Austrian vs. Keynesian Economics & Bastiat’s Broken Windows

The claim of the Austrian School that has scandalized members of other schools for 150 years is the following. The propositions of economics are universal. The principles apply in all times and all places, because they derive from the structure of reality and human action.

What brought about economic growth, inflation, or the business cycle in China 300 BC are the same institutions that drive phenomena in the United States in AD 2008. The circumstances of time and place change, but the underlying economic reality is identical.

That claim has made other economists - to say nothing of sociologists, historians, and politicians - scatter like pigeons. The Historical School poured scorn on this idea, and Carl Menger, the founder of the Austrian School, fought them tooth and nail. The Chicago School of positivists found the claim preposterous, and Mises and Hayek and Rothbard battled them. The Keynesians have long been outraged, and the postwar Austrian generation reasserted the truth. The socialists, who posit that rearranging property titles will transform all of reality, say that the claim is absurd, capitalistic nonsense.

But there it stands. No matter where or when, the essential prerequisite for economic growth is capital accumulation in a framework of freedom and sound money. The consequence of price control is shortage and surplus. The effect of money expansion is inflation and the business cycle. The effect of every form of intervention is to make society less prosperous than it would otherwise be.

The list of universals is endless, which is why every age needs good economists to explain and articulate the truth.

Well, I would like to add that there are universal fallacies too.

Frédéric Bastiat pointed to one: the belief that the destruction of wealth fuels its creation. He explains this by means of an allegory that has come to be known as the story of the broken window. Most famously it was retold as the opening of Henry Hazlitt's Economics in One Lesson, which is probably the bestselling economics book of all time.

A kid throws a rock at a window and breaks it, and everyone standing around regrets the unfortunate state of affairs. But then up walks a man who purports to be wise and all-knowing. He points out that this is not a bad thing after all. The man fixing the window will get money for doing so. This will then be spent on a new suit, and the tailor too will get money. The tailor will spend money on other items and the circle of rising prosperity will expand without end.

What's wrong with this scenario? As Bastiat put it, "It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way which this accident has prevented."

You can see the absurdity of the position of the wise commentator when you take it to absurd extremes. If the broken window really produces wealth, why not break all windows up and down the whole city block? Indeed, why not break doors and walls? Why not tear down all houses so that they can be rebuilt? Why not bomb whole cities so construction firms can get busy rebuilding?

It is not a good thing to destroy wealth. Bastiat puts it this way. "Society loses the value of things which are uselessly destroyed."

It sounds like an unexceptional claim. But herein rests the core case against everything the government does. Perhaps, then, we can see why the allegory is not better known. If we took it seriously, we would dismantle the whole apparatus of American economic intervention.

If you are with me to this point, perhaps you have a hard time believing that anyone really believes that wealth destruction is actually a good thing. Let me try to show that the fallacy is as pervasive as ever.

After every natural disaster, we at the Mises Institute start what we call the Broken Window Watch.

After Hurricane Katrina, the Labor Secretary said: "What will happen - and I have seen this in previous catastrophes and hurricanes - there is a bright spot in that new jobs do get created."

And The Economist said, "While big hurricanes like Katrina destroy wealth, they often have a net positive effect on GDP growth, as the temporary downturn immediately after the storm is more than made up for by the burst of economic activity that takes place when the rebuilding begins."

And the New York Times said: "Economists point out that although Katrina has destroyed a lot of accumulated wealth, it ultimately will probably have a positive effect on growth data over the next few months as resources are channeled into rebuilding."

After last year's California fires, we heard this. "In the odd nature of economic accounting, this will probably be a stimulus," said Alan Gin, a University of San Diego economist. "There will be a huge amount of rebuilding in the next couple of years, financed by insurance payments."

And CBS MarketWatch said: "Economists have noted the perverse reality that in the wake of disasters, re-construction spending helps the economy, even as people are still struggling to recover from their personal losses."

Note that personal loss here is deemed rather irrelevant compared with the beneficial macroeconomic results. Here we have a theme we find often in economics, the attempt to drive a wedge between what makes sense for individuals and what is good for society. We see this on display in this recessionary environment, when people are told to spend spend spend, even though most people understand that recessions are times for saving.

Continuing on, we find the Broken Window fallacy popping up even after 9-11.

Timothy Noah of Slate wrote: "We live in a very wealthy nation that responds to horrible disasters by spending large sums of money... It will also provide a meaningful Keynesian stimulus to a national economy that, let's face it, was tottering on the brink of recession well before Sept. 11. The recession may still come, but the countercyclical spending should help shorten it."

Another economist declared: "Initially, this could provide a significant boost to an economy that had been slumping. The construction industry could benefit from the rebuilding process. There may also be a boon for slumping tech sales, in replacing lost equipment."

Thus can we see the continuing relevance not only of Bastiat's allegory but also of the characters in the story. The posturing wiseguy who says that breaking windows is good for the economy keeps reappearing again and again. So entrenched is this mistake that we might call it official economic doctrine for the whole country.

Regards,

Lew Rockwell

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