For a long time economists have been trying to model their studies on physics, with its quantitative approach and predictive value.
This reliance on science has become a fashion among practitioners of other disciplines of humanistic studies, leading to a race in carrying out experiments, using statistics, and turning out stylized, formal descriptions.
A false sense of scientific rigor leads to overspecialization, exhaustive paradigms, and blatant obliviousness to the objectives of humanistic studies.
As these disciplines properly deal with aspects of human life, a formalized description that is universally applicable presupposes a reform of human nature.
Instead of adapting to the complexities of human life, the imperatives of a formal discipline call for a reduction of human life along purely economic principles.
Ethical scruples, a moral code of conduct, restraints and beliefs are considered externalities, inconveniences, interferences.
The life that cannot fit neatly into the paradigm has to undergo a process of adaptation that makes it compatible with economic principles.
An index of the spending on food in your overall expenditures is a measure of your prosperity: the more you spend on essentials like food, the more miserable your life is said to be.
Chinese used to regard the observation “you are putting on weight” as a compliment, but in some countries that condition means you cannot afford a workout in a gym.
Thus the ability to shed unwanted calories is deemed more desirable than the ability to fill an empty stomach.
These obviously ridiculous observations are enshrined in our economics: the slightest degree of drop in our consumption is a cause for concern, not consolation.
Capitalism successfully reduces human life to an art of accumulation, and no where is the art so perfected as in the United States.
But even in that paradise for economic exercise where consumption is king and hypersensitized to credit, the sudden economic slowdown makes some wonder what’s wrong with the economics.
“Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism” by George A. Akerlof and Robert J. Shiller attempts to explain some of the inherent flaws in standard economic principles from the perspective of psychology.
John Maynard Keynes said long-term rational calculation could not account for such economic decisions as opening a mine, building a factory or constructing an office building.
Such decisions “can only be taken as a result of animal spirits.”
In its ancient and medieval Latin form, spiritus animalis refers to a basic mental energy and life force. In economics today it refers to a restless and inconsistent element of ambiguity and uncertainty.
These spirits explain occasional fluctuations in capitalist economy that is believed to be on the whole quite successful.
“People have noneconomic motives. And they are not always rational in pursuit of their economic interests,” say the authors.
The animal spirits partly explain why confidence is so important in the deepening economic crisis.
When the lenders no longer trust the borrowers’ ability to repay, the financial markets freeze, and both consumption and production slow down.
“The two most significant depressions in US history were characterized by fundamental changes in confidence … and the willingness to press pursuits of profit to antisocial limits,” the book observes.
The two depressions occurred in the 1890s and the 1930s.
The lack of confidence is also an important factor leading to the current crisis, thus newspapers and pundits have been calling for restoring confidence for sometime.
This is revealing, because confidence itself implies “behavior that goes beyond a rational approach to decision making,” as the book asserts.
Confidence
Confidence can be created by stories, a figure or an upward tick.
The authors point out that people live by stories.
Our impression of a certain person is always suggested by a couple of stories associated with him or her.
Similarly, when we try to reconstruct our childhood, it is also just the reflection of a few episodes or vignettes.
However unreliable these reminiscences may be, they are still largely innocuous.
But stories are also at the heart of modern financial activity.
There is a myth that people make rational prediction about the future performance of stocks based on data.
In fact, the majority of small investors are inspired by a story of fabulous fortune made by an astute and self-made investor - such stories are always in good supply in a crazy market.
In other words, animal spirits are hard at work.
Cooked books and overbooked profits kite the value of corporate shares, but only when stories of windfalls give way to stories of Ponzi schemes and skullduggery does the tide go out and the nakedness of investing decisions stands revealed.
Journalists have played their role in spinning stories to exploit the gullibility of the masses. They are working harder than ever before now.
When the stock bubble in the 1990s burst, Americans began to move to real estate, as stories began to circulate about fabulous money made by buying and flipping real estate.
Such stories magnify the illusion of creating a lot from nothing, which is very exciting, but “unlike a trip at a normal amusement park, it was not until the economy began to fall that the passengers realized that they had embarked on a wild ride.”
Money illusion
The books also points out that classical economic theories suggest that wages and salaries are set by supply and demand in the job market, but in the real world the decision is also affected by many other factors, such as the perception of fairness.
It is very demoralizing for people to find that they get less than others for doing the same job, and it is hard for anyone to accept pay reductions, even in time of depressions (”downward money wage rigidity”).
As Paul Samuelson assumed in the 1960s, workers would bargain for nominal rather than real wages, because they are subject to money illusions.
On the other hand, employers also fear that people hired at lower wages may resent the perceived unfairness of the pay and thus undermine productivity.
“This simplest theory of unemployment - that firms want to pay more for their workers than what is merely necessary to attract them - seems contrary to common sense,” the book claims.
The authors are right in pointing out the inadequacy of conventional economics in understanding, not to say addressing, today’s economic woes, because they fail to take into account these animal spirits.
But it can be arguable if the book is a break with the tradition.
It is just another attempt at tinkering with existing faith in markets as rational, efficient, self-correcting, with a view to reestablishing a robust capitalist economy.
Given their limitations, we cannot expect the authors to challenge the underlying assumptions of modern economics, as discussed at the beginning of the article.