Broken Windows, Broken Principles

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In spending its way to economic recovery, the government boldly casts principles aside

Many Americans have experienced the adverse consequences of the recent economic downturn: retirement savings wiped out, jobs lost, or at least a general feeling of financial uncertainty. Our leaders in Washington have reacted by enacting a flurry of new government spending initiatives including bailouts, “stimulus packages”, and a vast new federal budget. The ultimate success of these policies–and the security of our economic futures–rest on a single premise, a wager made on a massive scale: that government spending can “stimulate” the economy and spark the renewed creation of wealth.

This idea is not a new one. Over 150 years ago, economist Frederic Bastiat penned his “parable of the broken window,” in which he examines the economic implications of a boy breaking a shopkeeper’s window in a fictional town. The townspeople observe that the shopkeeper will need to pay the glassmaker to fix the window, that the glassmaker might in turn spend those earnings at the bakery, that the baker would then spend that profit somewhere else, and so on. Therefore, they conclude, the broken window turns out to be not a loss, but rather a stimulus that starts a ripple effect of new economic activity. Far from being a problem, the boy’s destructive act seems to be a way to give the fictional economy a boost.

But this stimulus theory is a fallacy. Bastiat points out that while the spending on new glass is easily observed, there is a corresponding absence of spending that goes unseen. Forced to spend his savings on a replacement window, the hapless shopkeeper is now unable to pay for other things, like a newspaper advertisement or more shelves. The expense of buying a window is thereby a silent, unseen loss of potential business expansion. Thus, while the glassmaker might benefit from the increased business in the short term, it has simply come at the expense of the shopkeeper (and the other businesses he might have frequented). Overall, the total wealth in the economy has been decreased by the cost of a window.

While Bastiat offers an important and true lesson in his broken window parable, he offers something even more valuable in the method by which he reaches it: he carefully studies all the relevant facts in a case, their causes, and all their inevitable effects–in a word, he approaches economics as a science, as a study of principles. Just as the chemist needs to carefully study and understand all of the principles governing the elements in a substance to successfully predict how they will behave when combined with others, the economist must study and understand all the aspects of a given policy to determine what its actual effects will be. Conversely, just as the chemist who fails to consider all the factors in a reaction will fail to achieve his desired outcome (and potentially suffer grave consequences), so too does the shortsighted and unprincipled economist.

Observe the actions of the Bush and Obama administrations, which have been characterized by frenzy and impulse. From the first Sunday-afternoon announcement of the government’s seizure of mortgage giants Fannie and Freddie, to the bailout of AIG (but not Lehman Brothers), to the multiple enormous “economic recovery” spending bills rushed through congress in weeks, it has become clear that our leadership is flying by the seat of its pants–i.e., without reference to any firm principles at all.

Both Presidents Bush and Obama have defended their unpredictable, shifting policies on the basis of urgency: Bush dismissed critics in September, saying, “There will be ample opportunity to discuss the origins of this problem. Now is the time to solve it.” Obama has stressed repeatedly the need to “act boldly and swiftly” to avert economic disaster, brushing aside warnings of the long term economic damage caused by massive deficit spending, more restrictive regulation, and higher taxes.

While a sense of urgency in the face of crisis can be a virtue, it can only be so if it is guided by rational principles. When US Airways Flight 1549 was crippled by a failed engine, the efficacy of the pilot in assessing the damage and analyzing the options against his knowledge of avionic principles was crucial to his life-saving landing in the Hudson River. However, had his measured, rational sense of urgency turned into blind panic, the outcome would almost certainly have been much worse.

The government’s handling of the economic downturn has fallen into the latter category. Rather than analyzing the underlying principles at work, Bush, Obama, and Congress have demonstrated an inclination to do something, anything that seems superficially plausible to try to reverse course. They call this “harnessing the spending power” of government, which means transferring liabilities and losses from the balance sheets of select companies and individuals to the balance sheets of all taxpayers. By simply erasing the financial mistakes of some and handing the cost to others, we are told, the government can end the recession and return us to prosperity.

Given the seriousness of the circumstance, this type of swift action may sound enticing, but will it truly work? There is a telling parallel here between government spending and the fictional broken window. One of the clues to the fallacy inherent in the broken window theory emerges when taking the idea to its consistent implementation: If wealth could somehow be increased by breaking windows, then it would stand to reason that the townspeople should break every window in sight. And why stop there? If a glassmaker’s increased business indicates economic gain, why not destroy the entire town, so that the whole population could be put to work rebuilding what they once had? Obviously, this scenario would represent an enormous and senseless destruction of wealth, despite the resulting “full employment.”

Likewise, we should ask of the current economic policies: If the government can benefit the economy by paying off the debts of a few, why not pay off the debts of all? Why not assume the mortgages and credit card bills of the entire country? If this is the road to prosperity, what are we waiting for?

The answer, of course, was long ago given by Bastiat: spending money, in and of itself, creates no wealth. The “economic activity” we see as a result of government spending is simply the transfer of wealth from the pockets of some to the pockets of others. The result is only a rearrangement of wealth, not its creation (and actually a loss, when the overhead of government bureaucracy is taken into account). While the “improved” financial health of some may seem desirable in the short term, it necessarily comes at a higher cost down the road. Just as the broken window ultimately leaves the fictional town one window poorer, the economic stimulus bills leave us all deeper in an already deep hole of debt that will have to be repaid someday, somehow.

By focusing on the immediate and visible, while evading the long term, as yet unseen effects of their actions, our leaders are committing exactly the error that Bastiat warns us about. They are treating economics not as a science of principles, but as a day-by-day experiment where the rules are subject to change and cost is no object. We have already seen the damaging effects of the resulting climate of uncertainty in our markets, and we will continue to experience the fallout as the true costs emerge.

If we want to retain the standard of living we currently enjoy and see it improve in the future, we must combat this pragmatic, short-term mentality. Economic success requires recognition, not evasion, of the fact that the principle of cause and effect applies just as inexorably in financial policy as it does in the scientist’s lab. Only when we reestablish acceptance of this idea can we hope to reverse course and return to the road of long term prosperity.

Photo by Nancy on Flickr

Posted by on April 8, 2009. Filed under Business & Economics, Spring 2009. You can follow any responses to this entry through the RSS 2.0. You can leave a response or trackback to this entry
  • Pete Murphy

    In your last paragraph, you mention “cause and effect,” but nowhere in this post have you offered your opinion of what the “cause” of this economic melt-down might be. I’d be interested in hearing what you believe to be the cause and the solution.

    Pete Murphy
    Author, “Five Short Blasts”

  • Pete Murphy

    In your last paragraph, you mention “cause and effect,” but nowhere in this post have you offered your opinion of what the “cause” of this economic melt-down might be. I’d be interested in hearing what you believe to be the cause and the solution.

    Pete Murphy
    Author, “Five Short Blasts”

  • Rebecca

    Its easy to criticize and point out the errors in what someone is doing. More difficult, however, is coming up with a different, better option. Do you have a proposal?

  • Rebecca

    Its easy to criticize and point out the errors in what someone is doing. More difficult, however, is coming up with a different, better option. Do you have a proposal?

  • Noah Stahl

    Pete and Rebecca,

    Thank you for your comments. While my article was written to address the flawed approach evident in the government’s recent actions, it was not my intention to address the specific causes or solutions to the current economic problems.

    For more information on the latter, one of the best resources I’m aware of is the Financial Crisis page from the Ayn Rand Center for Individual Rights. You’ll find a variety of commentary addressing how the current situation came to pass along with analysis on what to do about it.

    For a financial expert’s analysis of the actual policies that precipitated the recession, I recommend watching the video on that page “The Financial Crisis: Causes and Possible Cures” by John Allison, former CEO of BB&T.

    http://www.aynrand.org/site/PageServer?pagename=arc_financial_crisis

    http://www.aynrand.org/site/PageServer?pagename=reg_ls_financial_crisis

  • Grant Williams

    Rebecca,

    I agree with your point. But, in my opinion, the thing that is most obnoxious about Mr. Murphy’s comment is his insinuation that because the author chose to write about the proposed “solutions” to the melt-down instead of on it’s cause, his point is somehow invalid.

    Mr. Murphy either lacks an understanding of proper scope within which writing must remain in order to be effective, or he simply left that comment because it challenged his assumptions too greatly and he needed an excuse to stop thinking about them.

  • Noah Stahl

    Pete and Rebecca,

    Thank you for your comments. While my article was written to address the flawed approach evident in the government’s recent actions, it was not my intention to address the specific causes or solutions to the current economic problems.

    For more information on the latter, one of the best resources I’m aware of is the Financial Crisis page from the Ayn Rand Center for Individual Rights. You’ll find a variety of commentary addressing how the current situation came to pass along with analysis on what to do about it.

    For a financial expert’s analysis of the actual policies that precipitated the recession, I recommend watching the video on that page “The Financial Crisis: Causes and Possible Cures” by John Allison, former CEO of BB&T.

    http://www.aynrand.org/site/PageServer?pagename=arc_financial_crisis

    http://www.aynrand.org/site/PageServer?pagename=reg_ls_financial_crisis

  • Grant Williams

    Rebecca,

    I agree with your point. But, in my opinion, the thing that is most obnoxious about Mr. Murphy’s comment is his insinuation that because the author chose to write about the proposed “solutions” to the melt-down instead of on it’s cause, his point is somehow invalid.

    Mr. Murphy either lacks an understanding of proper scope within which writing must remain in order to be effective, or he simply left that comment because it challenged his assumptions too greatly and he needed an excuse to stop thinking about them.

  • Amit Ghate

    Nice post Noah!

    —–

    In response to Rebecca who comments: “Its easy to criticize and point out the errors in what someone is doing. More difficult, however, is coming up with a different, better option. Do you have a proposal?”

    While I can’t speak for Noah, I’d suggest that the crucial principle to uphold is freedom — as enshrined and protected by individual rights.

    Under such a principle, the answer to the question: “How would you run the economy?” becomes: “I wouldn’t.” And neither would anyone else. Instead the “economy” would simply be the sum of all the voluntary production and trade between individuals and groups of individuals (a.k.a. corporations). Given such freedom, the market would allow the most efficient and rational processes and products to emerge, without any “commander” or “czar” (to use today’s jargon) to “guide” it.

    While the role of the government in such a system is limited, it is also essential, viz. to preserve individual rights via the courts and the police.

    And by the way, this system is not just a “proposal”, it was very nearly implemented in early nineteenth century America — in fact it even has a name: laissez faire capitalism.

  • Burgess Laughlin

    Noah Stahl’s article is rightly focused on methodology.

    Ideas drive history. If those who develop ideas — in the field of economics, for example — have proper methods, they will produce objective ideas. That means ideas that are drawn logically from reality and will therefore work when applied to reality.

    Current thinkers — in economics and other specialized sciences — need better methods, which is what Noah Stahl is offering: logical inferences from observation of facts and consideration of long-term consequences.

    P. S. — In my layman’s understanding of economic history, the closest the world has come to capitalism, the political system exclusively dedicated to protecting individual rights (especially the fundamental rights to life, liberty, and property), was in the USA in the 1870s, not earlier (a period of slavery, which is antithetical to capitalism).

  • Zev Barnett

    @Amit Ghate:
    Very good response.

  • Amit Ghate

    Nice post Noah!

    —–

    In response to Rebecca who comments: “Its easy to criticize and point out the errors in what someone is doing. More difficult, however, is coming up with a different, better option. Do you have a proposal?”

    While I can’t speak for Noah, I’d suggest that the crucial principle to uphold is freedom — as enshrined and protected by individual rights.

    Under such a principle, the answer to the question: “How would you run the economy?” becomes: “I wouldn’t.” And neither would anyone else. Instead the “economy” would simply be the sum of all the voluntary production and trade between individuals and groups of individuals (a.k.a. corporations). Given such freedom, the market would allow the most efficient and rational processes and products to emerge, without any “commander” or “czar” (to use today’s jargon) to “guide” it.

    While the role of the government in such a system is limited, it is also essential, viz. to preserve individual rights via the courts and the police.

    And by the way, this system is not just a “proposal”, it was very nearly implemented in early nineteenth century America — in fact it even has a name: laissez faire capitalism.

  • Burgess Laughlin

    Noah Stahl’s article is rightly focused on methodology.

    Ideas drive history. If those who develop ideas — in the field of economics, for example — have proper methods, they will produce objective ideas. That means ideas that are drawn logically from reality and will therefore work when applied to reality.

    Current thinkers — in economics and other specialized sciences — need better methods, which is what Noah Stahl is offering: logical inferences from observation of facts and consideration of long-term consequences.

    P. S. — In my layman’s understanding of economic history, the closest the world has come to capitalism, the political system exclusively dedicated to protecting individual rights (especially the fundamental rights to life, liberty, and property), was in the USA in the 1870s, not earlier (a period of slavery, which is antithetical to capitalism).

  • Zev Barnett

    @Amit Ghate:
    Very good response.

  • Dave

    Excellent post.

    Noah’s use of Bastiat’s parable and Rebecca’s comment reminded me of a story/technique I have used frequently when discussing some topic from an Objectivist viewpoint. I call it “The Vandal and The Windowmaker” and was just reminded of where I got the idea.

    In some conversations I’ve had, my “opponent” can run off a barrage of questions/comments/objections without much connection to the topic or have the patience to listen to a response. If the discussion deteriorates but I see some point in continuing, I state that it is easier to throw rocks at windows than to make the window in the first place. I point out that it can take time to develop a reasoned argument, support it, give examples, etc and that usually many hasty questions can be answered just by listening to the full answer. Sometimes it does have a positive effect on the discussion, sometimes not.

    I think it had occurred to me when watching one of those shouting matches on TV which presumably pass for political discourse these days. I remember muttering “pragmatic, rock-throwing vandals” and wondered why I had said it that way at the time.

  • Dave

    Excellent post.

    Noah’s use of Bastiat’s parable and Rebecca’s comment reminded me of a story/technique I have used frequently when discussing some topic from an Objectivist viewpoint. I call it “The Vandal and The Windowmaker” and was just reminded of where I got the idea.

    In some conversations I’ve had, my “opponent” can run off a barrage of questions/comments/objections without much connection to the topic or have the patience to listen to a response. If the discussion deteriorates but I see some point in continuing, I state that it is easier to throw rocks at windows than to make the window in the first place. I point out that it can take time to develop a reasoned argument, support it, give examples, etc and that usually many hasty questions can be answered just by listening to the full answer. Sometimes it does have a positive effect on the discussion, sometimes not.

    I think it had occurred to me when watching one of those shouting matches on TV which presumably pass for political discourse these days. I remember muttering “pragmatic, rock-throwing vandals” and wondered why I had said it that way at the time.