We Don’t Need “Animal Spirits” to Understand Economics
April 3, 2014
A recently published article at The Week, titled "How can we unleash positive animal spirits into the economy? Change the narrative," provides a clear example of what's wrong with the perception of economics and why modern economic approaches, possibly aiming to amend the shortcomings "identified" by this perception, is at a loss of explaining anything important.
Perhaps the title of the article, written by John Aziz, is sufficiently telling, but let's have a look at the assumptions and assertions in the first couple of paragraphs — and how they apply (if at all) to economics. Aziz begins:
Economics is a tough science. People are complicated — they have different (and unstable) desires, react differently to events, and view the world in different ways. Markets are complex interactions between millions of these different people.
It appears Aziz finds it highly problematic for economics that people have different desires. This is indeed a problem for a science attempting to understand or predict those desires. In this sense, I certainly feel for those psychologists working on such issues. But as an economist, it is hard to get puzzled by the statements. Rather, one feels excitement about the "complex interactions" that Aziz mentions. Yes, that's where it gets interesting — the social phenomena arising due to individuals' actions independently, in concert, and within an institutional framework. Here's where the economics is. So let's see where Aziz takes us from here:
In this respect, understanding the economy requires an understanding of people's motivations. They invest and spend money (or withhold from investing and spending money) to fulfill certain desires and objectives, such as making a profit, building a nest egg, or simply acquiring useful goods and services. Sometimes these economic decisions are rational. Other times, instincts like greed (during an economic boom) and fear (during and after a bust) can cloud our rationality.
This paragraph is at best puzzling. The first sentence makes no sense: why does understanding "the economy" requiring understanding "people's motivations"? It does not follow. The economy does not reflect the motivations, but people's actions based on them. In order to understand what happens to the water when ice melts we do not need to know what the source of heat is. In order to understand the storyline of a novel we do not need to know on what type of machine it was typed or printed. Likewise, we do not need to understand people's motivations to study the outcome of their actions.
Markets go through phases of mass optimism and mass pessimism — booms and busts. John Maynard Keynes called the forces underlying these phases animal spirits, the emotional and intuitive factors that drive economic decisions. They are an unavoidable part of economics, since there are questions that can't be answered in an easily quantifiable way. For example, am I investing in a company selling goods and services that people want? Is the market getting stronger or weaker? Are people feeling more confident about the future or less confident? Will interest rates — which set both borrowing costs and the return on your savings — rise or fall in the future? How about inflation?
More assertions. And they're even stranger this time. Obviously we need to throw in "animal spirits" as they are "an unavoidable part of economics" because they're not "easily quantifiable." It is difficult to make sense of this statement. What does it mean for the study of economics that motivations to the actions that bring about the phenomena we study are not easily quantifiable? And how can it be an improvement or a solution to this supposed problem to assert "spirits" as explanans? This is strange indeed! Not to mention how utterly unscientific such an arbitrary assertion is. (And let's not think about the article's outrageous mixing of Weberian-style "understanding" with "quantifiable" data.)
Let's consult the following paragraph:
Economists have gotten vastly better at addressing these questions than when Keynes was writing in the 1930s; for example, there are now business confidence and consumer confidence indices. But many of the actions we take still depend on gut decisions, for consumers and businesspeople alike.
The power of our animal instincts and the weight of our experience can override rational argument.
At least Aziz here acknowledges where economics went wrong: John Maynard Keynes. Getting "better" here translates to doing more of the type of cheap psychological and mathematical analyses that psychologists and mathematicians would be embarrassed to even consider. And, of course, constructing indices of aggregates of what is not "easily quantifiable" appears to be completely unproblematic to Aziz. Just like the "gut decisions" that we somehow need to understand to figure out the economy.
It is perhaps interesting to understand what sort of "gut decisions" made people purchase blue rather than green sweaters on that one sunny day, but it is rather irrelevant for the fact that quantity demanded of blue sweaters increased and that of green sweaters decreased — and that this caused changes to relative prices, the production structure, etc. Unless, of course, one thinks "understanding" the economy is the same thing as being able to predict and steer it in some specific direction. Unfortunately, many (including, it seems, Aziz — and Keynes) seem to think economics as a descriptive science is somehow not enough (or even, in a strange twisting of words, unscientific) whereas social engineering is the proper way to go to "understand" economics.
One does not need to think about this for more than a brief second to realize that there is something very wrong here, at all levels. It is no wonder that modern mainstream economics fails to explain economic phenomena if economists share this strange perception of what is needed to understand the economy. Mixing cheap psychologizing, indices of the unquantifiable, and a bunch of animal spirits is hardly a recipe for scientific success.
This type of pseudo-scientific drivel is an insipid waste of time at best, but it seems to be very fashionable and appears to be central in how people perceive (and do) mainstream economics. Though, of course, it means absolutely nothing. Sooner or later even the animal spirits will succumb to this fact.