THE BLOG
08/17/2012 11:31 am ET | Updated Oct 17, 2012

Policy Pseudocertainty

"Prediction is very difficult, especially about the future" -- Niels Bohr

Mitt Romney's top economic advisors recently released a white paper arguing that over the last four years, "uncertainty over policy -- particularly over tax and regulatory policy -- limited both the recovery and job creation." Other commentators have noted that Republicans (including several of those economic advisors) are at least as much if not more to blame for policy uncertainty, but there is an even more fundamental reason why this argument is completely silly: the future of government policy in a democracy is always uncertain. Unless Governor Romney wants to create a dictatorial regime able to prevent future policy changes, the real issue is not certainty but pseudocertainty.

What is pseudocertainty? Consider an experiment in which some subjects were told that there is a disease which is expected to afflict 20 percent of the population. A vaccine is available that will protect half of those who receive it, lowering the risk of getting the disease from 20 percent to 10 percent. Other subjects were told that there were two diseases which each would affect 10 percent of the population, and a vaccine which would completely protect people from one of them. Logically, these two scenarios are identical: taking the vaccine lowers the risk of illness from 20 percent to 10 percent. Nevertheless, only 40 percent of subjects given the first scenario said that they would take the vaccine, compared to 57 percent given the second one.

Why? The psychologists Daniel Kahneman and Amos Tversky have argued that people really like it when some undesired outcome is completely impossible, as in the second case, even when the overall risk is unchanged. More broadly, research has demonstrated that humans have a tendency to believe that we have more control over future events than we really do, and that the future is more predictable than it really is. From this perspective, the elimination of one particular risk offers an "illusion of control" which many people find appealing, hence the term "pseudo-" or false certainty.

Economists involved with public policy are particularly susceptible to false confidence, even though economic predictions have proven notoriously inaccurate. One might have thought that recent events would have induced some humility among those who not only failed to foresee the financial crisis of 2008 (in some cases, even denying that it was a possibility) but also made predictions about subsequent events that have proven completely wrong. Rather than acknowledge their own uncertainty, however, Romney's team is doubling down on their theories by asserting that the Obama administration has made things worse not simply with the policies they actually enacted, but also with the policies they might enact -- accusing them, in essence, of economic thoughtcrime.

While this claim has the political advantage of being impossible to disprove, it represents a remarkable degree of chutzpah coming from a group of economists obsessed with "rational" models of human behavior which downplay the importance of psychological factors in economic decision-making. In particular, these conservative ideologues reject the observations of one economist who long ago wrote quite incisively on the role uncertainty plays in economic decision-making -- John Maynard Keynes.

Keynes actually acknowledged the primary political point that Romney's conservative advisors want to make, namely that given the especially important role that confidence plays in investment decisions, "prosperity is excessively dependent on a political and social atmosphere which is congenial to the average business man." But he also thought that these decisions were less influenced by things like future tax rates than economists usually suppose: "Most, probably, of our decisions... can only be taken as a result of animal spirits -- of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities."

Moreover, Keynes was humble in claiming particular insight into what affected confidence, noting that "economists have not analyzed it carefully and have been content, as a rule, to discuss it in general terms," an observation no less true today than when he made it. In particular, while Romney's advisors are obsessed about the psychological importance of rewards for the successful, there is evidence that entrepreneurship can also be encouraged by providing protection for the unsuccessful in the form of a robust social safety net. Furthermore, the most important uncertainty facing any business person is whether there will be sufficient demand for their product or service, but, as Keynes also noted, their ability to predict this is "usually very slight and often negligible."

So, sure, uncertainty about future policy affects economic behavior, but we might as well acknowledge that attempts to reduce uncertainty in an inherently uncertain world are often more about illusion than substance, and carry within them their own set of risks. During the real estate bubble, for example, most Americans (including sophisticated investors) were quite certain that real estate values could only go up, and we all know how that turned out.

In short, when Republicans complain about policy uncertainty, what they really mean is policy that they don't like. Rather than asserting that Romney's election will provide a pseudocertainty to calm investors' nerves, they should focus their arguments on the quality of the policy itself, and let the American people decide if reduced regulations on banks and polluters and further tax cuts for the rich -- the primary policy uncertainties worrying Governor Romney -- are the right way to help an increasingly threatened middle class.