The Broken Window and the Scratched Record
There are two closely related economic myths that just won't die. The original myth from whence the other springs, is the 'broken window fallacy', eloquently exposed by Frederic Bastiat some 150 years ago in his essay 'That Which Is Seen and That Which Is Not Seen' , which uses the parable of the broken window to illustrate how economic thinking must go beyond the immediately observable effects of actions, and must also consider those that are not immediately evident. In the case of the broken window it is the fact that breaking windows is not a good way to increase economic prosperity. That which is seen seems to indicate otherwise at first glance – after all, the glazier is called in to replace the broken window, so he gets to do a job he wouldn't have gotten otherwise. With his income from replacing the window he will buy other things and so 'stimulate' the economy, or so the supporters of window-breaking would have it.
What isn't seen is that the shopkeeper whose window was broken must now deploy resources for the replacement of said window that he can no longer deploy for other uses. Thinking this properly through, one comes to the correct conclusion that breaking a window has made us poorer, not richer. After all, had the window not been broken, it would have continued to render its services at no additional cost, while the funds used in replacing it could have been used productively by the shopkeeper and thus would have added to his, and thereby society's, wealth.
This simple lesson in economics has passed by prominent commentators on economic matters ranging from Larry Kudlow to Nobel Prize winner Paul Krugman (no-one should be terribly surprised by that revelation), in . Like a scratched vinyl record that repeats the same thing over and over again, pundits can not let go of the fallacy, in spite of the fact that is has been refuted ages ago.
As Walter Williams of the George Mason University notes:
|“The broken-window fallacy was seen in a column written by Princeton University professor Paul Krugman after the terrorist attack on the World Trade Center, "After the Horror" New York Times (Sept. 14, 2001). He wrote, "Ghastly as it may seem to say this, the terror attack — like the original day of infamy, which brought an end to the Great Depression — could do some economic good." He went on to point out how rebuilding the destruction would stimulate the economy through business investment and job creation. Again, do the smell test. If Krugman is right, wouldn't the terrorists have done us a bigger economic favor if they had destroyed buildings in other cities?”|
That simple 'smell test' advised at the end of the above quote is really all that's needed. Anyone in possession of what is colloquially known as 'common sense', i.e. the ability to objectively appraise the shared continuum we call 'reality', should immediately be able to see through Krugman's fallacious argument. If the terrorists 'did us a favor' by destroying the WTC and thereby 'stimulating the economy', why not lay waste to entire cities?
This brings us to the application of the fallacy in the context of war, an idea that is even more firmly established in the minds of many people.
The most often heard contention in this context is that allegedly, 'World War 2 ended the Great Depression' – as though global destruction on a massive scale were an economically beneficial event.
War Prosperity Revisited
Ludwig von Mises gave us the best definition of so-called 'war prosperity' we have. It is short and to the point:
|“War prosperity is like the prosperity that an earthquake or a plague brings. The earthquake means good business for construction workers, and cholera improves the business of physicians, pharmacists, and undertakers; but no one has for that reason yet sought to celebrate earthquakes and cholera as stimulators of the productive forces in the general interest.”|
The myth about the beneficial economic effects of World War 2 mainly rests on 'GDP data'. As we have noted many times before, GDP is not a good measure of wealth creation, for a variety of reasons. In this particular case, it can be shown that the entire 'increase in GDP growth' brought about by the war was accounted for by the production of war materiel, i.e. tanks, bullets, bombs, guns, and so forth. Consumption per capita and private investment in the US remained firmly entrenched at the levels of the Great Depression throughout the war period, and even fell sharply during the years in which weapons production rose to its peak. There was no increase in general economic well-being.
In fact, the war was a period of strict rationing of consumer goods, as factories everywhere were retooled for weapons production. The man whom we must thank for most effectively exploding the myth about the economic beneficence of WW2 is Robert Higgs, who has thoroughly demolished the 'the war was good for the economy' argument in numerous essays.
The following quotes are from “Wartime Prosperity? A Reassessment of the U.S. Economy in the 1940s” – we recommend reading the article in its entirety but want to excerpt a few pertinent quotes here to illustrate Higgs' analytical approach. As Higgs points out, a command economy – which is what the economy became during the war years – can simply not be compared to a market economy by merely looking at statistics.
|“The accepted profile of the economy’s performance during the 1940s—peak prosperity from 1943 to 1945, followed by much worse performance from 1946 to 1949—is indefensible as a description of economic well-being. Further, the most widely accepted explanation of the events of the war years cannot withstand critical scrutiny. The prevailing misinterpretations of economic performance during the 1940s have arisen because historians and economists have failed to appreciate that the wartime economy, a command economy, cannot be readily compared with either the prewar or the postwar economy.”|
On war-time unemployment statistics:
|“To see more clearly what happened to the labor force, one can examine the percentage of the total (civilian plus military) labor force occupied in what I call the labor force “residuum.” This includes unemployed civilians, members of the armed forces, civilian employees of the armed forces, and employees in the military supply industries. This measure rose from 17.6 percent, almost all of it being unemployment, in fiscal year 1940 to more than 40 percent, almost all of it being war-related employment, during the fiscal years from 1943 to 1945, then dropped abruptly to about 10 percent during the fiscal years from 1946 to 1949. The extraordinarily high level of the labor force residuum during the war indicates that the “prosperous” condition of the labor force was spurious: official unemployment was virtually nonexistent, but four-tenths of the total labor force was not being used to produce consumer goods or capital capable of yielding consumer goods in the future. The sharp drop of the labor force residuum between fiscal years 1945 and 1946 marks the return of genuine prosperity.”|
On real output:
“In fact, price was “never a factor” in the allocation of resources for war purposes. The authorities did not permit “the price-cost relationship . . . to determine either the level of output or the distribution of the final product to individual uses.” Clearly, all presumption of equalities between prevailing prices, consumers’ marginal rates of substitution, and producers’ marginal rates of technical substitution vanished. Absent those equalities, at least as approximations, national income accounting loses its moorings; it necessarily becomes more or less arbitrary.
Some economists appreciated the perils at the time. Noting that the government had displaced the price system, Wesley Mitchell observed that comparisons of the war and prewar economies, even comparisons between successive years, had become “highly dubious.” Index number problems lurked around every corner. Much output during the war, especially the weapons, consisted of goods that did not exist before the war. Even for physically comparable goods, price structures and output mixes changed radically. Production of many important consumer goods was outlawed. Surrounding everything were the “obvious uncertainties concerning [price] quotations in a land of price controls and evasions.” Kuznets declared that the “bases of valuation for the war and nonwar sectors of the economy are inherently noncomparable . . . . It is impossible to construct directly a price index of war products that would span both prewar and war years.” Kuznets’s own efforts to overcome these problems never escaped from arbitrariness, as he himself admitted.
On real consumption:
“Most writers insist that real personal consumption increased during the war. In Seymour Melman’s flamboyant but otherwise representative portrayal, “the economy [was] producing more guns and more butter . . . Americans had never had it so good.”
This belief rests on a weak foundation. It fails to take sufficiently into account the understatement of actual wartime inflation by the official price indexes, the deterioration of quality and disappearance from the market of many consumer goods, the full effect of the nonprice rationing of many widely consumed items, and the additional transactions costs borne and other sacrifices made by consumers to get the goods that were available. When one corrects the data to provide a more defensible measure of what happened to real consumer well-being during the war, one finds that it declined.
“corrections considered above are sufficient, which is doubtful, one must recognize that consumers had to contend with other extraordinary welfare-diminishing changes during the war. To get the available goods, millions of people had to move, many of them long distances, to centers of war production. (Of course, costly movements to areas of greater opportunity always occur; but the rate of migration during the war was exceptional because of the abrupt changes in the location of employment opportunities.) After bearing substantial costs of relocation, the migrants often found themselves crowded into poorer housing. Because of the disincentives created by rent controls, the housing got worse each ear, as landlords reduced or eliminated maintenance and repairs. Transportation, even commuting to work, became difficult for many workers. No new cars were being produced; used cars were hard to come by because of rationing and were sold on the black market at elevated prices; gasoline and tires were rationed; public transportation was crowded and inconvenient for many, as well as frequently pre-empted by the military authorities. Shoppers bore substantial costs of searching for sellers willing to sell goods, including rationed goods, at controlled prices; they spent much valuable time arranging (illegal) trades of ration coupons or standing in queues. The government exhorted the public to “use it up, wear it out, make it do, or do without.” In thousands of ways, consumers lost their freedom of choice.
People were also working harder, longer, more inconveniently, and at greater physical risk in order to get the available goods. The ratio of civilian employment to population (aged 14 and over) increased from 47.6 percent in 1940 to 57.9 percent in 1944, as many teenagers left school, women left their homes, and older people left retirement to work. The average work week in manufacturing, where most of the new jobs were, increased from 38.1 hours in 1940 to 45.2 hours in 1944; and the average work week increased in most other industries, too — in bituminous coal mining, it increased by more than 50 percent. Night shifts occupied a much larger proportion of the work force. The rate of disabling injuries per hour worked in manufacturing rose by more than 30 percent between 1940 and its wartime peak in 1943. It is difficult to understand how working harder, longer, more inconveniently and dangerously in return for a diminished flow of consumer goods comports with the description that “economically speaking, Americans had never had it so good.”
On irrelevant macro models and the war-time reality:
“[...] In sum, the economy during the war was the exact opposite of a free market system. Every part of it was either directly controlled by the authorities or subject to drastic distortion by virtue of its relations with suppliers and customers who were tightly controlled. To suppose that the economy allocated resources in response to prices set by the unhampered interplay of demands and supplies in the markets for commodities, factor services, and loanable funds is to suppose a complete fiction. Clearly, the assumptions that undergird standard macro models do not correspond with the empirical reality of the wartime economy.”
“In 1940 and 1941 the economy was recovering smartly from the Depression, but in the latter year the recovery was becoming ambiguous, as substantial resources were diverted to war production. From 1942 to 1944 war production increased rapidly. Although there is no defensible way to place a value on the outpouring of munitions, its physical dimensions are awesome. From mid-1940 to mid-1945 munitions makers produced 86,338 tanks; 297,000 airplanes; 17,400,000 rifles, carbines, and sidearms; 315,000 pieces of field artillery and mortars; 4,200,000 tons of artillery shells; 41,400,000,000 rounds of small arms ammunition; 64,500 landing vessels; 6,500 other navy ships; 5,400 cargo ships and transports; and vast amounts of other munitions. Despite countless administrative mistakes, frustrations, and turf battles, the command economy worked. But, as always, a command economy can be said to work only in the sense that it turns out what the authorities demand. The U.S. economy did so in quantities sufficient to overwhelm enemy forces.
Higgs then notes that the war can only be said to have had a positive effect in that it changed people's expectations, especially as its end came into sight. Also, the 'forced savings' induced by the war economy provided the financial wherewithal to boost civilian production after the war. This was inter alia reflected in the performance of the stock market:
“Which brings us to what may be the most important factor of all: the performance of the war economy, despite its command-and-control character, broke the back of the pessimistic expectations almost everybody had come to hold during the seemingly endless Depression. In the long decade of the 1930s, especially its latter half, many people had come to believe that the economic machine was irreparably broken. The frenetic activity of war production — never mind that it was just a lot of guns and ammunition — dispelled the hopelessness. People began to think: if we can produce all these planes, ships, and bombs, we can also turn out prodigious quantities of cars and refrigerators.
When the controls began to come off and the war ended more quickly than anticipated in 1945, consumers and producers launched eagerly into carrying out plans based on rosy forecasts and, by so doing, made their expectations a reality. Of course, the ability to draw on the accumulations of financial assets built up by “forced saving” during the war was important, especially in conjunction with the Federal Reserve's continued support of bond prices. But the liquidation of those assets alone could not have turned the trick — if such tricks were possible, a government could produce prosperity simply by cranking the money presses.
Probably the most solid evidence of expectations comes from the stock markets, where thousands of transactors risk their own wealth on the basis of their beliefs about future economic conditions. Evidently investors took a dim view of the prospect of a war economy. After 1939, stock values dropped steadily and substantially; U.S. entry into the war in December 1941 did not arrest the decline. By 1942 the Standard & Poor’s index had fallen by 28 percent, and the market value of all stocks on registered exchanges had plunged by 62 percent in nominal terms. (Adjustments for price level changes would make the declines even greater.) The declines occurred even though current corporate profits were rising steadily and substantially. In 1943, as the tide of war turned in favor of the Allies, the stock market rallied and small additional advances took place in 1944. Still, in 1944, with the war economy operating at its peak, the stock market’s real value had yet to recover to its 1939 level. By early 1945, almost everyone expected the war to end soon. The prospect of a peacetime economy electrified investors. Stock prices surged in 1945 and again in 1946. In just two years the Standard & Poor’s index increased by 37 percent and the value of all shares on registered exchanges by 92 percent, despite a decline of current-dollar after-tax corporate profits from their peak in 1944. Did people expect the end of “wartime prosperity” to be economically deleterious? Obviously not.”
Higgs has written this essay back in 1992, and it should have once and for all led to a reassessment of how to properly interpret the war's alleged magical ability to 'end the depression'.
The only kernel of truth to the assertion that the war helped with ending the depression was as Higgs remarks the fact that the success of war production changed people's minds about what was possible. Their economic expectations, thoroughly damaged by the catastrophic Hoover interventionism and the even more destructive New Deal under FDR – policies that combined to transform what should have been a sharp but brief economic downturn into a seemingly never-ending age of economic misery – were changed by seeing what the economy was actually capable of.
However, we have just been reminded that the myth of war prosperity lives on. Just as the broken window fallacy has survived 150 years of refutation, so the idea that one can get wealthier by waging war in far-away places just will not die.
The Washington Post Pleads For Another War to Bring Back Prosperity
An editorial in the Washington Post by one David S. Broder, entitled '' , first gushes about the president's alleged intellectual superiority over his potential opponents in the next election, but then notes with regret that in spite of this, he is no longer the shoe-in he once was.
The reason? The bad economy.
Somehow, when the economy is bad, it can not possibly be the president's fault (we can't prove it, but we suspect Broder would credit the president without hesitation if the economy were in better shape) . A mysterious cycle no-one really understands is held to be at work. It is a 'tidal force', an accident of nature, the performance of which is apparently entirely independent of economic policy:
“The steps that have been ordered so far in Washington have done nothing more than put the brakes on the runaway decline. They have not spurred new growth.
But if Obama cannot spur that growth by 2012, he is unlikely to be reelected. The lingering effects of the recession that accompanied him to the White House will probably doom him.
Can Obama harness the forces that might spur new growth? This is the key question for the next two years. What are those forces? Essentially, there are two. One is the power of the business cycle, the tidal force that throughout history has dictated when the economy expands and when it contracts.
Economists struggle to analyze this, but they almost inevitably conclude that it cannot be rushed and almost resists political command. As the saying goes, the market will go where it is going to go.
In this regard, Obama has no advantage over any other pol. Even in analyzing the tidal force correctly, he cannot control it.”
We would take issue with the notion that Obama has 'correctly analyzed' the 'tidal force' that has proved so resistant to his well-meaning ministrations. Anyway, Broder has decided that evidently, nothing can be done about it. Otherwise it would presumably have been done already – and thus the president's current position at the top of the chain of command is of no use compared to 'other pols' (sic – that seems to be short-hand for politician).
So what is the second 'force' that Obama might 'harness to his advantage'? You probably already guessed it – it's war. Broder continues:
“What else might affect the economy? The answer is obvious, but its implications are frightening. War and peace influence the economy.
Look back at FDR and the Great Depression. What finally resolved that economic crisis? World War II.
Here is where Obama is likely to prevail. With strong Republican support in Congress for challenging Iran's ambition to become a nuclear power, he can spend much of 2011 and 2012 orchestrating a showdown with the mullahs. This will help him politically because the opposition party will be urging him on. And as tensions rise and we accelerate preparations for war, the economy will improve.”
Here we go again with the broken window(s). Neither is it true that 'World War II resolved the economic crisis', nor are 'accelerating preparations for a showdown with the mullahs' going to do anything of the sort this time around. The preferred method for financing wars is of course inflation – in this sense, there may be a short term inflationary illusion of prosperity provided by increased spending for war, to the extent that the central bank monetizes such expenditure. With 'QE2' on its way, a period of inflationary bogus prosperity is already in train; it will dissipate as soon as the inflation ends, or alternatively end once it leads to so much capital consumption and such a sharp rise in inflation expectations that the underlying currency system collapses. It can not possibly be sustained in either case.
As to Iran's 'ambition to become a nuclear power', the case for this allegation seems as thin as ever. We are not aware that the conclusions of the 2007 National Intelligence Estimate on Iran's nuclear ambitions have materially changed. As noted by Greg Thielmann in “The Iran Nuclear NIE of 2007: Revise, Reject, or Reiterate? “, the deliberations regarding an updated NIE show that:
“Comments by senior U.S. officials in 2010 have continued to endorse the principal conclusions of the 2007 National Intelligence Estimate (NIE), "Iran: Nuclear Intentions and Capabilities." This may come as a surprise for those accustomed to seeing that earlier document described by pundits and journalists as "flawed," or "erroneous." In fact, from the moment the NIE's sanitized Key Judgments were released in late November 2007, the estimate has been subject to virulent criticism, particularly by those who regret that it did not provide justification for a preventive attack on Iran's nuclear program.”
Many critics have impugned the motives of its authors. Former CIA Director James Woolsey has called the NIE "deceptive”. Rep. Peter Hoekstra, Ranking Minority Member (and former Chairman) of the House Intelligence Committee has called it "a piece of trash." There is some considerable irony in hearing such criticism from those intimately familiar with the inner workings of the intelligence community, who seemed to have sleep-walked through the serious professional lapses of the 2002 NIE on Iraq WMD.”
“There has been no retreat from the key historical judgment that Iran halted its nuclear weapons program in 2003 and no advance to a conclusion that Iran had decided to develop nuclear weapons. According to open source information, foreign intelligence services have suggested that some level of nuclear weapons program activity has been underway since 2003. (See, for example,Mark Hosenball, Newsweek, June 28, 2010). It is reasonable to conclude that Iran wants at least to develop the capability to build nuclear weapons.”
“ It would appear then that the long-anticipated "Memorandum to Holders," which is expected to update the 2007 NIE, is likely to revise it rather than revoke it by acknowledging that some kind of ongoing research on nuclear weapons is occurring, without questioning the validity of the 2003 halt that was detected or concluding that Iran has definitively decided to build a bomb. Iran's secret construction of a uranium enrichment facility near Qom, exposed and effectively neutralized in September 2009, deepened suspicions that Iran was interested in developing at least a breakout capability for clandestinely producing fissile material for weapons, independent of its existing LEU stockpiles, which are monitored by the International Atomic Energy Agency. However, if there were shocking discoveries of unambiguous nuclear weapons intent in the revelations of defectors like Asgari and Amiri, one would have expected to see an alteration in the phraseology used by senior U.S. intelligence officials to describe Iran's nuclear program. This has not happened.”
In short, the 'Iran WMD' story sounds a good deal less solid than the Iraq WMD story sounded at the time of its propagation, and we all know how that one turned out (still no WMDs found in Iraq after seven years of occupation, but lots of blood and treasure wasted in the process).
Let us just note here that going to war with a country on the basis of 'it might want to do something bad at some point in the future' does not exactly strike us as representing a good case. As pretexts go, they don't come much flimsier. Alas, Broder does not even concern himself with this point. To him a war with Iran is the only logical way of dealing with the situation. If it were not such a serious topic, the following quotes would almost be comical. Broder writes:
|“I am not suggesting, of course, that the president incite a war to get reelected.”|
Notwithstanding this disclaimer, that's exactly what he suggested in the preceding paragraph. Broder continues:
|“But the nation will rally around Obama because Iran is the greatest threat to the world in the young century. If he can confront this threat and contain Iran's nuclear ambitions, he will have made the world safer and may be regarded as one of the most successful presidents in history.”|
A brief back-of-the-envelope calculation reveals that Iran's defense budget at 2.7% of GDP is not only far smaller as a percentage of economic output than the US defense budget (4.3% of GDP at last count), but is a mere pittance in absolute terms at $9.17 billion compared to the $663.25 billion US budget. In fact it represents not even 1.4% of US spending on defense per annum. This is supposedly the 'greatest threat to the world' that requires yet another war to be preemptively stomped out? Color us doubtful on that score.
We agree with critics of Iran that its reactionary throwback government is odious and deserves scorn. However, it is up to the Iranian people to change this situation. No government, no matter how tyrannical, can exist without at least the tacit consent of its subjects. We would also note, Iran's government is hardly the most tyrannical on earth – in fact it has more democratic features (as flawed as those may be) than can be detected at the governments of many of the West's valued allies in the Middle East.
Regarding the nuclear question, the technology for constructing nuclear weapons is now about 65 years old. Any halfway modern nation with a sufficiently developed capital stock and a well educated work force should in theory be able to build nuclear arms if it so desires. We know that for instance South Africa secretly possessed six nuclear bombs, a fact that was only revealed to the world when it decided to disarm in the wake of the 1994 changeover from the apartheid regime to a democratic dispensation. It will not possible to bomb away Iran's know-how or the basic requirements for producing nuclear arms, unless one were to bomb the country back into the stone age by destroying it completely. We're not quite sure if the recipient of the 2009 Nobel peace prize , who is already waging two official and the occasional unofficial war, not to mention the ongoing 'war on terror' (i.e., a war on a strategy rather than a specific opponent) is prepared to wage yet another war, especially if it requires utter ruthlessness if it is to achieve its presumed objectives. It appears to us that persuasion and diplomacy are far and away the better choices of dealing with the situation.
Lastly, one thing is already certain: if such a war were to be waged, it would do nothing to improve the economy. On the contrary, the 'unintended consequences' would likely be severely negative. Soaring oil prices, rising inflation, deteriorating trade relations, rising danger of retaliation by terrorists, and further damage to reputation would likely add up to a deepening economic crisis rather than the boost to economic activity Broder hopes for.
In the end, a war is always about destroying property and ending lives – and even though the people and property to be terminated are in a far-way place, how can this possibly be a boon for the economy? The production of war materiel would certainly be increased, but this only means that fewer resources will be available for the production of things consumers actually want. 'War prosperity' will always remain an illusion.
President Obama wins the 2009 Nobel Peace Prize (we're not quite sure for what, but there it is…). Should he wage war on Iran to 'increase prosperity'? David Broder of the Washington Post thinks so.
(Photo Credit: )
(Cartoon by Adam Zygus)
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