Why do Chinese save so much and Americans so little? Why are financial prices so volatile? Why does real estate boom-and-bust repeatedly? Why are women and minorities more likely to be poor?
These are the last four "big questions" that Nobel Prize-winning economist George Akerlof and co-author Robert Shiller address in their new book Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Some of their answers will seem obvious to many progressives, but the answers are still economic heresy.
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Animal Spirits, Part III - Saving, Stock Prices, Real Estate, Minority Poverty
This week, Morning Feature explores Akerlof and Shiller's new book Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Wednesday we considered their rebuttal of the myth of the Rational Economic Actor. Yesterday we examined their answers to four "big questions" of recessions, banking, unemployment, and inflation. Today we look at their other four "big questions" of savings, investment volatility, real estate cycles, and minority poverty. Tomorrow we'll conclude the series with a critique of their theory.
Economic theories that assume we're Rational Economic Actors struggle to find answers for obvious anomalies. The fundamentals say we should save for unexpected expenses and our retirements, yet most Americans have net zero savings. Most corporations' assets, liabilities, and profits are quite stable day-to-day or month-to-month, yet short term stock prices remain unpredictable. History shows real estate is a marginal investment that only barely exceeds inflation, yet the real estate market sees periodic booms followed by inevitable busts. We're four decades out from the Civil Rights Act, yet women and minorities are still far more likely to be under or unemployed and struggling with poverty.
Technical explanations, once you wade through the jargon and equations, read more like excuses and denial than analysis. Akerlof and Shiller argue that only by understanding our animal spirits - individual and cultural impulses that drive our intuitive reasoning - can we explain these phenomena. The authors' answers probably won't surprise most progressives. What's surprising is that their answers remain at the fringe of contemporary economic theory.
Four more "big questions."
Yesterday we looked at Akerlof and Shiller's answers to the questions of why economies fall into depression, why central banks have power, why some can't find jobs even in a good economy, and why there is a long term trade-off between unemployment and inflation. Today we turn to the last four of their eight "big questions."
- Why is saving so arbitrary? Saving is not only important for individuals - to have a "rainy day fund" for unexpected expenses, and for retirement - but also for nations. Nations that save have a larger pool of capital to develop and maintain their potential. As recently as the early 1980s, Americans saved an average 10% of our incomes. Now we save an average 0%. The authors say the fundamentals haven't changed (I disagree somewhat), yet our behavior obviously has. They attribute that to a cultural change, shaped by stories that celebrate spending even in debt. Advertisers so often equate spending with "freedom" that whipping out the credit card becomes a patriotic act. Studies show Americans are more likely to buy an item, and to spend more for it, if shown a credit card (not their own). We know we should save - 76% of Americans say they save too little - but our culture of consumption trumps reason.
Note: I disagree somewhat with the authors here. The fundamentals of saving vs. consumption have changed, or at least our perception of them has. Saving requires some confidence in our exposure to risk. When our risk feels too high - when we almost daily hear stories of colleagues, family, and friends whose life savings were wiped out by an ordinary bad event like a job loss, illness, or injury - we have less incentive to be frugal self-investors. Bad events happen to everyone, and if we perceive that saving merely pushes back an inevitable collapse by a few weeks, why not enjoy the money while we have it? Most of us don't calculate this formally, but we do reason it through at an intuitive level. Still, this may be less a change in fundamentals than another story-explanation.
- Why are financial prices so volatile? Here the authors look at the wide variability of stock and other investment prices. The key, for them, is not merely that these variations can't be predicted, but that conventional theories can't explain them after they happen. Not even feedback-based models reproduce the same wide swings. The authors argue the technical variations are so magnified by mass psychology that investment markets are chaotic - not just disruptive but destructive - unless carefully and sensibly regulated.
- Why do real estate markets go through cycles? In this chapter the authors debunk the oft-repeated canard that "real estate can only increase in value." It's a persistent story because it feels as if it should be true. Land is basically inelastic in supply, and population growth implies increasing demand, thus it seems like prices should always increase. But they don't. Historical analysis shows residential real estate price growth barely exceeds inflation - 0.9% annual gain over the last century - well below the average 3.4% annual GDP growth since 1929. But unlike the price of most items, we tend to remember what we paid for a home decades ago. We look at the total increase, don't devalue it for inflation, forget past real estate collapses, and buy into the periodic stories that real estate is the path to personal wealth.
- Why is there special poverty among minorities? Over 40 years after the passage of the Civil Rights Act forbidding discrimination based on race and sex, women still earn only 68 cents on the dollar as compared to men, and the poverty rate among African Americans is three times that of whites. Black unemployment is double that of whites. And for Native Americans the statistics are even worse. Akerlof and Shiller refute the neoclassical technical explanations - which seem to me merely denials and excuses - and place the blame squarely on racism and sexism. Stories of white male superiority hurt women and minorities in two ways: they fuel intentional or negligent discrimination, and they cause too many women and minorities to give up. The authors reject claims that affirmative action is no longer needed, insisting such programs not only help to limit discrimination but tell a much-needed story of hope: "We're trying to correct past mistakes."
Most of the authors' answers to these four questions may not surprise progressives. The answers may even seem absurdly obvious. Yet these answers are heresy in neoclassical economics. Those seeking explanations for why so many supposedly brilliant economists overlooked the oncoming train wreck of 2008 need look no further than that fact: neoclassical economic theory treats ordinary human behavior as heresy, insisting we are all Rational Actors conducting transactions in transparent Efficient Markets. The Reagan Revolution replaced common sense with conservative fantasy.