Animal Spirits: Restoring Confidence in Nigeria

Ask a graduate economics class what determines the decision to invest and the common reply would be interest rates. Ask a finance graduate class, and they might go down the net present value route. Correct though these answers may be, a step outside the classroom and into the real world brings another contender: confidence.

A company will make an investment if it judges it to have a high likelihood of paying off. Similarly, a young Nigerian entrepreneur will pursue her business dream if she believes she has a decent chance of delivering on the vision. Interest rates matter but as John Welch, longtime CEO of General Electric, claimed, decisions are often made "straight from the gut".

John Maynard Keynes, perhaps the most influential macroeconomist of the last 100 years, famously used the term Animal Spirits to describe the human instincts and emotions that drive confidence and behaviour. 

Nigeria could do with spiritual support of the non-Babalawo variety. The government recently released an economic recovery and growth plan to run through till 2020. But many of the proposals will take time, and a short term boost is needed to speed up the process. Maybe animal spirits can help. 


The Confidence Spirit  

There are many reasons we should be concerned about confidence. Firstly, it has a direct effect. According to a Central Bank of Nigeria paper, consumer confidence has a causal effect on real GDP growth in Nigeria. In one specification, a 1% increase in the consumer confidence index resulted in a 2.48% increase in GDP growth. Disentangling the effect of "confidence" is tricky, and we should be sceptical of these findings. Nonetheless, such results have been consistently replicated and the relationship is sufficiently robust for confidence to be used to predict GDP growth.

In a book titled Animal Spirits, George Akerlof and Robert Shiller, two Nobel Laureates, provide a convincing case for the importance of animal spirits in explaining business cycles. They coined the term "Confidence Multiplier," similar to the standard Keynesian government multiplier effect. As per this effect, an initial increase in a unit of confidence increases income as people consume and invest, which in turn increases confidence, which increases income further – and the cycle goes on. This multiplier effect can go in the opposite direction and explains why relatively small hiccups or a loss of confidence in financial markets can spiral into a deep recession.

This theory illustrates how confidence can make Nigeria's reform policies more effective. For example, a significant amount of money is going to be spent on infrastructure and many workers or firms would be paid. The more confident these agents are, the more likely they will spend, start up a business, or invest.


The Credible Story Spirit

In the United States, President Trump's policy proposals and business-friendly measures have "reawakened animal spirits" according to JP Morgan CEO Jamie Dimon. Commentators have put the good US jobs data and US equity records down to a "Trump rally". While President Trump inherited a resilient economy, one reason he is rousing so much business confidence is the growing realisation of how serious he is about his promises.

You can see this in the executive orders, cabinet picks, and even the Mexico border wall, included in his proposed budget. I certainly thought the wall was a joke. Confidence has surged so much because Trump's declarations have become credible, for better or worse.  

The authors of Animal Spirits explain how the human mind is built to think in terms of narratives or stories. Importantly, stories are the infectious way in which confidence spreads. Trump has created a credible story and belief is driving the economy upwards.

APC had its story in the run-up to the election, and for some, the "Change" chapter has concluded. Criticism is growing, mainly on the economic front. But when President Buhari took his medical leave, there was a new story. Vice President Osinbajo's short reign managed to spark a new wave of optimism. His proactive behaviour and visits to the Niger Delta fueled the sense that he was serious about the Nigerian economy. The $500 million Eurobond proposal and the coincidental timing of the CBN's PTA and school fees policy backed this story up.  


The Naira Matters... Again

One of the primary drivers of confidence in Nigeria is the dollar exchange rate. Despite recent naira appreciation, jitters remain. There are questions about the sustainability of the CBN's fight against speculators. Further, the international community is likely to remain nervous until a more flexible regime, which doesn't depend on oil prices and reserves is established. Confidence in the naira is as important as what number the abokis quote.

Over the last two years, failing confidence in the naira caused capital flight as investors stayed away from our troubled economy. Subsequently, dollar scarcity pushed businesses to the brink. Stories of $1 billion of the foreign airline's earnings being trapped would have spooked investors, and the government needs to regain their trust.

Before we get carried away, let's remember that fundamentals still matter. There's a limit to what confidence can do for our young entrepreneur. She needs access to capital, markets, and expertise to thrive. But confidence will work in tandem with sound economic policies to create a quicker recovery.

With what has happened in the last two years, the road to rebuilding economic confidence is a steep one. Remember, confidence grows at the rate that a coconut tree grows, but falls at the rate that the coconut falls. 


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