Monday, December 19, 2011

Broken Windows and Diamond Rings

An uncomfortable reality of political ideology is the degree to which any given stance is predicated at least in part on economic assumptions.  Try as we might to corral a sense of objectivity and rationality into our views, at some point we must admit that there is just so much we do not know about the ways in which economies work.  This, even as stark and fundamental disagreement can be found among leading economists.

So take, for instance, the controversial concept of government stimulus, which in our recent case represented close to a trillion dollars of federal spending.  Projections have varied widely as to how stimulative it truly was, or could have been.  As soon as you begin to look closely at the underlying arguments, it becomes clear that any lay understanding is woefully inaccurate in forming anything but a shallow and fragile understanding.

And so, it is with this admittedly devastating caveat, that I, intrepid blogger, attempt to carve into the following subject.

I've long wondered about the relative merit of various forms of economic activity, in terms of their effect on overall productivity.  For instance, is a dollar spent on busfare to one's employer of more value than a dollar spent on a chocolate candy?  My question follows largely from the fact that as wealth has become increasingly concentrated into the hands of the rich, there has no doubt been a subsequent shift in the types of economic activity, from utilitarian spending to luxury spending.  Is the former type of spending better for overall growth?  It would seem that to the degree that spending is non-utilitarian, it is wasteful, and thus not only distasteful in terms of a moral reckoning in what ought to be a more fair and equitable society - as a sort of ill-gotten decadence, but distasteful in purely economic terms, as a net drag on the economy.

On first glance, one might say that there should be no real difference.  In each case, the dollar spent moves into the hands of another worker, who then uses it to purchase more goods and labor, and the production continues to be spread throughout the economy.  Monies spent on chocolate will fill the pockets of the chocolatier, who in turn pays his workers, buys his cocoa, etc.

Yet what about this feeling that paying for chocolate is somehow decadent?  It is certainly a luxury expense.  But what does that really mean?  No one will live or die because of it, unlike say basic food stuffs.  But no will will live or die, either, because of money spent on busfare.  Yet without it, considerable hardship might befall the rider; he may lose his job; he may have to purchase a car, leading to desperate sacrifices in other areas of his life.  Maybe the best way to think about the issue is in terms of the productive possibilities of each form of spending.  What are all the ways in which a bite of chocolate, by itself, contributes to productivity.  It surely has some merit, in that it represents a reward, something to strive for that encourages hard work elsewhere.  However this is a limited effect, and in many cases, certainly to the degree that its purchase has indeed been out of decadence, having long ago lost any meaningful pull on behavior, it could have as easily been done without.  Again, this is luxury spending, by definition.  Busfare cannot be done with in the same way.  When we look at long-term drivers of productivity, we see things like the invention of the steam engine,the automobile, the internet.  Chocolate, not so much.  While there have no doubt been great innovations in luxury, their utility in encouraging productivity is conspicuously unaccounted for.

In 1850, French political economist Frédéric Bastiat wrote the following parable about economic activity and productivity.  To economic theorists, it is known as The Broken Windows Fallacy.
     Have you ever witnessed the anger of the good shopkeeper, James Goodfellow, when his careless son happened to break a pane of glass? If you have been present at such a scene, you will most assuredly bear witness to the fact that every one of the spectators, were there even thirty of them, by common consent apparently, offered the unfortunate owner this invariable consolation—"It is an ill wind that blows nobody good. Everybody must live, and what would become of the glaziers if panes of glass were never broken?"
     Now, this form of condolence contains an entire theory, which it will be well to show up in this simple case, seeing that it is precisely the same as that which, unhappily, regulates the greater part of our economical institutions.
Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier's trade—that it encourages that trade to the amount of six francs—I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.
     But if, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, "Stop there! Your theory is confined to that which is seen; it takes no account of that which is not seen."
     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.
Bastiat's Fallacy is popular among Austrian economists, and those who favor small government.  Their attraction is based on the parable's illustration of hidden costs; they believe that government spending is not zero sum and represents money that could not have been spent elsewhere.  While this is true enough, what ultimately matters is the projected utility of the spending.  Of course wasteful government spending is a net loss in productivity.  Yet government spending that directs investment in a worthwhile investment that increases productivity, such as a bridge, or public school, is a net benefit.

My interest in the parable is also its illustration of hidden costs, although I'm more concerned with the effects of concentrated wealth and the hidden costs of luxury spending.  To the extent that luxury spending is by itself almost entirely unproductive, and that concentrated wealth encourages it, one can argue that the concentration of wealth leads to, as Bastiat's parable might frame it, much broken glass.  Better this wealth be put to productive use.  Lord knows there is no lack of need for it in today's society.

Not only are there hidden costs to pointless consumer spending, or that which has little inherent value, but so too are there hidden costs in frivolous investment.  I think it fair to claim that much of what caused the 2008 financial crisis was a direct outgrowth of sloppy investment: concentrated wealth led to overflowing pools of money, the manipulation of which was coordinated by greedy investment bankers who saw an opportunity to make enormous profits from money that was primed for recklessness by its decadent acquisition.

I recognize that I'm now far out of my comfort zone in understanding the Great Recession.  But one can confidently make a couple of claims.  Luxury spending and sloppy banking represent poor investments, and as such are defined by their hidden costs - their monies could have been put to more productive use.  There will be many who point to the many government boondoggles as evidence of waste.  The response to this is that there is plenty of good that government does (and often that which only government can do), and the larger controversy has likely much more to do with ideology and one's political and social preferences.  But the Broken Windows Fallacy simply reminds us that there are always hidden costs to spending.  These costs place spending in moral terms, that spending represents a choice between different net social outcomes.  This is a choice we make both as individuals and as citizens of a democratic government.

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