Two Booms That Weren't

In late 1990s, it was frequently stated that biotech would be for the following decade what computers had been for 1990s. I knew that this prediction was wrong. There is much more that can be done with computers than with biotech; and while I expect biotech to be a solidly growing industry as medical needs of the baby boomers become more pressing, I do not expect it to ever become as big as the computer industry.

Another economic misdirection, that I also saw to go nowhere from the start, was the housing boom of the last decade. I knew that there was no justification for it, and that it was going to crash; and it did. People were burned by the collapse of the .net bubble, and they thought that real estate was a safer investment. It wasn't. The computer industry boom of 1990s realized in real prosperity. The housing bubble resulted in living expenses risisng while incomes declined; and when it collapsed – as it was bound to have collapsed – the result was the worst economic crisis since Great Depression.

The main axiom of classical economics is that people's economic decisions are based on rational self-interest. In this case, we see very little of anything rational at all. In the first case the decisions were made based on wishful thinking; and in the second case they were made based on fear. Neither is rational.

Indeed, when we look at economic decisions that are made, we see far more influence of psychology than rational interest. I do not only talk of people who gamble away their money or stuff themselves with fattening food or buy expensive sneakers that they need to sell drugs in order to acquire or keep going back for plastic surgery treatments when they are already beautiful. I also talk, especially, of the influence of marketing. With Microsoft vs. Borland, VHS vs. Beta, and fast food chains vs. mom-and-pop diners, the inferior product rose to dominate the marketplace through superior marketing. And in marketing, psychology reigns supreme.

Keynes had another explanation for what drove economic decisions: “animal spirits.” That of course is a judgmental term, but psychology is not. It is imperative to figure out just how much of the economic decision-making that people make is based on psychology, and how much is based on reason. And then it will be possible to encourage more of the latter while controlling more of the former.