Who will drive Asia’s animal spirits?

Throughout history, humanity's creativity, innovation and courage have come from "animal spirits," leading it out of adversity. In the 1936 "General Theory of Employment, Interest and Money," English economist John Maynard Keynes famously saw that psychology played a great role in economic behaviour. He wrote, "Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits – of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities." 

Written in the height of the 1930s Great Depression, Keynes was clear-sighted to know that the market cannot shake itself out of a downward spiral with mere confidence. It took "animal spirits" – the courage to act when inaction is dangerous – to get the economy out of the quagmire (defined by Keynes as a liquidity or confidence trap). Instead of the market (or classical economists who thought the market would self-correct itself), Keynes recommended using the state to deploy fiscal expenditure – the state animal spirits, rather than the market. In his words, "If the animal spirits are dimmed and the spontaneous optimism falters, leaving us to depend on nothing but a mathematical expectation, enterprise will fade and die; though fears of loss may have a basis no more reasonable than hopes of profit had before."

The world today is caught in the same confidence trap – staved off only by central banks and governments willing to print money as the aspirin to cure the structural malaise of low productivity, social injustices and planetary imbalance. Neocons prefer to exploit the fear of war to ramp up defense spending. The Russia-Ukraine war has already cost hundreds of thousands of lives, billions of wasted ammunition, and destruction of the richest soil in Europe.  In China, growth and exports are down, youth unemployment is up and there is net capital outflow. The US stock market is the only one that seems to defy gravity, buoyed up by the "Magnificent Seven" tech companies riding on the prospects of domination in Artificial Intelligence (AI) and Big Data.  

However, since China is both a major producer of low-end semiconductors and buyer of high tech goods, further US-China trade tensions and sanctions would only cut corporate profits and reverse the stock market recovery.  

The success of the US tech stock market shows a marked difference between the US equity driven model compared with the European, Japanese and Chinese bank driven model. In the US, bank loans to the private non-financial sector amounted to only 51.2 percent of GDP at end-2022 (BIS data), compared with 89.6 percent for the Euro area, 123.9 percent for Japan and 185.4 percent for China.   

By their very nature, banks are risk-averse, collateral-based, and unwilling to finance innovation and venture capital. At the same time, they are prone to credit, liquidity and maturity risks, and they can face non-performing loans if real estate values, the primary backing for bank collateral, were to suffer. In a situation where the financial system is dominated by banks, with high domestic credit-to-GDP leverage, asking the banking system to lend more to reactivate growth is also a huge risk. You simply cannot push the real sector – which deals with the production side of the economy – on a finance string. This explains why quantitative easing since 2008 has not transformed productivity and instead worsened debt-leverage and social inequality.

The real sector is the real engine of growth through creativity, innovation and risk-taking. The state can only do so much in the infrastructure and regulatory area, but when regulations become more and more complex, even as central bank balance sheets expand, the private sector becomes too reliant on guidance from the state, becoming risk-adverse or seeking foreign pastures where the grass is perceived to be greener.    

Therefore, reviving the private sector's animal spirit is critical to future growth, as innovation, entrepreneurship and risk-taking go for winning gambits that would create revenue to compensate for system losses. National leaders like the former chairman of the Chinese People's Political Consultative Conference, Deng Xiaoping opened the animal spirits of Chinese entrepreneurs, including state-owned enterprises, by asking them to take risks. Former US President Ronald Reagan and UK Prime Minister Margaret Thatcher encouraged private enterprises and cut back state intervention in order to allow markets to grow. The state took risks in trusting the private sector to take market risks, but the combination worked.  

Faced with unprecedented shocks from the pandemic, growing geopolitical rivalries, wars and social protests as well as disruptive technological change and very complex regulations, the Asian private sector is currently buffeted and prone to "liquidity preference,"for not investing with the long term in mind, and in some cases, even cutting back debt.  

By definition, all state bureaucracies are torn by fear of failure, whereas the market is driven by hopes of success. When the state seeks to regulate more and more, the private sector votes with their feet. Investors seek short-term returns with lowest credit risks. Entrepreneurs sit on the fence. Unemployment rises, inflation and costs increase, expectations of the future become lowered. In the end, it all comes down to a confidence issue.

So here, we should remember what Keynes said in the General Theory, that when the state empowers the market, we are led out of the wilderness of despair. Confidence is a mindset game. Trust in the market involves risks. Former US State Secretary Henry Kissinger used to say that, "In crises, the most daring course is often safest."  

It is now time for Asian governments to unleash the market's animal spirits to take the bold steps that are indeed needed to pull ourselves out of the looming recession trap. 

Andrew Sheng is a distinguished fellow of Asia Global Institute, University of Hong Kong, and chief adviser to the China Banking Regulatory Commission.

Views in this article are the author's own.

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