Tracing consequences both seen and unseen.
Lee SharpeKrugman Gets The Broken Window Wrong
Posted at 12:03 am on September 12, 2012, by Lee Sharpe

Recently, Krugman wrote that if you think the iPhone 5 will boost the econonmy, then you believe in the Broken Window theory. The Broken Window Theory, more accurately described as the Broken Window Fallacy, is the belief that destruction can boost the economy, as people, companies, and governments spend to replace them. Krugman is a big proponent of this plan, even going as far to argue that spending to prepare against a space alien threat would be good for the econonmy, even if it turned out to be false.

But I’ll focus here on Krugman’s iPhone argument. He writes:

The key point is that the optimism about the iPhone’s effects has nothing (or at any rate not much) to do with the presumed quality of the phone, and the ways in which it might make us happier or more productive. Instead, the immediate gains would come from the way the new phone would get people to junk their old phones and replace them.

In other words, if you believe that the iPhone really might give the economy a big boost, you have — whether you realize it or not — bought into a version of the “broken windows” theory, in which destroying some capital can actually be a good thing under depression conditions.

If the iPhone 5 boosts the economy, and I believe it probably will, it’s because consumers feel it will create more value for them than the other uses they may have for their money. The “destruction” Krugman refers to people’s previous phones. But their other phones are not destroyed!

They could sell their old phone, give it to a family or friend, donate it to charity, or any number of other options. But they find purchasing a new phone to be worth it. If their previous phone was so truly bad that it doesn’t have other uses anymore and the best thing to do is throw it away, then by definition nothing of value has been lost, so even in this case there is no real destruction as meant by the Broken Window Fallacy, where the owner of property suffers an involuntarily loss.

But suppose there was an involuntary loss. Let’s say their old phone broke down and was out of warranty. In this case there certainly was destruction, and the person is buying the new phone to replace their old one. Maybe this is the case that Krugman means, although I would argue this is small minority of the iPhone 5 purchasers. But if these people wouldn’t have bought an iPhone 5 if their broken phone still worked, is that really a boost to the economy in the aggregate? Only if you look at what is seen (buying the iPhone 5 and creating employment in that industry). But we also need to look at what is unseen: Not buying the iPhone 5 would mean spending that money on something else, which creates employment in whatever industry the money would be spent on otherwise. So really when the person’s old phone breaks, the economy is down one phone, which makes it worse off, not better.

Krugman attacks the Broken Window fallacy, as he doesn’t believe it’s a fallacy at all. But the truth is that economic growth created by the iPhone 5 will be because it creates more value for consumers than it costs them to buy it, not because of any destruction that is happening. For a more thorough explanation of why the Broken Window Fallacy is a fallacy, I highly suggest watching this video:

Filed under: Economic Theory
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Henry Hazlitt"[T]he whole of economics can be reduced to a single lesson, and that lesson can be reduced to a single sentence. The art of economics consists in looking not merely at the immediate but at the longer effects of any act or policy; it consists in tracing the consequences of that policy not merely for one group but for all groups."
Henry Hazlitt, Economics in One Lesson






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