Uncertainty and Economic Recovery - Belaboring the Obvious

In the Wall Street Journal today:

Companies and small businesses... are in good shape and have money to spend. So why aren't they pumping more capital back into the economy, creating jobs and fueling the country's economic engine?

Quite simply, if firms can't see a clear road to economic recovery ahead, they're not going to hire and they're not going to spend. It's what economists call a "deadweight loss"—loss caused by inefficiency.

Today, there is uncertainty about regulatory policy, uncertainty about monetary policy, uncertainty about foreign policy and, most significantly, uncertainty about U.S. fiscal policy and the national debt. Until a sensible plan is created to address the debt, America will not fulfill its economic potential.

Uncertainty comes with a very real and quantifiable price tag—an uncertainty tax, so to speak. Over the past two years, amid stalled debates in Washington and missed opportunities to tackle the debt, the magnitude of this uncertainty tax has gotten short shrift.

Three economists, Stanford University's Nicholas Bloom and Scott Baker and the University of Chicago's Steven Davis, have done invaluable work measuring the level of policy uncertainty over the past few decades. Their research (available at policyuncertainty.com) shows that, on average, U.S. economic policy uncertainty has been 50% higher in the past two years than it has been since 1985. 

Based on that research, our economists at Vanguard isolated changes in the U.S. economy that we determined were specifically due to increases in policy uncertainty, such as the debt-ceiling debacle in August 2011, the congressional supercommittee failure in November 2011, and the fiscal-cliff crisis at the end of 2012. This gave us a picture of what the economy might look like if the shocks from policy uncertainty had not occurred.  

We estimate that since 2011 the rise in overall policy uncertainty has created a $261 billion cumulative drag on the economy (the equivalent of more than $800 per person in the country). Without this uncertainty tax, real U.S. GDP could have grown an average 3% per year since 2011, instead of the recorded 2% average in fiscal years 2011-12. In addition, the U.S. labor market would have added roughly 45,000 more jobs per month over the past two years. That adds up to more than one million jobs that we could have had by now, but don't.

He doesn't mention the biggest drag on job creation -- the looming "train wreck" of Obamacare.   But, other than that, this is right on.   When we talk about business decision-making -- starting a business, growing a business, buying new equipment, hiring new people -- we are talking about a constant weighing of risk and reward.   The higher the level of uncertainty, the more risk to any investment, which means that the reward must be correspondingly higher.   If the reward for starting a business isn't higher -- and why would it be when government regulation and mandates is constantly narrowing the profit margins of businesses -- the decision not to do something will seem more prudent.   And so capital will sit on the sidelines, or in the stock market, rather than in new businesses.   And, as a result, more people will be unemployed for longer.