I held off on buying any of the ‘oh no’s, a financial crisis, everything we thought we knew is wrong’ books, right until I came across George Akerlof and Robert Shiller’s “Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.” Akerlof’s work on asymmetrical information in markets (including finance) garnered a Nobel in 2001, while Shiller has been a bulwark of behavioral finance for years, publishing “Irrational Exhuberance,” a critique of the efficient markets model and a warning against the stock market bubble at its height in 2000. In addition, unlike the quick-turnaround financial manifestos that fill Borders bookshelves, Akerlof and Shiller apparently spent five years working on Animal Spirits.
So it is with great sadness that I report Animal Spirits brings very little to the table. The book is pitched as a battle against orthodox economics – represented by Milton Friedman – but the authors have appeared too late for the festivities. If they stopped by Friedman’s backyard, U of Chicago, they would have found the authors of “Nudge,” an earlier (and superior) book on behavioral economics and its implications on policy. In addition, they likely could have saved themselves some time and set aside the chapter on sticky wages and prices — or at the very least not pretended that they were presenting new ideas.
The authors’ points are generally shrug-inducing, nothing controversial or novel. The only thing inciteful about the work is the offense use of anecdotes and wanton speculation. For instance, the authors spend a great deal of print detailing how the 1920s were a period of disrespect for the law and violation of prohibition, which – viola – led into the Great Depression. If you think the connection of speakeasy’s with banking failure is tenuous, just wait, as Akerlof and Shiller proceed to associate the shifting post-depression economic tides with cultural change, as represented by the growing popularity of bridge:
By 1941, the end of the Great Depression, a survey by the Association of American Playing Card Manufacturers revealed that contract bridge had become the most popular card game in the country, and that 44% of U.S. households played it. Contract bridge is a game played by partners, who must cooperate-a social game that from the beginning was frequently recommended as a way to make friends or even find a beau. It was recommended as a means of learning social skills (though the game occasionally ended friendships or caused divorces). Contract bridge has only rarely been played for money.
Yet in the first decade of the twenty-first century contract bridge is in serious decline, viewed as a game for the elderly, with few younger enthusiasts. In contrast, in recent years poker-and especially its twenty-first-century variation, Texas hold ‘cm-has surged forward. These games are played by individuals for themselves alone, emphasize a type of deception variously called bluffing and “keeping a poker face,” and are generally played for money.”
Wow, you see where this is going. Apparently, our economic futures are tied to our preferences in card games! Thankfully, the authors conclude the baseless narrative with, “Of course we know there may be no link between what is taking place at the card table and what is taking place in the economy. But if card games played by millions of people shift the role of deception, wouldn’t we be naive simply to assume that such shifts do not also occur in the world of commerce?”
This method of argument dominates most of the book:
1. Begin with your understanding of the causal factors of X. The vaguer the language, the better.
2. State that standard theory doesn’t take into account your great findings. (Note: You may have to ignore actual standard theory; a good method is to ignore all literature and popular thought in the past 25 years; as a bonus, your target will likely not be alive to defend himself from your charges.)
3. Cherry-pick a cultural component (game, literature, random editorial) you can work into your narrative.
4. Incorporate component into your narrative.
5. Tack on disclaimer saying that clearly the examples in the narrative are just symbolic of your greater theory (protecting you from criticism).
6. State that you have just proven that your factors caused X.
7. State that your understanding is correct because, “You pick the time. You pick the country,” and you can do steps 1 through 6.
For another example, the recession at the close of the 19th century is described in light of the Wizard of Oz, which was published contemporaneously — “These and other images stay with us as symbolic testimony to the importance of some of the elements of our theory of animal spirits.””
And once more, the authors tack on a disclaimer and a splash of speculation into a section on the Depression:
We have no way of measuring to what extent such patriotic appeals for the willful reassertion of confidence helped ameliorate the Depression. We do know that when the British economy began to recover, the improved situation was attributed to such efforts. According to the venerable businessman and civil servant Lord Meston, “The real secret of our emergence from the trough of depression was that men and women in business had made up their mind to mind their own affairs and to make the best of them. This had kept trade and commerce honest and clean and had maintained a buttress of British credit and probity.”
This writing style reeks of, “We have no way to know whether Barack Obama is a Muslim. We do know that he has spent time in Muslim countries, and that some popular pundits think he could be a Muslim, but we admit we can’ t be sure.” Apparently, simply tacking on the disclaimer that you can’t really know excuses cherry-picking evidence that supports your cause and speculating wildly.
But it’s no fun without an enemy, so Akerlof and Shiller explain that orthodox economists simply don’t get it, insisting that “businesspeople and economists have always had trouble understanding the idea of an overheated economy,” which they describe as “a situation in which confidence has gone beyond normal bounds, in which an increasing fraction of people have lost their normal skepticism about the economic outlook and arc ready to believe stories about a new economic boom.” Setting aside the bloated language, is there anyone who doesn’t believe that Dutch bulbs were the subject of such overconfidence in the 17th cenutry, or tech stocks more recently? In the age of Pets.com, I am not quite sure who exactly the authors are arguing with.
The problem has never been “understanding the idea of an overheated economy,” the problem is how to mitigate the busts (presumably through dampening the booms). We have not figured it out, and Akerlof and Shiller, unfortunately, have little to say about how to do so. They instead have focused on confidence, fairness, corruption, and money illusion as the core of the animal spirits, and spend their pages explaining how each was present at economic recessions, generally through the employ of poor metaphors and anecdotes. Suffice to say, I didn’t find it very illuminating, and it certainly failed to advance the discourse.
I also found something off-putting about the book. Perhaps it was Akerlof adding a personal note to a section of social security, explaining that while serving as an advisor to then-Presidential candidate John Kerry, he argued for Kerry to more vociferously support social security during the campaign, and concluding the tangent by stating that Kerry would have won the election had he done so. Or implying that the decline in savings is associated with the rise in credit card use before adding yet another disclaimer that they actually don’t correlate very well, but in some ways we’ll never know, and regardless they “reflect aspects of American identity that must also he a major factor in the low and declining saving rate.”
Or perhaps it was the slightly off comparative history of the Toyota Motor Company and Industrias Kaiser Argentina (an auto company founded in Argentina). The utter certainty with which the authors speculate on the cultural identify of Argentinean line workers in the 1960s and how this translated into their company’s failure is astounding. Just as quickly then, the authors move on to explain how it feels to be poor and black, versus poor and white. Apparently, white poor people, as compared to black poor people, are “more concerned with money, than those who are higher on the social scale. This is the life that they have chosen, and they are responsible for living with it. ‘T’heir view of the world is, remarkably, a page out of Milton and Rose Friedman’s Free to Choose.”
I kid you not, Akerlof and Shiller are equating the typical poor white person with Friedman’s ubermensch. I am not sure how this equates with being anti-immigration, anti-free trade, pro-union. But I guess those are different poor white people.
Akerlof and Shiller are aware they are sensitive to attacks, because, in their eyes, “Most economists don’t like these stories of psychological feedback. They consider them offensive to their core concept of human rationality. And thev are dismissive for another reason: there are no standard ways to quantify the psychology of people. Most economists view the attempts that have been made thus far to quantify the feedbacks and incorporate them into macro models as too arbitrary, and thus they remain unconvinced.”
I take exception to that. I am fairly sure that most economists understand the important role of psychological feedback, and I doubt there are many who believe wholly in Akerlof and Shiller’s definition of “human rationality.” I am dismissive of this work because when it is right it is redundant, and it takes advantage of the fact that there are “no standard ways to quantify the psychology of the people.” The authors seem to luxuriate in the freedom that comes with no standard of academic rigor.
Behavioral economics has already given us some important lessons on how to correct for our psychological quirks on a microscale; some of which Akerlof and Shiller mention. We have not figured out how to mitigate panicked financial epidemics, and it is specifically here where Akerlof and Shiller fail to deliver the goods. All they have to offer is, “We then need to take stock. We need to realize that the stories people tell themselves about the economy exaggerate. There is a new need to protect them from these exaggerations. It requires a renewal of the view that financial markets require regulation.”
What sort of regulation? It is never specified. All we are told is that people can act irrationally in a market, so the government should regulate the market, and it hasn’t done enough in the past. That’s all we got.
They proceed to criticize their caricature of orthodox economics:
The story of the “invisible hand” and its consequences gives surprisingly detailed prescriptions regarding the role of government, even pertaining to questions of great specificity. But now people arc asking these questions anew. Here is a small sampling: How can we allow people of varying abilities and financial sophistication to express their preferences for investments without making them vulnerable to salespeople selling “snake oil”? How can we allow people to take account of their deep intuition about investing opportunities without inviting speculative bubbles and bursts? How can we decide who should be “bailed out” and when? How shall we handle cases of individuals and institutions who have been victimized and wronged? What should be the capitalization of banks? … The old answers to these questions seem not to be working. Everywhere that economists and their ilk mingle we see them reaching for new answers.
This book cannot give the detailed answers to these questions. It is our contention in this hook that the working of the economy, and the role of government in it, cannot be described solely by considering economic motives. Such description also requires detailed understandings of confidence, of fairness, of opportunities for corruption, of money illusion, and of stories that are handed to us by history. So the answers to these questions require much more information than could be contained here. However, this book does give us the background story within which all of these answers should be worked out. And it also stresses the urgency for setting up the committees and commissions to develop the reforms in financial institutions and the regulations that are so immediately needed.”
And so they finally tell you. Hundreds of pages later, you learn that they actually won’t be answering any questions in this book. (Unless you didn’t know that bubbles were related to overconfidence, and crashes underconfidence.) They give the reader a pat on the back and tell him to bare in my confidence, fairness, and corruption, and any other ‘animal spirits’ that might cause people to act irrationally.
This has been a long post as rambling as the book it criticizes, but I’ll add that I only felt compelled to write this review because I held such high expectation of this book and its authors. Behavioral economics is an exciting field with much to offer as we consider how best to model our 21st century financial institutions. Akerlof and Shiller have unfortunately added very little to the conversation.