Sep 05

Ever since the financial meltdown, and throughout this recession, people keep asking me if I’m optimistic about our future. I think people are actually asking two questions: Where does one naturally fall on the optimism spectrum? And is there a place for optimism in our present circumstances?

One of the most basic findings in behavioral economics is what’s called the “optimism bias,” also known as the “positivity” illusion.

The basic idea is that when people judge their chances of experiencing a good outcome–getting a great job or having a successful marriage, healthy kids, or financial security–they estimate their odds to be higher than average. But when they contemplate the probability that something bad will befall them (a heart attack, a divorce, a parking ticket), they estimate their odds to be lower than those of other people.

This optimism bias transcends gender, age, education, and nationality–although it seems to be correlated with the absence of depression. Depressed people tend to show a smaller optimism bias. They also have a more accurate take on reality–perceptions more in line with what actuaries figure to be their real chances of divorcing, suffering a heart attack, and so on.

UNDERESTIMATING RISK

It is interesting to ponder the utility of over-optimism. It’s not a simple matter, because it can both hurt and help us. Individuals often suffer because of an overly bright outlook. They wind up dead, or poor, or bankrupt because they underestimated the downside of taking a certain path. But society as a whole often benefits from behavior spurred by upbeat outlooks.

It’s the inverse of “the paradox of thrift,” which holds that saving money (instead of consuming) may be good for an individual but is bad for an economy trying to grow.

Overoptimism works the other way. Imagine a society in which no one would take on the risk of creating startups, developing new medications, or opening new businesses. We know most new enterprises fail in the first few years. Yet they crop up all the time, sometimes jump-starting entirely new sectors. A society in which no one is overly optimistic and no one takes too much risk? Such a culture wouldn’t advance much.

So are there objective reasons for optimism in the current recession? There are. Amid the countless half-empty glasses strewn about at the moment, there are many that could be viewed as half-full. Most important, there are lessons we can absorb–insights that point to ways we can improve things. And what’s more optimistic than believing in the possibility of improvement?

This recession has delivered a huge lesson in how far human folly and irrationality can lead us astray–into conflicts of interest, extrapolating long-term projections from short-term trends, putting too much trust in economic advisers, and so on. I don’t anticipate that the downturn will change human nature. We aren’t better, more thoughtful people now. And we’re unlikely to become phoenixes rising from our fiscal ashes. But I am hopeful that if we take these painful lessons to heart (and mind), we might create lasting changes.

There are signs we are doing so, sometimes because there’s no other choice. From my perch as a professor, I see undergraduates turning to volunteering, startups, and the pursuit of all kinds of dreams. And for the first time in many years, Americans are starting to save money. (This might not quicken the recovery, but it’s good for the economy long term.) Manufacturers are building smaller, more sustainable homes and cars. And some banks (banks!) are thinking about how to help consumers become more financially responsible.

Finally, it looks as if there are advances in banking regulations that will endure–those mandating clearer disclosures of mortgage rules, for instance, and those making banks more accountable. Changes like these are unlikely to prevent all future financial shenanigans. But I’m optimistic about their ability to prevent some of them.

This reflection first appeared in Businessweek

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