Heuristics and Small Business Response to Regulation

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Applying behavioral economics to the study of regulation could help improve attitudes among business owners.

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The explanation of why businesses oppose regulations is on its surface a very simple one. Regulations impose costs on businesses thereby imperiling their profitability and hence their survival. The reality, however, is more complicated. Economists have long added the nuance that some regulations help businesses, especially large ones, by serving as a barrier to entry for potential competitors.

But in recent years the vitriol about regulation has been extreme. Regulation has been blamed for worsening economic conditions in bad times and for hampering growth in good times. This vitriol has emerged despite evidence that the macroeconomic effects of regulation on employment and productivity are, at the most, ambiguous.

What explains the heated rhetoric over regulation, and how have businesses reacted to it?

We conducted a survey of 322 small business owners or managers in the manufacturing industry in the midwestern United States to try to understand better the vitriol of sentiment against regulation. We followed this survey up with eight in-person interviews of survey respondents. In the survey and the interviews, we asked questions about regulatory burdens, basic characteristics of the businesses, and the beliefs of business owners.

The responses we received pointed out the potential for behavioral economics to shed light on the behavior and attitude of regulated communities toward regulation. Behavioral economics, when applied to public policy, has largely focused on opportunities for governments to “nudge” regulatory beneficiaries toward decisions that better maximize their welfare. More recently, the behavior of public employees has fallen under the lens of behavioral economics.

But to date, there has been little research on the reactions to these requirements from those who are forced to take actions by the government to benefit others. In both our survey and our interviews, we found that business owners discussing their reaction to regulatory requirements displayed some of the heuristics described by scholars such as Daniel Kahneman, Amos Tversky, and Richard Thaler in other contexts. In a recent report on this research published in Nature, we highlighted four such heuristics.

First, reporting and recordkeeping requirements have an effect on business owners that is out of proportion to their calculated economic impact. Paperwork is always present for these small businesses and is a constant source of irritation. More costly requirements to install equipment or change manufacturing processes are one-time expenditures that may not be welcomed, but are quickly routinized and their purpose is often understood. Paperwork is always available to remind businesses of regulation, and such requirements often seem pointless to them because business owners rarely ever see the point of many of the records they are required to keep.

Second, businesses also tend to anchor their attitudes toward regulation in one incident. A fine for a violation that they deemed insignificant, or an interaction with a government representative during a regulatory inspection that is perceived as unfair, leads to a hostility toward regulation that can last for decades. The one incident does not even have to happen to the business in question. Several respondents cited violations they had heard about from competitors when describing their attitude toward regulation.

Third, the internet has made it much easier for all of us to gain reinforcement for our preexisting views. This phenomenon is also true for the regulated community. Survey respondents often heard first about regulations not from the government but from advocacy organizations or business groups. Once they hear about a regulation, business owners regularly go to online forums or talk to those in their industry to gain information. The information they get is largely negative. The behavioral literature describes this as the bandwagon effect.

Finally, regulation is a convenient scapegoat for setbacks in business. Both the surveys and the interviews indicated a desire to blame regulation for needing to lay off workers or cut back operations. Indeed, regulation may have sometimes been the culprit. But many of the cutbacks described occurred during the Great Recession. It is likely that other economic factors—or maybe even poor decisions by the business owner—had been at fault. This self-serving bias leads owners to place responsibility for setbacks on an external party—one that may be the subject of criticism in those online fora.

The application of behavioral economics to regulatory compliance is a field ripe for further exploration. Such exploration may improve regulatory design. In addition, there are practical implications from gaining a better understanding of the attitudes of those who must comply with regulations. The need for compliance assistance, retrospective review of regulations, and the production of “green tape” rather than “red tape” in regulation could both improve regulatory attitudes and regulatory compliance.

Stuart Shapiro

Stuart Shapiro is the associate dean of faculty at the Edward J. Bloustein School of Planning and Public Policy at Rutgers University.

Debra Borie-Holtz

Debra Borie-Holtz is an associate teaching professor at the Edward J. Bloustein School of Planning and Public Policy at Rutgers University.