Jack M. Mintz: How uncertainty has played havoc with the real economy
As this decade comes to close, markets are at an all-time high. The Dow Jones index is finishing within sight of 29,000, almost three times its level on Jan. 2, 2010. In part, this reflects the seemingly unstoppable American expansion since the 2008 financial crisis. But two-fifths of the decade’s jump happened from Nov. 8, 2016, to Jan. 22, 2018. During those 15 months the Dow rose 41 per cent.
How come? The U.S. economy obviously didn’t expand by two-fifths. Nor did anyone expect it to. Interest rates didn’t fall — in fact, they stayed flat until the first quarter of 2018 when tighter monetary policy finally started nudging them up. Corporate profits were also pretty flat during that period.
No, the real reason for the super-charged Dow Jones was the shift in investor perception of risks after the election of Donald Trump as U.S. president on Nov. 8, 2016. In the wee hours of election night, after it first became clear Trump had won, the market fell sharply, with investors worried about a very unpredictable president-elect. By morning, however, as investors reassessed the election’s outcome, the Dow reversed itself and began its breathless climb of the next 15 months as the Republicans pushed deregulation and tax reform. Even the U.S. economy was uplifted, with GDP growth hitting close to three per cent and nominal wage growth besting five per cent by 2018, the highest levels since the third quarter of 2014.
Canadians have a very good life even if we seek to do better
Since the first quarter of 2018, however, things have been decidedly less rosy. The Dow has been choppy, rising not much more than 10 per cent since then. The reasons? Shifting monetary policy, a slowing world economy, stalled policy development in a divided Congress and uncertainty from trade disruptive negotiations.
Uncertainty plays havoc with the real economy. If households, businesses and investors perceive more upside than downside risk, they will consume and invest more. If the world looks more than normally uncertain, however, confidence declines. Economic forecasters rarely include uncertainty in their economic models since it relies on what John Maynard Keynes called “animal spirits,” which are not easily measurable.
On the other side of the pond, U.K. economic growth has dropped from an annual rate of 2.1 per cent in the second quarter of 2016 to 1.4 per cent in 2019. The June 2016 Brexit referendum clearly left businesses and investors uncertain about Britain’s future. After Theresa May gambled on an election that led to a minority Conservative government, Parliament was too divided to vote for any outcome to resolve Brexit one way or the other. Uncertainty began to pull the economy down.
This cost of Brexit uncertainty was analyzed recently by France’s Fabien Tripier, who estimated a £16 billion annual loss to the U.K. economy. He calculated the number of media reports that mention “economy,” “politics” and “uncertainty” to develop an index of uncertainty going back 21 years. With these data, he then estimated the impact of this uncertainty on GDP growth, keeping in mind that some shocks to the economy happen immediately (like stock market valuation) while other impacts take time to trend (consumption and investment). What Tripier finds is that instead of the U.K. economy growing 1.9 per cent per year after the 2016 Brexit vote, it should have been growing 2.3 per cent annually.
It is therefore no surprise that Boris Johnson won a large Conservative majority on the promise to get Brexit done. The electorate still remains closely split between Remainers and Leavers, but many voters wanted to see an end to the parliamentary stalemate. Despite uncertainties about the trade talks that will dominate Brexit news in 2020, the FTSE index has risen five per cent since election day, better than the Dow Jones (at just 1.5 per cent).
As for Canada, the TSE index has risen this past decade by 45 per cent, far less than the Dow Jones. And unlike U.S. exuberance since Jan. 1, 2017, the TSE rose by a meagre 1,260 points to 17,120, a total of just eight per cent in three years. Much of this reflects our mixed economic record, which has undermined confidence. The economy has been boosted by U.S. growth but has also been hurt by trade frictions, higher business taxes and regulatory obstacles that have deterred investment, especially in the resource sector. Overall employment has grown by a solid 4.5 per cent since January 2017 although not so quickly in the resource and manufacturing sectors. But nominal business investment has grown only four per cent during this time and remains below where it was in 2014. That compares with 15 per cent growth in the U.S. over the same period.
As for 2020, Canadian growth should continue without a recession this year even if the economy is not booming, especially in the resource-rich provinces. Forecasts are never sure things, however, and a recession, if one arrived, would surely blow a hole in federal and provincial budgets.
As we enter this new decade, we can at least be thankful we do not face a worldwide war or economic depression, as many of our grandparents did almost a century ago now. Canadians have a very good life even if we seek to do better. So to the many readers of this column, I wish you continued good health and success in the coming decade.
Jack M. Mintz is the President’s Fellow at the University of Calgary’s School of Public Policy.