Krugman: More Regulatory Frictional Costs = Economic Growth

A recent Paul Krugman blog post not only rejects the broken windows fallacy (i.e. that destroying things and forcing people to spend to replace them does not actually create prosperity) but makes the case that when government creates regulatory compliance costs for businesses, it forces them to spend the excess cash that they are supposedly hoarding and thereby creates GDP growth.  Krugman writes:

As some of us keep trying to point out, the United States is in a liquidity trap: private spending is inadequate to achieve full employment, and with short-term interest rates close to zero, conventional monetary policy is exhausted.

This puts us in a world of topsy-turvy, in which many of the usual rules of economics cease to hold. Thrift leads to lower investment; wage cuts reduce employment; even higher productivity can be a bad thing. And the broken windows fallacy ceases to be a fallacy: something that forces firms to replace capital, even if that something seemingly makes them poorer, can stimulate spending and raise employment. Indeed, in the absence of effective policy, that’s how recovery eventually happens: as Keynes put it, a slump goes on until “the shortage of capital through use, decay and obsolescence” gets firms spending again to replace their plant and equipment.

And now you can see why tighter ozone regulation would actually have created jobs: it would have forced firms to spend on upgrading or replacing equipment, helping to boost demand. Yes, it would have cost money — but that’s the point! And with corporations sitting on lots of idle cash, the money spent would not, to any significant extent, come at the expense of other investment.

There is no doubt that government can create compliance industry jobs.  H&R Block owes its existence to a byzantine tax system.  It allows government to mop up excess labor and redistribute income, and does it in a less objectionable way than declaring war.   According to researcher Michael Hodges of the Grandfather Economic Report, regulatory compliance is already a $2T component of our economy and rapidly growing in recent years.  Is that a good natural solution to the problem of too much labor and too few jobs, or is there a downside?

Regulatory compliance costs obviously reduce competitiveness vs. foreign companies who do not have the equivalent regulatory burden.  As this could be overcome compensatory tariffs I do not think this is necessarily a deal-killer.  The more important objection is that it puts us further and further down the course of what Ayn Rand objected to: a handful of private producers are surrounded by a growing parasitical class of persons who, instead of being paid to dig holes and fill them in again, are instead paid to administrate an ever-growing set of mandated regulatory spending.  Regulators and consultants get paid by companies for:

- Tax compliance
- Clorofluorocarbon emission (ozone) compliance (Krugman's post cited this specifically as a job creator)
- CO2 emissions compliance
- Green energy compliance
- Racial/gender/religious/etc. equity compliance
- Sarbanes-Oxley compliance
- OSHA workplace safety compliance
- Security compliance
- Hazmat/pollution compliance
- Pricing compliance
- Insurance compliance
- Marketing compliance
- Labor compliance

And so on.  This is not meant to dismiss the need for regulation in the whole; clearly we are better off for having Hazmat and food inspection frictional costs and no economic argument should sway us from ensuring companies are not poisoning the public.  But also in the whole, these frictional costs are already 17% of our economy while not producing any tangible economic value, irrespective of the social value.

Creating jobs and spending through regulatory frictional costs is a slippery slope.  What happens when 5% of the population provide goods and services, and the other 95% are employed in make-work government compliance jobs supervising that 5%?  When 80% of a company's expenditures are mandated by government?  Who is John Galt?