The Stimulus: One Big Broken Window Fallacy

by on February 10, 2009 · 16 comments

broken windowSeeing Adam’s recent post on the stimulus and its advocates, I had to toss in my two cents.

2008 was the year of Schumpeter. Creative destruction was doing its thing, getting rid of many unproductive old-economy companies that were simply creating economic waste by keeping inputs from going to their highest-value use. But this scared a lot of people who had grown used to the benefits capitalism had given them and who were therefore quite risk-averse. Even the entrepreneurs, upon whose ingenuity growth rested, had grown risk-averse and were demanding bail-outs of their own. As the government gave into demands for stability, the risk-taking class upon which prosperity rested began withering away.

If 2008 was the year of Schumpeter, 2009 may be the year of Hazlitt. In Economics in One Lesson, Hazlitt describes a mode of argument all too common in politics: the broken window fallacy. The notion is that by taking money from some and spending it, the government is “creating jobs” and enhancing productivity because money is circulating. Of course, this ignores what the people whose money was taken would have done with it. In other words, it is not beneficial to just spend money, no matter how badly. That is precisely the point that Eugene Robinson and other stimulus proponents seem to have missed.

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About Alex Harris

A graduate of Harvard College who wrote his senior thesis on the political philosophy of Robert Nozick and a student at Stanford Law School studying technology law, Alex Harris is actually one of the least nerdy contributors to the Technology Liberation Front. When Alex is not buried in law school work, he works as an Adjunct Fellow at the Competitive Enterprise Institute. Prior to receiving that haughty title, he was a Google Policy Fellow, prolific blogger, libertarian lolcat creator, and lowly intern at CEI. Before that, Alex was a Koch Summer Fellow for the Center for Constitutional Studies at the Cato Institute. He has been published in the American Spectator and writes for the Stanford Law School’s Center for Internet and Society’s publication, Packets. Now, Alex spends more time with his iPhone than with people.

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  • http://techliberation.com/author/berinszoka/ Berin Szoka

    Well said, Alex. But let's give credit where credit's due: it was the great French (classical, I suppose I must add) liberal Frederic Bastiat who first explained (1848) the broken window fallacy—a century before Hazlitt (1946):
    Scroll down to Section 1.6 here http://www.econlib.org/library/Bastiat/basEss1….

    Here, for those interested, is Hazlitt's application of Bastiat: http://jim.com/econ/chap02p1.html

  • dm

    The problem, of course, is that people aren't spending their money at the moment. So the government proposes to borrow from the future (at very low interest rates) in order to invest today. If invested reasonably wisely, the future will be made richer thereby, and better able to pay off the debt.

    That the government can invest wisely is obvious — look at the pittance ARPA spent developing the Internet, and look at the bonanza of wealth that resulted. Another obvious wise investment is in public health.

    Yes, it's not a matter of just spending (and the Post columnist your colleague quotes does sound silly), but spending wisely. Unfortunately, it appears that some of the likely wise investments (education funding, building maintenance, moving the Federal vehicle fleet to hybrids) have been replaced with foolish ones in the form of tax-cuts, but that makes up a relatively small part of this stimulus bill.

  • http://www.openmarket.org/author/alex-harris/ AlexHarris

    What are people doing with their money? Probably not putting it under the mattress. More likely, investing them in the areas they think will likely generate the best return for them. If people on average make rational determinations (which is to say there is no systematic bias), then people will have made the right trade-offs between current and future consumption and the right decisions about what to invest in. Government spending screws with this determination.

  • dm

    “Probably not putting it under the matress”, you say. That's about the safest investment around at the moment — save government bonds. Oh! What if the government borrowed the money and did something useful with it? Best of both worlds!

  • http://www.openmarket.org/author/alex-harris/ AlexHarris

    I absolutely agree that the government doing something good with the money is better than the government doing something useless or bad. My point is just that we need to compare what the government is doing with the money to what its owners would have done with it had they been allowed to keep it — and that the owners' use is better than the government's, as it reflects a decision the owner has made trading off the costs and benefits of present use and various investments.

  • dm

    But take a look at the financial and stock markets. Bond prices reflect the fact that there are a heck of a lot of owners that would really like to use their money to finance government debt at the moment. That fact pretty much puts paid to your broken window fallacy.

    In other words, right now, purchasing government debt is a very popular investment — so the government might as well put that money to work, at stunningly low interest rates, to making the future richer.

    Your article seems to confuse the auto bailout, TARP (the financial-market prop), and the current stimulus plan. These are three separate things. The current stimulus is a mixture of things, including investments in the future, tax breaks, and a thin layer of pork (some of which may also qualify as investments — the contraceptive thing was actually a change to an existing program that would have saved the government money in the long run).

  • MikeRT

    That the government can invest wisely is obvious — look at the pittance ARPA spent developing the Internet, and look at the bonanza of wealth that resulted.



    I think you left out the minor subject of all of the billions of dollars that telecoms, cable companies, traditional ISPs and wireless providers have sunk into building out infrastructure. Not to mention all of the incredible amounts of labor that went into building all of the platform software that we take for granted. ARPA did a bang up job with what they did, but all they did was plant a small seed that was exploded into an incredible orchard over time by mostly private sector investment.

    Also, you have to consider counter-examples like Ada. Damn fine language. Too bad most of the work was an utter waste because the government never saw fit to actually get the ecosystem for the tools opened up to a competitive market until it was too late (and C/C++ started to replace it).

  • MikeRT

    The real issue, Alex, is that the average consumer will not spend that money in a way that is useful for the country. In most respects, what they're doing is siphoning off money from productive sectors of the economy and investing it in goods which are often not even made in the United States, or if they are, are probably dying industries. Just because their choices may be fairly rational, doesn't mean that their choices will be beneficial to the economy in general.

  • http://www.openmarket.org/author/alex-harris/ AlexHarris

    So, consumers spend money on stuff like this?
    http://www.theonion.com/content/video/sony_rele…

    I tend to agree with economists about revealed preferences – that is, that people's purchasing decisions tend to reveal how they value things. The amount of benefit those things generate is the benefits side of the cost-benefit analysis. Government decision-making just can't this side right (and nor can government accurately assess the costs of production).

  • http://enigmafoundry.wordpress.com eee_eff

    This isn't the broken window fallacy at all, and in fact government spending to stimulate the economy isn't at all an example of the broken window fallacy.

    What is operative here is psychology and momentum. If the economy is slowing down and everyone believes it is, it will continue slowing down…

  • http://www.openmarket.org/author/alex-harris/ AlexHarris

    That's true… IF, for some reason, when people think the economy is slowing down they stop doing ANYTHING useful with their money (either spending it or investing it). Just because customers are making a decision about present vs. future consumption and businesses wish they'd decide for more present consumption doesn't mean the economy is doomed. It just signals that we're paying down the debts we accrued in the past or saving to allow us to spend more in the future. Taking on trillions more national debt will only undo this sensible correction.

  • dm

    When will you get it through your head that the market has spoken. People want to buy government debt. It's the best investment there is, at the moment.

    Since that is the case, the government might as well go and build useful stuff with the money people are willing to loan them at microscopic interest rates.

    You keep chattering about people's choices — but people are making their choice to save with the government by buying bonds, even though those bonds yield tiny interest rates.

  • http://www.openmarket.org/2009/02/13/the-stimulus-and-the-broken-window-fallacy/ The “Stimulus” and the Broken Window Fallacy | OpenMarket.org

    [...] been a while since I posted here, but I thought OpenMarket readers may want to check out a piece I have up on TechLiberation that has generated a lot of heated discussion. I there argue that “2008 was the year of [...]

  • Alex Deam

    The stimulus isn't an example of the broken window fallacy. That's a gross misunderstanding of Keynesian economics. The broken window fallacy is a fallacy because the money is being spent by the shop owner who now has less money to spend and is worse off. But where is the money coming from in a Keynesian stimulus? It's coming from government borrowing. It's not coming from raised taxes (they should stay the same or be lowered overall during a recession). If the government doesn't step in and provide a stimulus, that money wouldn't have been spent, except in the future, when the economy is in a better position to pay back this debt.

    “My point is just that we need to compare what the government is doing with the money to what its owners would have done with it had they been allowed to keep it — and that the owners' use is better than the government's”

    So you favour a 0% tax rate then?

    The argument that government is inefficient compared to private entities is false. I think we can agree that several people acting as a group are better at making a decision than one person. So companies and governments are better at making decisions on the whole. And is there any inherent reason why a company should be better at making decisions than a government? Both are just collections of people after all.

  • Alex Deam

    The stimulus isn't an example of the broken window fallacy. That's a gross misunderstanding of Keynesian economics. The broken window fallacy is a fallacy because the money is being spent by the shop owner who now has less money to spend and is worse off. But where is the money coming from in a Keynesian stimulus? It's coming from government borrowing. It's not coming from raised taxes (they should stay the same or be lowered overall during a recession). If the government doesn't step in and provide a stimulus, that money wouldn't have been spent, except in the future, when the economy is in a better position to pay back this debt.

    “My point is just that we need to compare what the government is doing with the money to what its owners would have done with it had they been allowed to keep it — and that the owners' use is better than the government's”

    So you favour a 0% tax rate then?

    The argument that government is inefficient compared to private entities is false. I think we can agree that several people acting as a group are better at making a decision than one person. So companies and governments are better at making decisions on the whole. And is there any inherent reason why a company should be better at making decisions than a government? Both are just collections of people after all.

  • Alex Deam

    The stimulus isn't an example of the broken window fallacy. That's a gross misunderstanding of Keynesian economics. The broken window fallacy is a fallacy because the money is being spent by the shop owner who now has less money to spend and is worse off. But where is the money coming from in a Keynesian stimulus? It's coming from government borrowing. It's not coming from raised taxes (they should stay the same or be lowered overall during a recession). If the government doesn't step in and provide a stimulus, that money wouldn't have been spent, except in the future, when the economy is in a better position to pay back this debt.

    “My point is just that we need to compare what the government is doing with the money to what its owners would have done with it had they been allowed to keep it — and that the owners' use is better than the government's”

    So you favour a 0% tax rate then?

    The argument that government is inefficient compared to private entities is false. I think we can agree that several people acting as a group are better at making a decision than one person. So companies and governments are better at making decisions on the whole. And is there any inherent reason why a company should be better at making decisions than a government? Both are just collections of people after all.

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