The Good, The Bad, The Economy

Does human nature rule out a better world?

Economy Today: It’s Half in the Mind, You Know

In our economy, the mental and the material are inseparable.

 When you think of the economy of 2013, you might summon up images of a myriad of tangible things, including fleets of airplanes and high speed trains, skyscrapers and office parks, shipyards stacked with containers full of goods, and big box stores filled with consumer products.  The stuff in those containers and stores ranges from iPods, smartphones and tablet computers to kitchen gadgets, hair dryers, cosmetics, pharmaceuticals and food.  You might be tempted to measure the economy’s success by the quantities of such stuff produced, the square footage of houses lived in, the number of restaurant meals consumed, and other essentially material criteria.  An economy can indeed be thought of as the sum total of the ways in which people satisfy their material wants and needs.

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But an alien observer of our economy who could count up only these tangibles would be missing much of the action, because at least half of what determines how well we meet even our most material of needs exists in the software of human minds.  Beliefs, knowledge, imagination, and the psychology of human motivation are at least as important to our economy as are how many veins of coal and deposits of natural gas we tap into, the expanses of factory floors and equipment at our disposal, and whether rainfall and temperature are kind or unkind to our crops.  In a real sense at least half of the economy is in our minds.

Perhaps the most obvious example of the centrality of the mind to the economy is money itself, small sheets of paper having little utility for note-jotting, coins made mostly of common, low value metals, and billions of gigabytes of electronic ink on the balance sheets of banks, credit card companies, and pension funds.  It’s the stuff that greases the wheels of commerce and makes the world go round, yet it’s valuable only when the overwhelming majority of us believe that the overwhelming majority of us consider it so.  Its power has nothing to do with materiality and everything to do with shared mental conventions.

Our economic cycles of boom and bust also typically have little to do with any objective change in our material circumstances.  Workers and machinery may be idled during a recession not because of any sudden shortage of energy to power the equipment, food to feed the workers, or raw material from which to fabricate things, but because pessimism about demand leads producers to cut back on production and to lay off workers, generating a self-fulfilling shrinkage of demand.  The recession of 2008 – 9 began with a change in perceptions about the value of housing which, once sufficiently widespread, made many people feel poorer and less willing to spend while threatening the solvency of financial institutions which became less willing to lend.  There were just as many workers, just as many machines, and just as much raw material ready to keep producing the same amounts of stuff as before, but expectations and the notional positions of institutions built of layer upon layer of mental constructs (and electronic ink on balance sheets) threw sand into the gears of our economy.  Instead of producing stuff that people still wanted as much as ever, millions were sent home to pace the floors and worry, a sure sign that our economy is constructed of mental as much as of material stuff.   

Despite all of the real estate and other tangible assets we own, a surprising share of our wealth is also purely in our minds.  The bulk of our financial wealth consists of recorded claims on shares of companies, promises of repayment of business and government debt (bonds), and promises of repayment by banks and other financial intermediaries which have in turn invested our money in various equity and debt claims.  While company shares also represent nominal slices of the value of companies’ physical assets (factory buildings, machines, etc.), their value depends mostly on expectations that the companies in question will continue to put the trust others have in their brand names and the know-how of their employees to work generating revenue, so that someone else will want to buy the shares when we’re ready to sell them.  While part of the value of company debt and bonds rests on physical assets pledged as collateral, much of it rests on beliefs about the companies’ abilities to keep on doing what made them credit-worthy in the past.

A slightly less ephemeral form of wealth in the mind is human capital. Economists estimate that its value now greatly exceeds that of physical assets, meaning that knowledge, creativity, learning skills, and habits of mind including perseverance, punctuality, and ability to focus on future goals, account for most of our productivity.  Differences in such capital, and in the quality of institutions it supports, account for most of what differentiates the living standards of poor countries from those of rich ones.  Differences in knowledge and in cognitive abilities and orientations also account for much of the difference in income among individuals in given countries, our own included.

The most fundamental way in which our economy betrays the stamp of our minds, though, is on display in the way in which it’s organized.  Had a group of creatures possessing high intelligence but  having an ant-like psychology and social structure arrived to colonize the earth before the emergence of our own kind, it might have gone about harnessing the resources of earth’s atmosphere, seas and land masses by working out a rational division of tasks and carrying them out single-mindedly.  There’d be no need to offer enticements to any individual member of such a colony once it was clear that the plan of action made sense for the colony as a whole.  Humans, in contrast, are simply not wired to be motivated by a common goal on a sustained basis.  By and large, we do our parts in the overall business of feeding, clothing, and housing the members of our societies only when personally compensated for our trouble.  It’s our own natures, not the external nature from which we wrest our livings, that cause our economies to be structured as they are—in ways that activate complex mixtures of cooperative and competitive impulses.  From individuals and families seeking primarily to meet their own needs, not those of society, emerge markets and organizations of diverse types that somehow fill all of those big box stores and cargo containers with stuff.  From the ground up, then, our forms of economic organization bear the imprint of our psychological make-up, not just the imprint of the laws of physics that govern what we can produce and how.  For better and for worse, our economy is as much a mental as a material phenomenon.

Louis Putterman, Ph.D is an economics professor at Brown.

 

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