To have consumption, we must have production. We can produce our own
stuff, but most of us aren’t good at a Robinson Crusoe approach to life.
So, we usually produce a few things, in areas where we have a
“comparative advantage,” and engage in trade with others who do
likewise. When all of us work where we have skills, we win and society
wins — tremendously.
But usually, we don’t work alone and then
engage in trade. We work together in groups — often, large groups — to
produce goods and services. Why do we do this? Did you ever think about
why businesses exist at all? Economists point to three primary reasons.
First,
different risk preferences will lead some people to value the
(relative) security of employment. If 99 of 100 workers are risk-averse,
they would happily work for the 100th and let him deal with the greater
risks (and the potential big bucks) of ownership and entrepreneurship.
Second, bringing levels of production together often reduces
“transaction costs” — the cost of making trades happen. If we’re all in
the same building and trying to operate by the same mission, our costs
of transportation and communication should be much lower.
Third,
“economies of scale” can occur with larger production. For a variety of
reasons, the average cost of production often decreases when you produce
more. To note, it’s usually lower-cost to produce 70 units one — than
to produce one unit 70 times.
To encourage business, there is a
role for government. For example, the government enforces contracts and
protects the property rights of business owners and employees. Without
these functions, the incentives to engage in productive activity —
inside or outside of a firm — are greatly reduced.
Government also
provides a regulatory function in contexts where markets struggle. For
example, because we don’t have enforceable private property rights for
air and much of our water, firms have an incentive to throw their
pollution onto these common resources. As such, government should
protect common resources with effective regulation.
Unfortunately,
the government also uses regulations to make it more difficult for
businesses to participate in a market. The regulations are useful as
restrictions, in an effort to enhance monopoly power for cronies who
want higher profits and don’t want to compete as much. In
The Triumph
of Conservatism, Gabriel Kolko argued that the legislative agenda of
the Progressive Era was quite useful for enhancing the monopoly power of
those connected to political power.
But with both types of
regulation, government necessarily creates additional costs for
businesses — as they adhere to the regulations. Back to our point about
“economies of scale”: Uniform regulations generally provide an advantage
to larger firms, since they are in a stronger position to absorb these
costs. As such, regulation typically encourages the formation of larger
businesses and the reduction of small businesses.
A key exception:
Lawmakers often seek to mitigate this problem by exempting smaller
firms from certain regulations. For example, the Affordable Care Act
only applies to businesses with 50 or more employees. But this is
troubling for at least two reasons. First, the exemptions indicate that
the regulation is not really all that important. (If it were so
important, we’d mandate it for everybody.) Second, the cutoff is
arbitrary. Even if this regulation is good policy, the chosen number is certainly not revealed from on high.
As
with most public policies that expand the reach of government, the
benefits of enhanced regulation are obvious while its costs are larger
but far more subtle. We can see the benefits of mandated labeling on
food, but its costs are absorbed into price and smaller firms will tend
to be driven out of business. We can see the jobs saved by international
trade restrictions, but the higher prices and the greater job losses
are far more subtle. We can see the problems prevented by unlicensed
hair braiders and peanut farmers, but the costs are more insidious.
Economists
are fond of discussing the tradeoffs in personal choices, business
decisions, and public policy. But in the case of regulation, it’s
certainly troubling that the costs are so subtle. And it’s worrisome
that regulation tends to cause so much more trouble for small business.
If
Indiana wants to promote standards of living, then less regulation is
generally preferable — to protect small business, to enhance business
and to encourage competitive markets that will please workers and
consumers.
