Wish you were here ... doing paperwork.

Photographer: MLADEN ANTONOV/AFP/Getty Images

One Regulation Is Painless. A Million of Them Hurt.

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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“In one year,” wrote Warren Meyer in 2015, “I literally spent more personal time on compliance with a single regulatory issue -- implementing increasingly detailed and draconian procedures so I could prove to the State of California that my employees were not working over their 30-minute lunch breaks -- than I did thinking about expanding the business or getting new contracts.”

Meyer is the owner of a company that runs campgrounds and other recreational facilities on public lands under contract from the government. It doesn’t seem like regulatory compliance should be eating up so much of his time; he is not producing toxic chemicals, operating a nuclear facility, or engaged in risky financial transactions that might have the side effect of sending our economy into a tailspin. He’s just renting people places to pitch a tent or park an RV, or selling them sundries. Nonetheless, the government keeps piling on the micromanagement lest some employee, somewhere, miss a lunch break.

I know what you’re going to say: Employees should have lunch breaks! My answer is “Yes, but.…” Yes, but putting the government in charge of ensuring that they get them, and forcing companies to document their compliance, has real costs. They add up.

An economy with but one regulation -- employees must be allowed a 30-minute lunch break, and each company has to document that it has been taken -- would probably not find this much of a drag on growth. But multiply those regulations by thousands, by millions, and you start to have a problem.

A new working paper from the Mercatus Center attempts to document the cumulative cost of all these regulations. It finds that the growth of regulation between 1977 and 2012 has shaved about 0.8 percent off the rate of growth, costing the nation a total of $4 trillion worth of GDP.

Stories like Meyer’s are the tangible face of the economic theory. As is the fact that in the annual small business survey by the National Federation of Independent Business, taxes and government red tape are far and away the biggest issues that business owners cite as their most important problems. Forty-three percent of those surveyed cited one of the two as their top issue.

That matters, and not just because of business owners’ headaches. The burden of regulation is not distributed symmetrically. It falls heaviest on firms that deal with dangerous substances, yes.  But it also falls most heavily on smaller businesses, which cannot afford staffs of pricey compliance specialists to make sure that their desk chairs meet the new California workplace seating requirements. This may help explain why the number of firms is falling, and markets are consolidating.

Even within those businesses, the burden will tend to be disproportionately concentrated. Employment conditions are heavily regulated, so firms that employ a lot of workers to get a given level of output will have more regulatory overhead. And firms that employ a lot of low-wage labor get hit from every direction: Businesses like fast food and retail tend to have thin profit margins, so they don’t have a lot of room to absorb the extra cost, and they also can’t really cut wages to reflect the higher cost of labor, because they’re already operating at or close to the statutory minimums. A consulting firm that has five employees, on the other hand, will probably have a higher compliance cost per employee, but also much more room in pricing and profit margins to absorb that cost.

How much does this matter? Well, if you want to camp at Meyer’s rec sites, but can’t afford to pay Hilton prices to do so, it probably matters to you a lot. But it also matters to the rest of us, because when you add that burden up, it potentially has big effects:

  1. Regulations can knock the lowest-skilled workers out of the labor force, at which point they’ll struggle to get a better job. It’s fashionable to say that these are terrible jobs anyway: hard labor and they don’t pay enough, so who cares? But those jobs are where people learn the basics of work: showing up on time, being nice to the customer, attending to every detail, and so forth. The regulatory burden is effectively a cost wedge between the amount you pay your worker, and the amount it costs you to employ them; the bigger that wedge, the more likely it is that some people simply won’t be able to find employment. The result is a great human capital loss to the economy, and the devastation of unemployment.
  2. Small businesses are vital to the economy.  They’re sort of like the engine oil that lubricates the economy, because a lot of things aren’t profitable at a larger scale. For example, a few years back, I interviewed the owner of a wire basket maker in Baltimore, who was making racks for a car manufacturer to store their parts in on the assembly line. These were a cog in a great industrial enterprise, but he was turning them out in tiny batches -- six at a time, or a dozen. That sort of job simply wouldn’t be profitable for a major manufacturer, because the cost of retooling a big assembly line, and the bureaucratic controls needed to run a large firm, would eat all the profit margin. An owner-operator of a smaller business has a lot more flexibility, and the cushion provided by that flexibility is absolutely necessary.
  3. Regulations can make it unprofitable for small businesses to grow. Let’s say your firm has room to scale, and might even become a big business someday. That’s great! But now we run into the problem of small business carveouts. A lot of laws, including Obamacare, have them, so that politicians can claim their policy won’t affect small firms. The problem is that when you hit one of the thresholds, there is an absurdly high marginal cost to hiring the next employee, or taking in the next dollar of revenue. That can retard growth, which is not something the U.S. can currently spare

All of these costs have to be carefully weighed against the benefits of regulations -- and not just on a regulation-by-regulation basis, as is currently done, if such cost-benefit analysis is done at all. Each hour of a firm’s time that is sucked up by compliance is an hour that is not spent growing the firm, improving the product, better serving the customer. And as the number of the hours so spent increases, and the number of precious hours spent on growth and operations shrinks, each added hour we take is more costly to both the business and to the rest of us. With labor markets lackluster and growth underwhelming, that’s a cost that none of us can well afford.

  1. My grandfather, who owned a gas station, saw his regulatory burden mount steadily between the time he bought it in 1940, and the time he died in 2004, to the point where it consumed an outsize share of both his time and his emotional energy -- and occasionally dropped surprise six-figure bills on him for newly imposed compliance rules, which is not a sum that most small business owners tend to have lying around in their underground vault.

  2. There’s a lot of talk about how many jobs are provided by small businesses. This is somewhat exaggerated. Small businesses have a lot of churn, for various reasons. Most net new jobs are provided by a small number of high-growth companies, a fact which I’ve heard interpreted as saying that we don’t really need to worry about small businesses, only high-growth startups. Except that small businesses are a vital part of the economy for reasons beyond quantity of jobs added.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor responsible for this story:
Philip Gray at philipgray@bloomberg.net