Fear is Good

Fear is bad, according to conventional wisdom. Our economy is in trouble, we hear, because banks are too afraid to lend and consumers and companies too afraid to spend. Less lending and spending further depresses the economy, which begets more fear. And to top it all off, some analysts irresponsibly exploit these fears for their own ends, by arguing that the crisis may get far worse before it gets better, and in the process sensationalize and exaggerate the problem.

But, in this case, conventional wisdom is wrong. The truth is that fear is good. The economic crisis we’re facing is not at root the result of too much fear but of too little. If we had been more afraid for our economic well-being, we would have saved more, borrowed and speculated less, and been more cautious about letting financial wizards make bets with our money using opaque mathematical models.

Today, if we were more afraid for our futures and those of our children, we would be doing much more to address potential problems – such as climate change and nuclear terrorism – that could derail our societies tomorrow.

A few weeks ago, Globe and Mail writer Ian Brown made the anti-fear case in a widely discussed front-page article. The title said it all: “Divas of doom find their fame in peddling the direst of fortunes to pessimistic masses.” The “boom in doom,” Mr. Brown suggested, reveals our deep-seated masochism. “We seem to enjoy being told how much it’s going to hurt. Dire news makes us feel like grownups, serious once more.”

To commentators such as Mr. Brown, two of the worst culprits among today’s economic doomsayers are British historian Niall Ferguson and American economist Nouriel Roubini.

Mr. Ferguson, who now teaches at Harvard, recently made headlines by saying the current economic crisis will produce a wave of violence in unstable states around the world. “There will be blood,” he declared.

Mr. Roubini, a professor of economics at the Stern School at New York University, is one of the few economists who correctly predicted the causes and depth of the current crisis. Well ahead of nearly all other analysts, he highlighted the danger that banks and other financial institutions could lose so much capital that the overall financial system would stall. Now, he estimates that recovery, when it eventually comes, will be slow and weak.

People who disparage such analysis have got things exactly backward. Ultimately, it isn’t undue pessimism that is dangerous, but undue optimism. Over the past two decades, undue optimism produced irrational exuberance, housing bubbles and unbridled confidence in the benefits of financial innovation. Undue optimism also encouraged commentators to label anyone who expressed doubts about the trajectory of the global economy or about the dangers of financial innovation as a crank, which served only to discourage healthy skepticism.

Even after all the economic troubles we have experienced this past year, some commentators still want to attack these messengers rather than accept that their message has been, at least so far, fundamentally right.

In modern culture, fear and pessimism aren’t cool. We live in an age when happiness is the highest achievement, and no one admires people who are scared or downbeat. So it’s easy to put down anyone who points to future dangers – to ridicule them as doomsayers or Cassandras and impugn their motives.

Yet fear serves a vital purpose. Our ancestors evolved the biological capacity for fear because it helped them survive, which allowed them to pass their genes to future generations. Fear signals that something might be wrong in our surroundings and that we could be in danger. It helps keep us resilient in an ever-changing and often hazardous world. We should embrace fear, not scorn it. And we should listen to those whose fears might help them see dangers earlier and more clearly than the rest of us.

Our innate capacity for fear clashes with another deep human characteristic – a tendency toward optimism. Contrary to Mr. Brown’s claims, people aren’t naturally pessimistic. Psychological research has shown that we have, on average, a bias toward hopefulness when we gauge possible threats in our environment and our ability to respond to these threats. Most of us underestimate the difficulties facing us, just as we overestimate our ability to respond to those difficulties.

Our deep psychological dialectic between fear and pessimism on one hand and optimism on the other – between our contrary “animal spirits,” as economist John Maynard Keynes famously labelled these impulses – fundamentally shapes our economic behaviour. Most of the time, optimism wins, and too often this optimism gets out of hand. The result is a speculative boom, as we saw with the tech bubble 10 years ago and more recently with the U.S. housing bubble – an explosion of optimistic excess that was reproduced from Riga to Shanghai.

As the bubble expanded, the commentators who railed against pessimism and fear – and attacked people they identified as doomsayers – pandered to our natural optimism and helped to turn that optimism into denial of reality. They played as much of a role in creating the culture of complacency that led to our current economic crisis as the investment banks, rating agencies and financial hucksters who actually peddled toxic investments. They helped to make possible Bernard Madoff’s outrageous scam – and so many others too.

Eventually, though, reality bites. As upbeat perception diverges ever more wildly from underlying economic facts, even the most delusional optimism can’t overcome worry about market weaknesses. When perception suddenly snaps back to reality, the bubble implodes, and people can shift en masse from optimism to fear.

This is what has happened during the past year. And in such situations, fear does beget fear, and our economy does risk becoming trapped in a vicious downward spiral.

But the answer isn’t to return to the delusional optimism that caused the problem in the first place. The answer is to keep reasonable fear from becoming calamity-inducing panic, which is exactly what our best leaders, such as U.S. President Barack Obama, are doing right now.

What are the lessons? The first is that in today’s tightly connected world – under staggering demographic, political and environmental as well as economic stress – the burden of proof is now on the optimists. World-shaking crises are likely to appear with increasing frequency, and we’d be foolhardy to ignore people who warn of the dangers around us.

The bigger lesson is that we do, indeed, need to grow up. Collectively we have been behaving like adolescents – believing we’re invulnerable, living for today while ignoring tomorrow, and sneering at anything that smacks of prudence. But grownups do take life seriously, and they pay attention to their fears.