In Praise of Irrational Exuberance

Does a flourishing economy depend on delusion?

Big Questions Online , October 27, 2010

Does a flourishing economy depend on delusion?

Adam Smith thought so. In a famous passage in The Theory of Moral Sentiments he described a “poor man’s son, whom heaven in its anger has visited with ambition.” The young man imagines how much easier his life would be if he could live in a grand home, attended by servants and traveling by coach rather than on foot: “He thinks if he had attained all these, he would sit still contentedly, and be quiet, enjoying himself in the thought of the happiness and tranquillity of his situation.”

The man spends his life striving to achieve his dream. He becomes wealthy, with all the luxuries he imagined, but to get there he has to work so hard that he can never relax. “Through the whole of his life,” writes Smith, “he pursues the idea of a certain artificial and elegant repose which he may never arrive at, for which he sacrifices a real tranquillity that is at all times in his power.” The man is deluded by the glamour of wealth, tricked by an illusion. Yet his achievement is not only real but socially beneficial: “It is this deception which rouses and keeps in continual motion the industry of mankind.”

Many entrepreneurs aren’t even that lucky. They wildly overestimate their chances of success. But this second delusion, suggests economic historian John V.C. Nye, may be essential to maintaining an entrepreneurial culture. In a 1991 article titled “Lucky Fools and Cautious Businessmen,” Nye, now at George Mason University, argues that countries become economically stagnant when their business people become too mature and rational.

That’s what happened to Victorian Britain, he suggests, when it was surpassed by the United States and Germany. Britain had capable businessmen and good financial markets to support them. There’s no evidence that Victorian businessmen failed to invest wisely. The problem, argues Nye, is that they didn’t invest unwisely.

The odds of any given venture succeeding are, of course, low. But it’s rational to invest $1 million in a business that will fail nine out of ten times, as long as the tenth time will earn least $10 million. Nye is talking about irrational bets: investing $1 million on a one in 50 shot of $10 million. An entrepreneurial culture encourages those crazy bets as well, and a few startups get lucky. We should, Nye suggests, think of “the entrepreneur as the valiant, but overoptimistic investor rather than the heroic seer.”

Entrepreneurship is not, in this view, a rational risk calculation. It is, as critics of capitalism sometimes charge, a bit like gambling. The few big winners are usually people who shouldn’t have bet their time, money, and ideas. They overestimated their chances of striking it rich. But they beat the odds—to everyone’s benefit. These “lucky fools” create new sources of wealth, new jobs, new industries offering less-risky opportunities, and new technologies that improve life. Society plays the role of the casino, enjoying the spillover benefits from foolish bets.

If entrepreneurs are spurred by illusion, so in many cases are the consumers whose dreams they serve. As many a social critic has preached, we don’t really need most of the things we buy. We can certainly survive without another pair of shoes, a beach vacation, or an iPad. We just imagine we’d be happier with them. Sometimes we are. But even the most successful purchases rarely live up to our daydreams, which edit out all the flaws and aggravations. At the very least, we get used to what we have. The thrill of novelty wears off, and we start dreaming of something else.

In The Romantic Ethic and the Spirit of Modern Consumerism, the sociologist Colin Campbell calls this insatiable desire “modern self-illusory hedonism.” Modern consumption, he argues, isn’t driven by the traditional, satiable hedonistic desires for the familiar experiences of food, drink, or sex. It is more open-ended, a longing for something unknown and thus potentially transformative. The modern consumer, he argues, is a “dream artist” with “the ability to create an illusion which is known to be false but felt to be true.”

The glamour of new, as-yet-unexperienced goods or experiences thus contains an element of pleasurable, often deliberate, self-delusion. We not only enjoy new things. We also enjoy imagining how much we’ll enjoy them. Anticipation and desire themselves are part of consumer pleasure.

“The idea that contemporary consumers have an insatiable desire to acquire objects represents a serious misunderstanding of the mechanism which impels people to want goods,” argues Campbell. “Their basic motivation is the desire to experience in reality the pleasurable dreams which they have already enjoyed in imagination, and each ‘new’ product is seen as offering a possibility of realizing this ambition. However, since reality can never provide the perfected pleasures encountered in day-dreams (or, if at all, only in part, and very occasionally), each purchase leads to literal disillusionment.”

All this delusion can, of course, become destructive. But there’s more to it than mere foolishness. The illusions that spur entrepreneurial ventures and consumer daydreams point to the nonmaterial side of markets. Markets not only expand health and comfort, providing a sustaining material existence. They also spur ambition and imagination, the quest for achievement and the pursuit of meaning. They give us an opportunity to exercise our creativity, to enjoy the satisfactions of absorbing, productive work, and to fashion and express our identities.

Even the most seemingly materialistic daydreams—the transformed life we imagine in a new dress, a new car, a new house—allow us to rise above the here and now, projecting ourselves into an idealized future. In the process, we learn truths about who we are, what we desire, and who we might become. Those things may matter only to our minds, but that doesn’t make them any less valuable or any less real.