Optimism is vital for economic growth

The role of sentiment in financial and economic life can never be over-stated

Is every financial decision, every investment, a roll of the dice?

Is every financial decision, every investment, a roll of the dice?

Tue, Aug 27, 2013, 11:27

The role that sentiment plays in financial and economic life can never be over-stated. The formal modelling of expectations is central to what most macroeconomists do. Any investment, of any kind, from buying stocks and bonds to getting a mortgage depends, for the most part, on how we feel about the future.

Our ability to forecast the future is, in the opinion of this column, roughly nil. That immediately sets up a fundamental paradox: if we don’t know anything about the future, how can we possibly justify – or simply explain – investing in it? Is every financial decision, every investment, a roll of the dice? Or just delusional? The sense of paradox is deepened when we realise that without investment, lots of it, there can be no economic future. None at all.

Investing in the future only got going, in a serious way, in the middle of the 18th century. That was when financial markets came into being in a meaningful way and a proper system of connecting borrowers and lenders took off. Prior to that time it is striking to observe just how much per capita global growth there was from the stone age to the early 1700s: none at all.

That statement that often raises both eyebrows and questions, not least of which is how do we know what growth was thousands of years ago? But to the best of our limited knowledge, the world was a very Malthusian place, which meant that when growth did occur, the population quickly expanded to keep per capita incomes roughly equal. And when recessions occurred, the population shrank – died – to make sure things were kept on an even, subsistence based, keel.

Around 250 years ago, something odd happened: the simultaneous inter-related developments that came to be called first, the industrial revolution and, second, capitalism. One could not have happened without the other. Historians still argue over why all this took place.

Fundamentally, people discovered a way of systematically investing in their financial futures and did so, on a large scale. The availability of this capital helped fuel technological innovation and created the very new phenomenon called sustained economic growth.

Those original investors all believed they could at least believe in the future and probably also thought they could forecast it. Whether or not this was delusional, it displayed a very important driver of economies, both then and now: optimism. Without it, we are sunk.

Today, it is very fashionable to be a pessimist. With good reason, I can hear people say. The lingering effects of the banking bust are enough to leave anyone feeling miserable. Leading economists are publishing papers describing the last 250 years as being both unique and over.

Technological pessimists argue that inventions like electricity and the steam engine are unrepeatable; climate change worriers cheer when they hear the reasons why economic growth was a relatively short-lived aberration.

Writers of financial market newsletters are universally gloomy, often apocalyptically so: debt is everywhere and will soon sink the world. One famous fund manager has bought a lot of gold along with barbed wire and guns to defend himself during the coming global debt implosion.

Social media has rightly received a lot of attention for its darker side. Bullying and other forms of abuse are painfully obvious. But another shadow cast by the on-line revolution is the way it amplifies current moods by giving voice to those who seem to have the strongest feelings.

This columnist has been struck by how negative the mood is out there: is social media taking a kernel of truth (the very good reasons to feel less than cheerful) and amplifying it out of all proportion?

Of course, impressions from reading Twitter threads and comments at the end of on-line articles hardly amount to conclusive evidence of anything. Many writers and journalists are amazed by the way the internet is both a force for good and an attractor of lunatics. But not only am I struck by ongoing waves of pessimism, the reaction to any positive commentary (or plain old news) is revealing of something quite worrying.

Not only is the zeitgeist very bleak, when the few optimists out there mount any kind of defence of their views they are taken apart very quickly; the on-line ‘community’ lies waiting to ambush even the mildest expressions of positivity.

Optimism, whether rationally based or not, is vital for economic growth. It really is as simple as that. Somebody has to have a positive outlook. That, I think, is at the heart of why Keynesians rail against austerity: somebody has to spend, even if everyone believes, rightly or wrongly, that the future is bleak. Expectations, economic ones, really are self-fulfilling.

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