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Galston: How Political Gridlock Feeds Economic Uncertainty and Blocks Recovery

William Galston has an instructive post, "Political Paralysis Makes Us Poorer," up at The New Republic, which discusses one of the destructive economic effects of political uncertainty. As Galston explains:

...While we always make decisions in conditions of uncertainty, there are times in which man-made surplus uncertainty further clouds the crystal ball. This matters because beyond a certain point, uncertainty can paralyze decision-making. As economists Scott Baker, Nicholas Bloom, Steven J. Davis, and John Van Reenen recently argued, "Uncertainty can retard both investment and hiring as firms become more reluctant to make costly decisions that may soon need to be reversed. It can also lead households to adopt a more cautious stance in their spending behavior."

Emerging evidence suggests that this mechanism is at work in the United States today. Baker, Bloom, and Davis have constructed an Index of Economic Policy Uncertainty. During most of the past five years, this index has been at or near record highs. To be sure, separating policy uncertainty from the effects of low demand poses analytical challenges. Still, Bloom and colleagues used a macro-econometric model to estimate that net of other factors, the rise in policy uncertainty since 2007 has reduced employment by more than 2 million jobs below the level it would otherwise have reached. Based on that research, the Vanguard Group recently estimated that since 2011, policy uncertainty has created a $261 billion drag on the economy, reducing real GDP growth by a full percentage point per year during that period--the equivalent of more than $800 per person.

Galston adds that "reversing decisions in response to changed circumstances can be expensive" and "uncertainty can freeze us in place" with a fear of losses and a reluctance to invest, thereby depriving the economy of potential investments that can create jobs. Galston concludes "If this is correct, the much-discussed polarization of our politics is a problem for our economy, above and beyond the effects of inadequate demand, tight credit, and slowing export growth...When the American people say--as they do in overwhelming numbers--that they want their elected officials to stop fighting one another and start fixing the problems, they're not just asking for good government. They intuitively understand that what's going on in Washington is bad for their incomes and job prospects as well."

How this understanding will be translated into voting decisions will likely prove to be a pivotal factor in the outcome of the 2014 elections, and the candidates who incorporate it most effectively in their messaging should benefit accordingly.