Regime Uncertainty: Pirrong Debunks the Keynesian Debunking
By Robert Higgs | Monday September 5, 2011 at 10:24 AM PDT
As the idea of regime uncertainty has gained ground in recent years as a partial explanation of the economy’s failure to recover quickly and fully, economists and others invested in Keynesian thinking have begun to strike back. One such Keynesian debunking of regime uncertainty was offered recently by Gary Burtless and seemingly endorsed by Mark Thoma. Now, Craig Pirrong, an economist at the University of Houston, has debunked Burtless’s arguments.
Pirrong uses options pricing theory to show why the Keynesians are missing the point of the regime uncertainty concept and why, even on their own terms, their arguments for disregarding regime uncertainty and simply pumping up aggregate demand are wrong.
To adapt a familiar saying: first they ignore you, then they ridicule you, then they embrace the idea and claim that they had it first. We are now passing through Stage II.
Although I am pleased that the concept of regime uncertainty has come to be recognized in some quarters as an important part of our understanding the economy’s operation, I continue to be disconcerted that many of those who speak of it, including some of those who speak favorably of it, fail to understand its full scope. As I understand regime uncertainty, it has to do with widespread inability to form confident expectations about future private property rights in all of their dimensions. Private property rights specify the property owner’s rights to decide how property will be used, to accrue income from its uses, and to transfer these rights to others in various voluntary arrangements. Because the content of private property rights is complex, threats to such rights can arise from many different sources, including actions by legislators, administrators, prosecutors, judges, juries, and others (e.g., sit-down strikers, mobs).
Because of the great variety of ways in which government officials can threaten private property rights, the security of such rights turns not only on law “on the books,” but also to an important degree on the character of the government officials who administer and enforce the law. An important reason why regime uncertainty arose in the latter half of the 1930s, for example, had to do with the character of the advisers who had the greatest access to President Franklin Roosevelt at that time—people such as Tom Corcoran, Ben Cohen, William O. Douglas, Felix Frankfurter, and others of their ilk. These people were known to hate businessmen and the private enterprise system; they believed in strict, pervasive regulation of the market system by—who would have guessed?—people such as themselves. So, as bad as the National Labor Relations Board was on paper, it was immensely worse (for employers) in practice. And so forth, across the full range of new regulatory powers created by New Deal legislation. In a similar way, the apparatchiki who run the federal regulatory leviathan today can only inspire apprehension on the part of investors and business executives. President Obama’s cadre of crony capitalists, which he drags out to show that “business is being fully considered,” in no way diminishes these worries.
Thus, regime uncertainty is a multifaceted and somewhat nuanced concept. Many economists don’t like it because it cannot be measured and compiled along with other standard macro variables in a convenient data base. But, as I have tried to show for fifteen years, various forms of empirical evidence can be and have been brought to bear to show that regime uncertainty is not simply a figment of the analyst’s imagination or an all-purpose club with which the Chamber of Commerce whacks the government’s every move to increase taxes or augment regulations. Anyone who actually manages a business or makes serious investment can readily understand the idea. Keynesian economists, who generally do not manage businesses or make serious investments, view the idea as merely something their ideological opponents toss out to obstruct the application of their “science” in policy making. It is good to have analysts such as Craig Pirrong showing that the Keynesian rejection of regime uncertainty has no firm foundation.
Tags: Business, Economics, Entrepreneurship, Free Market, Great Depression, Law, Politics, Power, Property Rights, Regulation, Taxation, The State 
Regime uncertainty is a brilliant concept, and I can see why Obama’s foes would gravitate to it. It’s so nebulous, so vague that it can be applied in any situation, and cannot be disproven. It’s a perfect foundation from which to launch attacks against tax increases, increased regulations, or anything perceived as “anti-business” regardless of whether the policies are good or necessary.
I view it as disconnected from the ‘boots on the ground’. As a business owner who rubs shoulders with other business owners daily, I get a firsthand perspective from many of them regarding their specific troubles and concerns. It’s not a scientific poll, but it’s informative nonetheless. I just don’t hear concerns about uncertainty, or the possible effects of this or that regulation or legislation. I hear more concerns about decreased demand for their products or services. In my own industry, which is primarily B2B, we feel the secondary effects of the “belt-tightening” among our clients’ customers. There’s less demand, plain and simple. Businesses need their customers to come back, but they aren’t going to until they have jobs and money to spend. They are waiting to hire until they have enough customers to justify more labor. I don’t understand the desire to look for alternative explanations when it couldn’t be more clear what the problems are.
John | Sep 6, 2011 | Reply
If Keynes himself were alive today, it is at least conceivable that he might be writing papers or letters to President Obama advocating policies to reduce government activism and regime uncertainty. Consider this quote from The General Theory:
“[E]conomic prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man.”
Robert Dell | Sep 6, 2011 | Reply
There is no doubt the weakness in the economy is attributable to the weak, overleveraged consumer, to some extent. But you also have to explain why business fixed investment, as a percent of business cash flow, sunk to its lowest level since 1940, as Alan Greenspan contends in his paper, “Activism.” See here:
http://www.businessinsider.com/alan-greenspan-government-activism-2011-3
Robert Dell | Sep 6, 2011 | Reply
If you ever observe a school of small fishes just below a still surface of water you see them all swimming to the left and then, as of a single mind, all turn to the right. So it is in the affairs of men. Confidance abounds. Everyone borrows because prices always go up. Then it turns. No investment is safe. Pessimism reigns. This is the nature of man. The experts attempt to manipulate it this way or that, with money supply or tax incentives or sundry other means; but they only make it worse. The easy money feeds the bull and the fear mongering politicians feed the bear. Either way it has run its course.
Bags | Sep 7, 2011 | Reply
If you ever observe a school of small fishes just below a still surface of water you see them all swimming to the left and then, as of a single mind, all turn to the right. So it is in the affairs of men. Confidance abounds. Everyone borrows because prices always go up. Then it turns. No investment is safe. Pessimism reigns. This is the nature of man. The experts attempt to manipulate it this way or that, with money supply or tax incentives or sundry other means; but they only make it worse. The easy money feeds the bull and the fear mongering politicians feed the bear. Either way it has to run its course.
Bags | Sep 7, 2011 | Reply
Dr Higgs:
You make 2 points I have been trying to explain to others for the past 30 years, and that caused me to drop economics studies at university 30 years ago. point 1: regime uncertainty. point 2: I know of NO economists who actually own and operate a business. As you may infer, I have no use for governments and arm-chair economists. However, you, dear sir, are like a bright, guiding beacon on the shore for any sailor who cares to see. You are first and only economist I have read who makes any practical sense. A pity for me I was not your student. Thank you.
alzurzin | Sep 8, 2011 | Reply
No doubt John will claim that the real problem behind decreased business investment is insufficient aggregate demand. It’s a great explanation because it *always* applies to any slowdown in the economy. But I wonder how much the aggregate demand for food has dropped? And water? Maybe throwing wildly different sectors into an aggregate isn’t a good idea?
Russell Nelson | Sep 8, 2011 | Reply
Regime uncertainty, or call it regulatory uncertainty.
As a business owner, do you know how much your employee benefits costs will be in 2014 after Obamacare is fully implemented?
What will corporate and individual tax rates be in 2013 after the Bush tax cuts extension expires? Will they be extended? Or as Obama wants, increased.
Will the NLRB land hard on your plans to open a new plant in another state? Was this move against Boeing “good and necessary”?
These are just a few examples of how the Obama administration’s policies and attacks on business are freezing business.
OC Conservative | Sep 20, 2011 | Reply
Could John explain what makes a policy “good or necessary” or give an example of a “good or necessary” policy.
Dave Thomas | Dec 20, 2011 | Reply