Wednesday, September 29, 2010

The Broken Window Fallacy

There is a lesson which, apparently, every new generation needs to relearn. The need for the lesson presents itself in ever new and updated guises, but it is still the same lesson. What is more, our ability to forget how to apply the lesson seems to afflict more and more of us faster and faster, with each successive generation.

This is how a meme (by analogy to "gene", a core idea or concept that forms a thread, running through the generations) which is essential to a free society can devolve, over time. Our forefathers had it so inbred into them that they did not even have to think about it. Put yourself back in 1789, in the role of an imaginary newspaper reporter asking the newly inaugurated President of the United States, "Mr. Washington, sir, what will be your administration's program to create jobs after the Revolutionary War for all those soldiers who have returned to the economy?"

In that context, the question shows its idiocy: it could never have been conceived as a question to ask President Washington, let alone conceive of a way that his mind could have grasped the premise inherent in it. "What -- the government create jobs? Are you daft, sir? That is not the proper function of government. Nor do I perceive any means -- even it if could be assigned that task -- by which it could accomplish such an impossibility."

The logic behind Washington's imaginary response to this imaginary question is irrefutable. The number of people which government requires to perform its proper functions is (or should be) fairly constant over time, on a per capita basis. (Jobs may increase to service more citizens as population increases, but jobs per capita should decrease with increasing productivity, as well.) Moreover, since government does not manufacture goods for commerce, the only new jobs it could "create" would be for people performing more government services. And in a declining economy, there is less and less need for more postal workers, or for more health and safety inspectors.

Even more important, the only way by which government could create new jobs out of thin air is by spending money. (For example, it could, as Napoleon suggested, put people "to work" by paying them to dig holes and then to fill them up again.) But think -- where does that money come from? From our taxes, of course -- which is to say, from our money. Once we have given it to the government, we have that much less to spend on the goods and services that keep everyone employed.

A private business uses its revenues to pay its employees, but those revenues come from selling goods and services that people value, and for which they are willing -- voluntarily -- to pay the prices which the business asks for them. The customers of the business then put those goods and services to use in their own lives.

Now think what it would be like if government operated that way. How much would you be willing to pay for that new aircraft carrier (suggested subscription price: $4,500.00, if at least one million people subscribe)? Oh, yes, that approach certainly would work as a means of providing for the common defense: "Try the next guy down the street; I'll pass, thank you." And that is why taxes are coerced, rather than voluntary.

These facts are obvious; one could scarcely believe that anyone needs to be instructed about them. But now listen to this excerpt from a recent column by Time magazine's Joe Klein, who is on a tour through middle America, sounding out its employed and unemployed:

Ten days into my cross-country road trip and I'm not finding much of the fist-shaking, Tea Party anger that you see on television. People are freaked out, though. They're frustrated and anxious. They're not too thrilled with Barack Obama's policies — although even his detractors see him as sincere and trying his best to turn things around — and they're not at all convinced that the Republicans are prepared to offer anything better, but the anti-incumbent, anti-Establishment mood is palpable. They can diagnose the problems, but they don't have any strong ideas about solutions. Most of the people at brunch say the government is spending too much, but when I ask whether they'd rather see the government closing the deficit or spending money to create jobs, most of them say jobs. There are ideological contradictions aplenty, which leads me to conclude that the notion of America as a conservative or moderate or liberal country is a fiction created by those of us who sit on top of Mount Opinion. More than a few voters I've met seem to be conservative, moderate and liberal all at once. Pat Moll, a police officer who doesn't like Obama at all, thinks the government should spend money to "put people to work in real jobs that last."
Note the false choice which the economically illiterate Mr. Klein put to his equally economically overwhelmed interviewees: should your Government spend less, or should it create jobs? That is like asking whether the government should stop Saturday mail deliveries, or spend more to put a chicken into everyone's pot. It is talk such as this that pervades the discussions of people who have been thrown out of work, and when the country is in a depression. The sentiment may be understandable, but it has to be shot down for what it is: terrible economics.

My imaginary reporter's interview with a new President, so inconceivable in the context of George Washington, would be much more believable if we shift the context to 1933, just after the election of Franklin Delano Roosevelt. For he actually believed that by spending more money, the government could put people back to work. As we all know in hindsight, he was dead wrong. Unemployment grew still worse in the 1930's despite massively increased government spending.

Some people (such as the economically illiterate Paul Krugman -- see below) say that it took World War II to take us out of the Great Depression, but that is not accurate, either. The War put people to work in factories, making bombs which blew things up, and planes and ships which only the government could use. People got paid, to be sure, but wartime goods were rationed, because they were so scarce. The economy did not return to normal until well after the war, when business was free to compete for labor and resources, and goods were plentiful once again.

The fallacy that government can put people to work by spending tax revenues (or, still worse, borrowed money) has a name that is convenient to remember, given to it long ago by economist Henry Hazlitt, in a chapter entitled "The Broken Window" in his classic book, Economics in One Lesson. Here is a graphic presentation of "The Broken Window Fallacy" (note the prominence of the New York Times's Paul Krugman, one of the leading advocates of the fallacy, at its outset):

Oh, and Henry Hazlitt's "One Lesson"? It is this:

"The whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

"Economics is haunted by more fallacies than any other science known to man."
-- Henry Hazlitt in Economics in One Lesson



  1. Mr. Haley,

    I honestly believe that almost every generation contains too many who will not learn and too few who are both willing and able to learn, at least insofar as one is consdering matters economic. In the past few days I have been reading Fr. Richard John Neuhaus 1991 book Doing Well and Doing Good: The Challenge to the Christian Capitalist. The book was primarily engendered by JPII's 1991 encyclical Centesimus Annus. In it, Neuhaus discusses socialism and writes as follows:

    "...socialism, especially in its Marxist forms, continues to have a powerful appeal…. The appeal will no doubt outlive the supposed collapse of socialist theory and practice in recent years. Anthony Daniels, a distinguished student of Marxism, explains why this should be the case.

    "'Why should the philosophy of a man who died a century ago, whose prophecies have been confounded, and whose follwers have caused some of the greatest catastrophes in history, remain the single most important intellectual influence in the world today, more important by far than that of men of more profound insight? Marxism answers several needs. I has its arcana, which persuade believers that they have penetrated to secrets veiled from others, who are possessed of false consciousness. It appeals to the strongest of all political passions, hatred, and justifies it. It provides a highly intellectualized rationalization of a discreditable but almost universal and ineradicable emotion: envy. It forever puts the blame elsewhere, making self-examination unnecessary and self-knowledge impossible. It explains everything. Finally, it persuades believers that they have a special destiny in the world. For disgruntled intellectuals, nothing could be more gratifying. The end of Marxism is definitely not nigh.'"*

    I suspect that mankind's own concupiscence, the gratuitous inheritance from original sin, is not likely to be overcome this side of the return of Christ, Hazlitt, von Mises, Hayek and the Friedmans notwithstanding.

    Pax et bonum,
    Keith Töpfer

    *—The quotation from Daniels is from his article "He's Not Deat, Yet," The Spectator, May 11, 1991.

  2. If one goes out looking for analyses of whether FDR's passel of programs helped or did not help in the 1930s, you can find almost any answer you want to find, and most of those answers seem to me to be predetermined by the economic dogma to which the speaker subscribes. The most pessimistic view would be that nothing helped short of going to war, which isn't really what any Austrian or Chicagoan wants to hear either.

    As I've said to others, identifying Obama's economic notions as socialist or Marxist is simply cant. Obama's policies are perfectly standard Keynesian stuff, and Keynes's answer to the broken window "fallacy" is contained in his famous statement about the efficacy of burying jars of money to be dug up by eager entrepreneurs. My personal belief is that all economic theory is made outdated by the persistent effort to get past its "rules", and that since people act on the theories to which they hold, you cannot treat those theories as if they were like physical laws.

    What Washington undoubtedly thought about returning veterans was that for those who were healthy, their farms were waiting for them; and for those who were not, the government owed them a pension. (It's remarkable how often military pensions show up in the history of civil unrest.) The notion that the miller and weaver and seamstress were going to have a huge army laboring for them hadn't really sunk in yet, even though the social transformation was even then well underway.

  3. Maybe the Baker was going to use the money to buy a suit or maybe the Baker had the money in the bank earning interest. And so the bank had the money loaned out to a man who was using it to open a small business. If the Baker has to withdraw his money from the bank to replace the window, the bank has less assets to loan out to people who are starting small businesses.

    So the problem with the "Broken Window Fallacy" as told here is that it doesn't discuss the issue of the value of savings.

    It would be a different story if the Baker was "hoarding money", keeping gold stored in his closet or under a mattress. Then he wasn't planning to spend the money on a new suit or lending it to others. So, in that case there would be a stimulation of the economy from the broken window.

    I want to spend another minute exploring the importance of how savings are invested -- in the real world, people rarely hoard money in unproductive investments. However, government policies have driven interest rates so low and concerns for the value of the dollar so high that people are storing their assets in unproductive investments like gold. Wisely so for the individuals, but it is like storing money under a mattress for all the good it does the economy because the money is not being loaned out to businesses to invest in expansions, etc.

    Right now we have a lot of people holding onto their money; they aren't going to buy new suits and maybe not even repair broken windows. The government policies (and lack of same, e.g. unresolved tax rates) have paralyzed the economy.

  4. IMHO, the government is currently doing everything it can to break my windows in hopes of stimulating the economy. It won't work, but that is what the "powers that be believe."

    I know I have that glazier's card around here somewhere...

  5. Exactly right, Pewster. I agree with C. Wingate that slinging labels around does nothing to advance the situation; what needs to happen is that those with the power of the purse need to stop, regardless of whose long-dead name they say they are doing it in, trying to "create jobs" by using taxes and borrowed money.

    Perpetua correctly identifies a different problem -- namely, that those who have any money at all to spend find themselves in too uncertain a situation to foresee a good result, and so they just hold off on spending until the fog of uncertainty clears away a bit. Government indecision and paralysis are adding to the fog, not helping to clear it away.

    Even slaves figured out how to survive in the early days of the Roman Empire. But when the barbarians were at the gates and all bets were off, then it was every man/woman for himself/herself.

  6. In my view, all of these fallacies are simply consequences of a single major underlying one: That the economy grows when people spend more money.

    This line has been parroted so often it's taken as a truism, but when recast slightly, it becomes a bit clearer: "The economy grows when people consume at a faster rate."

    In fact, these are the results of a growing economy, which is caused not by people's wanting more--people always want more--but by increased production of wealth.

    Problems such as the broken-window fallacy tend to resolve themselves rather quickly when viewed with this blatant fact in mind--of course the community isn't better off, because the net production of valuable goods is brought from some positive value (plus one pair of shoes) to neutral (plus one window minus one window), and the same rationale is applicable to large-scale economic questions as well.

  7. Those with savings are moving to gold, silver, and oil to preserve their wealth until the market has cleared all the malinvestments from the economy and capital accumulation can begin afresh. The central bank -- the Federal Reserve -- is the chief culprit in the ruination of the economy: by forcing interest rates below market levels in order to "stimulate" the economy, investors are lured into pursuing projects that will prove unsustainable once the shortage of real loanable funds is realized. Projects go bust -- most glaringly, commercial real estate projects and subdivision development that must cease due to limited resources and shrinking demand [low rates cause consumers to stop saving and engage in "postive leveraging" to the point where that can no longer borrow and spend].

    So, those with gold, silver, and other valuable commodities will wait until the market has done its work of clearing the mistakes. But of course, the government, with its stimulus plans, and the Fed, with its monetary easing, are working overtime to stave off downward market pressures for the benefit of their clients -- which only prolongs the suffering and takes us to the precipice of default or (hyper?)inflation.

    Regarding broken windows du jour,