The Dull Compulsion if the Economic (vii)
A series of posts by D&S collective member Larry Peterson
(1) Peter Gowan‘s New Left Review (“probably [to me, definitely, LP] the most prestigious Marxist journal in the world”–John Lloyd of The Financial Times) piece on the role of the financial sector in the crisis. A challenging–though not unproblematic–analysis, and a must read.
(2) Contrarian–from a mainstream point of view–trade economist Ha-Joon Chang on the current, and exaggerated (if not somewhat hysterical), fear of protectionism.
(3) Michael Mandel questions recent productivity figures.
There’s been a lot of talk lately about the role of economists in the recent crisis, i.e. whether or not the abject failure of most of them to foresee anything close to the turmoil we are experiencing now, even (long) after bubbles of historic proportions had burst, has somehow accelerated the crisis. For example, one of the most popular econ blogs contains this post today. Last week, I noticed that Nobelist George Akerlof and Robert Shiller (of Case-Shiller housing index fame) had just published a book, called Animal Spirits, in which the authors seem to claim that human psychology provides the key to understanding the most important economic phenomena, including, presumably, the main issues surrounding the present crisis. Of course, this hearkens back to Keynes, who, in an age that witnessed the popularization of Freudian psycho-analysis, emphasized the interplay of psychology and emerging ideas of the macro-economy in a unique synthesis. Like Keynes, their argument is that traditional ideas of economic agency–even today–neglect much of the uncertainty, and, hence, the essential role of sentiment, in the formulation of decisions which inevitably contribute to aggregated economic performance. So far, so good. Of course, human psychology plays a role in economic behavior. And the type of economic models which fail to respect this will be found severely wanting, especially in times of crisis.
But Akerlof and Shiller then seem to take this rather banal point to absurd new heights.
Here I quote from the review of their book I read, from the German business daily Handelsblatt (translations are my own):
All economic crises, in the end, go back to psychological factors. “this view,” the researchers admit, “contradicts standard economic thinking.” So neither monetary policy nor expansion of the banking sector may be the actual cause of the crisis. The kernel of the crisis might rather be the mass-hysteria surrounding real estate that was dominant until 2007. Virtually all Americans seemed to have been convinced that house prices would continue to rise. A classic case of “animal spirits” according to Akerlof and Shiller.
Now I obviously haven’t read the book (it just came out, and I certainly wasn’t asked to review it), and this review, I suspect, is definitely subpar, but I’ve seen enough talk in the financial press about the rehabilitation of Keynes and of animal spirits that I detect that even this lackluster piece fits into a well-worn, and extremely misleading pattern. And, given the fact that economists failed to see the crisis coming, for them to indulge in this sort of myopia is kind of inexcusable. Let me explain what I mean.
This crisis is the result of the intersection of several manifestations of what I call “desperation finance,” in which economic actors squeezed by the unprecedented uptake of billions of new workers in the global economy, but fortified with exceptionally cheap money due to partially political considerations (wealthy countries’ politicians’ political fear of huge unemployment levels that would be the result of anything less than a hyper-accomodative monetary policy), found economic signals confused to an extent never seen before. And this was only exacerbated by a kind of ideological and institutional vicariousness that was itself unique, particularly in a so-called “information age.” So if psychology played a role, it wasn’t due to some kind of pristine irrationality of isolated individuals, but, at least in part to a historically specific insecurity that, in turn, contributed to the development of both perverse and ever-desperate incentives, on a mass scale. So, as real wages stagnated in much of the developed world for a growing majority (especially as outsourcing of labor to the poor world intensified), and responsibility for pensions, health costs and education grew, returns on investments funding the latter needed to grow, and to make up for losses sustained in prior bubbles; and Wall Street was all too capable, in a time of slack regulation that was unprecedented, to seemingly devise the means to meet this need, with much of the returns, for a time, accruing to them. Meanwhile, in the poor world, especially China, social provisioning was being clawed back by states that had to maintain competitiveness (and so had to keep social costs–and budgets–down, even of they had huge foreign currency reserves), and so even poorly-paid workers were forced to save at exceedingly high levels. And retrenching workers in deflation-hobbled Japan and a Germany that had just undergone an expensive reunification also added to the pool of global savings (not to mention exports). So, where global funding was concerned, on both supply and demand ends, you have something a little more complicated than an unprovoked and otherwise inexplicable “mass-hysteria;” in fact, the bubbles are all too explicable, given, as we have noted, the crazy incentives and situations faced by so many, ever-desperate (in spite of undisputed, rising living standards for many in the poor world, which have now, for many of them, now come to an end) people. And, it’s not like an infusion of “animal spirits” will allow, finally, investors to see the hidden worth of assets that remain on banks’ balance sheets; this too, seems to be implied in Akerlof and Shiller’s thesis. More to the point, the level of consumer demand that can survive such a crisis will lag far behind the altogether exaggerated profits expectations generated during a bubble sustained on such foundations, “animal spirits” or no.
Still, Akerlof and Shiller are far more anchored in reality than another Nobelist, Edward Prescott, who actually says the crisis is a result of workers’ forgetting new technologies and working procedures, in a kind of zombie-like reversion to lower working hours. I cannot possibly do justice to how bizarre this idea is, so I’ll quote Prescott directly, in a reposting courtesy of our good friend Brad DeLong:
Economic theory implies that, given the nature of the shocks to technology [i.e., that we occasionally, suddenly, unpredictibly and collectively forget about technologies we knew about two years before] and people’s willingness and ability to intertemporally and intratemporally substitute [i.e.,
that we occasionally, suddenly, unpredictibly and collectively decide that we want to spend fewer hours at work than we did two years before], the economy will display fluctuations like those the U.S. economy displays. Theory predicts fluctuations in output of 5 percent and more from trend, with most of the fluctuation accounted for by variations in employment and virtually all the rest by the stochastic technology parameter…. Theory predicts that deviations [from trend] will display high serial correlation. In other words, theory predicts what is observed…. The policy implication of this research is that costly efforts at stabilization are likely to be counterproductive. Economic fluctations are optimal responses to uncertainty in the rate of technological change … .
This kind of stuff is beneath contempt. But, to use the economic metaphor, the fact that it is taken seriously may act to reduce the level of debate, and to provide respectability to seeming alternatives put forward by people like Akerlof and Shiller (no, I’m not going to invoke the “Gresham’s Law” metaphor).