Can regulation beget innovation?

By Steven Pearlstein
Friday, July 16, 2010; A12

The big complaint from the business lobby these days concerns a "lack of clarity" about federal regulation that prevents companies from using all that cash piling up on balance sheets to hire workers and make major investments.

Then, without missing a beat, those very same business groups declare themselves unalterably opposed to any climate-change legislation that sets plant-specific targets for carbon reductions, puts a floor and a ceiling on the price of carbon, tells utilities exactly how much of their power should come from low-carbon sources or sets specific standards for the energy efficiency of cars and appliances.

Apparently the Chamber of Commerce types think Americans are so gullible that we won't notice their blatant and self-serving hypocrisy. In reality, it's only a certain kind of regulatory clarity they seek -- the clarity of knowing that old regulations won't be enforced and new ones will be dictated by industry lobbyists.

And here I was thinking how much progress had been made in getting past the stale political bromides.

When the business community demanded that regulations be subject to a cost-benefit analysis, that's just what happened, over the vehement objection of labor unions and environmental groups. The latest report from the staff at the Office of Management and Budget shows that the benefits outweighed the costs last year by record levels.

Then the business community demanded that regulators give up their command-and-control mentality and take a market-based approach that leaves it to each company to figure out how to meet goals. That's exactly what the cap-and-trade bill on carbon emissions is all about -- but now, apparently, that's not good enough.

It's been 20 years since Harvard Business School professor Michael Porter provided scholarly support for the notion that, rather than hamper economic growth and competitiveness, well-crafted regulation could actually promote it. Porter's first observation was that some of the world's most prosperous and economically vibrant countries were also those with some of the most stringent business regulations, such as Germany and Japan. His studies of specific industries also turned up numerous examples of new products and more efficient ways of doing business that came about only because companies and industries were forced to comply with rules.

Porter's musings, introduced in an article in Scientific American, have since spawned a cottage industry of researchers intent on proving or disproving his hypothesis. Its most controversial aspect was to suggest that profit-maximizing companies were ignoring opportunities to produce profitable new products or adopt more-efficient production techniques. Such a notion not only runs counter to the most basic principles of economics and efficient markets, but it also offends the sensibility of corporate managers, who find it preposterous that such opportunities could be revealed only when the EPA or an OSHA inspector knocks on their company's door.

But subsequent research confirmed what some of us have long since discovered -- namely that corporate executives can be stuck in their ways, averse to risk and unwilling to sacrifice short-term profitability for long-term gain. And as a result of these market "imperfections," sometimes a new regulation comes along that spurs innovation by forcing companies to look at things in new ways. That doesn't mean that regulation is costless, but it does suggest that, on an economy-wide basis, those costs can be offset by subsequent investment and innovation.

That, in fact, is the message I got Thursday from the chief executives of two of the country's electric utilities, who were only too eager to tell me about the billions of dollars they are ready to spend if only Congress would adopt one of several reasonable proposals on the table to limit carbon emissions. At this point they are so eager for regulatory "clarity" that they would accept a bill that, at least initially, applies only to their sector.

At Public Service Enterprise Group, the giant New Jersey utility, chief executive Ralph Izzo says his greatest fear is that Congress will do nothing about carbon emissions, the EPA will step in with regulation, and the next decade will be spent in endless litigation until global warming becomes a crisis. Better, he says, to bite the bullet and set a long-term price for carbon now, phase it in slowly and give businesses time and flexibility to adjust. At PSEG, that would mean immediately investing an extra $2 billion upgrading old plants, building solar and wind farms and helping customers with energy efficiency, with $10 billion more after that to build a nuclear power plant.

"We all know something will have to be done, but we don't know what and we don't know when -- and that's putting us in limbo," said Lew Hay, chief executive of NextEra Energy, the latest incarnation of the old Florida Power and Light. While Hay has lots of ideas of what he'd like to see in an energy and climate-change bill, he's at the point where even an imperfect bill is better than no bill at all.

Once the rules are set, Hay says he'll spend $3.5 billion on new wind and solar production, in addition to what NextEra is already spending, that he estimates will generate 50,000 jobs over five years. That would be followed by a $14 billion-plus investment in two additional nuclear power plants.

The problem in Washington is not that President Obama and the Democratic Congress have created a hostile regulatory environment for investment and job creation. Rather, the problem is the hyperbole and poisonous rhetoric from the business lobby that have created a hostile environment for political compromise. Over the years, Americans have shown that they can respond creatively, even profitably, to reasonable regulation. Apparently our business leaders have lost faith that we can do it again.

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