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!

–Polly Cleveland

Magic Mushrooms

It had been a rainy summer in Colorado. No surprise to find mushrooms as we hiked the Andrews Glacier trail in Rocky Mountain National Park. But these mushrooms! Three inches across, deep crimson with white splotches, glowing in the mountain sunlight! Amanita muscaria, the original deadly toadstool, the mushroom of fairytales, Alice in Wonderland’s mushroom. Not truly deadly—and safe to eat boiled—muscaria contains a psychedelic compound called muscimol.  Siberian shamans took muscaria to induce religious visions. Muscaria extract may have been the Soma of the Indian Rig Veda.

I first learned of psychedelic compounds in 1966, in a thrilling economic botany course taught by Richard Evans Schultes (1915-2001). I can still recite the Latin names of dozens of useful plants. In the lab, supervised by Schultes’ student, Homer Virgil Pinkley, we extracted caffeine from coffee beans, made soap, paper and perfume and examined specimens in the Harvard Botanical Museum. Schultes himself, now known as the “father of ethnobotany” had spent over twenty years in the 1940’s and ‘50’s living among the natives of the Amazon, studying their use of plants, including hallucinogens. He collected thousands of medicinal plants, some of which were named after him. He published nine books, including Plants of the Gods: Origins of Hallucinogenic Use, 1979, with Alfred Hofmann. I didn’t know it at the time, but Schultes’ research set off the psychedelic revolution of the 1960’s and ‘70’s. Schultes, proper Bostonian that he was, kept his distance. Schultes also first sounded the alarm about the destruction of the Amazon rain forest.

In 1970, I moved to Berkeley with my ex. I grew my hair long and stringy, kept two dogs, four cats, two chameleons from Israel, an African spiny lizard, a gorgeous brown and cream banded Sonoran kingsnake, and a three-foot spectacled caiman. The caiman was a gift from the laboratory of Alan Wilson, where it provided blood samples for research on the DNA clock—until it outgrew its tank. I kept my toothy little pet in the bathtub, and fed it surplus mice from the lab.

I also read Carlos Castaneda’s The Teachings of Don Juan: A Yaqui Way of Knowledge and its sequels. It was an enthralling account of anthropology student Castaneda’s experiences with a Mexican shaman, an account that expanded from a sober report to a poetic vision. I never actually tried any mind-altering substances. Not for lack of opportunity, but more from a sense that if I concentrated, I could find other ways of seeing, just around the next corner.

And I did find a new vision, a vision of social justice. In 1970 my ex and I worked in Ralph Nader’s project on Power and Land in California, studying how large landowners induced government to enhance their land values, notably by building unnecessary water projects. In the process, I encountered Henry George’s Progress and Poverty (1879). Now there was an eminently practical vision: social justice to arise from taxing the unearned income of wealthy property owners and untaxing the wages of the poor. That was the vision that sent me to grad school in economics, inspired my dissertation on inequality, and has kept me active ever since. No mushroom could do that!