Governance

Rules, Regulations, and Social Benefits

By Sandra Black ·

University of Texas, Austin

The Issue:

Many regulations that firms find burdensome have important social returns.

The Facts:

When there is competition between firms, workers are perfectly mobile, and consumers make their purchasing choices based on sound information, society overall benefits: goods are produced more efficiently, workers can opt for better working conditions, and consumers have access to lower prices and better quality. But, when these conditions are not fully met, the end result can be less than optimal. Under what circumstances can a case be made for government regulation?

But, when these conditions are not fully met, the end result can be less than optimal. Under what circumstances can a case be made for government regulation? When an activity firms conduct imposes a cost on others, they tend to do a lot more of it than they would if they had to be responsible for all the costs. Pollution is a case in point. Companies may pollute the air or the nearby water in the process of production. If the firms don’t pay for the cost of their pollution, society does, through mechanisms such as sicker citizens, lower quality of life and costs to future generations through climate change. The government can force companies to take account of the social costs of their production by making them take actions that limit the amount they pollute. For example, factories and energy-producing facilities that burn coal have been required to install “scrubbers” to reduce the amount of pollution they emit. The cost of installing these scrubbers reduces firm profits, but improves the environment around these facilities, and even across a much wider area. An individual company might benefit from the removal of regulations that prevent it from polluting, and its stock price could rise in anticipation of these benefits, but many others would be made worse off.

Companies may pollute the air or the nearby water in the process of production. If the firms don’t pay for the cost of their pollution, society does, through mechanisms such as sicker citizens, lower quality of life and costs to future generations through climate change. The government can force companies to take account of the social costs of their production by making them take actions that limit the amount they pollute. For example, factories and energy-producing facilities that burn coal have been required to install “scrubbers” to reduce the amount of pollution they emit. The cost of installing these scrubbers reduces firm profits, but improves the environment around these facilities, and even across a much wider area. An individual company might benefit from the removal of regulations that prevent it from polluting, and its stock price could rise in anticipation of these benefits, but many others would be made worse off. Providing consumers with important information is another example where government regulation can improve the lives of many people even while imposing some costs on individual companies. Consumers may have less information than firms do about the product the firm is selling, and it might be difficult for individuals to gather or evaluate relevant information. When individuals buy food or drugs, they may not know the contents of the products, which may limit their ability to make informed decisions. As a result, the government may regulate the disclosure of nutrition information or ingredients. Similarly, individuals buying a house might not know whether there is lead paint on the walls, so sellers may be required to disclose this.

Consumers may have less information than firms do about the product the firm is selling, and it might be difficult for individuals to gather or evaluate relevant information. When individuals buy food or drugs, they may not know the contents of the products, which may limit their ability to make informed decisions. As a result, the government may regulate the disclosure of nutrition information or ingredients. Similarly, individuals buying a house might not know whether there is lead paint on the walls, so sellers may be required to disclose this. Regulation can also limit activities whose harm may not be obvious to many consumers. An example of this is the Fiduciary Duty rule issued by the Obama administration. This rule requires financial advisers to meet a “fiduciary standard” and act in the best interest of their clients, even if the adviser would benefit from behaving otherwise. Some firms currently use commission-based fees, which create incentives for financial advisers to steer clients into products that may have higher fees and lower returns. This conflicted advice could be costing families an estimated $17 billion per year according to government estimates (for more details see this EconoFact post).

An example of this is the Fiduciary Duty rule issued by the Obama administration. This rule requires financial advisers to meet a “fiduciary standard” and act in the best interest of their clients, even if the adviser would benefit from behaving otherwise. Some firms currently use commission-based fees, which create incentives for financial advisers to steer clients into products that may have higher fees and lower returns. This conflicted advice could be costing families an estimated $17 billion per year according to government estimates (for more details see this EconoFact post). Workers in some industries may face hazardous working conditions that they may not know about or that they find difficult to avoid. These workers may not fully understand the danger they face, or they may find it difficult to negotiate with their managers because they have limited power in their relationship. Recent regulations passed regarding the presence of Silica and Beryllium at the workplace, for instance, limit worker exposure to these toxic substances and can save lives.

What this Means: While regulations may be costly to businesses, there are a number of reasons why we, as a society, should embrace government intervention and regulations when they lead to socially beneficial outcomes. Regulations and rules have benefits as well as costs. Deciding which rules and regulations are, on net, beneficial requires careful cost-benefit analyses, and in the past these were regularly undertaken to evaluate proposed federal rules. This was re-emphasized by the Obama administration in a 2011 Executive Order that called on agencies to re-evaluate existing regulations as to the appropriateness of the rule. However, the recent Executive Order issued by Donald Trump in January 2017 suggested that regulations should focus only on the costs (and not the net benefits) as a metric for future rules and also stated that “any new incremental costs associated with new regulations shall…be offset by the elimination of existing costs associated with at least two prior regulations.” This standard is unlikely to yield socially beneficial outcomes.

Over 90 regulations have been delayed, suspended or reversed by federal agencies and the Republican-controlled Congress since President Trump took office. The new administration has undertaken to undo many of the rules and regulations put in place under the Obama administration. And, if the direction of the stock market is any indication, investors are pleased with the change. However, there is an important distinction between the private benefits to individuals or companies and the benefits to society as a whole. While the stock market may be a good measure of the private benefit to listed companies, it is not necessarily a good measure of social benefit.