Is economic uncertainty really higher today than 8 years ago?
That uncertainty is bad for business is well-known. But what kind of uncertainty?
The Wall Street Journal reports that (i) economic uncertainty has been higher during the first thirteen months of the Trump administration than in the corresponding period of the Obama administration; and (ii) economic uncertainty early this year (January-February) was higher than its long-run average (1985–2010).
Neither claim is true.
The Wall Street Journal refers to an index of economic policy uncertainty developed by three academic economists, Scott Baker of Northwestern, Nicholas Bloom of Stanford and Steven Davis of the University of Chicago Booth School of Business. Their Overall Index of Economic Policy Uncertainty combines three components:
- how often selected newspapers mention ‘uncertain’ or ‘uncertainty’ in reference to the economy and economic policy. I would dub this “news uncertainty”;
- the number of federal tax code provisions which will expire in future years; and
- a measure of how much economists disagree on key economic projections.
The Wall Street Journal talks of economic policy uncertainty, but its claims hold only for “news uncertainty”; and the article does not even mention the broader and more complete measure. I find this surprising — and frankly misleading. The “news uncertainty” index is self-referential: this uncertainty is high because the Wall Street Journal and nine other newspapers have been saying it is.
If you take the broader Overall Index of Economic Policy Uncertainty, you find the exact opposite of what the article claims:
- Economic uncertainty during the Trump administration so far has been significantly lower than in the corresponding period of the Obama administration (an average of 109 for February 2017-March 2018 versus 141 for February 2009-March 2010) and lower than the average for President Obama’s two terms in office (134 for February 2009-January 2017; the results are similar if you take January as the starting month instead of February).
- Economic uncertainty during January-February 2018 was slightly lower than the 1985–2010 average (101 vs 103); for January-March it was slightly higher (106). I calculated all numbers based on the raw data that can be freely downloaded from Baker, Bloom and Davis, Economic Policy Uncertainty Index
You also find that overall economic uncertainty was significantly lower than “news uncertainty” during the Trump administration so far, and significantly higher than “news uncertainty” during the comparable period of the Obama presidency.
To put things in perspective, the Wall Street Journal’s argument is a bit like saying that February 2018 CPI data showed we face runaway inflation because fuel oil prices were up 21% year-on-year, when the overall consumer price index was only up 2.2%.
There is no doubt that stability and predictability — that is, lack of uncertainty — make for a better business environment.
We like a stable and predictable tax and regulatory environment, because when businesses take long-term investment decisions they already face uncertainty on the economic cycle, on consumers’ preferences and on technology — better if they don’t also have to worry about which taxes and regulations they will face over the investment cycle.
The Wall Street Journal seems puzzled by the current strength in business sentiment and investment:
“In theory, uncertainty about the economy and economic policy leads to less investment, less hiring and slower economic growth, though it would be hard to argue that is a problem now. Business investment rose 6% in 2017, up from an annual average of 3% during Mr. Obama’s presidency. Overall economic growth picked up last year and the jobless rate, at 4.1%, is at its lowest level since 2000.”
But there is no puzzle. As we saw above, overall economic uncertainty as measured by the three academics quoted in the article is actually lower, so it should not be at all surprising that investment is higher.
This is not a judgement on the two administrations. President Obama had a difficult start in the aftermath of the global financial crisis, while President Trump benefited from a consolidated recovery and a global economic upswing — though tax and regulatory reform over the last fourteen months have definitely improved the business environment.
Uncertainty is bad for business. An escalation of tit-for-tat protectionist measures would have a negative impact on business investment, for example.
But business leaders know how to handle a certain level of economic uncertainty, and the evidence is that they feel more confident today than they did eight years ago.
Business leaders don’t just read the newspapers. And they know that if there is one thing to feel uncertain about, is uncertainty itself — at least until economic journalism learns to hold itself to a higher standard.
[This article originally appeared on Forbes.com]