TheAgitator.com
Hurricanes and Broken Windows
Wednesday, September 29th, 2004It pains me to see how many people still buy into the broken window fallacy.
Some of you have speculated that because most of the money used to clean up from the hurricanes will come from insurance companies or from FEMA, that the broken window fallacy doesn’t apply — that this is all free money that insurers and the federal government were hoarding, all of which will now be injected into the economy.
No.
It isn’t as if the insurance industry is keeping a couple billion dollars sitting in a Self-Store, away from the rest of us, in case of an emergency. Rather, a good part of that money is invested somewhere. The rest is covered by catastrophic insurers, who also have that money invested. When insurers write checks, the money that covers those checks comes from other places, and could have been used to build new things, instead of to rebuild old things torn down by the hurricanes. The money going to Floridians isn’t coming from a cellar deep in the bowels of State Farm, it’s coming from State Farm’s shareholders, and from places where State Farm has invested its holdings. Floridians may be made 60 or 70 or 90 percent whole again, but millions of others will be paying for it.
Likewise, though Congress does keep a bit of the budget aside for natural disasters (which in itself is money better left in the hands of taxpayers, where it creates wealth), I doubt this Congress (particularly this Congress) had the foresight to set aside enough for four major hurricanes. We’re currently running a federal deficit. All of the money soon to be Florida-bound to pay for repairs would have gone somewhere else were it not for the hurricanes (preferably by never leaving the hands of the people who paid it in taxes).
Boil this down into simpler terms. You wreck your car, and in the process, you hurt your back. Your car insurer writes you a check. You get the car fixed. Your health insurer cuts you a check. You go to the hospital, and get your back fixed. Is the economy better off for your accident? If you subscribe to broken-window thinking, you say yes. You’re back in good health. Your car is fixed. You’re no worse off than you were before, and your mechanic and your chiropractor are doing better.
That’s baloney, of course. The money from your insurer came from somewhere else. It was pulled from the task of creating new wealth, and spent on merely getting you back to where you were before you had an accident. In fact, often that money comes from you, when you consider that every time an insurance company writes a check, premiums go up just a hair for all of its policyholders.
Of course, the reason why the broken window fallacy is so easy to embrace is because in the case of the hurricanes, the costs are diffused across the economy at large. Big insurers have money invested in all sectors of the economy, and have shareholders all over the world. The money for repair comes to the insurers a little at a time from lots of different sources. The cumulative costs are mighty, but they’re spread thin, and barely noticeable — at least to USA Today reporters. Whereas the money ends up in a relatively concentrated area. The cumulative benefits (or rather, repairs) are much less than the cumulative costs, but becasue they’re concentrated, they’re more noticeable. Look! They rebuilt their deck! And they added a jacuzzi!
As others around the blogosphere have opined, were broken window thinking true, Beiruit would be more prosperous than Boston, we should continue “bombing Iraq to prosperity” (who needs reconstruction?), and we ought to be wishing hurricanes, tornados and earthquakes on our poorest communities.
If you’re embarassed now, fret not. You’re in good company. Media people go broken window all the time.
Sadly, so do mainstream economists — one of whom writes columns for the New York Times, and is among a handful of favorites for the next Nobel Prize.
In a nutshell, there ain’t no such thing as a free broken window!!
I can think of three exceptions where fixing the broken window might improve the overall economy:
1. Money parked in nonproductive investments (such as gold coins) is used to pay for productive and efficient repairs.
2. Damage is in a problem area (flood prone land, bad neighborhood, California, etc.) and rebuilding occurs somewhere better.
3. A high unemployment region is devastated, and people take their insurance money and move to a low employment region.
I doubt that any of the above scenarios happen to a significant extent, but theoretically the economy could improve after a major disaster.
I still think it can be a net positive for America depending on how much of the total (invested) insurance pie is held by foreigners. I don’t think foreign welfare should be taken into account by American public policy in measuring whether a particular course of action–or random event–is wealth maximizing, any more than a criminal’s welfare should be measured in deciding to outlaw crime (I.e., what if he gets more pleasure from the offence than I get displeasure. From a strictly economic view, that exchange is wealth-maximizing is it not (setting aside moralisms about coercion and what-not)).
I also think if people are over-insured–and I’m not sure if they are or not–this can have an effect on things.
There is something puzzling in what you say Radley; you suggest the “economy” is not better off if you buy medical services from an accident. But if that was the next best thing for you to buy with your money–like other necessities, it’s at least Kaldor-Hicks efficient–then it’s no more a net negative then if you buy a security system for your house b/c of crime or a meal b/c you’re hungry.
P.S. For everyone who thinks I’m an idiot or immature, have you read The Problem of Social Cost by Ronald Coase. It blows your dogmatism to smitherenes!
What if the old window was cracked long before it got broken? Does replacing it with a perfectly good pane improve the economy?
Observing Florida hurricanes and reconstruction first hand since Donna in 1960, one thing has always stood out to me: most of the new stuff is an improvement over the things it replaces.
When Cleo and Dora ganged up to reduce the Duval County coastline to rubble in 1964, the result was not just a recovery for the nearly blighted beaches but a complete revitalization. Houses built in Dade county to replace the ones that Andrew blew away are stronger, now actually being built to code in many cases.
To rebuild a shattered deck is probably a good example of the broken window principle, but adding the jacuzzi is new production (and it’s not likely the insurance company or the government paid for it.)
Restoration after storms is nearly always more than just fixing what broke. In most of the cases I’ve seen, communities improve beyond their previous condition, and I suspect that’s good for the overall economy, too.
The money was invested elsewhere, but not necessarily creating wealth for the economy in any meaningful sense. Suppose the money was invested in the stock market. Insurance company sells stock. I suppose you want to argue the market maker will take money invested elsewhere and … but it’s far from clear that the end result will be fewer factories or services in the economy.
All insurance really is is speculation on the unexpected. It’s inverse betting - you pay in hoping never to win big, since that usually means catastrophe. The insurance company also hopes you don’t win big, since they’ve invested all premiums and kept the profit. The less claimed, the better for everyone in some weird sense.
But in terms of creating wealth, it’s best not spent by anyone. The insurance company of course would rather keep the wealth in their control, but by investing it broadly it does support wealth creation.
This is not to say insurance is a bad idea, though. It’s unfortunately necessary unless people are willing to absorb all costs for catastrophic events. Most can’t.
If a hurricane destroys your house, your place of employment, and eliminates your possessions, you have no wealth and, temporarily at least, no source of income. If this situation brings on a heart attack and you equally have no health insurance, well, you’re kinda screwed.
Except for roach’s soak-the-foreigners scenario, which is kind of another matter, all these theories assume irrational behavior. Now granted, irrational behavior happens, and thus accidents can bring unexpected benefit (gee it feels good when I stop hitting myself with a hammer!). But to ever expect irrational behavior across a large sample size such that we can expect net benefit from accidents or disasters over a large area is, well…irrational!
Dr. T - name one person or private sector organization that invests its money in non-productive ways. Factoring in risk/reward ratios of course….;-)
Even if you buy shares of the most boring stock you are effectively buying a low risk but low return investment, from someone else who perhaps will buy a Porsche with your cash. So then did you or did you not productively invest your money?
On broken windows:
The bottom line is that creating assets builds wealth, you know, 1+1=2. Destroying assets and then building them again is a zero sum game (if you are lucky), you know, 1-1+1=1.
The biggest problem is that this reasoning escapes all politicians, the odd Nobel laureate, and the Nobel Prize committee. In itself, this should be a criminal offence, I think, because promoting the broken window model of economic stimulation is akin to running a pyramid scheme or some other fraudulent activity.
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