Undercover Economist

The credit crunch: bad for your pocket, worse for your psyche

It will soon be a year since Lehman Brothers filed for bankruptcy. And two years since the queues began to form outside branches of Northern Rock. The Financial Times felt obliged to pen a defence of markets, before soliciting views on the future of capitalism.

Now that we are no longer staring over the precipice, wasn’t this all just a little excitable? Perhaps not. New research suggests that the crisis may shape the psyche of a generation, even if the crisis now passes quickly.

The evidence comes from economists, Paola Giuliano of UCLA Anderson School of Management and Antonio Spilimbergo of the International Monetary Fund. Giuliano and Spilimbergo rely on answers to the General Social Survey, which has been conducted in the US almost every year since 1972. Because each survey participant has an identified home region, Giuliano and Spilimbergo can compare survey answers with the economic performance of the region in question. (The regions are large: the US is divided into nine.) Regional economic performance can be choppy, so the researchers looked for outliers: when regional growth fell into the bottom 5 per cent of all regions and all years in the sample, the researchers counted this as a severe regional recession. This turned out to be a year in which the regional economy shrank by 3.8 per cent or more.

The question is: what impact did these severe regional recessions have on locals’ answers in the General Social Survey? The results are striking. Recessions do alter perceptions – or more correctly, they alter the perceptions of a certain group of people. Broadly, the recession experience pushed these people towards the left of the political spectrum. Recession-influenced respondents expressed a stronger preference for government redistribution, and they also tended to believe that success in life was more a matter of luck than hard work. (Separate research by the economist Thomas Piketty has shown, unsurprisingly, that people who believe that luck plays a big role are more comfortable with higher taxes – no wonder the FT felt moved to defend markets.)

In another answer, the recession experience seemed to push people towards the right: recession-influenced survey respondents also lose confidence in government institutions. Reading the political tea-leaves is a difficult business.

Giuliano and Spilimbergo regard their research as a contribution to social psychology as well as to economics because one insight to emerge from the work is that most people are not influenced by the experience of a recession. What counts is how old they were when the recession hit. People who are 18-25 when they experience a severe regional recession are influenced by that experience for the rest of their lives. Others are influenced much less; those under 17 or over 42 when the recession strikes do not seem to be changed by the experience. Whether the recession happened recently or many years before the survey also makes no apparent difference. This supports what psychologists call the “impressionable years hypothesis”.

The research also bolsters that of California-based economists Ulrike Malmendier and Stefan Nagel, who have discovered that the stock market returns experienced in early adulthood seem to influence investment decisions for decades afterwards.

I recently argued that many of today’s school-leavers and graduates will have their careers shaped for a decade or more by the recession. Perhaps it should be no surprise to discover that this is also a generation that may spend future decades firmly convinced that success in life has everything to do with luck.

Also published at ft.com.