Wednesday, August 17, 2011

Broken Windows

Yesterday, Matt Yglesias posted this about the broken window fallacy. Now the broken window fallacy is based upon the following parable attributed to by by Frédéric Bastiat:

Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—"It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?"

Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.

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.
The conclusion that the money spent on repairing the window would otherwise have gone to some other purpose is often given as an argument again Keynsian economics. Now, Matt gives a fine reply in terms of modern views on money and so forth, go read him, but it strikes me that the parable itself is a fallacy.

The claim that the money spent on repairing the window must come as a deduction from money spent elsewhere is certainly not, in general true. Unless everyone in the town is providing absolutely the maximum amount of labor that he can, that no time is spent on leisure activities beyond what is absolutely necessary to maintain optimal productivity, then people have the option of increasing their income by increasing the amount of labor they do. Let us assume that the baker can give up some of his ordinary leisure time today (no wonder he is cross with the child) and produce some extra confectioneries that he knows he can sell to the shoemaker. He uses this money to pay the glazier, who repairs the window to its original state, and then, as it happens, go to the shoemaker and uses the income from repairing the window to purchase a new pair of shoes he would otherwise have done without.

Now where do we stand. Well that still depends upon a number of factors, but let us assume that each of these purchases, the confections, the window and the shoes each cost one franc. In terms of cash money then a single franc was passed from the shoemaker to the baker to the glazier and then back to the shoemaker, leaving the status of cash money unchanged. Now it is true that each merchant is out the cost of the materials used to produce his product. But if each merchant is operating at a profit than the cost of the materials must be less than the one franc price at which the items were sold. It is certainly possible that, depending upon the profit margin for these three, that the total cost of the materials is less than the one franc price of replacing the window and that the net loss is less than that one franc cost and that all three now have more money to spend than would be the case had the window not been broken. The extra value comes from the extra labor done, which would otherwise not have been done.

It should also be considered that most likely the glazier values the shoes more than he does the pane of glass (his loss of materials) and the shoemaker values the confections more than he does the leather (his loss). The baker presumably is just out the value of his flour and eggs, but then his child broke the window. (Of course in that case he might get a bit better labor from the child, who most likely helps out in the shop, with less effort on the baker's part, at least for a few days, due to guilt). Also the pattern of people doing a bit more labor to make up for additional costs could be extended further, thus reducing the overall loss from this event. Perhaps the baker does a bit of further extra work for the supplier to the shoemaker in order to earn money to replace his (the baker's) store of flour and eggs. And then perhaps the shoemaker does the same with the supplier to the glazier to replace his store of leather and the glazier does the same to replace his store of glass. Now the loss is only to the materials used by the suppliers, and that again, if people operate at a profit will reduce the overall loss. Furthermore this braid could be extended still further to reduce the loss to whatever small value we like.

Now, the above, in detail, is not a likely series of events. But it clearly demonstrates that there exist options, centered around the provision of additional productive labor, whereby the broken window leads to an increase in the overall wealth of the society. The glazier gets new shoes and the baker still has money for purchasing a book, although perhaps a somewhat cheaper one. The claim that the broken window makes no difference, while it provides some benefit to the glazier, it must be an equal loss to someone else, is simply not the way people actually function.

Consider a more modern example. While traveling on the highway you see a stranded motorist with a flat tire. The person stranded is in no shape to change the tire (for whatever reason) so you change the tire. You have just done productive labor that would otherwise not have been done. You did it only because the tire went flat. Had the tire not gone flat you would not have done that, or any comparable, extra labor. It this example let us also assume that the stranded motorist will not take the aid for free but insists on paying you $20. Ok, now you've done $20 worth of productive labor that happened only because the tire in question went flat. You are ahead by $20, but the motorist is behind by $20, so no change at all, in line with the parable above. But the motorist, who is now out $20 might well decide to also find some additional labor to do, labor worth $20. But this is labor above and beyond which he would have done had the tire not gone flat. Perhaps he takes an extra shift at work, or he tutors on the side of a local school and takes on one extra student. Perhaps he mows an extra lawn, or takes on another babysitting job. I think I've made my point. Are we really to believe that nothing like this ever happens. I doubt it. Furthermore, once the flat tire has induced the motorist to take on additional labor, what is to constrain him from working only enough to replace the $20. If he is going to give up free time to work, he might as well do more than replace his loss and earn $30 or $40 or more.

It seems most likely to me that the broken window fallacy is itself the error.

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