Posts Tagged Broken Window

The Real Problem with the Broken Window Fallacy

John Quiggin recently posted on the “Broken Window Fallacy” (BWF), a parable beloved by libertarians, originating from Frederic Bastiat but finding its most modern exposition in Henry Hazlitt. The basic idea is that while breaking a window will seem to stimulate spending by providing work for a glazier, the money used to employ him could have been spent elsewhere, say by employing a tailor to make a new suit. Therefore, as a result of the broken window the community has only a window (what they started with), rather than both the original window and a new suit. We must look at the “unseen” in order to understand the true economic effects of smashing the window.

Quiggin tries to refute the fallacy thusly:

Implicit in the crowd’s reaction is the assumption that glaziers are short of work. If (as sometimes happens) glaziers have more jobs than they can handle, then there is no extra window – at best, the shopkeepers order simply displaces some other, less urgent, repair. Similarly, for Hazlitt’s riposte about the tailor to work, there must exist unemployed resources in the tailoring industry, so that the shopkeeper’s suit represents an addition to output. If not, the additional demand from the shopkeeper will raise the price of suits marginally, just enough to lead some other customer to buy one less suit. So, the story seems to imply that the economy is in recession, with unemployment across a wide range of industries.

Yet “rais[ing] the price of suits marginally” – such that the person most willing to pay receives the suit – is precisely what libertarians have in mind when they envision a market economy functioning nicely. Under the assumption of full employment and no broken window, the shopkeeper purchases a suit while the glazier is put to work elsewhere creating a new window. Under the assumption of full employment and a broken window, the shopkeeper employs the glazier, meaning that somebody who previously would have employed the glazier goes without, while the tailor is put to work for somebody who likes the suit slightly less than the shopkeeper. Aggregate welfare and wealth is decreased, even if the flow of production is the same.

Quiggin attempts to introduce the assumption of unemployment to counter the standard story:

With these facts in mind, we can tell a different story. Suppose that the glazier, having been out of work for some time, has worn out his clothes. Having fixed the window and been paid, he may take his $50 and buy a new suit. To make the story stop here, we’ll suppose that the tailor is a miser (a vice traditionally associated with the clothing industry, as with Silas Marner), and puts the money under his mattress. So, in this version of the story, the glazier and the tailor are both paid, and the social product is increased by a new window and a new suit.

But the social product is not increased. If the window were not broken, we’d have a window and a new suit. When the window is broken, we have a window and a new suit. The allocation of the suit has changed, but not the total product. Quiggin will never refute the BWF like this, on its own terms, because if you start with the premise that a window gets broken, you will inevitably end up at the conclusion that the world is worse off than before. Once the window has been broken, we have lost $50 worth of window and will have to replace it. Depending on your ethical presuppositions, you might view the redistribution as desirable, and the employment of the glazier as an end in itself, but this is another debate.

And this is the real problem with the BWF: it’s a complete straw man. Noone, anywhere, ever, has claimed that ‘breaking windows’ is a desirable economic strategy, or that it will somehow add to wealth or welfare. True, you can pick and choose your own auxiliary assumptions to add ‘silver lining’ to the story. Given that the window is broken, the fact that the glazier then wants to buy a new suit is better than if he just hoarded the money. Perhaps the new window is slightly nicer than the old one. Perhaps, as a commenter suggested, the shopkeeper has an emergency fund which is “psychologically separate” from his other money, so he still buys both the window and the suit. Or maybe the glazier has an apprentice who benefits from the training when he otherwise wouldn’t, while the tailor does not. We can do this all day but ultimately, the broken window devotes resources which could have been used – even if they were previously idle – to increasing wealth and welfare.

Should we utilise idle resources? The answer to this question needn’t have anything to do with breaking windows. Quiggin, like most critics of the BWF, implicitly recognises this, which is why he stresses that none of what he says “means that it’s a good idea to go around smashing windows during recessions.” So why start with the assumption of a broken window? We could instead tell an alternative story where there is no broken window. The tailor is unemployed, and there is a kid who wants a shirt but cannot afford it. The government prints $50 and gives it to the kid, who buys a shirt from the tailor, increasing the social product without any broken windows. This story is similarly arbitrary, demonstrating the ease with which we can formulate a parable to come to the conclusion we like. But the question of which story’s assumptions (in particular unemployment) are true or not is an empirical matter.

Quiggin, in trying to refute an abstract parable built on arbitrary assumptions by introducing his own, slightly different arbitrary assumptions, is fighting a losing battle. The BWF may or may not be useful for demonstrating a certain point, but it is not a model of the economy and it is not always and everywhere applicable to economic problems. If you are arguing with somebody who thinks repeating ‘Broken Window Fallacy’ at you will settle the debate, you aren’t going to convince them by telling them the ‘Broken Window Fallacy, version 2′. You simply need to stop having the debate in terms of Broken Windows, and start having it in terms of what is actually going on in the economy. Otherwise you’ll be forever trapped at a useless level of abstraction.

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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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