Wednesday, January 20, 2010

Regime Uncertainty and the Massachusetts Election

Modern economic historians who study the Great Depression are beginning to focus on business uncertainty as a key reason the Great Depression was prolonged. Economic historian Robert Higgs makes the case in a paper, “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War (PDF).”

According to Higgs, “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.”

Higgs quotes economists and historians to support his points that uncertainty freezes investment, the Roosevelt administration created an environment of uncertainty, and business investment stagnated during the Depression.

How Uncertainty Affects Investment…

In an economy where entrepreneurship is decentralized, economic actors will hold back on long-term investments unless the state makes credible commitments to honor its contracts and respect individual ownership rights.

From the book, “Empirical studies in institutional change,” economists Lee J. Alston, Thráinn Eggertsson, and Douglass C. North

Investment spending on an aggregate level may be highly sensitive to risk in various forms…[including] uncertainty over future tax and regulatory policy… a major cost of political and economic instability may be its depressing effect on investment.

MIT Economist, Robert Pindyck

What does provide some degree of protection is the political system, together with the economic pressure groups that ensure that the state does not go ‘too far’ in interfering with the owner’s control over assets. This politically determined thin line may be understood as the real definition of property rights conferred by the state, as distinct from the somewhat fictitious legal notion of property rights. How broadly property rights are defined in this real sense and how effective states’ (largely nonlegal) commitment is to their security is a more serious problem than the issue of legal protections against the more traditional form of takings.

Columbia University Law Professor, Andrzej Rapaczynski

How Roosevelt Created Uncertainty…

[The Roosevelt administration] abruptly and dramatically altered the institutional framework within which private business decisions were made, not just once but several times with the result that regime uncertainty was heightened and recovery substantially retarded.

University of Iowa Economics Professor, Gene Smiley

What kind of uncertainty? Consider the following programs, cited by Higgs, that Roosevelt introduced:

  • Agricultural Adjustment Act
  • National Industrial Recovery Act
  • Emergency Banking Relief Act
  • Banking Act of 1933
  • Federal Securities Act
  • Tennessee Valley Authority Act
  • Gold Repeal Joint Resolution
  • Farm Credit Act
  • Emergency Railroad Transport Act
  • Emergency Farm Mortgage Act
  • Home Owners Loan Corporation Act
  • Securities Exchange Act
  • Gold Reserve Act
  • Communications Act
  • Railway Labor Act
  • Bituminous Coal Stabilization Act
  • Connally (“hot oil”) Act
  • Revenue Act of 1935
  • National Labor Relations Act
  • Social Security Act
  • Public Utilities Holding Company Act
  • Banking Act of 1935
  • Emergency Relief Appropriations Act
  • Farm Mortgage Moratorium Act
  • Soil Conservation & Domestic
  • Allotment Act
  • Federal Anti-Price Discrimination Act
  • Revenue Act of 1936
  • Bituminous Coal Act Revenue Act of 1937
  • National Housing Act
  • Enabling (Miller-Tydings) Act
  • Agricultural Adjustment Act
  • Fair Labor Standards Act
  • Civil Aeronautics Act
  • Food, Drug & Cosmetic Act
  • Administrative Reorganization Act
  • Investment Company Act Revenue Act of 1940
  • Second Revenue Act of 1940
Higgs wrote that, “Taken together, the many menacing New Deal measures, especially those from 1935 onward, gave businesspeople and investors good reason to fear that the market economy might not survive in anything like its traditional form and that even more drastic developments, perhaps even some kind of collectivist dictatorship, could not be ruled out entirely.” Roosevelt, according to Higgs, “expressed a hostility bordering on hatred for investors as a class.”
[Businessmen in the 1930s] are not only, but they feel threatened. They realize that they are on trial before judges who have the verdict in their pocket beforehand, that an increasing part of public opinion is impervious to their point of view, and that any particular indictment will, if successfully met, at once be replaced by another.
Harvard economist, Joseph Schumpeter

Uncertainty rules the tax situation [in the 1930s], the labor situation, the monetary situation, and practically every legal condition under which industry must operate. Are taxes to go higher, lower or stay where they are? We don’t know. Is labor to be union or nonunion?… Are we to have inflation or deflation, more government spending or less?… Are new restrictions to be placed on capital, new limits on profits?… It is impossible to even guess at the answers.
Industrialist Lammot du Pont

For the most part the New Deal relied on private investment to stimulate recovery yet its rhetoric precluded the private confidence to invest. [Roosevelt] lost patience with corporation leaders, and younger New Dealers came to the fore who shared his reluctance to make concessions to conservative business opinion.… The men around Roosevelt were now highly skeptical of the ability of business to act in the national interest.
Cambridge University History Professor, Anthony Badger

Business leaders sincerely believed that the government was in evil hands…and preparing the way for socialism, communism, or some other variety of anti-Americanism.
Former New York University Economics Chairman, Herman Krooss

The Impact of Roosevelt’s Policies…
The failure of the New Deal to bring about an adequate revival of private investment is the key to its failure to achieve a complete and self–sustaining recovery of output and employment.
Economist & Former Chairman of the Philadelphia Federal Reserve, Lester Chandler

Perhaps the New Deal’s greatest failure lay in its inability to generate the revival in private investment that would have led to greater output and more jobs.
University of Leicester History Professor, Peter Fearon

Higgs makes the argument that the regime uncertainty didn’t truly end until, “the death of Roosevelt and the succession of Harry S Truman and his administration completed the shift from a political regime investors perceived as full of uncertainty to one in which they felt much more confident about the security of their private property rights. Sufficiently sanguine for the first time since 1929, and finally freed from government restraints on private investment for civilian purposes, investors set in motion the postwar investment boom that powered the economy’s return to sustained prosperity notwithstanding the drastic reduction of federal government spending from its extraordinarily elevated wartime levels.” “The New Deal,” concludes Higgs, “prolonged the Great Depression by creating an extraordinarily high degree of regime uncertainty in the minds of investors.”

Regime Uncertainty in 2009

A similar, though milder form of regime uncertainty, characterized the United States in 2009. The government nationalized most of the automotive and financial sectors, shoved an increasingly unpopular health care bill through the House and Senate that threatens to nationalize another sixth of the economy, rammed cap & trade (i.e., cap & tax) legislation through the House, created a pay czar to dictate private sector compensation, intends to pass union friendly “card check” legislation, is allowing tax cuts to expire, which essentially means a tax hike, and generally spewed anti-business rhetoric more worthy of Hugo Chavez than the U.S. government.

Much of the uncertainty ended last night with the surprise election of Scott Brown in the Massachusetts special Senate election. Brown provides a critical 41st vote to block cloture and allow the minority to filibuster legislation in the Senate. More important than the vote is the message Brown’s surprisingly strong election sends to moderates. If the GOP can take a Massachusetts Senate seat by a five point margin (i.e., it wasn’t close), all moderates in more conservative areas should be concerned.

Moderates now fear the voters more than their party leadership. Since politicians tend to put their self-interest first, this reduces the risk of passage of significant legislation that will fundamentally alter the business environment. While the administration’s pursuit of Keynesian economic policies will likely hinder, rather than help a recovery, this is a headwind that can be overcome.

The United States has always attracted business investment from around the world for our political and economic stability, reliance on the rule of law, and property rights. With regime uncertainty reduced, expect investment to increase. The business climate just took a tick up.

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