Time to pay down the uncertainty principal

As I write this, I don’t know who is going to win the presidential or gubernatorial elections. But one thing is for sure — the winners better fix the political uncertainty plaguing government before it wrecks the economy again.

Not everyone thinks the issue is important. Some politicians and pundits have dismissed recent concerns about policy uncertainty as nothing more than Republican partisans attacking the Obama administration’s tax, regulatory and health-care policies. They are mistaken. It’s more than a talking point, and it didn’t start with the election of Barack Obama.

The movement away from the predictable began under George W. Bush. In response to the “dot-bomb” recession it inherited from the Clinton years, the Bush team proposed one-time tax rebates followed later by tax-rate reductions with expiration dates some thought would be enforced. Others weren’t so sure. Neither enabled long-term planning by households and businesses. The Federal Reserve System contributed by keeping interest rates artificially low from 2002 to 2005, which helped inflate the housing bubble. When it popped, the Bush administration and the Fed turned uncertainty into chaos by bailing out some financial institutions and letting others fail.

All this happened before Obama took office in 2009. Unfortunately, his agenda introduced more uncertainty. His stimulus package was hastily constructed and aimed entirely at manipulating consumption in the short run instead of incentivizing investment for the long run. The Dodd-Frank financial-regulatory bill he signed into law in 2010 created new rules and bureaucracies with unknown costs and unpredictable effects on finance, insurance and other industries. Obama’s health-care legislation, rammed through Congress without popular support, set up a series of complicated decisions for families and businesses. Those decisions had to be made without knowing which parts of the legislation would survive judicial review, which parts would be implemented by states and which parts would prove impractical to enforce by the scheduled deadline of 2014.

My health insurer, Des Moines, Iowa-based Principal Financial Group Inc., gave up trying to figure this out and exited the business in late 2010. (So much for the promise that if I liked my health plan I’d get to keep it.) Many companies continue to run the numbers on the “pay or play” aspect of Obamacare — whether to purchase expensive, Washington-approved health plans for their employees or to bail out, pay a fine and let their employees acquire insurance through new state-purchasing pools.

There are good reasons to believe that uncertainty slows economic growth. Friedrich Hayek, Robert Lucas and Edward Prescott won their Nobel Prizes in economics in part for their work exploring the relationship between discretionary policymaking and economic performance. The title of one of Prescott’s most famous papers, co-written with Finn Kydland, says it all — Rules Rather Than Discretion: The Inconsistency of Optimal Plans. Even good policy doesn’t work if people doubt it will stick.

There are also good reasons to believe that uncertainty is increasing. Scott Baker and Nicholas Bloom at Stanford University and Steven Davis at the University of Chicago have constructed an Economic Policy Uncertainty Index for the past three decades. It includes variables such as the number and magnitude of tax policies set to expire, variation in economic projections and the extent of media coverage of policy disputes. Their work generated two major findings. First, uncertainty about economic policy has been about twice as high since 2008 as it was for the 23 years before then. Second, uncertainty is strongly and inversely correlated with economic growth. The more people are unsure about what’s going to happen next, the less risk they take. That translates into fewer investments made and jobs created. Two economists writing for the Federal Reserve Bank of Cleveland followed up by comparing the Economic Policy Uncertainty Index with small-business behavior from 1986 to 2011. Even after adjusting for factors such as consumer confidence and the business cycle, they discovered that increased uncertainty led to decreased willingness to hire new workers.

Whoever is elected president or governor should take the problem of uncertainty seriously. They need to fashion simple, understandable initiatives with some bipartisan support and buy-in from the general public rather than adopt stopgap measures or push big ideas through on party-line votes. For example, they could ask companies and households to give up cherished tax breaks and subsidies in exchange for permanent reductions in tax rates and government budgets. Whatever they decide, they had better make it concrete. Otherwise, the only sure thing will be more economic paralysis.

John Hood is chairman and president of the John Locke Foundation. You can reach him at jhood@johnlocke.org.