Regime Uncertainty and Growth

October 29, 2009

In a 1997 study, economist Robert Higgs persuasively argued that “the New Deal prolonged the Great Depression by creating an extraordinarily high degree of regime uncertainty in the minds of investors.”

Higgs defines “regime uncertainty” as follows: 

To narrow the concept of business confidence, I adopt the interpretation that businesspeople may be more or less “uncertain about the regime,” by which I mean, distressed that investors’ private property rights in their capital and the income it yields will be attenuated further by government action. Such attenuations can arise from many sources, ranging from simple tax-rate increases to the imposition of new kinds of taxes to outright confiscation of private property. Many intermediate threats can arise from various sorts of regulation, for instance, of securities markets, labor markets, and product markets. In any event, the security of private property rights rests not so much on the letter of the law as on the character of the government that enforces, or threatens, presumptive rights. 
An article in the Wall Street Journal provides evidence, albeit anecdotal, that a present day “regime uncertainty” could be inhibiting the economy’s ability to recover: 
W. Michael Brown has scaled back hiring plans in his Virginia auto-parts stores. Carl Redman halted an expansion project at his Oregon contracting business. Bill Hammack is preparing layoffs at his road-construction company in Georgia. The economy remains unsteady 22 months after the recession began, with banks restricting credit and consumers hunkering down. For these small businesses, and many others across the country, there’s an additional dark cloud: uncertainty created by Washington’s bid to reorganize a wide swath of the U.S. economy. 
But a health-care overhaul grinding through Congress could bring unknown new obligations to insure employees. Bush-era tax cuts are set to end next year, and their fate is unclear. Legislation aimed at tackling climate change might raise businesses’ energy costs. Meanwhile, a bill aimed at increasing transportation spending is stalled. 
The concerns expressed in the Journal article are clear: 
He’s worried about getting hit by higher taxes next year, which would cut into income to pay for expansion, raises, bonuses, new product lines and delivery trucks…”There’s so much trepidation out there,” said Mr. Brown. “The thing I’m struggling with is how the potential government takeover of health care coupled with impending taxes will impact my company.” 
Wharton School of Business Professor Raffi Amit cites the Obama administration’s pending overhaul of banking regulations as another drag…That combines with uncertainty about other issues, he said. “Obviously people are worried about what health-care costs are going to be. Nobody knows. Taxes, who knows?” 
Mr. Redman, vice president of Bear Electric Inc. of Donald, Ore., said he’d rather be expanding his operation during a recession, with prices for things such as land, equipment and construction likely more affordable. He’s also thought about adding to his 90-person staff. “We’d love to step out on the limb and hire more people just to get more folks working, but things are so frightening, and number one on that list is health care,” he said. “Second is taxes.” 
Sandy Abalos, of Abalos & Associates PLLC in Phoenix, is cutting benefits at her certified public accountant firm. She still pays 100% of health-care coverage for her 16 employees, but stopped making 401k contributions. She also stopped profit-sharing, a recent step to hold some cash in reserve in case health-care costs and taxes rise. 
The Journal cites the “stalled” transportation reauthorization bill, but this actually underscores the problem of having an industry become so dependent upon federal largesse: 
Paul Campbell, executive vice president of Wheeler Machinery Co., a Caterpillar dealer in Salt Lake City, said Utah’s contract work has ground to a standstill as well. “There’s very little private money going into any kind of construction,” Mr. Campbell said. “You take the federal contracts out of that and it gets a whole lot worse really quick.”

As the economy remains sluggish and federal subsidies and interventions continue to be touted as corrective medicine, Higgs’ recognition that the Great Depression was prolonged by government actions is a lesson policymakers would be wise to heed.



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