Get ready for a bunch of demand-side economists to tell you that the post-Hurricane Irene rebuilding phase is actually a good thing for future economic growth. But don’t believe it.
Who has it right?
Joshua Shapiro, chief U.S. economist at MFR, Inc., delivered my favorite quote on the subject to the New York Times: “If you’re in the middle of recession, you just wander around blowing up buildings, and that would be your path to prosperity. And clearly that’s not the case. It’s not the case with a natural disaster either.”
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Echoing this thought, Ian Shepherdson, the chief U.S. economist at High Frequency Economics, bluntly noted on CNBC’s website that “no one is made better off by the destruction of their home or workplace.” He acknowledged the benefits of reconstruction work, but he dismissed the idea that somehow this is a net win for the economy.
It sounds to me like both of these gentlemen are recalling the parable of the broken window, introduced by French free-market philosopher Frederic Bastiat in an 1850 essay called “That Which Is Seen, and That Which Is Unseen.” While Bastiat agrees that repairing broken windows is a good thing, encouraging the glazier’s trade and income, he argues that it is quite different from the idea that breaking windows is a good thing, in that it would cause money to circulate and encourage industry in general.
Why? Because a shopkeeper who spends money to fix broken windows cannot spend or invest that money on new ventures.
“It’s not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library,” wrote Bastiat. “In short, he would have employed his six francs in some way, which this accident has prevented.”
In other words, the business people who are spending to fix the damage of Hurricane Irene are not spending or investing that money on brand-new ventures or start-ups, or on ordinary goods and services. That’s the real economics of Hurricane Irene.
There was a lot of damage incurred along 1,100 miles of U.S. coastline. Tragically, 28 deaths have been reported so far. There were toppled trees, power-line disruptions, and flooding on damaged roads. Homes, commercial buildings, and factories all stopped for at least a couple of days. In some sense, the human distress has been even greater than the economic distress.
On the other hand, lost sales, foregone consumer spending, and temporary stoppages of production and employment will all be recouped in a relatively short period of time. Mark Zandi of Moody’s Analytics suggests that the economic toll will be in the billions, but not the tens of billions. (Remember, total U.S. GDP is roughly $15 trillion.) So there’s no black-swan event here that will throw our fragile economy into a double-dip recession.
Yes, the economic blow from Irene is noticeable, but it’s temporary. In fact, what makes this economic setback even less worrisome is that it occurred over a weekend. You really didn’t even lose two days of economic activity.
Restaurants, retailers, baseball games, and Broadway shows all shut down, but only for a short bit. And actually, there was a lot of consumer buying in the days leading up to Irene. People went to Home Depot and Lowe’s to find stuff to board up their windows. They went to Costco for food. And they went to Wal-Mart and Dollar General for all sorts of things.
When the final tally is in, Irene may or may not qualify as a top-ten hurricane. But the history of such disasters is that the national economy rebuilds and snaps back shortly thereafter. Nonetheless, the economic rebuilding essentially gets you back to where you were before the storm. Unfortunately, there is virtually no net new investment from all of this.
That said, if President Obama tries to use Hurricane Irene as an excuse to pour tens of billions of new infrastructure dollars into the economy, he’s barking up the wrong tree.
For just as Bastiat’s seen-and-unseen analysis holds for the shopkeeper repairing his window, it also holds for the impact of massive government spending on the whole economy. It’s a huge mistake, and a consequence of our fiscal profligacy, when private money is not spent on new investment because funds are absorbed by big-government borrowing.
If we are to restore strong economic growth and job creation we require measures like pro-growth tax reform or regulatory rollback and repeal. In this sense the new House Republican plan just released by Majority Leader Eric Cantor to repeal job-destroying regulations — especially on labor and the environment — makes a lot more sense than throwing money at FEMA for new infrastructure banks.
Breaking fiscal windows is just as ineffective as breaking the shopkeeper’s pane of glass.
– Larry Kudlow, NRO’s economics editor, is host of CNBC’s The Kudlow Report and author of the daily web log, Kudlow’s Money Politic$.
There's an important distinction with the broken-windows parable. If the shopkeeper's windows are broken, whether by vandals, by a storm, by an angry woodpecker, whatever, his profits by fixing them arises from making his business normal and hygienic. He shows that he cares about his atelier's appearance and will not tolerate small breaks. If this is not done, his business looks bad and he invites further damage from vandals.
When small repairs are in fact attended to, he shows that he cares about his appearance and potential customers conclude that he cares about his goods and services.
Isn't this the thinking that Rudy Giuliani employed so successfully in straightening out New York in the 1990s? Attend to small breaks, or in this case to small crime, and you will get far fewer large breaks/less serious crime?
Different broken windows. What you describe is the criminological broken windows theory introduced by James Q. Wilson in the 1980's. Not to be confused with the broken window fallacy introduced by Bastiat in the 1800's. The latter is about economics and not crime.
The difference is that fixing the broken window does not create any net new economic activity.
In the criminal justice sense, disuading future crime does not create new economic activity either. It just attracts that activity back from whatever parts of the city/state/nation that it had fled to in order to protect itself from crime.
@MarkW - "The difference is that fixing the broken window does not create any net new economic activity."
(Note: I agree with you, but I'm clarifying.)
It actually does create net new economic activity, which is why it's so easy to believe the fallacy. The problem is that it doesn't create net new wealth. What happens is that it makes the shopkeeper spend his SAVINGS on the window, or possibly take out a loan for the same purpose. All else being equal, he'll have the same sales as before (same "economic activity") plus he'll have caused "new economic activity" by fixing the window. But, he's poorer.
The flaw that Bastiat points out is that the savings WOULD have been spent on something else at some point. In the modern world, he could have added that savings typically sit in various kinds of bank or broker accounts, thus contributing either to the total pool of available credit or serving as an investment in other enterprises. Thus the shopkeeper has not only lost the price of the window, he has lost the interest on his savings or (worse) is stuck paying interest on a loan. AND he isn't investing as much as he would otherwise, so his lost wealth cannot contribute to society's credit/investment needs.
The value of capital in society tends to grow exponentially, if you let it. That causes "net economic activity" to increase exponentially, if you let it. The flaw of Keynesianism is believing that "forcing" increased economic activity grows the economy. It cannot. The economy cannot grow without also increasing net wealth. Destroying wealth can cause a temporary uptick as people work to fix what was broken as quickly as possible, but because long term growth depends upon net wealth/capital available, we end up exponentially behind where we would have been without the destruction.
Isn't Bastiat's broken glass fallacy parallel to the liberal theory of unemployment compensation? Nancy Pelosi is forever talking about unemployment payments building the economy, but it seems to me that the formerly employed would buy a lot more glass with full paychecks.
Bastiat's essay is a classic. But I think the short, modern explanation is that people get confused about the difference between assets and income. If someone steals money from my bank account, I may work overtime to replace it. My income this year (analogous to GDP) is consequently higher. But I'm not better off - my bank account is just back to where it was before the theft.
"Because a shopkeeper who spends money to fix broken windows cannot spend or invest that money on new ventures."
Mostly true, but not entirely. In the earlier days of banking, the credit cycles were often quite volatile with steep recessions, large asset deflations, and a lot of bank failures. This is why old-timers became economically parsimonious --- holding money as an appreciating asset. They would often be extremely thrifty, and after loss of money to bank failures they held reserves in a buried cream can. This money was neither invested or spent--- dead money to the economy.
If the shopkeeper was one of those pessimists, then spending for broken windows does stimulate the economy.
I suspect that the war bonds sold during World War II pulled a lot of hidden money back into circulation that was otherwise unavailable to the economy.
Did I miss the announcement that NR is running a "Most Pointless Article and Discussion" contest? If it's not too late, I vote for this one! The only thing missing is Larry the K talking over everyone.
Look at it this way - replacing a window costs money but doesn't result in any new asset value. The net value of the building has not increased - you got nothing tangible for your money. But installing a window while building a house does result in new tangible value.
Of course we all remember the economic boom that occurred after 9/11 due to the destruction of the Twin Towers. If you have forgotten, just ask Krugman about it.
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