Is it possible to talk ourselves into recession? To what extent do our moods affect economic behaviour? These are of course reasonable questions. But listen to this piece on the Today programme. What do notice?
The thing is, the discussion is entirely about consumer behaviour. A moment’s thought, however, tells us that confidence - and especially irrational moods - are more likely to affect corporate spending:
- no individual consumer is big enough to affect the economy. But a few firms are. Extreme pessimism or optimism in a few households, then, is irrelevant - but it might be very important in a few companies.
- There are millions of consumers, whose irrational optimism or pessimism might well cancel out. However, there are a few dozen large corporations that really matter for the economy, and there’s less reason to suppose the decisions these take will cancel out, not least because bosses have similar backgrounds and outlooks. As Chuck Prince, ex-CEO of Citigroup famously said, “as long as the music is playing, you've got to get up and dance.”
- Bosses are selected for over-confidence and conformity. This makes it more possible that bosses’ mistakes - either too optimistic or too pessimistic - will be correlated, and thus that mood swings might affect the economy.
Two facts corroborate these suspicions.
First, economists find it much harder to forecast capital spending than consumer spending. Since 2000, the average error (regardless of sign) in January’s forecasts for that year’s consumer spending growth has been 1.1 percentage points. The average error in forecasts for investment growth has been 2.7 percentage points. This suggests that conventional models - which focus upon observable factors such as interest rates and incomes - go more wrong in forecasting corporate than consumer spending. Which is a sign that perhaps corporate spending, more than consumer spending, is prone to swings in “animal spirits.“
Secondly, the behaviour of a small minority of firms determines whether we get recession or not. In the 1989-91 recession, 10% of firms accounted for 80% of the gross fall in sales and 85% of the gross fall in employment.
All of which raises the question. Why, given all this, should anyone discuss the role of mood and confidence solely in the context of consumer spending?
I fear there’s an ideological bias at work - which is all the more pernicious for being subconscious. I mean this in two senses.
First, there’s a reluctance to think of boardrooms as being driven by sentiment, psychology and mood. Journalists at least - even now! - think of “senior people” as being hard-headed experts, and only consumers as being ignorant and irrational (when Peter Lunn rightly disputed the latter I suspect he was going off piste).
Secondly, there’s a reluctance to acknowledge the role of power in the economy. Yes, consumer spending is determined largely by people’s wages and employment security. But what determines those? And what if the decisions that do so are systematically irrational or ill-informed? These are questions which are not to be asked. And in not doing so the BBC helps to avoid capitalists’ power and rationality from falling into question.
On the other hand if the Government and lots of economists and bankers say everything must be cut and there is an "inevitable" depression coming worse than the 1930s, business men might conclude that they should stop investing. And they would be right although they are helping to apply the self fulfilling prophecy. What I want to know is why the world ruling class have convinced themselves that there is an "inevitable" collapse on the way culminating in the fall of western civilisation to the rest of the world. Maybe they should DO SOMETHING constructive rather than wait around for the fall of Civilisation? Also far be it for me to defend BAE but if the State buys less munitions for example it will be necessary for firms that make munitions to sack workers and scrap capital. That is a rational response to demand falling and the result of political choices. Once a few of the big firms selling to the state have to cut back thats Investment knocked on the head. Less sales means less profits. So less Investment. That is no different to workers spending less as they fear unemployment is coming. Nothing irrational for the specific firm or worker.
Posted by: Keith | October 07, 2011 at 08:08 PM
well we talked ourselves into an unsustainable consumer boom ...
Posted by: Dipper | October 07, 2011 at 09:25 PM
... and why do commentators ignore any international perspective.
Our economy has been imbalanced, sucking in imports at an unsustainable rate. We need to rebalance, stop consuming as much, and export a bit more. Unfortunately the rest of the world isn't growing so we are stuck until the rest of the world picks up.
Having another drink may get rid of the symptoms of a hangover, but we all know that in the long term that isn't the answer.
Posted by: Dipper | October 07, 2011 at 09:29 PM
This is even more telling considering that there is a Tory-led coalition in power, which supposedly should be more in tune with execs...
Anyway, Chris, isn't this contraddicting something you posted last week about the income elasticity of consumer spending being lower than that of investment? If it is true that animal spirits are more pernicious for investments decided by execs than for consumers then the income elasticity of investments (due to further corporate tax cuts) should be nevetheless lower than the income elasticity of consumer spending...
Anyway, animal spirits are for people that can afford to hold on spending plans...and certainly those in power have more slack than ordinary citizens nowadays.
Posted by: Paolo Siciliani | October 08, 2011 at 12:43 PM