Animal spirits as a public good27.04.2017
The term ‘animal spirits’ originates from Keynes‘ famous ‘Chapter Twelve’ in his General Theory and plays an important role in understanding the ‘state of long term expectations’. My impression is that most economists use this term in a biased way, suggesting irrationality, and hence convey a negative bias in the meaning. However, Keynes’ original statement is positive, and actually negative in referring to rationality. His point is that economic depressions may reflect the dominance of rational adaptation to certain economic data, so that no economic actor perceives incentives to change the situation. Only ‘animal spirits’ can push the economy out of this dismal equilibrium.
Obviously, people with animal spirits help the entire economic community in breaking through dilemmas of rationality. So, they produce a public good. But doesn’t that mean that their behaviour is rational, from a different angle, namely social welfare? To put it in an almost paradoxical way; would a rational designer of society deliberately install a mechanism that generates animal spirits?
There is no rational designer in making people, but there is evolution. If we adopt the perspective of evolutionary psychology, we might argue that in the course of human phylogeny, our psychological set up was mainly shaped by developing capacities for managing interactions and even cooperation in groups. As I have argued in a paper published more than twenty years ago, therefore we need to check for every argument on human ‘irrationality’ whether it can be explained in terms of adaptations to living in groups. That does not automatically imply altruism, but means that a purely individualistic perspective on rationality is misleading. In terms of economic theory, we need to consider the possibility that certain psychological mechanisms in humans enable us to produce collective and public goods in groups which eventually also serve our own best interests. These mechanisms may contradict narrow conceptions of individual rationality as defined by economics. That is what entrepreneurs with animal spirits do, they help the economic community to get out of a trough of depression, and they might make huge profits from that. But this ‘might’ is the point: They take risk, and may also lose.
Coming back to Kahneman’s book that I already criticized in my previous blog post, we find exactly this reasoning, but without any consequence for his theory. In the chapter on the ‘engine of capitalism’ he writes about the positive role of overconfidence and optimism in driving the market, if not human society, even if that might lead to individually negative outcomes. He cites Dosi’s and Lavallo’s term ‘optimistic martyrs’ here. Well, our modern societies recognize their role, since the institution of limited liability, for some historians the crucial condition of the emergence of modern capitalism, can be straightforwardly interpreted as incentivizing the production of the public good of ‘animal spirits’.
In my 1994 paper, I coined the term ‘evolutionary rationality’ for this alternative approach to rationality. At that time, evolutionary psychology was just in the making. Kahneman sometimes refers to evolution (for example, in the context of loss aversion), but refrains from doing it systematically. But only evolutionary explanations can conceptually undergird any kind of integration between neurosciences, psychology and economics, because there must exist neurophysiological structures that enable certain behaviours that are rooted in human evolutionary history. In my 1994 paper, I already suggested the explanation of loss aversion as a biological adaptation. Kahneman argues that probably loss aversion is important for maintaining social order and the status quo in human groups. Loss aversion vanishes in people who adopt a ‘traders’ perspectives. That is crucial: It implies that the economic conception of rationality is bound to a specific understanding of the market. What is suggested as universal notion of rationality, is just a peculiar kind of rationality bound to the institutional context of markets. We should not adopt this standard to judge human rationality, or, as I prefer, reason, in all other contexts. However, as Keynes’ concept of ‘animal spirits’ shows, even for real world markets this approach may be misleading.
I think that we should discard the opposition between ‘rationality’ and ‘irrationality’. Vernon Smith, who shared the Nobel award with Kahneman, uses the notion of ‘ecological rationality’ as an overarching concept. In many circumstances, violating economic rationality is not irrational, but ecologically rational. We need to understand the underlying mechanisms, and present an evolutionary rationale.
My 1994 paper can be retrieved at:
Herrmann-Pillath, Carsten, Evolutionary Rationality, ‚Homo Economicus‘, and the Foundations of Social Order. Available at SSRN: https://ssrn.com/abstract=950590