Posts Tagged Henry Hazlitt

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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Zombie Criticisms of Keynes

Recently, a debate erupted between Austrians and Keynesians on Daniel Kuehn’s blog, and then later elsewhere, concerning matters that I, in my naivete, had long thought were settled. Sadly, it appears that once again, Henry Hazlitt’s supposed chapter by chapter ‘refutation‘ of TGT has been dredged up from the gutters of history, along with assertions about Keynes’ alleged totalitarianism.

I will start by briefly addressing some comments on Robert Vienneau’s previous exposition of Hazlitt’s book. There seems to be some confusion among the commenters who criticise Vienneau. It is quite clear that Hazlitt does not understand the concept of the marginalist supply curve, which posits that workers trade off leisure for work. Here he mistakenly asserts:

The ‘supply schedule’ of workers is fixed by the wage-rate that workers are willing to take. This is not determined, for the individual worker, by the ‘disutility’ of the employment – at least not if ‘disutility’ is used in its common-sense meaning.

He blatantly confuses the equilibrium between demand and supply with the curves themselves, an incredibly elementary mistake. Vienneau is correct to say that:

Obviously, then, the equality of the wage and the marginal productivity of labor is not enough to determine either wages or employment.

The marginalist theory require us to know both the wage rate  and the hours worked to determine employment. Do these people really expect us to take Hazlitt seriously when he can’t even describe the marginalist theory of employment?

Anyway, let’s move on to another section – hopefully everyone can agree that Liquidity Preference is central to Keynes’ theory, so I will focus on Hazlitt’s criticisms of this. Here is Keynes:

Thus the rate of interest at any time, being the reward for parting with liquidity, is a measure of the unwillingness of those who possess money to part with their liquid control over it.

Hazlitt begins with a typically snarky comment:

The economic system is not a Sunday school; its primary function is not to hand out rewards and punishments.

How petty. Keynes’ use of the word ‘reward’ is irrelevant in this case; he’s merely saying that interest is an incentive to get people to part with liquidity. Hazlitt is latching onto something quite meaningless here. Let’s continue:

If you wish to sell me tomatoes, for example, you will have to offer them at a sufficiently low price to “reward” me for “parting with liquidity”—that is, parting with cash. Thus the price of tomatoes would have to be explained as the amount necessary to overcome the buyer’s “liquidity-preference” or “cash preference.”

Keynes is obviously saying that cash has a role as a store of value as well as a medium of exchange. If it is not currently being used for the latter then it will be stored; should it be stored, a certain rate of interest will be necessary to make the buyer part with their liquidity and buy a bond or deposit it in a bank. Hazlitt completely fails to distinguish between the two uses and offers up a false equivalence based on this misunderstanding.

Hazlitt then appears to agree with Keynes for a while:

[People] hold cash (beyond the needs of the transactions-motive) because they distrust the prices of investments or of durable consumption goods; they believe that the prices of investments and/or of durable consumption goods are going to fall, and they do not wish to be caught with these investments or durable goods on their hands.

Here Hazlitt isn’t actually criticising Keynes at all, but simply restating his theory of the speculative motive. He tries to paint this as a disagreement by splitting hairs over the word ‘speculative’ – which is fairly typical of the blunderbuss contrarianism you will find throughout his book – but it’s quite clear that this is simply a restatement of Keynes.

Hazlitt goes on:

If Keynes’s theory were right, then short-term interest rates would be highest precisely at the bottom of a depression, because they would have to be especially high then to overcome the individual’s reluctance to part with cash—to “reward” him for “parting with liquidity.” But it is precisely in a depression, when everything is dragging bottom, that short-term interest rates are lowest.

That interest rates move pro-cyclically is no sufficient to disprove the LP theory of interest, as it is not the only factor determining the interest rate – in a boom demand rises and this pushes up interest rates; the latter happens in a depression. This is entirely compatible with Keynes’ economics and does not mean LP effects are absent or unimportant.

It is worth noting at this point that Keynes was mostly concerned with long term rates, which are what businesses actually use when making investment decisions. To this end, Hazlitt resumes agreeing with Keynes:

It is true that in a depression many long-term bonds tend to sell at low capital figures (and therefore bear a high nominal interest yield), but this is entirely due, not to cash preference as such, but to diminished confidence in the continuation of the interest on these bonds and the safety of the principal.

Right, in other words: their preference for cash or liquidity over more uncertain bonds. Which is what Keynes said.

As a brief note on Keynes totalitarianism: this seems to be based on Keynes mentioning several times that certain policies – both flexible wages (of which he disapproved) and various exchange rate mechanisms & capital controls, as well as active fiscal & monetary policy (of which he approved) – are more easily applied under totalitarian conditions. These observations are quite clearly true –  any economic policy, implemented word for word, is easier to apply under totalitarian conditions. This does not mean that totalitarianism is desirable, and you will not find Keynes saying anything of the sort. Furthermore, even if he did say such things, this is irrelevant to his economics.

There are good criticisms of Keynes to be made, but you will not find them with the likes of Hazlitt and Rothbard, who were quite clearly motivated by an overarching desire to ‘own’ Keynes, rather than debate. Rothbard actually wrote an entire book attacking Keynes as a person, which really is all you need to know about what he had to say. These people were not scholars, and their work is best consigned to the dustbin of history.

Addendum: Daniel Kuehn strengthens the argument about Keynes’ preface to the German edition of TGT.

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