Regulatory costs disproportionately affect small businesses

Businesses do generally operate under certain guidelines, termed regulations. These regulations in any shape or form act as guiding constraints on what business can and cannot do. But regulations come with a negative side; they increase costs for businesses that have to comply. Much worse than that, they increase costs disproportionately for startups and small businesses. Big and old businesses are in better financial status to withstand the rising costs that regulation entails. Small businesses, on the other hand, often operate on a close to negative cash flow. Any increase in costs can impact them significantly.

A recent NBER working paper has documented this fact by looking at cost of capital. Regulations reduce sales growth and increase firms’ cost of capital by a significant amount. However, large firms are usually in a better position to manage those costs so smaller businesses are much more impacted by regulation.

We find that higher regulatory cost results in slower sales growth, an effect which is mitigated for large firms. Furthermore, we find a one-standard deviation increase in our preferred measure of regulatory cost is associated with an increase in firms’ cost of capital of close to 3% per year. These findings suggest that regulatory risk is a major cost to firms, but the largest firms are able to manage that risk better.

The effect of regulation on small businesses has bigger impacts on the economy. Because regulations prevent small firms from growing and, sometimes, surviving, the economy is affected. Small businesses make up the majority of businesses and they account for majority of job creation. Regulation effectively stalls job creation, stagnates income growth, and generally reduces wealth creation.

Regulatory burden causes job loss

Source: US Chamber of Commerce Foundation

Regulatory burden causes wage loss

Source: US chamber of Commerce  Foundation

Regulatory burden causes loss in GDP

Source: US Chamber of Commerce Foundation