Tuesday, September 6, 2011

Regulation, Unemployment, and Cost-Benefit Analysis

Abstract: Regulatory agencies take account of the potential unemployment effects of proposed regulations in an ad hoc, theoretically incorrect way. Current practice is to conduct feasibility analysis, under which the agency predicts the unemployment effects of a proposed regulation, and then declines to regulate (or weakens the proposed regulation) if the unemployment effects exceed an unarticulated threshold, that is, seem “too high.” Agencies do not reveal the threshold, do not explain why certain unemployment effects are excessive, and do not explain how they compare unemployment effects and the net benefits of the regulation. Many agencies also predict unemployment effects incorrectly. The proper approach is for agencies to incorporate unemployment effects into cost-benefit analysis by predicting the amount of unemployment that a regulation will cause and monetizing that amount. Recent economic studies suggest that monetized cost of unemployment is significant, possibly more than $100,000 per worker. If agencies used this figure, there could be significant consequences for a wide variety of regulations.
[A] paper, by Morgenstern, Pizer, and Shih (MPS), uses a structural model to estimate the effects of environmental regulation on employment across “four highly polluting, regulated industries”: pulp and paper,  plastics, petroleum refining, and steel.43 MPS find that spending on environmental protection actually creates jobs in the net, at a (statistically insignificant) rate of 1.55 new jobs per $1 million in cost increases.

EPA applied the MPS study directly to its boiler regulation. EPA estimated that the regulation would create approximately $2.4 billion in compliance costs.44 MPS measured costs in 1987 dollars, while EPA’s boiler regulation was priced in 2009 dollars, so EPA applied a .6 multiplier in order to discount the regulatory costs to their 1987 value. Accordingly, EPA concluded that its boiler regulation would create approximately 2,200 new jobs.
The most recent and comprehensive paper on what we will call “wage effects”—the lost earnings of workers who are laid off—is by von Wachter, Song, and Manchester (VSM). The authors focus on male, middle-aged workers who were stably employed in the late 1970s. The workers are divided into three groups: those who remained employed, those who lost their jobs in mass layoffs (where employment at a firm declined by at least 30 percent), and those who lost their jobs in non-mass layoffs....

The average worker earned approximately $50,000 (in year 2000 dollars) in 1979. Not surprisingly, the average wage declines dramatically for workers who are laid off. Those who lose their jobs suffer an immediate wage loss of up to 33 percent (that is, some are rehired and obtain comparable or lower wages, while others are not). What is surprising is that although these losses decline, they may remain as high as 21 to 27 percent twenty years after the job loss. VSM calculate that over 20 years the average loss for a worker in their dataset ranges from $110,000 to $140,000. This range must be considered a lower bound for the cost of unemployment for an individual worker because losses most likely persist beyond 20 years.

Other scholars have found similar results, although no other study we are aware of examines earnings losses over twenty years.108 Most studies go no farther than six years. The studies find first-year earnings losses from 17 to 66 percent, with most studies clustering around 30 to 40 percent. The six-year studies find  last-year earning losses ranging from 0 to 47 percent, with most around 10 to 20 percent.
These numbers are high, but it is possible that the actual harm is somewhat less. First, to the extent that workers lose rents (the portion of the wage that is above market), the loss is simply a transfer—those rents will be captured by consumers or shareholders—and not a social cost....
The full paper is available free of charge at : http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1920441  

by Jonathan Masur and Eric Posner both of University of Chicago Law School 
University of Chicago Law School http://www.law.uchicago.edu via SSRN Social Science Research Network www.SSRN.com 
Olin Working Paper No. 571, Public Law Working Paper No. 359; August 4, 2011

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