Regulatory Burden, Productivity Growth, and Jobs
At the Davos meeting of the World Economic Forum, economists and market participants are surveyed, among other things, about the regulatory burdens faced in their countries. The results of this year’s survey, like those of the last few years, were not encouraging for the United States.
Since the 2006/7 rankings, the U.S. has fallen from
20th to 80th place among the 148 countries whose
representatives were consulted. Notably, in that time
frame, many emerging market countries have moved
toward more competitive regulatory regimes… while
the U.S. and much of the developed world has either
been moving in the opposite direction or lagging behind.
The Problem With Regulatory Burdens
Why should it matter that the U.S. is lagging in the creation of a business-friendly regulatory environment?
There are a few economic relationships that make this trend relevant.
Firstly, economists have noted a correlation between a country’s regulatory burden and its labor productivity
growth — that is, the amount of value created by the average wage worker.
Statistics from the OECD show the productivity growth rate sharply declining in the U.S. after the financial crisis
— a trend that has continued during the recovery. On the other hand, in Europe and more broadly across the
OECD, labor productivity has rebounded strongly after the crisis. In terms of annual productivity growth, the
U.S. is now a relative laggard.
Analyses by think tanks such as the McKinsey Global Institute and the Private Equity Council examined firmand
industry-level causes for the variation in productivity growth around the world. The Private Equity Council
reached this conclusion:
“… industries that are exposed to strong competitive intensity and that have a favorable regulatory environment
are more productive than sheltered industries or highly regulated industries… Because of regulations that limit
the scope of competition, some industries are overly fragmented and operate with low productivity…Historically, the United States does not prop up failing companies; this allows more productive companies to expand and take over the market.”
In other words, excessive regulation restrains the process of “creative destruction” which is the key to productivity growth. The chart below shows data in 2000 — when the U.S. had clear superiority. Less productive U.S. companies were more likely to shrink and fail, while more productive companies were more likely to grow — and growth is how jobs are created.
Frequently, we hear from some friends and colleagues the sentiment that Europe has struck a good balance between the interests of business and society — that the European welfare state is something that the U.S. should emulate. This is a sentiment that seems to have been expressed by many U.S. voters in 2008 and again in 2012. It can be seen in the Affordable Care Act and in the protectionist reluctance to embrace new free trade regimes.
We would observe, however, that Europeans have been increasingly willing to acknowledge the drag that their unsustainable welfare obligations place on growth. Verbally, at least, even leaders such as France’s President François Hollande (a Socialist) are now admitting that they need to deregulate in order to spur growth in productivity and employment. Whether they follow through is another story — but the path of austerity that many Europeans were willing to take after the Great Recession is hopeful.
In the U.S., on the other hand, we see what may becoming a secular trend in the opposite direction — towards greater regulatory burdens, lower productivity growth, and therefore anemic job creation.
In a study released during the financial crisis, economists Martin Baily and Matthew Slaughter made this prescient
“The collapse of the financial sector has resulted in calls for a much greater level of regulation for the U.S. economy. We agree that more effective regulation of this sector is needed to prevent another crisis. But we judge that it would be a serious mistake to allow a backlash from the crisis and over-regulate either the financial sector or the overall economy for this would give up the huge gains the economy has achieved as a result of deregulation and greater market competition. We need smart regulation that makes markets work better, not stifling anticompetitive regulation.”
Moderate Regulation Leads to More Growth
We continue to be bullish on the U.S. economy and U.S. equities. However, we are also always watching for longer-term trends. And we believe that where the regulatory regime is best — in short, adequate but not excessive — there will be the most robust growth.
If the U.S. continues on its present course towards heavier regulatory burdens that protect laggard firms and inhibit the rise of more dynamic companies, then we’ll be on the lookout for investment destinations with superior secular prospects.