The Broken Window Fallacy

"Life, which you so nobly serve, comes from destruction, disorder and chaos. Now take this empty glass. Here it is: peaceful, serene, boring. But if it is destroyed...
[breaks glass and robots come to sweep it up]
Look at all these little things! So busy now! Notice how each one is useful. A lovely ballet ensues, so full of form and color. Now, think about all those people that created them. Technicians, engineers, hundreds of people, who will be able to feed their children tonight, so those children can grow up big and strong and have little teeny children of their own, and so on and so forth. Thus, adding to the great chain of life. You see, father, by creating a little destruction, I am in fact encouraging life. In reality, you and I are in the same business." - Jean-Baptiste Emanuel Zorg, The Fifth Element

I mentioned the broken window fallacy in my last post on Paul Ryan, and thought it would be good to go over it a bit more here.

The fallacy of the broken window is possibly the most famous parable in all of economics. It was originally created by Frédéric Bastiat, a french economist, in 1850. It's essential purpose is to show that destruction does not help the economy, but in fact, hurts it. While this seems painfully obvious to most people, this fallacy comes up a lot, especially with politicians.

The parable basically goes like this.

A shopkeeper's careless son breaks a window. The shopkeeper was upset by this, naturally, but whenever he talked to anyone about it they just said "That sucks, but what would happen to the glazier if no one ever broke windows?"

The shopkeeper must now pay six francs to the glazier to fix his broken window. This act of destruction has therefore encouraged trade. That's obvious, or as as Bastiat said, "that which is seen".

It is wrong, however, to say that breaking windows is a good thing, that it benefits society, and that it encourages economic growth, then you are ignoring "that which is not seen."

If the window had not been broken, the shopkeeper could have spent his money on something else such as shoes, and he would still have his window. All these things are not seen, and that's what has been lost.

This accident has kept the shopkeeper for improving his life, but instead must work to get back where he already was.

The moral of the story is, of course, that destruction destroys things. It very clearly shows the idea of an opportunity cost, that is, the cost of what the shopkeeper could have done with his time and resources. If breaking windows really helped the economy grow, how much more would economic good could we do if we destroyed the entire house instead? Or even the rest of the town?

This fallacy has sneaked into modern economic theories in many ways.

By inflating the money supply, the Federal Reserve "encourages investment" by making the dollar worth less and less, making people want to buy things.

Keynesian's so called "wartime prosperity" employs men and scarce resources so that they may be blown up while also blowing up the other countries men and scarce resources.

During the Great Depression, farmers were payed to not grow crops and kill excess livestock so that the price of food would go up under the Agricultural Adjustment Act while people were starving. Destroying crops not put food in people's bellies.

Obama's "Cash for Clunkers" program bought up old cars with taxpayer money, then had those cars destroyed to encourage people to buy new cars.

Why, just a year ago Paul Krugman spoke of how faking an alien invasion would theoretically save the economy! These people are nuts!

"If we discovered that space aliens were planning to attack and we needed a massive build-up to counter the space alien threat, and inflation and budget deficits took secondary place to that, this slump would be over in 18 months. And then if we discovered, "whoops, we made a mistake," we'd [still] be better..." - Paul Krugman

Economic growth is no different than GDP to these people. Just a number on the screen. Spending, even wasteful spending, is what's important to them, and because of this flaw they miss the entire point of spending: Production. The purpose of the economy is the satisfaction of man's material desires by the production of goods and services.

The Effect of Minimum Wage

Caring for the poor is a popular position. If someone brands themselves as anti-poor, they are not likely to make many friends. Because of this, governments have issued many things that they label "pro-poor" legislation. And if you hate this, you must by extension hate the poor.

Of course whenever a politician speaks of being charitable, they do not mean themselves. Welfare states are not paid for out of the pockets of politicians. This is not charity, and you are not made a good person by supporting it.

But hey, maybe it does some good. People shouldn't expect to keep everything they earn with their sweat and blood, right? Well, not really. Let's look at one example: the minimum wage.

The minimum wage is a move for fairness, right? It keeps workers from being exploited, and guarantees them a decent living wage! We're stopping those greedy rich people from exploiting the poor.

Well, let's look at the root of this issue. Before the minimum wage, it was not like people were being enslaved. Rich people did not gather up the poor off the street, force them into buildings, and make them work for so little. These people voluntarily chose to work in this state. Because of self-ownership, I have a right to sell my labor for any price that I want. I could put my expected ridiculously high, or ridiculously low. That's my right. My body, my labor, my rules. Trying to set a minimum wage is not stopping exploitation, it's simply stopping voluntary exchange, which is our right to decide, not theirs.

They claim ownership of your labor, because you're too stupid to know what you're supposed to sell your labor for. And don't you dare go against our orders. The minimum wage is patronizing.

On top of being fundamentally morally flawed, the minimum wage has practical issues as well. What made us think that these people were really "exploiting" workers before? Why are most people paid above the minimum wage? Shouldn't these greedy businessmen just drop all jobs to minimum wage price so that they could get more money?

Like most things in economics, this gets back to supply and demand. Companies want to attract the best workers they can from other businesses. To do this, they offer things like higher wages, working conditions, and other benefits. To be able to buy labor, employers need to offer good things in return.

There is also the problem of eliminating jobs. Let's use an extreme example to show this flaw. What would be wrong with raising the minimum wage to $1000 an hour? The poor with jobs would certainly be a lot better off! But that's exactly the problem. The poor wouldn't have jobs. No one is going to hire someone else at a loss.

To illustrate this, lets look at two examples. In the picture below, Bob's work produced $10 profit and he was paid $8 per hour, leaving his employer with $2 profit. Now if the minimum wage was raised to $9.00 per hour, Bob would get a $1 pay rise. His employer would see that he could still make $1 profit from Bob's labor, and therefore will keep him. The minimum wage benefits Bob, at the expense of his employer who had previously paid market price for Bob's labor.

But Simon, in the picture below, is not so lucky. His job only produced $4 an hour. If his employer were to continue to hire him, he would be losing $5 per hour. Simon's job is simply not profitable any more, and he will be fired. And to make matters worse, since Simon probably has low skills, it will most likely be extremely hard for him to find work somewhere else, as other businesses will likely face the same unprofitable problem.

The poorest of the poor, the ones most desperate are the ones truly hurt by the minimum wage. We eliminate the best changes these people have to improve their lives. We turn our backs on the most needy. Those low paying jobs would be crap, certainly, but they could have provided valuable experience and allowed the poor to more effectively rise out of their situation.

This is why a minimum wage is often said to remove the steps from the economic ladder.

Now, I can understand how many people might take pity on those less fortunate than themselves. I really do, and I feel the same way. But the best way to solve their problem is not to dictate to them what they can and cannot sell something at. Without outside intervention, free markets are fantastic at equilibrating. If labor is cheap somewhere or there is high unemployment, that low priced labor attracts businesses. And as more businesses come into the market, wages go up as people compete more and more for labor. Unemployment levels drop because the cheap labor attracts new businesses and new jobs. That's what helps the poor.

Trying to interfere in this voluntary exchanges just messes things up.