Economics and the Fallacy of Composition–December 7, 2008

December 7, 2008

From Wikipedia: In Keynesian macroeconomics, the “paradox of thrift” illustrates this fallacy: increasing saving (or “thrift”) is obviously good for an individual, since it provides for retirement or a “rainy day,” but if everyone saves more, it may cause a recession by reducing consumer demand.

These days, most of us know that the most significant answer to the world recession is for citizens of the world to spend, spend, spend. Even with our ability to spend severely damaged, we can still spend–at least some of us can. And, the need to spend now is greater than ever, tho the capacity to spend is so much less.

While saving, in the long run, is a good thing–for governments, businesses, and for individuals, it’s not a good thing collectively just now.

The way this works is that if all of us spent (to avoid drifting into distraction from the main point, let’s assume we all spend on good things, like education, better schools, home improvements that have value, physical fitness, fuel efficient cars, etc.) aggressively, we’d quickly grow our economy out of the recession. If only a few of us spend (the wealthy, for example), it will not grow the economy. If only a few spend and we’re among the few, we deplete our personal savings and safety and it doesn’t help much. We may end up in poverty.

Provocative questions arise, when one stops to consider the fallacy of composition: Is it immoral for us (having a little money left) to retreat to cutting all our discretionary expenditures now–shouldn’t we be trying to spend all that we have, for the common good? And, what about government–it seems our budget (at least in the US) was already frighteningly deficit before the recession arrived. And now, it’s good for us to double or triple our deficit to get out of it? Yes, maybe so, if we do, how will we rein in these “temporary” excesses when we have rescued employment and growth?

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