January 12, 2011 10:48AM

Political Uncertainty and Investment: Empirical Results

An oft heard explanation for some of the weakness facing our economy, particularly investment and hiring, is that firms are concerned about policy uncertainty coming from Washington, be it health care, financial regulation, labor regulation, etc. For the most part, those arguments have been based upon anecdote or theory (see Bernanke’s 1983 QJE piece), with some difficulty finding strong empirical support either way. A forthcoming paper in the Journal of Finance helps to shed some light on the question, by providing more generalized estimates of the impact of electoral uncertainty on investment decisions.

The authors examine whether elections, particularly those that are close, have an impact on corporate investment. The logic behind the research: “if an election can potentially result in a bad outcome from a firm’s perspective, the option value of waiting to invest increases and the firm may rationally delay investment until some or all of the policy uncertainty is resolved.” Their sample is national elections in 48 countries from 1980 to 2005. These almost all developed, industrialized economies, as the unit of observation is a publicly traded firm. US companies constitute a large portion of their sample.

The results: holding all else equal, in terms of the economy and investment opportunities, elections “reduce investment expenditures by an average of 4.8%.” That’s a substantial hit to investment. The results are even larger when the incumbent is viewed as “market‐​friendly.” Of course one needs to be cautious in applying these results to non‐​election year political uncertainty. There are also reasons, some of which are touched upon by the authors, that political uncertainty in the US may have either larger or smaller effects. So while we might not know the exact magnitudes, I think its safe to say that the notion that political uncertainty depresses investment has both empirical and theoretical support (as well as a few anecdotes).