It is relatively easy to debunk the Broken Window fallacy, the idea that hurricanes or more generally the destruction of capital may be a tragic economic stimulus. Indeed, much has already been written on the opportunity cost of the new spending that may be unleashed by a natural disaster — in the last few days by Robert Murphy and Jim Quinn (and many others) and historically by Henry Hazlitt and Fredric Bastiat. When a window is broken, and money is spent on a glazier, the labour, capital and resources is only moving the economy back to where it was, and it has an opportunity cost — whatever might have been purchased with the labour, capital and resources had the window not been broken.
A Krugmanite might respond to this with the idea that when an economy is in a depression state, where vast quantities of labour and capital are idle, then this opportunity cost is less relevant. But this is not so.
A natural disaster will undoubtedly result in new economic activity that would not have taken place otherwise. Undoubtedly, labour, capital and resources that may n0t have been employed otherwise will be employed because of an earthquake, or a flood or a fire. But believers in the Broken Window fallacy are looking at the economy through a distorted lens. What they define as “activity” (i.e. GDP) is only one side of the picture. Yes, a major hurricane like Sandy might require $100 billion or more spent to repair the damage. Yet to only look at spending is to only look at one side of the picture — the flow. An economy is both stock and flow. That $100 billion of spending is flow to replace damaged and destroyed capital stock (houses, factories, roads, etc).
To grasp the full picture we have to look at both sides of the equation. If a hurricane like Sandy causes $100 billion of damage requiring $100 billion of spending to fix, then after that spending we are in aggregate no better off than we were before the storm. Without the storm, resources would surely have been deployed differently. But without the preceding hurricane damage, all spending is a gain because the spending is not replacing capital stock that has been destroyed. Let us assume that Sandy had blown herself out without making landfall, and that without the need for a major reconstruction, only 10% ($10 billion) of the $100 billion necessary to repair the damage was deployed in the economy. In aggregate, we are $10 billion better off than with the $100 billion of spending in the wake of the storm, because that $100 billion was merely making up for losses via destruction.
I hope that we can put the Broken Window fallacy to bed at last and agree that the “stimulus” effect of natural disasters, is merely a transitory illusion based on flow, while ignoring that that flow is merely compensating for loss in stock. There are benefits to natural disasters — like learning not to build in areas prone to flooding or volcanism, or developing building materials and techniques or other innovations robust to earthquakes or flooding, or the concept of natural-disaster preparedness and survivalism — but these are informational and not an economic “stimulus”.
And certainly, unemployment is a tragedy. But there are far better ways to reduce unemployment — like slashing red tape and cutting taxes for small businesses and startups — than the destruction of capital.
The really ironic thing about this great thinking post is that it demonstrates so clearly that the State-centred, so-called progressives actually inadvertently advocate actions which would result in stagnation, or even regression, all so that they can claim to have made sense of the world through some ostensibly complex theories. Wow.
Couldn’t agree more.
The State, is run by insecure idiots who envy business, and suffocate business through verbose policy documents, all because their mother never let them run a Lemonade stand.
The State provides an employment refuge for the children of the Elite, who would have otherwise wasted an expensive education. Instead of writing excellent though provoking philosophy, they even rules and regulations to give them a sense of control and purpose.
The State is akin to the hoodlum who breaks the window to keep the glazier in business. Without their hand in the red tape machine, the “glazier” would not maintain their position.
It vexes me to have a neighbour who can’t maintain his nature strip out the front of his house, who expects the State to develop a tender document to employ a sub contractor to do what the neighbour could have done in 2 minutes.
But according to Economists, increasing G i.e. government expenditure, increase GDP. We have to get away from the GDP numbers and concentrate on wealth for the median citizen. Averages and GDP when Governments borrow to increase the G is a lie.
All that I know is Australia has had more than 20 years of continuous GDP growth, yet housing is out of reach for minimum wage workers, when 38 years ago a minium wage worker could bring up a wife and 2 children.
If this metric was used, Politicians would be out on their arse.
Cobblers. Practically, there is genuinely extra, and not merely relocated, expenditure. Some, even much, of the repair work does adsorb resources that would otherwise have improved our wealth; but much does not, what this uses, labour in particular, was lying idle and would have continued thus until it ceased to be useable.
As Kornai (1979) showed, the strength of a capitalist economy is that it is predominantly constrained by demand constraints (as opposed to the resource constraints which are more dominant in a socialist economy). This leaves slack in the economy that allows the economy to adjust more easily to exogenous shocks, like hurricanes. But as I showed mathematically in the piece, additional demand to replace what has been lost or broken only replaces that which was there before. Obviously if a broken window (or hurricane) happens, the damage should be repaired as quickly as possible, and slack or idle resources will be put to work to do so. It is a good thing that there is the excess capacity to redeploy resources to fix broken windows (because obviously “broken windows” and natural disasters have always happened, and always will), but to equate this with “growth” or “stimulus” is to confuse a flow to replace a stock with flow to build above the pre-existing stock.
Broken windows are as good an example as many another, so let’s stay with them.
Replacing the glass – and installing it, and painting the putty – is labour-intensive, making this little cheaper than upgrading to PVC surrounds and possibly double glazing – particularly if we’re fixing not one window but lots, as in the aftermath of a hurricane. So if we’re sensible we end up with something better, which means with more wealth in the form of resources, if with less through their consumption in the.repair/refurbishment.
Storm damage damages our net wealth less than the repair bills indicate.
You make a fair point. Lets extend this theory and destroy all infrastructure through a war, and then we can end up with energy efficient housing, i.e. double glazed windows, double insulation walls. While we are waiting for the houses to be built we could house people in tents, and then when the houses are built people can go camping in these tents. We would be happier and healthier because we get to go camping and breath fresh air, stimulate the economy of remote areas etc.
My only agreement is that it maintains a skillbase, i.e. old craftsmen teaching their trade to juniors. But other than that it diverts labour/resources from areas that require it. In a depressed economy, cheap idle skilled labour, capital could make uneconomic projects viable.
I don’t see it as clear cut as this. Basically I’m not sure “Without the storm, resources would surely have been deployed differently. ” is true. In fact it seems quite likely that resources would not have been deployed at all.
If all you ever do is arm wrestle right handed and are suddenly called upon to use your left hand, you might rely less on your right arm for other things in life.
Being deployed differently could also mean not being deployed at all. But as I’ve shown, even if only 10% of resources deployed in the “stimulus” are deployed, you’re still 10% ahead of where you would have been, because the cleanup and rebuild is only about getting back to where you were before the storm. Even if your storm “stimulus” takes you beyond where you were to begin with, the same extent of progress could without the storm have been achieved with a lesser resource/capital/labour cost.
Yes I largely agree but I think the point is “could.. have been achieved”.
You might like this article then, it covers the same ground:
(and is anti-krugman to boot)
Another interesting take on the issue can be see here http://blog.tyrannyofthemouse.com/2011/12/broken-windows-part-i-pain-of-hard.html
It drives me nuts that so many people don’t ‘get’ the fallacy of the broken window being a good thing for an economy. Thanks Aziz for trying to explain it, but politicians and many economists will jump on the ‘economic stimulus argument’ and present it as a great opportunity to get people back into employment. It’s obvious that many people will now have extra work. A small silver lining to contrast with the tragic deaths and the massive destruction that would preferably never have happened, that they previously would not have had. So the logical extrapolation would be to suggest that if Sandy had totally destroyed New York, then the economic benefit would be even better. Why stop at only $100m of ‘stimulus’, or $100billion even? Actually, if the hurricane just circled the whole of the USA until everything went back to the stone age, we should be really happy with that level of ‘stimulus’. The construction companies and labout put to work will be the winners. Businesses not put out of business will scoop up displaced customers. Change certainly occurs, but the net benefit to the economy is negative. Trauma to people is negative. Losing homes is negative. Getting your window broken is negative. Getting killed by a drone is overwhelmingly negative, but someone made a profit by building it, and someone was employed making it. There are more losers than winners in a catastrophe. America will rebuild better than before, but I have a feeling the National Debt won’t go down as a consequence. The majority loses again.
Excellent point. You should campaign as the next President on creative destruction to get the economy moving. That will shake them into waking up!
I am just happy that I can be of some help by subsidizing the re-building of the ocean front houses owned my millionaires. Perhaps they can also buy new Tesla electric cars at a hundred grand and I can also be of some help there.
No grand plan is necessary to insure houses are not re-built on the sand. Simply set a phase-out of flood insurance subsidies. If you want to build on the Mississippi fine, but don’t expect me to fund your insurance.
Trees Come ‘From Out Of The Air,’ Said Nobel Laureate Richard Feynman. Really?
From different perspective point of view:
Life is all about birth – being – death – (re)birth – being – death etc, etc, etc……
The most important step is actually at the B E I N G (or living) stage. The beginning is also important but a very short period of time in compare with the BEING stage. Death is totally unimportant.
So PK has a relevant point which is to live the living which means to let the guys have some purpose of life and to give the guys something to do while they are living. Money is one of the things one must have during he’s alive.
Although one may be able to leave wealth and fortune to one’s offsprings, a natural event such as Sandy can wipe out everything. Or if not, one’s offsprings’ gambling thirst will do it. So people who worrying too much about their offsprings’ financial states as if their offsprings are all bunch of mental physical invalid dependents are just too overbearing. Their offsprings of the future must fight their own battles and create their own world they want to live in. The baby boomers are right about this.
“Life is all about birth – being – death – (re)birth – being – death etc, etc, etc…… ”
Of course, you can you look at it as, life is life, death is death.
The good thing about times like these is that the system reveals itself proportional to the melting away of layers of obfuscation.
Despite the obviousness of such, many [those who continue to be the winners in the current order] still must convince the majority that the mechanisms that line their pockets are at the very least, noble endeavors.
The professional class internalizes all this non-sense and that’s why it’s so difficult to change this mindset. So, it should not surprise anybody that TPTB would be in a tizzy when any opportunity to create more debt comes along.
The the extreme difficulty in creation of debt-money in a deflationary depression IS the crisis [as far as the banking/government interests are concerned]. As disaster is wonderful news for these people, war is their ultimate solution.
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Looks like you are assuming a closed economy where the $100billion spent on the damage came from within the economy. In reality, the central bank/treasury/federal govt injects new money into the economy during such disasters. Let us assume the damage is $100billion, and the govt injects $50billion towards reconstruction. This new money wouldn’t have come into existence if the window hadn’t been broken.
In a closed economy that you describe, when $100billion is lost and another $100billion is spent to fix it, ultimately $100billion is removed from the system, which over a period of time leads to a depression as the money supply dwindles.
In the case where the govt injects new money, say only $50billion, the economy would lose just $50billion. Adding new money during disasters does not lead to inflation as they replenish the loss.
What’s your thoughts on this?
Where does government get the money? Either from tax or borrowing. Central banks can inject direct (although $50 billion extra would be minimal by today’s QE standards, and would just be the equivalent of bringing forward a month of MBS purchases), but all treasury spending is appropriated from elsewhere.
A sovereign currency nation like the United States doesn’t have to borrow or tax to create its fiat money. So it is important to understand that for a federal government, taxes are not for revenue generation. Under a fiat monetary system, The government spends money and then borrows what it does not tax, because deficit spending, not offset by borrowing, would cause the fed funds rate to fall. The untaxed money in the economy is the deficit. As simple as that. The federal government is not revenue constrained in any way. It can create as much dollars as needed to keep the economy running, not too much(creates inflation when we have full employment) or not too little(creates recession and depression).
The Federal government has created its own revenue constraints inasmuch as the Fed is an independent central bank not allowed to directly fund the treasury. This is a self-imposed constraint, but real nonetheless.
“The federal government is not revenue constrained in any way. It can create as much dollars as needed to keep the economy running, not too much(creates inflation when we have full employment) or not too little(creates recession and depression).”
Well, in that case, the government should send everybody a check for ten million.
Do not forget that the Federal Reserve is actually a Private bank and charges the Federal Government (You) interest on all money printed. That is why you are getting deeper in debt. You are paying interest on interest.
Having a central bank is like marrying the most beautiful woman on the planet and then having to pay somebody else to service her needs.
I agree we are no better off after repairing hurricane damage. But at the end or your piece you say small business tax cuts would help. Aren’t they kind of the same thing? If you reduce the tax burden of small businesses by $10B, you add $10B to the debt. And if you cut spending $10B to pay for those tax cuts, it’s a ~$10B hit to GDP. Either way there is no net gain.
I think the bigger point is that extra spending and tax cuts help close the GDP gap, even though they aren’t a net benefit overall. Intelligent fiscal policy can help moderate the business cycle.
When it comes to taxes on small business, I’d say the Laffer curve will probably apply (certainly more than in the case of large corporations), i.e. rates may fall but total tax income will rise from more economic activity. Evidence is that small businesses create proportionately more jobs than other kinds of enterprise. More jobs means more taxpayers. And lower rates mean less tax evasion.
Since tax rates are the lowest they’ve been in at least 50 years, it’s safe to say we are on the left side of the Laffer Curve.
According to the CBO, the Bush/Obama tax cuts added $2.8T to the debt between 2001-2011. They also estimate that extending the Bush tax cuts will add another $3.35T to the debt between 2013-2022.
Small businesses and individual entrepreneurs are paying a much higher share of the burden than in recent history. Large corporations are paying a much lower share. Small businesses tend to create proportionately far more jobs per than large corporations. We have an unemployment crisis. You do the math. We need to shift the burden from job-creating small businesses back onto large corporations.
Also the CBO in the 90s projected a trillion dollar surplus by 2012. Every such projection must be taken with lots and lots of salt. Also the CBO says that Ryan’s budget will cut the deficit, which is absurd as Ryan’s budget has more holes than Swiss cheese. Bottom line is that if we can get to a jobs-led recovery tax receipts will soar again. Helping small businesses and startups by reducing their tax burden is as good a suggestion as any I’ve seen to get there.
I agree that small businesses pay too much compared to corporations. Not because of income tax, but because of payroll taxes. But taxes haven’t gone up for anyone since 1992. The current unemployment problem isn’t a result of high taxes, it’s the result of low demand.
Middle class incomes have been pretty stagnant the last 30 years. Up until 2007, they made up for it by borrowing. Now they are tapped out and paying off some of that debt, so the economy is weak. Things are picking up a little thanks to housing finally recovering. But the economy will continue to be weaker than normal until income inequality improves, or households resume borrowing.
Then shift the burden — raise corporate taxes, and cut for payrolls (and create job creation deductions for individuals running small businesses and startups, etc) — and we don’t have to rely on any Laffer effect. That’s been the change since the 70s — lower corporate burden, higher payroll burden.
But can’t the money that goes toward rebuilding efforts improve an affected area? Can’t run-down homes and cracked roads be replaced with new homes and better roads, thereby improving the community and, with any luck, the economy too? Just asking.
Yes, but improvements could be done for a lot less cost without any destructive force. Necessary improvements are ultimately done. All a hurricane does for broken/dilapidated infrastructure is bring them forward in time and destroy a whole lot of useful and functional stuff, too.
Yeah, you never want to “have to” do anything. Generally speaking, you will pay the highest price for ?? quality.
Disaster breeds poor economic outcomes. Look at the tremendous waste that occurred during the Katrina disaster/aftermath.
You forget about cleanup costs and overtime rates paid to do this. In an emergency the costs are higher as you can’t wait for cheaper deal etc. Planning ahead to do as you suggest is far cheaper.
So you agree that the answer to your question “Where does government get the money?” is NOT “Either from tax or borrowing.”
I can’t seem to reply to your last comment about the Fed.
No, the Federal government has set up the “either from tax or borrowing” constraint itself, but so long as it continues to abide by it then that is the answer.
MMT is superficially appealing on some levels, but there are too many political and social dimensions it doesn’t account for.
Against Bosses, A Conversation with Richard Rorty,
PRICKLY PARADIGM PRESS,
Click to access AgainstOligarchies.pdf
Should probably add:
A different broken window theory that would actually apply the hurricane destruction.
“Social psychologists and police officers tend to agree that if a window in a building is broken and is left unrepaired, all the rest of the windows will soon be broken. This is as true in nice neighborhoods as in rundown ones.”
Read the rest here http://www.codinghorror.com/blog/files/Atlantic%20Monthly%20-%20Broken%20Windows.htm
A much better broken window theory.
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