The Troubling Economics of Policy Making in an Uncertain World

Political and economic uncertainty is putting tens of thousands, perhaps hundreds of thousands out of work. In TH’s mind it is the biggest problem facing the global economy, and resolving the uncertainty is one of the cheapest ways of stimulating the global economy. It just takes political will.

As any student about to sit down and invest a chunk hours of his time writing a research paper knows, sometimes it is better to wait. While there are a variety of reasons for this behaviour (including simply procrastinating), one reason is perfectly sensible. Any decision, no matter what it is, must take into account uncertainty. This is especially so for costly, irreversible decisions like spending time writing an essay; because you never know, in the next day or so, you might just find out something more about the research topic that could boost your grade. Essentially, when there is uncertainty and a decision is costly and irreversible, the option to delay the writing the essay is valuable.

The same is true for firms making investments in new factories and new workers. So when there is economic uncertainty, they have an incentive to wait and see. Who knows, circumstance could change for the better tomorrow, or they could get worse. Either way, you will be better of making the decision with the new information.

The same is true for political decisions. Once a politician has decided to spend his political capital to support the budget vote, say, or a bill to bail out a bank, it is difficult to retreat from his position. So he will wait. Who knows, perhaps the economy will improve and austerity won’t be required, or the bank won’t need a bailout.

Not surprisingly, the option of waiting becomes more valuable the greater the uncertainty. So it is no wonder that at the moment, businesses around the world are investing: these are uncertain times. And, equally, it’s not surprising that politicians aren’t making big bold decisions to have a fiscal union in Europe, say, or avoid the fiscal cliff in the US.

The trouble is that one of the factors that is creating uncertainty for business is the political uncertainty due to a lack of action by politicians (see Chart **). While politicians are reluctant to make decisions because there is considerable economic uncertainty. In short, we are stuck in a Nash equilibrium, and it is starting to act as a really heavy drag on the global economy.

Source: http://www.policyuncertainty.com.

What can resolve our economic prisoner’s-like “dilemma”? The answer is political leadership. Politicians have an obligation to implement public policy to promote the public good. In this case, actions will speak louder than words. By acting, and resolving the political uncertainty, politicians can change the pay-offs in such a way that the incentives for business to delay investment are reduced. They can go further and turn political actions into actual policy action, by asking their bureaucracies to implement the policy quickly avoid what the Europeans now openly call “implementation risk”. Without prompt and decisive action, the outlook for the global economy is not good.

** Chart is comes from a group of clever academics (Scott Ross Baker, Nick Bloom and Steve Davis) who took the time to calculate political uncertainty index and publish it. You can get the data and read about it by visiting http://www.policyuncertainty.com.

3 thoughts on “The Troubling Economics of Policy Making in an Uncertain World

  1. Before the politicians, the thick as a brick bank regulatory establishment must understand. And I am not giving up on trying making them does just that.

    By allowing banks to hold much less capital when lending to “The Infallible” than when lending to “The Risky”, the regulators allow banks to earn immensely higher risk-adjusted returns on their equity when lending to “The Infallible” than when lending to “The Risky”.

    That is very dangerous because it make “The Infallible” so much riskier for banks than what they normally are… remember that only excessive exposures to “The Infallible” have always been the origin of major bank crises.

    That entirely distorts the economic efficient resource allocation banks are supposed to do; for instance by disfavoring more than normal the lending to “The Risky”, the group that includes small businesses and entrepreneurs.

    And, that regulatory discrimination in favor of those normally already favored, creates disfavors against those already disfavored, and is therefore also, simply put, odiously immoral.

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