Economists Do It With Models

Warning: “graphic” content…

Bookmark and Share
(Mostly) Correct And Creepy At The Same Time, Broken Windows Edition…

March 31st, 2010 · 20 Comments
Macroeconomics · Policy

So there’s this thing called the broken window fallacy that states that going around and breaking windows (or, on a larger scale, committing acts of terrorism) is good for the economy. Given that the word fallacy is right there in the name, it shouldn’t surprise you that breaking windows is not actually good for the economy.

The original broken window theory goes something like the following: Yeah, a window got broken, but that means that whoever’s window it was has to pay to fix the window. This is a cost to the guy with the broken window, but it is an equal benefit to the guy who gets paid to fix the window…and a benefit to the guy that makes the stuff that the window fixer buys with his newly-found profit, and the guys that make the stuff that that guy now buys, and so on. The argument is then the the benefits to these people outweigh the cost to the original dude with the broken window, so overall the economy is better off.

Is this line of reasoning valid? Some creepy dude here seems to be saying no: (Warning: fast forward the first bit if you don’t like watching planes fly into buildings, but be warned that you will miss some quotes from the likes of Paul Krugman and Nick Kristof that may or may not have been taken out of context.)

How do I say this tactfully…Dear video dude: You’re not wrong, you’re just being creepy and sensationalistic enough to make people suspicious. I felt like you were trying to recruit me into Scientology or something (with Bastiat in the role of Xenu of course), and you can see how well-received the people offering stress tests in the park are. As such, you might want to try a different approach. xoxo, econgirl

Creepy video dude’s reasoning is spot on, for the most part- what the original explanation of the broken windows idea doesn’t take into account is the notion of tradeoffs or opportunity cost. It assumes that the choice was between using money to fix the broken window or, I don’t know, not breaking the window and burning the money that would have been used to fix the window. In this situation, fixing the window is the better choice. The more realistic argument, in his view, is that the resources put toward fixing the broken window are resources that were taken away from other productive uses that would have had at least the same effect on the economy without the broken window.

Now, creepy dude quotes some pretty intelligent and well-known folks- Paul Krugman, Timothy Noah, and Nick Kristof– as espousing this broken windows argument. So what’s going on? Have these people just not done their homework? Or are they blindly pushing their liberal big-government agendas with no regard for the principles of economics? *smirk*

The explanation isn’t quite that simple…if you read closely, the fallacy of the broken windows argument rests on the idea that the money used to fix the broken window could and would be spent in another productive use. The could part is hard to argue, since fixing the window just gets you back to where you started, but the would part is questionable in some cases. When times are tough, people and companies tend to hunker down and limit their spending as much as they can. Unfortunately, this compounds the problem, since tough times are going to persist if no one is buying anything. In this case, the assumption of “well, the shop owner would have bought a new suit with the money if he hadn’t had to use it to fix the broken window” is called into question, since if the shop owner is scared about what the future is going to hold he’s probably socking his money away rather than buying a new suit. See how that affects the tradeoff at hand?

Let’s think about this in a larger context- are terrorist attacks or natural disasters a boon to the economy? The result of these events is that both private citizens and governments increase their spending because they really have no choice. This increased spending *is* helpful for the economy (in the short run) in as much as it represents an increase rather than just a shift. However, spending to repair something that is broken is certainly not better than spending to improve things and not have things get broken in the first place, it’s just more palatable from a political perspective since it’s viewed as more necessary. It’s worth noting that all of the quotes used in the video were referring to recessionary periods, i.e. times where people weren’t going to go buy the new suits instead if they didn’t have to pay to repair their houses. So is an earthquake and the follow-on spending better for the economy than people hunkering down and refusing to buy anything? Yes, strangely enough. Is an earthquake and the follow on spending better than no earthquake and equivalent spending on improvements? Of course not. Is an earthquake and follow on spending better than no earthquake and increased consumer confidence? Again, no. Therefore, the statement of whether a broken window or a natural disaster “improves” the economy depends on which situation it is appropriate to use as a comparison.

Why do people in general not understand these concepts? Maybe it’s because they are often taken out of context and applied bluntly where they don’t belong. Here’s John Stossel doing just that on 20/20, and also looking particularly creepy in the process:

Dear John Stossel: Please don’t use the broken windows fallacy argument to argue why government spending is bad overall, since that is not what the concept is about. There’s a big difference between spending with no net benefit (i.e. replacing what got broken) and spending to improve infrastructure. I know you really wanted an excuse to hurl baseballs (softballs?) through windows, but it’s hard to take you seriously when you are purposely destroying property while arguing (with no sense of irony whatsoever) that destruction of property is in fact detrimental to society. Also, try not to sound condescending while you’re doing it. That’s my job.

Note that I am not ignoring the fact that the money that the government spends comes from taxpayers. And yes, paying money to the government in taxes does prevent me from making some purchases that I would otherwise make. It is, however, important to realize that this trade is not always bad. There are certainly cases where my money is better used to contribute to fixing a pothole on a street that I drive down every day rather than used to buy one more Starbucks latte. (This is different from arguing whether it is economically beneficial to create the pothole in the first place.) Yes, it increases employment of hole-fixers and decreases employment of latte-makers, but I value the paved street more than I value the latte (as do others, hopefully, if the government is acting in the interests of the people). Furthermore, fixing the street is not something that I could have done myself. If I was just sitting on my money* rather than buying a latte with it, there’s not even any decrease in employment to be had. (This is not to say that the government should have the right to tax money that I am not using in the interest of the greater good. =P)

The overall point is that these concepts, which are often brought up in arguments about government spending, public policy and the like, are more nuanced than most people make them seem. Yes, we would prefer that there be no terrorism or natural disasters and people spend their own money in the most productive ways in order to stimulate the economy, and yes, we would like government spending to be limited to those socially beneficial items that we cannot provide in private markets. And yes, we could have gotten out of the Great Depression if people had decided on their own to start spending again, but until we can pass a law requiring people to spend money (yes, I see the irony in that point), government spending is one of the main levers available.

Note to all you sticklers out there: By “sitting on my money” I mean putting it somewhere where it doesn’t enter into the market for loanable funds, since that would affect interest rates and investment and such. I make this simplification because the incentives for businesses to invest are limited, even with low interest rates, if no one is buying anything.

Tags: Macroeconomics · Policy

20 responses so far ↓

  • 1 econgirl // Mar 31, 2010 at 5:37 pm

    I would also like to point out that another economics site posted this video with the commentary “These are exactly what is needed to reach younger people.” I very much respect the guys who wrote that, but I do wonder sometimes if they actually speak to any young people… 🙂

  • 2 Dave M. // Mar 31, 2010 at 5:39 pm

    I think the real point of the video was an attempt to somewhat discredit Krugman and Kristof, probably due to a perception that these two have enough influence over the administration or the media to warrant such strikes at their academic authority.

  • 3 econgirl // Mar 31, 2010 at 6:32 pm

    You don’t say. Then maybe I should also point out that it’s easier to take people seriously (or at least as not purely extremist) when they seem focused on providing information rather than pushing an agenda. It might also help to not have your organization’s name evoke thoughts of an Ayn Rand novel.

  • 4 Steve // Mar 31, 2010 at 8:51 pm

    how do you measure the effect during the recession? how do you make assumptions about what “would” have been spent otherwise?

    As far as I can see you can only make assumptions based on existing trends, so how do you cancel out the recession and figure out the true benefits? I can only see the deadweight loss.

  • 5 Eric // Apr 1, 2010 at 12:22 am

    I can’t speak to the context of the Kristof or Noah statements, as I didn’t read them firsthand, but the Krugman statement was (bogglingly) mostly in context: Krugman wrote the NYT column about 2-3 weeks after 9/11 and the column implied exactly what the creepy Bastiatista said: that 9/11 was, economically speaking, beneficial (a statement that, as you show, would need significant backing).

    (Also somewhat absurd is the allusion that he makes to the idea that Pearl Harbor was, in and of itself, what brought us out of the Great Depression — certainly, the rollback of parts of FDR’s policies, multilateral trade agreements and cooperation following the war, and other factors must be considered in stating unequivocally that WWII spending was better than the alternate universe where WWII never happened and rollback of FDR’s policies, multilateral trade agreements, etc. were identical.)

    Other than that, good post 🙂

  • 6 Coase Colored Glasses | The Creepiest Econ Video You Will Ever See // Apr 1, 2010 at 12:59 am

    […] can read her response to the video here. Essentially her point is that people generally apply economic concepts that are a little more […]

  • 7 Michael L. // Apr 1, 2010 at 11:30 am

    First, I think “creepy dude’s” name is Tom Palmer. What you did was the same thing he did to Krugman by calling him a name to discredit him. If your going to argue against someone, do it with logic and not insults.

    Second, Stossel has never said all government spending is bad. Like all libertarians, I’m pretty sure he would agree that pothole spending is something government should do, as well as defense and police. You make him sound like an anarchist which he isn’t.

    Third, your argument makes little sense because if we take it to the extreme, why doesn’t government simply tax all income in a time of crisis and spend it. That would most surely help the economy because nobody is spending any money.

  • 8 Michael L. // Apr 1, 2010 at 11:35 am

    Last thing,
    In fact he even says, “government spending should be based on THE MERITS OF THE SPENDING, not to create jobs.” That makes me wonder if you even watched the whole thing or just decided to skim over it and criticize him for it.

  • 9 JJ // Apr 1, 2010 at 1:11 pm

    There is a difference between measuring the flow of economic activity (RGDP) and social welfare which is partly based on the stock of assets, like houses and buildings. Does I increase? That’s not the point. Does GDP increase? That’s not the point either. Social welfare goes down because useful assets have been destroyed. If you’re not convinced, please volunteer to have your house destroyed for the good of “the economy.”

  • 10 Wilson P. Dizard III // Apr 1, 2010 at 1:31 pm

    Hello All:

    —-I agree with your analysis of the silly broken windows theory propounded in the video.

    —–However, I believe there is a much more useful broken window theory that comes from a different area of the social sciences and has been proven repeatedly by physical, in vivo experiments.

    —-The alternate broken window theory arose because of sociologists’ observation of the following incident:

    In a low-income, blighted urban neighborhood the sociologists/anthropologists were studying, one day an apparently operable, late model car appeared parked illegally on a street.

    Over time, the illegally parked car didn’t move, didn’t receive parking tickets and wasn’t vandalized.

    The apparent invoilability of the mystery car intrigued both the social scientists and the local residents.

    Rumors circulated that the car was protected from “on high,” meaning the criminal overlords who ruled the neighborhood.

    Finally, for no particular reason, one of the car’s back windows was broken, by some unknown person.

    Almost immediately, the car became fair game and was destroyed forthwith.

    Moreover, the street on which the car was parked quickly degenerated into a vandalized mess, with rampant graffiti, additional broken windows on cars and homes and other destruction carried out with impunity.

    Reversing this broken window phenomenon is a major driver of public transit systems’ programs to purchase graffiti-resistant subway cars and to remove or cover graffiti as soon as it appears.

    From what I have seen, these efforts by the authorities who control public spaces have succeeded not only in controlling the physical destruction of public spaces and infrastructure, but also potentially in reducing petty crime and other antisocial behavior in those areas.

    As far as the impact of increased savings by households or governments (or corporations, for that matter), it can vary depending on other factors.

    —-The larger economy can benefit if household balance sheets trend more in the direction of positive saving, as a whole, rather than dissaving.

    That phenomenon could, in the case of the US, reduce the pressure to import savings from other countries and, as a result, reduce outflows of interest payments.

    Of course, it matters a whole hell of a lot whether or not a government controls a global reserve currency, like Washington does.

    Personally, I believe that there is some evidence that US households have already, collectively, decided to increase their savings rates.

    I also think it is possible that the truly heroic savings rates of households in China may go down, even in the face of moderate or increased inflation.

    Increased saving in the face of disinflation or deflation is understandable but basically a destructive force, as in the US during the Great Depression or in Japan over the past decade.

    National economies bound by the straightjacket of a regional currency used by multiple economies with varying fiscal policies, creditworthiness, unemployment rates and balance sheets, like the parlous PIGS (Portugal, Ireland, Greece, Spain) countries, in turn, face completely consequences from increased government saving or reduced dissaving.

    In recent weeks, Ireland’s drastic budget cuts have made it the teacher’s pet of the euro zone.

    The Irish are being held up as moral examples to the EU’s southern tier. Look for them to get beaten up on the playground during recess.

    Meanwhile the French, in particular, blithely exceed the European Central Bank’s 3 percent limit for deficit spending. Hypocrites.

    In some circumstances, governments that are able to forgo borrowing because of saving occurring elsewhere in the economy can improve their balance sheets and reduce their premium over LIBOR, etc.

    On the flip side, when developing or emerging countries have been forced to adopt austerity programs to increase government savings, and the impact of these savings has fallen disproportionally on low-income residents, the resulting privation, starvation and political violence, not to say civil war, can lead to a lot of broken windows.

    That’s not to say that the IMF is always wrong, or even mostly wrong.

    But their level of callousness is astounding.

    Also, they tend to “assume away” the most important problems that face the economies and societies in which they intervene.

    This problem largely results from their slavish adherence to a now-discredited, highly dogmatic monetarist policy propounded by the Chicago School.

    Even St. Greenspan has admitted, “my bad,” in response to current commentary on how Fed policies contributed to the recent financial panic (to use a charming 19th century term for recessions).

    All these considerations lead to the following conclusion: let’s go out to Chicago, find the parking lot where the University of Chicago economics department staff parks their cars, and take wrecking bars (crowbars) to their windows.

    It would serve them right.

    Best, Wilson

  • 11 Edson Sagatti // Apr 1, 2010 at 2:20 pm

    Your whole “keynesian” argument would make sense if we agree the following statement is the truth:

    “When times are tough, people and companies tend to hunker down and limit their spending as much as they can. Unfortunately, this compounds the problem, since tough times are going to persist if no one is buying anything.”

    Stop and think about that… Why is it that saving money when times are tough is not a good thing? Does it really make sense to spend more when you have less?

    Unless you believe money falls from the sky. Oh but wait, even if it did fall from the sky (as it does from the central bank), you get INFLATION!!!

  • 12 econgirl // Apr 1, 2010 at 2:53 pm

    It only makes sense in that both booms and busts are self-fulfilling prophecies to a degree- if people think that times are bad and hunker down and stop spending, firms do in fact have to cut production and lay people off, which makes times bad. On the other hand, if people think times are good and loosen the purse strings, this spurs production and actually makes the economy better. You sort of get a chicken and egg problem- “if people thought the economy was better they would spend money and the economy would be better, so they would think the economy was better.”

    On a household level, of course it doesn’t really make sense to spend more when you have less, and people for the most part are doing the best that they can. The reality is, however, that this “good” behavior by households can have perverse effects on the overall economy. But, then again, so can households spending money that they don’t have. =P

  • 13 Andrew // Apr 1, 2010 at 3:29 pm

    Interesting post though I’m still confused. Above you state that a natural disaster or broken window *might* be beneficial if it occurred during a period of economic uncertainty when that money to fix it might not have been spent at all, at least in the near term.

    However, if money is not spent…then it is *saved* or *invested* either in a bank account or in the capital markets. Wouldn’t either of those be more beneficial to the economy? If saved, it strengthens balance sheets which may increase lending, which may increase productivity. If invested, again it increases the available capital to would be entrepreneurs or business who do have a productive use for the money?

    It seems to me that in arguing that spending on replacement is better than nothing, you are glossing over the fact that money not spent is not *destroyed* but would simply be made available through the capital markets.

    On a side note, while interesting that you value lattes less than paved roads, pedestrians, assuming they don’t own cars, might strongly disagree. Seems odd that you defend government spending on the basis of a personal value judgment.

  • 14 econgirl // Apr 1, 2010 at 4:04 pm

    Just wait until the car hits a pothole and veers onto the sidewalk, then ask the pedestrians how they feel. =P

    On a more practical note- in a lot of cities the government is actually responsible for the damage done to cars because of potholes, and this damage ends up getting paid for via taxpayer money. In that way, the pedestrian still has to give up some lattes because of the pothole, so I stand by my statement.

    As far as the savings and investment argument goes, the problem there is that, even if the funds are available, firms don’t generally want to invest if they don’t have customers. It’s super important to remember that markets have two sides and both have to be present in order for any activity to take place, and I doubt that you could entice company expansion with a high supply of loanable funds (i.e. low interest rates) if they don’t see the customers materializing any time soon. If firms don’t want to invest, then having households saving the money isn’t really very productive for the overall economy.

  • 15 Brandon Minster // Apr 1, 2010 at 9:42 pm

    I just read Krugman’s 9/14/01 article the quote was from, and I don’t think it was taken out of context. Later in the article he writes, “the driving force behind the economic slowdown has been a plunge in business investment. Now, all of a sudden, we need some new office buildings.” It’s hard to see that as anything but the broken window fallacy.

  • 16 econgirl // Apr 2, 2010 at 2:02 am

    That’s my whole point- he could be wrong and he could be right depending on what scenario is the relevant comparison. He is right in that the disaster was a forcing mechanism for spending that he seems to feel wouldn’t have happened otherwise, so yes, strangely enough, it’s better economically (ignoring the people issue, since there was a loss of a lot of productive people) than two towers intact and everyone keeping money under mattresses. What it’s NOT better than is having two buildings intact and spending the same amount of money on improvements (or anything else of value to society, whether government or individually financed) rather than repair. But that’s a harder case to make from a budget perspective, since a giant hole in the ground is kind of hard to ignore.

  • 17 Zombiehero // Apr 4, 2010 at 10:05 am

    Are you trying to say, that it’s only a BWF in some small extreme circumstances. That overall because we cannot know the counter factual, the BWF doesn’t apply?
    That’s the only conclusion I can come up with with your attack on the video and subsequent defense of Krugman.

  • 18 Brishen // Apr 6, 2010 at 7:32 am

    Personally, I believe that a broken window will help the economy, however, so does not breaking the window. The benefits are the same either way, which should be a justification for not doing it.

  • 19 Silence Doright // Jun 17, 2010 at 12:16 am

    Uh I don’t think government spending is the only lever. Isn’t monetary policy a viable solution to a depression?

  • 20 Forest // Jul 4, 2010 at 4:47 am

    Generally speaking I agree with the premise of the Broken Window Fallacy. However like many other things in life, I think it can only be true up to a certain point.

    If the destruction that occurs is singular in nature and requires simple replacement as in the case of the window then yes the Broken Window Fallacy is correct. However if the destruction is large enough as to significantly influence the underlying structure of the economy or business then yes it can be beneficial. Take a look at the Japanese and German economies in the postwar years. Like a forest fire, the complete destruction of their economies allowed them flexibility to restructure and refocus their human capital and capital towards newer and better purposes. Old ties, monopolies, oligopolies are broken and at least for a short period the barriers to entry are lowered.

    Moreover I would much rather be in a 2nd rate economy with a double digit (or near double digit) growth rate like China than I would be in a well developed stagnant growth economy such as much of the west.

    I am not saying that we should torch our economy in order to give us more flexibility and thus a better growth, after all this is supposedly what neo-conservative economists and the like believe that recessions help us with . Rather I am trying to say that the broken window fallacy is correct on the singular non-influenceable level. At a greater level however the forces of creative destruction take precedence.

Leave a Comment