The Broken Window Fallacy

Why breaking a window doesn't create more economic activity. A story from Economics in One Lesson by Henry Hazlitt and my thoughts on it.

There are some people in the world (and some policy makers too) who fall prey to the idea that direct intervention with the economic environment is the best way to stimulate growth. 

In fact, there is a government program called the Conservation Reserve Program that pays farmers not to farm. Confused? The primary goal is to reduce greenhouse gas emissions in an effort to limit climate change but if we focus on the economic portion of this, it doesn’t seem very sustainable.

If you’re going to start interfering in the economy, you need to remember that the economy is made up of the interactions of millions of people. This makes it an incredibly complex environment, with not only primary effects, but secondary, tertiary, quaternary, and on and on and on effects.

There’s a story Henry Hazlitt tells in his book Economics in One Lesson that I think illustrates this point clearly. 

Imagine a kid throws a brick through the window of a baker's shop which results in the baker needing to replace the window. He hires a window company, and pays $1000 for a new window. 

This is a good thing for the economy right? The window company earns $1000 that they wouldn't have otherwise, their employees benefit by having a job and earning an income, and that income is money they will spend with other businesses. Those other businesses will benefit, and the positive effects ripple forward on, and on. 

Well what about the original baker? At the beginning of this story, he had a window, and he had $1000. Now he only has a window.

Consider that the baker (as people usually do) had plans for that $1000. He was going to buy a new suit. If he’d had the opportunity to use that money the way he wanted to, he would have both a window, and a suit. 

But he only has a window now.

When you look at this secondary effect of the act of the brick going through the window, you can see that there wasn’t any economic growth. The baker had a window before, and he has a window again. 

Window ➔ Window

Versus if the baker had been able to purchase his suit, there would be both a window and a suit. 

Window ➔ Window + Suit

Nobody even thinks about the tailor (tertiary effects) and the potential growth from him selling a suit to the baker because he hasn't entered the scene yet. The window company is obvious. The baker is obvious. But you might never have even known that the tailor had a part to play. 

This is the danger of economic actions taken with only first order effects in mind. The example may seem simple, but the principles apply on a larger scale as well. When you force money from one party to another (i.e. taking tax dollars to pay farmers to not do anything), you aren’t creating any economic output. If you extrapolate this out to the extreme, you have ended up with a situation where nobody does anything productive and the government just gives everyone money to survive. Physics taught us that you can’t create something from nothing. Economies are the same way.

By letting people decide where they want their money to go, the economy will grow into the desires of its people. This creates a better situation for everyone, as demonstrated by the baker’s story. 

Are you focused on first order effects? Or do you stop to think about the true consequences of your actions? 

Don't forget about the tailor.