February 16, 2011

Regulatory Analysis: Understanding Regulation's Effects

Testimony Before the House Committee on Oversight and Government Reform
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Federal regulation affects our quality of life and cost of living during every waking moment. When my clock radio went off this morning, the music traveled through a portion of the airwaves reserved by the Federal Communications Commission for FM radio broadcasts. The natural gas that heats our home traveled through interstate pipelines subject both to the Federal Energy Regulatory Commission’s economic regulation and the Department of Transportation’s safety regulation. The county treatment plant that supplies my faucet with water must meet standards set by the Environmental Protection Agency. I use a disposable razor to shave because my good one got confiscated when I tried to take it on an airplane. The canned pear halves my family ate for breakfast each weighed at least 17 grams, and the largest one in the can was no more than twice the size of the smallest one, thanks to Food and Drug Administration food standards. On my way to work, I drop off my car at my mechanic’s shop to get its emissions checked. And that’s all just in the first hour of the day.

Yet that’s enough time to illustrate the complex blend of federal regulations and their effects. Regulation runs the gamut from important things like air quality, water quality, and pipeline safety to seemingly trivial things like fruit size.

Overall, the effects of federal regulation are big. The Office of Management and Budget (OMB), relying on regulatory agency estimates, reports that major regulations it reviewed during the past ten years produced annual benefits worth between $128 billion and $616 billion, at a cost of between $43 billion and $55 billion. OMB readily admits that these figures are incomplete, because for some rules agencies do not calculate costs, or benefits, or both. A report by Nicole V. Crain and W. Mark Crain for the Small Business Administration’s Office of Advocacy pegs the total annual cost of regulation much higher, at $1.75 trillion. Appropriations for regulatory agencies provide another measure of the importance of federal regulation; Congress appropriated $56.3 billion for regulatory agencies in fiscal 2010.

We count on regulation to accomplish some important goals that private markets don’t achieve. We also sacrifice a lot of other things to obtain the benefits regulation provides. Fundamentally, this is what much regulation does: it changes the mix of goods and services society produces and consumes.

The subject of today’s hearing is regulation’s effect on jobs. The Mercatus Center’s director of policy research, Dr. Richard Williams, supplied a summary of academic research on this topic in response to a request from Chairman Issa. Regulation can affect employment in two major ways. First, uncertainty about future regulation can prompt firms to delay investments until they have a better idea about what the “rules of the game” will be. This delayed investment delays job creation. Where there is either extended uncertainty or regulation that goes well beyond what other countries are doing, investment capital will find more stable or less onerous places to go, and the resulting jobs will be created overseas. Second, regulation can alter employment in particular industries by changing the mix of goods and services our economy produces. While the aggregate effect of particular regulations on overall employment is minimal, the effects on particular industries can be large.

In economic jargon, regulation “reallocates resources.” In plain English, regulation destroys some jobs and creates others. Whether that’s a good thing or a bad thing depends on whether the particular regulation increases or decreases the total value to consumers of the goods and services we produce, including non-market “goods” like clean air or safety from terrorism.

For this reason, the first step in understanding how regulation affects those jobs is understanding how regulation affects the allocation of resources in the economy. That’s why sound regulatory analysis is a fundamental precondition for understanding how regulation affects jobs or anything else we care about.

Executive orders on regulatory review affect the ways executive branch agencies conduct regulatory analysis and the ways they use regulatory analysis to make decisions. On January 18, President Obama issued Executive Order 13563, “Improving Regulation and Regulatory Review.” I would like to address three principal aspects of Executive Order 13563 that may affect the quality and use of regulatory analysis by federal agencies:

1. The executive order reaffirms longstanding standards and regulatory review processes that have been in force since 1993.

2. It requires agencies to develop plans for retrospective analysis of existing rules.

3. It adds “human dignity” to the list of qualitative values agencies should consider and directs agencies to consider regulatory approaches that “maintain flexibility and freedom of choice for the public.”

All of these are positive developments. But scholarly research on regulatory analysis, including the Mercatus Center’s own Regulatory Report Card, suggests that agency regulatory analysis needs substantial improvement. The executive branch and Congress could do much more to ensure that regulatory agencies conduct high-quality analysis and use it to inform their decisions.

The body of my testimony contains detailed recommendations to accomplish these goals. Let me briefly summarize:

Regulatory review. Regulatory analysis needs to be encouraged, enforced, and required for all federal agencies. Agency economists should have the independence to conduct objective analysis. Agencies should publish regulatory analysis before writing proposed regulations and explain transparently how the analysis affected their decisions when they issue regulations.

Retrospective analysis. OMB and congressional oversight committees should enforce the provisions of the GPRA Modernization Act of 2010 that require agencies to identify regulations that contribute toward their high-priority goals and periodically review their performance. Congress can encourage this by attaching real budget consequences to agencies’ failure to meet their goals over a sustained period of time. To ensure that regulations receive objective, fundamental review, Congress should establish an independent body, perhaps modeled after the Base Realignment and Closure Commission, to evaluate existing regulations and recommend ineffective ones for elimination.

Human dignity and freedom of choice. This language in the executive order suggests a new, welcome emphasis on assessing regulation’s effects on personal liberty. The benefits or costs uniquely attributable to regulation’s effects on personal liberty have not been incorporated very well into agency regulatory analysis or OMB guidance, and further research may be required to figure out how. In the meantime, the administration (or Congress) can create a presumption in favor of personal liberty by requiring agencies to first analyze and consider the regulatory options that impose the least restrictions on personal liberty.