Broken window facts and fallacies.
The broken window ‘fallacy’ is an enduring parable invented by Frédéric Bastiat in 1850, and popularized in English by Henry Hazlitt (chapter 2) in Hazlitt’s attempt to combat the rise of Keynesian economics after the Great Depression. The parable is primarily misused by austerians* in an effort to discredit Keynesian economics by associating it with a story about stupid policy: breaking windows. Austerians who misuse Bastiat’s parable of the broken window to refute Keynesianism are committing a Petitio Princpii fallacy. They assume what they purport to prove. They assume that breaking windows cannot grow the economy because there is already full employment. In Bastiat’s parable, breaking a window would simply redirect workers from doing the work they had been planning to do. In Bastiat’s original example, the person whose window had been broken was planning to spend the time creating new shoes and ended up repairing the broken window instead so there is no change in employment because he is already working as much as he wants to work. Because the parable assumes no resources are unemployed, obviously a broken window cannot reduce unemployment and grow the economy. But this is a straw-man argument because nobody argues for Keynesian stimulus when unemployment is low. Bastiat’s parable essentially assumes that unemployment is zero and then says breaking a window cannot reduce it below zero. That reasoning agrees with Keynesian theory because Keynesians support austerity when unemployment is zero, but when a recession causes unemployment to rise, a fiscal stimulus can do some good.
A parable about Robin Hood breaking windows can easily illustrate how Keynesian theory actually works. Suppose the Sheriff of Nottingham decides to hoard as much of his money and his lands as possible. He doesn’t buy services from the villagers nor let them hunt nor farm in his empty lands in Sherwood Forest and this creates unemployment. In the Robin Hood legend, he begins creating work for his band of merry unemployed men by stealing the Sheriff’s game animals from Sherwood Forest. They illegally hunt to feed the villagers and this is tantamount to breaking windows, but in this story they are destroying and devouring wild animals instead of destroying glass. When Robin Hood creates jobs stealing from the elites and giving to the poor, he is not simply redistributing resources, he is increasing GDP by putting unemployed people back to work (hunting) and using underutilized capital (Sherwood Forest). It would be more productive to farm the forest land, but the Sheriff’s men can easily control farmland and Robin Hood doesn’t have the military might to secure the land for farming. The best Robin Hood can do is steal illegal game in the lightly-guarded forest because the Sheriff’s gold and other possessions are impossible to steal because they are locked inside his heavily-guarded castle and Robin Hood cannot create jobs by employing the villagers to steal anything else.
If Robin Hood cannot steal the Sheriff’s unproductive hoard inside the castle, the only other way for Robin Hood to create jobs for the villagers is to get the sheriff to spend some of his hoard by destroying something the Sheriff will want to rebuild. A simple way would be for Robin Hood to use his arrows to break some castle windows. That gets the greedy Sheriff to spend some of his hoard again to hire unemployed villagers to rebuild the windows (and perhaps hire other villagers to guard against Robin Hood). This is mmutilitarian efficient because it grows GDP by making unemployed resources become more productive. Unemployed workers can produce windows and earn a living to feed their families. And some of the unemployed gold that the greedy Sheriff had hoarded becomes productive once again by circulating in the economy rather than just sitting idle in his treasury. Money is only productive when it is circulating and facilitating economic exchanges, so this also acts as a monetary stimulus. Note that monetarism works the same way as Keynesianism and ends recessions by punishing the hoarders and encouraging the spenders.
So breaking windows can be a useful stimulus if there is a recession caused by hoarding (which is the usual reason for recessions) and if it causes redistribution of under-productive resources from hoarders to consumers. But breaking windows would be a ridiculously wasteful kind of stimulus that nobody would advocate except if all other options are impossible. Robin Hood would much rather simply steal resources from the Sheriff and redistribute them to the poor because that would be a much more efficient stimulus. Robin Hood doesn’t want to break window just to be spiteful. His purpose is not make the Sheriff suffer. His goal is to help the poor and although breaking windows is a stupid way to do it, it may be the best choice in this unfortunate scenario where the Sheriff’s stupid hoarding is keeping everyone else desperately unemployed.
Keynesians don’t promote spending money on wasteful projects like breaking windows because there are so many needs that projects can try to meet.** Keynesians prefer to promote increased government spending on productive services like teachers and and investment like road building that inherently improves life. Although Keynesians mostly justify their policies using mutilitarian ethics, their policies usually also produce medianist outcomes because Keynesianism only works by redistributing resources from (mostly rich) hoarders to consumers closer to the median and below. Despite the differing ethical basis, medianism supports Keynsianism against austerians like Michael Kinsley and the BIS.
The Robin Hood parable illustrates why Keynesian economics is so politically polarizing. Keynesian economics only works by redistributing money from savers (richer than average) to consumers (less-rich than the average saver). That is why many rich elites are so passionate about opposing Keynesianism. Economists rarely acknowledge this fundamental reason for political tension because economists shy away from talking about redistribution, but it is baked into the Keynesian cake. The Robin Hood parable makes it memorable. The burden of government spending disproportionately falls on wealthy people in democracies. Wealthy people prefer to promote tax-cut Keynesianism as an alternative to Keynesian spending, but both forms of Keynesianism work in the same way. In the Disney version of Robin Hood, the Sheriff taxes the villagers too much and Robin Hood steals from the Sheriff and gives money back to the poor like a tax rebate. This is another form of Keynesian stimulus, but tax cuts only work to stimulate the economy if they increase the incomes of consumers who will spend the money and not if they increase the incomes of hoarders who simply lock more money away. Giving a tax cut to the Sheriff would do nothing unless he spent more to hire the villagers. Because the poor and middle class are better consumers than rich elites, a tax cut for the poor works much better to stimulate the economy than a tax cut for the wealthy people that pay the most taxes. Unfortunately, some tax-cut Keynesians are elites who just want an excuse to reduce their own taxes. Tax cuts for elites who hoard the money are ineffective stimulus compared with tax cuts for the median and below who have a much higher propensity to spend the money.
The elitist tax-cut ‘Keynesians’ have it backwards. Tax cuts for the middle and bottom of the income distribution are much more stimulative than tax cuts for the rich because non-rich people tend to spend money whereas the rich just tend to add it to their hoard. That is exactly what happened to much of the tax rebate checks that George W. Bush sent out in 2008. A lot of the money went to wealthier households who hoarded it, and what went to the median household (and poorer) was spent and that stimulated the economy. But high-income households pay most of the taxes and so a disproportionate amount of the tax rebate went to them and they tended to hoard it rather than spend it. Some research found little stimulative effect because even many of the low-income people used the rebate to pay back debt and thereby gave their money to the hoarders rather than spending it.
A reverse example is the payroll tax hike of 2013 which reduced take-home pay by 2 percentage points, but only on wages under $113,000. That means that almost all American workers had a tax increase this in 2013, but billionaires were scarcely affected. Whereas there was a tremendous fight in Congress about whether to raise taxes on the top 2% richest Americans, all workers saw our taxes rise without any struggle in Washington at all because Congress was more opposed to tax hikes for elites than tax hikes for ordinary workers.
Whereas medianism supports Keynsianism because it helps the median of the income distribution (and below), Keynesian economics is favored by mainstream economists on mmutilitarian grounds–because it increases GDP. Medianism agrees with the part of Bastiat’s parable that ridicules mutilitarian values. Bastiat’s parable is a good illustration of how mutilitarianism could go astray. Breaking windows (or a war, natural disaster, or pollution) never decreases GDP levels, so it is never bad according to naïve mmutilitarianism. Professional economists are rarely this naïve, but defenders of military spending sometimes come close. For example, Paul Ryan and Mitt Romney were criticized by libertarians for using this sort of mmutilitarian economic reasoning to support increased defense spending. But outside of military spending, Ryan and Romney had often used austerian logic against government spending that they opposed. So Ryan and Romney agreed with Keynesian logic for defense spending and tax cuts, but opposed Keynesian logic for many social programs.
Bastiat was attacking the mutilitarian logic that defense spending is always good for GDP. This is often derided by calling it military Keynesianism, but that is a misnomer because Keynesians support cutting government spending when unemployment is low. Military spending, like all government spending, is only good if it is more productive than its opportunity cost and the opportunity cost rises during economic expansions when businesses want more workers. In 2012, Ryan and Romney’s military spending priorities agreed with Keynesian logic because there happened to be high unemployment at the time and so there was a Keynesian justification for military spending. But Keynesians should support decreasing government spending when unemployment is low and Bush’s chief economic adviser Michael Boskin opposed defense cuts in the mid 1990s when unemployment was low by arguing that it would increase unemployment. That is not Keynesianism, it is a true example of the broken window fallacy. Keynesianism recommend cutting government spending because unemployment was so low. When resources are fully employed, Keynesians agree with the broken window fallacy.
When hoarding (wastefully saving) causes a recession, the opportunity cost of government spending is extremely low for spending that redistributes resources from the unproductive hoarders who have too much to the unemployed who have too little. During economic expansions when unemployment is low, the savings (mostly of older, richer people) are productively channeled by financial institutions to borrowers who need the money more than the savers. Like an invisible hand, finance channels the impulse to save and hoard into productive activity by lending savings to people with a greater need of the resources. When a recession happens, the invisible hand of finance stops channeling savings to put people to work. Instead, the invisible hand of finance puts savings into unproductive dragon hoards. Then the money leaves the economy which makes the economy poorer. Workers lose their jobs due to the lack of spending and factory owners go bankrupt because their factories sit idle. Keynes’ genius was in realizing how monetary and fiscal policy can be used to make the the clenched hand of finance relax and release the hoards to get people (and our capital equipment) working productively again.
* ‘Austerians’ are people who want the opposite of Keynesian policies. In many cases it is because they actually believe the broken window fallacy is a fallacy. Unfortunately, there has been little support for Keynesian policies in government after the beginning of the 2008 recession. Obama was Keynesian only for his first year in office and then he abandoned Keynesianism and became an austerian.
**Keynes is often quoted out of context about digging holes and then filling them up again in an attempt to discredit Keynesian ideas. He did say that it could be worthwhile to pay unemployed people to bury money so that other people could dig it up, but in this case he was writing a parable to ridicule the defenders of the gold standard. He was not suggesting digging holes as a stimulus plan. This is clear if you read the context of the quote that he sees the gold standard as encouraging people to wastefully go out and dig holes looking for money. Later in chapter 16, Keynes again discusses his earlier section about wasteful spending on digging holes and building Egyptian pyramids and reiterates that although it would work as a stimulus, it is ridiculous to think that such wasteful spending could be the optimal choice when there are many more useful things to produce.
For further reading: see how the textbook macroeconomic model of recessions should be written.