Since the economic bust and resulting recession, people often ask me whether I’m optimistic about our future. When we think about optimism from the perspective of behavioral economics, two important questions come to mind in light of our present circumstances. First, where do we naturally fall on the range from pessimism to optimism? And second, is there a place for optimism now?
So, is it in our nature to be optimistic?
One of the most basic findings in behavioral economics is what’s called the optimism bias, also known as the positivity illusion, or overconfidence. When people judge their odds of achieving good outcomes — getting a good job, successful marriages, healthy kids, financial success — they generally estimate these odds to be higher than those of other people. Similarly, when people judge the odds of negative outcomes befalling them — a heart attack, a parking ticket, divorce — they estimate these odds to be lower than those of other people. In other words, we’re pretty sure good things will happen to us and bad things won’t.
The optimism bias transcends gender, age, education and nationality, but it does seem to be related to depression; depressed people tend to show a smaller optimism bias and a more accurate perception of reality. These individuals view more accurately their chances of having a heart attack or losing their jobs. Depressed individuals aside, given this deep-seeded tendency for overoptimism, as well as its sheer magnitude, I suspect that, even in the current economic climate we are still overly optimistic. This tendency might have been dampened by recent events, but not fully deflated.
Is overoptimism good or bad for us?
The answer, of course, is both, depending on the situation. Individuals often suffer for their optimism — they behave rashly and then wind up poor, or dead. But society as a whole often benefits from the decisions that result from overoptimism. It’s a version of the “thrift paradox,” in which spending a lot is bad for individuals but good for the economy as a whole. Imagine a society where no one takes on the risk of creating startups, developing new medications, opening restaurants, starting new businesses. We all know most of these fail in the first few years, yet they crop up all the time. A society where no one is overly optimistic and no one takes too much risk would be a society of Eeyores. It is hard to imagine such a society advancing much. Thus, as with many of our irrational tendencies, there are countless half-empty glasses strewn about, but there are also many half-full ones.
So we are natural optimists, but are there any objective reasons for optimism given the current recession?
One of the main lessons of the recession is the extent of human folly and irrationality (conflicts of interest, extrapolating long-term projections from short-term trends, too much trust in economic advisors, etc.) and the extent of their devastating consequences.
Given this range of irrational tendencies, you might wonder where optimism can comfortably reside. Personally, I do not anticipate that this recession will significantly change human nature, but there is reason to believe that the lessons we’ve learned will make their way into habits, new businesses and better regulations. I don’t think we are in any way better, more thoughtful people — shining phoenixes rising from our fiscal ashes — but if we take these painful lessons to heart (and mind), we might create lasting changes in our environment. And looking at the general efforts of the government to reform the financial industry (for example, the attempts to place limits on overdraft fees, increase fiduciary responsibility for financial advisors, create more transparency of mortgages), it seems that we are on the path of doing so. And the good news is that it looks like some of these banking regulations will be around for a while. Although these regulations are unlikely to prevent all of our future financial shenanigans, I think they will prevent some of them.
Similarly, in the business sphere, companies are building smaller homes and smaller cars and even banks (banks!) are starting to think about how to help people make better financial decisions, such as spending less and taking more financial responsibility.
I also see the same general pattern in the personal domain as well. As a professor, I see that undergraduates, rather than flocking in droves to investment banking jobs, are turning to volunteering or startups, and pursuing all kinds of dreams. There are indications that Americans for the first time in many years are starting to save money, and while this might not quicken economic recovery, it is good in the long run.
So to answer our two questions: yes, we are naturally optimistic, and yes, there is a place for optimism – but only if we understand that our nature will not always direct us to the path of ideal decisions and that we need to put some limits on ourselves. We need to understand our optimism, our overconfidence, and the trouble they can get us into. We need to place some restrictions on our ability to follow up this overconfidence with action.