How Fictional Expectations Drive the Dynamics of Economic Developments

Jens Beckert

The financial crisis reached its apogee in the autumn of 2008: the market for mortgage-backed securities from US mortgage loans imploded. Investors who had made what they thought were safe investments in securities, suddenly found themselves facing massive losses. The writedowns required and the payments due from credit insurance policies brought the financial system to the brink of collapse in a very short space of time. Why had investors and economists failed to spot the warning signs of the incipient worldwide financial crisis? Markets are inefficient. The rationality assumptions behind economic theory founder on the complex reality of the economy; expectations cannot be understood rationally but are contingent visions of the future. Such “fictional” expectations play a central role in decisions and in the dynamics of economic developments, claims Jens Beckert.

Since the autumn of 2008, the analysis of the causes and effects of the financial crisis has been an important topic in the social sciences. Beyond the subject of regulatory reforms, the financial crisis has opened up a further discussion for social science research which can be summarized in a simple question: How can expectations in the economy be understood?
 
At the start of the noughties, investors had opted to buy mortgage bonds in the expectation of earning low-risk interest on their capital. These expectations were based on the ratings for the financial instruments and optimistic assessments of the growth in the US real estate market. In 2008, expectations changed abruptly against the backdrop of falling property prices in USA. None of the players in the market retained any belief in the security of the derivatives, and they all wanted to sell at the same time.

The future cannot be calculated

In both situations – buying and selling – investors' decisions were based on their assumptions of future developments. One thing is clear: such expectations are of crucial significance for the decisions made by economic operators and therefore for economic developments, both in growth situations and also in crises. But what are they based on and how do they change?

The central answer from realm of economic sciences is that expectations are based on the analysis of all available information including predictions with regard to which way important indicators of economic growth are going to move, and taken together they are accurate. Even if there are individual mistakes, the business world converges on the correct model of the future. The market price is therefore always an efficient price. But if that is the case, how did investors arrive at the convictions that persuaded them to buy asset-backed mortgage bonds the value of which later fell through the floor? It seems that their belief in a safe investment was based on a work of fiction made credible by rhetorical means and institutional signals.

»Sociologists and behavioural economists have long doubted the assumptions of rationality behind economic theory.«

Sociologists and behavioural economists have long doubted the assumptions of rationality behind economic theory. Market players by no means factor all the available information into their considerations, they are influenced in their decision-making by the social, cultural and institutional context and they make mistakes in their decisions which can be attributed to rigid thought patterns. In addition, it is a matter of first principles that future developments cannot be calculated in advance in a dynamic economy. Expectations cannot therefore be understood as rational, and decisions are not based solely on derived calculations.

This applies all the more to the turbulent environment of modern capitalistic economies in which future economic developments are to a large degree open and therefore uncertain. The present day offers convincing examples of this phenomenon: Who would have thought a few years ago that smartphones would have such a profound effect on the development of the overall economy? Who knows whether the euro will still be the common currency in three years' time? Who can say how the stock market will evolve in the next 12 months? Economic models cannot supply clear answers to these questions. However, players in the market have to take decisions in spite of the fact that the future is open and incalculable. And these decisions depend on the future projections with which the choice of a particular alternative is justified.

Acting as if

Expectations in conditions of uncertainty can be termed fictional. Fictional here does not mean that the ideas are intrinsically wrong; it is simply that they cannot be empirically verified, at least not until the future becomes the present. The current ideas of market operators with regard to the future condition of the world are fictional in the sense that they create a new, separate reality. Decisions taken in conditions of uncertainty are based on visions and projections which market players are convinced as being correct. Such fictional expectations are of enormous significance, as they are signposts in decision-making processes – in spite of the impossibility of actually foreseeing future developments. Market players act as if the future will unfold in the way they assume. Expectations are therefore stopgaps in the decision-making process with the aid of which the ignorance of actual developments prevailing at the time of the decision can be disregarded.

»Decisions are signposts in decision-making processes.«

The term fictional expectation follows from the analysis of fictional texts in the literary sciences. Because fictional texts are also characterised – albeit with significant differences – by the fact that the author is describing a reality he or she has conjured up. Fictional expectations in the form of narratives or stories are also communicated in the economy and that is where they unleash their impact.

One example: In November 2011, the US TV channel CNBC broadcast an interview with the influential raw materials investor, Jim Rogers, on the question of where the price of gold was going to go (www.cnbc.com/id/45472311). Rogers forecast in the interview that the price of gold, which at the time was around 1,700 US dollars per ounce, would – in the long run and after possible, substantial decreases – rise to 2,000 US dollars and, in the course of a bull market continuing for several years, could reach even 2,400 US dollars. Rogers did not provide a precise time frame for this expected development, stating that the bull market run has years to run. At the same time the British bank HSBC predicted for 2012 an average gold price of 2,025 US dollars. According to this forecast gold was deemed to be a lucrative investment. Statements such as this are repeated in the financial press on a daily basis, and they are part of everyday life. The forecasts are always linked to stories which make the expected future scenario appear to be a credible development. In the case of the price of gold, this is frequently the story of gold as a crisis currency.

It is worthwhile taking a closer look at such predictions. Actors predicting future price developments make claims with regard to the future state of the world which they are convinced will come to pass. But these actors are no more able to see into the future than anybody else. The assertion that the price of gold or the stock market will rise or decline cannot be validated empirically ex ante. Rather, it constitutes the pretense of a possible event that is intended to motivate us to act as if the price were to change to the predicted level. In this sense, such statements are fictional.

Figure 1 shows that predictions of a rising gold price in 2012 were wide of the mark. Instead of rising, the gold price has been in decline since then. The role played by such imagined futures in financial decision-making processes and economic development as a whole is considerable. Fictional expectations create justifications for decisions in conditions of uncertainty. Such justifications are necessary to ensure that decisions do not appear arbitrary, to coordinate them and to drive innovations. Fictional expectations provide the motivation for economic actions which will only turn out to have been right or wrong at a later date, and thereby contribute to the pace of economic growth.

Expectations as an engine for the future

According to this theory, decisions are not determined by economic calculation but are based on contingent expectations which could always be different. The narrative of a certain expected, future economic development could always be told differently. This results in two important consequences for social science research.

»Expectations are themselves means by which economic interests can be pursued.«

On the other hand, although the future cannot be foretold, expectations and the actions triggered by them can generate the very developments expected. In this sense, expectations can be performative. Technological innovations are one example of this phenomenon. At the beginning of an innovative process, no one can foresee whether the innovation will be a technical success and will also establish itself on the market. But the technological future imagined can only, if ever, become reality with the help of investments motivated by fictional expectations. Without a credible narrative at the outset, the necessary investment would not be forthcoming, and we would never find out if the future imagined is possible.

An altered understanding of economic processes

Beyond the financial markets, fictional expectations are doubtless relevant for all areas of the economy: capital investments, investments in human resources, consumption, innovative processes and the way in which money functions. They represent a key to the understanding of economic dynamics hitherto scarcely regarded in research. The conceptual worlds of the market players are the drivers of investment streams, introducing the momentum of creativity to the economy and equally new uncertainty. The economic dynamic is also driven by the human ability to conceive of a world that is different to the one experienced. This not only creates room for interesting empirical projects in economic sociological research but also opens a fruitful paradigm in social sciences in which the focus is on the expectations of market operators. “The future matters”: It is not just the past that is relevant in explaining social actions but also visions of the future.

Shifting attention to fictional expectations and the narratives with which credibility for certain expectations of future developments is created, also leads to a changed analysis of economic processes. The focus is on the meanings which economic assets and processes acquire through their interpretation. This is followed by the question of how such meanings are created, reinforced and altered. If expectations are fictional, there are no actions in the economy based solely on calculations, and any economic science is more likely to follow the model of hermeneutics than that of the natural sciences.