eachregulation was issued.
Conclusion
The President and Congress must do something to get the problemof growing federal regulation under control. Regulation at thefederal, state, and local levels is now costing the American peoplesomewhere between $810 billion and $1.7 trillion per year, evenafter taking account of benefits, or between $8,400 and $17,100 peryear per household. A major portion of this cost consists of theoutput that the American economy could have been producing todaybut is not because of over twenty years of excessive andinefficient regulation -- somewhere between $450 billion and $1.1trillion per year.
Another important cost of regulation is the failure to createmore employment opportunities for Americans who would like to work.Many regulations directly increase the cost of employing workersand therefore act just like a hidden tax on job creation andemployment. Unfortunately, regulation places especially heavyburdens on smaller and medium-sized businesses, which are theprimary engines of job creation. As a consequence, there probablyare at least three million fewer private-sector jobs in theAmerican economy than could have existed today if the growth ofregulation had been controlled and regulations had been moresensibly and efficiently designed.
While regulation has been taking a toll on employment throughoutthe last two decades, the toll has risen sharply in just the lastfour years. Moreover, two of the most significant and costly newregulations of the last four years -- the 1990 Clean Air ActAmendments and Americans with Disabilities Act (ADA) -- onlystarted to take effect a few months ago; some of their provisionswill not take effect until the middle of 1994. So the impact ofthese regulations on employment still lies in the future -- theheavy job losses due to regulation in the last three years havebeen caused by existing rules. In other words, the employment lossdue to regulation is almost certain to get worse if the Presidentand Congress do not take action.
Many specific federal regulatory programs deserve a drasticoverhaul. Even though repeal of such new regulatory programs as theClean Air Act Amendments and the ADA is politically unlikely, thePresident and Congress could act to lighten the overall regulatoryburden in other areas. Reform of deposit insurance and federalbanking laws, for example, could help the entire economy and woulddo much to alleviate the credit crunch that has restrained jobcreation by small and medium-sized businesses over the past threeyears. (See William G. Laffer III, "How to Reform America's BankingSystem," Heritage Foundation Backgrounder No. 810, February 26,1991; Victor A. Canto, "The Credit Crunch" (La Jolla, California:A.B. Laffer, V.A. Canto & Associates, April 20, 1990); VictorA. Canto, "The Credit Crunch Revisited" (La Jolla, California: A.B.Laffer, V.A. Canto & Associates, November 16, 1990); William C.Dunkelberg and William J. Dennis, Jr., "The Small Business CreditCrunch" (Washington, D.C.: NFIB Foundation, December 1992); PaulCraig Roberts, "Economic Dominoes," National Review, November 30,1992, pp. 37-42. As predicted by Canto and confirmed by Dunkelbergand Dennis, the credit crunch has mainly affected medium-sizedbusinesses and larger small businesses (that is, those smallbusinesses with at least 40 employees).)
But besides dealing with specific regulations, the regulatoryprocess itself is badly in need of reform. What is needed is forthe President and Congress to force agencies to inform Americans ofthe likely employment effects of proposed rules and to setpriorities in rule-making. If these reforms are instituted, thefederal government's regulation of the economy could be conductedwith the fewest pink slips for American workers.
© 1995 Persimmon IT, Inc.
