International BusinessV V: How to understand the global meltdown
“Consumer wants can have bizarre, frivolous, or even immoral origins, and an admirable case can still be made for a society that seeks to satisfy them. But the case cannot stand if it is the process of satisfying wants that creates the wants.”
J K Galbraith: The Affluent Society
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New arrivals in American Centre libraries almost all deal with the current financial crisis and the global meltdown. But despite the flood of books, quite apart from the op-ed articles by sophisticated financial professionals, no one really knows how long the current recession will last or how deep it will go. How could it happen? How did the financial industry get it so badly wrong? And what’s it to stop it from happening again? Why it will always happen—and why we are all to blame because of the crooked timber of humanity? George A Akerlof (Nobel Prize winner, 2001) and Robert Shiller, both professors at Princeton, have provided another take on the origins of the crisis in Animal Spirits: How Human Psychology Drives the Economy, and Why it matters for Global Capitalism (Princeton University Press, $24.95).
Akerlof and Shiller have borrowed the phrase ‘animal spirits’ from Keynes to argue what is wrong with the thinking of economists—that is, the psychology and irrational elements that govern personal choices and personal behaviour: the same irrational elements pervade economic behaviour.
Five elements constitute these ‘animal spirits’. Confidence, or the absence of it; fairness, or a sense of values, that is how people think and others should behave in periods of crisis; corruption and other tendencies towards anti-social behaviour; ‘money illusion’ or what money can buy (not just in material goods, but in terms of human happiness and contentment) without considering its real value; reliance on ‘stories’, for instance, inspirational accounts of how the Internet had led to a “new era” of productivity. Taken together, or even singly, these ‘animal spirits’ cloud understanding which explains the current crisis and thus paves the way for ways of dealing with it.
Akerlof and Shiller now apply this formula in case studies (to that extent this is a book on behavioural economics) which includes, inter alia, joblessness, savings, volatility of prices of financial assets and real estate, and poverty studies of Afro-Americans. The conclusions from each study have implications for policy, they maintain. That isn’t enough; they go further to highlight the limitations of macroeconomic theory. “The theories economists typically put forth about how the economy works are too simplistic. This means we should fire the weather forecaster.” And firing the weather forecaster means “giving up the myth that capitalism is purely good.”
As you go deeper into the crux of the argument, there are more questions raised than answers provided. What are rational questions from what they are not? What is an economic motive from a non-economic one? Can’t an economic motive differ from one theory, and one economist, to another? Doesn’t the whole debate depend on the words we use to define our concepts? There is a kind of circularity built into the main body of the argument which raises questions to every answer provided.
For instance, take the question of ‘confidence’, “the first and most crucial of animal spirits”. Is it rational or not to put my money into a bank in which I have confidence? Or in buying a house or stock? According to them, this kind of behaviour is irrational because ‘confidence’ is a kind of faith, not a matter or rational analysis. If we take their definition of rational (or what it is not) the whole edifice of capitalism which is built on risk-taking (that is, confidence) will fall to bits. As Shakespeare put it:
Our doubts are traitors
And make us lose the ground we oft might win
By fearing to attempt.
It is necessary to incorporate animal spirits into macroeconomic theory in order to know how the economy really works. In this respect the macroeconomics of the last thirty years has gone in the wrong direction.” And they go on: “And because we acknowledge the importance of animal spirits, and accord them a central place in our theory rather than sweep them under the rug, the theory is not vulnerable to attack.”
Akerlof and Shiller are free to believe that they have provided a fool-proof theory (all economists believe they are right) but they still have not provided an answer to the central question: “What is to be Done?”
All the same, it is worth reading if only to know why economists are people who don’t understand why something that works in practice doesn’t in theory!