HurriKeynesianism: Broken-Window Economics With Formulas

Reality Check (Nov. 27, 2012)

The fallacy of the broken window was first exposed by Frederic Bastiat in 1850, the year of his death. He argued that when someone breaks a window, this makes the victim poorer. So, it makes the community poorer.

But there was a false economic idea common in his era. The broken window will be repaired. The owner will spend money to repair it. This will stimulate the economy. There will be new jobs, new orders for glass, and profits for all.

This argument violates the fundamental principle of economics: there are no free lunches.

This argument is the central argument of Keynesianism. It was the central argument of Keynes himself. Everything else is jargon: "Putting the shuck on the rubes."

What is wrong with the argument? It ignores the things unseen. The new window can be seen. The workers installing it can be seen. What is not seen is the thing that the store owner would have bought if the window had not been broken. He might have bought inventory. He might have bought gifts for his family. He might have invested in a business. But he would have spent the money on what he wanted most. That is not seen. This video explains it very well.

After every natural disaster, we see articles on how the disaster is good for the economy. This video provides examples. Then it shows that these examples are bogus.

Lew Rockwell of the Ludwig von Mises Institute in 2008 reported this.

After every natural disaster, we at the Mises Institute start what we call the "Broken Window Watch." After hurricane Katrina, the Labor Secretary said, "[W]hat 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 from Alan Gin, a University of San Diego economist: "In the odd nature of economic accounting, this will probably be a stimulus. 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, reconstruction spending helps the economy, even as people are still struggling to recover from their personal losses."

UNDERSTANDING SANDY

Sadly, the economic experts are Keynesians. They filter new information in terms of the economics they learned in college. Here is a recent article, published on Bloomberg News. I will quote from it verbatim, so that you will know that I am not making this up.

Cataneo's experience shows how the storm is giving the U.S. Northeast -- and the rest of the country -- an economic boost that may eventually surpass the loss of business it caused. Reconstruction and related purchases and hiring may range from $140 billion to $240 billion and increase U.S. economic growth by 0.5 percentage point next year, assuming $50 billion in losses, according to Economic Outlook Group LLC, a Princeton, New Jersey-based forecasting firm.

There is a huge multiplier here. A $50 billion loss will produce between $140 billion and $240 billion in new wealth.

Implicit conclusion: What a shame that the losses were not $100 billion. Then think of the new wealth that would be rolling down on us in 2013.

Bastiat was writing in a pre-Keynesian era. There was no idea of a Keynesian multiplier in 1850. Keynes did not come up with this in 1936. Richard Kahn did in 1931. Wikipedia's article on Kahn says:

Kahn's most notable contribution to economics was his principle of the multiplier. The multiplier is the relation between the increase in aggregate expenditure and the increase in net national product (output). It is the increase in aggregate expenditure (for example government spending) that causes the increase in output (or income). His findings on the multiplier were first published in his seminal 1931 article, The Relation of Home Investment to Unemployment. Kahn was one of the five members of Keynes' Cambridge Circus. Kahn was also one of Keynes' closest collaborators on the creation of Keynes' General Theory of Employment, Interest and Money.

What is the multiplier? The Wikipedia article on "Keynesian Economics" tells us.

Two aspects of Keynes's model has implications for policy: First, there is the "Keynesian multiplier", first developed by Richard F. Kahn in 1931. Exogenous increases in spending, such as an increase in government outlays, increases total spending by a multiple of that increase. A government could stimulate a great deal of new production with a modest outlay if: 1.The people who receive this money then spend most on consumption goods and save the rest. 2.This extra spending allows businesses to hire more people and pay them, which in turn allows a further increase in consumer spending. This process continues. At each step, the increase in spending is smaller than in the previous step, so that the multiplier process tapers off and allows the attainment of an equilibrium. This story is modified and moderated if we move beyond a "closed economy" and bring in the role of taxation: The rise in imports and tax payments at each step reduces the amount of induced consumer spending and the size of the multiplier effect.

Let us return to the article on Bloomberg.

"Construction costs to rebuild all that was lost will be more than simply replacement because a lot of the work will also involve fortifying structures," said Bernard Baumohl, chief global economist at Economic Outlook. "We'll see construction ramped up, and that's going to bring in jobs and an increase in demand for material of all sorts, and that's going to further stimulate the economy."

Hurricane Sandy did impose loss. How much loss? Already, the experts are there with estimates. It "may reduce economic growth by 0.25 percent to 0.5 percent in the fourth quarter after it disrupted industrial production, retail sales and employment, according to economists at Goldman Sachs Group Inc. Most of the reconstruction will take place in the first quarter of 2013, adding as much as half a point to growth, according to a Nov. 21 note to clients."

How long will the stimulus last? Years!

The stimulus is likely to last longer. Insurance claims payments and government funds typically boost the economy for 18 to 36 months after a natural disaster like Sandy, said Jeff Burchill, chief financial officer of FM Global in Johnston, Rhode Island, a policyholder-owned insurer that writes coverage for businesses. "You get a lot of reconstruction and construction that otherwise would not have occurred," Burchill said in a phone interview.

This is surely good news for all.

Here is the Keynesian rule: Always ask the barber if you need a haircut.

Economic benefits of the storm will come as homes are repaired, rebuilt and refurnished, according to David Crowe, chief economist for the Washington-based National Association of Home Builders. Buyers of new homes spend an average of $8,000 on furniture, appliances and landscaping, he said.

Why is he so sure? Because he knows economic history. He saw what happened after Hurricane Katrina.

The economic boost from housing construction "would take place over several years," Crowe said, based on the experience of Hurricane Katrina, which struck the Gulf Coast in 2005. "And it wouldn't start until sometime next year out of the need to plan for what remodeling and construction the homeowner wants to make."

SHUCK-PUTTING

You, being a complete rube, do not believe that government spending or insurance company spending or washed-out owner spending will create wealth. You think hurricanes are bad.

You need help. You just do not understand. You do not understand the Master, who wrote in The General Theory of Employment, Interest, and Money (1936):

It follows, therefore, that, if the consumption psychology of the community is such that they will choose to consume e.g., nine-tenths of an increment of income, then the multiplier kis 10; and the total employment caused by (e.g.) increased public works will be ten times the primary employment provided by the public works themselves, assuming no reduction of investment in other directions (pp. 116-17).

Pay no attention to the phrase, "assuming no reduction of investment in other directions." Yes, yes, I know: this is what Bastiat had in mind: other directions. But he was old fashioned. He was a free marketer. Worse: he had no formulas.

What you need is some formulas. A Keynesian economist has got some for you.

Got that, rube? So, sit there and shut up. It's time for the government to come to the rescue.

Yours is not to reason why. Yours is but to pay and die.

CONCLUSION

The Keynesians are dominant. Theirs is the economics of incoherence. Theirs is the economics of shuck and jive. They are the tailors of the Emperor, who is dressed in all the finery that formulas can provide.

The public is expected to enjoy the parade. "Doesn't the Emperor look grand?"

The public is paying for his wardrobe. If the public were to admit the truth about the Emperor's wardrobe, they would conclude, "we've been shucked." They might be peeved. They might be more than peeved.

There is going to come a day when the public finally figures out they have been shucked. That will be a great opportunity for those few economists who sat on the sidelines and pointed out the transparent nature of the formulas.