There’s a nice headline in the Times today:Make us sell healthy food, supermarkets implore May.This invites the obvious reply: if you want to sell healthy food, why don’t you just do so?
The answer lies in competitive pressures. If any individual supermarket tries to cut salt in its products or refrains from special offers on unhealthy foods, it would lose market share to rivals.
Each individual supermarket’s rational attempts to maximize profits thus leads to an outcome which none of them really wants – the over-marketing of unhealthy food. This is an example of an arms race, a process whereby individually rational behaviour has results which are collectively undesirable. Here are some other examples:….Stumbling and Mumbling
Policy makers are keen to encourage people to save more money for retirement, e.g. via tax incentives. This is great advice for individuals; the more money an individual saves, the more comfortable their retirement. But is it also a good idea for society as a whole? What happens when everybody tries to save money at the same time?
To answer this, we need to understand the distinction between relative and absolute competitions. Think about a running race. An absolute competition pits each runner against the clock. In an evolutionary contest, where anyone who finishes the race in less than a certain time is allowed to have children, those with stumpy legs and flat feet will be replaced by the children of the fast runners. In future generations, the average person runs faster.
In contrast, in a relative competition, where competitors race in pairs against one another instead of against the clock, rules of fair play do not apply. One competitor is super fast. Unfortunately, he gets tackled from behind. In the ensuing brawl, he receives a solid blow to the head and passes out. The slower guy then wins. In each generation, the competition gets tougher, but not necessarily because the new generation runs faster. Strictly speaking, this relative competition does not favor being fast. What it favors is crossing the finish line before your competitor. Running fast is one way of crossing the finish line first. But evolution is a creative process, and there are many different ways of achieving the same goal. It is hard to predict which of the many solutions will triumph, and not all of the solutions are ones that we like.
If saving for retirement is an absolute contest, then policy makers are doing the right thing when they encourage people to save for retirement. But if saving for retirement is a relative contest, the incentives we give for retirement plans may achieve nothing, or even worse, do economic harm.
In the real world, it’s sometimes hard to figure out which competitions are relative and which are absolute. But the mathematics behind the two are different, and so are their outcomes. During my training in evolutionary biology, I learned to use a standard mathematical model in which competition was relative. In contrast, economists learn standard mathematical models that are based on absolute competitions. These default assumptions, built into the curriculum, can shape the way someone approaches a problem for the rest of their career.
As a result, economists are biased towards assuming that competitions increase prosperity. Evolutionary biologists like me are trained to have the opposite bias, instead assuming that competitions are zero-sum. In both cases, the truth is probably somewhere in between, but how we are trained affects which situations we see as “normal” and which as “special”, and which sort of mistakes we are most likely to make.Saving does not cause investment.
My recent book argues that saving for retirement has become a relative contest, but that economists dangerously mistake it for an absolute one.
Not only does the representative-agent model fail to provide an analysis of those interactions, but it seems likely that that they will defy an analysis that insists on starting with the individual, and it is certain that no one knows at this point how to begin to provide an empirically relevant analysis on that basis.You can't get there from here.
Cameron Murray has a new post up about logical fallacies and contradictions involved in setting up the AD-AS model in macroeconomics. I personally like the AD-AS model as a toy model of how an economy works. It misses out on a bunch of details, but I think it forms a fine basis from which to depart with more detailed model.
The focus of the Murray's post is the fallacy of composition, which I've seen used as a rhetorical device in many instances (the sum of government spending effects on local spending doesn't mean there is an aggregate effect, or prudent increased saving by individuals isn't prudent for the overall economic situation in the paradox of thrift). As a physicist, I've always thought of it as a strange rhetorical device. In physics we have large numbers of examples where the fallacy applies, but it is never used. I think the reason it is never used is that in general there is a specific effect at work and we'd refer to that effect instead of the "fallacy of composition" -- quark confinement, entropic forces, emergent dimensions in string theory, pretty much all of materials science.
I think the fallacy of composition would better be called the warning of composition -- an idea that warns you of:
- Effects that might go away at the macro scale (an example is the SMD theorem, and on this blog most of the details of how economic agents operate)
The warning of composition can help prevent you from making unwarranted jumps in logic. But sometimes those jumps are warranted (or you have explicit machinery for adding the effects together).
- Effects that might not exist at the micro scale, but do at the macro scale ("entropic forces", emergent properties, and on this blog nominal rigidity)
So let's look at the AD-AS model in the information equilibrium framework. It essentially lives entirely on the macro scale, so there isn't any fallacy of composition. We instead have failures of information equilibrium, exceptions and other micro effects.
Yesterday, 100,000 rioters clashed with police in Belgium over government austerity measures that will raise the pension age and reduce social services. These measures are, it was explained, “essential to keep the budget deficit within European Union constraints” (Belgian protesters clash with police over pensions and pay). This is utter nonsense and is yet another example of the confusion between money and wealth that is contributing to economic stagnation throughout the globe.
What we are witnessing is economic policy based on the fallacy of composition. The latter results when one assumes that what is true at the individual level translates to the whole.…Explaining Keynes without mentioning him.
Turner's warning of a secular stagnation for the UK is nothing compared to his grim diagnosis for Europe. The threats Turner identifies from extremely high household debt levels in the world's advanced economies are small beer in comparison to the dangers he thinks is facing Europe's currency union. And Germany is a huge part of the problem.…
Although I have huge respect for what Germany is as an economic success, a very strong political system…. And I entirely understand their fears of high inflation, etc., I think the predominant German attitude to macroeconomics is simply wrong. There’s a failure to deal with the fallacies of aggregation that are at the core of macroeconomics. It is not possible for the whole world to succeed in the same way that Germany succeeds. We cannot all be export led economies. We can’t all run surpluses unless we find another planet.Business Insider
For almost forty years neoclassical economics itself has lived with a theorem that shows the impossibility of extending the microanalysis of consumer behaviour to the macro level (unless making patently and admittedly insane assumptions). Still after all these years pretending in their textbooks that this theorem does not exist – none of the textbooks I investigated even mention the existence of the Sonnenschein-Mantel-Debreu theorem – is outrageous.Lars P. Syll's Blog
What does it take to produce large-scale social change? Most historians, if you catch them in an honest moment, will admit that the popular levers of social change, such as education or legislation, are bogus; they don’t really amount to very much. What does make a difference–and then only potentially–is massive systemic breakdown, such as occurred in the United States in the fall of 2008.Counterpunch
The near-standstill in wage growth for American workers hasn't just been good for their employers. It's turning out to be a potential bargaining chip for Canadian companies, too -- at least the ones looking to leverage their employees into accepting smaller paychecks.
A Caterpillar manufacturing plant in Ontario wants to halve its workers' wages, according to The Wall Street Journal. In its negotiations with the autoworkers' union, management is citing a similar Caterpillar plant in Illinois where employees earnless than half of what the Canadian workers make. It's the latest example of how low-wage workers the world over are being forced into an international race to the bottom.
Last year, the Swedish home-furnishings company Ikea opened its first factory in America, where employees start at salaries that are less than half the minimum wage common in Sweden, according to the Los Angeles Times.
Meanwhile, the low-wage jobs created in the U.S. often don't pay enough to cover basic living expenses like food, transportation and medical care, for which a salary of about $30,000 a year -- almost twice the federal minimum wage -- is needed....
let me add that the way the labor force participation rate increases during a boom, often to record highs, indicates to me motivation won’t be lost with a jg safety net/buffer stock vs unemployment as a buffer stock. During booms million of people take jobs who apparently don’t need the money, as they weren’t even looking for jobs and weren’t counted as part of the labor force or unemployed until the economy boomed. There is obviously more to motivation to work other than subsistence.
It’s the same argument today about unemployment comp causing unemployment. At the micro level anecdotal evidence is easy to find, but at the macro level that argument does’t make sense as anything but a kind of fallacy of composition.Warren Mosler
