Why the behavioural economists are wrong, a review of ‘Animal Spirits’ (Part One)

24 06 2009
 

Animal Spirits: How Human Psychology Drives The Economy, And Why It Matters For Global Capitalism, by George Akerlof & Rober Shiller

Animal Spirits: How Human Psychology Drives The Economy, And Why It Matters For Global Capitalism, by George Akerlof & Robert Shiller

BOOK REVIEW (Part One)
Animal Spirits: How human psychology drives the economy and why it matters for global capitalism, by George Akerlof and Robert Shiller (published by Princeton University Press)

 

“Keynes appreciated that most economic activity results from rational economic motivations-but also that much economic activity is governed by animal spirits. People have non-economic motives. And they are not always rational in pursuit of their economic interests. In Keynes’ view these animal spirits are the main cause for why the economy fluctuates as it does.” [1]

One of the most frustrating aspects of the recession has been the absence of serious examination of its causes. Of course, there has been huge coverage of the events of the recession. But at the level of serious analysis there has been a dearth of proper public discussion. The political and public domain has been dominated by trivia such as bankers’ salaries or MPs’ expenses. Public debates have been restricted because there are few people who are able to discuss the economy and politics in the same breath. Yet it is impossible to make sense of one without the other.

The demise of politics and the political sphere as a meaningful forum for discussing the economy has encouraged the search for other explanations, outside the sphere of politics or traditional economics. Some people, including influential people within the Conservative Party in the UK, have turned instead to the behavioural economists (BEs), like Robert Shiller and George Akerlof, for explanations and guidance. Shiller and Akerlof’s case is that it is the behaviour of individuals within the market system and their psychology which explains much of what has gone wrong.

 Behavioural economists reject the view that the recession can be explained in traditional economic terms. In particular they have in their sights the rational market theorists, more commonly known as the free market proponents who have been influential since the time of Thatcher and Reagan, who argue that free markets can regulate themselves.  The upheavals of the past two years in the world economy have discredited the rational market theorists, as the blame for the recession has fallen on to the unregulated  nature of the financial markets. The BEs conclusion is that markets are susceptible to the irrational behaviour of individuals. This irrational behaviour requires state intervention to counteract it and to reintroduce stability. In the wake of the global recession this explanation and remedy is falling on fertile ground.

But the recession is not a crisis inflicted on an otherwise stable system by the behaviour of irrational individuals, as ‘Animal Spirits’ suggests. The problems of present day capitalism are the product of historical and economic developments within the system itself. The idea that anybody can say, as Gordon Brown did, that we can have neither boom nor bust, is plain wrong. The recession is just as intrinsic to modern capitalism as the boom which preceded it.

Whether it is the overdependence of the UK on financial services and public spending, the lack of any underlying productive dynamic to western economies in general, the crisis of the political class and its impact on the economy or the likely effects of the rise of China, none of these developments are explained or accounted for by Akerlof and Shiller. Their argument is that capitalism can work fine if it only had a little more regulation:

Capitalism can give us the best of all possible worlds, but it does so only on a playing field where the government sets the rules and acts as a referee.[2]

We can agree with the BEs that the market, or capitalism, is not rational in the way that rational market theorists claim. The most singularly irrational aspect of capitalism is that decisions to invest are made by individual or groups of capitalists rather than by or in the interests of the majority of people. If the prospects for profitable investment look poor, because the expected rate of profit is too low or too risky, then money flows elsewhere. In the past ten years money flowed instead into apparently safe areas such as financial derivatives based on assets like housing etc . This created an unsustainable asset bubble which inevitably crashed and burned. Phil Mullan [3] calls this the financialisation of the western economies, the tendency for money to try to beget more money without going through the process of productive investment in new businesses.

In addition, capitalism is less and less able to stand on its own two feet as it becomes more and more established. The state often has to step in to try to prop up ailing industries, as the US government recently did with General Motors, or to subsidise whole ones, as the EU does with farming. The growth of financialisation and state support together represent the throttling of dynamic economic development in the west. The truly dynamic parts of the world economy are now in the east.

The approach to explaining the recession taken by the BEs turns reality on its head. Capitalism as a system with inbuilt tendency to crisis is let off the hook and the individuals who suffer from the recession are blamed for it.

Part two of this review will follow shortly

 


[1] Animal Spirits p ix

[2] Ibid p173

[3] http://www.spiked-online.com/index.php/site/article/4244/

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