Having written a glossary entry on the paradox of thrift this morning, I realised one was also required on the fallacy of composition. This it:
The fallacy of composition is the mistake of assuming that what is true for an individual or a part of a system must also be true for the whole.
In economics, this logical error underlies many policies that appear sensible when viewed from the standpoint of a single person, household, or business, but create harmful outcomes when adopted by everyone simultaneously.
The classic example is the paradox of thrift. One household saving more might be prudent. But if every household cuts expenditure at once, demand collapses, jobs are lost, incomes fall and society becomes poorer overall. The very goal that each individual sought, of greater financial security, becomes harder to achieve.
Other economic instances are widespread.
For example, if a business cuts wages, it might gain a competitive advantage in the short term. But if all businesses cut wages, consumers have less to spend, profits fall, and the entire economy shrinks.
In addition, if one country tries to run a budget surplus by reducing government spending, it might succeed at others' expense. But if all countries pursue surpluses through austerity, global demand collapses, and recession follows.
The fallacy of composition reveals why good economic management cannot be reduced to the household metaphor or household analogy so beloved by politicians. A currency-issuing government is not a family and cannot sensibly behave like one. Public deficits are a private surplus: cutting them inappropriately removes the income that households and businesses depend upon.
In short, the fallacy of composition warns that systems behave differently from their parts. Policies must be judged by their collective outcomes, not their superficial resemblance to individual prudence. Economic common sense for one is often economic nonsense for all.
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‘Not heard of that before!
Thank you. ‘Shall digest.
Thanks! very useful to have this clear definition for the logical glitch.
It applies in science. One water molecule doesn’t behave at all like a volume of water. A body structure doesn’t behave like the cells composing it considered alone. There, it’s called emergent properties.
Nothing frustrates me more than inconsistency with messaging, especially from politicians. Grow the economy by “tightening our belts” both personally and nationally, which we all here know doesn’t grow the economy. Especially pernicious is the narrative that moral failures are behind every personal or business failure (when we instinctively know the odds are stacked against us without access to capital).
Every single talking point it seems, has a counter productive talking point, policy or group of policies behind it. I loathe the lack of joined up thinking in our governance, and long for competant compassionate people to take up leadership roles! It really comes across as them (politicians) not caring about normal people, or that everything they say is contradictary.
Yes – this must be the hidden moral of hungry hippos too.
If each player only took one bite when the player on their right took a bite then that would be good for the overall well being of all the hippos.
If one player broke this rule and was smashing down on their hippo munching everything, that would be a good strategy for that player.
But when everyone smashes down on the hippos, that will be bad for society as quickly there will be no food left.