President Trump and many in his Administration claim that reducing regulation can boost GDP substantially. What sorts of regulatory actions by the President could promote significant growth?
Existing research on the costs that firms bear from government regulation sometimes takes account of observable physical costs associated with regulations – in particular, the staff hired to ensure compliance. Those physical costs produce higher expenses and lower profit margins. Previous studies have shown that these costs can reduce productivity and GDP.
Additionally, firms bear the cost of uncertainty about how rules will be enforced or changed. Uncertainty about regulation is a major component of its cost, which can lead firms to delay growth plans.
In President Trump’s first term, he was not able to do much to repeal existing regulations. But his statements, executive actions and appointments seem to have mattered by reducing new regulations and regulatory enforcement risk. New rules and strict interpretations of existing rules became less likely during his first Administration. Our research shows that Trump’s first term saw a major reduction in regulatory risk, which produced a large boost in growth.
New empirical methods associated with natural language processing (NLP) allow us to measure perceptions of regulatory prospects and the economic consequences associated with them. We find that discussions about regulation by executives and their investors (visible in the transcripts of quarterly Earnings Calls) have important predictive consequences. In our recent paper with Ruoke Yang (entitled “Measuring the Cost of Regulation: A Text-Based Approach”), we apply NLP tools to the transcripts of Earnings Calls for publicly traded U.S. firms from 2009 to 2019. Those discussions focus on forward-looking strategic thinking, and hence allow one to gauge the costs associated with new regulation and enforcement uncertainty.
Our study takes account of every occurrence of a discussion of regulation, whether that discussion entails either a prospective increase or decrease in the regulatory burden. We ask whether prospective net increases in regulatory burdens for public firms (which largely reflect policy uncertainty) have a chilling effect on their growth. To validate our judgments about prospective increases or decreases being discussed, we asked OpenAI to read the discussions and opine on whether they pointed to prospective increases or decreases.
By tracking the implications of regulatory discussions for subsequent profit margins and firm growth we were able to measure the relative importance of growth effects (related to regulatory uncertainty) and profit margin effects (related to changes in actual physical costs). Discussions of increased regulation are associated both with diminished profitability and with diminished growth, but the largest effects of regulation discussions in Earnings Calls are diminished asset and sales growth.
A standard deviation increase in our measure of regulation produces between a one and two percentage point decline in sales or assets, on average over the next four quarters, and the effect is much larger for small firms, which apparently incur higher costs of managing regulatory risks. We find similar negative effects of regulation on firms’ leverage. The decline in leverage appears to reflect the heightened risk associated with discussions of increasing regulation. This increased risk is also visible in higher post-Earnings Call stock returns. These findings point toward significant reductions in regulatory risk during Trump’s first term.
An important aspect of our approach is its ability to identify changes in regulatory costs at specific moments. We asked whether the outcome of the 2016 presidential election affected the regulatory uncertainties firms faced, with consequences for firms’ growth decisions after the election. The 2016 Trump election is especially useful for this sort of “event study” because the outcome was not known in advance, which meant that the election was a source of news.
When we examine the effects of the 2016 election on regulatory costs and their consequences, we discover several interesting patterns. First, immediately after the election, discussions between firms’ executives and their investors indicated perceptions of reduced regulatory costs going forward. Second, firms that had been discussing increases in regulation prior to the election saw relatively large stock price gains from the election result. Third, those same firms experienced a reversal in the adverse predicted consequences of prior regulatory discussions for their growth. In other words, Trump’s election in 2016 seems to have reduced preexisting regulatory risks, with identifiable large positive consequences for firm stock values and growth.
We interpret these findings as reflecting the power of a President to make credible signals to the market through important appointments and executive orders that can produce a sharp and immediate change in perceptions of regulatory risk, with large consequences for firms’ growth plans. They also suggest that in his second term, President Trump will once again be able to promote growth through that same channel, even if he fails to garner enough support to repeal important existing regulations.
