A further note on the broken windows fallacy

by on September 8, 2011 at 5:15 am in Economics, Uncategorized | Permalink

I’d like to second the points by Alex and also Bob Murphy.  An additional factor is that when a window breaks (never mind ongoing regulations and wealth taxes, which as Alex notes will be worse) wealth goes down.  Keynesians tend to overestimate the importance of flows and underestimate the importance of stocks and sometimes they neglect the latter altogether.  Just as there is a spending multiplier, there is also a multiplier from changes in wealth.  For instance declines in perceived wealth will cause people to spend less.  The Keynesian AD gains from a broken window have to stem from the difference between the spending multiplier and the wealth multiplier.  Under the permanent income hypothesis, there’s not a lot of daylight here.  Furthermore the perceived wealth decline, even if it doesn’t lead to immediate one-to-one reductions in spending, can persist over several periods.  Granted, PIH is not exactly correct, but still the net impact of stimulus on current employment and income won’t be that large because of the negative wealth effects.  Fiscal policy remains a weak pill.  The declines in housing prices in recent years really have taken their toll on AD so the wealth multiplier is not to be ignored.  The notion that a stable and sustainable restoration of AD actually requires some increases in perceived wealth is one of the most underrated ideas among today’s Keynesians.

I would make a few more general points:

1. It is possible that a broken window may increase employment and output and under sufficiently unusual assumptions it may also increase welfare.  But it’s not likely.  I think the point, showing the possibility of this exceptional case, should be a footnote in an intermediate macro text but no more.

2. The importance of wealth creation for human well-being is the more important lesson, by far, from economics.  There are plenty of productive investments by which government can improve matters, starting with fixing escalators in the DC Metro system, not breaking them!  Ultimately, in the Hansonian sense, the debate is about how much we should glorify wealth creators and in this regard Hazlitt not Keynes gets it right.

3. A more directly practical point is that tighter ozone regulation will spur some hiring but probably lead to labor market crowding out, rather than targeting the current unemployed. I don’t know if those regulations are a good idea or not but I do think the case for them has to stand on its own two feet and not on Keynesian principles.

1 Ken Rhodes September 8, 2011 at 6:30 am

>>…declines in perceived wealth will cause people to spend less.>>

Absolutely. But waitaminit! Take a dollar from a rich man and give it to a poor man. The rich man feels no poorer, but the poor man feels a little bit richer. Net spending goes up.

You may have inadvertently made the Keynesian argument for stimulus in a recession, even it it has to be funded with extra taxes on the rich.

2 Roy September 8, 2011 at 7:56 am

How do you know the rich man feels no poorer?
And how do you define rich? Take a dollar from me and I will feel poorer, it would be irrational for me not too since objectivrly I AM poorer by that dollar.

3 Ken Rhodes September 8, 2011 at 11:23 am

Roy, you are either very poor or very silly.

Do this “thought” experiment. Suppose you buy a PowerBall ticket in the hope of winning a bazillion dollars. Suppose you hit the PowerBall number, but none of the other five. You win three dollars. Does your spending change? Of course not, unless you are very poor now.

Now suppose, instead, that you inadvertently drop the ticket on the ground as you are getting into your car. You only notice it’s gone when you get home, so there’s nothing you can do about that. But some very poor guy happens to see it and picks it up. And the next morning that very poor guy discovers he has an extra three dollars. Does his spending change? You bet it does!

4 Ryan September 8, 2011 at 12:09 pm

Couldn’t net spending go down, if the rich man, who knows the tax man is coming, reduces his spending even more only because he knows he’s about to have it taken away from him so that some poor guy can purchase a powerball ticket? Honestly asking, as you seem to probably have a thought experiment for that one also.

Shouldn’t we take a more nuanced view as to what the spending is actually on?

5 Ken Rhodes September 8, 2011 at 3:29 pm

Ryan, apparently you didn’t read what I wrote, but imagined what I might have written. A rich guy buys no less food, clothing, transportation, tickets to sports and shows, etc., merely because he will be a little less rich. (We’re not talking about a *lot* less rich, here, just a little less.) A poor person, on the other hand, notwithstanding Mike’s absurd stereotype (see below) most likely spends his extra three dollars, not on “addictions,” but rather on something that will make him feel a little less poor for a few minutes. Perhaps some brand new socks to replace the old worn ones he wears every day. Perhaps a Big Mac and some fries for lunch, instead of the peanut butter sandwich he usually eats.

The original point of Tyler’s post was that there is a multiplier effect due to perceived change in wealth, and the multiplier works in both directions. I believe that point is ABSOLUTELY correct. My original comment merely pointed out that taking a relatively small amount of wealth away from wealthy people will generally not change their perception of their condition much, but adding that amount of wealth to poor people will DRASTICALLY change their perception of their condition. Just think of it on a percentage basis. I’m not wealthy, but I’m comfortable. Suppose I make $100,000. Reduce my annual income by 3.6%, and give that directly to a poor person who makes $18,000, and you will increase his annual income by 20%. So his perception of his increase vastly outweighs my perception of my decrease in terms of his subsequent behavior.

Which is all I wrote to begin with.

6 Ryan September 8, 2011 at 6:32 pm

Ken, apparently you didn’t read what I asked, but perceived it as some slight against your view. I only asked because I obviously read and questioned what you wrote. But, in your reply, you do a better job of explaining yourself.

I agree with you regarding perceptions of the poor and rich in terms of change in wealth (where percent change is the same). I’m asking you to follow this logic one derivative further and ask yourself, with a gifted 20% increase in wealth, what perception, does the poor guy have, regarding the need to produce more wealth for himself? What for the rich man? Assuming productivity and wealth parallel each other.

7 Al Brown September 8, 2011 at 8:59 pm

The rich man must take a dollar out of his investment portfolio to maintain his own consumption. That’s one less dollar to hire someone and a slight decrease in the amount of actual wealth created by that labor.

The poor man is not necessarily better off. He may just avoided the work required to get the dollar. Or the guy who would have given him a different dollar because he had the opportunity to earn it, no longer can.

8 AndrewL September 8, 2011 at 12:15 pm

how does anyone become rich by just discarding x% of their income?

9 Mike September 10, 2011 at 12:23 am

Wrong. The poor spend proportionately more on gambling than wealthier people. They apparently find greater utility in rolling the size than getting what a few dollars could buy.

You really don’t know any poor people, do you? They want for NOTHING that they need. All their basic needs are met by government and charity to the point that almost all their spending is on extravagances.

If I win $3 in the lottery, my spending changes exactly by the same amount as the poor person – we both spend $3 more. On the other hand, if a poor person and I split $30 million, I guarantee you I’d save more of it than he would.

Poverty is a disease of the mind, not an economic condition.

10 Mike September 8, 2011 at 2:09 pm

Given how quickly poor lottery winners lose everything, I’m not sure that making them feel richer is a food thing.

For many people, poverty is the only thing constraining their self destructive addictions. Give them an extra dollar and they waste an additional dollar.

You must not know many poor people.

11 Ken Rhodes September 8, 2011 at 3:13 pm

Mike, for most poor people, poverty constrains not their addictions, but their food, their clothing, their transportation, their children’s education, health, and fun, and their own opportunity to have a little fun, even if just by buying a one-dollar PowerBall ticket once in a while so they can dream of being rich.

I would say you are the one who doesn’t know many poor people.

12 Mike September 10, 2011 at 12:07 am

Which is why obesity, diabetes, alcoholism, and drug abuse are rampant among our poor.

Yes, I know many poor people. I teach 60 students a day whose families don’t have a pot to piss in, but these kids have the latest cell phones, sunglasses, basketball shoes, clothes, and jewelry. They drink, use drugs, and are almost all obese. They want for NOTHING, Ken, except for luxuries most of us wish we had.

Yeah, I know exactly what I’m talking about, Ken. In America, poverty is a symptom of the diseased mind, not an economic condition imposed on you. I was blessed with enterprising parents and valiant grandparents, but my family came to this nation with only the clothes on their backs. My ancestors left countries where the poverty you speak of exists.

13 KC September 8, 2011 at 6:08 pm

Speak for yourself, Mike. Seriously, speak for yourself. Is that what you do?

14 Claudia Sahm September 8, 2011 at 4:50 pm

I agree with what Tyler said in the quote you selected and not at all where you went with it. But you have every right to your interpretation. Here’s mine: A very interesting paper by “Surveying the Aftermath of the Storm: Changes in Family Finances from 2007 to 2009” by Jesse Bricker, Brian Bucks, Arthur Kennickell, Traci Mach, and Kevin Moore (http://www.federalreserve.gov/pubs/feds/2011/201117/201117pap.pdf) documents (among many other things) that more households say that they would reduce their spending after decline in wealth than after an increase in wealth. This result is contrary to standard theories, like the permanent income hypothesis (though I am sure there’s some bell and whistle that can square this circle.) In addition, I have done some unpublished analysis that suggests big drops in wealth might exert a larger drag on spending on than usual wealth effects. It’s hard to say, since big drops in wealth are thankfully rare in the post World War II period. Thus the amount of window breaking required to boost aggregate investment might lead to serious hit to aggregate consumer spending..which to be honest could use a positive, not a negative shock right now. I would guess Paul Krugman would agree on that last clause.

15 Jameson September 8, 2011 at 6:17 pm

“Net spending goes up.” But that’s just the thing–the point isn’t to increase spending, but wealth.

16 Ryan September 8, 2011 at 6:35 pm

Jameson, you said it better than I with much less words. “that’s just thing” !

17 Cahal September 8, 2011 at 7:26 am

‘3. A more directly practical point is that tighter ozone regulation will spur some hiring but probably lead to labor market crowding out, rather targeting the current unemployed. I don’t know if those regulations are a good idea or not but I do think the case for them has to stand on its own two feet and not on Keynesian principles.’

I think it’s fairly obvious that an increase in employment is not a benefit of extra regulations. Krugman said something stupid and got called out for it – I can’t believe we’re still having this debate.

18 Andrew' September 8, 2011 at 7:39 am

How ’bout the obvious point. If someone is making 100 widgets in our current low equilibrium, and then you tell them they MUST make 10 widgets. Won’t they just make 90+10 rather than 110?

19 TallDave September 8, 2011 at 8:01 am

The Keynesian AD gains from a broken window have to stem from the difference between the spending multiplier and the wealth multiplier.

Yes, thank you. I think a lot people tend to forget this.

20 FYI September 8, 2011 at 8:39 am

I don’t think Krugman is ignoring this. He is many things but dumb is not one of them. The problem is that he is currently a political operator and he *wants* to punish wealth creators to benefit what he considers the underclass. He is making political arguments through pseudo-economics.

That is the point I wish Tyler and all the other serious economists would make. Krugman cannot be part of the club anymore.

21 TallDave September 8, 2011 at 11:38 am

Yep. As I’ve said before, Krugman understands this but does not regard it as relevant — his unspoken view is that reducing unemployment justifies wealth destruction.

I think he even understands this will make us all poorer in the long run, but even with the relative comfort of poverty in 2011 America, alleviating the plight of the poor is his overriding moral imperative.

22 Andrew' September 8, 2011 at 12:51 pm

I understand your point, but to be fair, he didn’t say that the ozone scrubbers would save the entire economy. He could even say that he didn’t address the cost side at all.

His actual point is defensible if you accept (Krugman) Keynesianism. You already decided ozone scrubbers were a good idea, why would you cut it as an austerity measure?

23 TallDave September 8, 2011 at 2:09 pm

That’s true if you accept that ozone scrubbers are worth the benefit they provide, but he argues that doesn’t even matter. He’s perfectly happy to install ozone scrubbers that provide a zero benefit at nonzero cost, as long as it reduces unemployment.

24 Andrew' September 8, 2011 at 3:15 pm

I took it to mean that it didn’t matter for the Keynesian argument, which is what Keynes meant with his burying bottles of money analogy.

25 Mike September 8, 2011 at 2:14 pm

I’ll believe Krugman’s commitment to the poor when he adopts one or two unemployed families for the duration of their unemployment. I’m not impressed by people who are generous with other people’s money. Advocating for higher taxes on himself while simultaneously advocating policy measures he wants is not equivalent.

26 Cahal September 8, 2011 at 3:40 pm

That is a ridiculous premise. How on earth could he be expected to *adopt* unemployed people? The state is quite obviously in a better position to allocate resources than he is and is able to alleviate problems systemically, whilst charity and the like only serve as plasters.

27 FYI September 8, 2011 at 5:59 pm

Well, he could send extra money to the government then. The problem with most liberals is that they advocate policies that affect other people. This is similar to super rich people like Gates who are democrats but decided to create how own institution for charity. Why not just donate the money to the government? Or even worse, why do rich people always favor increase in income tax but never in capital gains?

Once you understand that the government is nothing but a corporation with a certain set of rules and goals (even though it has its own accounting standards) things become much easier.

28 Cahal September 9, 2011 at 6:16 am

‘Well, he could send extra money to the government then.’

I think you’ll find studies show that people are happy to pay more tax if everybody else does too. This is for 2 reasons:

a) If everybody pays tax, it has less of an impact on purchasing power over the long run
b) It ensures a significant amount of money is contributed.

Liberals are, almost by definition, concerned with coordination problems and fallacies of composition, which is why they advocate higher taxes over charity etc.

‘The problem with most liberals is that they advocate policies that affect other people.’

ALL policies affect other people. There is no such thing as this libertarian, ‘neutral’ fantasy world where nobody is influenced by government policy or by each other.

‘Once you understand that the government is nothing but a corporation with a certain set of rules and goals (even though it has its own accounting standards) things become much easier.’

You honestly think that government is comparable to a corporation? Have you ever studied politics?

29 TallDave September 9, 2011 at 3:58 pm

“All policies affect other people.”

This is like arguing not having a gun to your head is just like having a gun to your head.

30 Mike September 10, 2011 at 12:14 am

No, the state is clearly not in a better position to allocate resources to the poor. We’ve fought the war on poverty for four decades and poverty won. There are more homeless people now than before we had programs for the homeless. Government is subsidizing the problem, not eliminating it.

With the $10 trillion we’ve spent on anti poverty programs, you’d think we’d have found the cure by now.

31 Jeff September 8, 2011 at 8:45 am

The most important point here is that if they had agreed to set the standard between 60-70ppm nothing would have happened in the short term, aside from maybe a few rich consultants getting hired to figure out how best to meet them. The law would not require implementation plans from the states not in compliance for 3 years. The actual technologies employed to lower ozone wouldn’t exist for another 3 years, so we’re talking about a “stimulus” 6-7 years away.

32 E. Barandiaran September 8, 2011 at 8:58 am

I agree with all your points but there is one you don’t address. It’s the point that J. Wolfers makes in this post

http://www.freakonomics.com/2011/09/07/channeling-fdr-the-moral-case-against-unemployment/

Yes, we can agree that there is a moral case against unemployment. The relevant question, however, is what you are willing to sacrifice to create opportunities for employing everyone willing to work. Some economists –I don’t imply Wolfers to be one of them– seem to be ready to destroy wealth to create some opportunities. I hope Wolfers and other economists that agree with that moral argument make clear what they are willing to sacrifice.

33 TC September 8, 2011 at 9:48 am

We are lucky in that we have lots of pre-destroyed wealth in this country that we could just fix. We don’t have to decrease anyones wealth to repair our roads and public transit systems. This alone would be gigantic.

Then, fixing a few train bottlenecks here in Chicago and on the east coast would greatly increase our wealth as well.

I live in a really rich place, Oak Park, Il. You know you’re in a rich place when you have lots of big Frank Lloyd Wright houses in your town. Yet, the public transportation that goes right through the town looks like hell. The trains are really noisy, unlike the trains I rode on 20 years ago in Mexico city. I-90 looks like hell, and drives worse.

As far as I can tell, the argument here is: “well if the window isn’t broken, and someone breaks it, wealth is destroyed, so the stimulus of fixing that window needs to take into account the initial loss in wealth. ”

But this isn’t what we face in the U.S.. We face a situation where the windows were broken years ago. The “real” (lol on putting the word “real” in quotes) wealth was already lost.

The timing is really important. If we break a window in order to fix it, then the difference between wealth and stimulus might be important. Breaking that window results in a loss of wealth, there is no doubt about it.

So in this case, the difference in spending and wealth multipliers can be significant.

But, If the window is already broken, then we can’t value the broken window as we would an unbroken window.

In this case, fixing the windows broken in the past is clearly a gain in wealth, plus we get the stimulus from spending too. In this case, the correct calculation would be to ADD the spending and wealth multipliers, not difference them.

At least that’s what you’re arguing, I think. You’re arguing that we need to take the difference between initial wealth and final wealth into consideration. When we break a window today in order to fix it, this is a possible negative. This means you are arguing we need to take into account the positive difference between initial wealth and final wealth when we are fixing up windows that area already broken.

E. Barandiaran,

Sorry, this ended up being a response to Tyler and not to you. I agree- this is about the morality of unemployment vs. the morality of what we have to do to get these people employed.

34 FYI September 8, 2011 at 9:57 am

I don’t know what happens throughout the country but here in Utah we have construction all around. Roads are being repaired for the last 2 years non-stop. TRAX is spending 2.5 billion in light/heavy-rail expansion (http://www.deseretnews.com/article/700069890/2011-completion-date-for-two-TRAX-lines-announced.html)

I assume there is still some work like this out there but I doubt it would be enough to create the kind of ‘stimulus’ that people talk about.

35 Oldcat September 8, 2011 at 12:28 pm

Funny how you speak of your crumbling infrastructure in Chicago as if it were the product of some natural disaster instead of being a consequence of pouring billions of dollars into the laps of the most corrupt politicians in the country. The fact that they don’t even bother to throw you the bone of making the trains run on time is telling.

And you still can’t bring yourself to blame them for the problems they have caused.

36 Andrew' September 8, 2011 at 12:52 pm

Well, at least they don’t have food trucks.

37 D September 8, 2011 at 12:59 pm

Illinois, like Utah, still only has two senators. So even though it contains America’s third largest city and is the fifth most populous state, it’s only 28th in highway spending per capita. Utah is 24th.

http://www.commonwealthfoundation.org/docLib/20100623_HighwaySpendingbyState2008.pdf

38 Yancey Ward September 8, 2011 at 2:07 pm

The relevant comparison is square miles of federal highway X traffic load. This isn’t to say that Illinois isn’t getting short-changed at the federal level- I think they almost certainly are just looking at the road/population density map of the highway system, but it isn’t necessarily a closed case, nor that the numbers all that out of whack as when you look only at population.

39 TallDave September 8, 2011 at 3:48 pm

Oh no, not the infrastructure argument again.

The problem with road maintenance is not the lack of spending, it’s politics, corruption, and bad incentives.

Also, Oak Park may have been very nice when those mansions were built, but today it’s only nice for a collar suburb. (For one thing, it’s next to Cicero. No one wants to live next to Cicero.) Lake County is now the nice place to live.

40 TC September 11, 2011 at 10:19 pm

TallDave,

There were 2 billionaires living in OP and River Forest until 2008. Now, only one that I know for sure.

Yes, the north shore is “nicer” in many ways – for one it is larger. But there’s lots of money here. Lots and lots of money. It freaks me out how much money in this village of 50k people.

But in any case, it’s really nice here. Yes, cicero is right over there, but to say Oak Park is anything but one of the nicest places around is wrong.

Type in ‘best places to live Oa” into google and see what comes up. It will fill in Oak Park, il for you. Then you’ll have a few articles to read – take your time. Try that with “Glen”, or “Wil” or “Ken” or “Lake” and see what happens.

It’s really nice here, and it’s a wealthy town.

41 mark September 8, 2011 at 4:48 pm

“We don’t have to decrease anyones wealth to repair our roads and public transit systems.” is a very overbroad statement. A) It depends on the usage of the specific road and transit system; a bridge or transit system to nowhere does not create enough wealth to offset its cost,so destroys aggregate wealth. B) Depending on the distribution of wealth, someone’s wealth may indeed be destroyed, if merely transferred to others who get more benefit from the expense. C) If this statement were true as written, cost overruns and corruption in contract awards would not be objectionable, no matter how egregious. .
So: A well managed, well targeted infrastructure investment increases aggregate wealth. More than that, I doubt.

42 Bill September 8, 2011 at 9:08 am

Tax cuts for broken windows. That’s the policy we had in the past–circa 2001.

My, what a fine house we have.

43 Andrew' September 8, 2011 at 9:21 am

There is a correct tax rate, and that rate is what it takes to cover the correct spending rate. Currently the spending is wrong in both level and constitution, and thus the taxes cannot be right until the spending is corrected.

44 Bill September 8, 2011 at 10:12 am

Austerity to Prosperity!

45 Ron Potato September 8, 2011 at 11:04 am

Debt to Death!

46 Ron Potato September 8, 2011 at 11:05 am

Consumption is Productivity!

47 Ron Potato September 8, 2011 at 11:05 am

Loan Yourself a Dollar!

48 Bill September 8, 2011 at 12:14 pm

These slogans are oh so 2001.

49 D September 8, 2011 at 12:58 pm

Illinois, like Utah, still only has two senators. So even though it contains America’s third largest city and is the fifth most populous state, it’s only 28th in highway spending per capita. Utah is 24th.

http://www.commonwealthfoundation.org/docLib/20100623_HighwaySpendingbyState2008.pdf

50 Cahal September 8, 2011 at 10:18 am

Circles!

Spending is at the wrong rate so we have to cut it until it is at the right rate.

51 Andrew' September 8, 2011 at 11:10 am

Yes and no and…yes.

If you are spending on the wrong things and you can’t change out the guys who control the spending, the only option you have is cut the spending on the wrong things, which works out to cutting overall spending.

What we have is the Democrats have initiative on spending and the Republicans have the initiative on taxes. We used to have this “general welfare” idea. Now, in kind of a great stagnation of government, noone can think of anything for the general welfare, so we are evolving to transfers from taxpayers to tax receivers. This naturally aligns the two in competing constituencies. The politicians and pundits then naturally line up with the constituencies and we are where we are.

52 TallDave September 8, 2011 at 11:40 am

Solyndra FTW!

The DOE is actually arguing the half-billion dollars the gov’t threw in that hole was a successful program. These people just don’t get it.

53 Andrew' September 8, 2011 at 12:26 pm

One of the 10,000 ways NOT to make a lightbulb!

😉

54 Pat L September 8, 2011 at 2:34 pm

Dave: If I put $1000 each into two stocks, and one company goes bust while the other triples in value, am I a successful investor? The argument for Solyndra is that it wasn’t the only investment we made under that program. I don’t know what an overall analysis would say about that program, but cherry-picking a single company and ignoring any and all context is intellectually dishonest.

55 Nate September 8, 2011 at 2:53 pm

This is really good. You just kinda put your finger on it, right there.

56 TallDave September 8, 2011 at 3:59 pm

Pat L,

If I’m a major bundler for Obama, I visit the WH many times, and I walk away with $500M in loan guarantees for my company which almost immediately goes bankrupt, will the FBI soon be knocking down my door? (The answer is yes.)

Also, the DOE actually said the Solyndra investment was successful because, hey, they made some solar panels, and it’s not their fault it turned out no one wanted their overpriced solar panels.

Finally, please do point me to the $500M in federal money that went to a “green tech” company that tripled in value. Claiming there’s context without providing any is intellectually stupid.

57 Pat L September 8, 2011 at 4:27 pm

I don’t know if any government-supported green-tech company has tripled in value. Of course, depending on the scope of the program, that might not be necessary, or it may not have happened yet, but possibly may later. An analysis of government investment would have to take positive externalities into account as well. If Solyndra was an obviously non-viable company, they should probably tighten up their standards for funding.

There’s always context. It might even support your argument. I don’t have the time or inclination to do a full audit of the DOE, and probably neither do you, but that doesn’t make your argument any more persuasive.

58 TallDave September 9, 2011 at 7:53 am

Again, you seem to not understand that my argument was that it was dumb for them to hold up Solyndra as a sucesssful investment. I didn’t say anything about other investments (though again, please do share such information if you have it).

You’re just raising irrelevancies for which you have no data, which is not even an argument.

59 TallDave September 9, 2011 at 8:20 am

Also, even aside from the vapidity of arguing other investments might have done better and the irrelevancy to Solyndra specifically, your example doesn’t apply anyway — there was no equity stake in Solyndra offering a high reward to offset the high risk. If you loan $1000 each to two companies, and one doubles in value while the other goes bankrupt and pays you nothing, you are still a very bad investor (unless the interest rate is truly enormous).

Solyndra highlights the problem with gov’t investment: it tends to reward political cronies, and bureaucrats have little stake in what happens to the taxpayers money, so little that they can argue this $535M loan guarantee was actually successful. Gov’t has never been very good at picking winners and losers, and this episode shows why: corruption and indifference.

60 Tony September 8, 2011 at 10:48 am

“The importance of wealth creation for human well-being is the more important lesson, by far, from economics.”

I disagree. Once a country is wealthy enough that nearly all citizens have food, housing, and at least basic medical care, the most important lesson is the diminishing marginal utility of money. If the “wealth” of a country were scored by a log-average, wherein the utility of an individual’s consumption/wealth was measured as the log of its monetary value, then many economic assumptions would be turned upside down. Broken windows, if they caused redistribution of wealth, could easily increase overall utility in situations of high inequity even as it decreased overall wealth.

61 Cyril Morong September 8, 2011 at 11:16 am

But I think you have to assume that everyone has the same diminishing marginal utility of money to be able to say that redistribution works. And if we have higher tax rates which hurt incentives, then less wealth is created. Some of that wealth will go to the poorer people through, for example, consumer surplus. If we go with diminishing marginal utility of money, just a little more wealth to the poorer people would be important. Let’s say a rich person creates a new product and gets 90% of the social welfare in producer surplus. Then the poorer people get 10% of the increased social welfare in consumer surplus. That smaller amount might be extremely valuable to the poorer people using the logic of diminishing marginal utility of money. So any tax increase that hurts incentives and therefore hurts wealth creation might prevent this improved welfare for the poor

62 Urso September 8, 2011 at 11:47 am

What about the fact that people like feeling useful? And that if they don’t have something constructive to do (ie, employment), they’re more likely to do antisocial things (ie, drink)? Seems like at some point high unemployment is a problem regardless of absolute levels of wealth.

63 Ryan September 8, 2011 at 12:23 pm

Agreed. Just don’t use “antisocial (ie drink)” or “constructive to do (ie employment)”, for that matter. I know a lot of employed people who aren’t constructive and I know a lot of drunks who are definitely not antisocial. Semantics, I realize.

64 Urso September 8, 2011 at 2:07 pm

touche’

65 kebko September 8, 2011 at 12:26 pm

You are correct. The distinction, though, is between “Something constructive to do” and “Something to do”.

66 Cyril Morong September 8, 2011 at 11:23 am

One other issue here that Professor Cowen raises might be also be important. It is where he says “the debate is about how much we should glorify wealth creators.” This reminds me of something that Candace Allen (wife of Vernon Smith) said about entrepreneurs in a speech she gave to the Dallas Fed in 1997:

“One of the most striking points to make in understanding why entrepreneurs aren’t given more recognition is that even the most staunch supporters of the capitalist system often diminish and even dismiss the importance of entrepreneurs. The economists who have developed the sub- discipline referred to as the “new economic history” have been among the most effective at explaining the causal links between the market and economic progress. Yet most of the new economic historians downplay the importance of entrepreneurs and would argue against our placing them in the category of heroes.

Robert Thomas of the University of Washington argues, for example, that individual entrepreneurs, whether alone or as archetypes, just don’t matter. According to Thomas, a successful entrepreneur is no more important to the economy than the winning runner in a 100 yard dash is to the race. The winner gets all the glory, but if he had not been in the race, the next runner would have won by crossing the finish line a fraction of a second later, and the spectators would have enjoyed the race just as much. If Henry Ford or Bill Gates or any other successful entrepreneur had not made his pioneering contribution, someone else would have quickly done so. So, as Thomas tells the story, it is hard to justify special celebration of their accomplishments. But this view ought to be challenged.

Go back to Thomas’ race analogy. If the runners and their preparation before and during the race are simply taken as givens, it is no doubt true that removing the winner of the race would do little to reduce the benefits of winning. But the identity of the runners and their preparation and effort can’t merely be taken as a given. They are influenced by the social acclaim and praise afforded the winner. When champion runners are esteemed in the public’s eye, those with the greatest talent are more likely to become runners—to train harder and run faster.

The fact that the entrepreneur receives profits if he is successful is hardly a persuasive argument that entrepreneurial motivation is unaffected by public attitudes.

The point I am making here is that the public attitude is really a sum total of individual attitudes of citizens. If individual citizens do not value the qualities that make entrepreneurs able to go beyond the limits of what is considered to be possible and do not value the environment that allows and rewards those who do, then those citizens empower politicians and their special interest clients who consistently look for justification to tax away the financial gains of successful creators.

It is no coincidence that over the last century, as public respect for entrepreneurs has eroded, so have the constitutional barriers against what is best described as the punitive taxation of economic success.

Just as the society that doesn’t venerate winners of races will produce fewer champion runners than the society that does, the society that does not honor entrepreneurial accomplishment will find fewer people of ability engaged in wealth creation than the society that does.”

Here is the link

http://www.dallasfed.org/research/ei/ei9701.html

67 Justin September 8, 2011 at 11:26 am

I think Tyler’s last line is really important for the green movement to understand. They have increasingly deviated from arguments about negative consequences of climate change for our posterity, and instead try other reasoning (green jobs? economic recovery?) that is much more fragile. Although some of these ideas may have merits, the focus of the green movement should be on preserving the environment not improving the economy. It can be a nice side note, but not the main show.

68 Bill September 8, 2011 at 12:23 pm

When we describe government spending as a broken window, that is, something that is being spent for nothing, we are asking the reader to reach the conclusion based on the box we initially put the spending in. Quite naturally, you would say, why spend the money, it’s not efficient.

But, if you frame it as spending money for infrastructure which would make everyone else in a network economy more efficient or better off, or if you framed it as advancing spending now for something you would purchase later (in exchange for not purchasing it later), then I doubt (although I could be wrong) that many people would object, given high unemployment and deficient aggregate demand.

So, if you are going to be led by the frame that people put on an issue: think twice, and think for yourself.

69 Andrew' September 8, 2011 at 12:39 pm

The discussion is motivated by ozone scrubbers and specifically NOT their objective value, but their Keynesian value divorced entirely from their real value. And I use ‘objective’ and ‘real’ to distinguish from words like nominal and psychological/sentiment. If you have better words than these let me know what they are.

You are not getting much negative framing from around here. Where you are getting the positive framing about infrastructure spending now is almost everywhere else. The obvious question is, why should we trust that spending from now forward will magically be network efficiency positive when one of our big problems is that they haven’t done it yet?

70 mulp September 8, 2011 at 1:44 pm

” It is possible that a broken window may increase employment and output and under sufficiently unusual assumptions it may also increase welfare. But it’s not likely. I think the point, showing the possibility of this exceptional case, should be a footnote in an intermediate macro text but no more.”

What economists too often deny is nature. Quoting Neil Young quoting Devo, two Ohio ad agency execs, quoting Rustoleum ads, “Rust Never Sleeps”.

Thousands of bridges are slowly but relentlessly being turned into broken windows, decapitalizing the capitalism of the half century of government before Reagan when flipped the US from public capitalism to public decapitalism.

I see Reagan as apply his personal views of living off his past to the US nationally and concluding the nation didn’t need to rebuild everything built by Jefferson then rebuilt by Lincoln then rebuilt by Wilson then rebuilt by FDR then rebuilt by Eisenhower because Reagan no longer needed to rebuild the places he lived because they were more than sufficient for the rest of his natural life, so why sacrifice consumption on rebuilding things that don’t need to be rebuilt today or before Reagan died.

The I-35W Mississippi bridge was a broken window before Reagan died, but to economists like Tyler, he saw the bridge as perfectly fine because taping some plastic over it made the window and bridge work good enough that it could be considered as valuable as a new bridge but at a savings of $250 million dollars in higher taxes.

Until economists admit nature is not external to economies but a constant tax imposed by gods on every part of economies, we will never have economic growth by economic theory and practice, but only as a consequence of political power politics serving moneyed interest groups. Today the people who are increasingly vocal about the need for government spending are the very richest of corporations: these corporations need safe, well maintained, and uncongested transportation systems. They need clean water and air, and reliable power

Just don’t ask them to pay for building the public productive capital. Nor ask them to consume zero clean water and air, or pay for clean water and air and secure power – government benefits need to be free to corporations and CEOs. The cost of using newly created public capital should be no more than using the old paid off public capital: near zero.

71 Nate September 8, 2011 at 4:27 pm

This argument seems self-refuting. You argue that economic prosperity can only come about through government action, but by way of evidence, you point to crumbling infrastructure that’s 100% government owned and controlled. If you’re right that the government has been so poor at maintaining its own property over the last 30 years, how can you believe that it will be more successful in the next 30?

72 Cahal September 8, 2011 at 4:50 pm

But the poor maintenance is a result of anti government ideology. It is far worse in the U.S. than any other country.

73 Nate September 8, 2011 at 8:16 pm

How does anyone propose that this be changed, though? If the proposal that government can improve the economy only works so long as people with the right ideology (a “pro-government” one?) control and support it, this doesn’t sound like a very stable plan.

74 GiT September 10, 2011 at 6:31 am

It seems perfectly stable, insofar as it creates a virtuous circle.

People are pro-government if government benefits them.
Government benefits them if people are pro-government.

This certainly means there are barriers to getting it off the ground insofar as the obverse of this is a vicious circle (government harms people if people are anti government, people are anti-government if government hurts them).

But both possibilities (anti-gov or pro-gov) would be self reinforcing, and as such stable, in theory.

Of course both the theories are rather too simple to do much good.

75 Mike September 8, 2011 at 2:04 pm

Let’s cut right to the chase: shoot the unemployable people and burn down excess residential and commercial real estate. That prescription would be far more efficient than either a war (which destroys the most productive resources) or Keynesian stimulus which taxes the most productive resources to subsidize the least productive resources – the political effect of which is permanent taxes and subsidies.

A broken window by any other name still cuts right to the bone.

76 Gerard MacDonell September 8, 2011 at 3:38 pm

It would be pleasant if you were to stop generalizing about Keynesians.

77 Cahal September 8, 2011 at 3:42 pm

‘Keynesian’ basically means whatever characture the writer has dreamt up. ‘Krugman’ serves as an even better all purpose villain.

78 Jim Nazium September 8, 2011 at 3:53 pm

No, ‘Keyensian’ is a word with a specific meaning, describing people who hold a particular view on macroeconomic fiscal policy. ‘Krugman’ is a specific person with specific opinions on ecnomic policy.

79 Nate September 8, 2011 at 4:30 pm

And specifically, in this context, “Keynesian” describes a person who believes that decay and destruction can lead to prosperity in the form of jobs created during the process of rebuilding what has decayed and been destroyed when those resources would otherwise be stagnant and unused. Are there Keynesians who don’t believe that?

80 GiT September 10, 2011 at 7:35 am

Nate, to respond to your point @ 8:31 pm.

It would do you well to pay attention to Keynes’s language when you quote him.

1. “Enrich the community on balance.”

i.e. – some negative event happens, and it /can/ be outweighed by an unintended positive consequence of that event. This is clearly logically, and empirically, possible. (thank God that mountain slide killed by mother-in-law!, to give a black humor example)

2. “[various disasters] may serve to increase wealth, if the education of our statesmen … stands in the way of anything better.

i.e. there is some effect, which people could pursue via policy that would improve things, which they do not pursue. This effect can be triggered unintentionally. (This horrible tree is blocking my view, but my neighbor refuses to pay to cut it down! *zap* Oh look, it’s been destroyed by a bolt of lightning! Thank Zeus!)

And, of course, the basic policy, and the consequent effect, which Keynes is after is a redistribution of wealth. And, of course, Libertarians and so on think nothing can distribute better than a market. But Keynes disagrees. And he disagrees based on an attempt to identify sub-optimal equilibria, in theory and in reality. The success of this is a topic of substantive disagreement, not something that can be dismissed on the basis of a simplistic alleged fallacy.

It can be dismissed by very contentious arguments about the impossibility of planning contained in the all too familiar anti-statist/collectivst/socialist/leftist/whatever-epithet-du-jure-is-apt rhetoric. But none of these arguments are quite so simple as Bastiat presents them in his parable – the man was going to buy shoes and a book, so obviously it follows that all wealth in an economy is similarly efficiently designated at all times in all circumstances (even for heroin addicts and 5 year olds!). To say that it really was that simple would be a disservice to those who have argued for the premise, or something close to it.

Quite simply, destruction being better than nothing is sometimes the case. Fleming destroyed an experiment and found a treasure. If he had known to perform the right kind of experiment, he wouldn’t have had to ruin a perfectly good one by negligence. But he didn’t know better, and so his incompetence was a boon.

Destruction being better than nothing may certainly not be true for macroeconomics, but if so it’s not untrue because destruction being better than nothing is never sound, which would have to be the case if we were to bring the word ‘fallacy’ into our discussion.

81 Cahal September 8, 2011 at 4:54 pm

Keynesian seems to mean a lot more than a guy with views on macroeconomic fiscal policy in a lot of the blogs I read. It serves as:

a) A self evident insult
b) A socialist/communist
c) A big spending guy who just wants the government to employ everyone
d) What Keynesian economics *actually* is (though this is rare)

Krugman is accused of being a corporatist, a socialist, an anti-Obama ideologue, a pro-Obama shill, and more.

Nate, you have demonstrated my point by saying that a ‘“Keynesian” describes a person who believes that decay and destruction can lead to prosperity’

82 Nate September 8, 2011 at 8:31 pm

How did I prove your point? I didn’t slur or smear Keynesians at all, I merely stated that they actually believe. Am I wrong? It seems to me that the view that destruction and waste can bring prosperity originated with Keynes himself. In fact, here it is, straight from the horse’s mouth, in chapter 10 in Keynes’ The General Theory of Employment, Interest and Money:

From part VI, first paragraph:
“If this is accepted, the above reasoning shows how “wasteful” loan expenditure may nevertheless enrich the community on balance. Pyramid-building, earthquakes, even wars may serve to increase wealth, if the education of our statesmen on the principles of the classical economics stands in the way of anything better.”

From part VI, last paragraph:
“Ancient Egypt was doubly fortunate, and doubtless owed to this its fabled wealth, in that it possessed two activities, namely, pyramid-building as well as the search for the precious metals, the fruits of which, since they could not serve the needs of man by being consumed, did not stale with abundance. The Middle Ages built cathedrals and sang dirges. Two pyramids, two masses for the dead, are twice as good as one; but not so two railways from London to York.”

He may not endorse destruction and waste as a first resort, but he’s clearly saying that they’re better than nothing. See for yourself:
http://www.marxists.org/reference/subject/economics/keynes/general-theory/ch10.htm

83 Foster Boondoggle September 8, 2011 at 4:19 pm

I like how “wealth creators” is being used as a synonym for “people with assets”. Regardless of what these people do with their assets they are to be glorified, at the expense of those who provide labor. Thus, for example, we need to get rid of the capital gains and estate taxes.

84 Nate September 8, 2011 at 4:40 pm

How could the actions of these people possibly have a detrimental effect on “labor” if the laborers freely agreed to the terms offered by the “wealth creators/people with assets”? Is the issue that you believe exploitation to be possible even within the realm of freely chosen decisions between consenting parties?

85 Ian Lippert September 8, 2011 at 4:25 pm

If anyone is interested I wrote a really long post in another forum I post on http://forumserver.twoplustwo.com/showpost.php?p=28358283&postcount=1482 where Krugman’s original article created a lot of debate

Here’s a snip:

To understand Krugman’s theory we have to look at the conditions that Keynes was trying to address when he wrote the General Theory. During the great depression the problem Keynes wanted to solve, and the condition that Krugman’s theory is based off, is the condition of idle resources that was affecting the economy at the time. This paradox, that can truly seem puzzling on its surface, is that there are people that want to work, businessmen that want to invest, and factories that are ready to be used. The only problem, and the reason all the resources remain idle, is that no one is really sure what needs to be invested in. Coming off of years of failed investments can create a type of lemon problem where investors cannot be sure how likely their investments are going to be successful. When this is the state of the economy it is far more valuable for the investor to sit on their cash holdings until the whole thing blows over, at least they hope. This pessimism, which may be considered the animal spirits, actually is rational for each individual investor but may create a level of investment that is lower than would be if the investors had a better macroeconomic “view” of the economy, ie irrational from the macro-view.

I am going to assume that resources are idle when the earthquake hits and that significant destruction is created within the city. I will also assume that the people of the city are able to substitute out of their previous demands and increase their demands for reconstruction in such a way that the decrease in the productive capacity of the city is not greater than the stimulus created by the reconstruction effort, ie the aggregate demand of the city is not reduced. This will be argued by the Austrians but for simplicity I want to stick with the Keynesian frame of the problem and set this complication aside.

The whole reason this earthquake can put the idle resources to work is because the new demand to be satisfied is neccessary and obvious, it doesnt take a genius to figure out that investing in the reconstruction will pay immediate returns. The argument that the Keynesians make at this point is a simple argument of opportunity costs. You have the world where the earthquake happens and resources stop being idle and since the resources that have been un-idled are greater than the lost productivity of the city this situation is better than the counterfactual of no earthquake and resources remaining idle. In the short run, it is very possible that there could be some net benefits to destruction.

The big problem that is faced by the Keynesians is the long run. What happens when the reconstruction efforts are over and we return to the world where there are no obvious investment opportunitites? There are a few possible outcomes here and it is at this point that the Keynesian argument falls apart since they fail to show how their theory is not a BWF fallacy in the long run.

86 Ian Lippert September 8, 2011 at 4:28 pm

The whole point of the broken window fallacy is to point out the fact that its not simply the exchange of money that is important to overall wealth but the production and trade of resources that is facilitated by the exchange of money.

87 mark September 8, 2011 at 4:57 pm

I must make one additonal comment on Krugman’s argument. He contends that the smog regulation would be good because it would “force companies to spend” and “companies have lots of cash laying around”. Those quotes aren’t exact but pretty close.

That is an “all men are Socrates” kind of fallacy. Some “companies” have “lots of cash laying around” Other” companies” own coal -fired generating plants that are affected by the regulation. But they are not the same companies! The ones who own coal-fired plants do not have lots of cash laying around. Apple and Google have lots of cash laying around but they do not own coal-fired generating plants. It’s like saying all Nobel Prize winners teach economics or all economists have Nobel Prizes, just because some do.

88 Margaret September 8, 2011 at 5:02 pm

Broken windows and lost lottery tickets are thought experiments devised by people with too much time on their hands and too little contact with actual businessmen and actual workers.

Here is a simple fool-proof plan to jump start the economy: 1) Cut unemployment benefits from 99 weeks down to 4 weeks, 2) Cut the minimum wage down to $4 per hour. Everyone who wants to work will have work; every teenager, every unskilled person, every part-timer, every full-timer, every seasonal worker, everyone who has given up looking for work. Businesses will be able to expand. Jobs will stay in the US and jobs will come back to the US. The government will save money and we will have (as close as is possible) full employment. This is not perfect but let’s not ignore the good in pursuit of the best. Working is always better than not working. A $4 per hour job is better than no job.

89 figleaf September 8, 2011 at 6:39 pm

Yes! I love this idea! My mortgage is ~$2,000/month! At $4.00/hr I could make two payments a year instead of none!

Average rent around here is ~$900/month, at $4.00/hr I could afford rent almost nine months out of the year!

What’s clever about this plan, of course, is that by driving minimum wage down to $4/hr, bankers would pretty much have to write down loans roughly ten cents on the dollar, which would help further drive down the price of real-estate, which in turn of course wipe out any equity I have remaining in my house, assuming I could find a buyer. Landlords would pretty much have to follow suit.

Vendors like, say, Apple could only charge $9.00 for a bottom-of-the-line iPod instead of $49.00, etc. Oh, unless Apple just couldn’t do that. In which case at $4.00/hr nobody would buy iPods! In which case another ~50,000 Apple employees would be made available to compete for all those other $4.00/hr jobs!

With any luck we could finally get the minimum wage down where it needs to be — the $1/day average that works so well in so much of Asia, Eastern Europe, Africa, and South America! Then we’d have fuller than full employment and we’d all be rich!

We’d all win!

figleaf

90 Nate September 8, 2011 at 8:36 pm

What makes you think Apple couldn’t charge $9.00 for an iPod if the social conditions demanded and supported it? You already understand that housing prices and rents would fall; why not durable goods as well?

91 Margaret September 9, 2011 at 5:36 pm

You’ve got a point figleaf, my plan would certainly be skewed towards giving the most help to the people at the bottom who need it the most. People with $2000 a month mortgage payments and iPods won’t get much out of this. Oh well.

92 figleaf September 8, 2011 at 6:28 pm

And of course a further-further note on the broken window theory is that no credible Keyensian has ever suggested such a thing.

At best they, like, say, Yglesias, note that fixing a broken window increases liquidity, although even then they note that it would be a terrible idea. And then they typically go on to say that instead of “stimulating” the economy by tearing down public or private infrastructure one should instead “stimulate” it by developing infrastructure.

So for instance while breaking windows and replacing them with the same windows might be a really terrible idea (not least because of the wealth multiplier!) a CCC-style initiative that offered to replace old windows with new energy-efficient windows (or even just no-longer-painted-shut-90-years-ago ones) would not only provide jobs, and potentially reallocate energy to more productive uses than staving off drafts, it would increase the sense of wealth, or at least well-being, of recipients.

If the idea of fixing the “undeserving” up with new windows makes you balk, you could just do the Rudy Giuliani stunt of going around and fixing *previously* broken windows. (To ward off new window-breaking say the program only involves fixing windows that have been broken the previous winter or summer.) I’m not sure if it’s true that fixing broken windows really helped boost New Yorker’s sense of social wealth and confidence, but almost every one I’ve ever spoken to *thinks* it increased their sense of social wealth and confidence.

figleaf

93 Claudia September 8, 2011 at 8:43 pm

Just ask the UK how there drastic austerity plan went? I’d rather not have riots here even if it meant a little less take home pay for me. Clearly you would not have to feed your kids on nothing. Workers…employed or otherwise…are human beings aka people with feelings, dreams and responsibilities. Right?

94 Al Brown September 8, 2011 at 8:47 pm

If you destroy my car, I have to take money out of the bank to buy another. I add to the demand for cars. I must reduce my consumption of other things now or later, or my heirs will have to.

If millions of people also have to do the same, the price for cars goes up. People have to spend more on cars and can enjoy less of other things. More capital is diverted to the auto industry to increase production of cars.

Interest rates have to go up, unless government is holding them down artificially. If it is holding them down, more money must be created, which reduces the buying power of the existing dollars. The number of cars people can afford to buy declines.

Destroying things destroys wealth. The effects are not direct or immediate, but they are real.

You can create bubbles, effectively transferring wealth from people who buy in as the bubble inflates to those selling into it. And when the bubble collapses, sellers realize the actual loss, the illusion of value created by the bubble is now gone.

The effects of bubbles are obvious, as obvious as the gravitational effects of the moon. But EVERYTHING that goes on also has effects, even if they are not as obvious as a bubble or as distant or as small as Pluto.

You destroy my car and the tiny effects ripple throughout the global economy. And, yes, its impossible to demonstrate that. But its as real as the gravitational effect of pluto on my fingers as I press down on this keyboard.

95 Roga September 8, 2011 at 9:55 pm

The question we need to ask is: “Who’s window are we breaking?” I think Buffet has already made it clear he can afford and would prefer to have a couple of his windows broken. And, if it helps you get out your collective frustration it’s a hell of a lot cheaper for a society than when we have to choose between who’s necks are being broken.

96 Floccina September 8, 2011 at 10:31 pm

Even if you believe that broken windows can kick start growth in a time of unemployment, you have to think that there has to be a better way!

97 gVOR08 September 9, 2011 at 8:17 am

This post is, I think, as close to a concession as we’re likely to get from Cowen. Can we drop this broken window topic and move on?

98 Boonton September 9, 2011 at 12:19 pm

I think something to consider about breaking windows….the broken window is a minus to wealth, but the new window is a positive. The fact is, though, if a window is wealth, then it is an asset. If its an asset, then it depreciates. Since you rarely replace a used broken window with another used window, the fact is you are probably replacing the old broken window with a brand new window that is worth more than the depreciated one you just broke. Hence you’re actually getting a net wealth increase unless the window that just broke was brand, brand new or you respond to the broken window with some subpar type of remedy (such as using duck tape to put it back together…in that case you’d go from a used window to a crappy used window with tape on it instead of going from a used window to a new one).

Krugman is correct but in order to ‘violate’ the broken window fallacy the following must hold:

1. The economy must be operating at under full employment.

2. The broken window must actually be replaced with something of equal or greater value

99 Mike C September 9, 2011 at 8:30 pm

Econ 101 or Common sense 101
A broken window does not have value and does not create value. The money would be better spent on a meat slicer so the deli can create value for their customer over and over again.

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