Wednesday, August 31, 2011

Irene and the Broken Window “Fallacy”

Doug Matacons argues that Paul Krugman is wrong with what Doug calls the “broken window fallacy”:

What this argument ignores, and what people like Krguman and this Politico reporter refuse to recognize is the simple fact that destruction does not create wealth. The money that will be spent to rebuild, repair, and recover from Irene will doubtless line the pockets of the various contractors that will be hired to perform said work, but to argue that it “creates wealth” is simply a fallacy. By some estimations, the losses from Hurricane Katrina will total in the tens of billions of dollars. That’s wealth that doesn’t exist anymore, it’s gone. The money that will be will be used to pay for the recovery already exists and, rather than being invested in other projects, it will go toward repairing the damage caused by natural disaster. A home damaged by Hurricane Irene will be no more valuable after it is repaired than it was the day before the storm hit, for example. And this analysis doesn’t even take into account the losses from lower consumer spending that businesses will feel as a result of the storm, all of which will reverberate out into the economy as a whole.

Doug then applies to Frédéric Bastiat for this line of new classical thinking:

It is not seen that, since our citizen has spent six francs for one thing, he will not be able to spend them for another. It is not seen that if he had not had a windowpane to replace, he would have replaced, for example, his worn-out shoes or added another book to his library. In brief, he would have put his six francs to some use or other for which he will not now have them.

Yes – economists like Krugman and Keynes must be “bad economists” for looking out at the real world and recognizing that we are far from full employment. I would like to give a lot of credit to Irwin Kellner for this:

The bad news is pretty obvious: Countless houses and cars were smashed by fallen trees; there was lots of water damage from the storm itself, as well as from the water that spilled over from nearby rivers and lakes — and even from the ocean. Widespread power outages left millions in the dark, spoiling food and depriving people of air conditioning. Many businesses had to shut their doors for as long as a week. For retail outfits, this is lost revenue that is unlikely to be made up. The damages have yet to be totaled up, but estimates of $7 billion or so seem to be common ...For their part, restaurants either forced to close their doors or bereft of their usual complement of customers will not be able to make up these lost receipts. The same goes for other retailers like gasoline stations and department stores. Theaters will be unable to make up for the last-minute walk-ins at canceled performances. Cities like New York, which shut down their mass-transit systems and waived tolls on bridges and tunnels, will be unable to recoup these losses as well. Although occurring more than halfway through the third quarter, the effects of this storm could be enough to reduce growth in the gross domestic product by anywhere from a half to a full percentage point.

In other words, Irwin starts with all those negative impacts from Irene that we can see. But Irwin goes onto to note the boost to aggregate demand expected to come in the last quarter of this year. Is Irwin being a bad economist for not seeing the crowding-out effects that Bastiat talked about? Of course not! Shall we repeat? We are far from full employment!

1 comment:

Sandwichman said...

Bastiat's "fallacies" are of the same type as the lump of labor. They begins with an idealization of the economy and then criticizes responses to actual deviations from that ideal as "fallacies".

There is a grain of truth to the fallacy claim in that destruction does not in itself create wealth. In some circumstances, however, destruction can instigate repairs whose consequences extend beyond mere restoration. In that case, destruction becomes a rationale for the creation of wealth.

On the other hand, it would be a fallacy to assume that destruction will always lead to a more than compensating response. Crowding out can occur and it may even occur at less than full employment, depending on labor mobility and substitutability between labor and capital.