Thursday, July 16, 2020

Are Regulations "Job Killing"?

The traditional models of regulations and growth treat regulation as an adverse productivity shock (more inputs for the same output) in order to help the environment, fairness, or some other social good.  But a productivity shock has opposing income and substitution effects on labor supply.  Arguably a regulation that works as a productivity shock has no aggregate effect on jobs.

Reminded how Gary Becker many times told me that "somebody benefits," I do not endorse the productivity-shock model of regulation, at least as relates to the Federal regulations added and removed over the past 20 years.  In economics jargon, the "rectangle" created in a market by regulation is not entirely wasted: some of it is a transfer to special interests and therefore not an income effect in the aggregate.  This kind of regulation is more like an excise tax with the revenue paid to special interests.  Excises taxes unambiguously reduce aggregate equilibrium employment.

As the CEA showed in the 2019 and 2020 Economic Reports of the President, many of the regulations removed by the Trump Administration were more like the excise tax than like a productivity shock.  That's why special interests fought back so hard (and a couple of times, they won).  

[Even a productivity shock reduces employment in the short run to the extent that it reduces the productivity of investment.  i.e, that's another way that the "job killing" can occur.  There is another interesting case in which the rectangle from regulation is a transfer from Americans to foreigners in which case the employment reduction is outside the country.]

The sign of the effect on the employment of the regulated industry is also ambiguous.  If the regulation is a transfer from consumers to producers, with no adverse productivity effect, the regulation will reduce industry employment because that transfer is achieved by restraining supply.  But that frees up resources for other industries, which is why the aggregate employment effect can be nil.

To the extent that regulation reduces productivity in the regulated industry, we need Marshall's Laws of Derived Demand to sign the effect on industry employment.

One application provided in Chicago Price Theory is the regulation of illegal drugs.  Their demand is price inelastic in the sense that drug prohibition reduces consumption (although see here for a tragic exception) while it increases what consumers spend on drugs.  The price elasticity of demand is an important part of Marshall's Laws.  For illegal drugs, the result is more people working to (or serving prison time for) grow, manufacture and distribute illegal drugs because law enforcement reduces their "efficiency."  But those people are coming out of other activities, which is why the aggregate employment effect can still be nil.