[Editor’s Note: This article in the Wall Street Journal on September 25, 2013 provides interesting insight that perhaps ending the “fight” between the President and both houses of Congress is more important to adding jobs than who is right]
Policy Uncertainty Paralyzes the Economy
Getting back to the
2006 level of uncertainty would add 2.3 million jobs.
By WILLIAM A.
GALSTON
Endless strife over public policy increases
uncertainty, and greater uncertainty slows growth. Beyond all the damage that
political hyperpolarization inflicts on public trust, it undermines what the
American people want most—jobs for themselves and expanded opportunity for
their children.
A
growing body of economic research supports this linkage between policy-based
uncertainty and the real economy.
Over the past few years, Stanford-based
economists Scott Baker and Nicholas Bloom teamed up with the University of
Chicago's Steven Davis to develop a measure of economic policy uncertainty and
to explore the effects of changing levels of uncertainty on the economy.
Between 1985 and 2007, they found, uncertainty varied within a narrow and
mostly predictable range, moving up in response to presidential elections and
international conflicts and then subsiding. Since then, however, policy
uncertainty has risen to historically elevated levels, with the
peaks—corresponding to events such as the collapse of Lehman Brothers and the
initial defeat of the TARP legislation—surging above that after the 9/11 terror
attacks.
In a finding that today's policy makers would do
well to ponder, the highest level of policy uncertainty ever recorded—in
mid-2011 as Washington struggled with the debt ceiling and narrowly averted
default—stood at two-and-a-half times the average of the past quarter century.
Since 2007, policy-induced uncertainty has become a larger and larger share of
overall economic uncertainty.
This story makes intuitive sense. But how much
of a difference does uncertainty make in the real economy? To answer this
question, Messrs. Baker, Bloom and Scott make use of a statistical technique
for which Christopher Sims won a 2011 Nobel Prize in economics. They find that
restoring 2006 levels of policy uncertainty could increase industrial
production by 4% and employment by 2.3 million jobs over current baseline
estimates—enough to bring unemployment down by about 1.5 percentage points.
It's easy to dismiss a single innovative study:
Every index is controversial, as is every model and statistical technique. But
in July 2013, Sylvain Leduc and Zheng Liu, two researchers at the Federal
Reserve Bank of San Francisco, published a paper that took a different route to
a very similar result. Their point of departure was a historical relationship
known as the Beveridge curve: As job openings increase, the unemployment rate
tends to fall. The Great Recession has disrupted the terms of this
relationship, however. The unemployment rate has fallen much less than the rise
in job openings suggests that it should have, and there are more jobless
workers per job opening than in previous recoveries.
The San Francisco Fed researchers find that
heightened policy uncertainty has become increasingly important in the job
market. It turns out that as uncertainty rises, the intensity of businesses'
recruitment activities wanes, lowering the rate at which firms fill jobs. By
the end of 2012, the researchers calculate, heightened policy uncertainty
accounted for about two-thirds of the shift in the Beveridge curve. Their
bottom line: "[I]f there had been no policy uncertainty shocks, the unemployment
rate would have been close to 6.5% instead of the reported 7.8%"—a result
that aligns remarkably well with the Stanford/Chicago team's conclusion.
In testimony before the Senate Budget Committee
on Tuesday, an intellectually and politically diverse panel—Allan Meltzer
(Carnegie Mellon), Chad Stone (Center on Budget and Policy Priorities) and Mark
Zandi (Moody's Analytics)—agreed that policy uncertainty is a drag on the
economy. Mr. Zandi's model suggests if political uncertainty had remained at pre-recession
levels, output would be $150 billion higher and unemployment would be 0.7%
lower than they are today—smaller effects than the other studies indicate, but
still very significant.
If this emerging body of research is correct—and
it is more than plausible—then elected officials should ask themselves some
hard questions. Both parties are sure they are right about what's needed for
economic growth. But when our governing institutions are closely as well as
deeply divided, as they are today, neither side can get its way. Each party
faces the same choice: It can fight on in the hope that a governing majority of
the people will come to see things its way, or it can compromise with the other
party to bring the fight to a close.
So far, both parties have chosen to fight,
believing that their preferred prescriptions for the economy would yield much
better results than could any feasible compromise. But the fight itself is
taking a toll on the economy and is making life worse for millions of
Americans. Maybe that's why the people are pleading with their elected
officials to compromise. It's time for Washington to start paying attention.
A version of this
article appeared September 25, 2013, on page A15 in the U.S. edition of The
Wall Street Journal, with the headline: Policy Uncertainty Paralyzes the
Economy.
