Saturday, December 10, 2011

Response to "Regime Uncertainty and the Labor Market"

This is a response to the post here.

So, Prof. Horwitz's question can be stated as follows:

A) If regime uncertainty can explain why capital expenditure has not recovered AND
B) Labor and capital are complementary
C) Does regime uncertainty also explain low employment?

The answer, deductively, is yes. The discussion then became disputing (A) and, to some degree (B). I'll take (B) first. All capital needs people to operate it, although certain machines need very few people. But for capital to be increased without a commensurate increase in labor would imply that there was labor available to operate the machines. With a low employment rate, to me this doesn't pass the smell test. As Prof. Ebeling suggests, we can learn from Hutt's idle resources definitions.

On to the discussion of regime uncertainty. Prof. Horwitz last sentence has a critical clause that may have gone unnoticed. Importantly, Prof. Horwitz mentions regime and policy uncertainty, not just regime uncertainty. This is important because they are about different types of uncertainty.

Before I go on, it must be noted what the uncertainty we're talking about here is. When a firm is analyzing a project to determine its expected value added (net present value or NPV), the analyst will come up with dozens of point estimates of NPV. Regime and policy uncertainty don’t change the center of the mass of NPV estimates. Uncertainty changes the dispersion, so that the probability of NPV being negative has gone up.

By Higgs (1997), regime uncertainty is generated when the state, be it politicians or bureaucrats, take actions (including making speeches) that potentially threaten the property rights of businesses. An example of this type regime uncertainty is bailing out Bear Stearns but not Lehmann Brothers. Now we’re confused: which thing are you going to do next? So we have regime uncertainty.

Obamacare creates continuing regime uncertainty because of the fights about it. I believe Prof. Rosser is correct in this. But note, it is not the desirability of the law that is at stake here. It may be ‘good’ legislation in a utilitarian sense (or not) but that’s not the point. Businesses do not know now if the law, or how much of the law, will be passed, and therefore cannot forecast accurately labor costs.

Actions by the EPA (e.g. Keystone pipeline, mercury emissions controls) also create regime uncertainty. I would argue the bureaucracy is a more important source of regime uncertainty. On this issue, I recommend Sanford Ikeda’s “Dynamics of the Mixed Economy.” The point here is that actions by the EPA create greater uncertainty about even the viability of projects. Why start a plant that the EPA will shut down?

Now policy uncertainty is different. A good example here is Dodd-Frank. That thing is passed, we don’t worry about it being passed or not. The uncertainty is due to the unknowns of the legislation itself. What will be the effects of Dodd-Frank? Much like Sarbanes-Oxley, it’s going to take years to find out. But likely much worse than SOX because there’s a lot more stuff in there.

Why do people seemingly talk about regime uncertainty so much right now? I think it’s always there, to greater or lesser degrees, but the pernicious effects can be covered up during a boom. When the tide goes out, though, we see who’s been swimming naked. What I mean is that we’ve always had political and bureaucratic interference to greater or lesser degree. Right now, during the bust phase (recovery is debatable) regime and policy uncertainty has more bite.

Does regime/policy uncertainty explain the entire low employment? I doubt it. As mentioned here and as carefully researched by Casey Mulligan (see his NBER papers) Say’s law is alive and well in labor markets. So other forms of intervention that are not regime/policy uncertainty related are probably creating problems, like minimum wage and unemployment benefit extensions.

My last point is that regime/policy uncertainty is a hard sell because it is not really quantifiable. But the need to quantify everything is one of the great failings of the neoclassical research program. What’s important is what affects human action. The need to quantify everything is quite common, but often leads to shallow thinking. 

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