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The Hidden Business Benefits of Regulation

How embracing sensible legislation can unlock opportunity.

Businesspeople tend to dislike government regulations, and it’s easy to see why: Many regulations are inflexible, yet businesses have unique characteristics that cry out for sensible customization of the rules; most regulatory agencies are inefficient bureaucracies whose red tape often slows business operations; and some costly regulations produce little or no discernible public benefit. The upshot is that many business leaders are mad as hell at government, and spend lots of time and money in pursuit of a holy grail called deregulation.

In 1962 Milton Friedman became the first serious, modern American economist to advocate the deregulation of business. Over subsequent decades, he and his disciples would call for the total dismantling of the FDA, OSHA, EPA, CPSC, USDA, FTC, and other alphabet agencies. Following Adam Smith, Friedman firmly believed that businesspeople are motivated by economic self-interest and, therefore, won’t voluntarily engage in activities that aren’t profitable. He thus believed some manufacturers would pollute the air and water, some meat packagers would stuff dead rats in sausages, some pharmaceutical firms would pass off snake oil as a cancer cure, and some toy companies would put lead paint on toddler teething rings. These “free-riders” could offer cheaper goods that threatened the market positions of their more virtuous competitors. Nonetheless, Friedman concluded that regulation was unnecessary because injured parties could simply sue offending companies for damages, and that threat would serve as a sufficient disincentive to corporate misbehavior.

In Friedman’s free-market world, there would be no upper limit to the amount courts could award injured parties, and no restrictions on class-action suits or on lawyers working on contingency. Since the prospect of costly litigation is as unpalatable to most corporate leaders today as regulation, they want to have it both ways: deregulation and limits on litigation. But that implies that all businesses will self-regulate, which is a lofty goal. In fact, until greed and sin vanish from this earth, businesses might just as well curse the darkness as to demand such total self-regulation.

Instead, it is in the best interest of businesses to learn to work with governments to write sensible regulations that target bad apples. In fact, there are solid economic reasons for virtuous businesses to support regulations in such areas as employee safety and health, and food and product safety, where a level playing field is necessary to prevent free-rider advantages going to competitors willing to pursue gain at the expense of the public interest.

Businesses should work with governments to write sensible regulations that target bad apples.

For example, in the 1970s the growing problem of air pollution in the U.S. would not have been addressed if the nation had waited for the auto industry to voluntarily introduce catalytic convertors. If virtuous manufacturers had taken the lead and adopted those costly devices, they would have found themselves at a significant price disadvantage against converter-less competitors. When Congress passed the Clean Air Act mandating such equipment, they in effect leveled the playing field to the benefit of all car manufacturers.

Similarly, society can’t depend on the benevolence of convenience-shop owners not to sell cigarettes and booze to minors. Indeed, the laws prohibiting such sales benefit virtuous shop owners because they prevent their less scrupulous competitors from gaining the advantages of increased market share.

Moreover, deregulation can generate long-term costs for responsible businesses. A few years back, California’s then governor, Arnold Schwartzenegger, signed a bill easing fire prevention regulation during construction of buildings that resulted in short-term savings for some builders. But when a major fire in March 2014 destroyed a large building under construction in San Francisco, owners of nearby buildings also destroyed by the fire—and insurance companies covering the hundreds of millions in damages—were left wondering if the short-term savings had been worth it.

Over the years, occupational safety and health regulations have spurred the substitution of new technologies that not only were safer but more efficient. Such gains in efficiency have also resulted from technological substitutions necessitated by legislation designed to reduce air and water pollution in manufacturing. Given that, the recent court ruling removing the section of the Dodd-Frank Act requiring manufacturers to disclose the source of minerals used in their products (to determine if they came from areas in Africa where human rights abuses are rife) may prove, assuming it stands, to be a pyrrhic victory for business. Doubtless, the due diligence required in tracing the supply chain of tin, tungsten, and tantalum back to their original sources demands a costly process of investigation, but my sources in Silicon Valley privately confide that they were benefiting from taking a closer look at their supply chains, hoping to find ways to substitute for some expensive minerals, and identify more cost-effective sources of others. One manager told me this process was causing his company to examine easy assumptions they had made about their operations that, on closer scrutiny, didn’t hold up. He didn’t say his company was happy about the legislation, just that they had decided to quit complaining and turn it to their benefit. Certainly not all executives and organizations subscribe to this point of view, and it will be an interesting regulatory issue to watch unfold.

In general, then, it might benefit responsible businesses to work with governments to write effective legislation aimed at the irresponsible behavior of the short-sighted few. Moreover, I suspect that if the business community dropped their unrealistic and unattainable demands for deregulation, and took up the cause of sensible regulation, they might turn some of their harshest critics into allies.
James O'Toole

James O’Toole is director of the Neely Center for Ethical Leadership at the University of Southern California’s Marshall School of Business.

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