Political Entrepreneurs Are Crowding Out the Entrepreneurs

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Entrepreneurs launching "disruptive technologies" are reshaping markets across the U.S. economy, often by disintermediation and innovation. While these new products and services provide consumers more choices and better value, regulators have place increased attention on these activities, from car services such as Uber and Lyft, to those offering accommodations like Airbnb, to pop up restaurants running afoul of local health codes. In many instances, these new products emerged because innovators were one step ahead of the regulators. But as the regulatory state grows, these innovators will face new challenges from regulators.

Entrepreneurs and regulators work in different spaces, with completely different views of the world. For the entrepreneur, the world is fast-paced and dynamic. The goal of the entrepreneur is to identify unmet demands in the marketplace and develop the products to meet these demands. This requires innovation, adaptability, and the willingness to take risks. Regulators, on the other hand, live in a static world. By definition, regulation is backward-looking, designed to address purported market failures that have already emerged, focusing on data about past market behavior.

As government has expanded and the administrative state has taken hold, entrepreneurship faces two significant new challenges. First, the increasing web of regulations-federal, state, and local-make it more difficult for entrepreneurs to exploit opportunities. One recent report puts the cost of federal regulations just over $2 trillion. And another study highlights the problem of "regulatory accumulation" that requires entrepreneurs and businesses to comply with a host of regulations, many of which are outdated but nonetheless remain on the books. The Code of Federal Regulations is now of 170,000 pages, making compliance a burden for any business. In fact, a recent study found that between 1949 and 2005, regulatory accumulation slowed economic growth by an average of 2 percent per year.

New demands may be identified, but regulatory barriers may prohibit entrance into the marketplace. For example, Uber and Lyft identified a significant opportunity in the market for local transportation and are successful because they offered a significant increase in consumer welfare. However, both services are facing regulatory threats, prompted by entrenched interests and regulators ill-equipped to address new technologies that do not conform to a regulatory model that has remained virtually unchanged for decades. Similarly, the Federal Communications Commission is threatening to impose common carrier regulations dating back to 1934 on internet service providers deploying technologies that did not even exist when the law was passed. Regulatory accumulation may pose particular problems for the internet, a dynamic and continually evolving technology that must respond to the latest improvements in computing technology. Regulations evolve in a much slower framework, with important decisions about resource allocation being transferred to political and regulatory processes with much longer time horizons.

The second challenge arises because the nature of entrepreneurship changes as the role of the state expands. Israel Kirzner, perhaps the most prominent economist in the field of entrepreneurship extols the importance of entrepreneurs as driving the discovery process that is at the core of a market economy. Entrepreneurs live in the world between the equilibria that define neoclassical economics. They are the driving force that move markets, discover opportunities, and coordinate economic activity. Entrepreneurs thrive in the market by identifying new ways to satisfy consumer demand, providing goods and services at the lowest cost. In the real world, however, the line between markets and government has blurred and not all entrepreneurial activity is of equal value.

The entrepreneurial calculus may change in response to institutional changes brought by an expanding regulatory state. Some entrepreneurs will focus more on redistributing existing rents through the political process rather than innovating for the benefit of consumers. But it comes with strings attached, as committees in Washington and an alphabet soup of federal regulators have more to say about the success of these companies than will the consumer. Building a better mouse trap becomes secondary to passing the right law.

Economists call such political entrepreneurship rent-seeking, spending valuable resources to influence the political process for private gain. With the government's prominence growing in sectors across the economy, from energy, to health care, to financial services, rent seekers are engaged in political entrepreneurship that does not have the same welfare-enhancing properties of market entrepreneurship.

As political entrepreneurs crowd out economic entrepreneurs, society shifts from the positive-sum game of wealth creation to the zero-sum game of wealth transfers. This demonstrates the importance of institutions. As the rule of law is overwhelmed by the administrative state, it becomes more difficult to harness the beneficent power of the market. The administrative burden of tax and regulatory structures distorts incentives and diverts resources from productive entrepreneurship to more destructive rent-seeking opportunities. Entrepreneurs play a vital role in any economy but only well-defined market institutions can harness their creative powers in a way that promotes economic growth, innovation, and consumer welfare.


Wayne Brough, Ph.D is Chief Economist and Vice President of Research at FreedomWorks.  

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