Thursday, August 13, 2009

Breaking Windows Left and Right

My response to the cash-for-clunkers program has been lukewarm at best, but I couldn't figure out exactly why I didn't very much like the program. I think I've now figured out why.

Frederic Bastiat was a French economist and theorist in the 1800s who created what is known as the "broken window fallacy," which goes something like this: A boy throws a rock and breaks a shopkeeper's window. The shopkeeper will have to spend $50 to have it repaired. The townspeople gather around and sympathize with the shopkeeper, but then they suggest that this will give some additional work to the window-maker. This additional work will give him some more money that he can spend on buying bread, which helps the baker. The baker, now that he has some extra money, will go out and buy a new pair of shoes, benefiting the shoe-maker, and so on. Far from being a tragedy, it seems as though the broken window is a good thing that will benefit the community because it creates more opportunities for work, thereby giving people more money to spend.

The fallacy is the fact that we're considering only one side of the equation. Yes, it is true that the window-maker, the baker, and the shoe-maker will all benefit from the extra money that the shopkeeper will have to spend repairing the broken window. But what if the shopkeeper was going to spend that $50 on a new coat? The coat-maker, if he had gotten that $50, would then have gone out and spent it on a new chair, and the chair-maker would have used that money to buy some books to read, and so on. The window-maker won, but the coat-maker lost, and the shopkeeper has to spend $50 repairing a window when he could have spent that money on something that would have given him more enjoyment. Society is in fact worse off because nothing has changed except that the shopkeeper now has a broken window.

If you have ever taken introductory economics, you would have learned the difference between stocks and flows. The people who say cash-for-clunkers will stimulate the economy aren't lying -- GDP will indeed increase. But this is increasing flows (GDP) at the expense of stocks (the total amount of wealth the country has).

If it were actually a good thing that the boy broke the window, then we should be encouraging young boys everywhere to be breaking windows left and right. This would give the window-makers a huge amount of work and will increase GDP and stimulate the economy! In fact, why stop there? If we want even more GDP growth, we should create a huge, destructive war that will put everyone to work. I think there's a certain country in the Middle East beginning with "I" and ending with "q" that the US could invade... oh wait, we already did that. How beginning with "I" and ending with "n"...?

No matter how hard we might try, you cannot create wealth using schemes and gimmicks. Wealth comes from hard work. Unfortunately, until we clear out the sickness that is still infecting the American and the world economic system, it's going to be a long time until we can have any true, sustainable growth.

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