Posts Tagged Broken Window

On the Relevance of Hayek and Bastiat

Me on twitter:

I am primarily referring to their two well-known (on the internet, anyway) essays, The Use of Knowledge in Society, and What Is Seen and What Is Not Seen. Libertarians and conservatives consider them seminal, perhaps even irrefutable rationales for a private market economy, while leftists generally don’t consider them that important.

I shouldn’t be interpreted as saying people who aren’t impressed by Hayek and Bastiat’s essays are smarter or more perceptive; I just think one’s attitude towards these two essays reflects the libertarian-left divide. I’ll try to explain why as a leftist, I found them underwhelming – perhaps good starting points, but little more.

Bastiat’s essay made a good point at the time: when we look at government spending, we need to remember that it comes from somewhere, and consider the ‘unseen’ effects of taxing. The story he uses to demonstrate this is one where a window is broken and the community observes that the money paid to fix it generates income. This, however, ignores that the money paid to fix it could have been used to, say, buy shoes from a shoemaker, and a result the community could have had it all: the window, shoes and the income. The broken window was therefore a net loss, even though it appeared to generate income.

Bastiat is right within the confines of his own examples, but really the real world throws up so many confounding factors that there is no need to invoke him in contemporary debate. Even when ‘Broken Window’ effects take place, Bastiat himself is not necessary.

People consider Bastiat relevant when discussing tax and spend – if you take money from one place and put it into another, you cannot only observe the positives of where you spend it; you must look at the negatives at the source of tax. But generally these things are considered separately anyway, and negative effects are incorporated into the analysis.

Taxation can have a negative impact on output, but it can also have a positive impact: if the taxed were going to save their money; if an activity is tax-deductible; if we are taxing economic rents, and so forth. If there are going to be negative effects, we can discuss them, too, but this generally revolves around elasticities, dead weight loss income versus substitution effects, and so on. I am not here to debate which of these effects is stronger: the point is that we have moved beyond Bastiat.

Similarly, arguments about stimulus/spending generally revolve around the claim that there are unemployed resources. The ‘crowding out‘ argument – that government spending will displace private sector spending that would have happened otherwise – retains Bastiat in some sense, but really it too has moved beyond him. What we need to discuss – sometimes empirically – are liquidity preference, multipliers, unemployment and the like. Again, there is no need to invoke Bastiat’s essay.

Hayek’s essay centres around the point that, since knowledge in society is highly dispersed among individuals and groups, the best way to coordinate this is through a price system. Individuals buy and sell at certain prices which reflects their knowledge of demand, supply, technology and whatever else. Thus the market system helps to coordinate and bring together dispersed knowledge in a way a single central planner or group of central planners could not do.

The essay does have something of an unsupported feel to it – Hayek’s idea that prices reflect knowledge (and not, say power) is never really justified. Having said that, it is overall a good rationale for a market economy, specialisation and the division of labour as a way to distribute resources.

My major problem is how one-sided his essay is. It would have been greatly strengthened if he’d acknowledged the limits of markets in coordinating dispersed knowledge – for example, that people have disparate knowledge opens the door to fraud, which is pervasive in both small and large quantities. That most people do not know the conditions, location or process by which their goods were produced is actually a justification for a lot of regulation: ensuring people have information about their products, or feel safe that somebody else has ensured they are not being deceived. Hayek does not mention fraud at all.

Furthermore, Hayek retains the phony markets versus governments dichotomy. In his essay there are basically two entities: private folk with dispersed knowledge, who are good, and ‘the government’ – apparently a massive leviathan with its own homogenous set of knowledge – that interferes with this process. But the government, too, is fragmented: the local policeman in a small town shares roughly the same knowledge as its inhabitants; similarly, a regulator will probably know something about the field they are regulating. Note that this is not necessarily an ideological point: that regulators have similar knowledge to the regulated opens the door to regulatory capture. But again, Hayek and his followers do not explore this issue.

Finally, Hayek completely disregards the democratic process in his arguments (if you think saying ‘Public Choice Theory‘ refutes democracy please do not comment). It is far to say that private individuals have a degree of influence over the actions of public enterprise, whether through voting, petitions, protests or what have you. In some ways, democracy brings together dispersed knowledge and wants too, even if it may be, as with markets, imperfect. (Incidentally, local knowledge is actually a good argument for worker democracy, something Chris Dillow is fond of pointing out.) Hayek explores none of this, but if he did his essay would be stronger no matter the conclusions.

In fairness, I may be commenting more on how Hayek’s essay is used rather than his original intent, as it was written during the rise of central communism. But my points apply to many of his modern followers. Perhaps something similar could be said for Bastiat, who did at one point offer limited support to public works programs during recession.

In summary, my problem with these essays is not that they are ‘wrong;’ Bastiat is right, but no longer relevant, and Hayek is roughly right, but incomplete. In the case of Bastiat I see no further need to invoke him, even though we may remember the essence of his point; with Hayek, I feel his essay would be far more respectable had he explored the implications of local knowledge a little more. At any rate, this is something that his proponents should be doing, rather than holding his essay up as pure truth.

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A Word on Economic ‘Fallacies’

I’ve developed an aversion to the use of the word ‘fallacy’ in economics, as it seems to be little more than a tool people beat others over the head with when they don’t want to engage in critical thinking. Often, the so called ‘fallacies’ that are trotted out in economics are used inappropriately and the stories told to justify them require exploration.

Here I present the three worst offenders – note that I don’t disagree with all of them entirely, but just wish to highlight that the story is often not a simple as it seems and cannot be captured by simply shouting down your opponent with the word ‘fallacy’.

The Broken Window

In the essay ‘What Is Seen And What Is Not Seen‘, a 19th Century economist named Frederic Bastiat  wrote a story about a boy who breaks a shopkeeper’s window. In replacing it, the shopkeeper gives money to the glassman, and the town observes that the broken window provided a boost to the local economy. However, Bastiat emphasises that this fallacy ignores the unseen fact that, had the window not been broken, the shopkeeper would have bought a new pair of shoes. Hence, there is no net gain for the economy.

Don’t get me wrong, it’s an important essay with an important point: if you look at only the benefits of government programs, you miss the hidden costs – where the tax money would otherwise have been spent, money unspent due to tariffs, and so forth.

However, Bastiat makes two hidden assumptions:

(1) All money that is spent would have been spent elsewhere – call this Say’s Law.

(2) That the replacement for the proverbial broken window is not better in any way.

The problem with (1) can be demonstrated by supposing that the shopkeeper was, in fact, not going to spend his money at all – in that case there would have been a boost to the economy. Not the best way to boost income, perhaps, but an income boost nonetheless. If the economy is not at full employment then spending more money does not require that you displace existing spending – to argue the opposite is to argue that private sector spending cannot increase employment either.

The problem with (2) can be illustrated by supposing that the shopkeeper’s window had been in a poor state to start with. In that case, replacing the window would have had a degree of benefit to the shopkeeper greater than in the more simple version of the story. After all, proponents the broken window fallacy often speak approvingly of creative destruction- replacing old capital and ideas with new, better capital and ideas. A similar logic applies – again, going around breaking things that seem worn out isn’t a suggested strategy for development, but it’s not as clear cut as it first seems. (‘Broken windows’ can also become a rationalisation for renovation – ‘it’s about time we redid the shop front anyway’, etc.)

Lump of Labour

This ‘fallacy’, as with the rest of labour economics, was born as a reaction to working class political movements in the late 19th century. It is basically an argument against shorter working hours – the claim is that you can’t simply ‘split up’ existing working hours, as the productivity of one sector of the economy has an impact elsewhere. Therefore, working people don’t understand econ101, etc.

The vacuousness of the fallacy can be seen in defenses of it, which seem to insist that higher productivity implies more income and more work. Take, for example Paul Krugman’s hot dog story:

But wait–what entitles me to assume that consumer demand will rise enough to absorb all the additional production? One good answer is: Why not?

Great. I’ve got a better answer: Why? Why not reduce working hours? What about limited natural resources? What if people don’t want twice as many hot dogs?

The blogger named ‘Sandwichman‘ appears to have made it his task to demolish this supposed ‘fallacy’, and has a website devoted solely to this cause. Sandwichman’s main point is that Lump of Labour proponents often mischaracterise their opponents as assuming there is a ‘fixed’ amount of work to be done in an economy, when of course they do no such thing. Discussions over the amount of work to be done is irrelevant to discussions of how that work should be distributed.

Correlation-Causation/Post Hoc Ergo Propter Hoc

Confusing correlation for causation, of course, is a fallacy, but this does not justify the mirror image delusion that correlation is meaningless. Often an observed correlation in the data has an implicit, intuitive causal link, such as alcoholism and recessions, corporate savings and unemployment, or, in the case of austerity, spending cuts/tax increases and a stagnating economy (I have seen some on the right shout down criticisms of austerity producing low growth as post hoc ergo propter hoc. Of course this is ridiculous – we know exactly why austerity produces low growth) .

If, as in the case of Steve Keen’s work on private debt, you have a clear theoretical link between two things, strong correlation, and the numbers changing in the right order (a decline in private debt acceleration portends lower growth), these things cannot be dismissed on grounds of correlation causation and post hoc ergo propter hoc.

Of course, there are many more – even the well established logical fallacies are prone to misuse and misconception (if you think about it, appeal to authority is historically quite a large component of scientific progress). Specifically, economic fallacies are generally an attempt to look for easy answers in a complex field, when the real story is often far more nuanced. It is important not to fall into this trap of lazy argumentation that often pervades the internet.

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