Regulations as hamster wheels

published Nov 16, 2015

A dynamic explanation of the effects of so-called "regulation". Anonymous authorship — found online.

When considering the effects of regulatory legislation on industries, it's interesting to consider the interplay between the government and the firms being regulated.

Regulations act as a barrier to entry for firms. In order to start a firm in an industry, compliance costs must be paid out. This acts as a damper on the number of startups that can be created in the industry. If it costs $1 for a firm in an industry to comply with regulations, then a lot more investors will be able to start a firm in that industry than if there was a minimum of $50 million in compliance costs. If $50 million becomes a floor in terms of capital requirements to enter an industry, much fewer firms will be started since it is much more difficult to raise $50 million to start a firm. This, of course, benefits established firms that already have significant amounts of revenue to pay the costs of the regulations. Startups in the industry are increasingly shut out as compliance costs rise.

The question arises, however, as to what motivates a government to regulate, aside from gaining power over an industry. To understand the motivations behind industry regulations, it is best to look at certain effects of the regulations. One major effect of regulation is the creation of jobs. If regulations are imposed on a firm, that firm has to fill positions in order to comply with the regulations. These positions range all the way from CCO (chief compliance officer) to junior level auditor. Of course, some of these jobs might exist without government-imposed regulation, since a firm will often self-regulate in order to appease their customers. One example of this is in the software industry. The software industry does not have regulations pertaining to all aspects of their software services or products. However, in order to appease their customers, software firms will employ quality assurance or QA workers in order to boost the quality of their software and increase customer satisfaction. QA positions would exist in software firms with or without government regulation.

An example of a job that probably would not exist without government regulation would be a job in a financial firm that pertained to 'know your customer' (or KYC) regulations. A financial firm is in the business of making money, wherever it comes from. As long as the firm is making money, the individuals within the financial firm probably do not care where the money came from, and their customers also do not care where other customers' money came from. The firm would gladly accept money from any source, as any profit-seeking firm would. However, in the name of protecting citizens from terrorists, drug dealers and money launderers, KYC regulations imposed by the government force financial firms to gather information on their customers, and report activity that is deemed suspicious.

Therefore, there are two kinds of jobs: jobs that would exist without regulations and jobs that would not exist without regulation (or regulatory jobs - reg. jobs for short and non-regulatory jobs - non-reg. for short).

One aspect of this job creation is that it is two-sided. On one side there are the employees of the firm with reg. jobs and on the other side there are government jobs that exist to audit the firms' compliance. When a new regulation is imposed on an industry, jobs are created within the industry to comply with the regulation, jobs are created within the government to enforce compliance and on a marginal basis new entrants into the industry are shut out.

The effect of this is that it tends to cause the industry to go towards an oligopoly, or even a monopoly. This drives consumer prices up since there is less competition in the industry. When consumer prices and the cost of living goes up, people scramble to fill the reg. jobs in order to pay their bills, even though they may be fully aware that their job exists solely to comply with government regulations. With consumer prices higher and people willing to work longer hours in order to make a living, the population as a whole is less of a threat to the established political order. This is just as high schoolers in a classroom are less of a nuisance than high schoolers hanging out around town during the day. Leisure time is the enemy of an established political order because it gives people time to pursue political change that can go against the established political order. If someone is working 60 hours a week to make ends meet, they probably are going to have a lot less time to devote to their political convictions. The necessity to work many hours a week to make a living is surely a damper on grassroots political efforts.

With the regulatory process in place, a cat and mouse game emerges between the government and the firms being regulated. The firms, in seeking to maximize profit will seek to lower their compliance costs by innovating new ways of complying. For instance, a firm might outsource the writing of a software system in order to replace individual reg. employees within the firm. The new software automates regulatory compliance. The larger established firms cannot prevent startups from automating regulatory compliance, and so their advantage over the startups can be diminished due to automation reducing compliance costs. Therefore, regulations that are more complex (or are non-automatable) are passed, raising the compliance costs again and reducing the new entrants into the industry once again as well. More reg. jobs are created and the cycle repeats.

The ultimate conclusion of this process would be the existence of a single firm that has millions of reg. employees and a government agency that has millions of employees to audit and regulate the single monopoly firm. Aside from the destruction of technological progress, the end result is a huge swathe of the population going to work every day producing nothing of value. With the huge amount of jobs that may be lost in the near future due to automation, these reg. jobs could be a replacement for welfare. Essentially, the large established firms provide welfare to people through the reg. jobs in return for keeping out new entrants in their industry. The government gets a more politically viable form of welfare for the people and a population with much less leisure time due to high costs of living.

N.B: if you need real life confirmation of this model, ask yourself how the medical industry works in the U.S. right now. Then ask yourself why the Bitcoin market in the U.S. is beginning to look exactly like this model predicts.