UNCERTAINTY IS THE ENEMY OF RECOVERY

 

The Wall Street Journal

Uncertainty Is the Enemy of Recovery

At Vanguard, we estimate that policy uncertainty has created a $261 billion drag on the U.S. economy.

Mr. McNabb is chairman and CEO of the Vanguard Group.

EXCERPT FROM THIS ARTICLE:  Investor anxiety is a critical component in all of this. We’d be foolish to take comfort in the strength of recent stock-market performance. Until the U.S. debt issue is resolved for the long term, market gains and losses will be built on an unstable foundation of promises that cannot be kept.

Anyone hoping for signs of a healthy economic recovery was disappointed by lower-than-expected GDP growth for the first quarter of 2013—a mere 2.5%, far short of the forecast 3.2%. Meanwhile, the stock market continues to soar, hitting record levels in recent weeks. It’s a striking disconnect, and one that is discouraging and confusing for Americans as they seek to earn a living and save for the future.

Companies and small businesses are also dealing with the same paradox. Many are in good shape and have money to spend. So why aren’t they pumping more capital back into the economy, creating jobs and fueling the country’s economic engine?

Quite simply, if firms can’t see a clear road to economic recovery ahead, they’re not going to hire and they’re not going to spend. It’s what economists call a “deadweight loss”—loss caused by inefficiency.

Today, there is uncertainty about regulatory policy, uncertainty about monetary policy, uncertainty about foreign policy and, most significantly, uncertainty about U.S. fiscal policy and the national debt. Until a sensible plan is created to address the debt, America will not fulfill its economic potential.

Uncertainty comes with a very real and quantifiable price tag—an uncertainty tax, so to speak. Over the past two years, amid stalled debates in Washington and missed opportunities to tackle the debt, the magnitude of this uncertainty tax has gotten short shrift.

Three economists, Stanford University’s Nicholas Bloom and Scott Baker and the University of Chicago’s Steven Davis, have done invaluable work measuring the level of policy uncertainty over the past few decades. Their research (available at policyuncertainty.com) shows that, on average, U.S. economic policy uncertainty has been 50% higher in the past two years than it has been since 1985.

Based on that research, our economists at Vanguard isolated changes in the U.S. economy that we determined were specifically due to increases in policy uncertainty, such as the debt-ceiling debacle in August 2011, the congressional supercommittee failure in November 2011, and the fiscal-cliff crisis at the end of 2012. This gave us a picture of what the economy might look like if the shocks from policy uncertainty had not occurred.

We estimate that since 2011 the rise in overall policy uncertainty has created a $261 billion cumulative drag on the economy (the equivalent of more than $800 per person in the country). Without this uncertainty tax, real U.S. GDP could have grown an average 3% per year since 2011, instead of the recorded 2% average in fiscal years 2011-12. In addition, the U.S. labor market would have added roughly 45,000 more jobs per month over the past two years. That adds up to more than one million jobs that we could have had by now, but don’t.

At Vanguard we estimate that the spike in policy uncertainty surrounding the debt-ceiling debate alone has resulted in a cumulative economic loss of $112 billion over the past two years. To put that figure in perspective, the Congressional Budget Office estimates that sequestration may reduce total funding by $85 billion in 2013. Clearly, the U.S. debt situation is the economic issue of our generation.

But it’s not just about the numbers. Every time lawmakers seemingly get close to a deal that will restore fiscal responsibility but instead fail, we at Vanguard hear the concerns of investors. They ask: How does this affect my retirement fund? What about my college savings account? How does this affect my taxes? Would I be better off putting my savings under the mattress?

Investor anxiety is a critical component in all of this. We’d be foolish to take comfort in the strength of recent stock-market performance. Until the U.S. debt issue is resolved for the long term, market gains and losses will be built on an unstable foundation of promises that cannot be kept.

Developing a credible, long-term solution to the country’s staggering debt is the biggest collective challenge right now. It should be America’s biggest collective priority, too. Any comprehensive deficit reduction must take on the imbalance between revenues and expenditures as a share of GDP. That means entitlement reforms, spending reductions and additional tax revenues.

This does not have to be about European-style “instant austerity.” Because the U.S. dollar is the world’s reserve currency, America doesn’t have to balance the budget tomorrow.

The key is to provide clarity to businesses, financial markets and everyday savers and investors. Make no mistake: A comprehensive, long-term, binding plan that brings the budget into balance over a reasonable time frame is essential. If Washington fails to achieve one, the consequences will be harsh.

The good news is that if reform is enacted, and the costly pall of uncertainty is lifted, the U.S. economy has the potential to bounce back, creating the growth and jobs that are so badly needed. I am confident that our leaders in Washington can make it happen.

Mr. McNabb is chairman and CEO of the Vanguard Group.

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