Economic sophistry

Image: Ekaterina Astakhova


The collective performance of everyone in the system cannot simply be inferred from understanding the behaviors of its individual components.

“Sophistry” is an argument with fraud, that is, constructed with the conscious intention of deceiving the interlocutor, while “fallacy”, on the contrary, would be without fraud. Although it is constructed without the intention to deceive, it would be deceptive all the same.

Since sophistry is a thought or rhetoric intended to mislead, it is presented with apparent logic and meaning for laypeople. However, it has micro fundamentals that contradict the macro ones – and leads to mistakes.

For example, the methodological individualism approach focuses on the actions and decisions of individual agents. These parts are components of a complex system emerging from interactions between these diverse decisions. They may be different from each other and still result in a collective pattern identifiable by macroeconomic analysis – and distinct from the intentions of individual agents!

Therefore, the collective performance of everyone in the system cannot simply be inferred from understanding the behaviors of its individual components. This logical fallacy occurs when one assumes what is true for the individual parts of a system is true for the whole.

When confronting several hypotheses or explanations, for a macrosystemic phenomenon, the simplest one requires the fewest assumptions or premises and is the most mentally plausible to human beings. However, an excessive simplification may not be able to explain all of reality or observed data, including because there will be other equally simple explanations to be tested. Science requires measurement or hypothesis testing.

The Parsimony Paradox indicates that a general increase in personal savings leads to a decrease in aggregate demand. According to economic science, there will be a reduction in production or income and this, in turn, will reduce future savings. Is it a sophistry or a fallacy?

Paradoxically, personal savings are good for individuals, but not if everyone stops spending! Preaching the massification of savings is not a good policy…

Another sophistry of composition appears in corporate finance. When companies hire workers, they increase their production costs. In a short-term analysis, a salary squeeze can increase company profits.

However, workers receive wages and spend part of their income on goods and services, contributing to effective demand in the economy. According to economic science, a cut in the wage bill leads to a drop in demand for products and services and harms companies if they produce goods and services intended for domestic consumption. After all, wages are costs for companies, but the wage bill is a component of aggregate demand. Is it a business dilemma?

In the case of public finances, the sophistry of composition appears in the extrapolation of personal finances, made by orthodox tax experts, when they proclaim: “the internal public debt must be paid at some point”. Similarly, all banks would have to pay all their debts to their depositors on some catastrophic day. Or all public companies will have to be dissolved, someday, to pay all obligations to individuals investing in their shares or debentures. Debt is to be rolled over!

One threat is composition sophistry in bank finance. If there is full endogeneity of digital and/or written currency in the banking system, it will not be good for the banks, because the monetary multiplier could go to infinity!

The monetary multiplier is the quotient ex post between the end-of-period balances of the means of payment (paper money held by the public and demand deposits) and the monetary base (paper money in circulation and bank reserves). It expresses the way in which banks together, that is, the banking system, create money.

If paper money held by the public disappears, the incentive to maintain monetary reserves in banks will decrease. Thus, the only monetary control will be via the requirement for a compulsory banking reserve by the Central Bank, otherwise the multiplier would reach infinity, if a monetary shock against a given aggregate supply did not occur first, generating “true inflation” – and the requirement.

When banks operate with high leverage (assets relative to equity), they are more exposed to market shocks and systemic risks, as occurred in the 2008 GCF. If depositors perceive a large bank to be at risk of bankruptcy due to low-quality assets or substantial losses in their operations, they panic and withdraw their deposits en masse.

This bank run has devastating effects on the bank and, through contagion and/or demonstration effects, on the banking system as a whole. If many depositors withdraw their money at the same time, the bank may run out of sufficient reserves to meet all withdrawal demands, leading it to insolvency and/or bankruptcy, if the Monetary Authority does not come to its rescue.

Finally, there is also composition sophism in international finance. Investors can follow the trend of a boom in asset prices around the world. Then, when everything is going well for them and the countries with a surplus in their trade balance, suddenly, one economic power decides to wage a trade war against an emerging one because of the structural deficit in its trade balance and starts adopting protectionism in its internal market, establishing barriers to import.

In this unstable context, any problems in one part of the system, such as a banking collapse in one country or a foreign debt crisis in another, can spread to affect other parts of the global financial system. This is due to complex interconnections and chains of contagion.

Therefore, economists need to be trained as analysts of complex systems. They comprise many interactive components with the ability to generate a new quality of collective behavior through self-organization, with the formation of temporal, spatial or functional structures.

In colloquial terms, to explain it, just remember: “in the company of two, three result in complexity”… The real world goes far beyond pairs and/or binary reasoning, like Tico-e-Tico (“2 neuron” without S and without talking to each other in DR – “Relationship Discussion”).

Complex systems, as they are chaotic, are characterized by extreme sensitivity to initial conditions. Their emergent behaviors are not easily predictable or completely deterministic. Therefore, a reductionist approach (type bottom-up or bottom-up) is an incomplete description of a complex macro-systemic phenomenon. It also requires an analysis top-down (from top to bottom) complementary.

It should be warned: complex does not mean complicated. Something complicated comprises many small parts, all different, and each of them has its own role in the dynamic “mechanism”. A complex system results from many similar parts, whose interactions are capable of producing globally coherent behavior.

Complex systems have many parts interacting through behaviors according to simple, individual rules. But the behavior of the system as a whole cannot be predicted just based on these simple rules, as they occur in family, emotional, professional, religious, political ties, etc.

Their interactions result in emergent properties. As Aristotle wrote: “the whole is different from the mere sum of its parts.” It configures itself, dynamically, at each moment and at each scale of analysis.

In addition, Aristotle also said: “the only truth is reality”. However, today, transdisciplinary integration of different levels of reality is sought: objective, consensual and personal.

Objective reality is that which is “concrete and given, independent of belief”. Consensual reality is what is “agreed to be real” by the collective, for example, money or market valuation. Personal reality is what is considered “real to ourselves”. A personal value, however, may not be validated, neither by the collective (such as consensual), nor by the objective (such as solid objects) – and the person lives in a parallel reality. Don't religious people and atheists live in parallel worlds?

The conclusion is: truth is a provisional approximation because there are different levels of reality. I remember Hegel saying: “truth is the whole”. It is unattainable…

*Fernando Nogueira da Costa He is a full professor at the Institute of Economics at Unicamp. Author, among other books, of Brazil of banks (EDUSP). []

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