The Economist joins the regime uncertainty crowd
Has The Economist been reading my blog recently? Over the past two weeks, the newspaper that used to justify the use of more and more monetary and fiscal stimulus to push firms to invest (as the only reason why they would not invest was lack of demand) seems to have suddenly waken up to the fact that, after all, regulatory regime uncertainty could well be part of the current low business investment problem. This is welcome but a little late.
In a short Buttonwood article last week, the newspaper asserts that “arbitrary decisions by governments may reduce business confidence, and thus inhibit the investment the politicians want to see” and that:
What troubles businessfolk and investors most is the random nature of the process. They do not know where the next tax will be levied or regulatory boot descend. When rules are proposed, it can take ages for the details to emerge, making it hard for companies to plan ahead. That is the most insidious—and most underestimated—form of political risk.
The piece highlights that, in the latest World Economic Forum competitiveness survey, Singapore ranks first in terms of regulatory burden, whereas struggling EU countries are ranked close to the bottom: Spain is 125th, France 130th, Greece 144th, and Italy 146th. The US has also experienced a huge collapse over the past seven years regarding the perception of its regulatory burden: 23rd to…..80th. It’s probably not going to help the economic recovery, is it?
In this week’s edition of the newspaper, the Free Exchange column takes a look at recent research on uncertainty and investment. Results are striking:
They find that doubts about tomorrow have a big influence on what happens today. For every ten percentage points their measure of uncertainty rose, investment fell by one percentage point. During the financial crisis of 2008-09, for example, they calculate that implied volatility rose by almost 40 percentage points, suggesting a drop in investment due to uncertainty of just under four percentage points. That implies that uncertainty accounted for around half of the total drop in investment during the crisis. And it is not just spending on physical assets that declines. The authors find that other long-term outlays—hiring staff and launching advertising campaigns—also plunge when uncertainty rises.
Interestingly, The Economist also mentions the banking sector:
Governments, however, are still breeding fears about the future. The most glaring form of uncertainty in the rich world is fiscal. In the euro area cash-strapped peripheral states rely on bail-outs from richer members or the IMF. As each round of talks—on a banking union, or a deposit-insurance scheme—approaches, sensible bosses decide to wait and see what happens. In America endless budgetary brinkmanship has led to a quarterly debate over whether the government will default on its debts (the next deadline is in February). This is self-imposed uncertainty. If the fiscal path were a little clearer, the reduction in uncertainty should spur investment and output, which in turn should improve the fiscal picture. To cut the debt, first clear the doubt.
Of course, The Economist falls short of claiming that stimulus does not work. Of course not. It declares that even more stimulus is necessary in uncertain conditions. Someday they’ll hopefully notice the fallacy in such logic…
Chart: The Economist