CON: Should the US loosen regulations on businesses?

Disruptive effect of bailouts, not over-regulation, is real culprit behind snail-like recovery

Posted: Friday, October 15, 2010

SANTA CLARA, Calif. - The Oct. 8 jobs report showed that the U.S. economy shed 95,000 jobs in September.

The private sector created a mere 64,000 jobs, well below the roughly 100,000 per month needed to keep employment stable and even further below the 400,000 a month needed to significantly reduce unemployment. In fact, numbers from the Bureau of Labor Statistics reveal that the current job creation rate is well below the rate recorded as the economy rebounded from the five previous recessions.

Some argue that regulations advocated by the Obama administration are anti-business and one major reason for this jobless recovery.

For example, a recent report by Goldman Sachs' Jan Hatzius calculated that the Basel III bank capital requirements, strongly advocated by the Obama administration, will reduce future U.S. GDP growth by 2 percent.

This viewpoint holds that new regulations, by increasing costs for financial institutions, health care companies, energy firms, and others will dampen economic growth.

Even if one accepts questionable calculations such as these, it is extremely unlikely that recent regulatory reforms have had any effect yet on job creation. The more likely culprit is the administration's "bailout approach" to business.

A thriving economy undergoes a process of constant natural selection. Less efficient firms fall away, while more efficient, innovative firms take their place and grow.

This process is especially important as an economy attempts to recover from a contraction. To the extent that government policy props up inefficient businesses and prevents them from failing, it prevents those businesses that are more innovative and efficient from growing - and hiring.

For example, in the last recession the death of many steel companies, such as National Steel and Birmingham Steel, cleared the way for healthier firms such as Nucor Steel and U.S. Steel to grow and led to job creation.

In the recession before that, the death of once-dominant mini-computer makers like DEC and Wang gave way to the rise of now-dominant personal computer makers like Apple and HP.

Explicit bailouts of firms in the financial services and automotive industries - involving both the Bush and Obama administrations - and implicit bailouts of countless other firms receiving money via the bloated $787-billion fiscal stimulus package have slowed the market's natural selection process.

And this has occurred at a critical time - in a recession - when it is especially important that poorly managed firms fall away and clear the way for better-managed competitors to grow and create jobs. For example, while GM needed a bailout, Ford Motor Co. did not; yet Ford and its suppliers were not rewarded for their ability to run their firms more efficiently.

This slowdown of the natural selection process has not been confined to businesses. When the Obama administration bailed out homeowners in default on their mortgages via loan modifications, it slowed down the process by which ownership of assets was transferred to those best capable of developing those assets.

This friction in turn hampered recovery in the residential real estate industry - from real estate agents to home builders to the home improvement industry.

In the end, according to government figures more than half of the loans that were modified returned to default within six months. So this policy benefitted a few for a short period of time but delayed the recovery of several large industries - thus slowing job growth.

The regulations advocated by the present administration - something that has not yet impacted hiring, and will likely reduce economic volatility in the long run - are not the problem.

In order to create jobs, businesses have to grow. And for businesses to grow we cannot allow the poor decisions of individuals and management teams to get in the way of more capable people. We have to allow natural selection to function in the marketplace.

• George Chacko is an associate professor of finance and Carolyn Evans is an associate professor of economics at Santa Clara University's Leavey School of Business and Administration. Readers may write to them at SCU, 500 El Camino Real, Santa Clara, Calif. 95053.

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