An Economy of Faith and Trust By DAVID BROOKS

January 16, 2009
Op-Ed Columnist
An Economy of Faith and Trust By DAVID BROOKS

Once there was just Newtonian physics and the world seemed neat and mechanical. Then quantum physics came along and revealed that deep down things are much weirder than they seem. Something similar is now happening with public policy.

Once, classical economics dominated policy thinking. The classical models presumed a certain sort of orderly human makeup. Inside each person, reason rides the passions the way a rider sits atop a horse. Sometimes people do stupid things, but generally the rider makes deliberative decisions, and the market rewards rational behavior.

Markets tend toward efficiency. People respond in pretty straightforward ways to incentives. The invisible hand forms a spontaneous, dynamic order. Economic behavior can be accurately predicted through elegant models.

This view explains a lot, but not the current financial crisis — how so many people could be so stupid, incompetent and self-destructive all at once. The crisis has delivered a blow to classical economics and taken a body of psychological work that was at the edge of public policy thought and brought it front and center.

In this new body of thought, you get a very different picture of human nature. Reason is not like a rider atop a horse. Instead, each person's mind contains a panoply of instincts, strategies, intuitions, emotions, memories and habits, which vie for supremacy. An irregular, idiosyncratic and largely unconscious process determines which of these internal players gets to control behavior at any instant. Context — which stimulus triggers which response — matters a lot.

This mental chaos explains how people can respond so quickly and intuitively to so many different circumstances. But it also entails a decision-making process that is more complicated and messy than previously thought.

For example, we don't perceive circumstances objectively. We pick out those bits of data that make us feel good because they confirm our prejudices. As Andrew Lo of M.I.T. has demonstrated, if stock traders make a series of apparently good picks, the dopamine released into their brains creates a stupor that causes them to underperceive danger ahead.

Biases abound. People who've been told to think of a high number will subsequently bid much more for an item than people who've been told to think of a low number. As Jonah Lehrer writes in his forthcoming book, "How We Decide," there are certain circumstances (often when there are many options) in which gut instincts lead to the best decisions, while there are other circumstances (sometimes when there are a few options) when calm deliberation is best.

Most important, people seek relationships more than money. If behaving a certain way helps a stock trader or a regulator fit in with his crowd, he's likely to keep doing it without too much rigorous self-examination.

A thousand mental shortcomings contributed to the financial meltdown. Republicans have tried to explain it by pointing to irresponsible policies at Fannie Mae. But that only explains a piece of what's happening.

This crisis represents a flaw in the classical economic model and its belief in efficient markets. Republicans haven't begun to grapple with the consequences.

For years, Republicans have been trying to create a large investor class with policies like private Social Security accounts, medical savings accounts and education vouchers. These policies were based on the belief that investors are careful, rational actors who make optimal decisions. There was little allowance made for the frailty of the decision-making process, let alone the mass delusions that led to the current crack-up.

Democrats also have an unfaced crisis. Democratic discussions of the stimulus package also rest on a mechanical, dehumanized view of the economy. You pump in a certain amount of money and "the economy" spits out a certain number of jobs. Democratic economists issue highly specific accounts of multiplier effects — whether a dollar of spending creates $1.20 or $1.40 of economic activity.

But an economy is a society of trust and faith. A recession is a mental event, and every recession has its own unique spirit. This recession was caused by deep imbalances and is propelled by a cascade of fundamental insecurities. You can pump hundreds of billions into the banks, but insecure bankers still won't lend. You can run up gigantic deficits, hire road builders and reduce the unemployment rate from 8 percent to 7 percent, but insecure people will still not spend and invest.

The economic spirit of a people cannot be manipulated in as simple-minded a fashion as the Keynesian mechanists imagine. Right now political and economic confidence levels are running in opposite directions. Politically, we're in a season of optimism, but despite a trillion spent and a trillion more about to be, the economic spirit cowers.

Mechanistic thinkers on the right and left pose as rigorous empiricists. But empiricism built on an inaccurate view of human nature is just a prison.

http://www.nytimes.com/2009/01/16/opinion/16brooks.html?sq=Brooks%20An%20Economy%20of%20Faith&st=cse&scp=1&pagewanted=print

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