Many of us have heard about the broken window fallacy. But for those who might be unfamiliar or need reminding, let us briefly go over this.
Suppose the economy in my town is struggling and I want to do something to help. What could I do to help the local economy along?
Let us suppose that I am a good Keynesian. I agree with Keynes that spending money is itself a good way to stimulate the economy. I figure that perhaps I should try to find ways to get people to spend more money on stuff. Now how to do that?
I pass by a construction site and see a big pile of discarded bricks. Next to that is a row of shops with nice sparkling new windows. Those look nice and expensive. Someone surely paid a lot for them. I wonder how much it would cost to replace them…
And that is when I get a brilliant idea! What if I were to take the bricks and smash the windows! Not just these nice new windows, but as many windows as I could? Then the shopkeepers would have to spend money buying new windows. Instead of hoarding all their money in big fat bank accounts, they would put their money to good use and give it to the glaziers to replace their windows! All that spending would be good for the economy!
That would be more money for the glaziers and then they could spend that money somewhere else and so forth. Imagine the economic boon to be gained. And all I have to do is run around town smashing windows! See, this is very literally a broken window fallacy we are talking about in this example.
It might seem rather obvious that this is an extremely foolish plan. Surely nobody would do this. And indeed, very few people would ever do this. Many people might accept that this is indeed a very bad idea.
So why mention it? Because while a lot of people might not go around smashing shop windows, this illustrates the serious flaws in a lot of peoples economic thinking.
Perhaps the most obvious problem with this is that it focuses very much on only the most immediate consequences of this act of vandalism. The shopkeeper will indeed have to replace his window. The glazier will indeed receive some money for his work.
But we must look beyond this and look at the bigger picture. Now the shopkeeper has a broken window and he must pay, say, $500 to replace it. That is $500 he could have used to invest in his business. He could have bought stock, spent it on advertising or hiring extra help during busy times. He could have used that money to help grow his business and get more customers or increase the productivity of his business.
Perhaps he was planning on saving that money or investing it in some other business. Either way that money could have been used to help fund other businesses and make them productive. All while earning the shopkeeper a little interest on his $500.
Either way, before he lost his window, he had the value of the window and $500 he could have spent on growing his business, paying staff, put in the bank or any number of things which are of unquestionable economic benefit. But after the window was broken, he has only the value of the window and no $500.
Yes, the glazier is $500 richer, but how much does that matter? His gain is the shopkeeper’s loss and so the economy is not any better off than it was before. The $500 simply exchanged hands.
Perhaps this helps to show why spending is not itself any kind of economic boon. Just because money has changed hands, it does not follow that the economy is growing or that wealth has been created.
We need to ask ourselves if the mere act of spending money is an economic plus. Does the fact that money changes hand mean that wealth has been created?
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