{"id":44628,"date":"2019-03-19T15:28:46","date_gmt":"2019-03-19T15:28:46","guid":{"rendered":"https:\/\/www.lse.ac.uk\/granthaminstitute\/?post_type=news&p=44628"},"modified":"2024-08-16T10:24:19","modified_gmt":"2024-08-16T09:24:19","slug":"mind-over-matter-how-expectations-generate-sustainable-wealth","status":"publish","type":"news","link":"https:\/\/www.lse.ac.uk\/granthaminstitute\/news\/mind-over-matter-how-expectations-generate-sustainable-wealth\/","title":{"rendered":"Mind over matter \u2013 how expectations generate sustainable wealth"},"content":{"rendered":"\n

Dimitri Zenghelis writes on how our expectations of the future shape the world and how we generate wealth, and determine whether and how we meet our climate and sustainability targets.<\/em><\/p>\n

A sympathetic instructor once explained, as I scrambled to untangle mangled poles from the snowy base of a hapless fir tree, that the best way to avoid skiing into trees is to look at where you want to go and not where you don’t. Expectations, she noted, have a habit of becoming self-fulfilling. So it is with generating wealth.<\/p>\n

Wealth depends on expectations and expectations depend on psychology. Individual assets, priced correctly, reflect the value of the discounted sum of the stream of future benefits they generate. The morning after a stock market crash, the quantity of factories, land and labour which generate output have not diminished, but the expectation of their ability to generate profits in the future has.<\/p>\n

There was an estimated 2.7 trillion barrels of accessible crude oil in the ground in the early 19th century. But until James Young invented oil refining in 1850, its value was negligible. Today, there are roughly 1.7 trillion accessible barrels left underground. At $60 a barrel their value comes to around $102 trillion. But if that oil is burnt without capturing the carbon, we will blow our global climate targets by a wide margin. So what is it really worth? That depends. The oil in the ground does not change, but society does, including how it uses oil. The value of tin or lithium, video recorders or GPS receivers, archery or coding skills depends on how they complement other assets from which returns are derived.<\/p>\n

This forward-looking element is precisely what makes wealth a better indicator of sustainability than annual output or GDP. But just how are expectations formed? The first place we look is to history and experience. Each innovation builds on the past. Physical infrastructure, habits and behaviours complement each other in ways which can be locked-in for decades<\/path><\/svg><\/a>. For example, sprawling cities are generally car-dependent and citizens value roads, while dense cities rely on public transport and citizens value pedestrianisation and cycle lanes.<\/p>\n

But expectations are also forward-looking. After all, it is the technologies, tastes and behaviours of the future that will determine the value of the assets we invest in. People base their decisions on how they anticipate others will act. Social psychologists have long understood that solving coordination problems requires policy to guide behaviour by anchoring expectations through developing ‘common knowledge’<\/path><\/svg><\/a> as the basis for collective action, coordination and altruism.<\/p>\n

We can see this happening in energy and transport. The belief that the world is shifting to a low carbon future is prompting greater investment in renewables and electric vehicle networks, lowering their costs and, as they outcompete fossil fuels, helping make the belief self-fulfilling<\/path><\/svg><\/a>. One study describes<\/path><\/svg><\/a> how once the “clean innovation machine” has been “switched on and is running,” it can be more innovative<\/path><\/svg><\/a> and productive than the conventional alternative.<\/p>\n

Getting to this point took decades of concerted policy effort to overcome the inertia of history, build new constituencies, lobbies and institutions and replace old networks. But these complementarities raise the possibility of multiple equilibria<\/path><\/svg><\/a> in global technologies which are path-dependent and highly sensitive to initial conditions and to expectations.<\/p>\n

Last year, Paul Romer won the Nobel Prize for economics in part for pointing out that investing in assets can change both the character and the rate of growth. For example, buying computers induces smart ideas on how to use them which in turn increases the returns to buying computers. Commenting<\/path><\/svg><\/a> on the theory of endogenous technological progress, for which he is famous, he writes that “instead of suggesting that we can relax because policy choices don’t matter, it suggests to the contrary that policy choices are even more important than traditional theory suggests.”<\/p>\n

By the same token, the Paris Agreement of 2015 succeeded because it shifted expectations from a narrative based on burden-sharing and sacrifice to confront a global problem (which bred distrust and ill-will) to voluntary contributions emphasising self-interest and opportunities<\/path><\/svg><\/a> from investing in low-carbon assets.<\/p>\n

Credible leadership and innovation from business and government can change the real world<\/path><\/svg><\/a> by creating and destroying wealth<\/path><\/svg><\/a> through steering social norms, technology networks and markets. Few predicted that by now renewables would be the world’s biggest source of annual investment in energy generation, outpacing coal, oil, gas, nuclear and hydro combined. LEDs’ share of the global lighting market has gone from less than 5% to more than 40% in the past six years. No serious auto manufacturer is committing its scarce R&D budget to the combustion engine. By contrast, many fossil fuel companies find themselves in financial trouble. For all President Trump says, US coal is now expected to decline faster than under the Obama era<\/path><\/svg><\/a>.<\/p>\n

Actual or expected changes in policies, technologies or the threat of litigation<\/path><\/svg><\/a> (arising when parties who have suffered loss and damage from climate change seek to recover losses from businesses and governments), are likely to prompt further rapid reassessment<\/a> of the value of a large range of carbon intensive assets, as changing costs and opportunities become apparent.<\/p>\n

Expectations also play a central role in determining the value of social capital<\/path><\/svg><\/a>. Partha Dasgupta describes<\/path><\/svg><\/a> the essence of trust as “someone entertaining correct expectations regarding someone else’s promises”. He adds: “Failure to cooperate could be due simply to an unfortunate pair of self-confirming beliefs, nothing else…even when appropriate institutions are in place to enable people to cooperate.”<\/p>\n

Because of this, society can tip from cooperation to non-cooperation merely on account of a change in expectations. People who woke up in the morning as friends can yield machetes by the afternoon. The value of social capital can collapse overnight.<\/p>\n

Thankfully, such rapid swings are rare as social capital, like knowledge, and physical capital, also depends on history, making it highly path-dependent<\/path><\/svg><\/a>. Individual beliefs are influenced by values and social norms which, in turn, are influenced by the products of society, such as institutions, trends and technologies. Complementarities exist across assets.<\/p>\n

People and firms will have more incentive to collaborate and connect ideas in a trusting society, thereby increasing the potential for creativity and innovation. As Ed Glaeser<\/path><\/svg><\/a> puts it: “In some communities, the level of investment is high and the return to investment is consequently high.” In an echo of the technology story, he says: “These complementarities raise the possibility that there exist multiple equilibria in the levels of social capital investment… Multiple equilibria models explain how small differences in initial conditions can generate large divergence in long-run levels of social capital.”<\/p>\n

In short, we build the world we value and we value the world we build. Early choices matter because people base their decisions on how they anticipate others will act, so sustainable wealth creation leaves no room for complacency or fatalism. Leadership from business and credible policy from government can steer expectations, direct technical, social and institutional change, and irreversibly shape the world we live in. As I found out on the slopes, expectations become facts on the ground. But if we don’t monitor and measure those facts, what hope do we have of shaping them?<\/p>\n

This commentary was first published<\/path><\/svg><\/a> in the Bennett Institute for Public Policy, Cambridge’s series The Wealth Economy<\/path><\/svg><\/a>.<\/em><\/p>\n\n","protected":false},"excerpt":{"rendered":"\n

Dimitri Zenghelis writes on how our expectations of the future shape the world and how we generate wealth, and determine whether and how we meet our climate and sustainability targets.<\/p>\n\n","protected":false},"author":23,"featured_media":44633,"template":"","tags":[247,115,219,1732,105,294,1731],"news-category":[16],"topic_area":[4697,4698],"class_list":["post-44628","news","type-news","status-publish","has-post-thumbnail","hentry","tag-behaviour","tag-energy","tag-innovation","tag-social-capital","tag-sustainability","tag-transport","tag-wealth","news-category-20-commentary","topic_area-energy","topic_area-behavioural-responses"],"acf":{"exclude_from_sync":{"ref_value":"field_560538b0e7350","value":"1","type":false,"post_type":""},"downloads":{"ref_value":"field_52f16cc1a80f2","value":false,"type":"repeater","post_type":""},"rss_newsletter":{"ref_value":"field_54f5c2c1544d8","value":"","type":false,"post_type":""},"profile_link":{"ref_value":"field_52f164b5189e9","value":["dimitri-zenghelis"],"type":"relationship","post_type":"profile"},"article_link":{"ref_value":"field_52eee3c7f0586","value":"","type":false,"post_type":""},"article_link_title":{"ref_value":"field_5322399d89d42","value":"","type":false,"post_type":""},"spotlight":{"ref_value":"field_52f80896506d3","value":"","type":false,"post_type":""}},"yoast_head":"\nMind over matter \u2013 how expectations generate sustainable wealth - 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