Bridgewater State University

Virtual Commons - Bridgewater State University

Management Faculty Publications Management Department

2013

The Impact of Government Policy on Economic

Growth
Jon L. Bryan
Bridgewater State University, jbryan@bridgew.edu

Virtual Commons Citation

Bryan, Jon L. (2013). The Impact of Government Policy on Economic Growth. In Management Faculty Publications. Paper 23.
Available at: http://vc.bridgew.edu/management_fac/23

This item is available as part of Virtual Commons, the open-access institutional repository of Bridgewater State University, Bridgewater, Massachusetts.
 The Impact Of Government Policy On

Economic Growth

J. L. Bryan

Ricciardi College of Business, Bridgewater State University,

Bridgewater, Massachusetts, USA

e-mail: j bryan@bridgew.edu

Abstract

Government pol icy has always had a significant influence on economic growth and new
business formation. During the past two decades, policy uncertainty has grown in the United
States as the polarization of the electorate has intensified. The stark political differences are
increasingly on display by elected officials in Washington. The recent political brinksmanship
surrounding the so-called "Fiscal Cliff' is one example of the costly policy uncertainty facing
U.S. businesses that is now endemic in Washington. While much of the focus of the Fiscal
Cliff debate was on the constituents who would lose benefits or see their taxes increase, there
was less attention to the debilitating impact of poorly fashioned policies, and policy
uncertainty, on the nation's businesses and the impact on the economy. Those issues were
most significant for small businesses and entrepreneurship, which account for more than fifty
percent of U.S. private sector economic activity. Through a review of the literature, this paper
examined the consequences of government policy uncertainly and sought to identifY gaps in
the related literature, especially those arising from the application of new policy tools. The
research found that contemporaneous monetary policy may be having a greater impact upon
business activity than previously identified and is an area in need of further study. While the
policy uncertainty and its impact on business expansion discussed in this paper are principally
associated with the U.S., the implications can be readily applied across borders. The results of
- this analysis will be helpful in enhancing the understanding of these important policy issues,
which are commonly excluded from policy debate and often given insufficient treatment in
post secondary institutions of management practice.

Keywords

Policy uncertainty, Economic growth, Entrepreneurship, Quantitative easing

1. Introduction

Conditions of uncertainty have always been a part of the economic environment of free
enterprise. Entrepreneurs and business strategists commonly seek opportunity in that arena. In
the past two decades, however, policy uncertainty has risen to a level that makes forward
economic planning and the search for opportunity more inscrutable for even the most adept in
business challenges. In both United States and the European Union, the lack of new business
formation, partly attributable to rising uncertainty, has contributed to stubbornly high levels of
unemployment and underemployment.

140
The jobs that are being created in the U.S. are typically not of the quality of past economic
recoveries, leaving many newly-employed workers in the unenviable position of remaining on
various modes of government assistance, even after acquiring their new employment. As
reported by Rampell (2012), "lower-wage occupations, with median hourly wages of $7.69 to
$13 .83, accounted for 2 J % of job losses during the retraction. Since employment started
expanding, they have accounted for 58% of all job growth ."

The policy uncertainty and related decline in small business startups is taking a toll not only
on the traditional lower wage occupations, but on college graduates as well. According to Sum
(2013) of the Center for Labor Market Studies at Northeastern University, 36% of college
graduates were working in jobs that did not require a college degree (Figure I). That rate was
less than 28% in the year 2000. Such underemployment can impact future earnings, as college
skills dwindle. It also increases the difficulty for them to pay their student loans, purchase a
home, or become married, since their wages are typically 40% below their peers working in
traditional college graduate careers (Luhby, 2013).

40
37
34.3
35
31.4
30.3
30 27.4 -

25

20

15

10

o
2007 2008 2009 2010 2011 2012

Figure 1. Recent College Graduate Underemployment Rate (%)­

(Source: Northeastern University - Center for Labor Market Studies, 2013)

In addition to the lower skills and wages in many of the post 2008 recession jobs, uncertainty
has contributed to a significant increase in the number of temporary employees. In "Is the U.S.
Turning into a Nation of Temps," Fastenberg (20]3) notes that the "hiring rate of temp
workers is five times that of hiring overall in the past year ... and the number of temp workers
has been rising steadily since the recession-impacted year of2009.

Supporting Fasten berg's research, Dhanya and Woh I (2013) reported that the largest retai ler
in the U.S. has embarked upon a strategy has in recent months been only hiring temporary
workers at many of its U.S. stores, the first time the world's largest retailer has done so
outside of the holiday shopping season. Internally, Wal-Mart calls these temporary
employees flexible associates. According to Fastenberg (2013), the number of part-time
workers at Wal-Mart has risen from just 1% of its 1.3 million employee workforce to 10% in
just one year. Given the employer's size, that has had a chilling impact on the already tepid
market for full-time employment, and the trend has been adopted by many other large
employers as well.

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These difficult economic conditions have contributed to a decline in middle-class aspirations
in America. While the question of policy uncertainty has received broad study, it is likely
that the new and artful strategies of important policy making institutions, such as the U.S.
Federal Reserve, have produced gaps in the literature.

This paper wi II review the work of researchers in this area, seek to identify gaps, and attempt
to find new methods for understanding the implications of rising policy uncertainty. The
paper focuses on the negative implications of policy uncertainty due to the current climate of
lethargic GOP and job growth, while recognizing that there are positive components of
uncertainty that many businesses have and will continue to successfully exploit (Sawyerr et
al. , 2003).

2. Prior research on policy uncertainty

The most recent and robust study on the implications of government policy uncertainty for the
U.S. economy was conducted by Baker et al. (2013) in their seminal Measuring Policy
Uncertainty. The authors found that businesses delay investment and hiring in times of
uncertainty. The authors identified several factors that were influencing the uncertainty,
including debt and spending problems associated with the so-called "Fiscal Cliff' that was
looming in Washington, the continuing problems in Europe, and the lingering impact of the
housing crisis.

The authors created an index of policy uncertainty through an intensive study that sampled
5,000 newspaper articles to assess whether they actually discuss policy uncertainty. They also
compared the index against the frequency of the word "uncertainty" in the Federal Open
Market Committee (FOMC) Beige Book. They also analyzed stock market movement that was
initiated by policy news (Baker et al., 2013).

The authors concluded that, in times of high uncertainty, businesses delay investment and
hiring. They determined that the rise in uncertainty from 2006 to 20 II cut employment by as
many as 2.3 million jobs and industrial production by up to 4%. They found that taxes,
government spending, and fiscal policy accounted for 40% of policy-related economic
uncertainty in the period from 1985 to 20 I I percent. Monetary policy accounted for 33% of
that diminution (Baker el ai, 2013).

Following the research of Baker el al. (2013), Gulen and Mihai (2013) investigated how
corporate capital investment at the firm and industry level is affected by policy uncertainly.
Their research found that policy related uncertainty is negatively related to firm and industry
level investment, and the economic effect is substantial. 'They found that approximately two
thirds of the 32% drop in corporate investments observed during the 2007-2009 crisis period
can be attri buted to pol icy related uncertainty.

Interestingly, they also found the relation between policy uncertainty and capital investment is
not uniform in the cross-section of U.S. firms. It is significantly stronger for firms with a
higher degree of investment irreversibility, for firms that are more financially constrained, and
for finns operating in less competitive industries. Policy uncertainty is also associated with
higher cash holdings and lower net debt issuance. They noted that "overall, these results lend
empirical support to the notion that policy-related uncertainty can depress economic growth
through a decrease in corporate investment. This decrease is related to precautionary delays
induced by investment irreversibility and to increases in the cost of external borrowing"
(Gulen and Mihai , 2013). Their research added an important component to the topic, by
quantifying the drop in corporate investment related to policy uncertainty. Further, they found

142
that these basic effects maintained their relationship cross border, specifically citing countries
such as Canada, the United Kingdom, France, Germany, and'ltaly,

In his paper Economic policy uncertainty in the U S and Europe: A cointegration test, Sum
(2012) also examines policy uncertainty in and its trans border applicability. Sum concludes
that heightened policy uncertainty in a major nation can have a direct or indirect effect on the
world economy. His study focused on the relationship between economic policy uncertainty
between the United States and Europe. The results reveal a long-run equilibrium relationship
(cointegration) in economic policy uncertainty between the United States and Europe. Sum
indicated that the results "provide evidence of the interconnectedness of economic conditions
between the United State and Europe in line with the international transmission and spi II-over
literature" (2012).

Johannsen (2012), in When are the effects of fiscal policy uncertainty large?, found that
uncertainty about short-run and long-run fiscal policy can cause large falls in consumption,
investment, and output, and have depressed economies across the globe. He also noted that the
fiscal impact on the economy is small when the monetary authority is not constrained by the
zero lower bound (ZLB). He presents empirical evidence indicating that shocks to policy
uncertainty had larger effects on the U.S. economy during, the Great Recession, a period in
which the Federal Reserve's policy rate has been at its effective lower bound, than in the
preceding years. Johannsen postulates that relatively high real interest rate continue to
encourage households to forego consumption in order to save, which decreases demand and
causes the economy to contract. Importantly, his work concluded prior to the launch of the
Fed's massive and unlimited $85 billion per month program of quantitative easing known as
"QE3,"

Giertz and Feldman (2012), in The Economic Costs of Tax Policy Uncertainty: Implications
for Fundamental Tax Reform, argue that uncertainty fosters rent-seeking, which represents a
shift between productive and unproductive or destructive entrepreneurship. They found that
"with little policy uncertainty, higher returns may be sought from investing in productive
activities. However, when government is receptive to policy changes, the returns from rent­
seeking (through lobbying, political action committees, etc.) may be more appealing. When
policy uncertainty does not otherwise exist, politicians sometimes manufacture it."

They concluded that enduring reform of the tax code would produce efficiency and higher
productivity, with the effects widely distributed. However, as they noted, that wide
distribution of benefits creates an environment among policy makers that becomes ripe for
~'carve outs" by influence-seeking lobbyists willing to pay rent to effect their goals. Giertz and
Feldman (2012) agreed that societies relying heavily on " institutions that reward rent-seeking
tend to stagnate; societies that rely on institutions whose wealth is achieved through private
competitive markets tend to prosper. "

Dunkelberg (2013), chief economist for the National Federation of Independent Business
(NFIB) noted the counterproductive implications of Fed policy, stating that "uncertainty
probably increases with the size of the Fed's portfolio, He hypothesized that Fed policies
made no contribution to the improvement of the economy, or even slowed it down, by creating
uncertainty and fear among investors, Dunkelberg, in the NFIB's April 2013 "Small business
economic trends" indicated that over 60% of small business owners, a record number, had no
interest in further borrowing because the funds did not have a high probability of generating a
return. With more than 50% of jobs in the U.S. created by small businesses and entrepreneurs,
Dunkelberg's findings cast a sobering view of the stimulative impact of the Fed's quantitative
easing programs,

143
3. The impact of quantitative easing

A review of the seminal work for Baker ef al. (2013), Measuring Policy Uncertainty,
demonstrated the exhaustive efforts of those authors in identifying indications of public policy
uncertainty in the public domain . The authors distinguished between the level of policy
uncertainty derived from fiscal issues and monetary issues. They concluded that, between
1985 and 2011 , taxes, government spending, and fiscal policy accounting for about 40 percent
of the policy uncertainty, with 33% precipitated by Fed policy. They determined that the
uncertainty led to a postponement of business investment in hiring.

While this author found it unnecessary to further examine their rigorous work surrounding
fiscal pol icy, it was apparent that the authors' work concl uded prior to the imposition the
largest tranche of the Fed's quantitative easing, known as "QE3." Further, it appeared that the
authors' method of analysis might not fully capture the pol icy uncertainty impl ications of any
of the Fed's quantitative easing programs, given that media articles reporting on the QE
programs would focus on the enhancement in economic prospects to flow from the programs,
rather than policy uncertainty. That is especially true .with the Fed's latest, and, by far, the
most robust program ofQE3, which provides for a continuing flow of$85 billion per month as
long as the Fed determines that the economy is sufficiently weak. Thus, media articles
following QE3 would, once again, focLis on the certainty, or predictability, of Fed policy,
which would have likely lowered the authors' 33% calculation. That reduction in the
robustness of the monetary component would have given the Fed a higher level of policy
credence than warranted, a theory supported by the data reported by Dunkel berg (20 13).

In the research by Dunkelberg of the NFIB, businesses surely look at a different policy
scenario when contemplating the later, more voluminous states of quantitative easing, such as
at QE3. First, the massive amounts of monetary intervention by the Fed were, in large part,
precipitated by a stunning failure of fiscal policy, or lack thereof. The use of the Fed to
intervene in the salvation of the economy, to the near exclusion of Congressional and
Executive Branch action, is unique at current levels and indicative of the dysfunction in the
political system. More importantly, small businesses realize that, despite the announced
duration of the Fed's QE3, it is a poor substitute for enduring tax and investment policies and
will someday come to an end . They appear to comprehend that the unwinding of perhaps more
than $4 trillion from the Fed's balance sheet could cause significant GOP shrinkage and
calamitous conditions in the economy. From the NFl B research, those businesses clearly
question whether the incipient recovery in the economy will be able to survive the removal of
Fed stimulus, and thus, as shown in the data, are unwilling to borrow and expand under these
conditions of uncertainty.

Due to its time frame, the Baker ef al. (2013) work does not appear to identify this component
of uncertainty. From the NFIB "Small business trends" report of April, 2013, it is clear that
this QE uncertainty is extant for small business and impacting their expansion and job
creation. Further research, with in depth quantitative and qualitative surveys of businesses,
both large and small, will be necessary to better determine the impact on the economy from
this component of Fed policy.

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4. Fiscal policy and entrepreneurship

Entrepreneurs and small businesses have a lesser incentive to develop and grow in an
environment shrouded in policy uncertainty, such as the current, highl y-contentious climate
that remains deeply impacted by the 2008 financial crisis (Patterson , 20 II and Barnes, 2012).
Governments around the world were faced with extraordinary challenges following the failure
of Lehman Brothers and the near-collapse of the global financial system. In the United States,
the federal government increased spending from 21.4% of gross domestic product (GOP) in
2007, to a high of 27.3% in 2009, including the historic budgetary legislation in the Troubled
Asset Rei ief Program (TARP), an expenditure of $860 billion . With T ARP and additional
measures, U.S. government "stimulus spending over the past five years totalled more than $4
trillion " (Laffer, 2012), but has not achieved a significant growth in jobs and output. In fact,
the recovery from the recession that ended in 2009 has been the weakest since World War II
(Wiseman, 2012) . The growth of nonfarm employment in the U.S. has been the most muted of
any post-recessionary period since 1981, despite the record federal spending and stimulus
programs.

This has been the first recession in the post-war period that combined U.S. federal , state, and
local government employment has fallen. Most of that employment loss is at the state and
local level , where budgets must be in balance and deficits are not allowed. As a result of the
myriad headwinds in the current cycle, such as falling housing prices and weak tax revenues,
states and local governments have been a significant drag on the U.S. economy.

The rise in bankruptcies of U.S. cities, despite the public sector budget cuts and layoffs, has
reduced small business investment and an increased economic uncertainty. With 706,000 jobs
lost by state and local governments from May 2009 through June of 20 12 (Dewan and Rich,
2012), those important sectors of the economy are creating another large obstacle to economic
recovery and a deterrent to new business creation. According to Nayab (20 II), such unstable
political conditions and uncertain government policies suppress entrepreneurship. The historic
financial problems of the public sector in the U.S. economy exemplify the instability and its
impact on the economy. According to Haltiwanger et al. (2012), the start-up rate of firms has
declined from "as high as 12 percent to 13 percent, as a percentage of all firms, in the 1980s to
7 percent or 8 percent in recent years."

5. Uncertainty in trade policy

According to the U.S . House of Representatives Committee on Small Business, entrepreneurs

and small businesses face a variety of barriers that significantly inhibit their ability to compete
in the export market. Those barriers include higher tariffs , and anti-competitive technical
standards. Adding to the global issues, some nations, including the U.S. create complex
domestic rules regulating international trade. Entrepreneurs must navigate multiple federal
agencies to obtain that license. With their limited resources, entrepreneurs and small
businesses rely on free trade agreements to navigate the complexities of international trade
(2012) .

Despite the agreements in place, their complexity and uncertain, or disparate, enforcement
have deterred entrepreneurial activity in international markets. Unfair trade practices,
especially the theft of intellectual property (IP), deter small business engagement in that arena.
According to the U.S. House of Representatives, China is the preeminent offender, including
dumping, intellectual property theft, and market access. In total, domestic finns lost an
estimated $48 billion from this theft. Notably, only one percent of the 27 million small
businesses are engaged in export (2012).

145
The U.S. Government has been a failure in consistently ensuring that trade agreements with
nations like China have been "fair" as well as "free." Large enterprises have the scale and
clout - for the present - to better monitor and limit intellectual property theft. The U.S. could
impose more significant penalties on certain Chinese manufacturers and products where IP
theft is known. The lack of strong action by the U.S., as some allege, may be due to fear of
losing the nation's key source for its debt-fuelled economy. To stimulate entrepreneurial
development and to restore manufacturing jobs in the U.S., the nation must take a stronger
stance against global IP theft.

In a positive signal for entrepreneurs and a possible shift toward a tougher posture on
violators, on February 29 of this year the Obama administration signed an executive order to
target the unfair trade practices of nations such as China. Commerce Secretary John Bryson,
who will appoint the deputy director, said his department "is committed to making it as easy as
possible for U.S. businesses to build things here and sell them everywhere." (Barklay and
Favole, 2012).

6. Lobbying and its impact on entrepreneurship

Increased lobbying and the rapidly growing outside influence on lawmakers in Washington
and other political circles of power have an outsized negative impact on entrepreneurship
(Figure 2). Small businesses and entrepreneurs do not have the financial resources or
infrastructure available to larger entities, leaving them relatively unable to mount a viable
defense when they are confronted by regulatory issues. As derived from Baumol (1990), when
the need for lobbying increases, more of an entrepreneurs time and resources must be utilized
in non-innovative rent seeking activities, such as lobbying government officers instead of
productive activities.

1 1.2 ,

0.8

0.6 -1----­
0.4

0-
0.2

2000 2002 2004 2006 2008 2010 2012

Figure 2. Outside Spending in U.S. Federal Election Cycles (Billions of Dollars)

(Source: U.S. Federal Elections Commission)

146
The increase in outside monetary influence in recent years has been historic, with $1.1 billion
spent in the 2012 cycle. Given that more than 50% of all new jobs created in the U.S. are from
small businesses, the growing and outsized influence of larger firms could explain some of the
sluggish job growth that America has experienced. Significantly, entrepreneurship is
fundamental to a society's long term growth, due to its ability to transfer new knowledge into
commercial applications (Audretsch et al., 2006).

The implications of the increases in non-productive rent seeking are not unique for small
business, though more profound due to their resource limitations. The cost to an economy of
rising rent seeking, typified by Figure 2, adds a debilitating dimension to any free market
economy that increases uncertainty and reduces opportunity for ascension of the middle class.

7. Conclusion

The role of governments can be helpful in fostering entrepreneurship and economic growth.
Most efforts to stimulate business creation and expansion have been in the form of tax
incentives. While preferential taxation, such targeted capital gains reductions and investment
tax credits can be helpful , other, sometimes more subtle policy factors ofpredictability that are
noted in this paper, can be more enticing. Chief among them is an environment in which a
medium- to long-term assessment of government policy is possible. In the U.S., for example,
the lack of policy visibility in a politically divided nation, and fear of new regulations, taxes,
and rent seeking by lobbying groups, is having a chilling effect on new business creation.

Some Western nations are recognizing the value of providing a more positive viewpoint from
government, and one that can diminish policy fears harboured by entrepreneurs. The U.K. 's
Department of Business, Innovation, and Skills recently announced the elimination or
modification of 3,000 rules that impacted small companies. The U.K. 's Business Secretary
noted that " in these tough times, businesses need to focus all their energies on creating jobs
and growth not being tied up in unnecessary red tape" (Vina. 2012).

Entrepreneurs and small businesses realize a nation that has incurred more debt in just four
years than in its entire 200 year history, increased the rent seeking in its bastions of political
power, and effectively printed nearly $4 trillion, as is the case for the U.S., is on an
unsustainable trajectory. As a result, the government's job creating and GDP enhancing eff0l1s
have produced modest, and arguably unsustainable, results. Some of these same issues are an
impediment to business formation elsewhere, such as the European Union. Until a more stable
environment, built upon policies that engender private sector growth and investment is visible
to the job creating cadre, we can expect sub-par economic growth and missed opportunity.

Further study is needed to quantify the impact of contemporaneous issues in policy

uncertainty, such as quantitative easing. Research that would include a broad sampling of
small business leaders would assist in closing the gaps in the literature and enhance the
understanding of effective policy . The benefits of such an enhanced understanding would be
beneficial on a global basis.

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