Broken Windows: Economic Activity vs. Real Wealth

Thankfully, Hurricane Irene wasn't as destructive as projected. Nevertheless, it created some speculation as to whether its destruction would boost the economy. After all, there would be more jobs in construction and related industries.

Free-market writers see this as Frederic Bastiat's "Broken Window" Fallacy. Here's how Art Carden describes it at Forbes:

 "Here’s Bastiat’s lesson, restated again: suppose a ne’er-do-well child throws a rock through a storekeeper’s window. The storekeeper is obviously unhappy because he has to pay to replace the window, but someone points out that the storekeeper’s new spending will stimulate the economy because after all, he provides income for the glassmaker, who might then spend his new income on a new suit, which provides income for the tailor, who might spend his new income on a meal at a fine restaurant, which creates income and employment for the people who work in the restaurant. What looks like a curse is actually a blessing.

"Except that it isn’t. What this ignores is that if he hadn’t had to replace his window, the shopkeeper could have used his money for something else. Perhaps he would have bought a new suit himself, and then somewhere along the line someone else would have purchased new windows. Perhaps he would have saved it and provided capital for a firm that wanted to expand production or for an entrepreneur who would have started a new business. The broken window leaves the world poorer by one window. Wealth has been destroyed."

One broken window is bad. Hurricanes, other natural disasters, and wars are worse. Each will break lots of things. The money spent and jobs created in repair and reconstruction could have been used instead in the production of more goods, greater expansion, or increased innovation.

The hurricane may stimulate "economic activity" as people dip into their savings to replace lost goods, insurance companies make payouts, and governments restore infrastructure. As money changes hands, there may be an appearance that the economy is "growing" in terms of Gross Domestic Product (GDP).

But no NEW wealth is generated. Really, is anyone really better off?

  • Are the people in better shape because they had to dip into savings?
  • Will insurance policyholders see reduced premiums?
  • Are citizens richer because their government is running even greater deficits to rebuild infrastructure?

Stephen Horwitz elaborates on this idea at FEE:

"Then why do so many people argue that such disasters are good for the economy. The answer, I think, is that they look at the matter in terms of something like Gross Domestic Product (GDP), which is a 'flow' not a stock. GDP measures the amount of 'economic activity' that takes place in a particular period, such as a year or a quarter. If we imagine a series of pipes that carry water to a large bucket, GDP measures how fast the water is moving through the pipes, while wealth is how much water has accumulated in the bucket at the end. Those arguing that disasters will boost the economy are arguing that the need for repairs and replacement will lead to more spending and thus a higher flow of economic activity.

"The more sophisticated critic might argue that if resources were idle, a natural disaster can bring them out of idleness and thus create wealth. As the great liberal economist W. H. Hutt argued in 1939, being 'idle' does not mean that a resource is 'unproductive.' Cash in a drawer is performing the service of being available to its owner, which is how the owner prefers it over having to spend it repairing a window. Idled workers might prefer their current use of their time to the wage that the market is offering. Even if idled labor is brought into employment, we have no grounds for automatically claiming that its gain is greater than the disaster victims’ losses.

"In our own economy many resources are idle not because markets failed, requiring an external stimulus to activate them, but because of malinvestment during the previous artificial boom. This is true of both capital and labor. They remain idle because bad policies, such as prior fiscal stimulus programs, and uncertainty about the future created by government prevent them from finding genuinely sustainable and productive employment. Disasters can’t fix these problems; only time and freedom can."

Here are more articles on the Broken Window Fallacy, some written before Irene hit America's shores, some after: