Animal Spirits, by Akerlof and Shiller

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, by George Akerlof and Robert Shiller, 2009

Yale Prof. Robert Shiller, author of Irrational Exuberance (2000; 2005), predicted the 2008 financial collapse years before it happened. The Case Shiller Home Price Index, founded with his partner, Wellesley Prof. Karl Case, had shown an unsustainable explosion in housing prices. However, few took them seriously.

Last year, Shiller partnered with UC Berkeley Prof. George Akerlof to produce Animal Spirits–elaborating on the psychology that inspires “irrational exuberance” and other mass human behavior that affects the economy. The book responds to the “rational expectations” model–the claim that markets, freed of government intervention, will solve all economic problems because on average people understand and act rationally in their own self-interest. This model, associated with the University of Chicago and Milton Friedman, has dominated conservative thinking since the Reagan administration. Opponents now blame the model for lax regulation that allowed the crash of 2008.

The book is both engaging and disappointing. Engaging in its application of the new field of behavioral economics to puzzles such as “involuntary unemployment.” Disappointing in that ultimately it offers only tired old pop Keynesian policy prescriptions for the economy.

Akerlof and Shiller identify five classes of shared thought patterns affecting economic behavior. Sharing is key: people feel tremendous pressure to adopt the views of their associates, or of groups to which they feel attached.

The first pattern is confidence in the future–or lack thereof. This is what John Maynard Keynes called “animal spirits”: the enthusiasm or pessimism driving investors. According to the authors, overconfidence spurred excessive and foolish investment in the housing markets; loss of confidence caused credit to dry up.

Then there’s the sense of fairness. One of the startling revelations of experimental economics is that people in any society will actually incur costs themselves to punish someone they view as acting unfairly. Fairness also explains why, in hard times, employers will lay off some workers rather than cut wages–workers, perceiving a wage cut as intrinsically unfair, would become angry and unproductive.

There’s corruption and bad faith. The euphoria of a boom also brings out what the authors call the snake oil salesmen–the Bernie Madoffs and their ilk. In fact, every recession or depression brings out scandals.

There’s “money illusion.” Unless inflation is rampant, people don’t notice; hence they take wage increases as deserved. Which is why they see wage cuts as unfair. The authors convincingly demolish the Chicago school argument that people accurately anticipate inflation, so that it doesn’t matter.

Finally, there are shared stories. The most famous American story is of course the Horatio Alger rags to riches story, which still attracts immigrants from around the world. But there are negative stories too. The authors cite the classic sociological study of poor urban African Americans, Tally’s Corner by Elliot Liebow, to illustrate how a story of unfair treatment can trap men in self-destructive patterns. The authors argue for strong affirmative action to counteract this story.

But in the end, the authors come up with a model as much divorced from “reality-based” economics as the “rational expectations” model they attack. It is a model in which unpredictable shifts in public opinion can jerk the economy around independent of reality. Therefore, strong Keynesian intervention–ie “stimulus spending”–can create a “confidence multiplier” to get the economy back on track.

An alternative model holds that, yes, animal spirits do affect the economy, often destructively as when the recent real estate bubble stimulated overinvestment in housing, together with a failure to save. Public policy should redirect this energy to more productive channels. That includes taxing land values to dampen the bubble, and limiting overextension of bank credit against inflated values. That also includes untaxing labor–especially lifting the Social Security payroll tax on low wage workers–to liberate small business.

Overall, Animal Spirits makes a fascinating read–but beware the policy snake oil!

1 comment to Animal Spirits, by Akerlof and Shiller

  • pat aller

    Thanks, as always, Polly, for polishing my brain. I read both the monopoly capitalism & animal spirits reviews.

    Will Lissner was writing about monopoly capitalism when I began at Schalkenbach Jan 1980. Your examples are horrendous, but look at the smaller ones, Duane Reade eating up any other drugstores; all the breakfast cereals costing the same (I use Fairways organic oats by the bin). Certainly The End of Poverty? film showed how water monopoly in Cochabamba (Bechtel, mostly), fish pond monopoly in Kenya (an Arkansas firm), & other sins lead to immediate scarcity & impoverishment & desperation.

    Off the subject, RSF sent me, when I ordered some other things, the two AJES book issues devoted to the 6th & 7th annual conferences of the International Society for Universal Dialogue. In case you haven’t read them, ISUD is composed of philosophers seeking world peace. They’re not total unknowns; president during 6th conf is head of philosophy at Queens College. 7th conf president is Russian, now at Fort Valley State College, GA (US GA, of course). Writes redundantly.

    I’ve nearly finished both tomes, quite interesting if idealistic beyond belief. Much tribute to Kant, also to post-modernists, especially Habermas & someone I didn’t know, Apel. Peace involves respecting all of our world, including animals & plants & rivers & mountains, whatever. Makes sense, to a degree. Since 7th conf was held in Hiroshima, much is made of what can happen when we don’t respect or try to understand the other. While I’d like to see one of these guys (few are women) at a UN session trying to agree on a simple statement or document, their ideas are noble.

    At any rate, if you lack for something to read at the beach, mountain, lake, kitchen, try these. The first is more illuminating, but the final essay in the 7th tome, on transculture, is both loopy & inspiring. Progress! Hi to Tom & the families, pat