A Fallacy of Composition

By J.D. Alt

The commentary on one my recent posts included the following statement: “It’s a fallacy of composition to imagine that what we can’t afford individually is affordable collectively.”

I cannot get this sentence out of my mind. It seems to pinpoint a central cognitive dissonance that enshrouds our thinking about money. The common-sense logic of the phrase seems to say, at first glance, that if each citizen of a nation cannot afford to pay for, say, a road from village A to village B, then collectively they cannot afford to pay for it either. However, if they pooled their money, with each citizen putting in a little bit, it seems clear they might be able to collectively cover the cost. So the person who wrote the comment cannot have intended to mean what, at first glance, the sentence seems to say. They must have meant something deeper.

What they meant to infer, I believe, is that—at any given point in time—the sum of all the citizen’s individual holdings of Dollars is a fixed amount, and if this summation of their individual capital is not enough to build the road, then it is a fallacy to believe the road can be built. Thomas Pikkety, in his new block-buster book Capital seems to promote this same idea: public debt, he teaches us, is what the state can borrow from the citizens. By inference, the state cannot borrow more than what the citizens have. It is therefore logically impossible for the citizens collectively—in the form of the state—to spend more than they have, in aggregate, as individuals. This logic permeates our culture and helps us calculate what we can and cannot  do as a collective society.

There is another possibility, however, for understanding how the road from village A to village B can be built. Assuming the road-building materials and tools are available somewhere close to the villages—the gravels and shovels and rakes—and assuming the labor needed to build the road is available as well, and further assuming the citizens want a road to connect village A and village B, it then becomes clear the only thing needed to make the road happen is enough DOLLARS to buy the materials, rent the tools, and pay the labor.

Given the situation just described, it is absurd on its face to visualize the road-building materials lined up in piles along the intended route, the tools laid out upon the ground in front of the men and women who want to provide their labor—and imagine the work cannot proceed for lack of Dollars. Here we are, ready to go, but all we can do is sit on the ground and WAIT for someone to find the Dollars to pay us. Ho-hum. And if we don’t find the Dollars pretty soon, the labor will just wander away and climb back in the trees where it came from.

But this is, if we could only see it, the very reason Dollars were invented—so we DON’T have to wait.

What do I mean by that? I mean this: it is nonsensical to imagine that the number of Dollars available is what determines what people can accomplish. Instead it is what people can accomplish that determines how many Dollars exist. This is the essential dynamic of Modern Money systems. Modern Money is the unique social invention that enables nations of people—so long as the real resources and citizen’s labor are available̶—to collectively build national goods and services. It has nothing whatsoever to do with the amount of capital the individuals of the society possess at any given point in time (in spite of what Thomas Pikkety tells us.) It has everything to do with what people collectively decide needs to be done, and what real resources are actually available to do it with.

How can this possibly be? How, operationally, can the potential accomplishments of people determine how many Dollars are available to pay them to actually implement those accomplishments? In a nutshell, the answer has four parts:

  1. The people decide to form a nation and become its citizens, agreeing to abide by the rules they, the citizens, collectively impose on themselves as a nation.
  1. The nation (the collective form of the citizens) establishes a Central Bank and a Treasury—and then simultaneously does two things: (a) it issues a national currency (money created by fiat, or “fiat money”) and (b) it imposes a tax on the citizens which can ONLY be paid with the national currency.
  1. Having agreed to abide by the rules (which now include paying taxes) the citizens become willing to provide the nation (the collective form of the citizens themselves) with goods and services in exchange for the fiat money they need in order to pay their taxes. Subsequently, the citizens use that same fiat money as the means of measuring the value of goods and services produced and exchanged privately amongst themselves as well—(i.e. the fiat money becomes the unit of exchange in the nation’s private economy.)
  1. The nation’s Central Bank and Treasury now have the task of continuing to issue the national currency—and collecting it back in taxes—in quantities as needed to match the actual potential and need the citizens have for producing goods and services. If the citizens have an actual need and potential for production for which there is not enough currency, the Central Bank and Treasury will simply issue and spend the required currency into existence by purchasing the goods and services, or otherwise causing them to be purchased. If the citizens have too much currency relative to what they are actually capable of producing (rising prices) the Treasury will increase the currency it collects back in taxes, re-establishing the balance.

Recently there was a piece on the PBS News Hour illustrating the dramatic and dire need for us, as a collective nation, to begin understanding Modern Money as quickly as we possibly can.

The news piece was about a new wonder drug which has been proven to cure hepatitis C—a devastating and, ultimately, deadly viral infection. The “news”, however, was not about the drug being proven 100% effective, but rather about the fact that we can’t afford it. The PBS piece did the math: the drug that cures the infection costs $1,000 per pill, taken for 120 days = $120,000 per cure times an estimated 5 million Americans currently infected with the virus. Framed this way, the question posed is: how can we come up with $600 million Dollars to cure the folks who have just this one disease? The implied message was clear: there simply aren’t enough Dollars to pay for all the pills. Obviously, the real resources exist to produce the pills (since they are, in fact, being produced) but there aren’t enough Dollars to buy the number of pills we need. So the pill manufacturer—just like the villagers sitting beside their tools and road-building materials waiting for Dollars—the pill manufacturer is sitting beside his pill-making machine waiting for Dollars that, according to the commentators on PBS, are going to be virtually impossible to find.

Big numbers, apparently, frighten us. We couldn’t possibly get our hands on the giga-billion Dollars necessary to buy all the wonder drugs that are rapidly becoming technically feasible. But this is the real fallacy of composition—the cognitive dissonance that prevents us from rationally understanding and managing the most fundamental aspect of our socio-economic contract: MODERN MONEY. The big numbers we should be frightened of are the millions of American citizens who are under-nourished, under-housed, under-educated, and under-cared for—and the massive number of our citizens who are sitting idle beside stacks of available materials and arrays of available tools while uncounted lists of useful things need to be accomplished. Those big numbers mean the thing we thought we were creating when we agreed to form “a more perfect union” is beginning to fail.

16 Responses to A Fallacy of Composition

  1. Allen Edwards

    I was also struck by the reader’s comment. Here’s why:

    “… the fallacy of composition, which basically consists of the false belief that the whole is nothing but the sum of its parts.”–economist Lars Syll

    I.e., your reader misunderstands the fallacy and/or was misusing it.

    • golfer1john

      Me, too. If he had said

      “It’s a fallacy of composition to imagine that what we can’t afford individually cannot be affordable collectively.”

      That would have been the proper use of the term “fallacy of composition”.

  2. Great points. There do seem to be a super majority of folks that think we borrow money domestically and from China/Japan in the same manner as I go to the bank for a car loan

  3. Where does Piketty say that public debt is what the state can borrow from its citizens? That would have been more or less true in the 18th and 19th Centuries as well as a good part of the 20th, perhaps not because of any necessity but because no one though of the possibility outlined in this post.

  4. Excellent point. Part of the problem is to do with the ever present household budget metaphor. In my individual world much of what I want to do is restricted by the quantity of money in my possession. We cannot imagine money as an infinite resource for a sovereign nation, because for the individual it is a restricted resource. We, unthinkingly, equate amounts of money with amounts of resource. Perhaps we even fear that if money loses its power as a measurement of available resources, resources that are deemed scarce, the nation will go crazy and use up all the available resources until there is nothing left. Personally, I find it liberating to think that all that stands in our way for recapturing the vibrancy of civic life experienced after WW2, is the realization that money is just a way of bring groups of people together to accomplish collective goals. The limits are our imagination, and our willingness to work together for mutual benefits.

  5. Nichol Brummer

    In this case, the problem is not purely monetary, but it is also how to negotiate the price of one pill. If one company has the patent, and the monopoly right to produce this one pill. Should they ask that much per pill, taking all those people hostage that have hepatitis C? Maybe the company makes enough on the few pills they sell that they’re not even interested in increasing their production?

  6. Joe Firestone

    I think your commenter had it wrong, and while I like your very well-written rebuttal, I think a briefer reply is very possible also. Specifically, the economist’s fallacy of composition is another name for the sociologists notion of the aggregative fallacy. An aggregative fallacy occurs when people try to deduce an attribute of the whole by through mathematical operations over the attributes of the parts. Here the reasoning of your commenter is that the limit of money the government can possess is the sum of all the money owned by the components of a nation because it can only acquire money through taxing or borrowing. That reasoning incorporates the assumption that the nation as a whole, represented by its Government, can’t have money-creating capabilities, since its components can’t. That assumption is false, as your commenter might have ascertained by reading the US constitution.

    So, your commenter was wrong in his/her inference. In addition, however, you did not commit a fallacy of composition in asserting that the Government could supply the money to pay for collective action; but your commenter was the one who committed it by asserting an untrue aggregative proposition which he/she assumes to be true.

    Btw, another equally famous fallacy in sociology is called the Ecological Fallacy. It occurs when someone imputes a property of some collective to its individual components. And it occurs when someone tries to conclude from a correlations among properties of a collective that analogous correlations occur at he individual level of behavior. Conceptually the ecological fallacy is the inverse of the aggregative fallacy.

  7. “the pill manufacturer is sitting beside his pill-making machine waiting for Dollars”

    That it can only demand at such a high level because of patent and copyright monopolies granted by the state.

    The mechanism by which we create and discover new medicines is similarly broken because of the idea that Dollars are things rather than a social convention. Which then allows certain individuals to hold the lives of others to ransom all because they have been granted the ability to ransom people’s lives by the state.

    A sensible state would realise that discovery of new drugs and medicines is a public service and that it should be publicly funded out of public universities. Yes let manufacturers compete with each other to *produce* the drug in the most efficient manner, but there is no way on earth we should permit people’s lives to be held to ransom by granting and enforcing exclusive property rights over ideas.

    • John Christensen

      I couldn’t agree more with this view. It seems to me this is what much of the world once did when it came to developing medicines and treatments. The manufacturers would jump in only after most of the research and development work was completed to compete in the development of the least expensive commercial product.

      Enter neo liberalism and the public private “partnerships”. I seem to remember reading somewhere, that in Canada it was proposed that a publicly funded university researcher in the pharmaceutical field should only obtain public grants when there is a private industry “partner” involved (not certain if it became the rule). It is bitterly ironic that drugs and devices developed with plenty of public money could be sold to cash strapped public hospitals at prices that challenge a largely taxpayer funded provincial system’s ability to pay for them.

      When private intellectual property rights are assigned to medical developments, profit maximization rather than public health and safety, automatically becomes the priority, leading to many unintended and undesirable consequences. Extremely expensive drugs to treat life threating diseases would seem to fall into this category.

    • golfer1john

      A major part of the cost of developing new drugs is the legal cost of defending lawsuits that allege injury due to the drug, and paying the claims if the suit is successful. TV is full of ads by lawyers soliciting clients. Call 1-800-BAD-DRUG.

      If the government develops another thalidomide, what becomes of those victims? Or is it the manufacturer who pays the claims out of his retail price of $1.29 a pill?

  8. J.D Alt what you are talking about is the use of money as “permission” or determinant for how we spend our time so we can collectively have stable well-being. In this connection the following two writings are of interest:-

    http://www.ianwelsh.net/what-is-an-economy/

    http://www.newschool.edu/scepa/publications/workingpapers/archive/cepa0212.pdf

  9. Thank you J.D. We have all been looking for the simple MMT narrative that can be easily understood by ordinary citizens–assuming they’re even slightly curious–to understand Modern Money. This piece does exactly that. Please keep up the good work!

  10. Erick Borling

    I’ve never seen such a superb set of constructive responses. I also wish to congratulate you Mr. Alt for a moment of genius in your essay wherein you stated that “it is what people can accomplish that determines how many Dollars exist.” That is extremely profound even among the vast quantity of analysis on this site.

    After contemplating the vexatious fallacy you cited, previous commenters to your post are correct, the alleged fallacy was presented in an erroneous manner. One of the pernicious evils of false statements is that in order to slay them, the reply must be three times as lengthy. That is because the falsehood must be 1) shown to be false; 2) the alternative (truth) must be postulated instead, and 3) the whys of both should be painstakingly presented in the argument.

    In the present political milieu that’s trubble for the reason that the economics conversations really should include morals and values as a central concern but to the radcon “values voters,” are still thinking in terms of Calvinism, gold standard, and chicken-little frightfulness that our fiat currency will explode in our faces in a cataclysm of either 1) Weimar inflation or 2) a posse of Chinese bond vigilantes.

    Again, great essay. -E

    • golfer1john

      “the radcon “values voters,” ”

      You’re right about everything, but …

      If it is your intention to make that difficult and complex argument, and persuade people, change their minds, it’s probably not best to start out by mocking them.

  11. I believe the first and most vital step for our culture is to grant each other the right to free and fair shares of the land and its resources so we can make ourselves self sustaining. Without this we are beholden to the corp/gov jobs and their dictates for the right to a decent quality of life, and to the basic vital necessities of life. The terror of the common people is perpetrated by the right of the banks and our government plus the corporations to control the money supply, to control the use of our land, to control the jobs and incomes we have to keep ourselves alive. With this much power they can simply menace us with the loss of any one of these to throw us into terror about our future survival. They use this to bribe us into fighting their wars, to working for the Halliburtons and the Montsantos, and into voting for their Manchurian candidates working for the corporations only.

    Through taxes, bailouts, mortgages based on our own signatures only, plus compounding interest on fiat money we have long since PAID IN FULL for America and we must claim it as our own to do with as we see fit.

    When we grant ourselves the right to the land and its resources as our birthright and as our human right we will have empowered and secured ourselves with a steady platform from which to safely cease our support of any entity that would exploit or threaten us. Free land = free people, truly free people can build an economy and a government that serves US.

  12. “Anything we can do, we can afford”
    -Keynes