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GHEI: Uncertainty and unemployment

Leadership vacuum in Washington is driving down the economy

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Amalaise has fallen over the economy. At a time when we should have fully recovered from the Great Recession, we're still 4 million jobs short of where we were just a few years ago. Doubts about economic policy, particularly forthcoming changes in taxes, has turned this "recovery" into a job loser.

If there's one thing investors and employers hate, it's not knowing what lies ahead. To make a proper investment decision, they must predict what's going to happen. The world is rife with unknowns. What the global economy is going to do, what the weather is going to be -- these are economic questions which must somehow factor into business calculations.

Policy uncertainty is another beast altogether. Two recent studies offer hard evidence to back the intuition that confusion about what Uncle Sam is going to do has dampened the recovery, leading to subpar job creation. Stanford University economists Scott Baker and Nicholas Bloom joined the University of Chicago's Steven Davis in using a variety of measures, such as news stories and the number of federal tax code provisions set to expire, to construct an index of policy uncertainty levels. The results show entrepreneurs have more doubts today about where policy is headed than just a few years ago.

The economists estimated the rise in uncertainty from 2006 to 2011 resulted in a 16 percent plummet in private-sector investment and an employment drop of 2.3 million jobs. Their findings are consistent with earlier studies, such as the one by Harvard's Dani Rodrik, which showed uncertainty acts like a tax on investment. In fact, the literature on the depressing effects of uncertainty is vast. No less an authority than now-Federal Reserve Chairman Ben S. Bernanke argued as far back as 1983 that higher uncertainty encourages firms to postpone high-expense investment.

In a just-released study, San Francisco Federal Reserve economists Sylvan Luc and Zheng Liu offer more hard evidence of uncertainty's depressing effect. When people don't know what government will do next, they're less willing to invest and spend. They found higher uncertainty levels during the Great Recession increased the unemployment rate by 1 to 2 percent. That is, if uncertainty levels had remained stable, they say, "the unemployment rate would be closer to 6 or 7 percent rather than to the 8 or 9 percent it actually registered." Each percentage point difference means 1.5 million wind up in the unemployment lines.

Things are only getting worse with the fiscal cliff looming and Congress and the president failing to do anything about it. In 2010, Congress waited until December to decide on extending the George W. Bush tax cuts -- and even then they limited the extension to two years. The House has already voted to extend these rates, but as long as Senate Democrats and President Obama stall on the issue, investors and firms will stay on the sidelines. That means millions of unemployed Americans will keep searching fruitlessly for jobs that never appear.

Nita Ghei is a contributing Opinion writer for The Washington Times.

 

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