Globalist Analysis

Cognitive Dissonance and the Financial Crisis

How did the financial crisis demonstrate the need to accommodate cognitive dissonance within our institutions?

Takeaways


  • The global crisis should inspire our sense of humility. We need more humility when looking at the world, in particular the emerging world.
  • In efforts to find ways out of the crisis, OECD countries have cooked up exactly the recipes that they advised emerging economies against.
  • Yesterday's truths are not only being questioned by the rising, shining emerging countries, but also from within, by some of the institutions originally created by developed economies.
  • Cognitive dissonance is as rare and precious as a white pearl.

One of the aspects of the cognitive crisis that is part and parcel of the global financial crisis is that the OECD countries have lost the authority to give seminal lectures to the emerging world on how things should be done.

In efforts to find ways out of the crisis, OECD countries have cooked up exactly the recipes (fiscal stimuli, massive debt, nationalization of banks and so on) that they advised emerging economies against, when these countries were facing their respective crises in the 1980s and 1990s. What is more, OECD countries have done so on a massive scale.

This asymmetry has quite rightfully been highlighted by emerging economies from India to China, from Brazil to South Africa.

Once a upon a time, OECD countries presented themselves as sole masters of “best practice,” yet at least now we are discovering that other “non OECD” countries can be sources of best practices — and further, that from Iceland to Greece, not everything that glittered in the “first-class” OECD countries was gold.

Nevertheless, something even more intriguing is going on: Yesterday's truths are not only being questioned by the rising, shining emerging countries, but also from within, by some of the institutions originally created by developed economies.

For example, it is striking that the International Monetary Fund has become one of the great defenders of fiscal Keynesianism, particularly given that in the 1990s it was the very organization that pushed for austerity throughout the emerging world, preaching the benefits of shock therapies in Latin America and Asia.

In April 2010, the same organization sent ripples through the financial world when it suggested the imposition of two global taxes on banking for open discussion in the G20 — the forum that brings together the main developed and emerging economies of the world.

Further, in a study published at the beginning of 2010 that shook the academic world and central banks alike, the chief economist of the IMF, Olivier Blanchard (previously professor of economics at MIT), shattered another great taboo when he proposed nothing short of the (slight) relaxation of inflation goals.

The example of the IMF is interesting because it highlights an institution's ability to reinvent itself. It is hard to avoid noticing that this institution has been singularly bolstered by the crisis, which without doubt has given it a unique opportunity to become a protagonist on the world stage again. This is an opportunity that the IMF's top management has masterfully made the most of.

Yet perhaps the key to this successful repositioning lies precisely in the IMF's ability to regenerate and subvert itself, i.e. to exhibit cognitive dissonance and innovation, not only by tolerating this internal dissonance, but rather by promoting it (Blanchard's hire alone evidences this audacity).

This is a feat of great merit, since whether public or private, national or international, none of our institutions tend to favor dissonance. Very much on the contrary, they tend to limit disruptive, innovative potential.

Consider, for example, the remuneration of bankers via the (now infamous) bonus system, invented to reward those who have (supposedly) made money. Where are the reward systems for those who have avoided losing money?

Cognitive dissonance is as rare and precious as a white pearl. It is key to promoting innovation and to reinventing oneself.

Since antiquity, we have seen that cognitive dissonance is a difficult path to tread. Alejandro Aménabar's recent film, "Agora," reminds us of this, telling the story of the female astronomer, Hypatia of Alexandria, who was carved up and burnt over 1,600 years ago for being a thinker considered to be (too) independent and dissonant.

Thankfully, cognitive dissonance no longer leads to such dramatic ends. Nevertheless, we should remember that Lehman Brothers' risk analysts, rather than being applauded for drawing attention to the bank's risky transactions and dubious accounting methods (months before the fall of the bank), were swiftly dismissed.

In a number of his essays, Albert Hirschman, perhaps one of the best thinkers of the last century and a regenerated and reinvented economist-turned-philosopher, insists on the importance of self subversion and the need for cognitive dissonance. Being based as they are on real experiences, his reflections are far more useful than abstract notions formed in a library.

In the 1940s and 1950s he saw firsthand how the Marshall Plan and later the World Bank in Colombia preached systemic truths, sketching out grand theories and schemes later to be magically replicated in diverse realities in very different countries.

Hirschman retells this cognitive experience in one of his essays insisting that in the end, these political economic prescriptions are often "politically foolish, socially explosive and economically counter-productive."

The global crisis should inspire our sense of humility. We need more humility when looking at the world, in particular the emerging world. Maybe best practices are not only here, but also there. It should also invite us to reflect on the need to rethink how we can better, and more extensively, accommodate the capacity for cognitive dissonance within all of our institutions.

The solutions are multiple, and there are no magic potions or paradigms to apply or reapply. Cognitive dissonance spaces have yet to be invented and re-invented.

Herein lies the key for those who will be able to regenerate and reinvent themselves — in short, who will innovate, be they part of the business world, international organizations or governments. It is also the key to avoiding such massive cognitive bubbles and cognitive failures we have been — and still are — witnessing.

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