Cutting Anti-entrepreneurial Red Tape through Smart Regulation

Jonathan Ortmans, President, Public Forum Institute

As with any politically loaded term, any attempt at honest discussion of ‘regulation’ risks getting caught up in a web of assumptions and intellectual shortcuts.  One common fallacy is to put government regulation (e.g. patent laws, health care, tax compliance regulations, etc.) on one end of a continuum in which innovation and entrepreneurship are the opposite policy preference. However, judging by the discussion at the National Academy of Public Administration (NAPA) conference on regulation and innovation, a new approach seems to be emerging in innovation discussions: that the freedom to innovate is not governed by how much or how little regulation innovators face, but how smart it is. 

Entrepreneurs, the drivers of the economic recovery, have the most to gain from a smart, sensible regulatory environment because their ventures tend to be smaller in size, and thus often bear a disproportionate cost of regulation. Small firms do not have the large legal and compliance staffs of larger companies, and therefore find compliance to be more difficult and expensive.

Unfortunately, not all federal regulatory statutes currently require the agencies that set rules to satisfy abenefit-cost and a cost-effectiveness test before issuing those rules. As a result, government might be “over-correcting” market failures, hurting entrepreneurship and thereby impairing economic growth. For example, strict regulations currently govern the commercialization of new technologies developed in any of the government’s laboratories.

Our leaders should pay particular attention to “market-like” or of market-assisted regulation approaches to regulation (e.g., using tradable pollution permits) wherever possible. Regulation that utilizes market-oriented approaches rather than direct controls is often more cost-effective because it enlists competitive pressures for social purposes, according to an Office of Management and Budget study. Further, the various government levels should work together to establish a clearinghouse of benefit and cost information on rules.

Of course, another critical feature of innovation-friendly regulation is avoiding ‘industry capture.’  All too often the structure of regulation privilege large, established firms as they seek to raise barriers against up and coming competitors. Arti Rai from Duke University noted the dilemma: “innovation comes disproportionately from small firms, yet they lack the ability to influence agencies.” 

The regulation of entry is a critical issue. Cross-country evidence shows that regulation plays a critical role in the individual decision to start a new business. The same research showed that even individuals who have business skills and social connections are less likely to engage in new entrepreneurial activity when entry regulation is more stringent.

A regulatory approach that that recognizes the innovating role of small startup enterprises throughout the economy can enhance productivity and competitiveness by increasing innovation and technological diffusion. If there was ever a time to ‘get smart’ on regulation and innovation, it is certainly now.

Jonathan Ortmans is a senior fellow at the Kauffman Foundation where he focuses on public policies to promote entrepreneurship in the U.S. and around the world. In addition, he serves as president of the Public Forum Institute, a non-partisan organization dedicated to fostering dialogue on important policy issues.

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