Opulence and Regulation

by Russ Roberts on September 9, 2004

in FDA, Regulation, Standard of Living

Heard a fascinating talk from Sam Peltzman tonight over at AEI called "Regulation and the Natural Progress of Opulence."  He began by invoking Book III of the The Wealth of Nations: "Of the Natural Progress of Opulence."  Smith talks about how capital naturally flows to its most profitable use and how this in turn, helps create the slow and steady increase in standard of living.  But in Europe, Smith noted, this progress is partially thwarted by various regulations:

According to the natural course of things, therefore, the greater part of the capital of every growing society is, first, directed to agriculture, afterwards to manufactures, and last of all to foreign commerce. This order of things is so very natural that in every society that had any territory it has always, I believe, been in some degree observed. Some of their lands must have been cultivated before any considerable towns could be established, and some sort of coarse industry of the manufacturing kind must have been carried on in those towns, before they could well think of employing themselves in foreign commerce.

But though this natural order of things must have taken place in some degree in every such society, it has, in all the modern states of Europe, been, in many respects, entirely inverted. The foreign commerce of some of their cities has introduced all their finer manufactures, or such as were fit for distant sale; and manufactures and foreign commerce together have given birth to the principal improvements of agriculture. The manners and customs which the nature of their original government introduced, and which remained after that government was greatly altered, necessarily forced them into this unnatural and retrograde order.

This is often the way economists look at regulations—they have costs and we hope the benefits from the regulation outweigh these costs.

Peltzman’s thesis is that there are two other relationships between regulation and progress.  In the first, progress thwarts regulation.  Government’s effort to achieve a particular goal is thwarted by the natural response of individuals and market forces to interfere with what they wish to do.  He gave three examples—automoblie safety regulation, the Endangered Species Act and the Americans with Disabilities Act.  In each case, the natural process of resource movement and incentives caused these well-intentioned regulations to either achieve nothing (cars were made safer but people responded by driving more recklessly), next to nothing (the ESA caused people to destroy habitat for fear of losing any property rights in it leading to virtually no improvement in the lot of endangered species) or worse, less than nothing (the ADA reduced employment of the disabled by raising the cost of hiring disabled people).  In each case, natural forces which were improving matters were deemed to be bringing about insufficient progress.  Government regulation was put in place to speed things up.  But the failure to account for changes in behavior caused all of these regulations to go awry.

The second relationship between progress and opulence is that opulence shields regulation.  This was the truly depressing part of the talk.  Here Sam argued that because we steadily grow wealthier as a nation, destructive regulations look much better than they really are.  The best (or perhaps the right word is "worst") example he gave was the FDA.  Ineffective or dangerous drugs get weeded out by the market.  Not immediately and harm can be done.  But impatience with that imperfect process leads to the FDA.  Fewer ineffective or dangerous drugs make it to market.  But as a result of preventing this harm, a different harm is incurred: effective, safe drugs take longer to get to market as a result of the lengthy approval process.  As one summary of this phenomenon noted:

A 1974 study by University of Chicago economist Sam Peltzman concluded that since 1962 the new rules had reduced the rate of introduction of effective new drugs significantly—from an average of forty-three annually in the decade before the amendments to just sixteen annually in the ten years afterward. Peltzman also found that the regulations also made it difficult for companies to introduce drugs that competed with existing drugs, thus reducing competition in the industry.

Peltzman argues that thousands more lives are lost than saved, but that no furor is raised because the natural progress of opulence results in improved overall health.  It’s hard to notice the detrimental effect of the FDA.

These views of Peltzman’s are of course, sacriligious.  Automobile safety regulations and the FDA, for example, are presumed to do good.  There’s no need to actually eaxmine the effectiveness of what they do.  Peltzman’s courage in questioning this received wisdom has led to important understandings of the actual effects of regulation.

My takeaway from Peltzman’s talk was that the glass is both half-full and half-empty.  Half-full because we continue to enjoy the natural progress of opulence.  Half-empty because it is very hard to uproot destructive regulation when it is shielded by that progress.

For an example of how regulatory regimes take credit for results that would have happened anyway, go here and scroll down to the bottom post about Ralph Nader.

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