Economic Theory Demonstrates the Harms of (Most) Regulation

Economist Scott Sumner, who works at the Mercatus Center and Bentley University, has an interesting new blog post up at EconLog (a blog I highly recommend everyone interested in public policy follow. Sumner, Bryan Caplan, David Henderson, and other amazing economists have excellent sub-sections). Sumner’s post is all about demonstrating why most regulations are counterproductive.

Sumner uses a simple example: Imagine if the government were to pass a pro-consumer regulation and ban ATM fees. This, according to Sumner, would be counterproductive.

Banks will see this as a cost increase, and pass the cost on to consumers in other ways. Can I be sure this will occur? No, but it’s very likely. Suppose I told you that Congress passed a 10-cent increase in the gas tax. What would you expect to happen to gas prices at the pump? Most people would expect a 10-cent increase. In fact, the oil industry is perhaps the industry where taxes are least likely to be passed on to consumers. That’s because the supply of oil is less elastic that the supply of almost any other good, including banking services. So if you think gas taxes are passed on to consumers, then you should be even more certain that I’m right about the elimination of bank fees being passed on to consumers in other ways, such as fees on deposits, or lower interest rates on deposits. …

If consumers pay less in one place and more in others, does the regulation actually hurt consumers? Yes it does, because it also hurts bank efficiency. Eliminating ATM fees will reduce the profit maximizing number of ATMs, which will make banks less efficient. Since tellers cost more than ATMs, the cost increase passed on to consumers will be larger than the saving from ATMs.

Now, this logic applies to most regulations. But note the word “most.” Indeed, Sumner concedes that this logic does not apply to regulations that are meant to address market failures, like “monopoly power, externalities, and information asymmetry.” So some regulations are necessary.

But the logic does apply to regulations liberals love, like overtime pay.

Sumner ends with a plan to reduce regulation. He closes with, “We’d be better off passing a law sun-setting all regs, and the entire Federal tax code, in 2025. Then give Congress the next 9 years to set about re-passing all the regs and taxes that actually make sense.”

Interesting idea, but it’s dangerous. I think it puts too much faith in Congress to do the right thing. Not only that, but it assumes members of Congress won’t make the same mistakes they’ve already made. If history serves as any guide, I suspect they would pass new laws that are just as bad, if not worse. But there’s some food for thought.

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