Economic Uncertainty Will Stunt Your Growth

I don’t let my children consume caffeine. When they ask why, I tell them that it will make them small and tiny (not that those aren’t the same things). What I mean to tell them is that caffeine can stunt their growth. If they want to be big and strong, they should drink their milk.

Most people want their economy to be big and strong. While caffeine won’t stunt economic growth, economic uncertainty will. Economic uncertainty shortens the time horizons of economic actors. As a result, economic decisions are made to maximize short term results rather than long run growth.

The decision to invest in new capital, while made today, is based on the future expected profitability of that capital. The larger the rate of uncertainty (variance) in possible profitability, the less investment there will be. The same thing holds for consumer durables. One’s decision to buy a new home or car is a function of one’s future expected earnings. Greater uncertainty in earnings lowers current consumption.

A major source of economic uncertainty is government policy. As new policies become law more often and become more complex, economic uncertainty increases. Businesses start putting their “best and brightest” in charge of government compliance and government lobbying, instead of in production.

Just as FDR’s alphabet soup of New Deal policies created economic uncertainty that prolonged the Great Depression (see The Forgotten Man by Amity Shlaes), so too the onslaught of health care reform, financial reform, the consumer protection agency, and the threat of cap and trade has increased our current economic uncertainty and therefore slowed our economic growth.

Terry Miller and Kim R. Homes, in their 2010 Index of Economic Freedom rank countries according to their level of economic freedom. They find that economies that are freer tend to have higher average incomes.

Country Per Capita Income

Free $28,091

Mostly Free $23,253

Moderately Free $6,819

Mostly Unfree $1,478

Repressed $1,796

Sure economic freedom will increase growth, but the important thing to notice above is that repressed economies perform even better than mostly unfree economies. I propose that this is due to the fact that while repressed economies don’t allow much economic freedom, they do provide greater certainty regarding future economic policies. This certainty allows people to plan ahead and act accordingly.

If the moronic dictators of the world can even see why uncertain economic policy is harmful, why can’t our government?

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