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.
In the United States, and in much of the world that shares aspects of US Business culture, it is common to say the consumer is king. Politicians of parties across the ideological spectrum speak about consumer sovereignty as if it is an ordained right. Neo-classical economists blithely assume the conditions of perfect markets in their theories and models, and proclaim that the consumer is always sane, always correct – and that the actions of many consumers will serve the larger social good. The development of capitalism created the conditions for the development and distribution many innovations that have improved the lives of people around the world. Just think back to the world that your grandparents grew up in, where people who owned an icebox and a radio were considered middle class.
However, today global consumption is on an unsustainable path of growth. Global populations inexorably increase, energy resources decline and become more expensive to obtain by the day, and the ability of the biosphere to sustain the throughput of resources that our consumption requires is diminishing. How did we get here? If the consumer is king, and can do no wrong, how did we move onto this unsustainable path? First of all, regarding consumer sovereignty, it is inaccurate to lay the culpability for purchasing decisions entirely on the lap of consumers. Marketers are adept at creating needs and wants where they did not exist before. We consumers apply meaning to, and use our purchases as a sort of language, or shorthand, to denote status. Governments subsidize and incentivize certain behaviors, like the pervasive subsidies in energy industries. Governments even encourage consumption through monetary and tax policy. So the idea that the consumer is king is problematic. So, the question remains, how did we get to the point where consumption is unsustainable?
We have long treated the resources that come from the Earth not as finite commodities, but rather as our dominion. For example, we charge homeowners for the extraction, delivery, and disposal of potable water, but we do not consider the water itself a finite resource. We have only recently considered what it takes to maintain healthy watersheds, to ensure sustainable water supplies. However, water is essential to the manufacture of most consumer goods. How can the price of those goods not reflect the value of the finite resource, fresh water? When water supplies dry up, water will have to be obtained in the energy intensive process of desalination. Fossil fuel energy supplies, like water, are finite resources. We humans are not good at planning for the long term of future generations. The concept of the Seventh Generation, which originated in The Great Law of the Iroquois, asks whether the decisions made today will benefit descendents seven generations into the future. A home products company that aims to inspire that kind of long-term thinking adopted the Iroquois principle in their name. However, Seventh Generation is a rarity in the business world today. The assumption by many in society today is that resources will never decline, that we will always find a new source or supply to maintain our exponential growth. That thinking is leading us on a path toward decline.
Can we create a new prosperity, one that is sustainable? To do so we will have to consider resource use from a perspective of our collective future, and beyond our individual perspective. For some people, that may mean sacrifice. Both father and son President Bush declared that “The American way of life is not negotiable” when considering how to confront climate change. The problem is that the American way of life, as it stands today, is just not sustainable. Both the government and communities of individuals must create policies, incentives, and actions to promote a new kind of consumption, and a new consumer mindset. We must strive for quality, minimize throughput of resources, and consider the entire life cycle of products, ensuring that materials can be reused or recycled. We must design our communities so that we plan for the long term, and think generations ahead, planning for a future with expensive energy and finite resources. Many of the consumption decisions we make on a daily basis are habits that people don’t consider – we need to design products so that consumers are aware of both what the product provides, and what the cost is. However, it is not enough to buy ‘green’ products, we must reconsider what we really need. To create a sustainable consumption, we will all need to tread carefully and purposely into the future. Otherwise, we consumers will find ourselves unprepared for the future we create.