Saturday, April 12, 2008

The Broken Window fallacy

I was just watching Neil Cavuto (well, listening, since I was facing the other way), and heard some moron advocate the economic fallacy that “creative destruction is good for the economy”.

The idea is an odd one, and easily disproven, even though it is a popular fallacy.

The scenario is this: a shop keeper is open for business when some young ruffian comes along and tosses a brick through the front window of his shop, shattering it. People come along to see the damage and start contemplating that the broken window is actually a good thing, because the shopkeeper will now have to hire a glazier to replace the window, and the glazier therefore gets business he might not have otherwise gotten. The glazier will then be able to spend that additional income on things he needs, causing additional ripples throughout the economic cycle, and that must therefore be a good thing for the economy as a whole.

Therefore, destruction is a good thing for the economy.

One problem.

The shopkeeper, who had been slowly accumulating a small sum of money he had wanted to spend on (say) a new suit, must now perforce spend those accumulated funds on a new window instead of the new suit he had wanted. So instead of having a window and a new suit, he is forced to be happy with just having the window. And while his money would go to the glazier, causing that ripple, it is now not going to go to the tailor, who would have made the new suit, and then spent that income in those expanding ripples, exactly as the glazier did.

But now the economy is missing a new suit, and is just that much poorer, since the wealth that would have created it now must be used to repair the damage. But because this new suit is never seen (since it was never made), the missing suit escapes the notice of the public, and the only one who knows about it is the shopkeeper. This is because Need is not the same as Demand. The shopkeeper didn’t need a new window, because he already had a window, and the savings would have been used for a different demand.

If you ever hear anyone arguing that natural disasters are good for the economy, feel free to laugh at them, and invite them to stand behind what they believe by destroying their belongings.