One of my favourite theories about the long post-war boom is that wage inflation was low in the 1950s despite full employment because workers remembered the Great Depression of the 1930s and so were too scared to exploit their bargaining power to demand higher wages. However, as those who remembered the 30s retired to be replaced by those who had only known full employment, wage militancy increased in the 60s and 70s.
It is, however, not just workers who can be cowed by memories of hard times. So too can be stock market investors. Ulrike Malmendier and Stefan Nagel have shown (pdf) that Americans who experienced recessions in their formative years hold fewer stocks and more cash than those who experienced better times even decades later. Other research (pdf) has found that much the same is true of Europeans. What’s more, those scarred by recessions tend to hold more value stocks and fewer growth ones.
In fact, it’s not just bad economic experiences that have a scarring effect on risk attitudes. Alessandro Bucciol and Luca Zarri have found that people who suffered the death of a child or natural disaster are also more risk averse years later.
All this is consistent with Hyman Minsky’s financial instability hypothesis (pdf) – the idea that economic stability is inherently destabilizing. Traders who have only known good times are likely to take on more risk, thus increasing financial fragility. And when the bust comes, it increases risk aversion thus giving us a period of financial stability which eventually increases appetite for risk. And so on.
Other research by Professor Malmendier corroborates this. She’s found that banks (pdf) that were under-capitalized and fragile many years ago operate today with higher capital buffers. Organizations can have memories as well as individuals.
It’s not just financial investments that are affected by such scarring. So too are non-financial ones. Still more research by Professor Malmendier has found (pdf) that “CEOs who experience the Great Depression early in life display a heightened reluctance to access external capital markets.” I find it plausible that the 2008 crisis has increased firms’ desire to hold cash and dampened their willingness to invest.