The Broken Window Fallacy- The Real Cost of Destruction

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All too often you hear about the economic benefits of going to war. This misnomer is so ingrained in American culture that conventional wisdom suggests that armed conflict is good for business. Few are willing to question this enduring presupposition. Some are even so bold to claim that World War II ended the Great Depression. Over the years, experts have started to refute such claims. That does not mean that many are still not exalting the economic virtues of war.

 

Economists such as Noble laureate Joseph Stiglitz point to the technological advances of the War on Terrorism as being one of the advantages. Even if so, there are a myriad of other costs that most likely outweigh such developments. Overall, war is costly. Morally, financially, and diplomatically.  War is far from the only category of calamitous events that are seen to be profitable. Natural disasters are also seen as an unfortunate but lucrative means of stimulating the economy. However, are any of these widely held assumptions true? The 18th-century political/economic/legal theorist Frederic Bastiat would ardently disagree.

 

In Bastiat’s essay That Which is Seen, That Which is Not Seen introduces a concept that undermines arguments for the economic benefits of war. This is the conceptualization of the Broken Window Parable, colloquially known as the Broken Window Fallacy. The general assertion of this postulation is that the efforts to recover from destruction do not benefit society.

Everybody must live, and what would become of the glaziers if panes of glass were never broken?” …..

Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier’s trade — that it encourages that trade to the amount of six francs — I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.

It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented. …

Let us take a view of industry in general, as affected by this circumstance. The window being broken, the glazier’s trade is encouraged to the amount of six francs; this is that which is seen. If the window had not been broken, the shoemaker’s trade (or some other) would have been encouraged to the amount of six francs; this is that which is not seen….

And if that which is not seen is taken into consideration, because it is a negative fact, as well as that which is seen, because it is a positive fact, it will be understood that neither industry in general, nor the sum total of national labour, is affected, whether windows are broken or not……

…….suppose the window not to have been broken, he would have spent six francs on shoes, and would have had at the same time the enjoyment of a pair of shoes and of a window.

Now, as James B. forms a part of society, we must come to the conclusion, that, taking it altogether, and making an estimate of its enjoyments and its labours, it has lost the value of the broken window.

When we arrive at this unexpected conclusion: “Society loses To break, to spoil, to waste, is not to encourage national labour; or, more briefly, “destruction is not profit.”

The hypothetical shopkeeper did not obtain any benefit from restoring the broken window. The labor and money expended to replace the window that was already initially purchased. Operating as a financial redundancy.  The shopkeeper did not get full utility of the window nor did he plan to replace it. Rather he had to allocate time and money repurchase an item he already had. All because the glazer may benefit from this turn in vicissitudes, that does not mean everyone does because the shopkeeper is at a loss. The benefit is at the expense of the shopkeeper. This unexpected and unnecessary expense prevents him from spending money on productive goods and services. In contrast to merely replacing what he already had, only serving as a detriment. It is analogous to intentionally burning down a town to revitalize the construction industry in the county. The lost time, man-hours,  and money makes such an endeavor a waste of resources.

An excellent modern-day application of this concept was demonstrated by Art Carden, a fellow of the American Institue for Economic Research (AIER). Carden details how while at the gym he accidentally shattered the screen on his iPhone. Superficially, this appears to be an overall net benefit for the economy as a whole. After all, the iPhone vendor and Apple just gained another sale. No one actors in the economic benefit. Art merely squandered the time and money to replace an item he already had. The provincial view that Art’s misfortunate is an economic benefit does not take into account what else he could have done with that very same money. He mentions in the article how he could have put the money towards a family vacation rather than a redundant financial obligation. Mirroring the scenario contrived by  Bastiat back in the 19th century.

Arguably one of the best interpreters of Bastiat’s Broken Window Parable was the economic writer Henry Hazlitt. Hazlitt applied the idea of the Seen and Unseen to government spending. Similar to expecting economic stimulus from destruction, perceiving the benefits of government spending only takes into account the most conspicuous consequences. As detailed in Hazlitt’s benchmark book Economics in One Lesson government spending operates as a form of destruction. It redirects resources (time and tax dollars) to efforts, not within the needs or wants of the taxpayer. For every government job created there is a job in the private sector lost. Tax dollars levied from a business could have been utilized to hire more staff (which is the unseen consequence). Hazlitt succinctly demonstrates this in his description of public works:

Here again, the government spenders have the better of the argument with all those who cannot see beyond the immediate range of their physical eyes. They can see the bridge. But if they have taught themselves to look for indirect as well as direct consequences they can once more see in the eye of imagination the possibilities that have never been allowed to come into existence. They can see the unbuilt homes, the unmade cars, and radios, the unmade dresses and coats, perhaps the unsold and ungrown foodstuffs. To see these uncreated things requires a kind of imagination that not many people have. We can think of these nonexistent objects once, perhaps, but we cannot keep them before our minds as we can the bridge that we pass every working day. What has happened is mere that one thing has been created instead of others. (Page 20)

At its core, it is a natural fallacy to assume that job creation is always a net positive benefit. Unfortunately, it is not that simple. Applying Occum’s Razor would lead us to a very shallow understanding of economic impact. The public sector operates differently than the private sector. So how is it possible for the government institutions to determine the optimal number of plumbers in the economy? Again we fall back to the economic knowledge problem, fundamentally that golden mean cannot be ascertained. Sure research can be conducted. The possibility of data not being applicable to actual economic behavior is always lurking in the background. Sampling error, perhaps?! A business owner may not know the precise ratio for ideal production. Considering the purveyor of a business is the one actually producing goods and services they would have a better estimate of market demand.

At this point is most likely clear that destruction does not lead to more wealth. Rather you are wasting resources. That is the fatal flaw in the assumption of assuming a war will jump-start the economy. First off, the tax dollars allocated for armaments could be better spent by the private sector. We don’t see the businesses that are not started due to the taxes levied to fund a war. The second point is the cost of restoration. Money allocated to repair damaged infrastructure and civilian homes. If you want to take a morbid turn you can also calculate the expense of unexpected funerals.

 

Starve The Beast- Does this Method Really Cut Spending?

 

 

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What it means to be a political conservative has drastically changed throughout the course of American history. The meaning in a political context has even shifted from the defining proclamations of Barry Goldwater in The Conscience of a Conservative. Arguably a seminal pamphlet in defining conservative values in the 20th Century. I personally feel that conservatism much like any other body of ideas has its advantages and drawbacks. One value of conservatism that has been slowly eaten away by political opportunism has been fiscal responsibility. While not personally a conservative, this is a conservative value I am fully on board with.

 

The irony is that in the modern era of the 21st century even purported conservative politicians are not fiscally conservative. Making this virtue a relic of a bygone era. Profligate spending was a  policy fixture of both Bush administrations and even prevalent in the Regan administration. It appears as if President Trump will also follow suit with veering away from budgetary constraints.

 

Interestingly enough Libertarian/ Conservative icon the economist, Milton Friedman, felt as if he had found the solution. This remedy is referred to as a Starve the Beast policy. Which is based upon a rather linear concept, simply cut taxes as this will discourage spending. Certainly, a novel postulation that appears to have been underneath our noses this entire time. Does this theory hold water upon the scrutiny of empirical analysis? This question has been highly debated among scholars of all stripes. Not to mention fiercely defended by Friedman-fanboys. As brilliant as Friedman was it does not make him infallible. There is sufficient evidence to suggest that Friedman was dead wrong about the overall impact of the Starve the Beast method of cutting spending.

 

One fact that should be noted is that while many conservative Republicans have anointed Regan with the status of a demigod, this is to some extent a shallow perception. The beloved cherub of the conservative shrine was not the most fiscally responsible president. It turns out while Regan may have cut taxes, he actually increased spending. These findings represented in a 2009 study published by the Cato Institue.  The study found overall that cutting government tax revenue created the illusion of decreased spending. A firm nod to my previous blog entry addressing Fiscal Illusion. Overall, based on the result of the cited research it does not appear as if the data backs up Friedman’s claims.

 

From the standpoint of science, replication of results is the validation of the data obtained. It veers away from the potential of findings being an anomaly caused by sampling error. Thankful for our friends over at the Cato Institue have conducted further studies pertaining to Starve the Beast policies. Researcher Michael J. New conducted a regression study of the relationship between expenditures and taxation from 1981-2005. It was found that even when adjusted for wartime spending, limiting tax revenue did not effectively curtail discretionary spending. Substantiating the previous research of William Niskanen.

 

It is excellent that these studies have exposed the numerical shortcomings of simply cutting taxes. However, what is causing the profligate spending to continue even when tax revenue is decreased? Now it is time to applaud the advocates of the Austrian School of Economics and Public Choice Theory for acknowledging the role of inflation. If the printing presses are running the possibility of funding without direct tax dollars is on the table. This is a massive blindspot in Milton Friedman’s thinking, but an understandable one. Utilizing inflation for financing expenditures is circuitous means of procuring funding. Not an obvious means of generating revenue. Also, it is important to remember he was a proponent of monetarism making him less apt to question the government’s role in controlling the currency supply. However, considering the disastrous economic effects inflation can bring it is something that should always be questioned.