A Sugar Pill for the Economy

“A wave of optimism has swept over America’s business leaders, and it is beginning to translate into… investment … that bolsters economic growth, spurs job creation—and may finally raise wages” says a January 1, 2018 front page New York Times article that discusses the administration’s policy of regulatory rollbacks.

The writers admit, after a few paragraphs of such expressions of opinion, that there is little evidence that regulatory laxity leads to more growth, and in fact, that the evidence (largely overlooked in the article) strongly suggests the reverse. More on this later.

So, the article is saying that if you can fool the business community into thinking a policy will work, then it really will. This is like suggesting that if you offer a sugar pill instead of medicine to  patients suffering from a disease, they will get better. The sugar pill, called a placebo, is given to test the effect of the real medicine. It is used to define zero effect.

The sugar pill does nothing—in fact, eating too much sugar is unhealthy—but some people think  it works. Placebos, however, are no way to cure our ills.

The article suggests that lax regulation creates growth because it “unleashes the ‘animal spirits’ of companies”, and that it creates “confidence” in the economy that encourages more investment.

“Animal spirits”!  Really? I thought economics was about the profit motive, but the article suggests it’s about hormones.

What about “confidence”?

It makes sense the Trump administration would rely onconfidence” to boost economic growth, because one of the first examples of a businessman trying to sell the public on the value of confidence was Herman Melville’s “The Confidence-Man.”  Yes, confidence-man had the same meaning in 1857 as it does today.

Our economy has been sick for a long time—median household income has not really risen since 1973. But trying to cure it with sugar pills makes things worse in two  ways. First, it weakens policies that need to be strengthened. Second, it allows us to avoid or postpone taking medicine that really works.

Why is rolling back regulations bad for the economy? First, we’ve tried this before, and  it’s led to disastrous results. Regulatory rollbacks in the American financial sector were a key contributor to the mortgage meltdown of 2007-2008. These rollbacks were not limited to the government’s regulations, but also included laxity by private sector credit rating organizations.

California deregulated its electricity supply in the mid-1990s and the result was a near-collapse of the state’s utility system in 2000-2001 and a permanent increase in electric rates of 40%. This failure demonstrated the key role of regulations in defining how competition can work in a free market. In the absence of such regulations (in California’s electricity markets in the late 1990s), companies such as Enron could engage in unfair practices that raised prices.

Rollbacks in regulation (and tax cuts) were part of New Zealand’s policies starting in the 1980s and the outcome was that at the end of the policy the country had gone from about the top of the list of economic performers among the OECD nations to about the bottom.

Second, evidence shows that regulation, particularly environmental regulation, increases growth by encouraging innovation and competition. Business leaders, in my observation at least, are not lacking in “animal spirits.” But they often operate in business environments  where innovation is considered risky to your career, and in which you can make money by doing more-or-less the same thing year after year. There is no need to worry much about competition because you know that the competition is doing it, too.

Regulation pushes companies to find new ways of working effectively that usually  improve their productivity and profitability along with accomplishing the direct goals of the regulation.

The Trump administration has not rolled back many regulations, and NRDC has challenged them in court when they have tried, with great success to date.

And even if the administration does roll back regulations, taking advantage of the situation isn’t always good for business. The article suggests that “electric utilities…might be able to invest in upgrading power plants that run on fossil fuels.” But real utilities are smarter than this: they are retiring old power plants because they are economically uncompetitive regardless of regulations. In addition, it would be foolish to make a 40-year investment based on  the anti-regulatory policy of a  four- or even eight-year administration.

Regulatory certainty increases investments. Companies plan to invest to meet the regulations, but usually find that they can increase productivity and improve their product by doing other things at the same time. That means even more investment and more profit. Rollbacks decrease certainty. Confronting investment in an uncertain environment, the best answer is "wait".

Regulatory rollbacks are a sugar pill that business leaders should join environmental advocates in rejecting. They create investment uncertainty and put the economy at risk of the very failings that caused the regulations to be proposed and adopted in the first place. In my experience, heavily regulated states (such as California) and countries are growing as fast or faster than ones with lax regulation. Remedies, whether for health problems or for economic ones, should be prescribed on the basis of what works, not blind “confidence”.


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