Uncertainty and Investment
Matt Yglesias argues that regulatory uncertainty can deter investment.
Writing about a DC bar that had to close its doors because it couldn’t get a liquor license, he writes that this isn’t just bad because of the loss of economic activity from that one bar but also because it’s
a sign to would-be entrepreneurs everywhere that their potential investments are much riskier than a superficial read of market conditions would suggest.
Well, exactly.
I’ve been an entrepreneur, startup advisor and technology journalist, and I’ve always been surprised at how risk-averse venture capitalists seem. Isn’t the whole point of their job to take risks?
And yet most venture capitalists have very narrow sets of criteria under which they invest.
The answer is that risk isn’t unidimensional. Whenever you undertake something there are many factors that can go wrong. And it’s precisely by mitigating risks in most of these factors that you feel comfortable taking bigger risks along other factors.
So a VC will try to back a team that’s located in Silicon Valley, has the right pedigree, etc. and minimize all these other risks precisely because she’s taking a big risk on an untested product in an untested market.
To take another example, let’s say you’re a company that’s thinking about building and operating a bridge.
This type of investment typically entails spending a ton of money upfront, and then using money from toll fees and the like to recoup your investment over time. For these big types of projects, the time frame is generally measured in the decades. Usually these investments are leveraged: you borrow most of the money to build the bridge and then pay back interest out of the cashflow from the tolls.
That means you need to take into account not just how much it’ll cost to build the bridge and how many people will use it and how much you think they’ll pay (30 years from now!) but also things over which you have even less control like, say, interest rates and inflation.
Now let’s say you’re looking at two bridge projects, one in Germany and one in Argentina. Let’s say for the sake of argument that they are identical in terms of how much they’ll cost, how much you can expect to recoup (nominally), etc. What’s inflation going to be like in Argentina in 30 years? What about Germany?
Well, no one can say for sure. But one can guess. One can note that inflation has been pretty moderate in Germany for over 30 years. One can note that Germany’s political culture is hellbent on keeping inflation under control, even if this entails considerable other costs. One can note that Germany is in a region, Europe, that has had generally sound monetary policy and credible central banks.
Meanwhile, one can note that Argentina defaulted on its loans and dramatically devalued its currency a decade ago and that it hasn’t yet come to an agreement to the satisfaction of all its bondholders. One can note that not only is inflation rampant in Argentina right now but that the government is actively involved in denying the extent of the phenomenon, going so far as harassing analysts putting out inflation numbers that contradict the government’s figures.
Again, let’s say that on the “pure” business metrics, the two bridges are the same. Something tells me the bridge in Germany is going to get built, and the one in Argentina isn’t.
Of course, it’s possible that this is wrong. Maybe one day Germany decides to debase the euro to keep its exports competitive and hits onto an inflationary cycle that gets out of control. Maybe Argentina elects a former hard-left trade unionist who realizes that credibility with international investors will help regular people in Argentina and manages to keep Argentinian economic policy “orthodox.”
But right now, there’s just a lot more uncertainty associated with building a bridge in Argentina than in Germany, and this means that, ceteris paribus, Argentina will get less investment than Germany.
All of which is to say that, yes, regulatory uncertainty can and does indeed deter investment. And the key to grokking that is to understand that it’s precisely by making some criteria more certain that entrepreneurs and investors are freed to take more risks.
Certainly it doesn’t mean that there aren’t a lot of politicos BS-ing about this. It’s not an argument against all regulation (indeed in some cases good regulation is better than no regulation). And after taking the US federal government to the brink of default, the Republican Party is arguably the least well placed in talking about “certainty.”
But, “uncertainty” matters.
The “regulatory uncertainty” argument, primarily promulgated by right-of-center thinkers (for obvious ideological reasons), struck me as theoretical plausible. Which is to say, in theory everything you say makes logical and intuitive sense.
My problem has always been the lack of empirical rigor when making those claims. To assess the validity of the uncertainty argument. For example, PEG has only offered anecdotal evidence, which while certainly a valuable data point is hardly dispositive one way or the other. I’d argue we would need to know the following:
1) what laws and regulations are contributing to regulatory uncertainty?
2) Can (1) be quantified? Is the law contributing a small, infinitesimal amount of uncertainty or is it a significant amount? How would we know the difference?
3) Can the negative affects from the law’s uncertainty be quantified? Is this uncertainty literally depressing investment and GDP by some \measurable percentage or is this just a minor annoyance?
4) What would be the consequences of discussing repeal of the law (increasing uncertainty because we don’t know if the law will become repealed or not?) and actually repealing the law (consequences could be good or bad)? For example, while the law might increase regulatory uncertainty it may also reduce the chances of theft, fraud, and TBTF, and financial crises.
5) How would repeal of the law affect other laws? Would it increase uncertainity? If so, by how much? Would the impact of repealing law X affect other laws in such a way that the ultimate impact of repealing the law or regulation would be a net negative?
This is not to say whether a law is good or bad on the merits. Furthemore, I thnk a regulation or law should only exist if there’s a need for it as opposed to not doing any harm. However, that’s completely orthogonal argument to the question of “regulatory uncertainity”.
— Joseph · Aug 28, 04:38 PM · #
The problem with “uncertainty” is that it’s such a vague term; it basically just means “something bad might happen.”
In Matt’s bar example, the problem is being unable to get the license that it needed to operate. In your bridge example, the problem is high inflation. In both cases, investment is less attractive because there’s a significant chance that something bad-for-business might happen. A bar can’t operate without a liquor license, so the risk of being denied a license dissuades investment. High inflation would be bad for the bridge investment, so the expectation of high inflation dissuades investment.
“Uncertainty” as a political argument is too often left vague. It’s just a generic way to oppose any new policy that you don’t like – this policy is new so it increases uncertainty and uncertainty is bad for the economy. To be a genuine argument rather than a buzzword, you need to be specific about what the risk is. You can’t just say that the policy increases uncertainty, you have to specify that it increases the chance of X and that X is bad for business, and you need to back up both parts of the argument.
— Brad · Aug 28, 06:21 PM · #
While I’m sure I can’t speak for PEG, when I say uncertainty what I mean is arbitrary law making (particularly with regards to taxes), inconsistent enforcement, and dramatic changes with far reaching effects. All of these result from a government that thinks it has not just the ability, but the responsibility to fix everything, wipe away every tear, and save the world for democracy at the same time.
Still, I find people who think the insanity of the last few decades can be fixed by regulatory reform highly amusing. We’ll grow our way out of this! Well, I hope you’re right. But I doubt it. Regulatory sanity is a small step in the right direction.
— Gabe Ruth · Aug 29, 12:52 AM · #
I’m not exactly sure what to say to people like MattY and PEG who think regulatory “uncertainty” is something to be concerned with, given that we’re just a few years away from a lack of regulatory oversight practically destroying the modern economy.
Mike
— MBunge · Aug 29, 12:41 PM · #
Speaking of science, PEG, are you ever going to allow response when you assert that “life begins at conception” is just a scientific principle so obvious that only an idiot would disagree? Some of us are actually biological scientists (and not idiots) and yet do disagree. (Also CO2 molecules don’t “redirect infrared variations”, whatever the fuck that is supposed to mean. Do you think that, before you assert that this or that “scientific proposition” is beyond questioning, you could bother yourself to understand it, first?)
— Ch3t · Aug 30, 01:44 AM · #
Well, for once Mr. PEG seems to have made a nuanced, narrow argument avoiding assertions of obvious consensus. And lo, the knee jerk trolls come out to call him an idiot for not acknowledging the Universal Consensus of biological scientists. Good one, PEG. He who hath ears, let him hear.
— Gabe Ruth · Aug 30, 06:15 PM · #
The Great Depression lasted as long as it did because of uncertainty. Roosevelt “experimented” with everything. Neither his enemies nor his friends knew what he would try next. Political scientists and economists have reached consensus. Why do we treat Yglesias as if he has an original thought?
Oh, I get it. It’s because Yglesias is a lefty and no lefty can possibly attribute lack of investment to uncertainty. Lack of investment is a result of greedy entrepreneurs hoarding cash. I just heard Bob Beckel say it again.
PEG:
And after taking the US federal government to the brink of default, the Republican Party is arguably the least well placed in talking about “certainty.”
They are the least well-placed? Only in that Republicans are always the least well-placed by media bias. Do you honestly think we were going to default? Did you think that if Obama chose not to pay Social Security recipients it was Republicans’ fault? Do you believe anything Obama said during the debt “crisis?”
— jd · Aug 30, 11:41 PM · #
PEG’s only citation for evidence in support of his proposition is a link to nothing but him making the same assertion last week. Apparently he doesn’t know how this whole “evidence” thing works, yet.
— Chet · Aug 31, 01:21 PM · #
Whatever happened to that fearless two-fisted entrepreneurship and “creative destruction” that we like to brag about during good times?
— Paul Zrimsek · Aug 31, 02:03 PM · #
Of course it can deter investments. But the question is how effective are regulations that are often designed by and implemented by industry professionals to begin with? The argument is these people should know what is necessary, but what you’re really doing is just letting the fox design the layout of the hen house.
— Alex · Aug 31, 03:02 PM · #
Of course it can deter investments. But the question is how effective are regulations that are often designed by and implemented by industry professionals to begin with? The argument is these people should know what is necessary, but what you’re really doing is just letting the fox design the layout of the hen house.
— air max 2009 · Sep 6, 06:18 AM · #