Animal Spirits

On the cover of the paperback version of George Akerlof and Robert Schiller’s Animal Spirits, the blurb, from Time’s Michael Grunwald, is “Animal Sprits [is]… the new must read in Obamaworld.”  In March of 2011, two years after President Obama took office and Animal Spirits was first published, it is clear that the President and his economic team were reading from this playbook.  However, it is also clear that the President missed an opportunity to communicate to the public why he took the actions that he did.  As the United States moves forward in a so-called jobless recovery, and divisiveness and friction rule across D.C. and the country, our economic policy is hobbled and scattershot.  Support for the American Recovery and Reinvestment Act has wavered in the last two years, and the public’s drop in support killed any political will for more stimulus spending.  The public apprehension and political failures are ironic, actually, because in Animal Spirits, Akerlof and Schiller write about an earlier misinterpretation of Keynesian economics, during the Great Depression.

In 1936 John Maynard Keynes’ The General Theory of Employment, Interest, and Money was published.  Keynes charted a course between classical economists that argued that less regulation would allow private markets and rational actors, via the famous ‘invisible hand,’ to create jobs, and socialists that argued for the state to direct the economy.  Instead, Keynes took issue with the idea that only rational actors governed the economy; he believed that noneconomic, non-rational, animal spirits actually caused involuntary unemployment and economic fluctuation.  The government should not be too authoritarian, like the socialists argued, but it should also not be too permissive, like the classical economists argued.  Unfortunately, in an effort to create consensus with classical economists, supporters of Keynes removed most of the animal spirits, hoping that they could convince the broad public as quickly as possible to adopt Keynes’ fiscal policy prescriptions (just like President Obama allowed political expediency to rule his economic platform).  Unfortunately, this watered down theory was vulnerable to critique by neo-classical economists like Milton Friedman.  The central thesis of Akerlof and Schiller’s book is that these animal spirits, cast off in the midst of the Great Depression, remain a prime cause of our contemporary economic difficulties.  In fact, these ideas have emerged once again in the field of behavioral economics.

There are five animal spirits that the authors resurrect from The General Theory:

1) Confidence, the trust and belief that leads rational actors to make some irrational decisions, which amplifies business cycles

2) Fairness, often pushed to the backburner in economic textbooks, often trumps economic concerns and impacts both wages and prices

3) Corrupt Behavior and Bad Faith, economic activity with sinister motivation, was clearly evident in the recent economic crisis and recession, but can be clearly traced back through all of the major economic bumps in our past

4) Money illusion, disavowed by neo-classical economists like Milton Friedman, remains a contemporary concern as people continue to be confused about the impact of inflation and deflation

5) Stories, the narratives we create to describe human experience, often seem true and nurture speculative bubbles (like the housing bubble) until the bubble pops and the story changes

In the aftermath of the global economic shock, when many of the great economies of the world continue to stumble towards recovery, Akerlof and Schiller’s analysis is perfectly timed.  They clearly trace the impact of these animal spirits on the economy, from the Great Depression through the stagflation of the 1970s, through the recessions and the Savings & Loans crises of the 1980s, the recession and the tech bubble of the 1990s, and finally to the Enron debacle, the housing bubble, and the jobless recoveries of our recent past.  Akerlof and Schiller are true Keynesians; they appreciate the power of the free market to create economic opportunity, but they also appreciate the damage that these animal spirits can make in the economy.  The vast neo-classical deregulation that started in the 1970s and continued through the last decade did not take into account these Animal Spirits, and the vast economic turmoil was the result.

Confidence is one of the most important animal spirits – it leads ‘rational actors’ to what Federal Reserve Chairman Alan Greenspan described as “Irrational exuberance.”  If one looks back to the stock market of the 1890s or the 1920s, or the tech and housing bubble of our recent past, confidence is clearly evident.  Remember in 2004 when some of your friends said that housing prices could never fall?  That is confidence gone astray, irrational exuberance.  That is also a story that we all told each other, which seemed irrefutable logic, until it wasn’t.

Fairness has a big impact on unemployment. The neo-classical theories about how a labor market would clear itself revolve around wage efficiency, the idea that employers will pay the lowest wage and employ as many people as possible.  Unfortunately, the labor contract is more complicated than that, and the transaction only starts when the wage is agreed upon.  Schiller and Akerlof show that wages vary a great deal, and employers often pay more than they need to, to secure a motivated and skilled workforce.  Fairness affects both the employer and the employee.  The wage that workers deem fair is almost always above the market-clearing wage; this ensures that wages will remain sticky even during economic downturns, despite the fact that the ranks of the unemployed grow.

Money illusion also impacts wages; neo-classical economists argue that there is a Natural Rate of unemployment, but wage rigidity is partly due to the fact that people are largely unaware of the impact of inflation or deflation on their purchasing power.  A survey they conducted with a group of economists and a second group representing the general public shows the money illusion clearly: reacting to the statement “I think if my pay went up I would feel more satisfaction… even if prices went up as much,” 90% of the economists disagreed, while 59% of the general public agreed.  Fairness and money illusion clearly affect the setting of wages, behind the scenes of economic logic.  Akerlof and Schiller argue that we should “fire the forecaster,” and forget, once and for all, the myth that capitalism is pure.  They argue that safeguards must be built to protect the general public from the excesses of capitalism.  They also make clear that the stories that we tell each other are often irrational and exaggerated, and we must be protected from these exaggerations.

Like I mentioned above, it is clear the Obama Administration used Animal Spirits as a playbook in their efforts to prevent the economy from falling into a Depression.  Schiller and Akerlof advocated the use of the Discount window, as well as other provisions taken by both the Federal Reserve as well as the Treasury Department to prop up the banks.  To their credit, they also predicted that “the injections may make the banks richer, and therefore less likely to become insolvent, but they will not necessarily lend more money.”  As a result, the Government ended up taking extraordinary measures to ensure that money was available for mortgages and loans.

Ultimately, the actions taken by the Administration fell short of what Keynes, or Schiller and Akerlof would advocate.  The stimulus was insufficient, and the government did not act aggressively enough to regulate the banks.  But like the Gulf Oil spill last summer, I think the biggest loss was the failure to take advantage of the moment to educate the General Public of the external costs of our capitalist economy.  If a better effort were made to explain to the general public the Animal Spirits, how they impact the economy, and the logic of the stimulus and TARP, our response could have been more sustained, more consistent, and less contentious.  Keynesian economics could have stepped into the clear light of day, but instead the lessons of these animal spirits and their impact on the economy remain lost to much of the general public.  Because the problem of Too Big To Fail was not confronted, we will undoubtedly once again be in a position to deal with the consequences of leverage and risk that these global institutions create.


Review of The Shock Doctrine, by Naomi Klein

I was born in 1976, and came of age in Ronald Reagan’s ‘Morning in America.’   After reading Naomi Klein’s 2007 book The Shock Doctrine: The Rise of Disaster Capitalism, I feel as if a veil has been lifted from my perception of history, and the important events of my youth stand out in new significance.  The story told in this important book centers around Milton Freidman, and the fundamentalist capitalist beliefs espoused at the University of Chicago School of Economics, where Freidman taught.

Klein’s main thesis in the book, which travels across continents and decades, is that in order to implement the fundamentalist economic policies espoused by the Chicago School, a clean slate is required.   The technique to facilitate that clean slate is what amounts to the shock doctrine.  Klein uses a quote from Freidman’s introduction to his seminal work, Capitalism and Freedom to quantify the shock doctrine.  Freidman observes that:

“Only a crisis – actual or perceived – produces real change.  When that crisis occurs, the actions that are taken depend on the ideas that are lying around.  That, I believe, is our basic function: to develop alternatives to existing policies, to keep them alive and available until the politically impossible becomes politically inevitable.”

The crisis that Freidman describes is crucial.  To analyze how that crisis and the clean sheet are created, Klein uses torture as a metaphor, tracing the ghastly experiments at McGill University by psychiatrist Ewen Cameron, under the direction of the CIA (through its MK FrUltra program).

Dr. Ewen Cameron

Cameron believed that in order to teach his patients new behaviors, old pathological patterns needed to broken up to create a tabula rasa.  The way to create that blank slate was to attack the mind with electricity, uppers, downers, and hallucinogens to, in Cameron’s words, “disinhibit [the patient] so that his defenses might be reduced.”

The CIA provided grants to Cameron starting in 1957; at this point Cameron started upping the number of shocks to unprecedented levels, increasing the dosage of drugs, and experimenting with sensory deprivation and extended sleep.  The CIA took the fruit of Cameron’s research and produced a handbook, Kubark Counterintelligence Interrogation, a secret manual on the interrogation of resistant sources.  The CIA taught these methods to authoritarian governments including Chile, Guatemala, Honduras, and Iran.

Klein traces the introduction of this fundamentalist form of capitalism over the last 40 years and finds that:

“Seen through the lens of this doctrine… some of the most infamous human rights violations of this era, which have tended to be viewed as sadistic acts carried out by antidemocratic regimes, were in fact either committed with the deliberate intent of terrorizing the public or actively harnessed to prepare the ground for the introduction of radical free market ‘reforms.’”

Argentina, Chile, and Bolivia were part of the first wave of the imposition of Freidman’s reforms, and those junta regimes used disappearances, as well as torture techniques from the Kubark handbook, to eliminate opposition to the implementation of reforms.  Klein also views the 1990s crises in China, Russia, and Asia through the lens of the shock doctrine, and closely looks at the role of the International Monetary Fund in creating the necessary shock condition.  Ultimately, Klein turns to 9/11, Iraq and Sri Lanka to show the rise of disaster capitalism as a global movement.

Economist Milton Freidman

In the 1960s, at the University of Chicago, Freidman saw a United States where its capitalism was tainted by “interferences”  (fixed prices, minimum wage, public education); while they may have provided benefits to the public, these interferences polluted the equilibrium of the market and inhibited market signals.  Freidman and his fellow Chicago economists (including his mentor Friedrich Hayek) wanted to purify the market, to get rid of these interferences.  Friedman saw the mixed economy supported by John Maynard Keynes as the enemy to be defeated.

Freidman’s prescription was as follows: remove as many rules and regulations as possible, privatize most state assets, and cut back most social programs.  Taxes should be low, and flat, if they should exist at all.  Protectionism was sacrilege to Freidman.  The invisible hand should determine prices, and there should be no minimum wage.  These were bold steps to take, even in the capitalist United States.  In order to prove his theories, Freidman would have to demonstrate them in the real world. He found a laboratory in Chile, one of the Developmentalist, mixed economies in South America that sought to find a middle road between the Cold War economic extremes.

These economies were linked around the United Nations Economic Commission for Latin America, based in Santiago Chile, and headed by economist Raul Prebisch.  In the 1950s and early 1960s, the Developmentalist economies prospered, and nurtured a burgeoning middle class.  However, American multi-national companies like Ford convinced the United States government create a program that, starting in 1956, educated 100 Chilean economists at the University of Chicago.  These Chileans, indoctrinated in Freidman’s fundamentalist beliefs, were unable to change Chile, however, without America’s help.

After the 1970 election of leftist Salvador Allende, the new government promised to nationalize sectors of the economy that were being run by foreign corporations.  President Nixon declared a virtual war on Chile through the Ad Hoc Committee on Chile, which included ITT, owner of 70% of the Chilean phone system.  Ultimately, in September 1973 General Augusto Pinochet took power in a military coup, but before the coup, the Chicago boys prepared a set of laws and regulations known as “The Brick” which went into effect immediately, a 500 page economic bible full of deregulation, privatization, and social spending cuts.

General Augusto Pinochet

Unfortunately, by 1974, counter to the expectations of Freidman and the Chicago Boys, inflation doubled to 375%.  The Chicago boys argued that the medicine wasn’t strong enough, and Freidman himself came to the country in 1975 to personally make the same case.  Freidman urged another 25% spending cut, and even more deregulation.  Unfortunately, in the next year the economy contracted by 15%, and unemployment reached 20%.  In fact, the economy did not start to improve until 1982, when Pinochet was forced to follow Allende’s advice and nationalize many companies.  Ultimately, the real legacy of Freidman’s prescription in Chile was that by 1988, 45% of the population had fallen below the poverty line, while the richest 10% had seen their incomes increase 83%.  But it wasn’t just poverty that eviscerated the middle class; Pinochet used the techniques in the Kubark manual to torture prisoners, who instead of being arrested, were “disappeared.”  In fact, the CIA trained Pinochet’s security forces, along with those in Uruguay and Argentina.  Ultimately, in South America, that was the effort required to create a tabula rasa: military coup, economic shock, and torture.

Klein’s conception of the Shock Doctrine is most clear when she looks at the brutal dictatorships in South America, as well as South Africa’s transition and Russia’s paradigm shift in the 1990s.  Klein’s analysis of Russia under Yeltzin is powerful.  I was in high school and college during those years, and my impression was formed from the jingoistic American press.  Klein makes clear that the IMF and Jeffrey Sachs, economic wunderkind, produced the kind of pressure that resulted in tragedy and mass killings.

However, Klein’s argument loses coherence when she looks at China, the United States, and Sri Lanka.  In the United States, Klein makes the leap from Freidman laissez-faire economics to the privatized homeland security apparatus.  I applaud the critique of Donald Rumsfeld, a Freidman acolyte, but it doesn’t fit the overall thesis.  In China, Klein describes the protestors as resisting the free market reforms of Deng Xiaoping.  Klein argues that most of the protestors opposed free market reforms, and that Xiaoping attacked those protestors to quell the rebellion and implement reforms while the Chinese population was still in shock.  This narrative is historically tenuous, at best.

However, the larger point of Klein, particularly as demonstrated in South America, is valid.  Freidman’s fundamentalist free market reforms require a tabula rasa, and the middle and lower classes will naturally oppose the lowering of their standard of living.  In order to create the tabula rasa, some level of force will be required.  The research that Ewen Cameron completed at McGill University is particularly troubling, especially in light of the torture that the United States implemented in Iraq.  In fact, Iraq is a Pandora’s box that should continue to produce troubling revelations.  Hopefully, those revelations will remain in the public consciousness the next time that we want to create the kind of fundamental change that President Bush wanted to in Iraq, that General Pinochet wanted to do in Chile, and that dictators have long sought to do in the name of the free market.


Are evangelicals becoming liberals?

Don’t look now, but the Southern Baptist Convention is turning into a bunch of liberals.  At least that is how hyper-partisans like Glen Beck and Sarah Palin would describe them.  Recently, the SBC has come out in favor of environmental regulation and comprehensive immigration reform, two issues that put them at odds with conventional right-wing ideology.

First of all the SBC passed the following resolution in the wake of the ongoing oil spill in the Gulf of Mexico:

“The Convention called on the government “to act determinatively and with undeterred resolve to end this crisis … to ensure full corporate accountability for damages, clean-up and restoration … and to ensure that government and private industry are not again caught without planning for such possibilities.”

Dr. Russell Moore, the dean of the School of Theology at Southern Baptist Theological Seminary and preacher at Highview Baptist Church near Louisville, Ky., helped pass the resolution.  He believes that conservatives should not, as Milton Friedman preached, have a lassez-faire view of government regulation:

“We, as Christians, believe in sin. That means if people are sinful, if all of us are sinful, then all of us have to have accountability — and that includes corporations.  Simply trusting corporations to go about their business without polluting the water streams and without destroying ecosystems is really a naive and utopian view of human nature. It’s not a Christian view of human nature… Human flourishing means a healthy natural environment, and it simply isn’t good for ourselves or for our neighbors to live in a world that is completely paved over and in which every piece of green land is replaced with a Bed, Bath, and Beyond,” he says. “That’s not how God designed human beings to live.”

In addition to that resolution, leaders in the SBC are coming out in favor of comprehensive immigration reform that includes both border security and a path to citizenship for undocumented workers.  Richard Land, head of SBC’s Public Policy Arm, is trying to convince Conservatives that compromise makes political sense:

“I’ve had some of them appeal to me. They say, ‘Richard, you’re going to divide the conservative coalition.’ And I said, ‘Well, I may divide the old conservative coalition, but I’m not going to divide the new one.’ If the new conservative coalition is going to be a governing coalition, it’s going to have to have a significant number of Hispanics in it, that’s dictated by demographics, and you don’t get large numbers of Hispanics to support you when you’re engaged in anti-Hispanic immigration rhetoric.”

Land believes that the fight over the Hispanic vote is being won by the Democrats, which could put Republicans in a bind for years to come:

“The people who have been anti-immigration have lost every one of these arguments,” he says. “They lost it with the Irish in the 1830s and ’40s and turned them into Democrats for three generations. They lost it with the Italians in the 1890s and the early part of the 20th century and turned the Italians into Democrats for three generations. I mean, you know, do they want to do it with the Hispanics too?”

It is surprising for me to discover that I agree with the Southern Baptist Convention on two major issues.  It would be a big coup if Conservatives could make the shift the SBC is advocating.  I am confident, however, that Sarah Palin’s opposition to environmental regulation will win the day.  I am also confident that Republicans will continue to look only at the short term on immigration, as their base gets older and older.  In other words, despite their best efforts, I don’t think the SBC will be able to save the Republican Party.


Prosperity without growth?

Ronald Reagan once said, “There are no great limits to growth, because there are no limits of human intelligence, imagination, or wonder.”  In the United States, growth is mostly unquestioned as a source of prosperity and happiness.  In fact Reagan, under the influence of economist Milton Friedman, believed that the U.S. could prosper, as long as the economy was freed from government influence.  Neo-classical assumptions rule U.S. economic development, to the point where politicians of the right and the left wings both fervently believe it in. Barack Obama, during a campaign speech in Berlin, said:

“This is the moment when we must build on the wealth that open markets have created, and share its benefits more equitably. Trade has been a cornerstone of our growth and global development. But we will not be able to sustain this growth if it favors the few, and not the many. Together, we must forge trade that truly rewards the work that creates wealth, with meaningful protections for our people and our planet. This is the moment for trade that is free and fair for all.”

Obama, like Reagan, believed that growth was essential, but he felt that we should take some of the surplus and provide it to the poorest Americans.  He also understood the importance of “meaningful protections for… our planet.”  Based on the policies his White House has proposed during the first 18 months of his administration, Obama clearly believes that we can protect the planet – preventing runaway anthropogenic climate change – by relative decoupling, a reduction in the ecological intensity per unit of economic output.  Like Reagan, he has faith that Americans will continue to discover technology that will make unending growth possible, with greater efficiency and greater performance.

However, that faith in human innovation is running directly into the ecological limits that Earth provides.  With a growing population, with increasing standards of living, unending growth is in doubt.  In Prosperity Without Growth, Tim Jackson examines the dilemma of growth, and how prosperity and flourishing relate to it.  He writes that: “the truth is that there is as yet no credible, socially just, ecologically sustainable scenario of continually growing incomes for a world of 9 billion people (the United Nations projected 2050 global population).”

If we assume that continuing growth is not sustainable, then what norms can guide economic activity?  Jackson identifies an important factor that helps to inspire our need for growth, our “tendency to imbue material things with social and psychological meanings:”

“Consumer goods provide a symbolic language in which we communicate continually with each other, not just about raw stuff, but about what really matters to us: family, friendship, sense of belonging, community, identity, social status, meaning, and purpose in life.”

With the limits of growth, on an Earth with an expanding human population, finding ways to circumvent that opulence, to find a way to short-circuit the positional race.  In the United States, that race was known under the mantra ‘Keeping up with the Joneses.‘  The task, it seems is to decouple those important qualities, which Martha Nussbaum identified in her essay “The Good As Discipline, The Good as Freedom,” from material opulence.    In contemporary societies, the institutions that can best influence and nurture that decoupling would be religious and community groups.  Institutions that would be most affected by that kind of shift would be groups like the Chamber of Commerce, that favor growth at all costs.

Additionally, another norm that can help to guide the transformation of the economy, and society, would be an emphasis on quality in everything that we produce.  Right now, the goal of growth encourages the production of cheap, disposable objects that consumers will need to replace.  These cheap goods are often produced on the other side of the Earth from where they are consumed, in Third World economies.  An emphasis on quality, and the nurturing of artisan producers, would help develop local economies to sustainably, and collectively, prosper.  The nurturing of local production would also reduce transportation, and environmental costs.

Our companies are designed to maximize efficiency at the cost of people and the planet.  To trace one example, by making meat production local, the meat becomes more expensive; however, that meat better bears its cost to the environment and to our continued prosperity.  This emphasis on quality and local production would impact the global business world, namely the companies which have grown on such a scale as to become more powerful than many States.   For example, ConAgra is a dominant player in food production.  They are already being affected by the locavore movement, and have bought numerous brands in order to find a niche in that economy.  The question of course, is whether we, as consumers, will nurture the artisans instead of the ConAgras of the world.


Indeed, the world is ruled by little else.

Economist Milton Friedman

John Maynard Keyes wrote in 1945 that “the day is not far off when the economic problem will take the back seat where it belongs, and the arena of the heart and the head will be occupied or reoccupied, by our real problems – the problems of life and of human relations, of creation and behavior and religion.”  In the United States, we have pursued a policy of unquestioned growth and expansion, following the recommendations of prominent economists with an ardor that borders on religiosity.  However, the economic problem, as Keynes described it, has not taken a back seat, but rather has the developed world in the grip of a severe recession.

In the United States we have always looked to economists for the magic to make our economy go.  Milton Friedman, winner of the Nobel Prize in Economics, believed that a free market economy could expand and prosper with minimal government interference. Alan Greenspan, an admirer of Friedman, was revered as an enabler of unending growth during his service as Chairman of the Federal Reserve; he received the Presidential Medal of Freedom, the inaugural Harry S. Truman Medal for Economic Policy, the inaugural Thomas Jefferson Foundation Medal in Civilian Leadership, and was named both a Knight Commander of the British Empire and a Commander of the French L’Egion D’honneur.  Presidents from Ronald Reagan to George W. Bush all trusted Greenspan with the keys to the economy.  During the same time period, Bill Clinton, a Democrat, trusted economist Larry Summers’ advice that deregulation of banking and finance would also lead to continued growth; that was the height of Milton Friedman’s influence.  Barack Obama appointed Summers to be Chairman of his Economic Council despite the fact that his policies were partly at fault for the current economic crisis.  Why do all of these Presidents, from Reagan on the right to Obama on the left, put so much faith in these economists?  Keynes, in The General Theory of Employment History and Money (1935), addressed this question.  He wrote that:

“The ideas of economists and political philosophers, both when they are right and when they are wrong, are more powerful than is commonly understood. Indeed the world is ruled by little else. Practical men, who believe themselves to be quite exempt from any intellectual influence, are usually the slaves of some defunct economist. Madmen in authority, who hear voices in the air, are distilling their frenzy from some academic scribbler of a few years back. I am sure that the power of vested interests is vastly exaggerated compared with the gradual encroachment of ideas.”

The economic policies of the United States have become more and more complex since Keynes’ time.  Over the decades, as the United States left the Gold standard, and created a dynamic economy reliant on the growth of consumption and continuous expansion, we have relied and trusted economists to make it all work.  Most Americans who do not work on Wall Street have trouble understanding even some of the basic terminology and concepts used in finance today.  Many of us learned what a Collateralized Debt Obligation was last year, and discovered how debt was securitized in such complex ways that even some of the old hands in charge of major firms didn’t really understand.  Americans trusted economists to drive our growth, and while many don’t understand the problems we face, they expect economists to create a deus ex machina to miraculously get us out of the recession and onward to unending growth.