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Opposing Austerity

Apr 12, 2012 • Behavioral Economics, Economic History, Environment, Government, Macroeconomic Measurement, Regulation, Thinking Economically, Uncategorized • 135 Views    No Comments

Thinking about our fiscal woes, I keep returning to the fallacy of composition.

Here it is:

When one farmer harvests a huge crop and sells it, her profits soar. But if every farmer grows more and sells more, then the price drops. Similarly, if one person races out of a theater, she easily exits. When many do, it is tough to get out.

The point? Sometimes what is good for a single person becomes a problem when everyone does the same thing. Economists call it the fallacy of composition. Harrisburg, Pennsylvania’s fiscal plight reminds me of the fallacy of composition.

The Harrisburg story begins when they decide to retrofit their trash incinerator with borrowed money. If every garbage truck pays a fee, the incinerator business can be exceedingly profitable. At first though, the mechanics do not work and then the EPA says the facility does not meet federal standards. Each time, the community borrowed and upgraded. The result? The incinerator cost $326 million. A city with 50,000 people owes $326 million. And then the recession hits. The result? A debt crisis.

With local officials resisting, the governor of Pennsylvania mandates austerity. His representative says sell municipal parking garages, cut fire and police wages and pensions, sell the incinerator. But, the Harrisburg city council, a 4-3 vote, says no.

Responding to individual incentives, law makers reject the austerity policies that are best for their community. Individual law makers are each doing what is best for them. Anyone who supports tax hikes, wage freezes and pension cuts might not get re-elected. And then ultimately, as with a farmer’s bumper harvest or a fire in a theater, when enough law makers act similarly, everyone suffers. Sounds like the fallacy of composition.

My Bottom Line? For controlling Medicare and Social Security spending, do we have a fallacy of composition problem?

This article tells the whole Harrisburg incinerator story while NPR’s Planet Money tells the sad tale of the receiver who was sent to Harrisburg to solve their fiscal problems. As for Greek legislators, as this article tells us, the bribes that flowed to legislators will evaporate if they support austerity.

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