Wednesday, November 14, 2012

Can broken windows increase output?

I have recently read a blog post by Marcus Nunes, aka Historinhas, called "In Bastiat´s day it was about 'Broken Windows'. The modern equivalent is 'Broken Cars'". This post is not about that, but it still got me thinking about that old fallacy, first identified by Frederic Bastiat.  In brief:

Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son has happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—"It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?"

Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.

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.

But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, "Stop there! Your theory is confined to that which is seen; it takes no account of that which is not 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.

This is basically a statement of what one might consider "normal circumstances" from a welfare economics perspective. At full employment, broken windows-like shocks are just causing output to be used in a different way. Thus, instead of a shopkeeper increasing his own satisfaction by buying new shoes or adding a book to his library, he must replace the window. Under normal circumstances, replacing broken windows reduce consumption of what the shopkeeper would otherwise like to purchase and its associated utility. The fallacy is further compounded if it leads to a decrease in investment, which would reduce output and not just one-off satisfaction. This is the general case, but not every case is identical to this.

Let us say that there are two factors that are operative: first, the economy is depressed; second, something prevents the central bank from being able to bring the economy to full employment, like a liquidity trap. The classic case is that the interest rate controlled by the central bank is approximately zero (why it is often called the zero lower bound) and the bank is unable to affect expectations sufficiently to restore full employment. In this case, a broken windows-like shock raises the opportunity cost of delaying repairs or similar spending. The repair takes place, which increases output without a corresponding reduction of output on other things, either investment or consumption.

It should be quite obvious that if the economy is depressed, it would be supremely stupid to go around destroying things to stimulate it. If there are things to repair, repair them, but if there aren't, then there is good reason to consider investing in future output: building roads, bridges, ports, airports, telecommunications, manufacturing plants, education, health care, etc.

This is the direction the recovery should take in the United States. There is plenty to be done, idle resources that can be put to better use and the government can borrow cheaply to do it.

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