9/1/2011 - The Broken Window Fallacy

The Broken Window Fallacy

Chris Mayer So hurricane Irene is over with, but it didn’t take long for economic commentators to make fools of themselves.  David Kotok is the chairman and chief investment officer of Cumberland Advisors. He was on the radio with Larry Kudlow, who asked him about the economic impact of Irene. Kudlow noted how Irene tracked over 1/10th of the nation’s economic output. Here is Kotok writing about it to his investors afterward about Cumberland’s response:  “We are now upping our estimate of fourth-quarter GDP in the US economy. Billions will be spent on rebuilding and recovery. That will put some people back to work, at least temporarily. We speculate that Washington may set aside the usual destructive and divisive partisan political wrangling and act in the interest of the nation. That means there will be a flow of federal financial assistance to the disaster areas.”  This is horrible, horrible reasoning. It is the old broken window fallacy, which we see trotted out by otherwise intelligent people anytime there is a natural disaster. These people say that destruction is an economic boost, as we busily rebuild what was lost. It’s a shame people continue to repeat this. The great economist Frederic Bastiat killed this idea decisively in an 1850 essay, “That Which Is Seen and That Which Is Unseen.” It remains a classic essay on economic reasoning. In his usual witty manner, Bastiat wrote a parable about a boy who breaks a window. The “seen” is the glassmakers who have new business they didn’t have before. That’s what people like Kotok focus on. But as Bastiat wrote: “It is not seen that as our shopkeeper has spent 6 francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his 6 francs in some way, which this accident has prevented.”  Kotok’s point about federal assistance is particularly depressing, because he seems unable to recognize that this is simply money taken from someone else. Please don’t fall for the broken window fallacy. And please correct anyone you hear using it. It seems the first step in basic economic literacy. Hurricane Irene was a dead loss for the economy. Period.  http://dailyreckoning.com/the-broken-window-fallacy/