Animal Spirits and the Indian Economy

Animal Spirits and the Indian economy

The phrase “Animal Spirits ‘appears occasionally in think pieces by economists but there is never any explanation or definition attached and most of us non economists view it as just another clever, emotive phrase with no specific or formal implication.

In fact, however, the phrase describes a formal, ‘behavioral economics’ approach to economic problems and economists George Akerlof and Robert Shiller have written the definitive book on the subject titled ‘Animal Spirits: How Human Psychology Drives the Economy, and why it Matters for Global Capitalism.’

Taking a lead from John M Keynes, the authors argue that economic decision making is not based on rational economic calculations and motivations alone. A great deal of economic activity is dependent on nonrational drivers which they define and give the label ’animal spirits.’

One conclusion from this acceptance of the existence and significance of ‘animal spirits’ is that the theoretical conclusion that free markets automatically determine the most optimal distribution of resources , based on the assumption of economic rationality alone driving economic behavior,  is incorrect. In the real world of ‘animal spirits’ Adam Smith’s ‘invisible hand’ will not ensure the best of all possible economic worlds and there is need for careful monitoring and regulation of the capitalist drive towards profit maximization. There have to be carefully and clearly defined  rules and an efficient ‘referee who enforces them’. This is the role of the state-to not only ‘give full rein to the creativity of capitalism’ but also ‘countervail the excesses that occur because of our animal spirits’.

The five different aspects of animal spirits that impact economic decision making are a sense of confidence, of fairness, the extent and degree of acceptance of corruption and bad faith, money illusion and stories.

Confidence in our society , its institutions and the future determine economic behavior and performance and is in turn impacted by them .Our sense of fairness determines economic behavior especially that relating to price setting and wage determination while corruption impacts almost every economic decision. The inability to see through the effects of inflation-the difference between nominal values and real values- has major consequences for wage flexibility and investment decisions and finally the need of the human mind to ‘think in terms of narratives, of sequences of events with an internal logic and dynamic that appear as a unified whole’-in short the need for ‘stories’ that in turn determine motivation-also impacts economic action.

 The authors examine several major economic phenomena to validate their theoretical framework. Among these are the Depressions of the 1890s  and the 1930s, the financial crisis in the early 21^st century engendered by the housing bubble and related  invention of ‘exotic’ and toxic derivatives,  the consequences of the infamous Enron corruption scandal and the enduring poverty of black people in the US. 

Their research leads the authors to conclude that  animal spirits are indeed significant drivers of economic decision making and must be taken into account for understanding  economic  behavior and for formulating  appropriate and effective economic policy.

In the Indian context the ‘theory’, if it can be so labelled, of animal spirits seems prima facie to be singularly useful in understanding economic events and behavior. Consider, for instance, the apparently endless crisis enveloping the public sector banking system. These banking entities have apparently disbursed enormous volumes of public funds in their care to dubious investors, or more accurately, investors with dubious intentions, who have defaulted on repayments and created a mountain-that appears to be growing steadily- of non- performing assets. Given the extent of the problem and that such banks are government owned and so cannot be allowed to fail, government has pumped in large sums to ‘recapitalize’ these banks and bring them back on their feet .The unanswered question of course is whether the banks were simply incompetent on a massive scale or complicit in what was a set of huge  scam operations wherein large sums of public moneys were misappropriated by clever fraudsters .More importantly, what prevents the banks from repeating their past performance.

The  I&LFS story only serves to underline the problem of how corruption, bad faith and sleepy and sloppy regulators can create an economic crisis of enormous dimensions. Animal spirits are evidently real and significant and must be factored in every attempt to understand the Indian economic reality.

We have witnessed a transformation of the Indian economy since the growth spurt in the 1980s and the reforms-partial and gradual though they were- of the 1990s.The strength of ‘free and open markets’ has been amply demonstrated over the last thirty odd years. What we seem to have forgotten, however, in the euphoria of high nominal and not- quite- so- high real growth rates is the dark side of the force .The theory of Animal Spirits reminds us  to watch out for that very real dark side and put in place strong -efficient and effective-regulatory institutions.

As a natural reaction to the stifling economic environment created by an incompetent, corrupt and bureaucratized state dabbling in a strange version of socialism, we have now a swing towards untrammeled ‘capitalism’. While it is true that the business of government is not business, the state must not forget what its business really is- providing the conditions necessary for positive animal spirits to function freely and simultaneously regulating the more unruly and destructive manifestations of such animal spirits.

A study of the Indian economic experience within the framework provided by ‘Animal Spirits’ offers fascinating possibilities. What for instance explains the Indian fascination for hoarding gold? Why are we so reluctant to pay taxes and more generally why do we display little civic sense? What makes us so vulnerable to ‘us versus them’ stories? Is it the lack of confidence in the state engendered by a long and painful transition from a feudal to a colonial dispensation both of which were characterized by an extractive , exploitative and unjust state that did little towards alleviating either absolute poverty or stark inequality? Is the continuation at the grass roots - post Independence - of many colonial characteristics of the state machinery responsible for a lack of confidence in the institutions of state and related economic behavior?

A detailed study requires a larger canvas and a different platform but suffice it to say that Animal Spirits are important and their functioning in the Indian context merits study.