No government policy can remove the risk of investment; the best they can do is not add to the risks by adding uncertainty to the environment.
The reason that strangers from all over the country will congregate to a blackjack table at a casino is not to avoid risk. They seek risk, but every player seated at the table knows the rules and the rules never change. Actually they seek reward, but are more than willing to accept the risk that rides with it.
They know that if the dealer is showing a six and the player shows a ten, then the prudent risk is to double down. If the player draws a nine and the dealer draws a five and a queen, the player loses. That is a risk the player willingly accepts.
But if the player displays 19 and the dealer ends up with 19 and instead of calling a draw takes your money because the rules changed this morning, then this table and the casino will start to empty.
We are more than willing to take a risk when the rules are fixed, but are not willing to do so when the rules are either a) not known or understood or b) constantly changing.
Taxes and regulations are friction costs that decrease the return on investment and therefore make marginal investments less prudent. Higher friction costs reduce incentives to invest but this is limited as long as they are stable and known. We can still make prudent investment decisions if we know in advance what the costs are.
But when we do not know what the rules are, if they are constantly changing, and if every elected fool keeps harping on their desire to increase friction costs further, then the rules are never known or trusted and investment is stifled far more than from the mere friction costs the government imposes.
“You did not build that” is a clear signal that you do not deserve the fruits of your investment and are therefore obligated to return more of your profits to the government. “The rich need to pay their fair share” is the echo of Occupy Wall Street that seeks further confiscation of investment returns.
Because of this added uncertainty from the bully pulpits, even a drop in friction costs may not create the incentive it normally would if investors have no confidence that it will last. The tax cuts of George Bush had an expiration date. This muted their effect especially as the deadline approached and the Democrats took control of Congress. Nobody had faith they would be renewed.
And because of this uncertainty there is a preference for liquidity. Investors prefer a vehicle they can turn to cash quickly; preferable for about $9 and a click on their computer. Systemic uncertainty is a drag on housing prices, and is compounded by the collapse in housing prices in recent memory. It is also a drag on starting a business which can be even more difficult to sell.
The stock market increase is driven by a number of forces; the liquidity preference, regulations which favor larger public companies, low interest rates which is fueling stock buybacks, and the absence of better investment alternatives. Unfortunately, the one driver that is missing is increasing productivity and the main reason is that the systemic uncertainty and the friction costs has stifled the capital investment that drives long term wage and economic growth.
The Keynesian demand stimulation of cheap money has not stimulated production and investments in productivity. The stimulus of cheap money is perhaps offset by the increase in systemic uncertainty and other friction costs. The left blames the depth of the 2008 financial collapse and refers to the claim of Reinhart and Rogoff from This Time It’s Different that such severe financially centered corrections are slower to recover. But perhaps they are slower to recover because the same polices are enacted that do not work.
And they offer for consideration that we may entering a structural change that is unable to match the productivity gains of previous eras. This is the theme of Robert Gordon’s The Rise and Fall of American Growth: The U.S. Standard of Living since the Civil War . It seems that periods of stagnation create demands for explanations that avoid the accountability of the policies enacted to address the problem.
Still, there is a point to be made that we may be in the throes of a structural shift, but these transitions are never understood until they are well established. The desire and pretense of intellectuals and policy elites to manage them does not clarify or illuminate them. If we are in the midst of such structural changes then central policies will more likely serve only to obscure and delay the efforts of the economy to adjust.
Perhaps instead of Reinhart and Rogoff and Gordon, the elite should meditate on the messages in Matt Ridley’s The Evolution of Everything where spontaneous order is explored or Deidre McCloskey’s Bourgeois Equality which explores the underlying cultural principles of ethics and virtues in their role that led to the stellar economic growth we have experienced in the last few hundred years.
Instead of explaining why growth eludes us we should examine the effects of the policies we have enacted and better understand what worked before.