Home Politics Fear the Unknown: How Policy Uncertainty Hurts Growth

Fear the Unknown: How Policy Uncertainty Hurts Growth

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We have endured an extraordinarily slow economic recovery for more than seven years. The slow pace of economic recovery cannot be attributed to lack of effort by public officials. On the contrary, public officials have set new records trying to “stimulate the economy” through expansions of debt and bank reserves.

Many people assume that strong government policies deliver good results. Other people think that government policies are ineffective. There is a third possibility: government policies can backfire and make matters worse.

Governmental policies can and do cause uncertainty among private entrepreneurs.

Indexing Uncertainty

The idea that governmental policies have made matters worse is not mere conjecture. There is evidence that governmental policies have slowed recovery from the 2008 Crisis. Researchers at the University of Chicago have assembled an economic policy uncertainty index.

The economic policy uncertainty index estimates the level of doubt and confusion in the private sector caused by government policies. How? The economic policy uncertainty index draws upon newspapers and other written sources to estimate policy-generated uncertainty. Differences in economic forecasts indicate uncertainty. Temporary policies set to be terminated, not automatically renewed, indicate uncertainty. Newspaper commentaries that mention uncertainty also signal uncertainty.

Policy-driven uncertainty rises during political turmoil or elections, and during the implementation of major new policies and programs. Recent implementation of new policies (i.e. The Affordable Care Act, Dodd-Frank, and The Recovery and Reinvestment Act) left employers wondering about how these new laws will affect their costs.

Dragging Down Growth

Attempts by Republicans to undo The Affordable Care Act created even more doubt about future economic conditions. Bad policies should be undone, of course. However, intense political fights over the future of major policies and programs do make it harder for entrepreneurs to go forward with new projects. Public bureaucrats may also react to uncertainty by holding off on new hiring.

Policy driven uncertainty was high during the 2008 crisis, and also during the slowest part of the post-crisis recovery.

How can the effects of policy uncertainty be quantified more precisely? One of the most disconcerting aspects of the slow recovery is the relative lack of job opportunities. Those who watch economic reports carefully have become accustomed to disappointing monthly reports from the Bureau of Labor Statistics.

The Job Opening Labor Turnover Survey (JOLTS) provides regular data on hiring and firing in national labor markets. Monthly jobs reports have shown some improvement in some months during the past year, but hiring has generally been slow for many years now. Why has the job market been so weak? Slow job growth is certainly not the result of inaction on the part of government officials. On the contrary, people in government have borrowed and spent money faster than ever before.

How does economic policy uncertainty relate to the slow rate of hiring in recent years? To test the relation between policy uncertainty and hiring it is useful to lag hiring, to check for any delayed effect that uncertainty has on hiring. Causes, do after all, preceed effects. In order to get a clear view of the uncertainty/hiring relationship, it is useful to check the entire subprime boom, bust, and recovery.

A plot of the Economic Policy Uncertainty Index against hiring during the 2002 to 2016 period, lagged by two months, reveals a clear and expected negative correlation.

There is in fact a 57% correlation between policy-driven uncertainty and lagged non-farm hiring. High levels of uncertainty are followed by less hiring. Low levels of uncertainty are followed by higher levels of hiring. Could the correlation between uncertainty and hiring just be mere coincidence? Perhaps. Once should consider more than just data when judging the validity of a cause-and-effect relationship.

Theoretically speaking, the idea that policy uncertainty would dampen hiring is sensible. A 57% correlation indicates that a causal relationship between two variables is very plausible. When theory and data point in the same direction, few doubts should remain.

Stop “Helping”

Slow hiring over the past seven years adds up to a tremendous loss of potential increases in private wealth. While what is done in the past is just a sunk cost, lessons from the past can help us to avoid costly waste in the future. Many people assumed that private bankers caused the 2008 Crisis, and that governmental policies could fix the economic situation.

It is easy to assume that, since employers have been reluctant to hire more employees, we must turn to public officials for help. There is real evidence that government policies that were intended to help have had the unintended consequence of hindering recovery.

Government has grown rapidly in recent years, with few signs of having a positive effect on economic conditions. Governmental programs often have perverse incentives, incentives that result in economic waste. There is another issue to consider: governmental policies can and do cause uncertainty among private entrepreneurs. At least part of the solution for the weak economic recovery of the past seven years would then simply be for politician to stop trying to fix our problems: laissez-nous faire.

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