Uncertainty and Growth: What (else) is Wrong with America

user-pic
"The importance which the certainty of law has for the smooth and efficient running of a free society can hardly be exaggerated. There is probably no single factor which has contributed more to the prosperity of the West than the relative certainty of law which has prevailed here."
Two years into the crisis, the US finds itself with fewer jobs, slower growth, and a higher unemployment rate than expected in the government's worse case scenarios. The current debate concerning America's troubles is focused mainly on monetary and fiscal policy: more or less stimulus, higher or lower taxes, and the expansion or contraction of government programs. 

While the source of America's pain is in monetary and fiscal policy (artificially low interest rates, wars, programs to encourage sub-standard home loans), one of the keys to its recovery lies in a different field: The law.

As noted in the quote above, taken from Hayek's 1960 title Constitution of Liberty, the lack of a clear legal framework and the arbitrary decisions by government make it difficult for business and individuals to make plans for the future.  Making an investment requires a certain level of trust, even faith, in the future. Peter Sztompka, in one of the most important works on this topic, points out that "to show trust is to anticipate the future. It is to behave as though the future were certain". And of course, Trust always "refers to the actions of others" - whether it is other individuals, business, or government organizations.

Responding to the current crisis, the US government, under both Bush and Obama, took a variety of arbitrary actions that increased uncertainty and damaged the delicate fabric of trust within the economy. A few examples off the top of my head:

1. Lehman Brothers was allowed to go bankrupt, while other "too big to fail" financial institutions were rescued both before (LTCM, Bear Stearns) and after (AIG, Fannie, Freddie, et al);

2. Companies from certain industries - for example, General Motors - were nationalized and "rescued", while others were left to their own devices; and even

3. Oil giant BP was forced by the US government to deposit $20 billion in a future "Claims Fund" as a punishment for the massive oil spill at "Deepwater Horizon".

Note that the issue here is not with the actions themselves, but with their arbitrary nature - the fact that they are not based on any pre-defined law or principle. It is also not a matter of left or right - I am not saying that Obama should have done this or Bush should have done that - only that both of them should have done things within clear and pre-defined boundaries. When the government bails out one bank and lets another go bust, the public is unsure as to how the government will behave in the future. When the government "punishes" a large company without going through the standard legal proceedings, the public is unsure as to how the government will behave in the future, and the rule of law is being undermined. 

The examples above are also fine case studies in unintended consequences. In all three instances the government wanted to calm the public and prevent chaos and uncertainty. In all three cases the outcome was exactly the opposite.  The policy itself matters less than the manner in which it is executed. As the British historian and jurist F.W. Maitland pointed out more than 100 years ago: "Known general laws, however bad, interfere less with freedom than decisions on no previously known rule". 

Investors and entrepreneurs can flourish even within the most rigid system but only as long as they get all the "bad news" in advance and can plan accordingly. So, if - as some of his critics claim - Obama is a communist, that's fine, as long as he tells us in advance and adapts America's legal system accordingly. Who knows, once he does that, perhaps Americans will enjoy GDP growth of 10% per annum, just like their "comrades" in the People's Republic of China. 

2 Comments

I really enjoy your blog. Especially insights on Ze Mozerland.

Good to have you back. Interesting reading as usual.
(There's a typo in the first quote 'efficietnt'.)

Note: The views and observations expressed on this web site are published for the sake of public discussion and do not represent my personal opinion or the opinion of my companies, clients, and/or employers. If you would like to get my opinion on anything, ask me.

This page contains a single entry by Dror Poleg published on September 26, 2010 4:00 PM.

Israeli Society in Five Sentences or Less was the previous entry in this blog.

Is Capitalism all about Greed? is the next entry in this blog.

Find recent content on the main index or look in the archives to find all content.