The Broken Window Fallacy – An Economics Lesson for the Obama Administration

A very nice piece on the Broken Window fallacy, perhaps the simplest way to describe the damage of government intervention: Broken Windows, Broken Principles:

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.

Read the whole thing.

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