Obama’s Stimulus Plan And The Broken Window Fallacy

I was watching CNN a couple of mornings ago (It was on the TV in the doctor’s waiting room so I had no choice) and I remember them talking about how the Obama administration plans to launch another economic stimulus plan very soon. One person asked “how many jobs do you think it will create?” My answer to this question is that it will create no jobs and in this thread, I’m going to explain why I believe this.

In 1850, a French economist named Frederic Bastiat wrote an essay called “That Which Is Seen And That Which Is Unseen”. In this essay, Bastiat popularized what is referred to in economics as the “Broken Window Fallacy”. It tells the story of a little kid in the middle of a small French town, throwing stones around for fun. Eventually he makes a bad throw and one of the stones breaks the window of a baker’s shop. The baker walks out of the shop and he’s upset about the window because he’s going to have to pay a glassmaker $50 to manufacture a new window and install it in place of the old one.

A lot of people would be tempted to say “well, the broken window was actually a good thing because it creates jobs for the glassmaker” but this isn’t actually the case. Imagine if, after work was over, the baker planned to run down to the tailor’s place and buy a few new aprons and toques and the cost of these clothes was about $50. Well, scratch that plan. That $50 is now going towards a new window. So it DOES create jobs for the glassmaker but it subtracts jobs from the tailor. Meaning the economy doesn’t grow, it stays exactly the same. When people say that the broken window creates jobs, they’re committing the Broken Window Fallacy.

There’s a second purpose of this story that not quite as many people realize: In some ways, the glassmaker represents the special interests groups who lobby the government to create policies that benefit the special interest groups but at the expense of everyone else. Imagine if that little kid was actually the glassmaker’s son and his father told him “now go out there and destroy a couple of windows so we can make some money. But make it look like an accident!“ Wouldn’t that be trippy? Things like that happen all the time.

Saying “war is good for the economy” is another good example of the Broken Window Fallacy. Weapons manufacturers, computer parts manufacturers and bankers are examples of groups that often try to convince the government to go to war because it means more profit for them.* But wars cost BILLIONS of dollars. Think of what we could be spending that money on if we didn’t have to spend it killing each other. On a more obvious note, since when is going around smashing windows and killing people a good thing?!

Many people don’t realize that governments have no resources of their own. All the money the government has, it gets in 1 of 3 ways**: by taxing the citizens, by borrowing it from another country (raising our national debt in the process) or by having a central bank create the money and loaning it to the government (and since there’s no gold standard, the amount of new money that can be created is endless). It would be different if the government could create new wealth in the same way a private sector company does but the government is just working with redistributed wealth. An Obama stimulus plan would just mean taking money from the citizens and then giving it to certain groups of citizens.

Consider this: if I went to every single residence in your neighborhood, took half of everyone’s money and then spent 100% of this money at the local mall, can you really say that I’m “stimulating the economy”? I mean sure, the retail stores at the mall would benefit GREATLY from this and so would the manufacturing firms that build their products…but at the same time, your neighborhood would be left in poverty, meaning it would be a zero sum game. Once again, the success of one group only exists because of the failure of the other group.

Bringing special interest groups back into the picture, I’m betting that a lot of this money is going to go towards traditionally Democratic voting blocs, I.e. alternative energy companies, labor unions, animal rights groups, just to make sure they vote for him in 2012. I’m betting some of the money is also going to go towards more neutral groups, such as people who build & maintain highways, roads & other infrastructure. This buys the highway operator vote. I wonder what other votes the administration might try to buy.

We cannot created jobs using redistributed wealth aimed towards enriching and buying the votes of certain special interest groups at the expense of the American people as a whole. True job creation is only going to come when we

-increase the percentage of money that we put into savings
-used the money we’ve saved to start new private sector businesses
-pursue economic policies that make saving money an attractive idea (no more inflation)
-repeals laws that contribute to monopolies so that market competition can breathe new life into the economy***
-focus on creating thousands of small firms, not a small amount of gigantic firms
-create jobs where we produce things, I.e. farming, manufacturing, mining, fishing, refining (you can’t base an economy around “education” or “health care” as we foolishly have been trying to do since the 1970s!)

*read General Smedley Butler’s “War Is A Racket” for the full picture of this concept.
**I’m not actually sure about this, there might be some other ones but these are the 3 major ones.
***Sometimes this means the same thing as deregulation. For example, when Obama increased regulation of the tobacco industry, one of the biggest supporters of the new law was Phillip Morris. Why? Because the new regulations hurt their smaller competitors and made it harder for new ones to enter the marketplace.

_________________
"It is a melancholy fact that massive works of the intellect do not spring from the abstract workings of the brain and the imagination; they are deeply rooted in the personality." -Paul Johnson

INFP, 4w5 sx/sp

I don't know very much about economic policy, but I don't understand why it wouldn't help if the government created more jobs that didn't exist in the past. If the government started on a new environmental project, for example, wouldn't that help employ people who were once jobless?

_________________
Officially given up personality theory. I don't need a test to know myself!

Permission to butt in...

You always have to look at the bigger picture when assessing whether new jobs are creating real wealth (true net value/positive gains) for the economy.

Let's say a software company decides to market an anti-virus product that they developed. But to create an opening in the market for their product, they decided to first create a computer virus that affected a million computers.

Let's say your computer was affected by the virus the company created. When these one million computer users (including you) buy the company's anti-virus product for $10, naturally, the company earns from the sales. And the computer users get their money's worth by installing the anti-virus that cleans up their computers. But the $10 M that went into the economy because of the anti-virus sales simply got transferred from the pockets of the buyers to the bank accounts of the company owners and to the employees that built the anti-virus software for their crooked company owners.

It's clear that the buyers lost $10 each which went to the pockets of the company and its employees. And the buyers not only lost $10, they also lost the time they could have spent working on their computers, and possibly, lost the files that took time and energy and electricity to produce. The buyers lost money and value in terms of time and energy. They only recovered their computers and their productivity by losing money ($10) to the software company. One step forward for the company, one step backward for the buyers - the market stays in the same place; only the money changed hands; no net value was created as a whole.

Whatever value was gained through the buying and selling of anti-virus software is offset by the losses sustained by the folks whose computers were damaged by the virus.

Buyers: -$10M worth of damage to their computers
Sellers: +$10M worth of anti-virus sales
-------------------------------------------------
Total wealth created for society: $0

**************************************

So let's say that the government started several new environmental projects to solve some urgent problems. But they first allowed these environmental problems to happen by allowing big manufacturing companies to dump their toxic waste in rivers and landfills without imposing penalties on them.

To do the toxic waste clean up, environmental jobs had to be created. Half a million people had to be employed. So yes, the problem created jobs in the environmental sector.

Of course, the jobs had to be created to clean up the environment, we're not arguing against that. But if the government had simply enforced stricter environmental laws in the first place, the clean up job wouldn't have been necessary. The environment would not have suffered losses, and the people who would have been employed in the environmental sector could now be employed to provide other much-needed services that could create true net value for society.

Envronmental Sector: + Billions of dollars worth of income
Another Sector: - Billions of dollars worth of opportunity cost (valuable services that could have been rendered by the same workforce)
------------------------------------------------------
Total wealth created for the economy: $0

*********************************

Lesson learned: Job creation does not always translate to (positive) net gains (wealth creation) for the economy. When one of two parties in a transaction sustains a loss equivalent to the gains of the other party, then the transaction results in zero total wealth created.

only Keynes and people who agree with him

anyhow my take on job creation:

at best it pushes back the issue. if you create a bunch of jobs, for example, by commissioning the building of a bridge, then you put money in the hands of consumers. but once the project if over that bridge doesn't continue to generate revenue and either the consumers didn't spend the money in the first place, which means the "stimulus" failed, or they did and they are broke again, which means they need another stimulus. i assume the justification is to get people over the "rough patch" until the economy has time to recover again, but taking money from the very people who would be in a position to create more permanent jobs (ie richer people, people with capital to invest) doesn't seem like a good way to encourage that. i admit i am no expert, but this is how it appears to me.

and for added awesomeness:

_________________
Isn't it pretty to think so?

The thing that this analogy doesn't account for is importing and exporting.

Eg: If I lose my temper and break my door, it will provide employment/income for a local carpenter to fit it, probably a not-so-local joiner to fabricate the door, and the foresters/sawmill operatives/logistics company to get the raw materials to the joiner. My money stays in this country up until it is banked, and inevitably invested overseas.

Now, if I lose my temper and break my TV, it will provide employment/income for a local retailer, maybe a logistics firm to get the TV from the port to the retailer, but after that the employment/income is provided to overseas shipping companies and the TV factory in South Korea. In this instance my money is partly ending up outside of my country's economy.

Just a thought...

This is my take on it.

The health of an economy is determined by its liquidity, how much money is flowing around the place, where to, and how quickly. Generally speaking high liquidity = healthy economy, low liquidity = unhealthy economy (though not always, as various stock market bubbles can attest to).

Economic depressions are periods of extremely low liquidity, there's not a lot of money around and what there is isn't being exchanged from person to person/business to business etc. (it's got no flow, yo).

The idea of a stimulus package is to encourage an increase in liquidity by getting people to spend their money instead of holding on to it. But to do that people need to have enough money to spend, and so the Government creates jobs for them to do, for which they can then be paid for.

However those wages have to come from somewhere, and because there's not enough liquidity during the depression to be able to borrow money directly from the economy itself then they have to get it some other way.

Amongst their options are:

1) Print more money. This creates the illusion that there's more money around, which encourages people to spend more, thereby increasing liquidity. But businesses don't always buy into the illusion (in fact in can be argued that they rarely do, if ever), they know there isn't really any extra money around and so they increase their prices (inflation) to ensure that they're still getting the same real value for their goods/services. People can't get any more stuff for their money than they could before, and so they stop spending, and so liquidity dries up again.

2) Borrow from a place outside your economy. This is just the same as when you borrow money anywhere, it lets you pay for stuff now, but you have to pay it back later, usually with interest.

3) Instead of borrowing from today Governments can choose to borrow from the future, by spending money now that they don't actually have, the hope being that by the time it comes to pay the bill the economy will have improved enough for them to be able to afford it.

4) Lower taxes. This leaves more money in people's pockets and so they have more to spend. Of course, lower taxes means cutbacks in public services, which is not always a popular decision.

Personally I think stimulus packages can work, but only if the money is both borrowed wisely and spent wisely. Borrow the wrong amount from the wrong places for the wrong rates and you're screwed. Equally, spend it in the wrong places, such as on a white elephant somewhere or on projects that don't employ enough people or don't last long enough or don't pay enough, and you're also screwed.

So it's a risky business, and so should be handled with extreme caution, but I do think they are a potentially useful tool for getting out of an economic depression. The real trick is though, to avoid getting into a depression in the first place.

_________________
What would the world be, once bereft
Of wet and of wildness? Let them be left,
O let them be left, wildness and wet;
Long live the weeds and the wilderness yet. - Gerard Manley Hopkins

But what if you're employing people who would otherwise be jobless, people who couldn't find work in other services?
. . . Sorry if it's a stupid question or something. I really don't know much about economics.

_________________
Officially given up personality theory. I don't need a test to know myself!

why would they be unable to find work unless the gov't handed to them? if its because their work isn't worth anything then you really are throwing money away. if their work *is* worth something then someone other than the government certainly could pay them for it....

_________________
Isn't it pretty to think so?

Because there isn't work for them to find? During depressions businesses don't have the money to hire extra people, in fact they tend to lay off some of the people who already work for them. So assuming you want to try to encourage extra liquidity in the way I mentioned in my earlier post (by putting more money in people's pockets by getting them working), then if businesses aren't hiring that means the government has to do it instead.

_________________
What would the world be, once bereft
Of wet and of wildness? Let them be left,
O let them be left, wildness and wet;
Long live the weeds and the wilderness yet. - Gerard Manley Hopkins

Not a stupid question.

Job creation obviously serves the interests of those employed, especially in the interim when there may be no other jobs in the market. No contest there. People must have jobs. People must find a way to feed themselves.

The context of the hypothetical balance sheet assumed that the workforce could have been gainfully employed in other sectors that produce something of value. This is just incidental to the specific example I used, but the point to consider is that if jobs should be created, it is better (in the long-term) to create them within a system that actually produces positive net income for the economy as a whole. Otherwise, the systems you are setting up will bleed the economy to death in the long term.

_________________

If you used stimulus money to employ people who would otherwise be jobless, it's still a zero-sum game because that stimulus money comes from We The Taxpayers. If those taxes were eliminated, we could be spending the money doing something else in the private sector. I could hypothetically invest some of my money in building a factory if the government wasn't taking it in taxes to use as stimulus money. Factories employ people, right?

When General Motors was a private company, they had to work using the money that their stockholders invested in the company. Now that they've been nationalized, they're getting taxpayer money redistributed to them through the apparatus of the U.S. and Canadian governments.

One important thing I forgot to mention is this: In economics, wealth doesn't mean how much money you have. If I had 1 million dollars today, you'd probably say I'm a rich man. But if I had 1 million Deutschemarks in 1923 Germany, I'd only have 1/4000 of the amount of money to buy 1 mug of beer. What wealth actually refers to is how many items of intrinsic value you possess. For example, the intrinsic value of a house is that you live in it and it keeps you safe and comfortable from the outside world. The intrinsic value of a car is that you can use it as transportation. The intrinsic value of a factory is that it produces goods. The intrinsic value of a refinery is that it synthesizes crude oil into material that is safe to make consumer products from...paper money doesn't have intrinsic value, unless you want to use it as a tea envelope or a paper airplane. Whoosh!

That's why I talked in the first post about needing to creating jobs in the United States where we produce things. These things we produce make us wealthier because of their intrinsic value (and as a humanitarian benefit, they make any country we export these products to wealthier).

It makes formerly unemployed people richer but it makes the rest of us poorer.



It's okay. Most people don't. As Henry Hazlitt said, it's "haunted by more fallacies than any other study known to man." I think alot of economic education is purposely made confusing by the government, so the people don't understand how the economy works and due to ignorance will be more hesitant to fight against certain policies.

I know you're a couple years younger than I am. Have you taken an econ class before? It's okay if you haven't but it's a very good idea to take at least 2 when you're in school.

I became interested in economics through learning about the Federal Reserve, which is an unfathomable scam that no one can afford to ignore. I became even more interested when the recession came around because of the Fed's role in creating the recession. So maybe my background makes me more interested in learning about it than others, who knows?

Here are some things I've learned along the way to help you out.

-Economics is alot simpler than most people realize. You don't have to be a Wall Street financier or a Standard & Poors bond researcher to understand it. 90% of all high school students can understand it if they make a serious effort to, especially if you (like myself) are an AP Student.

-The two best definitions I've ever seen of economics are "The study of how finite resources are allocated among competing uses" and "economics is an attempt to answer 3 questions: 'what do we produce?', 'how do we produce it?' and 'who do we produce it for?'" Understanding these definitions helps to clear up alot of confusion.

-There are laws in economics, the same as the laws of physics and mathematics. The economy can't operate outside these laws. One law that everyone should memorize is "people respond to incentives in predictable ways".

-Economics is tied to psychology and philosophy because all 3 of them are based around human nature.

-Microeconomics is in my experience a much better class than Macroeconomics to take if you want to gain a good understanding of how the economy works. Micro focuses more on humans and individuals and how the choices we make every day effect the economy as a whole. It's more of a personal/psychological approach to the economy.

-Be skeptical. Turn every piece of information over in your head and debate it with yourself before you conclude if it's true or not. But be ESPECIALLY skeptical if your professor mentions John Maynard Keynes in a positive manner and praises him. (letting my personal bias show)

Other than that...I wish you the best.

*pats her on the head and gives her a cookie*

_________________
"It is a melancholy fact that massive works of the intellect do not spring from the abstract workings of the brain and the imagination; they are deeply rooted in the personality." -Paul Johnson

INFP, 4w5 sx/sp

Thanks for that very informative post of yours. While it is true that the economy has handed the President an utter catastrophe, still he managed to take it from getting even worse. The White House have spoken that the stimulus package of Barack Obama was a success though unemployment rate have generated public doubt and created the opposition to gain political score by insisting that the stimulus has failed. As I can see, the economy is better now than on Bush's administration. I hope that this will continue to get better in the years to come.

Bumping this thread purely to post the new(ish) follow-up to this video.

_________________
What would the world be, once bereft
Of wet and of wildness? Let them be left,
O let them be left, wildness and wet;
Long live the weeds and the wilderness yet. - Gerard Manley Hopkins