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Behind the numbers: The economics of confidence

08 May 2018

Illustration of leaders holding up economic confidence graphDirectors’ confidence in the economy returned to positive in March - albeit only just - after almost a year in the red.

The announcement of ‘sufficient progress’ on Phase 1 of Brexit negotiations in December, followed by the more recent progress on a transitional arrangement, has helped to clear some of the clouds businesses have been facing for the past 18 months. That helps to explain the move from outright gloom toward fence-sitting on the economy’s prospects.

But whilst the move into the black is certainly noteworthy, what is even more striking in our confidence data – which we’ve been collecting on a consistent basis since July 2016 – is just how sensitive business sentiment is to political events and communications.

Confidence is clearly an amorphous issue, but it’s also a crucial component for economic growth. Faith in the future business environment is essential for directors to make key decisions on their organisation, whether that means expanding their workforce or launching a product. It’s certainly no surprise that our survey data is simultaneously showing a pick-up in business leaders’ employment and investment intentions for the year ahead, just as confidence has improved.

Graph showing business confidence over economic confidence

Data from IoD Policy Unit’s March Policy Voice survey of members, featuring 693 respondents, conducted between 8-27 March 2018.

The implication for policymakers is quite evident then: clear communication and greater engagement with the business community is a core determinant of economic growth. But the wider question is, if clarity and good news can boost directors’ mood, is there actually a case for ‘talking up’ the economy more generally, and being more upbeat?

Whilst that may cut against the British character, there are plenty of reasons to celebrate the economy, despite what the news bulletins might say. The UK is ranked 8th in the World Economic Forum’s Global Competitiveness Index, it launched 589,000 start-ups in 2017, and the capital remains the top global hub for the financial services industry.

Whether such positivity can displace negative news is however questionable. Humans have a negativity bias, meaning events of a more downbeat nature have a larger effect on one’s psychological state than neutral or positive information. Of course, that served an evolutionary purpose to keep our eyes on risks and danger.

But this cognitive bias also shapes the social, political, and economic environments humans have created. As such, economic research has found that people derive more satisfaction from news with negatively biased information, which in turn has driven media outlets – in their desire to shift newspapers and gain ‘click-fall’ – to focus on publishing bad news. When it is good deeds, best practice, and progress versus crime, corruption, and failed policies, positivity just isn’t likely to pay their bills.

Another theory is that we’re generally more positive about the world than it actually is—otherwise we’d simply despair and not achieve anything – and so when negativity does penetrate our thinking it is felt all the more readily.

Of course, positivity plays a key role in entrepreneurialism.

Many directors wouldn’t be in business if they weren’t optimistic, while remaining alert to negative news is a vital feedback to make necessary business improvements. Reflecting this, our firm-level confidence data has remained doggedly upbeat, at 47% in March, despite temporary hits from the recent political turbulence. And, business leaders shouldn’t be afraid to rejoice in the strengths of the economy even if the social currency, and biological norm, is cynicism.

Sure, being upbeat should be about celebrating genuinely positive news, and not merely trying to game our moods upward with fake news or hysteria, which can dramatically and irrevocably take the wind out of investor’s sails when the fundamentals are ultimately shown not to stack up. The stock market tends to operate very much in this manner.

Nonetheless, confidence certainly has a role to play. After all, the timely release of our good news data on Friday the 13th may have helped to push up sterling on an otherwise news-less day. But alone, it is no substitute for tangible economic progress and positive policy outcomes. 

Tej Parikh, Senior Economist, IoDTej Parikh

Tej holds a Bachelor’s degree in Economics from University College London, and a Master’s degree in International and Development Economics from Yale University.

Prior to joining the IoD, he worked as an economic analyst at the Bank of England in roles across monetary and financial policy. Subsequently, he moved to Cambodia where he was a journalist focusing on economic and private sector development for a national newspaper. He has since been a freelance political risk consultant and journalist, covering Europe and Asia in particular.

He has published for numerous international media outlets including Foreign Affairs, the Guardian, and The Diplomat, and is currently an active member of London’s Great Debaters Club.

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