Deinonychus antirrhopus

Stating the Obvious: Regulation and Economic Growth

This article in the September 2003 NBER Digest states the obvious, or what many have thought to be the case, that economic regulation has an impact on capital investment.

In a new paper, Regulation and Investment (NBER Working Paper No. 9560), NBER Research Associate Alberto Alesina and co-authors Silvia Ardagna, Giuseppe Nicoletti, and Fabio Schiantarelli examine the relationship between product market regulation and capital spending. Their study is based on differences in regulation among OECD countries. Alesina et al exploit the fact that while most OECD countries have deregulated product markets over the past three decades, they differ in terms of their starting points and the timing, nature, and intensity of reforms. For example, the United States started deregulating in the 1970s. In 1977, 17 percent of U.S. gross national product was produced by fully regulated industries, and by 1988 this total had fallen to below 9 percent of GNP. The United Kingdom was another early reformer, while the laggards include Germany, France, and Italy.

The researchers demonstrate that a number of measures of regulation – in particular barriers to entry – are negatively related to investment. The implications of the analysis are clear: regulatory reforms – in particular those that liberalize entry – are very likely to spur investment; tight regulation of product markets restricts investment.

This isn't that surprising in my opinion when one considers that capital investments could play a role in the strategic behavior of firms. When there is regulation a firm no longer faces as much competition and the strategic aspect of capital maybe lessened.

Another interesting result is that privatization plays little role in investment. The others note that prior to privatization political pressure might have been influencing nationalized industries to over invest. Hence with privatization investment is curtailed to bring it back in-line with profit maximization.