A new theory that’s gaining some ground in economics and finance is extrapolative expectations, which says that people tend to mistakenly think that recent trends are going to keep going. That theory could help explain financial bubbles. But I also believe it can help explain a lot of the anger we’re now seeing in the political world — especially the rage that led to the rise of Donald Trump.
During the 2016 election, people often debated whether Trump’s supporters were motivated by economic anxiety. Plenty of evidence showed that Trump voters weren’t doing worse, economically speaking, than those who voted for Hillary Clinton. But that might not be the whole story.
To see why, take a look at the Financial Trust Index. A University of Chicago Booth School of Business team, headed by Paola Sapienza and Luigi Zingales, tracks how much people trust various economic entities — banks, the stock market, mutual funds and large corporations. As you might expect, poor people tend to have less trust in the economy than do the wealthy. But in most of the years since 2008, non-Hispanic white Americans — who formed Trump’s main support base — reported less trust than nonwhites. That’s surprising, given that whites tend to earn more and have higher levels of wealth.
My hunch is that it’s a result of extrapolative expectations. Look at the wealth patterns for white and black households during the last few decades: In percentage terms, black people have fared worse since the housing crash (and the pattern is similar for Hispanics). But black and Hispanic households never had that much wealth to begin with — they’ve gone from a small amount in the bank to a very small amount. And there was never a long sustained trend of black wealth-building; in fact, black wealth started declining years before the financial crisis.
White households, on the other hand, accumulated a good deal of wealth during the ’80s, ’90s and early 2000s, and the trend was smooth and steady. The average white person, extrapolating the trends of the past few decades, would have expected a comfortable retirement. If people have extrapolative expectations, then a white American in 2007 counted on house prices and stock prices carrying him or her ever upward through the ranks of the middle class.
The financial crisis and the housing bust put an end to that. Extrapolative expectations were dashed, and what people thought were unbreakable trends turned out to have been bubbles and blips. Suddenly, instead of a comfortable retirement or a properous middle age, many white people faced a future of uncertainty, where they would have to scrimp and save like their parents and grandparents.
When dreams are dashed, the result can be very negative emotions. Economists Miles Kimball and Bob Willis have a theory that happiness comes from surprises. When you get more than you thought you would, you’re happy; when you get less than you expected, you’re dissatisfied or angry. That theory fits with a lot of survey data on happiness. It’s not just how much you have that matters, it’s how much you have relative to your past expectations.
When those expectations are the extrapolative kind, the hit to happiness from a bursting bubble can be particularly severe. If people were fully rational, they’d see the ups and downs of the markets as business as usual. But if people believe in trends, then a sudden downturn in asset prices after decades of increase shatters one’s hopes and dreams in an instant. A bright imagined future crumbles to nothing in the space of a few short weeks.
So this is a possible explanation for why white Americans were angrier at banks and large companies than their minority counterparts. Their extrapolative expectations were more optimistic to start with. Having known nothing but enrichment for three straight decades, they suddenly found that this wasn’t just the way the world worked — that in fact, wealth doesn’t just build itself for most people in most time periods.
Critics of this theory will point out that whites in coastal cities that had the biggest housing bubbles tended to go for Hillary Clinton. But the educated whites who tended to lean toward Clinton have an additional kind of wealth — human capital, the value of their skills and credentials. That wealth didn’t decline when housing crashed. But for many whites without a college degree, housing wealth — and maybe a pension or 401(k) — was all they had.
The idea that political instability comes from frustrated expectations is hardly new. Modern economic theory might put flesh on that old theory’s bones, showing the deep, fundamental reason why good times give rise to crisis. Once people believe their lives are on an upward path to prosperity, even a temporary bump in the road can cause an explosion of rage.
Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.