Akerlof and Shiller Heart Higgs?
By Arnold Kling
George A. Akerlof and Robert J. Shiller do not come to praise mainstream macroeconomics.
Keynes’ followers rooted out almost all of the animal spirits…that lay at the heart of his explanation for the Great Depression…They…minimized the intellectual distance between The General Theory and the standard classical economics of the day.
This is from the preface of their forthcoming book, Animal Spirits. The most surprising passage is on page 70:
Economic historian Robert Higgs concludes that in the United States, “Taken together, the many menacing New Deal measures, especially those from 1935 onward, gave businesspeople and investors good reason to fear that the market economy might not survive in anything like its traditional form and that even more drastic developments, perhaps even some kind of collectivist dictatorship, could not be ruled out entirely.” Such worries drove business investment to very low levels and brought corporate plans for expansion to a standstill.
Otherwise, I would not count on the authors finding much common ground with Higgs. I will offer a Masonomist perspective on the book.Keynes used the term “animal spirits” to describe the irrational motives of entrepreneurs, who make risky investments in an environment in which the probability distribution of returns cannot be known. Akerlof and Shiller (henceforth AS) use “animal spirits” as a broad term to describe any motivational force that leads people to deviate from pure rational calculation.
One important component of animal spirits is confidence. Trade among strangers and long-term investment require confidence. AS seem to believe (as do I) in a Minsky-esque model, in which investor sentiment goes from wariness to confidence to over-confidence. In the over-confident phase, bubbles emerge. When a bubble pops, people revert to wariness.
Another component of animal spirits in the AS formulation is what they call corruption and bad faith. On p. 26, they write,
But the bounty of capitalism has at least one downside. It does not automatically produce what people really need; it produces what they think they need, and are willing to pay for…if they are also willing to pay for snake oil, it will produce snake oil.
I would suggest substituting “representative democracy” for “capitalism” and “vote” for “pay” in the preceding passage.
In fact, for all of the eclecticism that Akerlof and Shiller demonstrate, they utterly fail to mention public choice theory. Instead, their model of government is the shockingly naive metaphor of a parent. In the preface, they write,
The proper role of the government, like the proper role of the advice-book parent, is to…give full rein to the creativity of capitalism. But it should also countervail the excesses that occur because of our animal spirits.
AS believe that government paternalism is justified. They point out that people are not equipped to choose investments wisely or to save the correct amount. I will grant that this is true. That means that people should outsource their decisions to those who are wiser. In fact, we tend to do that. Many people invest using mutual funds, for example. The question that AS need to answer is why people should be compelled to follow the financial advice of government officials. What makes government officials immune from overconfidence, corruption, and susceptibility to stories? In fact, if government officials are the repositories of investment wisdom, why are state and local pension funds in such dire straits? Why do we have a Medicare program that is unsustainable?
One element of animal spirits in the AS depiction is the creation of stories. On page 89, they say that the initial story that people told themselves about mortgage securities is that they were a superior form of risk management.
But then the story changed. The new story…suggested that securitization and exotic derivatives could be nothing more than a new way of selling snake oil.
If mortgage securitization is snake oil, then it was snake oil that was patented and marketed by the U.S. government. Government agencies and government-sponsored enterprises established the mortgage securities market.
Recall what I wrote in my essay on Masonomics:
The Chicago economist says, “Markets work. Use markets.”
The MIT economist says, “Markets fail. Use government.”
The Masonomist says, “Markets fail. Use markets.”
In the end, AS have written a book that represents the MIT point of view against the Chicago point of view. They write as if a transfer of power from markets to government implies taking decisions away from imperfect individuals and giving the authority to an omniscient, benevolent agency. Masonomics, with its strong background in public choice theory, rejects the model of government as benevolent. And with our grounding in Hayek, we cannot regard government as omniscient.
I can agree with AS in terms of much of their description of financial crises and their consequences. I share their rejection of mainstream economics and the pure Chicago school. However, their utter failure to address the Masonomics alternative means that they have made no headway in persuading me of the value of their prescriptions.