Regulation

8 Economics Lessons #6

Governments hand down regulations and we follow them. They set regulations for the issuing of driver licenses. They set regulations limiting the amount of pollution a factory can spew out into the air. They set regulations on how much cash a bank must keep on hand in order to remain solvent. They set regulations that specify the requirements for a business license for an entrepreneur. It is undeniably true that every regulation has a cost

As Charles Wheelan points out in Naked Economics, government regulation interferes with the operation of the free market. The market will normally allocate resources where they stand to return the most in value. Regulations act as tolls on this activity. One example from the book is on the requirements to pass the bar and become a lawyer. If the requirements were lowered, lawyers would become cheaper to use which would allow more people to make use of lawyers when necessary. Regulations raise the cost of seeing a lawyer. So, are regulations, in and of themselves more helpful or harmful to an economy? There's no easy answer to this dilema.

Now, there is no question that too much regulation can stifle innovation and raise the cost of doing business. Many third world companies are over-regulated to the point that the average individual does not have the resources to so much as start their own business. (It costs 260 times the per-capita GDP of Bolivia for a Bolivian to procure the necessary approvals to start a business.)

Still, like everything in economics, regulations require trade offs. Sometimes it is in our collective best interest to stifle the effects of the market a bit. Regulations help keep the air we breathe clean. They help keep the drugs we're prescribed safe. After the Glass-Stegall Act, they kept banks from taking too many risks and all but eliminating bank runs.

It is the Glass-Stegall Act that shows us the ultimate truth of regulation. These regulations were gutted by Congress in 1999, led by Republican Phil Gramm, and we are now suffering the consequences of that decision. Regulations are often onerous, but they are, so often, necessary. Like everything in economics, the use of regulations is a balancing act. The government has to find the right level to protect the people from the worst abuses of business, while not stifling growth to the point that the people are harmed. Republican claims that regulations are inherently bad are just ridiculous.

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