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  • Writer's pictureSergio Focardi

Panta rei: an ancient aphorism that describes modern economies

Heraclitus is an ancient Greek philosopher who was born in Ephesus in 535 BC and died in the same city in 475 BC. Heraclitus is a dark thinker whose thought came to us through some aphorisms. The most famous of Heraclitus' aphorisms is probably Panta rei Greek phrase meaning that everything flows, everything changes. "You cannot bathe twice in the same water of the river," Heraclitus argued.

In the following centuries the question of whether reality is a static object or a moving flow occupied the minds of many philosophers. Scientists have also fought with the problem of change. What changes? The structure, the set of relationships? Or is there really a reality that evolves objectively?

Economic theory is closer to the notion that reality is static or, rather, is a slow flow in equilibrium like a great river. Economic theory was born when large economies were mainly agrarian economies. An agrarian economy produces an output that might change quantitatively but not qualitatively.

The industrial revolution and the scientific progress of the eighteenth and nineteenth centuries made it possible to produce many new products and services. However, the crucial aspect of industrial economies was the possibility of producing large quantities of products and services. For example, the automobile was a formidable innovation. However, it is the spread of the automobile that has captured the imagination, starting a process of growth in the number of vehicles in circulation. Today, in industrialized countries, there is almost one car for every person.

Economic theory developed as a quantity theory. Still today, textbooks and mainstream mathematical models hypothesize that economic output is a single commodity whose quantitative dynamics can be studied by assuming a simple relationship between quantity produced, quantity of capital and quantity of labor.

Unfortunately, this qualitatively static view of an economy that produces a measurable amount of output is far from the current reality. Since the end of the Second World War, advanced economies have become progressively more complex and have developed processes of qualitative evolution. Advanced economies are now complex evolutionary systems. Complexity is given not only by the increasing complexity of products but also by the complexity of the relationships between economic agents and the process of creating the symbolism associated with products.

It is possible to measure economic complexity and changes in economic complexity. Measures of economic complexity were introduced by Cesar Hidalgo and Ricardo Haussmann at MIT. These measures are indirect measures of complexity based on the structure of exports. They essentially assess a nation's innovation capabilities based on its export data. Luciano Pietronero and collaborators at the University of Rome have introduced similar measures.

Yet neither economic theory nor politics accept that the economic and social world is changing rapidly. We have not seen an evolution of economic concepts that fits into a complex and evolutionary economic reality. Even today, important decisions are made, such as deciding interest rates, on the basis of concepts and theories that are no longer applicable.

In some previous posts, and in some articles, I have discussed how the classic concept of inflation is not suitable for modern economies. Inflation in the classical sense is defined as the change in the prices of products and services. More precisely, inflation is defined as the growth of prices while deflation is defined as the decrease in prices.

This concept of inflation is suitable for qualitatively static economies where products and services change characteristics slowly. However, it is impossible to use a concept of inflation as price changes with economies whose products and services and structure are constantly changing. It is impossible to compare the prices of products and services over periods of more than twenty or thirty years because in these periods the products and services change completely.

In a previous post I gave the example, referring to Italy, of the change in the average salary of a worker or employee that was about 180 euros per month in 1980 (at the rate of 2000 lire for one euro) and has grown more than eight times up to 1500 euros per month in 2020-2021. Over the same period, the change in the consumer price index was 5.6 times. In other words, we had 560% inflation over a 40-year period.

According to the classical concept of inflation, this means that consumer prices have risen by 560%. But this statement does not reflect reality in the slightest. In 40 years, products and services have changed qualitatively in a radical way. In addition, new categories of products and services have appeared, such as personal computing, mobile phones, social networks, low-cost cruises and many others. In addition, even simple products such as pasta have entered into an image creation mechanism. The pasta that is advertised by a famous chef as a testimonial is a different product than pasta without testimonials.

The products and services that remain constant over long enough periods are very few and do not represent the entire economy whose structure of connections changes continuously. The reality is that it is not possible to consider inflation as a change in prices over medium-long periods of the order of a few decades.

Over short periods, one or two years, inflation as a change in prices applies only to a subset of the universe of products and services, the basket used for inflation estimates. Highly complex products and services outside this subset cannot be considered as subject to inflation.

Then, inflation as conceived and measured today, is a theoretical concept that roughly expresses the change in prices over short periods. When it is reported over long periods by multiplying the values each period, it is a theoretical concept that is difficult to interpret. If interpreted as a price change it leads to conclusions that are difficult to believe. It is not credible that the consumer price index rises two or three times what we consider real growth. Inflation measured today is likely to be a bad indicator for decisions.

In a future post I will discuss how, in modern economies, the concept of economic growth requires us to consider qualitative growth, the growth of complexity. Unfortunately, despite living in a world that evolves rapidly in qualitative terms, politics and economic theory remain anchored to fundamentally static visions.

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