Wednesday, June 4, 2014

Cities that want to thrive should lower their regulation costs

In an earlier post I talked about the catch 22 of revitalizing a struggling city. Cities can try to attract employers in the hopes of luring employees i.e. new residents, or they can try to attract new high skilled residents in the hopes of luring employers. Both of these approaches have their problems.

In my opinion cities should be focused on creating a good business environment for all potential employers, not just those they target with special incentives. They can do this by decreasing the amount of regulation and taxes businesses face. This is not just another call for government handouts to businesses. Even liberals realize that jobs are important for keeping people out of poverty. Every dollar that is earned by someone is one less dollar they need in government transfers. That is also one less dollar the government itself needs to raise through taxes.

Businesses want to make a profit. They do that by selling a product or service that people are willing to pay them for. We can represent a businesses profit function like this:

Profit = (Price x Qty) - (wages x labor) - (rent x capital) - (regulation costs + taxes)

The above equation shows that the residual left over after a business has sold their product for a particular price and then paid their workers, their capital costs, their regulation costs, and their taxes is their profit. Cities have control over the taxes and the regulation costs. If they lower them companies will make more money, all else equal.

In particular I think regulation is one of the biggest burdens to new business formation and it is also an easy thing to decrease. Many liberals are against decreasing taxes because they think the government should be doing stuff to help people. I disagree with them and think that the stuff the government does is often wasteful, but let's just go with that for now. Cities can also decrease the regulatory burdens new businesses face.

Mandatory inspections, licensing, lot requirements, zoning rules, building requirements etc. all add to the costs of doing business. If the city is doing these things and charging the businesses for the cost of these "services" there should be no reduction in city revenue if they are slowly phased out, or at the very least minimized. That is because the cost of an inspection to a business should be equal to the cost the city bears in providing that inspection. If that is true then eliminating it does not impose any costs on the city.

I am not sure how many cities actually do this but they should. I don't think cities should look at inspections and licenses as revenue generating activities. When that happens cities become reluctant to eliminate unnecessary regulations because they rely on the profit those regulations make them. City governments are supposed to provide public goods and mitigate externalities. They should not be profit making entities.

I think that city governments that focus on their core purpose will be more successful in the future because they will create a business environment that is good for all businesses, including start ups. Entrepreneurs can create the next great industry in a lot of different places, and cities that focus on creating a good environment for entrepreneurs have a better chance of become the center of the next great agglomeration economy. Cities with low regulatory burdens are attractive places for entrepreneurs, who often do not have the political clout of established business owners and thus find it harder to navigate the red tape often thrown up by crony politicians. I plan on doing more research on this in the future and will share my results.

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