Economic Stagnation and Regime Uncertainty

Somewhere recently (I think at the League of Ordinary Gentlemen, but perhaps at The One Best Way), I mentioned the concept of regime uncertainty as a key to the length of the Great Depression and a possible factor in the slowness of our current economic recovery. Not everyone was persuaded. Just for the record, here’s are links to Robert Higg’s “Regime Uncertainty: Why the Great Depression Lasted So Long and Why Prosperity Resumed after the War” and here’s his discussion of regime uncertainty in relation to the current economic slump. Gary Wolfram buys it. So does Tad deHaven. It’s still not the mainstream economic position, though, and is most popular among those of a Hayekian bent.

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About J@m3z Aitch

J@m3z Aitch is a two-bit college professor who'd rather be canoeing.
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17 Responses to Economic Stagnation and Regime Uncertainty

  1. D. C. Sessions says:

    The last time I looked, Hayek’s school doesn’t go in for quantifiable models, so barring parallel universes for control groups their ideas aren’t falsifiable. This seems to fall into that category too.

  2. James Hanley says:

    D.C.,

    Hmm, a few quibbles. One, quantification helps with falsifiability, making it both easier and more certain, but isn’t a strict requirement.

    While non-falsifiable research isn’t generally as good as falsifiable research (for the reasons listed above), non-falsifiable work is not without value (unless you’re willing to reject ~99.9% of historical research as lacking any value).

    Finally, the quant economists, to the best of my knowledge, have simply ignored the regime uncertainty concept instead of trying to quantify it. It’s certainly not the easiest thing in the world to quantify, but not at all impossible. (The biggest problem is probably small sample size.)

    And while I don’t share the Austrians’ antipathy toward modeling, my inner historian does like the historical/process approach. Tyler Cowen’s In Praise of Commercial Culture and Creative Destruction are almost entirely numbers free, but provide a greater understanding of markets in cultural goods than any quantitative research by itself could. And of course the two methods can be complementary, which is the best of all possible worlds.

  3. D. C. Sessions says:

    Having reviewed the methods, it looks a lot like the “See! I found some results that go along with my hypothesis!” stuff that the alt-med crew do. No attempt whatever to consider or compare alternate factors.

    Notably, for instance, the surveys today don’t include those which ask businesses to compare factors including lack of demand. Being rather close to one business that’s investing heavily in development, those are the tradeoffs we’re making. Government policy is very, very far down our list of concerns compared to inventory and sales prospects.

    That may be why I’m inclined to pay attention to the business surveys that include demand as one of the options, but there you are.

  4. James Hanley says:

    Fair enough, but I think it’s a plausible enough hypothesis (it’s not like “grounding” in the alt-med stuff) that it’s worthy of more careful research. Sure the Austrian folks should do that, but their failure to do so doesn’t mean the quants shouldn’t. Quants are as human as anyone else, and they, with the usual exceptions of the handful of innovators, have the normal tendency to stick to what’s familiar, but that can’t be used as evidence that a different hypothesis is unworthy of their attention. (I say this as someone closely allied with the quants in my field, despite not being a true quant myself. Please don’t see me as a critic of quant work–I’ve fought too many battles defending it over the past decade and a half.)

  5. AMW says:

    Hanley, you’re providing a real trip down memory lane for me this week. Gary Wolfram is the man who inspired me to become an economist. Before taking a class with him I was headed down the path of becoming a shudder poli sci major.

  6. AMW says:

    D.C., I think you have a point about demand as a big factor. If Ed Leamer and (more recently) Vernon Smith and Steve Gjerstad are right, housing is the main factor in business cycles. When housing crashes, household balance sheets go in the red and consumers end up spending a big chunk of their money paying down debt. This diverts a lot of demand from consumption, and business starts drying up. If this really is the (or a lot of the) underlying story of business cycles, the current one is taking so long because we’ve gone through a particularly bad housing crash and it’s going to take some time to put household balance sheets back in the black.

  7. D. C. Sessions says:

    When housing crashes, household balance sheets go in the red and consumers end up spending a big chunk of their money paying down debt.

    Arguably because mortgages are the big not-really-discretionary budget item. Short of starving the kids, just about anything else on the budget is going to be sacrificed to keep the house — cars, clothing, medical, most of the food budget, you name it.

    However, I’ll suggest that the US economy in recent years was particularly vulnerable thanks to the heavy reliance on credit for even everyday operation. When their home equity took a dive, many of them suddenly found their credit lines (e.g. limits) gone as well — which gave them no choice but to cut back spending dramatically while paying down the consumer loans. Buy a new car or anything else that would normally be bought on credit? It is to laugh.

    Then there are the second-order effects: all those people out of work. Consider it a multiplier of unknown magnitude.

  8. AMW says:

    Granted.

  9. James Hanley says:

    AMW,

    Apparently I needed to have met Gary Wolfram at the right time.

    I was just looking at my bookshelf today and noticing that my political economy/economics collection was larger than my collection for any other identifiable subfield of political science.

  10. Michael Heath says:

    When the president met with business leaders in December that room clearly communicated their reluctance to invest was exclusively due to a lack of domestic demand. They also whined about regulation but I’d bet that had no impact on their budgets. Cite: http://goo.gl/7brUr

    I can’t even imagine big businesses having such a qualitative factor drive their business planning as uncertainty about what D.C. will do. It’s not rational when you consider how budgeting works and finance determines the cost of capital (which does calculate a variety of risks).

    I can imagine some business leaders jawboning about it merely to push their politics on the bully pulpit they enjoy, that’s human nature, especially when their team is on the sidelines. But does it drive their actual business planning? I’ve never seen it and I was an intimate part of a very large supply chain that extended well beyond my own company (Bigger companies now share collated data of future purchases so their supply chain can plan ‘bricks and mortar’ requirements beyond the forecasts provided to the street).

  11. D. C. Sessions says:

    Seconding a slightly different perspective on what Mr. Heath writes:

    Business taxes come out of profits. The problem in a depression is not that it would be nice to make a few percent more profit, but that you’re not making a profit at all. When your income doesn’t cover expenses, the taxes you would be paying if you were making a profit aren’t terribly high on your list of worries.

  12. Michael Heath says:

    To pile on to D.C. Sessions point.

    Taxes are typically ignored as an issue with the exception of three instances:

    1) Making decisions about the location of operations
    2) Stagnating revenue growth opportunities has one’s financial and accounting talent looking inward to continue earnings growth.
    3) Mature, cash cow industries with little R&D investment (their effective rates are higher than those plowing cash from operating profit back into R&D).

    I am not a fan of businesses paying any taxes beyond the amount needed for government to directly service their operations and to capture their or their consumers’ externalities, mostly due to # 2. It’s a waste of intellectual capital for some of our best financing and accounting experts to be focused on tax avoidance rather than earnings growth through increasing organic revenue growth, acquisition, more productive operations, or innovation. Because a company’s effective tax rate can vary, companies do put talent on tax avoidance projects but normally if they’re top line growth opportunities are limited or they fall into category 3.

    Ezra Klein posted an interesting graph that roughly compared effective rates between some industries: http://goo.gl/SDXDH

  13. James Hanley says:

    It’s not just taxes that are part of the regime uncertainty theory. In fact I’d argue that taxes aren’t a very big part of it at all. The argument is mostly about the regulatory future and whether government actions will make the U.S. a more attractive or less attractive environment for investment.

    Given that governments certainly have the capacity to do that, and that businesses can adjust their investment plans accordingly (and would be irrational not to do so), there is sound logic behind the theory (which is not an argument that it’s been demonstrated, of course–methodologically, that’s a different issue). Look at Russia in the mid 1990s, for example. After eagerly investing, western investors suddenly pulled out rapidly. That followed a number of actions by the Russian government that made the expectation of return on future investment much less certain. It’s not quantitative data, of course, but it looks a lot like regime uncertainty from where I sit.

  14. Michael Heath says:

    James,

    It’s been long recognized that given Democrats conceding the reality of AGW, there exists uncertainty about demand for gasoline when planning gas refinery capacity at the aggregate level. I’m not sure if my anecdotal observations of these stories is actually true but that seems to the meme and it appears credible. However beyond that issue, which predates the past recession and even the Bush presidency, I’m hard-pressed to understand how private investment has been significantly stymied since coming out of the last recession in a manner that has a significant impact on jobs at the aggregate level due to uncertainty in the future regulatory environment.

    Are you making that argument? I get the rhetoric exists, I’d argue out of mere convenience but not due to fundamental happenings when it comes to business’ strategic and budgetary planning. Instead I take businesses’ word as its relayed through the street that in spite of a low cost of capital, investments are currently modes to stagnant due to both a lack of demand and lack of sufficient government investment, not because of ambiguity regarding some future regulatory environment and again, changes in effective tax rates.

  15. James Hanley says:

    Not directly on topic, but perhaps of interest, economist William Shughart warns us not to be too optimistic about Obama’s pledge to review regulations to replace outdated regulations and streamline burdensome ones. He’s not the first president to make that promise, but he’d be the first one to accomplish it.

  16. D. C. Sessions says:

    It’s like the people who insist that we could balance the budget without cutting popular programs if we just got rid of “waste, fraud, and abuse.” Which I’ve seen some claim to account for 60% of the budget.

    Funny thing, though: every President since at least Nixon has promised to cut “waste, fraud, and abuse.” So if it’s 60% now, just imagine what it was under Eisenhower!

  17. James Hanley says:

    D.C.,

    Waste fraud and abuse is everything I don’t think the government should fund. Adds up to 60% easily. /tongue in cheek.

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