The Broken Window Fallacy is trivial

In his essay, What is Seen and What is not Seen, Frédéric Bastiat wrote his famous parable, the Broken Window Fallacy (BWF). A boy breaks a shop keeper’s window and the shop keeper is forced to replace it. Townspeople sees that the broken window caused a boost in economic activity, which they think is good for the economy. But no, says Bastiat, the town is wrong. What we are ignoring is the unseen, i.e. if the shop keeper’s window wasn’t destroyed, he might have spent his money elsewhere; “It is this third person who is always in the shadow, and who, personifying what is not seen, is an essential element of the problem.” Destruction, though it may increase economic activity, ultimately results in a net loss in the stock of wealth. The resources used to replace destroyed capital could have been used elsewhere for more productive purposes:

From which, by generalizing, we arrive at this unexpected conclusion: “Society loses the value of objects unnecessarily destroyed,” and at this aphorism, which will make the hair of the protectionists stand on end: “To break, to destroy, to dissipate is not to encourage national employment,” or more briefly: “Destruction is not profitable.

Bastiat doesn’t just talk about broken windows. He also talks about taxes, the military, protectionism, and many other economic issues. Sometimes Bastiat’s lucid writing and colorful analogies shed light on the importance of opportunity cost. Other times, particularly his discussion of public works, Bastiat is prone to hand waving (1). Either way, it’s a fun essay that does a wonderful job of talking about opportunity costs, better than any modern economic textbook.

But for some reason, Libertarians view the BWF as some sort of magic bullet. They obsess over Keynesians’ supposed ignorance about the unseen and frequently use the parable on a variety of policy issues.  This is complete nonsense. In reality, the BWF doesn’t really shed light on any policy issues that Keynesians emphasize. At best, the analogy provides a trivial piece of insight that has been known by economists for decades.

I’m going to borrow an analogy from Gene Callahan to show this, except I’ll use some figures to convey the point better. I’ll also relax some of the assumptions in Bastiat’s original essay. Consider two scenarios.

In Scenario One, there’s an isolated valley. In the valley lives a wealthy landowner who lives in a mansion worth $100. There is also a large number of poor subsistence famers who live on farms worth a negligible amount. The farmers were prosperous when the landowner was constructing his estate, but now he is done and there is no other work around. The wealthy owner is sitting on $1000 dollars of idle capital while the farmers are barely surviving.

Let’s say a tornado comes along. It completely destroys the landowner’s mansion and he is forced to rebuild. He now has a need to employ all of those poor subsistence farmers, the flow of economic activity increases, and a year later, the mansion is rebuilt. Visually, it will look something like this:

Year 1 House Idle Resources Total Wealth
$100 $1,000 $1,100
Year 2 House Idle Resources Total Wealth
$100 $900 $1,000

In Scenario 2, we have the same exact circumstances, but there is no tornado. Instead, 3 years later (on Year 4), the wealthy landowner decides to build a large addition to his mansion. It costs $100 to build, but will be worth $200 when finished. He again has a need to employ all of those poor subsistence farmers, the flow of economic activity increases, and a year later, the addition is built. Visually, it will look something like this:

Year 1 House Idle Resources Total Wealth
$100 $1,000 $1,100
Year 2 House Idle Resources Total Wealth
$100 $1,000 $1,100
Year 3 House Idle Resources Total Wealth
$100 $1,000 $1,100
Year 4 House Idle Resources Total Wealth
$100 $1,000 $1,100
Year 5 House Idle Resources Total Wealth
$300 $900 $1,200

Stocks vs. Flows

In debates over the merits of the BWF, Libertarians tend to emphasize stock of wealth, i.e. the value of all wealth in the economy measured at a specific time, while Keynesians tend to emphasize flows, i.e. the measure of economic activity over a period of time (e.g. GDP or investment per unit time). So in my example above, it’s obvious that Bastiat’s fallacy holds true. The second case has a larger stock of wealth than the first case. In fact, I would argue that Bastiat’s parable holds true in any scenario where resources or capital is destroyed. Libertarians would argue that this is unequivocally a bad thing. But this isn’t exactly obvious.

Whether stocks or flows matter at any given moment all depends on the context. In my example, while the stock of wealth decreases in scenario 1, we could say the economic flows are more important. Those poor subsistence farmers need an income to alleviate their suffering. Meanwhile, the landowner is sitting on a huge amount of idle resources. So Scenario 1 is better for farmers because they are employed earlier, thus alleviating their suffering earlier. Claiming that resources are allocated from more efficient uses, I think, completely misses the point here.

Whether or not the BWF really matters is ultimately an empirical question. Unless you can effectively demonstrate 100% crowding out, then it might not matter if the BWF holds. The economic flows could outweigh the net loss in economic wealth.  To determine that, we need to look at things like the distribution of wealth, employment, comparisons of utility, and host of other “unseen” variables, not just the stock of wealth and economic activity. “Destruction is bad” is not an a priori truth.

The Broken Window Fallacy is a straw-man

Another problem is that the BWF is often employed as an blatant straw-man. When Keynesians are advocating for fiscal policy during a recession, that do not mean we should break windows. Analogies about alien invasions or digging holes (2) are colorful metaphors. What Keynesians really mean by fiscal policy is increasing employment by using idle resources on things that we would consider productive, e.g infrastructure or R&D. This has absolutely nothing to do with the BWF unless you assume 100% crowding out, which doesn’t apply during a recession.

You could dispute this and emphasize the importance of the “unseen”, but that’s an empirical question. Preaching the BWF gets you nowhere and you have to actually show that employing idle resources in the short run is worse than the alternative. Of course, that’s really hard to do, which is why we continue to have debates over fiscal policy.

It’s obvious the BWF is at best a trivial insight. Destruction of resources and capital is (almost always) bad for the economy. Great to know, but no serious economists advocates destruction as a solution to our economic woes. And while the “unseen” is the main focus of Bastiat’s original essay, it’s something that economists have written about for literally centuries. Citing the BWF without some sort of empirical evidence adds nothing to the conversation and handwaving doesn’t refute any Keynesian argument about macroeconomic policy.


Notes:

1. It’s worth noting that Bastiat allows for the use of public works and counter-cyclical policy during a crisis in his essay:

As a temporary measure in a time of crisis, during a severe winter, this intervention on the part of the taxpayer could have good effects. It acts in the same way as insurance. It adds nothing to the number of jobs nor to total wages, but it takes labor and wages from ordinary times and doles them out, at a loss it is true, in difficult times.

However, it’s still quite obvious that he’s relying on the assumption of full employment when talking about the unseen.

2. The frequently cited quote from Chapter 10 of the General Theory:

If the Treasury were to fill old bottles with banknotes, bury them at suitable depths in disused coalmines which are then filled up to the surface with town rubbish, and leave it to private enterprise on well-tried principles of laissez-faire to dig the notes up again (the right to do so being obtained, of course, by tendering for leases of the note-bearing territory), there need be no more unemployment and, with the help of the repercussions, the real income of the community, and its capital wealth also, would probably become a good deal greater than it actually is. It would, indeed, be more sensible to build houses and the like; but if there are political and practical difficulties in the way of this, the above would be better than nothing.

Links:

Stocks, Flows, and Bastiat by Daniel Kuehn

Yglesias on Broken Windows: couldn’t have said it better myself by Daniel Kuehn

Correcting the Keynesians on the Broken Window Fallacy by Robert Murphy

Goodnight, Irene by Gene Callahan

The Broken-Window Fallacy by Robert Murphy

A Word on Economic “Fallacies” by Unlearning Economics

Debunking the Broken Window Fallacy by Robert Nielsen

Hazlitt, Keynes and the glazier’s fallacy by John Quiggin

The Real Problem with the Broken Window Fallacy by Unlearning Economics

Actually, Breaking Windows is Good by Matt Bruenig

References:

1. Bastiat, Frédéric, and W. B. Hodgson. What Is Seen and What Is Not Seen: Or Political Economy in One Lesson .. London: W.H. Smith and Son, 1859. Print.

Advertisements

2 Comments

Filed under Economics, History, Home

2 responses to “The Broken Window Fallacy is trivial

  1. I had read that Keynes quote, “fill old bottles with banknotes, bury them at suitable depths in disused coalmines” a few times before coming across it in context in the original. I was really taken aback to find that it was actually an extension of a discussion about gold mining. Keynes was saying that investment in gold mining happens when the economy is in the doldrums such that capitalists have no productive way to preserve their wealth and so turn to gold. The gold mining investment can then mitigate the economic slump. Keynes was just saying that gold mining is as pointless as buried bottles of banknotes and it would be much better to do something useful -or that was how I took it.
    I think the quote out of context gives people a very dim view of Keynes. It makes it seem as though he is advocating using state fiat to herd people around through pointless toil.

    • It’s just like how people take “In the long run we’re all dead” quote completely out of context. Keynes’ most virulent detractors often have never read any of this books and rely on shoddy interpretations. It’s unfortunate.

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s