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

  

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

BOOK REVIEW (Part Two)
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)

“Animal spirits…is an economic term, referring to a restless and inconsistent element in the economy. It refers to our peculiar relationship with ambiguity or uncertainty. Sometimes we are paralyzed by it. Yet at other times it refreshes and energises us, overcoming our fears and indecisions.” [1]

The first part of this review contested  Shiller and Akerlof’s claims that the recession is caused by the irrational behaviour of individuals. There is however much more in their book to challenge.

I once talked to a behavioural psychologist whose job was to improve the behaviour of children in the classroom. The first thing he told me was that to do his job properly he had to completely ignore the, often tragic, social backgrounds of the disturbed children. Instead, he focussed entirely on strategies for changing their behaviour by psychological tricks which were akin to those used to train dogs. I was reminded of this when reading Shiller and Akerlof’s approach to some major economic and social issues. They too ignore the historical and social factors which have led to many of the phenomena they discuss and instead present them as merely behavioural oddities.

Their view is that human economic behaviour is determined by a combination of five things: confidence, fairness, corruption, money illusion, and storytelling.

These are all relatively straightforward concepts, except perhaps for money illusion. Money illusion is a term used to explain why people will oppose wage cuts, even if the prices of what they buy are falling in deflationary times, more than they will fight for wage rises at a time of inflation when everything is getting more expensive.

Why do workers resist wage cuts and not fight as strongly for indexed linked rises?  Rather than a psychological reason, is it not more likely that workers understand that once they have conceded the need to accept pay cuts that they will have handed power to their bosses to do so again, to keep coming to the well? Is it not also likely that compared with this, the need to combat inflation, a future event which like all future events is uncertain, will seem less of a vital issue? The authors approach to this is typical of many of the points they make. They persistently choose to interpret attitudes arising from social and historical experience as hard wired psychology. Often this leads to observations which are so stunningly banal that you are left wondering whether these authors simply need to get out more. Take the following examples:

‘people rarely quit their jobs in recessions’[2]

‘people tend to want to work in higher paid industries’[3]

‘students…really don’t seem to care how much they save’ [4]

Their emphasis on the importance of storytelling also takes them away from understanding what is perfectly clear and rational behaviour based upon experience. They claim that the high savings rate in China and other new economies is down to the ‘story’ that ‘there is no shame in being poor in China, since this is viewed as a transitional state’[5], therefore people do not consume. However as many people have pointed out, in a country with often rudimentary social and medical insurance[6], savings are an essential to fall back on when times get tough.

The answer to most of the problems the authors riase is state action of one kind or another. For example, a discussion on racial discrimination in the US describes the situation of black Americans thus,

‘there is the notion among both blacks and whites that there are two groups, we and they. This very notion is part of daily reality. This notion – as much as low financial assets and skill levels – is responsible for the continued poverty of African Americans.’[7]

The experience of racism in the US is reduced to a ‘story’ which reinforces social stereotyping. The authors do not recognise that racism, where it exists, needs to be combatted through political means. Their suggestion instead is positive discrimination, action by the state.

Of course, there are many aspects of human behaviour which appear to be irrational. We can usually see them more clearly when we look at other people’s cultures rather than our own; and there’s the clue. Generally speaking these types of behaviour are the product of a specific cultural and social experience. Sometimes it is also true that we take our lead from what other people do, as in buying houses or shares in a rising market. But this is a perfectly rational thing to do in the absence of information as to why this is a bad idea.  Very few people can call the top or the bottom of any market, and those that do are often just lucky. In the mean time we all try to take as much advantage of it as we can.

The rise of behavioural economics is a symptom of the paucity of proper historical, political and economic analysis of society. In that sense it is just as much part of the voodoo culture of the day as the types of behaviour it disparages.

 

[1] Animal Spirits p4

[2] Ibid p103

[3] Ibid p103

[4] Ibid p116

[5] Ibid p128

[6] http://www.ft.com/cms/s/0/f0a488ac-ebe2-11dd-8838-0000779fd2ac.html

[7] Animal Spirits p164

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

 

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

 

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[1] Animal Spirits p ix

[2] Ibid p173

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