Real regulation problems.

Meaty post from Reihan Salam over at The Agenda. It’s all worth a read but it’s all over the place. There was much to like, though.

One section worth discussing. Reihan is quoting a lot from other sources, but here he writes:

If we accept this framework, the deeper cause behind insufficient business investment becomes clear. Incumbent firms aren’t as frightened of new entrants as they should be.

Think about this across sectors of the economy. Sectors in which barriers to entry are relatively low are sectors in which firms are not stockpiling huge amounts of cash. Rather, firms are in a never-ending arms-race against rivals and potential rivals. They must engage in exploratory investment in order to maintain some fleeting advantage.

But then a few things happen: incumbents find ways to protect themselves through the patent system, as Alex Tabarrok and Michael Heller have argued. And regulations designed to protect workers and consumers grow so onerous and complex that new entrants are stymied by them.

This is what he means by the “incomplete neoliberal revolution,” which he metaphorically describes in totality as the “invisible hand” and the “invisible foot.” Today, we have more of the hand (upside profit motive) but we never really got around to the foot (decline/irrelevance from defeat).

What I like about this is that it offers a more eloquent way of articulating the problems of the current regulatory environment than the kind of whiny and inane “regulatory uncertainty” argument. Conservatives are consistently hammered by the left, with Paul Krugman at the helm, when they invoke the “confidence fairy” argument of unemployment: businesses won’t hire because they don’t know what their costs will be under Obama’s regulatory assault on free enterprise.

The way in which what Reihan is saying is better is that it comes across as less pro-business and more pro-free enterprise and thus seems less like implausible and shallow kowtowing to the business lobby and the 1%. It is also seemingly more plausible, although that is largely irrelevant from a political standpoint.

Instead of

Regulatory uncertainty –> hiring cost uncertainty –> less investment in expansion

the connection becomes

Current/prospective regulatory burden –> barriers to entry –> less emphasis on innovation versus deleveraging/productivity increases at incumbent firms –> less investment in expansion

Notice the connection shifts to the effect of regulations on prospective new firms, while the investment effects still fall on incumbent firms. This seems more plausible because 1) we know incumbent firms are investing meagerly and 2) regulations are intuitively more likely to have influence on the margin in making the decision to take startup/innovation risks to enter a market versus whether to simply bear increased costs and stay in business.

In fact, knowing that regulations could raise barriers to entry opens up the possibility that firms face a net positive effect of regulation on profit, rendering increased compliance costs negated. But this still doesn’t challenge the narrative that investment would remain low because the action incumbents take is not dictated so much by the regulation as by the adverse competition effects. Knowing a startup isn’t going to cause industry upheaval means you can hunker down, bring in a few consultants, and exploit cost-cutting and stream-lining. You might invest in automation, but you’re not investing in much expansion and you’re not hiring new labor.

Ironically, this means that left-championed policies adversely empower capital over labor. No one should want that.

This is a potentially powerful argument for conservatives because it’s not pro-business — we’re actually trying to eat into firm profit by making incumbent firms vulnerable to disruptive innovation. What’s better for society, Apple sitting on $80 billion in cash as a patent war chest, or Apple with little in cash on hand in a better patent environment? The latter, duh. Think of all the dead-weight loss in foregone innovation and unspent investment — patent attorneys’ fees notwithstanding.

This narrative also challenges the left on their basic assumptions about the efficacy of certain regulations. Not to say that regulations are bad, but they cannot be all upside with no downside risk. This speaks to that.

Here’s a great and scary chart of bank mergers from the recent past up to 2009

Yeah. This is what happens in an economy with higher barriers to entry. And what’s scary is that this is the industry we most agree needs new regulations. But to the extent that financial reform solidifies the market concentrations of the few winners that emerged from the financial crisis, that reform has made our financial system even more vulnerable and unhealthy from a pro-market perspective.

I’m bearish on conservatives articulating this well. But I think it’s terribly salient. Great work to Reihan for piecing all this together. And go read the original in full.


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