Blessed Are the Peacemakers
OK kids, this broken window stuff is really getting out of hand. The problem here is that we’re not even arguing over economics anymore, we’re arguing over who said what and getting really huffy. (As usual, I am totally right and everyone who disagrees with me is either stupid and/or lying, but I’m used to that by this point in my life…)
Here are some possible positions that people might have. Note that in the following, I am going to assume for the sake of argument that it makes sense to quantify “economic benefits” to particular individuals in dollar terms, and that these benefits/harms are interpersonally comparable. I don’t want to argue about the legitimacy of such a move (feel free to do so in the comments); I’m just trying to clarify everybody’s arguments so we can resolve this dispute, and let Miller Time commence.
POSSIBLE POSITIONS ON DESTRUCTION AND THE ECONOMY:
(A) It is good on net. E.g. an earthquake wrecks a $1 billion building, this causes the owners/insurers to spend $1 billion repairing it (so they are that much poorer). However, because there were originally unemployed workers, they benefit $800 million from that round of spending–they valued their leisure at $200 million but now have $1 billion more in income. However, there are further rounds of spending and income generation because of the famous multiplier. When all is said and done, the original $1 billion in extra spending generated $1.84 billion in extra income in the economy. When you subtract out the 20% because of lost leisure, the gain (disregarding the loss of the building) is $1.47 billion. Subtracting the original loss of the building, there is still a $470 million net social gain. The economy truly is that much better because of the earthquake. Some people lost and some people benefited, but in general people are richer–all things considered–because of the mild earthquake.
Note that this approach isn’t susceptible to exaggeration. If the earthquake had caused $10 trillion in damage, the effect would flip, because once we hit full employment the multiplier would drop to 1 (instead of 1.84), and also because the opportunity cost would jump to 100%, not 20%. (I’m not sure if these are two sides of the same coin, or two separate considerations. I’m going on 5 hours of sleep and 9 hours in the car today, and remember, I’m not a Keynesian. But I think a Keynesian could fix up the above to be “right.”)
(B) It is bad on net, but because of originally unemployed resources, it isn’t as bad as the original gross damages would suggest. E.g. an earthquake wrecks a $1 billion building, this causes people to spend $1 billion repairing it, so the owners/insurers are $1 billion poorer. However, after all the rounds of new spending, the originally unemployed workers gain (say) $300 million over and above their foregone leisure. So society on net is worse off–by $700 million–but it’s not out the gross tab of $1 billion as a libertarian would have naively thought.
(C) It is bad on net, just as the gross damages would suggest, because the economy was originally at full employment. (This should be obvious; the economy is down $1 billion because of the earthquake.)
(D) It does $1 billion in gross damages, and net damages, even though there were initially unemployed resources, because the Keynesian “multiplier” is goofy. (This is the position I was arguing for in my Mises article and in the comments here at this blog.)
So I claim that tons of casual statements in the media fall under (A) above. Further, I claim that Krugman has been slippery and it’s not at all clear whether he agrees with (A), or the weaker claim (B). For sure, if Krugman thinks (B), then (A) should just be a matter of empirical case studies; there’s no theoretical reason to think (B) is possible but (A) is not.
My position is closest to D, but I’m not sure if mine is equivalent. I’m saying that in any case where you can point to any benefit to someone as a result of a wealth-destroying disaster, you can achieve the same benefit without the loss of wealth. (e.g. instead of breaking the window, just take $X from the building owner and give the glazier a welfare payment)
So no matter how close to “full employment” you think the economy is, or how “idle” you think resources are, there is still a net social opportunity cost to an economic disaster which eliminates the supposed benefit of getting those workers employed; and any right-thinking method of cost accounting or economics would regard the net cost as equal to the lost wealth; and those that don’t are preached by economists who have truly lost sight of their field’s grounding.
***
There’s a more fundamental point here though (that I should make on my blog rather than introduce another tangent). Note that everyone keeps assuming that “obviously” the window has to be fixed (i.e. that the best use of a marginal unit of resource is to apply it to fixing the window until it is restored to its previous state).
But hidden in that (admittedly reasonable) assumption is a kind of thinking that shows the real mechanics behind broken window effects and the merit of the Austrian/PSST-coordination theory of recessions. To the extent that people were idle before the window breaking AND it is obvious that the window must be immediately fixed, has accomplished something noteworthy: it has clarified for people what the optimal use of resources is.
This is, assuming (to be most generous to Keynesians) that some recession was going on, entrepreneurs were having a hard time establishing sustainable patterns of specialization and trade, a hard time recognizing opportunities and finding ways to employ workers (and capital goods) that best utilize those means. The assumption of the importance of fixing the window thus has a hidden significance: it answers everyone’s question about what they should be doing next! Instead of hunting around for what’s in demand, what’s not, and how we can adapt to this new reality, we have an easy answer: you gotta fix this window, and you know how to do it.
But that hidden assumption effectively assumes its conclusion! For imagine: what if someone broke a window in a run-down neighborhood *already* littered with broken windows? Well, then it’s not such a pressing matter to have this one fixed, is it? It’s just as “obviously” a “good” use of resources to fix this one as it would have been to fix any of those other broken windows!
So we see the true source of any purported benefit from breaking a window: the sudden contraction in our uncertainty about what needs to be done, given available means and wants. But breaking a window needn’t solve this problem either!
(Please tell me I’m making sense.)
Oops, “it is obvious that the window must be immediately fixed, has accomplished something ” should be
“it is obvious that the window must be immediately fixed, the breaking of the window has accomplished something “
Excellent point about the assumption that the window will be fixed. What if the shopkeeper can’t afford to repair the window and he just closes down? Do we still have a net gain?
Thanks! (You caught my attention for a minute there because I have a brother named Joshua, and your icon pic looks just like him!)
You are making sense.
You are saying in the event of a disaster immediately visible trade opportunities may arise to once again reach an optimal distribution of material goods.
But the disaster may also do no such thing.
e.g. a hurricane comes through an area full of *idle* homeless people, and destroys the few homes that exist there. Everyone knew that homes are the material good people need even before the hurricane but for whatever reason people were still idle (no trade opportunities to build the homes that gave more utility than just bumming around all day). So its very possible the hurricane does nothing to stimulate anything (although due to diminishing marginal utility, maybe some trade opportunities that gave more utility than bumming around might arise for the first house or whatever)
Oh, I agree — any optimality in the reconstruction will only be relative to the situation as it was *given* the disaster — it would still have been better for the disaster not to happen. It’s just that part of the *appearance* of stimulus is due to how it’s easier to identify opportunities.
It’s like an unemployed job-hunting dude accidentally drives into a lake. Previously, he didn’t know what to do — lots of things to try, but no idea whether any of them will get him a job. Now, he knows EXACTLY what he needs to do (GTFO of the car and to shore) — no more ambiguity there! But he’s still much worse off than if he hadn’t driven into the lake at all!
Note that everyone keeps assuming that “obviously” the window has to be fixed
No, you are not making sense. Actually, everyone keeps assuming that obviously the window didn’t need to be fixed in any case.
It’s all about what kind of assumptions one makes on the net saving / spending behaviour of participants, as it has already been explained.
http://consultingbyrpm.com/blog/2011/08/correcting-the-keynesians-on-the-broken-window-fallacy.html#comment-23007
To buy the explanation you linked to you have to accept that, absent government intervention, prices don’t adjust to clear the market. That is the issue here.
You are asking people to accept a conclusion based on a premise they do not accept.
That has to do with the lack or not of spare capacity to increase production. That’s another extra assumption which might be independent of the behavioural ones.
Anyway I don’t understand why all the fuzz about this broken window fallacy. It’s only a fallacy under certain assumptions but not under different ones.
Possible outcomes range from a clear net loss (the broken window is not repaired) to some net gain through the spending multiplier.
The only thing that can be argued about is the likelihood of each outcome, which depends on the likelihood of your behavioural assumptions, and the existence of spare capacity to increase production without raising prices.
Possible outcomes range from a clear net loss (the broken window is not repaired) to some net gain through the spending multiplier.
Spending multipliers don’t create economic gains.
If everyone started to spend 100% of their incomes immediately on consumption, then the multiplier would skyrocket, but the economy would collapse.
No, you are not making sense. Actually, everyone keeps assuming that obviously the window didn’t need to be fixed in any case.
Wrong. All the Keynesian and anti-Bastiat arguments assume that if you break the window, someone will pay to have it fixed, because they will regard it as the best use of resources.
I have now demonstrated why this is subtly assuming away a critical dynamic, which accounts for the apparent benefits of window breaking when examined closely.
I am the master.
True, the master of puppets (austrians).
So… like a puppetmaster then (aka a puppeteer)?
Wow! The coordination point idea is definitely cool.
I think it can be completely expressed in resource terms (without any money or multiplier confusion). We can imagine two alternate scenarios, one with the broken window (P) and one without (Q). For each scenario, consider the net set of goods which would be produced. If P is Pareto superior (let’s say that the coordination gains from repairing the broken window will produce the window AND more goods than Q), then everyone is better off in P (with the broken window!)
In addition, I think you’re making another point. It’s true that any actor who perceives scenarios P and Q can nudge the economy toward P (or at least campaign for it). But you’re saying that he can also construct an even more superior scenario R in which we keep the window unbroken. We just go to the guy who owns the window and point out the pattern of production that could be kicked off by funding the glazer. If the resulting pattern is really Pareto superior, then he will fund it voluntarily!
Exactly! One more person who gets it!
I wish I could have written Silas’s comment myself. Bravo!
I love it when you always come in with a cool head after things get out of hand.
I’m with you on (D).
The multiplier doctrine is utterly fallacious. The only incomes that can possibly rise on the basis of it are profits, not wages. They cannot claim that what they really mean by it is that an inflation financed round spending will result in a rise in the demand for labor and other factors of production. The multiplier doctrine explicitly states that incomes are raised only insofar as the additional incomes relating to the additional revenues are consumed, that is, NOT saved and spent on labor and other factors of production, and that the rise in incomes will be higher the larger is the “marginal propensity to consume” and will be lower the larger the “marginal propensity to save.” If any of the additional income is saved, then it is a “leakage” and is detrimental to recovery.
The notion of “income” is treated as a positive, which means even if the incomes are entirely generated by consumption spending, then it is allegedly economically beneficial. If everyone took their earnings and consumed the entirety of it, then incomes would grow substantially, for consumer goods companies. But it would be an impoverishment, because the demand for capital goods would collapse to zero, and the demand for labor would collapse to zero.
Keynesians simply don’t understand that macro-economically, consumption depends on saving and the production process, both physically and monetarily, not the other way around. All wages are paid by savings, not consumption. All capital goods are paid by savings, not consumption. Savings are in fact the overwhelmingly greatest source for most spending in the economy.
The lunacy inherent in (A), that “wealth destruction can be good for the economy on net,” is quoted by Krugman on more than one occasion. As Murphy quoted Krugman as saying (regarding the Fukushima disaster):
“And yes, this does mean that the nuclear catastrophe could end up being expansionary, if not for Japan then at least for the world as a whole. If this sounds crazy, well, liquidity-trap economics is like that — remember, World War II ended the Great Depression.”
I don’t see any “it will only benefit some people, in some locations, in specific jobs/sectors, but will be a net loss.” No, Krugman clearly claimed that it will definitely create a net benefit for the world economy as a whole.
You can’t get any more NON-SPECIFIC AND UNIVERSAL than that!
How in sam blazes can Keynesian apologist visitors to this blog insist that Austrians are not interpreting the Keynesians correctly?!?! IT’S RIGHT THERE IN BLACK AND WHITE, PEOPLE. Krugman claimed in plain English that the Fukushima disaster will DEFINITELY create UNIVERSAL net gains (that’s what EXPANSIONARY means) for the world economy, and he also claimed that there is a likelihood that it will generate net gains, i.e. economic expansion, in Japan.
How in the heck are we to read this as “The Fukushima disaster MIGHT creates SOME gains for SOME people in SOME locations in SOME specific circumstances?” as the apologists are yammering on about?
All you ignorant yahoos who accuse Murphy of straw manning the Keynesians should appreciate how much he is bending over backwards in being so charitable to your lunacy. Frankly, none of you deserve it. You deserve ridicule and contempt.
Exactly. I still don’t see how we’re strawmanning the Keynesians here. Krugman said Japan’s earthquake could be expansionary… to which I ask, Why did investors jump into bonds immediately following the earthquake if things were going to be expansionary? Are Keynesians smarter than investors… ok, maybe I shouldn’t ask…
wrt bonds, austrians are even dumber than keynesians who still don’t grasp MMT.
Wrt bonds, MMTers are so dumb that they call inflation “increasing savings.”
Wrong again Dumbo. They call government bonds savings of the private sector, which is what they are.
They call government bonds savings of the private sector, which is what they are.
False. They call net savings an increase in private cash balances because they are brought about by government deficits.
Government bonds are not the only way the private sector can save.
Net Savings = Income – Spending = S-I
S-I= G-T + X-M
And Income – Spending = Increase in cash balances.
Exactly what MF said. You sure are getting tiresome.
And Prof. Murphy,
This the reason I am uncomfortable calling cash balances as savings. I am afraid that gives the MMTers a foot in the door.
Net Savings = Income – Spending = S-I
“Savings” is just cash to the MMTer.
“Net savings” is inflation.
To say that the private sector cannot net save unless the government runs a deficit is just saying that if the government inflates, then the increase in cash balances means that the government must have inflated.
So what?
MamMoTh,
Can you clarify why the MMTers equate government bonds and private savings?
It’s true that some private individuals buy government bonds. They may also deposit the cash in banks or mutual funds which buy these bonds. However:
(1) Any government bond which is bought by the Fed stays on the Fed balance sheet, right? It’s not an example of private savings. The Fed has removed the bond from the private sector and injected reserves in their place. As long as the reserves stay at the Fed (as long as they’re not used to buy new bonds), these reserves are a form of private savings which is not government-bond-based.
(2) Some individuals may choose to purchase other financial assets with their cash (and not government bonds). They may buy gold. Or they may buy corporate debt. Why is the government bond purchase any more of a “save action” than these purchases?
(3) Certainly someone who just keeps a lot of cash in a safe is engaged in private savings without any government bond help.
(1) bonds are functionally a savings account at the Fed. When the private sector buys a bond, it shifts money from a reserve account to a bond account. When the bond arrives at maturity the Fed shifts the money plus interests back to the reserve account.
(2) savings in a currency can only be in cash, reserves or bonds. you can call buying gold or other asset saving, but someone’s got to do the saving in currency, could be the seller of gold or someone else
(3) yes, bonds are savings, but savings are not only bonds, they can also be cash or bank reserves
“well, liquidity-trap economics is like that”
Your claim that this is universal and true everywhere is directly contradicted by the quote by Krugman preceding it.
So yes it is a straw man.
.So yes it is a straw man.
The universality context was the economy as a whole, and not some people, in some locations, in some industries, which would have made sense.
No it wouldn’t. It can only make sense for the economy as a whole or not. This is basic microeconomics, either it is valid, because of the assumptions underlying it are valid or it is not.
As I said in the other thread Marshall recognized as much in his principles v1, he assumed a stable/fixed numeraire. This is very old (neo)-classical economics.
When there is however trouble with the numeraire there is trouble with the whole economy as money is traded in all markets. The result is that you can get conclusions that are contrary to basic (micro-)economics, exactly because one of the assumptions is violated.
No it wouldn’t. It can only make sense for the economy as a whole or not. This is basic microeconomics, either it is valid, because of the assumptions underlying it are valid or it is not.
That’s what I said. They argued it is true for the economy as a whole.
Yes under specific circumstances. It’s not always true, it is contingent on the assumptions made and the validity of said assumptions.
Krugman’s argument and that of other Keynesians is, usually this is not the case, however now this assumption is not true, and therefore x in making this assumption approximately true again, can be a net benefit.
Yes under specific circumstances. It’s not always true, it is contingent on the assumptions made and the validity of said assumptions.
ALL circumstances are “specific.”
Circumstances are specific events.
The criticism is that it is wrong to say whole economies benefit when individuals’ wealth is destroyed.
It is correct to say that SOME individuals may benefit. But not “the economy” which is what Keynesians like Krugman keep saying.
Krugman’s argument and that of other Keynesians is, usually this is not the case, however now this assumption is not true, and therefore x in making this assumption approximately true again, can be a net benefit.
Are you friends with Kuehn? You have his talent of saying things without saying anything.
NET BENEFIT TO WHOM???
MF, are you friends with Roddis? You have his talent of saying things without saying anything.
MF, are you familiar with Krugman’s 1998 paper “It’s baaack”?
If not, just have a look, I think that will clear up our mis-communication.
MF, are you friends with Roddis? You have his talent of saying things without saying anything.
You didn’t answer my question:
You said:
“Krugman’s argument and that of other Keynesians is, usually this is not the case, however now this assumption is not true, and therefore x in making this assumption approximately true again, can be a net benefit.”
I asked:
NET BENEFIT TO WHOM???
Silas, yes you’re making sense. It’s definitely a whole new twist to things.
With an attitude like that, you should apply for the job of a London plod.
Jokes aside, my position would be (B) but bordering towards (C) depending on circumstance. By the way, Krugman’s position is only that (A) is possible due to his “liquidity trap” magic, not that (A) will always happen… good thing that Murphy nuanced is with “once we hit full employment the multiplier would drop to 1” which as far as I can tell is in line with Krugman’s position (although the definition of “full employment” is no doubt itself a can of worms).
Hmmm, quote formatting blowout… nasty stuff.
Bob, it’s not about the unemployed resources, it’s about why they are unemployed.
Imagine you have a stomach ache, and along comes Dr. Keynes and tells you: well Sir, I believe we’ll need to take out your appendix. You’re operated, your appendix is taken out and you feel better. Does this mean now that Dr. Keynes would cut out the appendix of everyone with a stomach ache?
As I read you, this is the argument you’re making about the Keynesian position.
To sum up my own position:
1) Bob’s description of Krugman’s views seems more or less correct. Krugman may or may not think that disasters are a net benefit to the economy, but he has not theoretical basis for saying that they couldn’t be a net benefit.
2) Since the Bastiat’s parable assumes full employment, Krugman’s statements do not commit the broken windows fallacy.
3) You can agree with the above and still think that Krugman’s statements were wrong for other reasons (e.g. they rely on Keynesian macronomic assumptions, which are bunk).
2) No, it doesn’t. There is an opportunity cost even if there were idle resources.
“Now, this is a very artificial example, I grant you… it is set up to show a *possibility*, and not a likelihood. But at his blog Bob Murphy also agreed that my example showed exactly what I intended it to show.”
Let’s see the possibility Gene is pointing us to.
This possibility is a case where a valley’s population consists of one lone rich individual and a group of poor individuals who can only work as construction workers. These two particular assumptions are very interesting: (A) there are individuals who can work very very specific type of work; they can not work anything else than construction. (B) there is one lone individual who somehow got rich, but Gene does not reveal to us how could that happen;
So, we know that miraculously one guy got rich and others are poor and can do only X (building).
Please note that these assumptions are very very narrow. They are so narrow that it leaves the impression that the guy who thought of the example tried very hard to think of a completely IMPOSSIBLE AND ABSURD situation in order to “disprove” the broken window fallacy, by pointing out that in this situation there is possibility that the conclusions from BWF are not valid.
Since Bastiat lived in the reality, I do live in the reality and human beings as a whole live in the reality and not in some situations that can be possible only in the human mind of Gene, the BWF conclusions apply to the reality, too. When he wrote about the “unseen” he did not care about non-existent situations.
————–
I believe that a fair statement that resolves the topic is this:
A disastrous event that destoys resources can not make the human welfare better than it would have been in case the event did not happen. Not only that but it is
certain that it will make it worse because the accumulated stock of goods will be diminished.
—————
Respectively these “boosted employment” and “Economic activity” theories do not refute in NO WAY the above statement. As many people have pointed out already – economic activity does not mean an increase in wealth; and the “no net crowding out effect” is incorrect because even if the rich guy hoarded his money before the event, it does not mean that he eventually wouldn’t have spent it, after all it is money – media of exchange – it does not matter whether he spends it sooner and “creates” employment in the present or spends it later and “Creates” employment in the future.
I believe that if you are an “employment guy fetishist” who cares only about the present (this means that your are a Keynesian by the way) than you could argue that it is better for the economy of the rich guy who hoards his money gets his house destroyed, which will create employment in the present. But this is MERELY an opinion regarding your preference. It does not mean anything above that.
Worse than that, they can only do construction for one particular employer, they are unable to build houses for each other. They were prosperous in the past when this employer paid them, but all the gold they were paid just vanished when he stopped paying them.