Montreal, January 15, 2011 • No 285

 

Adam Allouba is a business lawyer based in Montreal and a graduate of the McGill University Faculty of Law. He also holds a B.A. and an M.A. in political science from McGill.
 

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What Remains Seen and What Remains
Unseen, 161 Years Later
 

by Adam Allouba
 

          A recent Globe and Mail series on dementia's toll estimated that this horrible disease costs the Canadian economy $15 billion annually. One reader sent in the following reply:
 

[W]e are contributing to the economy because of dementia, not costing it.

We buy plane tickets or gas to visit our parents; we hire cleaning and yard people for their homes; we pay for nurses or caregivers; we pay for their rooms in retirement or nursing homes; we hire lawyers to draw up powers of attorney and wills; and we pay accountants to do their taxes.

We've created a whole industry around people with dementia.

 

          Ms. Langdon’s letter reveals two things:

          (1) She is a devoted daughter who does her best to care for her aging parents.
          (2) She is a lousy economist.

          Wait a minute – caring for people with dementia requires spending money, which creates jobs. So isn’t Ms. Langdon just stating the obvious when she asserts that the “dementia industry” contributes to the economy?

          In fact, her economic reasoning is fatally flawed. She should not, however, feel too much embarrassment over her mistake, since it is a distressingly common one. Ms. Langdon’s error lies in her assumption that the sole economic consequences of dementia are those that are immediately visible: the nurse paid for in-home care, the attendant hired to help feed patients, the lawyer retained to draft a power of attorney, and so on. What she has missed are the unseen effects, best explained by a long-dead French economic theorist.

What is Seen and What is Unseen

          In 1850, Frédéric Bastiat penned his final work: Ce qu’on voit et ce qu’on ne voit pas. It opens with his elegantly simple parable of the broken window: A boy accidentally breaks a man’s window. The man’s neighbours console him with the thought that at least the child’s mischief will provide a glazier with work. After all, “what would become of the glaziers if panes of glass were never broken?”

          Bastiat points out the crowd’s error in considering only the broken window’s visible effect: the glazier’s work. The unseen effect is that the money spent on the replacement window is not spent elsewhere. Instead of a window and, say, a new pair of shoes, the man is left only with the window. The boy’s carelessness has left the man – and his village – poorer.

          The essay applies the same reasoning to other situations in which people often focus only on the immediate impact of economic behaviour, such as military spending, art subsidies or public works programs. What is seen are the jobs of the soldiers, artists or labourers and the ripple effect of their spending. What is unseen is the economic activity foregone by the taxpayers who finance those operations. They would have used those funds to consume other goods and services, thereby spending the same total amount as the state – without wasting resources to collect, budget and spend the money.

          Has the flaw in Lynda Langdon’s reasoning become apparent? Her letter refers only to what is seen: the employment of the nurse, the attendant, the lawyer, etc., resulting from someone’s mental illness. What is unseen is how that money would have been spent had the person been well – perhaps a car or a vacation. Instead of employing a nurse, those funds could have employed an autoworker or a pilot and instead of a sick (but well-cared for) patient, the person’s child could have a healthy parent and the new car. Incidentally, as Bastiat explains, even if you assume that the money would instead have been saved and not spent, that simply makes the funds available to lend to someone else to spend.

Modern-Day Applications

          Over a century and a half later, Bastiat’s crusade against illogic has a long way to go. The broken window fallacy and the failure to consider what is unseen are everywhere.

Stimulus

          Think back to the dark days of 2008: plummeting stock indices, failing banks and even a collapsed national economy. From the blackness came forth a cry: stimulus! In February 2009, President Obama signed a $787 billion package to jolt the economy back to life. White House economic advisors warned that without this measure, unemployment could peak in 2010 at 8.8%. Almost two years later, the jobless rate stands at 9.4%, down from a high of 9.8% in November 2010.

          Perhaps, despite the mistaken projection, things would be even worse without the stimulus. But while we can see the effect of the stimulus – police officers hired, teachers kept on, etc. – we cannot see the private investment that would have been made with the resources commandeered by the state. In other words – and as many predicted – perhaps the stimulus stimulated nothing. Maybe it just shifted spending elsewhere, in the process wasting resources on bureaucrats to shuffle money around. This theory is supported by a Harvard professor’s recent analysis showing that barring truly exceptional circumstances, a dollar of government spending produces less than a dollar’s worth of economic benefit.

Strategic Investments

          Both within and without a recession, politicians extoll “strategic investments” as a means to create jobs. Bastiat’s logic argues that this approach is doomed to fail. Indeed, when we attempt to see the unseen, it looks pretty ugly. A 2007 study by a pair of Laval University economists found that government support for a new aluminum smelter translated into an annual cost of almost $275,000 per job created. A 2008 literature review found “near unanimity [among economists] in the conclusion that stadiums, arenas and sports franchises have no consistent, positive impact on jobs, income, and tax revenues,” meaning that the abundant subsidies for such things have no economic justification. A 2009 study of Spain’s massive renewable energy program estimated that 2.2 jobs were destroyed for every green job created.
 

"Just as no one would tell the hero of Bastiat’s parable to smash more windows, no one would think it makes economic sense to intentionally demolish a city, flood a neighbourhood or start a war. Otherwise, vandalism would not be a crime but a civic duty!"


          But have governments re-examined their thinking? Of course not. Point out that the state cannot magically create something from nothing and, as Bastiat sighs, “it is said, ‘the thing is so plain it is quite tiresome,’ and they vote as if you had proved nothing at all.”

(Un)creative Destruction

          But these errors pale in comparison to the greatest folly of all: the notion that destruction is good for the economy. As wrong as it is counter-intuitive, the idea that refuses to die continues to receive a great deal of air time.

          The day after 9/11, Timothy Noah attempted to find a whopper of a silver lining in a Slate piece titled, “Will Terrorism Resuscitate the U.S. Economy?” Noah pointed out that as the US “responds to horrible disasters by spending large sums of money […] in seeking to harm America, terrorists will probably end up in making it more prosperous.” After Hurricane Katrina devastated New Orleans in 2005, a federal reserve economist told The New York Times that “the process of rebuilding of property contributes to an increase in output,” though he did acknowledge that “in some sense it would be easy to argue that we have been made worse by the hurricane.” Shortly after the massive 2010 Haitian earthquake, American studies professor Kevin Rozario wrote in the Wall Street Journal that “catastrophes [can] present extraordinary opportunities to make improvements.” He called natural disasters “engines of urban development and economic growth,” extolling “the material benefits of destruction.”

          Shaking your head at these arguments? Just one question before you pat yourself on the back: what ended the Great Depression? If you said, “World War II” then I’m afraid that you’re solidly in the Noah and Rozario camp. Don’t beat yourself up, though – even Nobel laureate economist Paul Krugman claims (in his newspaper column, mind you, not in peer-reviewed scholarship) that the war jolted the economy to life.

          Economist Robert Higgs has persuasively argued that while mobilization ended chronic unemployment, actual prosperity only returned after the war. But even without the empirical argument, does the idea that war is economically beneficial make any sense? Can devoting resources to building weapons – goods that destroy other goods (and people) – really make us richer? What if, in order to save lives, the Axis and Allied powers had shot their bullets into the ground, bombed empty fields and sank their own ships at sea? And in that case, could we trigger a boom by simply paying people to dig holes and fill them up? Of course not, even if John Maynard Keynes himself wrote otherwise.

          This argument is truly the mother of all broken window fallacies – and one wonders if anyone really believes it. After all, just as no one would tell the hero of Bastiat’s parable to smash more windows, no one would think it makes economic sense to intentionally demolish a city, flood a neighbourhood or start a war. Otherwise, vandalism would not be a crime but a civic duty! As Bastiat explained, “To break, to spoil, to waste, is not to encourage national labour; or, more briefly, ‘destruction is not profit.’” And yet Paul Krugman, among others, insists that spending almost $1.2 trillion on the Iraq and Afghan wars has boosted the US economy (most Americans disagree). Good news, America: a few more terrorist attacks, a couple more invasions, and happy days are here again! If only this kind of thinking were limited to satire.

But What if…

          It is easy to concoct a scenario in which the broken window fallacy does not apply (For an attempt to argue that natural disasters are good despite the "broken window" effect, see: "How disasters help"). A tornado destroys decrepit buildings that should have been taken down years earlier. Public subsidies finance a new molecule that cures cancer. And, yes, the window is replaced with a new, energy-efficient one that recoups the installation cost.

          But there is no reason to expect the government, with all its warped incentives to act based on political expediency rather than sound economics or science, to pick the right winners. And no sane person would expect random devastation to coincidentally destroy only things that already needed to be knocked down anyway. So while every rule has an exception, the former is usually a better guide for policy than the latter.

          Bastiat’s work remains incomplete and basic economic fallacies have a kind of immortal quality. Even so, his legacy remains a powerful one – and now that you’ve been introduced to it, that’s one more person inoculated against the idea that the road to riches is paved with illness, bureaucracy or destruction.