Humans Can Be Irrational, and Other Economic Insights

Books of The Times

‘The Map and the Territory’ by Alan Greenspan
By BINYAMIN APPELBAUM
Published: October 20, 2013


Alan Greenspan, the former Federal Reserve chairman, writes in his new book, “The Map and the Territory,” that he has been thinking about bubbles since the financial crisis of 2008. Specifically, he has been trying to understand why he and so many other economic forecasters failed to see the housing bubble that caused the crisis.

 

Alan Greenspan





THE MAP AND THE TERRITORY


Risk, Human Nature, and the Future of Forecasting

By Alan Greenspan

Illustrated. 388 pages. The Penguin Press. $36.


The mistake, he writes, is that forecasters treated humans as rational decision makers — a functional fiction that no longer seems functional. But Mr. Greenspan sees a way forward: Humans, he writes, are irrational in predictable ways. What economists like to call “the animal spirits” can be incorporated into economic models.

“I have recently come to appreciate that ‘spirits’ do in fact display ‘consistencies’ that can importantly enhance our ability to identify emerging asset price bubbles in equities, commodities and exchange rates — and even to anticipate the economic consequences of their ultimate collapse and recovery.”

This is promising stuff. It might even make an interesting book. But the subject barely holds Mr. Greenspan’s attention for a single chapter.

The rest of this book is instead devoted to a discursive tour of recent economic history, punctuated by conservative policy prescriptions. He declares that he no longer finds it possible to make economic forecasts because of “governmental restrictions against competition in domestic markets.”

This tour has its attractions. Mr. Greenspan, one of the nation’s most astute economic observers, has a rare talent for framing economic trends. He writes, for example, that as the value of the nation’s economic output has increased since the 1970s, the weight has not. He means this literally: If everything “Made in the U.S.A.” in 2013 was placed on a giant scale, it would weigh about as much as everything “Made in the U.S.A.” in 1977. It’s hard to imagine a more vivid illustration of what it means to say that the United States has shifted toward a “knowledge economy.”

Still, Mr. Greenspan has been talking about the weight of the economy for a few decades now, and much of this book feels similarly familiar.

Accounts of the financial crisis, in particular, have assumed the character of Mr. Potato Head kits. There is a box of standard explanations, and each writer picks the ones he finds most appealing. Mr. Greenspan’s Potato Head is made up of predictable parts: He blames the government for encouraging subprime lending but absolves the Federal Reserve’s policy of low interest rates.

He has not tried to enliven this account with any history of his involvement as Fed chairman from 1987 until 2006. He covered some of that ground in his 2007 memoir, “The Age of Turbulence,” but that book, written before the financial crisis, already seems dated.

In this new book, Mr. Greenspan writes that the crisis could have been entirely prevented by stricter capital standards, which would have limited the unstable reliance of financial institutions on borrowed money. But he does not explain that under his leadership, the Fed played the lead role in creating rules that let banks set their own capital levels, with predictable results.

“The marked increase in risk taking of a decade ago could have been guarded against wholly by increased capital,” he writes. “Regrettably, that did not occur, and the accompanying dangers were not fully appreciated, even in the commercial banking sector.”

The most provocative part of the book is Mr. Greenspan’s assertion that government spending on Social Security, Medicare and other entitlement programs is the reason that the American economy has grown more slowly in recent decades. He writes that taxation of upper-income households is reducing their ability to invest in new ideas and new machines and new buildings. Less investment yields less innovation, slower growth in productivity and less economic growth.

With an economist’s precision, he calculates that this decline in investment has reduced growth since 1965 by 0.21 percentage points a year — “a consequential difference,” he writes, of about $1.1 trillion in lost output.

Americans must choose, he writes: “Do we wish a society of dependence on government or a society based on the self-reliance of individual citizens?”

This is actually an optimistic view about the stagnation of innovation and growth. Robert Gordon, an economist at Northwestern University, has won a wide audience for his view that we’ve simply run out of transformative ideas. Mr. Gordon and other economists also see a wide range of other problems, including an aging population, declining educational achievement and rising income inequality.

Mr. Greenspan is suggesting that the problem can be fixed by throwing money at it.

Yet it is not obvious that the American economy has been suffering from a lack of financing. While Americans saved less, the rest of the world was only too happy to shovel money into the United States. Mr. Greenspan in this same book subscribes to the view that the housing crash was caused in part by an overabundance of foreign investment in the American economy.

Furthermore, taxation cannot be the reason Americans are saving less. The New York Times reported last year that most Americans in 2010 paid a smaller share of income in taxes than households with the same inflation-adjusted incomes paid in 1980. Mr. Greenspan notes that the wealthy are paying more in taxes — but that is only true because they are making more money. Households earning more than $200,000 saw the largest decline in taxation as a share of income.

It’s also worth noting that productivity and growth have sagged most dramatically since President George W. Bush cut taxes in 2001.

Maybe another round of tax cuts would turn things around.

Or maybe we really are just running out of new ideas.



A version of this review appears in print on October 21, 2013, on page C4 of the New York edition with the headline: Humans Can Be Irrational, and Other Economic Insights.

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