Thursday, July 23, 2009

Fallacy of the Broken Window

Anyone who has studied economics is familiar with the parable of the broken window. One day in a peaceful small town some kid throws a rock through the Baker’s window. Understandably the baker is upset about this because now he has to buy a new window. A Keynesian economist comes along and declares this to be a good thing because this stimulates economic activity, as the Baker will buy a new window enabling the Glazer to make purchases he would not have otherwise been able to, creating a ripple effect throughout the economy. He calls it "The Parable of the Broken Window."

But a Misean economist comes along and calls it "The Fallacy of the Broken Window” instead of "The Parable of the Broken Window" because the Keynesian assumes the Baker's money was doing nothing and is now being put to use. The Misean says that we do not know what the Baker might have done with the money, what he would have spent it on instead. The Baker might have purchased, for example, a newer and better oven, increasing his productivity. Instead of everyone being better off, because bread is now cheaper and more plentiful, the town is really only poorer by the amount of one window. This is commonly referred to as the problem of the unseen.

Socialists and Keynesians hate the fallacy of the broken window. It undermines their entire view. Creative destruction and central planning do not create wealth if the story of the broken window is considered a fallacy instead of a parable. But for a long time the only response was to say that calling it a fallacy is wrong. But now it seems there is circulating in the discussions of central planners a new counter to "The Fallacy of the Broken Window." Some central planners are starting to call it "The Fallacy of the Fallacy of the Broken Window."

Their argument is that we do not know that he would have spent the money in a productive manner. Since we do not know that the money would have been used productively if the Baker's window were not broken, and we do know that the money was used productively since the Baker’s window was broken, the certainty of productive use in the latter situation means that the problem of the unseen is a fallacy and therefore advocating for the former situation is uninformed.

There is a major problem with that counter argument.

While it is true we do not know exactly what the Baker might have spent the money on otherwise, we do know it in a few broad categories. He would either have saved it, spent it, or given it away.

If he gives it away then the three options pass on to another person, who either spends it or saves it or give it away. Eventually the wealth will get spent or saved, so this option can be ignored as simply regression.

If he spent it, then it is a given it would have been spent in a productive manner given that people do act in their own rational self interest within the confines of their knowledge. To say it was spent in an unproductive manner is a subjective value judgment that Keynesians are not actually capable of making. This is also true if the recipient of giving the money away spends it.

Finally if he saves it, it is a use. This is the biggest Keynesian stumbling block, but as all Miseans know saving is not detrimental to the economy. Saving is how a person is able to consume in the future. The Baker might be saving up for that new oven, and in another month would have been able to purchase it, but now cannot because his savings must be spent unproductively on a new window. If the money is saved in a bank, the bank lends it out for economically productive purposes. But even if the money is saved in a box buried in the back yard it is still being put to the economically useful activity of saving for the purpose of future consumption.

The central planner's response to "The Fallacy of the Broken Window" by calling it “The Fallacy of the Fallacy of the Broken Window" is actually "The Fallacy of the Fallacy of the Fallacy of the Broken Window."

2 comments:

tee said...

Very timely article. I was just thinking about this today as our federal government has taken the role of the kid throwing the rock. The CARS program as already destroyed 250,000 functioning cars and now seeks to triple that number.

Andrew said...

Thank you for your informative and valuable information!
The clunker-cars-owners could put their money into better use for now or maybe for the "future". This clunkers' "stimulation" would promote over-production in an already-over-supplied economy. The automobile industry's health will be very interesting to observe in the coming months, 4, 6, 8 months...when and if some of the those car owners cannot afford to repay the borrowed money for their "new cars".