What is the negative effect of government regulations?

Stack of binders.

This year marks the 50th anniversary of the Apollo moon landing. A lot has changed since that incredible event, including the size and scope of the federal government. From 1970 to 2017, the number of words in the Code of Federal Regulations (CFR) nearly tripled from 35 million to over 103 million. This increase in regulation reduced economic growth and lowered Americans’ incomes, and now new evidence shows that regulation has especially harmful effects on the country’s low-income residents.

Of course, not all regulation is bad. Regulations that focus on basic worker or consumer safety often have benefits that outweigh their costs. But many regulations on the books today go way beyond basic safety, which isn’t surprising considering the rapid growth of the CFR just mentioned. Such regulations protect established businesses by limiting entry or increase firms’ costs without providing an offsetting safety benefit, harming workers, customers, and potential entrepreneurs in the process.

And this harm is not just theoretical. The studies in a recent issue of the academic journal Public Choice focus on how regulation impacts lower-income people and many of them find harmful effects.

One study by Dustin Chambers, Courtney A. Collins, and Alan Krause finds that regulation leads to higher consumer prices—a 10% increase in total regulation leads to about a 1% increase in prices. They also find that low-income households spend more of their money on the goods and services most prone to regulation-induced price increases. This means too much regulation worsens the financial problems of people who are already struggling.

Another study by G.P. Manish and Colin O’Reilly finds that more intense banking supervision and regulation is associated with greater income inequality. They attribute this finding to regulatory capture, in which banking-industry insiders capture the regulatory process and use it to promote the interests of established banks at the expense of competitors. The result is fewer banking options for low-income households which makes it harder for them to accumulate wealth.

A third study by Dustin Chambers, Patrick McLaughlin, and Laura Stanley finds that more federal regulation is associated with more poverty at the state level. Using a measure of the federal regulatory burden imposed on each state, they find that at 10% increase in a state’s regulatory burden is associated with a 2.5% increase in the state’s poverty rate.

In addition to these studies, others show that too much regulation reduces employment growth and business investment, both of which contribute to lower wages for workers.

Luckily, people are starting to pay closer attention to the costs of too much regulation. Several state governments have either reduced regulations or set up processes to do so. Kentucky has set up a red-tape-reduction initiative that has already repealed or amended 27% of the state’s administrative regulations. Rhode Island is engaged in an ambitious program to reduce its regulatory burden and the state’s Code of Regulations recently won an innovation award. Virginia also has a bipartisan plan in place to reduce unnecessary regulation and Idaho is in the process of analyzing its entire regulatory code after lawmakers failed to reauthorize it.

Not to be outdone, the Trump administration has tried to take similar steps at the federal level. So far it has been unable to repeal as many regulations as Trump initially hoped, but it has significantly slowed the growth of new regulations, as shown in the figure below from the Regulatory Studies Center at George Washington University.

Regulation count in first two years.

The administration has also pressured states to reform their occupational licensing and reduce land-use regulations that drive up the cost of housing. The effectiveness of these actions remains to be seen but since both types of regulation disproportionately hurt low-income people it’s encouraging to see that the administration is skeptical of them.

Regulation has costs and benefits, but for too long the costs were largely ignored. As a result, there’s too much regulation at all levels of government and recent research highlights how all this regulation is particularly harmful to the country’s poor. Regulatory reform efforts in Kentucky, Rhode Island, Virginia, and other states—along with the federal reforms—are a good step towards simplifying the maze of regulation entrepreneurs must navigate and more states should follow their lead.

Many sectors of the business world have long complained about government regulation. Corporations and their spokespeople often denounce government rules as irrational impediments to profits, economic efficiency, and job creation. Unsurprisingly, many firms have used loopholes, moved operations abroad, and violated antitrust laws as they attempted to deal with regulations.

In reality, American businesses have both prospered and suffered due to an ever-increasing number of rules and a complicated tax code. As a result, the relationship between firms and the government can be either collaborative or adversarial. More importantly, the rules have protected consumers from exploitative practices. Below, we'll look at some of these regulations to see why their impacts on businesses can be difficult to determine.

• Government regulation of the U.S. economy has expanded enormously over the past century, prompting business complaints that interventions impede growth and efficiency.
• Proponents of intervention say it’s necessary to mitigate the adverse impacts of unregulated commerce, which range from environmental damage to labor abuses.
• Some interventions aim to help the private sector by providing clear guidelines, loans, and advice to businesses.

Congress passed the first antitrust law in 1890 and followed that with periodic changes in corporate tax rates and increasingly complex regulations governing business. The business community has generally opposed laws, regulations, or tax levies that it thinks impede its operations and profitability. A common argument against overregulation and excessive taxation is that they impose a net cost on society in the long run. According to critics, government regulations slow disruptive innovations and fail to adapt to changes in society.

Others argue that there are good reasons for regulation. In pursuit of profit, businesses have damaged the environment, abused labor, violated immigration laws, and defrauded consumers. Proponents say that is why publicly accountable elected officials are in charge of regulation in the first place. Furthermore, some rules are essential for civilized competitive businesses to flourish. Few legitimate firms wish to engage in racketeering or participate in the underground market.

In any case, we now have entities and regulations to limit the alleged excesses of the free market. Businesses complain about many of these rules while also lobbying to have other rules changed in their favor.

In the wake of major corporate fraud at several companies, including Enron, Tyco, and WorldCom, Congress passed the Sarbanes-Oxley Act in 2002. The act governs accounting, auditing, and corporate responsibility. Many in the business world opposed the bill, claiming that compliance would be difficult, time-consuming, and ineffective. Furthermore, they predicted that the law would not protect shareholders from fraud. This position gained some support when numerous financial frauds, such as Bernie Madoff, were exposed during the 2008 financial crisis.

President Richard Nixon created the EPA by executive order in 1970. The agency regulates the disposal of waste materials, restrictions on greenhouse emissions, and controls on other pollutants. Companies required to comply with these rules have complained that the restrictions are costly and compromise profits.

Some firms regard the FTC as a foe of business. It was created in 1914 to protect consumers from deceptive or anti-competitive business practices. These can include price-fixing, the formation of monopolies, and fraudulent advertising.

Congress created the Securities and Exchange Commission (SEC) in 1934. It regulates initial public offerings (IPOs), ensures full disclosure, and enforces rules governing stock trading.

Pharmaceutical companies often complain that the FDA needlessly delays the approval and marketing of certain drugs. They often demand additional or more extensive clinical trials, even when the drugs have already shown effectiveness. The high costs of getting drugs approved may deter small firms from entering the market. Furthermore, the FDA has been criticized for delaying approval and human trials of drugs for people facing life-threatening conditions.

Perhaps the most substantial criticism of government regulations is that they create the potential for regulatory capture. When that happens, the agencies supposedly responsible for protecting consumers come under the control of the industries they are supposed to regulate. The regulator may actively create barriers to entry and divert public funds for bailouts to benefit favored firms.

Regulations can increase the power of dominant and abusive firms if policymakers are not careful when they create new rules.

Hundreds of assistance programs from the government—in the form of money, information, and services—are available to businesses and entrepreneurs. The Small Business Administration (SBA) arranges loans for startups. It also provides grants, advice, training, and management counseling. The Commerce Department helps small and medium-sized businesses increase overseas sales of their products.

An often overlooked service that the government provides all businesses is the rule of law. The U.S. Patent and Trademark Office offers protection of inventions and specific products from illegal infringement by competitors, thus encouraging innovation and creativity. Patent and trademark violations are punishable by hefty fines and subject to civil actions that can be costly if the defendant loses.

On top of all of this, the government occasionally takes extraordinary steps to protect businesses in dire economic conditions. Some economists claim that the Troubled Asset Relief Program (TARP) and the economic stimulus plans that followed averted a repeat of the Great Depression. Similarly, the Coronavirus Aid, Relief, and Economic Security (CARES) Act may have prevented many firms from going out of business in 2020.

Other economists insist that the government should not have intervened and that free markets should have been allowed to weed out business failures. No matter which side you agree with, there is little doubt that the corporate world would look very different without these programs.

The government can be a friend of business, providing it with financial, advisory, and other services. It can also be a friend of the public, creating and enforcing consumer-protection, worker-safety, and other laws. Unfortunately, governments also have a long history of trapping nations into patterns of long-term decline through overregulation.

This conflict will probably never be completely resolved because there will always be disputes between different segments in any society. As technological breakthroughs continue, the dual nature of the government's relation to businesses may become increasingly regulatory and collaborative at the same time. The key to success may be preserving the government's role as a neutral referee even as the rules of the game keep changing.