Magazine article Management Today

Thus Confidence Doth Make Cowards of Us All

Magazine article Management Today

Thus Confidence Doth Make Cowards of Us All

Article excerpt

Any economic measure given too much prominence starts to misbehave.

During Britain's long recession and, it seems, interminable wait for economic recovery, one subject has received more attention than most. Confidence, among businessmen or consumers, has been seen as a key factor in determining when, if not whether, the upturn is to come.

Norman Lamont, in citing the rise in business and consumer confidence of last autumn, clearly though that he was on to something. The Treasury, which goes over the Confederation of British Industry's quarterly trends survey with a fine-tooth comb, and plays close attention to other business and consumer surveys, was convinced that, with optimism increasing, recovery could not be far behind.

Most economists agreed. I remember suggesting to the Bank of England, at the time, that this heavy emphasis on confidence, particularly in the official forecasts, was risky. Might it not be another manifestation of the phenomenon whereby any economic measure that is given undue prominence mysteriously starts to misbehave? It was a former Bank of England economist, Charles Goodhart, who gave his name to Goodhart's Law - any measure of the money supply chosen as a target by the authorities automatically becomes subject to distortion.

But to return to the matter of confidence. Economist have long been aware that it is a vital ingredient in the recovery recipe. You can lead a horse to water by establishing the right conditions for an upturn but you cannot make it drink. John Maynard Keynes, in his General Theory, wrote of the |animal spirits' which cause businessmen to invest and consumers to spend. |There is the instability due to the characteristic of human nature that a large proportion of our positive activities depend on spontaneous optimism rather than on mathematical expectation .... Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits - of a spontaneous urge to action rather than inaction.'

Lamont and his Treasury officials were on fairly solid ground when they thought that last autumn's recovery in business and consumer confidence was a harbinger of a general economic upturn. Why, then, was I suspicious, and why did rising 28 confidence at that time not translate into orders, deliveries and new investment?

One reason, I think, was that the business and consumer surveys of September, October and November of last year were tainted by the Chancellor's own optimism. There was a self-feeding process at work. The more that Lamont and his Cabinet colleagues told the country that recovery was under way, the more that people and businesses started to believe it. Intentionally or otherwise, the Government was involved in what one might describes as a confidence trick. If everyone could be persuaded to feel more optimistic, then that increased optimism could be expected to show through in increased economic activity.

What we have learned, I think, is that recoveries have to be built on stronger foundations than this. Businessmen duly filled in their survey forms, and expressed their belief that things were getting better, and waited for the orders to come in. When they did not, they had reason to feel disappointed, hence the subsequent drop in confidence as we came to the end of 1991 and in the early weeks of 1992.

Another reason is that it is easy to misunderstand the nature of confidence, as it is recorded in questions in business and consumer surveys. …

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