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

1 07 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 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


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Economists behaving badly: why individual behaviour is not to blame for the recession

27 05 2009

Bromley illustrationsLast week I attended a meeting with Robert Shiller, a behavioural economist and author of Animal Spirits.  As I have discussed previously, behavioural economics is becoming increasingly influential, particularly as an explanation for the recession and how to get out of it.  Essentially Shiller and others are offering psychological reasons for why people make apparently irrational decisions in the economic sphere.

Shiller’s argument last week boiled down to saying that the recession was caused by lack of confidence, an extension of FD Roosevelt’s proclamation during the 1930s depression that ‘all we have to fear is fear itself”. If you listen to the podcast you will see that in response to  questioning from  Richard Sedley and myself, Shiller is quick to concede that psychology cannot explain everything.


Two reasons why behavioural economics is on the rise

In the current climate of economic and political meltdown however, behavioural economics does not have to be a coherent theory of everything in order to be important. It is becoming increasingly influential because it plays a dual role in the current period of turbulence:

1)  it allows us to feel that it was the mistakes of the greedy bankers, driven by over confidence and corrupted by easy money that caused the recession. In that sense it takes away the necessity to think through what really caused the recession and the underlying political and economic problems that need to be resolved.

2)  if we are irrational beings as Shiller and others suggest, then the State is justified in stepping in to protect us from ourselves. Behavioural economics becomes another reason why the State needs to intervene more, not less, in all aspects of life.

This is why behavioural economics has been taken up by the Obama administration, the British Conservatives and people in New Labour. They are all looking for an explanation, any explanation, so that they can avoid tackling the really hard issues.