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obamaEconomic regulation and its counter-effect on economic growth — a rising background issue until now — has just vaulted to the front pages with President Obama’s recent speaking tour, signaling a redirection of policies and mischief ahead.

The concern about regulation today, as always, is that it is leads to a hardening of the economic arteries that restricts entrepreneurship and negates the income and jobs that follow.

In limited circumstances, well-structured regulation can be worth the economic cost by yielding benefits most found in the areas of health, safety and the environment, as China can attest.

But most economic regulation is mindless and costly — not just in terms of opportunity cost, but also government administrative costs and the reporting and compliance costs that come with operating under a regulatory regime.  All of that reduces real economic activity and real income, so regulation is effectively an out-of-the-limelight, macroeconomic issue.

When the Fed complains endlessly about “headwinds” to economic growth, it implicitly recognizes regulation as a ghost factor that neutralizes its own monetary policy. This leads to the economy repeatedly falling short of the Fed’s expectations and yet more accommodative policy, as occurred this week.

When R.A. Posner studied the common causes of regulation in 1974 (another regulatory era), he observed that regulatory intervention is a tempting option for those in government who don’t believe that market prices and allocation mechanisms create desired social or economic outcomes.

Posner also indicated that income inequality is a further cause for governments to turn to regulation.

Hence, there is nothing like a Great Depression or Great Recession with depressed income and wider inequality to become a regulatory breeding ground that indeed deepens the macroeconomic quagmire.

Slowing economic growth comes about when regulatory barriers and costs makes production less viable, at least in the U.S.

As former Intel CEO Paul Otellini explains it, even the job- and income-generating computer chip industry is moving away, not just for production but also for R&D.

The decision to relocate or stop production altogether occurs when the rules of regulatory fiat restrict investor incentives to deploy capital and enterprise to activities in which prices and profits are rising, and divert them away from activities in which the reverse is true.

This is the heart of the system in which prices direct the commitment of resources, a policy that used to be known as laissez faire — a case for the passivity of central direction.

According to Wikipedia, “laissez faire stems from a meeting in about 1680 between the powerful French finance minister Jean-Baptiste Colbert and a group of French businessmen led by a certain M. Le Gendre. When the eager mercantilist minister asked how the French state could be of service to the merchants and help promote their commerce, Le Gendre replied simply “Laissez-nous faire” (“Leave us be”, lit. “Let us do”).”

But regulation becomes a costly visible hand of government that overrides the “Invisible Hand” in which Adam Smith also saw the market providing for wants as a superior guidance for outcomes.

As indicated above, the most fertile time to give rise to perceived needs for regulatory corrections to market outcomes would presumably be the shock of a Great Depression. Due to that and the exigencies of World War II, the command economy emerged out of Washington DC and bureaucrats, as they came to be known, overrode economic decision making.

And of course, it creates scarcity that markets do not rectify.

My views on the subject were formed early on. As a teenager I accompanied my father to Washington, where he testified at a hearing conducted by the now-defunct Interstate Commerce Commission having to do with the difficulties of obtaining trucking capacity, which was obstructed by a command-and-control agency for a myriad of perceived purposes — take your pick.  For me, it was an introduction to government and a lasting impression of regulation. (I was impressed with the stately Hearing Room!)

By the 1970s, following decades of regulatory dead-weight loss, the wisdom of Washington’s visible hand was questioned by yes, a Democrat, Jimmy Carter, who lead the way to deregulation industry by industry and agency by agency, followed up in the 1980s by Ronald Reagan and Maggie Thatcher in the U.K. The repulsion of mindless regulation then appeared to be a bipartisan conclusion.

By 2007, celebrating 25 years of economic deregulation, Robert Crandall of the Brookings Institution calculated that the 25-year deregulation movement dating from Carter’s time had liberated the regulatory controlled economy and reduced prices by 30 percent in the industries it directly affected.  Hence, deregulation represented a substantial gain in real income per person.

But alas, the celebration of the deregulatory gains in America was premature.

At the very time when Crandall was tallying the gains from deregulation, we were on cusp of a great financial/economic shock and a spreading war on terrorism that had the same one-two punch to send Washington back down the regulatory road as it did in the 1930s and 1940s.

In today’s environment, the regulatory and tax tone is simply anti-business, not just preventing new firms from getting off the ground, but also causing large companies to redirect activities to those countries where business is most welcomed.

To add to the compulsion for regulation in this Great Recession, the U.S. government is in a financial bind.  Without the ability to legislatively change broad-based tax rates or benefits, it does so in a de facto way by putting its citizens through a greater burden of proof for tax deductions and eligibility to receive benefits as an indirect means of deficit control.

Art Laffer, a classmate who went on to be a champion of supply side economics, has studied the regulatory and compliance costs imposed from U.S. taxation. He deems these amounts to be 30% of total income taxes collected, increasing with tax complexity. That’s the situation we’re in now that the fiscal bind is ramping up.

Which brings us to Obamacare.  Not only is there regulatory complexity and reporting to produce and receive benefits, but moreover the loss in aggregate efficiency in U.S. production could grow even larger. For example, John Mauldin reports that many businesses are reorganizing their work forces to deflect the Obamacare tax by working with subcontractors that employ no more than 50 workers each who work fewer than 30 hours per week.

But how do you document lost production from the loss of the cohesiveness of a work force? It would be like fielding an NBA basketball team with a group of underpaid rented part-timers on the way to their next hiatus. (Incidentally, to appreciate the role of player connectivity and continuity in professional basketball, take a look at Phil Jackson’s new book, “Eleven Rings”).

Also in this post Great Recession re-regulatory environment, let me not fail to mention the costs of financial regulation.  There are crippling reporting and compliance costs involved, so multiple government agencies can judge the appropriateness of a loan for both borrower and lender in banking.  As a result we are not using our financial resources provided by the Fed.

As the graph indicates, we are in an unprecedented situation in which trillions of dollars of excess commercial bank cash reserves are sitting on deposit at the Fed rather than being loaned out.  While indeed there are other causes as well for the unloaned cash accumulation in commercial banks, financial regulation is under-rewarded for praise.

To attempt to document the growth of regulation, some have taken to counting the numbers of new regulations that have been codified which is more than alarming, but only implies economic loss without measuring it. Others count the number of regulatory and compliance lawyers and accountants.

But the Weidenbaum Center at Washington University in St. Louis and the Regulatory Studies Center at George Washington University in Washington, D.C., have put the regulatory compliance and administration cost in dollar terms. They jointly estimate it to be 11.6% of GDP as of 2011, and no doubt rising with complexity.

But how to put a cost on the whole ball of wax of regulation so as to clearly see the implications for lost growth?  After all, it’s not possible to generate statistics on what didn’t happen.  That is, it is effectively impossible to measure the opportunity cost of investments not undertaken, nor plants not built, nor inventions and potential jobs that fell by the wayside, except indirectly by the lost output capability of the U.S. economy.

On that there is one rough measure of the decline in the pre-Great Recession projections of the U.S. Potential GDP. The estimate of the frontier of possible output has shrunk and the supply side of GDP is projected to be growing at a slower rate than previously projected.  This is a very rough measure of the shrinkage of the supply capability of the economy.

Other evidence of malaise reported by Lacy Hunt includes the fact that real median household income today is back to its 1995 level. Something is clearly amiss, and it’s not from a lack of mega-demand-side fiscal and monetary policy.

In a rare reflective moment regarding jobs not created and middle-income not produced, President Obama this past week conducted a series of hinterland college speeches in which he indicated that jobs and middle-class opportunity were missing from the American landscape and that we are suffering “unfairness” in income distribution. The opportunities are not there any longer for the middle class, he proclaimed.

Well how do you achieve fairness in income distribution except to redistribute from the top down?  Rather than uttering income redistribution and being declared a socialist, he prefers “fairness” making himself a modern day populist in today’s discussion of the “isms.”

To be sure, there is a link between a lack of business development and middle-income jobs, but it runs from a lack of incentives or ability to navigate past regulations and taxes, obtaining financial resources and being unleashed to produce so that middle class jobs are forthcoming.

But in Obama’s world, the linkages run from middle class income to generate spending for companies to prosper. He explains this phenomenon as “leading with the middle class, an economy that grows from the middle out, not the top down.”

If this were physics, he would have gravity running upside down.

But it is welcome that after nearly 4 and a half years as President he is grappling with how to effectively produce jobs in America. Let’s hope he is a fast learner.

What I find interesting is that for the few one-off exceptions to promote an enterprise in order to keep jobs, the President provides subsidies, special tax breaks and a reduction in the paperwork that needed to be filled out (which to him seems but a minor irritant).  Now the question is, can this selective perception be generalize to all endeavors?

It’s important since we have amply demonstrated that demand side policies have been applied beyond their useful limits, and supply side policy is all that is left. But what it requires is for the control freaks in Washington to let go. They must leave laissez-faire alone.

Since most lawyers who run for office are on a mission to do something to make a difference, laissez faire is not their inclination, and Obama has indicated that he will use executive orders that push the limits of Presidential power.  For that reason, I’m not optimistic, as regulation is an adverse macroeconomic policy and income redistribution (under the guise of income “fairness”) eliminates income differences at lower levels of income for all.

It will probably take another farmer President like Jimmy Carter who toiled under the USDA to appreciate the virtues of laissez faire and allow it to thrive again.

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