Deconstructing consumer confidence

August 28, 2008 BY danariely

Why are Americans so gloomy? It may be all about the yoked dog and ‘learned helplessness.’

We have a market paradox on our hands. Consumer confidence is close to a 40-year low, suggesting that the economy is in worse shape now than in times that seemed far darker, such as the early 1980s, when both inflation and unemployment crept into double digits. Yet many of the current economic indicators, including inflation and unemployment, are rather positive — or at least not as negative as consumer sentiment implies.

So why are consumers, myself included, so gloomy?

I suspect that one answer lies in a psychological condition caused by prolonged exposure to unpredictable negative events called “learned helplessness.”

The basic experiments on learned helplessness use two dogs, each in a separate room. In the control dog’s room, after a bell rings the dog gets a mild electrical shock — just enough to annoy and surprise him. This dog has a switch to turn off the shocks and quickly learns to use it.

The second dog is yoked to the first but has no bell and no switch. Every time the control dog gets a shock, it too gets a shock until the control dog flips its switch. So, objectively, both dogs get the exact same treatment, but the yoked dog has no ability to predict or control the shocks.

Next comes the test. Both dogs are put in a “shuttlebox” — a large box divided into two compartments by a low fence. From time to time a warning light comes on, and a few seconds later the floor of the shuttlebox emits a mild electrical shock. If the dog jumps from one compartment to the other, the shock is immediately terminated. Even better, if the dog jumps over the fence upon seeing the warning light, there’s no shock at all. As you might expect, the control dog quickly learns to jump over the fence on cue; though understandably a bit anxious, he’s relatively happy.

And the second, yoked dog? You might expect it would be just as motivated to escape the shocks in the shuttlebox. But this is where the results get very interesting, and somewhat depressing: The yoked dog just lies in the corner of its cage, whimpering.

The yoked dog learned in the experiment’s first stage that shocks happen unpredictably and inescapably — and it carried that mind-set into the shuttlebox. This dog learned to be helpless in its general approach to life, exhibiting symptoms similar to suffering chronic clinical depression.

Americans are currently a bit like the yoked dog, exposed to an alarming sequence of market disasters. First, it was the Internet stock bubble. Then housing prices. And now oil prices and the banking crisis. All these came at us in quick succession and in direct contradiction to the prevalent advice given by financial advisors and the media. To give a personal example, about the time I got my first job, we were all told that technology stocks were the wave of the future and the best way to invest our money. When that bubble burst, we were told that housing was the best possible investment — but as my wife and I recently learned, this also was not the best advice.

So is the low level of consumer confidence and general depression justified? Perhaps not in terms of the hard numbers of the economy, but, from a psychological perspective, it’s an expected reaction. The question then is what to do to fix our sorry state.

One idea comes from psychologist James Pennebaker at the University of Texas at Austin. Pennebaker’s research has repeatedly shown the active process of trying to make sense out of traumatic events — often done through writing — can help individuals recover from them.

From this perspective, it might be useful to think about how we consume news. We have access to news 24 hours a day on TV, radio and online — but much of it is sensation-seeking rather than sense-making. Even stories about the economy take the shape of gossip about people who are struggling, who have lost their jobs and can’t pay for gasoline. A conscious effort to analyze and explain these economic crises is not only an important journalistic duty, it is also an essential element of our national mental health.

But we still need to think about how to prevent such economic shocks. In fact, in our current vulnerable state, I am worried that another immediate shock — most likely to occur in the healthcare market — could be too much for us to bear.

I suspect that the only way to regain a sense of order, predictability and control is to have government take very clear and substantial steps to regulate the markets — steps far beyond the patch-up jobs the Federal Reserve Bank is doing now. In fact, I suspect that the Fed’s attempts to impose order seem so random, idiosyncratic and capricious to most consumers that they do little to relieve our sense of chaos.

We need forward-looking policies that stave off potential problems in markets that have not (yet) failed. Or at least policies that sort out in advance how we will deal with crises as they emerge. Under what circumstances the Fed bails out banks, for instance, and what would be the consequences for the shareholders, the bank and the bankers. I suspect that only such large-scale and forward-looking policies will help us regain our general sense of order, predictability, control and trust — and stop feeling like the yoked dog.

This comment also appeared in the LA times