The Broken Windows Fallacy
The chairman and chief executive officer of Cumberland Advisors, David Kotok, emails:
We are now upping our estimate of fourth-quarter GDP in the US economy. Billions will be spent on rebuilding and recovery. That will put some people back to work, at least temporarily. We speculate that Washington may set aside the usual destructive and divisive partisan political wrangling and act in the interest of the nation. That means there will be a flow of federal financial assistance to the disaster areas. We also suspect there will be a rapid response rather than Katrina-type delays. FEMA lives under a microscope these days.
We expect GDP growth in Q4 to exceed 2% and maybe approach 2.5% to 3%. This will be accomplished with low inflation and very low interest rates. The earthquake-hurricane rebuilding will pile on the recovery of the manufacturing sector.
Mr. Kotok may want to reread Frederic Bastiat's 1850 essay on "That Which is Seen, and That Which is Not Seen":
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.
Let us take a view of industry in general, as affected by this circumstance. The window being broken, the glazier's trade is encouraged to the amount of six francs; this is that which is seen. If the window had not been broken, the shoemaker's trade (or some other) would have been encouraged to the amount of six francs; this is that which is not seen.
And if that which is not seen is taken into consideration, because it is a negative fact, as well as that which is seen, because it is a positive fact, it will be understood that neither industry in general, nor the sum total of national labour, is affected, whether windows are broken or not.
In other words, the billions spent on Irene recovery would have otherwise been spent on, or invested in, something else. As for the "flow of federal financial assistance," that money has to come from somewhere, too — borrowing that must eventually be repaid, or tax money that otherwise would have been spent on, or invested in, something else. Not to mention the moral hazard — if the federal government is going to provide disaster assistance, an individual is less likely to buy flood insurance, and a local politician is less likely to hesitate before ordering local businesses to shut down.
by Editor | Aug 28, 2011 at 12:59 pm
Related Topics: Government Spending, Stimulus, Taxes
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