05 Oct The broken window fallacy
The broken window fallacy states that if money is spent on repairing the damage, it is a mistake to think this represents an increase in economic output and economic welfare. If money is spent on repairing a broken window, the opportunity cost is that individuals cannot spend money on more productive goods. The broken window doesn’t increase overall output – it merely shifts an economy from productive output to maintaining the existing situation.
The broken window fallacy can be used to criticise the argument that war is good for the economy.
Original Broken window Fallacy
The broken window fallacy was introduced by a French liberal economist Claude-Frédéric Bastiat (1801 – 1850). In 1850 he wrote a short article: “Ce qu’on voit et ce qu’on ne voit pas” (“What is Seen and What is Unseen”) In the article, a boy breaks a window. However, the local people decide that the boy has helped the local economy. Their reasoning is:
- Shop owners employ a glazier to repair the window, who gains extra income.
- The glazier sees an increase in income which he then uses to spend in other shops – benefitting other shop-keepers. (This increase in spending creates a ‘local multiplier effect’)
- Overall, it seems that the local economy has benefited from a flurry of economic activity – even though it came from mending the broken window.
The unseen effects
However, Bastiat doesn’t stop there. He considers the ‘unseen’ effects. If the shop owner spends 50 Francs on repairing a window, then isn’t able to spend these 50 Francs on a new outfit or new equipment for his business. Therefore, while a glazier benefits, the tailor loses out. The broken window has not increased the stock of good and services. Repairing the broken window has merely replaced what was already there.
Furthermore, if the window hadn’t been broken, the shop-owner could have used the time and money to invest in a more efficient production process. This would have led to a rise in net investment – rather than just gross investment to replace the depreciation (broken window)
Breaking a window and repairing it, leads to an inferior outcome to a possible alternative, which is investing in increasing the stock of new capital. However, the missed capital is less visible than the more visible signs of giving the glazier work.
GDP and happiness
Another consideration is that economists have traditionally placed great value on GDP (national output) as a measure of economic success. However, this ignores real living standards and general happiness.
A broken window causes unhappiness – it is a waste of resources. No-one enjoys spending money on repairing something that was needlessly broken. If the shopkeeper had been able to spend money on something productive like a new coat – he would have gained more satisfaction than reluctantly having to spend money to overcome carelessness.
Behavioural economists have suggested that we place greater value on things that we own. The cost of repairing a broken window may be 50 Francs. But, we may have been willing to pay 100 Francs to avoid the painful situation of seeing a broken window and repairing it. See: loss aversion.
Another consideration is the unseen effect of a broken window on the morale of local people. Suppose it takes a few days to repair. In the meantime, people have to view a boarded-up window. This kind of broken window may discourage people from feeling safe walking around town. Many studies have suggested that smashed windows, litter e.t.c. can all contribute to long-term negative effects.
The fallacy of the broken window rests on the concept of opportunity cost – The next best alternative foregone. If you have to spend money repairing a window. The opportunity cost is what else that could have been bought and produced with the same sum.
The fallacy of the broken window and Keynes
To complicate matters, the economist John Maynard Keynes argues there is a situation where the parable of a broken window is not a fallacy.
Suppose an economy is in a deep recession, unemployment is high, confidence is low and people are not spending but hoarding savings in unproductive uses (e.g. cash under the bed). In this case, repairing broken windows really could stimulate economic activity.
If many are unemployed due to insufficient economic activity, the stimulus of repairing windows could create sufficient demand in the economy to create new employment prospects.
In this case, the opportunity cost of repairing broken windows is low because the shop-keepers would not be investing or spending it on anything else. Repairing the broken window is forcing people to spend their unused savings.
(There is an ancedote that during the Great Depression, Keynes was in a restaurant when he noticed waiters had nothing to do. He started to throw napkins on the floor. He wanted to illustrate the concept, it was good to create economic activity and avoid unemployment)
Amid a depression, a major war effort can create demand and employment, which seems to lead to an improvement in economic welfare and GDP.
Of course, the same effect of a war stimulus is that an economy could have spent money on building hospitals rather than going to war.