More effective leadership in politics would be a good thing, but leadership to what end? Shiller’s behavioural economics-wrong again

18 02 2010

..in the aftermath of the bursting of the largest bubble in history, in the property market as well as other markets, we see that a social-psychological phenomenon, over-confidence, was not managed by leaders, and its subsequent collapse represents the deepest cause of the financial crisis.

The essential banality of behavioural psychology when applied to politics or economics was revealed again today in Robert Shiller’s latest article on leadership in the United States. Shiller, the joint  author of Animal Spirits contrasts unfavourably  the leadership of Obama and Gordon Brown during the present recession with that of Franklin D Roosevelt during the Great Depression of the 1930s. His conclusion is

Leadership matters. But it can be effective only sometimes. And leadership in a crisis cannot undo all the damage of lack of leadership in the past.

so sometimes leadership works and sometimes it does not. Excellent work Sherlock! Shiller cannot even explain why on its own terms Roosevelt’s leadership was effective, merely pointing out that it appeared to help bring an end to the Depression. Such a narrow reading of the economics of the 1930s is itself absurd. The US economy was finally brought out of the Depression by World War Two and the tremendous boost to production and innovation that came with it.

There is now widespread acceptance that politics and the political process in the West are in acute crisis. (See this desperate analysis of UK politics for example). It is tempting at times like this to yearn for the smack of firm government. It is certainly true that seeing political leaders taking firm and decisive action evokes at least some respect, even if one disagrees with the particular approach, and is better than leaders who vacillate and seem constantly uncertain of even their short-term, let alone their long-term goals.

But Shiller and others over-emphasise the subjective element of leadership. It is interesting that the only other example he gives of effective leadership in a crisis is of Winston Churchill during World War Two. Churchill is significant because he combined strong personal leadership qualities with a well-defined cause, the survival of Britain in the face of a deadly enemy. Before the War  Churchill was a renegade who lacked significant influence. After the War he was a totem Prime Minister. It was the unique political environment of the War which gave content to his leadership skills. He engaged with the strong patriotic feelings still at that time present within large sections of the British people and inspired them to keep fighting.

President Obama is a man with obvious and admirable leadership qualities. His problem is that he is leading a nation which is in relative economic decline and he has no political framework available within which to address this problem. The story of the United States is of continuous progress and global domination. US politics is finding it impossible to deal with a world of relative decline. Shiller’s emphasis on confidence is very American. The story of the US is one in which confidence is the key to success.

There is something very attractive about this ‘can do’ approach to life and there is much about it which we who are immersed in the deep cynicism of British culture could emulate. British political leaders are dwarves compared with Obama, so the problem here is even more acute. However the mirror image of US style confidence is those other figures familiar from American fiction, the confidence trickster, the snake oil seller and the quack doctor. Confidence and optimism are all very well, but the main problem facing politics today is its emptiness and lack of vision. Shiller does us all no favours by focusing on the wrong problem and the wrong solution. The medicine of confidence he prescribes is the modern equivalent of snake oil.

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2 responses

19 02 2010
Leigh Caldwell

I’m glad it’s just “Shiller’s behavioural economics” which is now at fault and not behavioural economics in general! Broadly I agree with you about him, though there is a bit of truth to the ideas about confidence.

Some psychological effects, especially if widely held, can be self-fulfilling to an extent. This is not to dismiss the importance of other factors – productivity, investment, innovation are all crucial too. But alongside these, the progress of the economy is partly influenced by the people’s assumptions and beliefs about the progress of the economy.

The problem with Shiller’s ideas is he has no way to say how important psychology is relative to other factors – one of the main contributions of economics as a discipline is it gives a way to be quantitative about the impact of different factors in a model. I don’t think Shiller has even considered how to determine when, and to what extent, confidence makes a material difference to growth.

7 04 2010
ELIAS KARAVOLIAS

Behavioural psychology applies to central bankers, regulators and politicians as much as it
does to investors ! Prime ministers,finance ministers are exhibiting the behavioural phenomenon of overconfidence in their future self-control .Why should behavioural psychology be seen as something applying only to investors?
Where is behavioural politics, behavioural central banking, or behavioural regulation? Remember
the Fed policy statements around the end of the 1990s? The ones that kept referring to the
technology-enhanced rate of GDP growth? Wasn’t this herding around a bad idea the very
same herding then fuelling the NASDAQ bubble?
Shiller’s behavioural economics is an approach for financial economics, let’s be honest and fair with him…
Leadershsip and economic policy decisions making are elements of a phenomenon called BEHAVIOURAL MACROECONOMICS…Please,try to understand the difference… For example, if you had to decide -as a Greek finance minister- between IMF or markets, are you sure that depends only on the art of….leadership? Do not forget the rule of the politics: be afraid of the markets when the society’s welfare depends on your decisions…
Kind regards
Elias Karavolias,
Lecturer ,Institute of Diplomacy and Global Affairs,Athens
Director, Upgrade London Partners,
Non-executive director, SF Global Fund( Sofia Finance Group)

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