Friday, November 9, 2012

A Flood of Fallacies

By Sheldon Richman

There's nothing like a natural disaster to bring a flood of economic fallacies in its wake. Hurricane Sandy was no exception. The two fallacies that emerged—even before the storm hit—are 1) recovery will boost the economy, and 2) price controls are necessary to prevent harmful gouging for badly needed consumer goods. We'll examine the first this week and the second next week.
You don't have to look far to find examples of the view that no matter how bad the world looks after a natural disaster, there is always a silver lining in the need to rebuild. It seems to make sense. Buildings are damaged or destroyed, streets and bridges torn up, water and sewage facilities knocked out of commission. To fix it all up, labor, machinery, and materials will be needed. That means jobs for the unemployed and tasks for idle resources. Happy days are here again! 

"As devastating as it was, Sandy's impact to the national economy will likely be negligible: The short-term loss to economic output should be made up by long-term spending to rebuild,"writes Matthew Phillips of Bloomberg Businessweek. "Whether it's recovering from a war or cleaning up after a natural disaster, periods of severe destruction are usually followed by sharp bursts of economic activity. Money pours in from government and insurers to repair infrastructure. Homes get rebuilt, debris cleared. As a result, the overall economic growth that follows a natural disaster can often outweigh the wealth it destroyed." 

"Disasters can give the ailing construction sector a boost, and unleash smart reinvestment that actually improves stricken areas and the lives of those that survive intact," adds Peter Morici, economist and printer pitchman.  

Likely the most startling example of this line of thinking is Nobel laureate Paul Krugman'sclaim after the 9/11 attacks: "Ghastly as it may seem to say this, the terror attack—like the original day of infamy, which brought an end to the Great Depression—could even do some economic good... . Now, all of a sudden, we need some new office buildings... . Rebuilding will generate at least some increase in business spending... . Now it seems that we will indeed get a quick burst of public spending, however tragic the reasons." 

And yet something doesn't seem right about this story. There's good in mass destruction? Can that really be?  

It seems too good to be true—and it is.

This was pointed out over a century and a half ago by Frédéric Bastiat, the French free-market liberal, who had an unequalled knack for explaining economic principles and exploding popular fallacies in terms any interested person could understand. Unfortunately, too many professional economists still don't get it.

Bastiat demolished this fallacy in an essay called "What Is Seen and What Is Not Seen." In it he tells the story of an unfortunate shopkeeper whose "incorrigible son" breaks a window.  

"If you have been present at this spectacle," Bastiat wrote, "certainly you must also have observed that the onlookers, even if there are as many as thirty of them, seem with one accord to offer the unfortunate owner the selfsame consolation: 'It's an ill wind that blows nobody some good. Such accidents keep industry going. Everybody has to make a living. What would become of the glaziers if no one ever broke a window?'" 

The lucky glazier of course will spend his new income, as will the people he trades with, and so on. The community will be richer—thanks to the mischievous lad. Right? 

Well, no. Bastiat has no doubt the mishap is good for the glazier. "The glazier will come, do his job, receive six francs, congratulate himself, and bless in his heart the careless child," Bastiat wrote. "That is what is seen.

But does the event enhance the general welfare? Bastiat thinks not: 

If, by way of deduction, you conclude, as happens only too often, that it is good to break windows, that it helps to circulate money, that it results in encouraging industry in general, I am obliged to cry out: That will never do! Your theory stops atwhat is seen. It does not take account of what is not seen.

It is not seen that, since our citizen has spent six francs for one thing, he will not be able to spend them for another. It is not seen that if he had not had a windowpane to replace, he would have replaced, for example, his worn-out shoes or added another book to his library. In brief, he would have put his six francs to some use or other for which he will not now have them.

The need to fix the broken window, then, has merely diverted money to the glazier from whoever would have received it had the window not been broken. But this is not a mere diversion. 

Remember, our shopkeeper awoke that morning with both an intact window and six francs. Had the window not been broken, he would have ended the day with an intact windowand new shoes or a new book. Instead, he ended his day with a window—and that is all—because he had to spend his six francs just to regain the condition he enjoyed when the sun came up. He is poorer than he would have been, and therefore so is the community (no sale for the shoemaker or bookseller)—precisely because the window had to be replaced. Bastiat sums up: 

We arrive at this unexpected conclusion: "Society loses the value of objects unnecessarily destroyed," and at this aphorism, which will make the hair of the protectionists stand on end: "To break, to destroy, to dissipate is not to encourage national employment," or more briefly: "Destruction is not profitable." 

The error that Bastiat exposed has since been dubbed "the broken-window fallacy." How misunderstood it is can be seen in Phillips's statement, "Economists call this the broken window effect" (emphasis added) and his quoting Michael Englund, chief economist at Action Economics: "To an economist, breaking a window always boosts GDP." 

No, no, no! The broken-window effect (or theory) is something else entirely and has nothing to do with recovering from disasters. What Phillips and Englund are talking about is a fallacy—an error!—not an effect. Notice that Englund refers to a boost in GDP. It is true that a disaster will boost GDP because money will be spent. But as we now know thanks to Bastiat, boosting spending is not the same as increasing wealth. (On the difference between growth and the illusion of growth, see my article here.) 

One last item must be addressed. During and after a recession, some people may remain unemployed and some resources idle. Couldn't recovery from a disaster mobilize those people and resources? Perhaps. But that doesn't change the fact that scarce labor and resources will be devoted merely to putting things back together, rather than to creating new wealth. The only reason for mass unemployment and grossly underused resources is that government policies are blocking recovery from the earlier recession—which itself was caused by the central bank's previous inflationary boom.  

Fortunately, we don't need disasters to put people and resources to work. All we need is the politicians out of the way. The freed market will do the rest.

A Flood of Fallacies originally appeared on The Project to Restore America. Learn more about The Project. 
 Sheldon Richman is the vice president of The Future of Freedom Foundation (FFF) and editor of its monthly, Future of Freedom. He is the author of three books published by FFF:Separating School & State: How to Liberate America’s Families (1994); Your Money or Your Life: Why We Must Abolish the Income Tax (1999); and Tethered Citizens: Time to Repeal the Welfare State (2001). Previously, Richman was the editor of The Freeman (Foundation for Economic Education), 1997-2012.  


  1. ""Economists call this the broken window effect"....."To an economist, breaking a window always boosts GDP."

    Judas Christie, I'm about as cynical as they come and even I didn't suspect that these people are that stupid and/or deceitful. Amazing.

  2. Tom Woods has spoken about this as well, here's some of it on YouTube:

  3. I can guarantee you that the price of mulch will be cheaper next year.