Alaskanomics's Blog: How Much is Uncertainty Costing the State of Alaska?
By Mouhcine Guettabi, Assistant Professor of Economics, Institute of Social and Economic Research UAA
Due to the decline in oil prices, the state has had to rely on savings to fund government for the last few years. The legislature has, however, not decided how it intends to fund government activity going forward. Given the size of the deficit and the paucity of non-oil sources, it seems that a draw from the Permanent fund is necessary. While, understanding the potential short term effects from the imposition of taxes or government cuts seems to be fairly well understood, we try to quantify below the potential investment losses stemming from delaying a decision that provides fiscal stability.
What is the scale of private capital spending in Alaska?
While there does not exist a database of private and public capital spending by year for the state of Alaska, we have yearly construction forecasts which use as a proxy for these activities. In figure 1, we show that non-oil private spending between 2013 and 2017 declined by 410 million dollars. In figure 2, we show that O&G capital spending peaked in 2014 at 4.25 billion dollars and was only 2.43 billion in 2017. In other words, capital spending- including oil and non-oil- decreased by more than 2.5 billion dollars in the three years since oil prices declined.
Image courtesy of Alaskanomics
Figure 1: Private sector construction spending (No Oil and Gas) between 2013 and 2017.
Is there any academic evidence linking uncertainty and investment?
Baker, Bloom, and Davis (2013) construct a novel index of economic policy based on a diverse array of metrics, performing tests of the index’s validity through a human audit of 3,500 newspaper sources and other common-sense measures. They find that the increase in policy uncertainty that followed the onset of the Great Recession had significant negative effects on aggregate investment and on employment as well as on consumption expenditures. Matching firm-level data with the data series of this index, Gulen and Ion (2013) find that economic policy uncertainty can explain up to 32% of the drop in corporate investment over the 2007-2009 time period.
Do we know anything about the effect of uncertainty at the state level?
Gao and Qi (2012) find that municipal bonds issued by state governments immediately before a gubernatorial election pay a premium of 6 to 8 basis points due to this electoral proximity. Jens (2013) estimates the investment-suppressing effect of a gubernatorial election on the state-level investment during the quarter of the election at between 5% and 15% depending on the subsample, with the closeness of an election exacerbating the decline.
Does the information above allow us to determine how uncertainty affects the Alaska economy?
Private Construction spending in 2017 is supposed to be around 4 billion dollars. Using the 5 to 15% estimated by Jens (2013), we would conclude that the direct effects of policy uncertainty is costing the state somewhere between 200 and 600 million in private capital spending. The decline in spending due to policy uncertainty would indicate that waiting is not a costless option. In fact, the losses due to uncertainty are important and similar in magnitude to the ones the economy would experience due to a tax or further government cuts.