Sunday, November 9, 2008

Magical Thinking and Economic Stimulus

One of the classical anthropological concepts in the field of cultural anthropology is that of magical thinking. To get of flavor of what this phrase means, let's take a look at the wikipedia definition,

In anthropology, psychology, and cognitive science, magical thinking is nonscientific causal reasoning that often includes such ideas as the ability of the mind to affect the physical world, correlation equaling causation, the law of contagion, the power of symbols, and the meaningfulness of synchronicity.

Magical thinking can occur when one simply does not understand possible causes, as illustrated by Sir Arthur C. Clarke's suggestion that "any sufficiently advanced technology is indistinguishable from magic" (see Clarke's three laws), but can also occur in response to situations that are largely random or chaotic, such as a coin toss, as well as in situations that one has little or no control over, especially those one is emotionally invested in. (Indeed, this can be seen as a special case of failure to understand possible causes: specifically, a failure to understand the laws of probability that guarantee the occurrence of coincidences and seeming patterns.)

Sir James George Frazer and Bronisław Malinowski said that magic is more like science than religion, and that societies with magical beliefs often had separate religious beliefs and practices. The difference between science and magical thinking emerges in 17th century philosophy. Both worldviews are mechanistic and based on causality, but the scientific worldview is distinguished by the scientific method and by skepticism, requiring the falsifiability of any scientific hypothesis.

Now, in the old days of Frazer and Malinowski, magical thinking, as an explanatory concept, was used to distinguish the pre-modern peoples of the world from the modern. It took the work of more contemporary anthropologists and comparative cognitive scientists like Ed Hutchins and Michael Cole and many others to show that people, particularly non-"modern" people, are more "scientific" or "rational" in their reasoning that had been previously thought and the work of Bruno Latour and his colleagues to show that "moderns" like scientists deploy more magical thinking in their work than had been previously thought.

I am interested in magical thinking today because it seems to run rampant in contemporary discussions of what to do about the sagging economy in the United States, and the world more generally.

The LA Times for today, Nov. 9, 2008, has a front page article titled, "Economists see revival of of an old fix," reported by Richard Simon and Jim Puzzanghera. In the article, they report on the changing beliefs among policy advisers and law makers regarding the sort of "economic stimulus" that might offer a solution to the current economic malaise. I suppose that everyone remembers the stimulus checks that were sent out in the late spring and early summer of this year. Those checks were intended to get the American consumer spending again. The purpose of which, according to Douglas Elmendorf, a former economist for the bankermen at the federal reserve, was to stave off what was believed at the time to be, "a very sharp, short drop in economic activity." Once the consumers received their cash, it was believed, they would spend it in whatever way they though best, with multiplier effects extending out into the broader economy, allowing economic growth to accelerate, or at least continue.

Seems, though that the economic stimulus Plan A didn't work. We have crack reporting in the Parade Magazine that accompanies the Sunday LA Times this morning that of the $78 billion in checks that were sent to American households, only $12 billion were spent! The rest was either saved or used to pay down household debt. No wonder, household sector debt remains at record levels (having gone from about 70% of GDP in 1998 to over 100% of GDP just ten years later!). Moreover, the money that was spent did not necessarily help the American economy exclusively. I have read that of that $12 billion that was spent, much of it paid for items made in China and other countries, meaning that many of the purported multiplier effects of the new consumer spending went to help workers and their employers overseas!

Why didn't stimulus Plan A work? My guess is that the policy essentially reflects magical thinking on the part of its designers. Rather than take a good hard look at how we got into the current economic crisis and how households in particular were coming to really struggle with unprecedented debt together with a nasty spike in commodity prices from corn to gasoline, the preference was to base the policy on an imaginary American consumer and an imaginary American, indeed global economy.

Anyone who rationally studied the credit bubble of the 2000's (and the slower paced credit expansion of the last 30 years) would realize that economists like Douglas Elmendorf, were simply fools on parade. The economy was clearly not in store for a "sharp, short drop in economic activity." The economy had already been in the early phases of a long, protracted credit crisis going back to early 2007! As we now know, the credit crisis has only worsened since that time. Indeed, many non-economists not employed by the bankermen had been working diligently in civil society communities on the blogosphere to do just that, rationally study the present economic disaster. To come to the conclusion that the economy was in for a short, sharp decline absent the economic stimulus, and with it likely to continue on a torrent of expansion was simply a case of magical thinking, not based in a careful study of our current economic situation at all.

So, do we have more policies inspired by the magical thinking orf our dear elites and their subordinate teams of crack advisers. Based on the reporting in the remainder of the LA Times article the answer clearly is, "YES." Elemendorf suggests that, "Now we're in a situation where it looks like were going to be in a prolonged downturn." So, since there is plenty of time to get going, the federal government can think of slower policy responses, specifically stimulus Plan B that would involve spending about $100 billion on improving the nation's infrastructure. The goal here is to create new jobs, rather than to stimulate the economy directly through instant consumer spending. The US Government could spend as little as $75 billion and create 1 million new jobs (again with the assumptions that there would be multiplier effects for each dollar spent by the federal government). Indeed, Mark Zandi, an economist for Moody's estimates that each dollar of USG spending on construction stimulus will generate $1.59 of new economic activity.

This last bit should serve as warning enough that some magical thinking is driving the latest policy debate. If it were the case that government spending on infrastructure generated a 59% return we could safely rely on government construction spending as the mainstay of the entire US economy. Unfortunately, missing in such assertions is the critical question, "What the heck will those additional dollars, each and everyone borrowed from the taxpayers of the future, be spent on?" New roads? To where? The road infrastructure of the US is already highly developed. School improvements? Terrific idea for the kids, but this cannot generate additional economic growth in the near term! People do not use the schools to generate present economic activity, they are places for investment in future human capital (i.e, children who will become educated adults). It may be nice to have a school without leaking pipes or with nice new shelving, but this is not likely to make much of an impact in how well educated our children will be in the future. Once the money is spent, it is not likely to generate additional work. Green jobs? What the heck are those? And, if they cannot be sustained by additional revenue growth in those industries after receiving government support in the one time stimulus package, they will not remain long.

Indeed, it is this last point that has me worried about the magical thinkers of our policy makers and their bankermen. If the federal government spends $100 billion more this year on construction of the infrastructure, it is not likely to create more jobs at all! Rather the stimulus Plan B can only hope to keep some jobs in place that will otherwise be lost in this worsening downturn. California and other states are staring into the abyss as we speak. Layoffs of state employees are highly likely without some federal support to shore up their current fiscal year budgets. No doubt some of this stimulus will be targeted at faltering state budgets. So, in reality, the best anyone can hope for is that the additional $100 billion of federal spending will help keep some of the jobs (against the aggregate of jobs in the nation as a whole). It certainly cannot hope to add new jobs, nor can it hope to sustain growth into the future-- unless the additional spending becomes permanent--worsening the budget deficit all the more.

So, on balance, we probably could use less magical thinking, and more cold, hard realism. There is no way we can dig out of the bubble the bankermen created with additional government spending. The global economy needs to work off the credit excesses of the last three decades. The only way for that to happen is to bring spending in line with current economic realities (rather than in line with the fantasies of endless future prosperity and growth). Spending less of necessity means fewer jobs. Coming to grips with that reality and thinking of ways to financially help struggling families and individuals until the economy stabilizes once again (at a much lowered state) may be the least magical policy option going forward.

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