Image Credit: Gulf News

There is something very difficult to formalise about human beings. Something that we attempt to glimpse at, but something that we do not achieve with our theories.

All too often, we overlook the power of the narrative in the cause-and-effect of economic relationships. And it is this critical variable where our insight falls short of grasping the underlying nature of the reality.

Why do narratives affect economics? Because when we want to understand a recession, we have to understand why people stop spending. Recessions occur when people stop buying things; they may decide to not buy a new car or house — but why not?

We say that people stopped spending because a recession struck, but that doesn’t explain why the recession started. In Dubai, we had the Great Recession of 2008, an event that transpired nearly a year after the global economy starting contracting.

Its effects still linger on today and we still talk about it. When we read the newspapers at that time, strangely enough, analysts dismissed the possibility of house prices crashing in 2008, even though the world economy had started flashing warning signals a year earlier.

The 2008 market crash is a terrible story, but also a memorable one. When we go back in time, we find remarkable narratives in newsprint. For example, even though it was fashionable to display signs of wealth at that time, people were upset about the rapid cultural changes that were taking place in society and that many such concerns were being expressed in social media about how expensive things had become and how Dubai had lost its cultural touch and changing too quickly.

This uptick in worries happened because of something that behavioural economists called the “affect heuristic”; the fact that people were upset at the certain changes happening around them. There was concern being expressed at the rising cost of living, rising debt levels, the softening world economy, the loss of cultural heritage, and the like.

All these events helped to create a mood among the public, it made them feel edgy and perhaps even concerned. This then fed into the behaviour of them starting to hold off on purchases, especially on large ticket items, which caused the recession.

In other words, these were well structured narratives that went viral, well before we even coined the term, and caused what the economist and psychologist Peter Brooks called “animate the sense making apparatus”. Prices started falling.

Then people started worrying about prices falling so they held off even more, which then led to a cascade effect.

This event had repercussions later on. For example, the recession of 2009-11 was relatively short-lived; house prices and employment levels started to rise in late 2010, which led many to believe that when prices started falling again in 2014, history would repeat itself.

This is why analysts started forecasting a recovery in prices as early as late 2016, only to be proven wrong again and again. Even though oil prices recovered, geopolitical considerations meant that it was once again unfashionable to display wealth, and this, combined with the effects of uncertainty that technological changes ushered in (eCommerce versus traditional retail), meant that demand fell.

Analysts started fretting about oversupply concerns in real estate, which contributed to and amplified overall anxiety levels, and the resultant fall in demand ushered in job losses that exacerbated the downturn. Again, it may be this narrative that contributed to the protracted economic sluggishness that lingers on today.

Why do economists miss out on these stories that are behind these economic fluctuations? One reason is that they operate with a standard tool kit, and the narrative is not part of it. Economists do simultaneous equations and teach general equilibrium theory, and by the time they are done, there is very little room left to incorporate other factors.

But whilst there is room for quantitative analysis, there is also room to collaborate with other humanities, those that can give insight into narratives and why certain story structures work and others don’t.

If these narratives become part of the toolkit, then our understanding of economic fluctuations can improve dramatically in the years to come.

— Sameer Lakhani is Managing Director of Global Capital Partners