Wednesday, August 31, 2011

An interesting and revealing comment on the Broken Window Fallacy

Bob Murphy writes this in his own comment thread:

"Believe it or not, you guys, Blackadder (and maybe Gene?) were actually backing me into a corner. Last night, I fired off something like, “So unless you think taking money from people and handing it to the unemployed is ‘good for the economy,’ you can see my analogy was sound.”

Well duh, Krugman et al. would say, “Of course we think that’s good for the economy–we call it unemployment benefits. Haven’t you been paying attention?”

But now I don’t need to concede anything, because Gene and Daniel Kuehn are assuring me that “nobody” ever held this position. No one has ever said that the extra economic activity caused by employing idle resources, could more than compensate for the initial disturbance that set it off, right?

What I've argued (and to my knowledge, all Gene has argued) is that no one that I'm aware of has said that destruction from disasters is a net benefit for the economy. Under certain conditions it can provide some quirky gross benefits, but nobody makes the case that it's a net benefit. Any ambiguous language used by Krugman like "some economic good" (which I think clearly means "gross benefit" becasue of the use of the word "some" - implying other "economic bads") should be easily clarified by the accompanying analysis and by the readily observable fact that Krugman is not a warmonger or a reveler in the misery of others.

This is obviously very different from what Bob attributes to us here. Here Bob says that we think that taking money from someone else and handing it out would be a net benefit for the economy.

Is this better than a hurricane destroying wealth to convince someone to spend money on repairs? Of course it is. We have no wealth destruction effect, only an income transfer (let's assume the redistribution isn't occuring out of taxes on wealth). Since the broken window itself is an important part of the broken window fallacy, getting the broken window out of the picture and just moving around money obviously improves the situation.

But still, Bob is talking about taking money from one person and giving it to another. Could it stimulate GDP and employment? Yes, I'd agree it probably could in a situation like the one we're in now if it amounts to transfering money from people with relatively high liquidity preference to relatively low liquidity preference. Of course there is an opportunity cost associated with that transfer, but in the current underemployed environment the stimulative impact is expected to exceed the opportunity cost.

But notice how Bob sneakily slipped in "taking money"*. This isn't what Keynesians propose. Some liberal Keynesians have a chip on their shoulder about the rich and oppose things like extending the Bush tax cuts, but that doesn't come from their Keynesianism - it comes from their liberalism (or perhaps even darker corners of their psyche). The boilerplate Keynesian position is to increase spending and lower taxes during a downturn. So there is no proposal of taking money from anybody. The point is to create money or other safe, liquid assets (like, say, Treasury debt) for which there is an excess demand.

Bob goes on:

"(Be careful how you answer guys. If you concede that a simple wealth transfer from a rich saver to an unemployed guy who will spend the $$, could generate net benefits to the economy–as least in Krugman’s view–then you are dead in the water. All you need is a small enough disaster that goads such transfers from rich to idle in order to generate these gains that will compensate for the disaster’s direct destruction of wealth.)"

This is technically true, but I don't see how it's relevant. What we're dealing with here is an opportunity cost the size of the transfer and a benefit the size of the transfer plus some residual due to the fact that we're below full employment. Yes, if Bob can think up some sort of destructive force that causes very small amounts of damage but for some strange reason induces a very large amount of spending during a period below full employment I could agree that there may be some net benefits associated with it. But that doesn't seem to be what we're talking about at all. The spending (for which, let me reiterate, there is an opportunity cost that already weighs down on any gross benefits) that we talk about is usually repair spending, right? We need to fix the window. We need to fix the nuclear power plant. We need to rebuild Germany and Japan. These aren't situations where we have big spending because of small destruction. We have big spending precisely because we have big destruction.

And in any case, even if Bob can come up with a situation where the destruction plus the opportunity cost is lower than the spending plus any multiplier, why not just create new money that doesn't have a lot of the downsides and in addition to the multiplier effect of a transfer, also has an effect on the interest rate?

* - of course I don't really think he was being "sneaky". It may or may not have been intentional, but regardless of his intent it's a crucial phrasing.


  1. Keynes had a number of rather ugly things to say about the rentier class, about the profit motive, etc., so I think you can get that attitude from Keynesianism. Keynes seemed to have a real on his shoulder regarding people, well, making money.

  2. Also, if you read "Conscience of a Liberal," Krugman goes on and on about wealth disparities, etc. Recently Krugman also wrote a column questioning the notion that somehow those seeking medical care are, well, consumers.

    Keynesianism slides very easily into paternalism and other like isms because Keynes was a paternalist; his is completely riven with such ideas. He states repeatedly in many places that governments need to be active in all manner of ways - which to my mind is simply an invitation to corruption and other similar negative consequences.

    You cannot ignore the anthropological attitudes of Keynes and his followers.

  3. Funny how disagreeing often gets construed as ignoring.

  4. Well, the point is that Keynesianism has the imprimatur of "science" when it is largely about political philosophy and what proponents of Keynesianism (who are almost exclusively modern liberals) see as a just and appropriate social order. That's fine IMO. So it is the presuppositions that matter most when it comes to any ideological stance (that includes mine as well).

  5. Could you clarify why you think that? Most Keynesian material I read is completely devoid of political philosophy. Again, I think you are reading blogs and popular pieces by Keynesians and completely missing what Keynesianism actually is.

    Keynesians have all sorts of different political philosophies, but Keynes himself was a reform liberal and many outspoken Keynesians today are also reform liberals. But that has little to do with Keynesianism itself.

  6. That blog post/comment I left on that other thread actually does kind of argue that under certain circumstances there can be a net benefit of a broken window.

  7. Well, a "reform liberal" naturally sees a largish role for government across a very wide spectrum (indeed, a lot of the language reform liberals use illustrate that I'd say in some rather ugly terms - well ugly to me at least). Thus it isn't surprising that "reform liberals" latch onto Keynesianism because it is essentially a substitute for the "social democratic" or "democratic socialist" policies found in much of Europe.

    Anyway, I was up much of the night nursing a fever so I am going to stay in bed today, sleep and try to recover. Have a good day of classes.

  8. I mean, I argue kind of what you are arguing more explicitly. If the government employs "pent up" savings at nonexplosive interest rates its a net benefit.

  9. So, you're still going to act, in contradiction of all the evidence, like Krugman actually inserts the caveats about disasters not being a "net economic benefit"? Okay, but this just puts you further and further from the people you're defending.

  10. A quick clarification, Daniel: I totally understand and endorse your claim that for Krugman (and you), the best possible outcome (given that we are in a liquidity trap) would be for the government to run a higher budget deficit, and spend the money on socially useful things like R&D, bridges, literacy programs, job training, etc.

    What I am saying is that I think it's possible in the Krugmanian framework that *relative to the current do-nothing status quo*, a small disaster could make us richer *on net*.

    I agree with you that Krugman has never said this explicitly, but on the other hand he has never denied it either. As far as I know, you are the only public Keynesian who has explicitly said that a disaster always makes the economy poorer than it otherwise would have been.

  11. It seems to me it seems like you are stating the the less strong position that there is no net effect but then you seem to go on to argue there is a net effect by invoking stuff like the condition that there is below potential GDP.

  12. Hey Daniel,

    Can you clarify something please? I always get mixed up by what people mean with the multiplier.

    So let's say there's a $1 billion disaster. This forces businesses to invest $1 billion replacing all the broken stuff.

    Suppose the multiplier right now is 1.84.

    So what does that mean? I thought it meant that total GDP ends up being $1.84 billion higher than it otherwise would have been. Is that right? Or does it mean GDP is just $840 million higher than it otherwise would have been?

    If it means the former, then the disaster is good on net, right? Because even netting out the $1 billion in wealth destruction, the economy is still "up" $840 million. (I guess you'd want to net out the lost leisure from the previously unemployed workers too, but presumably that won't wipe it all out.)

    So please clarify what the multiplier means in this context. I think it means the former, meaning the standard Keynesian position would have to mean that disasters are good, even on net, for the economy, so long as they induce spending that doesn't completely fill the output gap.

  13. Bob, that aspect of the multiplier has always intrigued me. Surely, I am not an economist (I only dabble), but I always assumed that 1x=x.

  14. Bob Murphy -
    Maybe I'm missing something, but you seem to be saying:

    - $1 billion from destruction of wealth
    - $1 billion from opportunity cost of reconstruction
    + $1 billion from reconstruction
    + $0.84 billion from multiplier.

    That seems to put you in the hole 0.16 billion. How is that a net benefit? What am I missing? It is a gross benefit in the GDP flow, of course, which is equal to + $0.84 billion

    As I said towards the end of the post, yes you can conceive of a situation where the net benefit would be positive but I can't imagine how such a theoretical situation would be relevant. What disaster does less damage than its own clean-up effort?

    Your assumption that $1 billion of damage results in $1 billion of reconstruction is extremely generous anyway. Wouldn't we expect them to reconstruct less than what was destroyed, and to string it out over a longer period of time?

    We can generate thought experiments where you might get a small net benefit, but I can't conceive of a case where they would mean anything.

  15. Isn't the whole debate here about whether there is $1 billion in opportunity cost or not?

  16. Daniel, let me try it this way. (I'm not trying to trap you, I'm really trying to think this through.)

    Suppose John Boehner was visited by the ghost of Keynes Past and realized he was being a jerk. So he capitulates and lets the government run a $1 billion higher deficit this year, by building (say) a bunch of bridges with a market value of $1 billion.

    However there is an additional $840 million in economic activity. Let's assume it creates $840 million worth of new cars.

    (I know it's unrealistic to say it's all in durable stuff; just trying to keep it simple.)

    The only real opportunity cost here--assuming no crowding out--is the forfeited leisure of the unemployed workers.

    So it seems to me that if the extra $1 billion in government investment is due to Boehner's guilty conscience, then society is $1.84 billion richer.

    So, if it takes a $1 billion disaster to get Boehner off his duff...aren't we still up $840 million?

    The crucial thing (to me) are the twin Keynesian ideas that there are (a) currently idle resources and hence no opportunity costs in eliciting output from them, and (b) multiplier effects from an initial burst of spending.

    Like Andrew said, in your accounting above, I don't see why you are putting a $1 billion opportunity cost from the spending. I thought (like him) that that's what we were arguing about, and that if there was (hypothetically) no crowding out, then there would be no opportunity cost at all.

  17. So I guess what it comes down to (possibly) is yes, it's an empirical matter, but I think the issue is, should the penalty due to forfeited leisure be higher or lower than the gain from the multiplier?

    If workers didn't care whether they were idle or not, and if there were no multiplier, then a disaster would have no effect on society. It would just be a wealth transfer from the victims of the disaster to the previously unemployed workers. After the disaster, the victims would be out the amount of the disaster, but the workers would be up that amount. Total wealth would be the same (because the workers would have repaired the actual damage).

    In reality, of course, the workers on net wouldn't have benefited from the full amount of their paychecks, because it's a hassle to have to actually build stuff. But if you think that there are sticky prices blah blah blah, then the new spending by the victims has spillover benefits. Thus other unemployed workers can be mobilized, creating net new wealth over and above just replacing the destruction. So if the spillover effect is bigger than the construction workers' preference for gain.


  18. So if a store owner has to spend money on his window rather than shoes we all agree there's an opportunity cost, right?

    The same is true today. If my stuff got wrecked in a disaster I would have to divert money from other uses to replace it. Sure we've got idle resources, but that doesn't mean people have a billion dollars sitting around - we're still purchasing things. We're probably keeping some resources idle so perhaps the situation would be marginally better, but I don't see how one could claim that the full amount would be.

    This is exactly why Keynesians don't like raising taxes to finance new government spending. It nullifies the whole policy because you're giving purchasing power to government by taking it away from other people (not to mention the fact that that would be distortionary).

    As for the penalty of forfeited leisure - I'd presume most workers are being hired (directly or indirectly) out of unemployment, right? So it's not clear their utility from leisure is very high.

  19. re: "If workers didn't care whether they were idle or not, and if there were no multiplier, then a disaster would have no effect on society. It would just be a wealth transfer from the victims of the disaster to the previously unemployed workers. After the disaster, the victims would be out the amount of the disaster, but the workers would be up that amount. Total wealth would be the same (because the workers would have repaired the actual damage)."

    No, this seems to miss Bastiat's whole point.

    1. You have a reduction of wealth due to the disaster itself.

    2. As you say here, workers who do the rebuilding get more income, but

    3. The shoemaker gets less income.

    2 presumably cancels out 3 when there's no multiplier (which you stipulated), and then you still have this big gaping hole from 1.

    So no, I would not say it's "just a wealth transfer" in the absence of the multiplier. As Bastiat points out - it's a loss.

  20. Daniel Kuehn:

    So if a store owner has to spend money on his window rather than shoes we all agree there's an opportunity cost, right?

    The same is true today. If my stuff got wrecked in a disaster I would have to divert money from other uses to replace it.

    And now we're back to the full Frederic... Forcing the shopkeeper to buy a new pane of glass is bad, because otherwise he would've bought shoes with that money.

    I thought the whole objection to this line of reasoning was that the shopkeeper might not have spent the money, he might not have employed somebody else.


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