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Tuesday, July 5, 2016

Economic Growth and Regulatory Relief

by Roy C. Smith and Ingo Walter

Low rates of economic growth today seem to pervade the world economy. Few in China, Japan and emerging markets are happy with their economies’ performance. Politically, Brexit appeared to center on migration issues, but British voters have long chafed at the EU’s lack of economic growth and excess of regulatory micromanagement from Brussels. Many “leave” voters thought they’d be better off avoiding the stifling bureaucracy and simply playing by the rules of global trade as the US, China and other non-EU members do.

 But US growth has also fallen short, accounting for much of the skepticism and mistrust of the voting public. So far, the presidential campaign has been depressingly deficient in drawing-out the economic policy issues that will have a far bigger effect on American lives than almost anything else debated by the candidates.

Growth issues are crucial. Since 2000 U.S. GDP growth has averaged less than 2% per year, and seems to be stuck there for the foreseeable future. The average growth rate over the previous 50 years was about 3.5%. That difference, compounded over the years, is enormous. It is reflected in lower real per-capita income, private sector capital spending, renewal and new investment in infrastructure, productivity improvements, and other important roots of economic performance.

Meanwhile, the funds available to pay for federal, state and local pensions and the various social programs that most Americans expect their government to provide as “entitlements” are running out. Without faster growth they will require drastic changes. And the career prospects and the prosperity of future generations worry many American parents long accustomed to making progress from one generation to the next.

No wonder the voters are testy, and receptive to populist pitches to create major changes and start over.

Americans should be asking the candidates “Where’s the growth?” and “How are we going to get it back?” Without it, the U.S. will confront an economic future much like continental Europe and Japan. Standards of living may seem fine for the time being, but beneath the surface prosperity the prospective future wellbeing of the citizenry, the nation’s vitality and its global standing are gradually dissipating.

During the grueling primary season the surviving presidential candidates have invariably paid lip service to growth idling well below its potential, and the need to somehow hit the “reset” button. And yet there have been no coherent roadmaps for how this can be done.

Hillary Clinton and the Democrats, pushed hard to the left by Bernie Sanders and Elizabeth Warren, are focusing their campaign on re-slicing the economic pie by progressively alleviating “income inequality” through direct intervention such as trade protectionism, increasing the minimum wage, easing student-loan debt, tougher regulation of banks, and boosting taxes on hedge fund managers and others among the rich. The trouble is there’s no free lunch, and the policies tabled so far are more likely to shrink the pie than to enlarge it, and in the meantime, rival political factions will fight viciously over the shrinking slices.

One early presidential candidate, Jeb Bush, was alone in putting forward a plan to restore U.S. growth to a 4% level and jettison the “new normal” of 2% that has seemed to be acceptable to the Obama administration.  His plan included a major tax reforms, especially cuts for the middle class, to be paid for by eliminating some deductions and benefits provided to industry and wealthy individuals. The Bush plan was straight out of the old Republican playbook that has been in place since the Reagan era, but nevertheless had support from credible economists. The only plan on the table was cast aside along with Mr. Bush when the Trump juggernaut rolled over him.

Trump’s anti-trade economic plan – one that also offers major tax cuts but no changes in entitlement programs – has little credibility and omits the specifics needed for proper evaluation.  Republican voters will have to take it on faith that their party’s legacy economic policies will survive in a Trump presidency. But he has not signed on to these policies and up to now has proven to be  fundamentally unpredictable.

The basic Republican package – cut taxes to encourage consumption and investment - paying for it through borrowing if Congress fails to enact spending cuts – admittedly comes with a big increase in the federal budget deficit. That deficit, however, is now down to about 2.5% of GDP (compared to 10% in 2009), so there is some headroom in a one-off effort to kick-start the U.S. growth engine.

The Democratic plan differs mainly in where taxes should be cut and raised, with a “progressive” slant, making it more likely to boost the U.S. fiscal deficit over the longer term. Probably Congressional gridlock will prevent the Democrats from enacting their plans unless they can take control of the House of Representatives (possible, but not likely). Nor will Republicans be able to do much to enact their own programs without controlling sixty votes in the Senate (also possible, but not likely).

So it matters less what the candidates say they want to do than what they may actually be able do, mainly through their executive powers.

A president can wield significant economic power through regulation and  enforcement, and support and encouragement of the private sector (or not)   because federal regulation is now so pervasive and mostly relies on rules written by civil servants in the various administrative agencies.

Three recent studies shed some light on the cost of regulation in the U.S. A report by James Gattuso and Diane Katz of the Heritage Foundation (2016), found that in the first seven years of the Obama Administration new federal regulations reached a cumulative annual cost to the private sector of $108 billion, with the federal government spending additional $57 billion on enforcement. This represents “an unparalleled expansion of the regulatory state,” the authors claim.

            Another study by Bentley Coffey, Patrick McLaughlin and Pietro Peretto for the Mercatus Center at George Mason University (2013) estimated that the cumulative cost of U.S. regulation across 22 industries from 1977 to 2012 caused by “the distortion of investment choices that lead to innovation” amounted to an average annual reduction of the U.S. economic growth rate by 0.8%. The study concluded that if regulation had been held at constant levels since 1980, the U.S. economy by 2012 would have been 25% larger.

And a study by Mark Perry at The American Enterprise Institute (2013), concluded that the aggregate economic cost of regulation in the US since 1949 -- i.e., the total cost of compliance and reduced investment -- led to a 2% average annual reduction in U.S. GDP growth.

There are many other studies like this, including one cited recently by Speaker Paul Ryan, that point to the high residual drag on economic growth caused by regulation. Indeed, in 1993 the Clinton Administration established the National Partnership for Reinventing Government aimed specifically at cutting federal regulatory costs.

Of course, regulation can have value to individuals, businesses and American economy generally.  It protects the system against fraud, dangerous products, monopolies and various other forms of exploitation. It aims to make markets for goods and services fairer and more competitive.

Nevertheless, several studies including one by the Office of Management and Budget, note that the benefits of regulation have to be subtracted from their costs to obtain a meaningful idea of the “net regulatory burden” (NRB) imposed on the economy. The argument is that the NRB in the U.S. has grown to a level where it seriously damages growth and constrains the effectiveness of pro-growth policies regardless which political party is in power.

This “excess” regulation involves an economic burden through obsolete, ineffective, impractical, duplicative, market-distorting requirements that impact private-sector activities. NRB is certainly not entirely responsible for the drag on U.S. economic growth. But it is probably responsible for a good deal of it, and may be the most fixable in a new administration.

There seems to be a lot that can be pared-away. The Gattuso and Katz study points out that a great deal of new regulation (or stricter enforcement of existing rules) has been launched in the Obama years through the powers of federal agencies. Although some of these “executive authorities” have been challenged in court, few have been overturned.

Some of the principal launchers have been the Environmental Protection Agency, the Department of Transportation, the Department of Energy, the Anti-trust Division of the Department of Justice, the Federal Trade Commission, the Department of Health and Human Services, the Federal Communications Commission, the Financial Stability Oversight Council, the SEC, the CFTC, the FDIC, the Consumer Financial Protection Bureau, and the Department of Homeland Security.

Most of this new regulation appears to have been motivated politically and ideologically, and not subjected to Congressional approval or independent economic review. Canceling, simplifying and reducing the accumulated regulatory underbrush could release considerable economic energy to help restore growth, and is doable even with persistent Congressional dysfunction.

During its term in office, the Obama Administration also became increasingly unfriendly to business – it has blamed the financial crisis of 2008 on greedy businessmen and their Republican supporters instead of the more complex confluence of factors actually responsible. That attitude may have affected consumer confidence, fears of further layoffs and reduced appetite among businesses, particularly small ones, for investing for the future.

Obama’s regulation-inducing pessimism isn’t easy to explain politically, given that 85% of all working Americans are employed in the private sector. It would seem to make more sense for politicians to back an initiative that could instead unlock pro-growth potential.

It is possible that President Hillary Clinton would turn her back on the Obama regulatory policies, but at this point the likelihood of her championing a de-regulation turnaround seems low. President Trump - if properly advised and focused - might do so, but how such an effort under his control would turn out is impossible to predict.

In most presidential campaigns, the candidates move towards the center after gaining their nominations.  After all, in January 2016 a Gallup Poll reported that 42 percent of all voters are now self-declared independents (i.e., moderates) that do not respond to the extreme positions typical of primary campaigns in which only 17% of voters participated in 2016. Clinton, however, may not bother to shift towards the center if Trump continues to drop in the polls, more because of his extreme personality than his extreme positions.

Perhaps the best that can be said for Clinton’s presumptive economic policy directions is that, based on her pragmatic Clintonian family DNA (and her own wealth accumulated since Bill left office), she may at heart be a moderate Republican dressed up in Democrat clothing.

And the best that can be said for Trump is that, if elected, he will have revealed a powerful political majority that truly wants radical change in areas that affect the pocketbooks of average Americans. If that cohort is as large as Trump hopes it is, then he will have license to do radical things, whatever they might be. Some of these things, we assume, would be pro-business.

But if it turns out not to be large enough to elect Trump, then we are in Hillary’s hands. Will those hands be more Obaman than Clintonian?  Much of future growth hangs in the balance.

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