Econ101 – Broken Windows, Friedman, Wages, Automation


The Broken Window Fallacy is a fundamental concept of economics (and logic).

Frederic Bastiat wrote a allegory it into his book, "That Which Is Seen, and That Which Is Not Seen” in 1850 (but the principal is broader and older than that), and unsurprisingly the point of the allegory was illustrate how humans naturally see a benefit to a policy/action and think that’s all there is, but they often miss the far bigger (and harmful) unseen results. Learning to get past the seen-benefit/unseen-cost fallacy is the foundation of economics as a science. Without doing that, it’s just opinion and politics. And don’t just take my word for it, Henry Hazlitt summed up economics as:

“The art of economics consists in looking not merely at the immediate but the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."

What is the Broken Window Fallacy/allegory?

You can read the original in an old/formal style (linked below). The modernized version is as follows:

A vandal breaks a Baker’s window with a brick and runs off.
A crowd is drawn to the noise, sees the broken glass on the bread and pies, and start to comment on the tragedy.
 
But one person in the crowd, let’s call him, "Paul Krugman” says, “Hold on there, this isn’t all bad: look at the upside! The baker is going to have to pay the Glazier $100 for a new Window, who will then use that money to buy new shoes from the cobbler, and a meal from restauranteur (pointing them out in the crowd). They will spend those profits around the town as well. (He offers examples how it helps each of them). That one smashed window will go on providing money and employment in ever-widening circles, these are called Keynesian multipliers — thus that that little brick throwing hoodlum, far from being a public menace, was a public benefactor! The only problem with what he did, was he didn’t break more windows! Then we could have the prosperity of FDR’s New Deal. or Johnson’s Great Society!” (I might be ad-libbing a little bit).
 
The crowd murmurs and starts to see the wisdom of Krugman’s insights, saying he should write for the local Newspaper! Maybe the crowd should start breaking all the windows to help the towns economy?!
 
Another in the crowd, let’s call him, F. A. Hayek says, “Hold on there. You’ll falling prey to the biggest fallacy in economics: looking at only the seen and not the unseen."
 Hayek goes on, "Yes, the Baker will spend that money on a new Window (the seen benefit), but if he didn’t have a broken the window, the Baker would have had the window AND the $100, AND all of those baked goods to sell. The damaged goods would have benefited all the buyers that wanted to buy/eat he goods (for $50), the baker still would have spent the $100 on that new suit he wanted (so the Tailor would have gotten the money), and he would have spent the baked goods profits on hiring a helper (who would spend that money too). So if the window wasn’t broken the economy would have gotten $150 + delicious baked goods and another worker employed — now all the economy gets is $100 to replace a Window that shouldn’t have been broken in the first place!"
 
As the crowd ponders that, the Nobel Committee gives Paul Krugman the economics prize, and then the crowd divides up into the two camps: those who can do math and economics, and those who support Keynesianism. (a little epilog not in the original version). 

The whole point of the allegory is that the economy doesn’t win by destroying something of value, no matter how much the flim-flammers (Keynesians) try to convince the gullible otherwise. This has been known for hundreds of years, but there’s still a large contingent who can convince the gullible that destroying perfectly working cars (Cash for Clunkers), or burning down city blocks in Detroit, will some how leave you more rich than you started out.

Milton Friedman goes to China/India

There’s a famous economics fable of Milton Friedman going to China/India, that tries to explain the same thing in a different way (the story predates him, but he did tell variants of it).

 Milton was in China/India in the 1960s and visiting a worksite where a new canal was being built.
He was shocked to see that, instead of modern tractors and earth movers, thousands of workers had shovels and were toiling away.
He asked the foreman, "why there were so few machines?"
The government bureaucrat proudly explains, “You don’t understand. This is a jobs program.”
To which Milton replied, “Oh, I thought you were trying to build a canal. If it’s jobs you want, you should give these workers spoons, not shovels!"

The point is that value (Money) is derived from the product of work (the output / canal), not the input or how much you pay for it

No matter how much you’re overpaying, you’re still not going to come out ahead (“no country has taxed themselves into prosperity”, though a few have tried). The reason is because all that money came out of the taxpayers pocket (and thus the economy) in the first place. The only true new value was the product (the canal), everything else was loss (borrowed/stolen money). By doing it slower, and more costly, there was more loss.

So if government pays 100 people to do the work that 5 guys could do with earth moving equipment, you come out behind because you wasted the productivity (potential output) of 95 people. Some will claim that you employed an extra 95 people, but that benefit is more than offset that you had to take that money out of the economy (plus overhead/bureaucracy/waste) to pay them. Thus the hidden cost is those 95 workers could have been doing something else to adding REAL value to humanity or their own lives, instead of just wasted paying for 100 people to dig a ditch that 5 could have done without governments help. Even if those 95 did nothing, and sat at home, that is less a burden on the economy/taxpayers than getting paid to do something that could have been done better without them. 

Minimum Wage and Automation

Minimum wage is a variant of the same thing. Again, value (Money) is derived from the product of work (productivity/results), not based on what you paid for it. You can keep raising your costs for something by paying more, but unless productivity/output is growing at least that same amount, then you’re not coming out ahead. The MORE you have to pay for a burger or a bridge, the more the economy loses (the velocity of money slows as the money is getting consumed for less productivity/output). Thus investment slows. There’s no way you can pay more, and get less in return, and make it up in volume, despite what Krugman tells people. The cheaper it costs you to get something done, the more time/money/productivity you have left over to do other things: e.g. spending it on improving the company/economy in other ways. It’s a variant of the broken Window. 

Automation is the other side of the same coin: visible costs with invisible gains. Every job that you replace with something more efficient (less expensive and better), the better the macro economy becomes. But people see the lost worker, not all the savings to all the consumers. You not only made more goods for less money (which means more people can afford them, and all of them get a little more left for other things), but you freed up labor (workers) to do things more beneficial for society (even if that’s just free time). Almost everyone wins.

But what about the workers that  lost their jobs?

While there are certainly a few casualties, MOST that lose their jobs, lost a dull, repetitive, and menial job, and can go on to doing something better and more meaningful (and hopefully more valuable) with their lives. So, on average, more will benefit in the long term, even if they lose a little in the short term. Since there are more consumers than producers, in a macro-economic sense, the benefit to the many more consumers could still be a net win for the economy, even if those producers never produced again. This is why when we shipped jobs to China (with cheaper labor), a few people lost their jobs, but all of us got our goods for cheaper prices, and the economy grew during that outsourcing. Micro we might lose (if it’s YOUR job, it’s a bigger deal), but Macro we win (since you buy those goods/services for less). There’s another econ fable that goes, “a recession is when your neighbor loses his job, a depression is when you lose yours”. The truth is it’s just narcissism getting in the way of thinking broader than ourselves (and thinking of economics) 

Michael Moore (a propagandist) did a faux-documentary called Roger and Me, about all the lost jobs at GM during the late 80’s. Ignoring all the lies and deceptions in the film, Michael Moore went back and talked to some of the folks, a few years later in Pets or Meat: The Return to Flint (as did some others), and what had happened? Most of the people talked about how much better their lives were not working in that damn factory, the creative destruction that destroyed their old jobs also got them off their asses and into something better. So in the micro, they thought their lives were ruined. In the macro, most (but not all) of their lives ended up better a few years (or decades) later. 

So in the big picture, the gains surpass the losses — but that doesn’t stop the chicken little’s. They’ve been predicting this doom and gloom for the entire history of mankind:

  • Herding and farming was going to put the hunter/gatherers (nomads) out of business, it would be horrible — except for the better housing and food and lifestyle
  • When Gutenberg invented movable type, people really complained, “what about the monks who did transcription” — turns out they started making beer instead
  • When we created the steam engine, they said, “what about the workers” — and the industrial revolution was going to destroy civilization (seriously). How are 
  • The robotics craze in manufacturing in the 70’s, and how that was going to destroy factory workers
  • Computerization was going to destroy office workers
  • The Internet was going to destroy all retail/shopping

Every productivity improving device brought out the naysayers. And decades later, we know it enriched far more lives than it harmed. This is repeated over and over again, throughout history, Malthusian naysayers telling us that industrialization or population or pollution (CO2, etc) would destroy our economy and displace all the workers (if you didn’t give them money/power and reverse it), and for 1,000’s of years, they’ve been completely wrong. Instead civilization generally got much better for far more people than it got worse for — unless they listened to the chicken little’s, and they tried to stop it, then it got worse for everyone. (Think Stalin’s USSR, Mao’s China, Pol Pot’s Cambodia, Kim Il Jun’s Korea, and so on). Thus, informed people realize the historical averages and successes and how much better our lives are than our Great-Grandparents (in almost every dimension). And other will prey upon the gullible’s fears.  Who knows? One of these days, they might be right? But chicken little is hoarse from screaming the same message (and being wrong) for the last 15,000 years or so.

NOTE: There are a few legitimate micro-economics examples. They’re just not representative of the bigger picture: macro-economics, and how much better things really are. So that’s the difference between micro-economists like Paul Krugman, who think little picture, and short term. And the macro-economists that can think about the entire system and the long term. Which is why the latter can overcome our primitive fear of the unknown or change, and not become cave dwelling luddites, or Keynesian spouting troglodytes.

Conclusion

So while the non-economists keep falling for the visible costs and ignoring the invisible gains (or vise versa), mostly because them cherry picking what matters to them (called Politics). We’re smarter than that, and will look at all the data and think like scientists (economists) — and look back at history at every one of the failed predictions of doom, that lead to greener pastures for all (most), because we moved demand for labor from lower skill, boring, repetitive (and low value) tasks, to higher skill/value/entertaining ones, and our economy has flourished under that creative destruction.  Because most improvements in production, increases value to consumers, and there will always be more consumers than producers of any good.

Henry Hazlitt said,

"Economics is haunted by more fallacies than any other science known to man."

Mostly, it’s just the one fallacy today: seen benefits are more important than hidden costs/consequences. (When the truth is just the opposite). 

I try to educate believers by taking their arguments to them next level and asking them if it still applies: 

  • If breaking a window stimulates the economy, why don’t we have the air-force buzz our cities at supersonic speeds and break ALL our windows?  Would that help more?
  • Why not evacuate the people, nuke the cities, then rebuild them better? That would create lots of jobs!
  • If replacing heavy equipment with shovels is good, why not blindfold them so it’ll take longer, or have half of them work against the other half? Make it take 10x as long or never finish? 
  • If $15/hr is good, why not $150? Are you selfish in not sharing?

The point isn’t to reductio ad absurdum them, but to try to get them to see that they’re not winning (if they think bigger / about the macro effects). Scale doesn’t change anything. Paying more for less isn’t a win to society. Spinning your wheels destroying something of value, only to replace it, isn’t a win either. Now if you’re replacing it with something better, that might be different – but then it should be the consumers choice (not the regulators choice) — as the consumer is much better (historically) of making the right choices than the politicians are. 


References

Chicken Little Clucking

NOTE: If Chicken little ever is right, it will be because progressives/government converting us from a free and thriving economy, to a more managed one (less efficient and less adaptable). The less quickly labor costs can adapt, the more regulations slowing people from creating jobs and competing on the global market, the more education is required for jobs that don’t actually need certifications, and so on, the slower we’ll adapt to all the changes, and the more we lose in each of those tacks into the wind. The same with regulatory, taxes, laws and other burdens on the economy (adaptation). The global market doesn’t care what your excuses are — it will just keep moving forward without you. So the world is getting more competitive and global. We’re no longer the freest economy (which helped us out tack the competition in the past). We have huge burdens (social programs, safety nets, debts, obligations) that help people, at the cost of burdening growth and adapting to a more competitive market. So it’s not rosy for us as a country, if we choose to become a stagnant dystopian bureaucracy, like Europe. But in the global sense, it will keep getting better for more people than it hurts. Just hope that you’re not one that is on the wrong side of Darwin’s teeter-totter.