Broken institutions impede job growth

June 18, 2013

In the Wall Street Journal‘s Saturday Essay, Niall Ferguson writes that our broken institutions are a greater impediment to job creation than either fiscal or monetary policies:

Bureaucracy run amok in “Brazil” (1985)

Nearly all development economists agree that good institutions – legislatures, courts, administrative agencies – are crucial. When poor countries improve their institutions, economic growth soon accelerates. But what about rich countries? If poor countries can get rich by improving their institutions, is it not possible that rich countries can get poor by allowing their institutions to degenerate?  …

Why is it getting harder to do business in America? Part of the answer is excessively complex legislation. A prime example is the 848-page Wall Street Reform and Consumer Protection Act of July 2010 (otherwise known as the Dodd-Frank Act), which, among other things, required that regulators create 243 rules, conduct 67 studies and issue 22 periodic reports. Comparable in its complexity is the Patient Protection and Affordable Care Act (906 pages), which is also in the process of spawning thousands of pages of regulation.  You don’t have to be opposed to tighter financial regulation or universal health care to recognize that something is wrong with laws so elaborate that almost no one affected has the time or the will to read them.

Who benefits from the growth of complex and cumbersome regulation? The answer is: lawyers, not forgetting lobbyists and compliance departments. For complexity is not the friend of the little man. It is the friend of the deep pocket. It is the friend of cronyism.

Our thoughts on cumbersome regulations back in 2010 still rank as one of our most-viewed posts:

In what we first took to be satire from The Onion, the SEC has ruled that companies should warn investors of global warming risks.  The story can actually be found in the 1/27/10 New York Times.

After a couple humiliating years of being behind the curve on protecting investors, and despite being still short of manpower, the SEC has nonetheless found the time to address one of the most alarming deficiencies in corporate disclosures that exists today: the absence of boilerplate in every 10-K addressing the problem of global warming.

A better idea: let investors know that “legislation concerning global warming” (as opposed to global warming itself) poses a risk to business.  But given that 10Ks can’t possibly be long enough to encompass all the bad potential legislation out there, maybe companies just need to disclose that “Your government poses a myriad of potentially devastating threats to our and all businesses.  Please call your Congressman if this worries you.”

Such complexity gives larger firms an advantage over smaller firms, who lack the resources for lobbying and compliance.  This damages national competitiveness because it undermines the entrepreneurs who create the next generation of companies, jobs, and wealth.  As we previously wrote about a 2008 study that explored the role of large and small companies in different national economies:

At the international level, the 2008 study by La Porta and Schleifer contemplates the “informal” firms operating in gray or black markets, who intentionally avoid scale in order to avoid detection, and therefore lag in productivity gains, have trouble financing growth, and seldom mature into larger firms.  For those countries, larger – i.e., formal – is better, but obviously these reasons don’t apply to the U.S. economy.  We also suspect that in many of those countries, national wealth is skewed by the large (often government-run) operations who extract natural resources.   Any nation that favors its large corporations will indeed see less wealth created by its small businesses.  Over the long term it will see less wealth created, period.

Anyone who’s worked for a large corporation – especially in an R&D department – would not rely primarily on that model for innovation.  Anyone who’s worked for a large corporation – especially in a dying industry – would not rely primarily on that model for job growth.  Yes, start-ups lack the economies of scale and R&D budgets of larger firms; but that’s the support venture capital provides.  Those start-ups that do gain traction are able to raise capital, and, with hard work and a little luck, become large companies.

Mr. Ferguson goes on to cite the U.S.’s poor performance in surveys of competitiveness…

Each year, the World Economic Forum publishes its Global Competitiveness Index. Since it introduced its current methodology in 2004, the U.S. score has declined by 6%. (In the same period China’s score has improved by 12%.) An important component of the index is provided by 22 different measures of institutional quality, based on the WEF’s Executive Opinion Survey. Typical questions are “How would you characterize corporate governance by investors and boards of directors in your country?” and “In your country, how common is diversion of public funds to companies, individuals, or groups due to corruption?” The startling thing about this exercise is how poorly the U.S. fares.

In only one category out of 22 is the U.S. ranked in the global top 20 (the strength of investor protection). In seven categories it does not even make the top 50. For example, the WEF ranks the U.S. 87th in terms of the costs imposed on business by “organized crime (mafia-oriented racketeering, extortion).” In every single category, Hong Kong does better…

Asked to name “the most problematic factors for doing business” in the U.S., respondents to the WEF’s most recent Executive Opinion Survey put “inefficient government bureaucracy” at the top, followed by tax rates and tax regulations.

…before ending with an optimistic note about the Southeast’s (and two other) growth corridors:

In a functioning federal system, the pace of institutional degeneration is not uniform. America’s four “growth corridors”—the Great Plains, the Gulf Coast, the Intermountain West and the Southeast—are growing not just because they have natural resources but also because state governments in those regions are significantly more friendly to business.

Our region’s superior overall business climate extends well beyond the matter of suffocating regulation and include pro-growth tax policies, lower public sector debt burdens, and stronger job creation  (The actual climate happens to be conducive to a great quality of life as well.)

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