Does the Broken Window Fallacy apply to stimulus spending?

What’s the broken window fallacy?
I was walking down Broadway and saw that the outside pane of a new restaurant had been smashed with a bottle. Thinking about it, I realized – this means there will be more business for the window-putting-in business in Columbia! Sure, it costs the owner of the shop, but it leads to more spending, which is good!

But really:
Wait a second, now. The person who is trying to open this new restaurant obviously has lots of things they’ve been planning to buy. What if, in having to fix the window, they decide against buying a fancier tablecloth or set of cutlery. Everything’s a trade-off after all, and resources are scarce. So no benefit has really been created (except for the window company) and the entrepreneur opening a new restaurant might lose out on making their business the best it can be.

The anecdote originally involved a butcher shop having its window broken and a crowd of people all agreeing that this actually helped the window maker and the criminal had done a good thing. They forgot about the tailor, who the butcher had planned to buy a suit from but couldn’t anymore because he had to pay for a new window. The story comes from Frédéric Bastiat‘s 1850 essay “That Which is Seen and That Which is Unseen.”

How can government spending be equated with the broken window?

The story is all about opportunity costs and trade-offs. Taxes and government borrowing divert resources from what they’d be used for in a completely free market. There are two big costs to consider:

1. The classic problem of taxation: deadweight loss.

2. The hidden costs of government borrowing.

The idea here is that government borrowing and debt soaks up money that could be used by businesses or consumers. Also, inflation is sometimes referred to as a “hidden tax” on earnings.

Does this mean stimulus spending or “investment in infrastructure” is hopeless?

I’m not convinced. Why?

  1. Taxes aren’t being raised to pay for the stimulus spending. (Except maybe on the “job creators.” They’ve had a good 30 or so years of low taxes. In actuality, fewer than 98 percent of small-business owners would be affected by an increase in taxes on the highest income brackets.)
  2. Interest rates are so low right now that it’s insane.
  3. Yes, inflation partially caused by all the quantitative easing (imaginary money printing – this video is hilarious) is not the best thing. But the Fed is working on making its plans more explicit to stimulate long-term investments – and they’ve made it clear they plan to keep inflation and interest rates low.
  4. What’s the butcher’s new suit or decor for the restaurant in this equation? Corporate hiring and expansion. Unfortunately, non-financial company cash holdings hit the highest level since 1945 in the last quarter. They’re sitting on piles of cash. Not that they don’t have reasons: the specter of another global crisis sparked by European banking looms menacingly in the distance.
  5. Consumers and businesses are so worried about the future of the economy that they’re saving up, just in case. Vicious cycle ensues, making a downturn even more likely. Government spending in the form of infrastructure investment and tax breaks for consumers and job creation could moderate this. Contrary to popular Republican gospel, small business owners aren’t actually that concerned with regulation.

It’s all about the trade-offs.

What are you more worried about? The government debt and record deficits? Or high unemployment, rising poverty and growing income inequality in the United States?

Note: I don’t claim to know all that much about economics. This is just me trying to apply a little bit of logic to a story my current Econ teacher told in class and how it relates to current issues.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s

%d bloggers like this: