Regulation is good for business

originally published on Open Salon on May 29, 2010

A lot of economists and business people will tell you that regulation is the enemy of business, that a free market left alone functions optimally and that government invariably screws it up – the more regulation, the worse.  According to this model, the private sector is inherently efficient while government is inherently inefficient. In an awful lot of circles, this is dogma, accepted as truth by definition.

It is also complete crap.

It is based on the assumption that people are focused economic actors who concentrate overwhelmingly  and effectively on personal gain while being impeded by meddling bureaucratic social engineers who work for the government. This is as naive and silly as anything Marx ever wrote about the fundamental character differences between workers and owners.

So how is it complete crap? Why doesn’t the model work?

To start with, because being in the private sector doesn’t make you smarter than anyone else. I’ll give you an example from the 1980’s, during the Reagan administration:

A major corporation, I don’t remember which one (it may have been Ford) decided its payroll was bloated with too much middle management so it laid off a bunch of people, claiming this action would make it leaner and more efficient. Wall Street bought this explanation and the company’s stock rose. Other companies noticed this so, for the next two or three years, any time a company wanted its stock price to go up, it laid off a bunch of people and its stock rose.

I’ve been in business for over thirty years. Allow me to offer you a pearl of wisdom gleaned from decades of observation (drum roll, please):

Healthy companies hire people.

Wall Street managed to forget this overwhelmingly obvious point for over two years. By the way, did all these layoffs make these companies leaner? Well, no, what it made them was…….smaller. Why?

Because when you announce to your employees that there are about to be layoffs, they all start looking for work. Which ones find work fastest? The best ones, of course. These companies skimmed their own top talent right off the top and presented them on silver platters to their competitors.

Oops.

Say what you want about people who work in the public sector, you can’t realistically claim given evidence like this that they’re inherently more, uh, intellectually challenged than the guys in the private sector. Opposition to regulation on the grounds that the private sector is intrinsically more sensible doesn’t really hold water.

A second reason the model doesn’t work is because some of those vaunted market forces can screw it up. What makes free enterprise work is competition. (Anyone on Wall Street will tell you that – I’ll amend that: Everyone on Wall Street will tell you that.)  The trouble is that when you let markets operate with complete independence they have a nasty tendency to develop monopolies which kill the competition that makes the system work. What prevents our market from turning into a series of monopolies? Antitrust legislation, of course, courtesy of Teddy Roosevelt. In other words, regulation is what saves the market from not behaving like the market any more.

Every once in a while someone in a given industry will suggest that the government let the industry regulate itself. This typically doesn’t work. Why not? Because it favors the least ethical, most short-term actors. Whoever does something unethical gives his/her company a competitive advantage, forcing the competition to follow suit. We end up with the lowest common denominator from a behavior standpoint. What regulation accomplishes is raising the floor of the lowest common denominator: “You can’t go any lower than this.” That regulation can be in any number of areas including, for example, environmental damage or worker safety. An advantage of regulation is that business people can curse out the government for interfering in business, then go home without having to explain to their kids why they’re polluting the environment or their employees are getting killed (or both if they’re at BP or in the mining business).

Pollution brings me to another area where the model doesn’t work: The assumed feedback loops aren’t everywhere they need to be. The way the model is supposed to work is that people outside a company change its behavior by taking their business elsewhere; the company in question will then change its behavior to attract business back. It’s a pretty good feedback loop. This process breaks down when dealing with the question of environmental damage because the primary victims of said damage are rarely important customers of the polluter in question. How does a market self-regulate when the necessary feedback loop doesn’t exist?  It doesn’t; the only efficient way to regulate it is through government regulation.

Some of the more hard-core free-marketers might suggest just allowing pollution as a market consequence. The trouble with this is that environmental damage is typically way more expensive than preventing it is. However, while it may be more expensive to the country in general in terms of loss of GDP because of damage to other industries (such as fishing) or increased medical costs brought about by air pollution or toxic waste, it may not be more expensive to the polluter, meaning we as a country have a vested financial interest in stopping the pollution in question while the polluting company may not. Overall GDP is obviously a business interest, in this case best protected by government regulation.

I favor effective regulation largely because it’s way cheaper than the lack of it is. Here are a few examples:

During the first Bush administration we had the S&L Crisis. It cost us billions in bailouts. What you might not know is that all the S&L’s  that had problems were located in Texas and Maryland, primarily Texas. Not a single New York-based S&L had a problem, because New York State regulations kept them out of that kind of trouble. So, the responsible taxpayers of New York essentially had to bail out the irresponsible taxpayers of Texas.  Regulation would have been cheaper and, in fact, state regulation limited the damage.

Second example: There are a number of chemical dumping/toxic waste sites around the United States that the federal government has paid at least in part for cleaning up. What is the money called that is dedicated to this process? Superfund. A word to the wise here: When the organization that has spent more money than any other single organization in the history of Planet Earth, the United States Congress, calls something “Superfund,” you know you’re dealing with an astronomical amount of money. Not only would prevention have been cheaper, the expenses for prevention would have been borne primarily by the private sector where they belonged.

If you want a third example, ask the board of directors of British Petroleum if they’d be better off right now if there had been effective regulation when they drilled that well in the Gulf. By “effective” I mean something other than the existing system of inspectors who apparently allowed companies they were supposed to be policing to inspect themselves and, in some cases, write up their own inspection reports.

There’s one other reason the model won’t work: Because people are driven by social factors at least as much as they are by financial gain and the model doesn’t have a way to take this into account. Here’s an example of that you probably aren’t expecting:

If you were the human resources director of a major corporation and someone from the Board came to see you and said: “We are arbitrarily yanking your access to over half your talent pool for the purposes of hiring and promotion,” tell me you wouldn’t be tempted to chase that person down the hall with a meat cleaver. However, this is exactly what American business routinely did to itself, for social rather than economic reasons, prior to the Federal Government stepping in and forcing them to be more efficient. How did the Feds do that? It’s called Affirmative Action. I know, you’re used to arguing about the justice aspects of Affirmative Action but those aspects don’t pertain to this conversation. Regardless of your opinion about Affirmative Action in general, the fact is that it addressed a gross and arbitrary inefficiency that was pervasive throughout the private sector in America – without it, most female and minority employees and executives wouldn’t be where they are today, which would be an almost unthinkable waste of talent. Thank you, Federal Government.

There are plenty of examples of regulation saving businesses money. I’ll give you another: CAFE standards. These were first put in place at the beginning of the seventies, forcing American car companies to produce small, fuel-efficient cars at a time when they didn’t want to build them. However, in 1973 the Yom Kippur War took place followed by the Arab oil embargo of the United States, giving us a temporary period of gas shortages and high gas prices. At just this point, Japan established a serious position in the American market by exporting small, fuel efficient cars to us from Toyota, Datsun (now Nissan), and Honda, with others shortly to follow. They took an enormous market share very quickly because of  gasoline shortages and prices. What saved Detroit was that CAFE standards had forced them into producing small, fuel-efficient cars so that when the Japanese invasion happened, the Big Three had enough answers in stock to keep their doors open.

How much richer would we as a country be if enough regulation had been in place to stop the 1929 stock market crash? Or the S&L crisis of the eighties? Or the mortgage crisis of 2008? I’m not claiming that regulation is without its costs, but I am claiming that in each of these cases those costs don’t begin to approach the savings they’d have given us.

There is at least one other area where we could use some new regulations (or at least different ones): Income polarization. With wealthy hedge fund managers paying only 15% income tax while teachers pay more like 25% at a time when we’re running historic deficits and are at war, something has to change. Our tax policies favor the very rich at a time when the rest of us can’t afford to support them, and some of them can’t afford for the rest of us to run out of money because without us their businesses won’t stay open. (Some of the very wealthy agree – Bill Gates has basically said they’re undertaxed, and he’s far from alone among the very wealthy with that opinion.) Without new regulation here, we stand a serious chance of going down the tubes as a nation.

If you look back over this blog, please notice one thing: One hundred percent of the case I’ve made is based on money. I’ve written in favor of more government regulation, more equitable taxation, stronger environmental regulation/enforcement, and even Affirmative Action without using a single social or political argument for any of them. They all make sense based on finances alone. I haven’t seen this done before and, frankly, I don’t understand why not, because even people who don’t like government interference in social (or even environmental) matters don’t like wasting money. Nobody likes wasting money. So let’s please stop.