Japan Disaster and Broken Window Fallacy

Can the massive destruction caused by the Japanese earthquake, tsunami, and nuclear meltdowns stimulate the economy?

Freedom Works president Matt Kibbe wants to debunk the notion that the national disasters in Japan will stimulate economic recovery.

Over two centuries ago, French economist Frederic Bastiat debunked this myth by introducing the broken-window fallacy.

Many prominent economists have claimed that the natural disaster will boost Japan’s already fragile economy. After expressing sorrow for the people of Japan, former White House economics adviser Larry Summers said, “it may lead to some temporary increments in GDP as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake, Japan actually gained some economic strength.” Any economist is dead wrong to claim that there is a silver lining in a natural or man-made disaster. As it turns out, earthquakes and tsunamis are not stimuli. Destruction will not create prosperity.

[…]

Those in the Obama administration are famous for touting the broken-window fallacy. Frederic Bastiat’s broken-window fallacy explains why high taxes, subsidies, tariffs and “stimulus” programs have made our economy worse. Advocates of these government programs only focus on what can be visibly seen while ignoring the unintended consequences. The “stimulus” may create some public works jobs but it does so at the expense of taxpayers. It has taken away money from taxpayers in the private sector and sent it through the hands of politicians in Washington to spend for us. These taxpayers would have spent their money on goods and services that they value, which would have created jobs in the private sector. We just cannot visibly see all the jobs that would have been created without the $819 billion “stimulus” package.

Let’s put an end to one of the most dangerous and popular economic fallacies. We are all poorer as a result of natural or man-made disasters.

Kibbe’s right that disasters are inherently bad and we shouldn’t look to them as a force for economic recovery. And Bastiat is right that breaking a window and subsequently replacing it provides no stimulus, since the transaction is zero-sum.

Given the sheer destruction that’s taken place across Japan, it’s hard to see how it won’t result in a net loss economically. And that’s to say nothing of the horrible toll of the tremendous loss of life.

All that said, it’s certainly possible that some long-term economic gain could be made here. Legend has it that Japan and Germany recovered more quickly than the victors in World War II precisely because of the level of destruction bombings wreaked on their infrastructure. Unlike a shop window broken by a child–Bastiat’s famous example–the replacement is likely to be substantially better than the original. Old factories and dwellings will be replaced by more modern, efficient variants. Old businesses that were just hanging on will be hastened into obsolescence because the owners will take the insurance money and reinvest it into something potentially more sustainable.

So, something good can come of all this. It’s just not going to be worth the cost.

via Tabitha Hale

FILED UNDER: Economics and Business, Natural Disasters
James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. john personna says:

    Do we actually have “counter-factuals” on Germany and Japan? Both nations were able to attempt world domination … not the kind of thing poor nations can attempt.

    I’d say no. While recovery miracles are often cited, we don’t know how kick-ass Germany would be had Adolf been satisfied with a re-industrialized nation, and gone for trade after that. Heck, “market-fascism” probably would have been more successful than the “market-socialism” we see today.

  2. john personna says:

    BTW, I believe it was P.J. O’Rourke who said communism only worked in one place, East Germany, and only there because there was never a political system invented that would stop the Germans from going to work.

  3. James Joyner says:

    John,

    Deductions made from the postwar miracles in Germany and Japan are partly speculative, of course. But it’s doubtless true that building 1950s- and 1960s-era factories gave them a leg up on societies whose 1920s- and 1930s-era factories were still functioning and therefore upgrading them was hard to justify.

    But, no, we don’t have any way of knowing what would have happened had we not had the war and the two economies were allowed to proceed without that interruption/forced reconstruction.

  4. john personna says:

    No James, I do not accept this “doubtless.”

    The Germans made a lot of great stuff before (and during) the war. They were building practically space rockets, remember? (Not to mention the Volkswagen.)

  5. john personna says:

    (As I get older it becomes clear to me how ingrained “just so” stories are in the consciousness, how they allow us to “not think,” and how many counter-factuals are missing.

    It is really easy, when you look at these “benefits of rebuilding” stories to say “wait a minute” and “why not look at them as the _continuation_ of progress by very productive nations?”)

  6. john personna says:

    (See also “why they should not have told us Germany/Japan stories on the eve of Iraq’s invasion.”)

  7. wr says:

    I confess I can’t understand why Kibbe is so desperate to insist that there is absolutely no way that there could ever be any good to come out of this disaster. If we were faced with a choice between having a devestating earthquake and taking the gain that might follow, or sticking with the status quo, okay. But the earthquake happened.

    Oh, wait, This turns out not to be about Japan at all. It’s another hysterical screed from an anti-civilization feudalist screaming about how government and taxes are always evil, and thus the only way to help people is to let billionaires transform the entire nation’s wealth into gold coins they can keep in their vaults like Scrooge McDuck.

  8. michael reynolds says:

    Actually, John, the Nazis had built a slave-labor economy that was already being outperformed by the Soviets’ slightly-less-slavish economy, and was blown to smithereens by the staggeringly effective American chicks-and-4F’s economy of the same period.

    After the war the Germans not only had no slave labor, they had rather less labor than they had before the war, what with having managed to lose between 6 and 8 million people — more than 10% of their prewar population.

    So they built new factories less dependent on slave labor, or untrained labor of any kind, and they very quickly recovered and then came to dominate Europe economically.

    Japan likewise had its economic model altered by virtue of napalm and nukes. And they, too, rapidly recovered.

    England, by contrast, struggled. So did relatively unharmed France.

    Let’s say that you own a factory which makes crappy cars. Let’s say you’re a bit of a lazy entrepreneur because after all, you’re rich, so why wear yourself out? Let’s say by virtue of all this you have political sway sufficient to discourage competition.

    Then let’s say a B29 flies overhead and suddenly no more factory.

    So some guy named Honda comes by and builds a shiny new factory which relies on automation and precision.

    (Incidentally Germany’s vaunted jets were shite. Fast, yeah, if you didn’t mind a near-kamikaze one-way ticket approach.)

  9. michael reynolds says:

    The point is not that destruction is good in and of itself. But that sometimes it is.

    As usual with real life there are no fixed rules that apply in all circumstances. Something I’m sure economists will “discover” in another 70 or 100 years.

  10. Dave Schuler says:

    It;’s better thought of as a parable than as a fallacy. It’s only a fallacy if you neglect to account for the capital loss.

  11. ponce says:

    Wonder if the insurance companies can afford to pay off all the damage?

  12. PD Shaw says:

    WR, so you think that the BP disaster was good for the Gulf because it brought so much economic activity?

  13. PD Shaw says:

    ponce, if their insurance is anything like ours is these days, the earthquake coverage will exempt earthquakes.

  14. EJ says:

    There are two different concepts going on here that people are confusing. There’s the static aggregate demand increase from rebuilding that is an overly simplistic and naive Keynesian argument (broken window fallacy) and then there is the potential that this stokes an innovation cycle via accelerating the “creative destruction” process. If there is indeed a positive growth aspect to this, its due to the latter dynamic, not the prior.

  15. Hi! Behonest I do not care if it helps our economy.I hate to profit from a disaster overseas.This can easly happen here.

  16. wr says:

    PD — That’s a ludicrous question, and refers to an argument no one is making. I doubt there is a single individual anywhere in the world who believes that this earthquake was a good thing, or who would have wished for it to happen if he had a choice in the matter. The question posed in this article was whether this natural disaster could, in the end, boost Japan’s economy. The author’s claim is no, because he is pushing a pet theory that government spending is always bad.

    I don’t claim to know how Japan will end up after this. Obviously it’s a horrible tragedy in terms of lives lost and lives disrupted. But if the Japanese take Kibbe’s advice, theyll simply crawl under the rubble to die instead of doing everything they — and their government — can do to rebuild.

  17. Steve Verdon says:

    Legend has it that Japan and Germany recovered more quickly than the victors in World War II precisely because of the level of destruction bombings wreaked on their infrastructure. Unlike a shop window broken by a child–Bastiat’s famous example–the replacement is likely to be substantially better than the original. Old factories and dwellings will be replaced by more modern, efficient variants. Old businesses that were just hanging on will be hastened into obsolescence because the owners will take the insurance money and reinvest it into something potentially more sustainable.

    Which explains the obvious policy of why countries bomb themselves to enhance long term economic growth.

    Lets try a simple simple model. We have a GDP with $100. Growth happens at the rate of 1.02 each year. Now we suffer a huge economic catastrophe and GDP is now reduced to $75, and economic growth is reduced to first 1.015, but due to modernization 15 years later jumps up to 1.03 for 15 years then back to 1.02. How long to get back to where they would have been without the catastrophe? Hmmm, with these parameters, never. What level of growth would be needed to get things back to “original trend”? Lets suppose growth doubles and stays at that level for 83 years (plus the $100 year, and the catastrophe year of $75 that gives us a 100 year window), you would catch up in year 37. Of course, we need a heroic assumption to get there.

    Which again gets back to my sarcastic comment. I’ll believe this argument when countries start carpet bombing older cities, or industrial facilities as a way of spurring future economic growth. For example, when the we start bombing Detroit (after evacuations of course), then I’ll consider this argument has having at least some minor validity.

    …then there is the potential that this stokes an innovation cycle via accelerating the “creative destruction” process

    I think this would be a hard argument to make, because it would then also point to self bombing by various countries as a viable strategy for improving economic growth. Also, there is no assurance that creative destruction has to result in an improved economic environment overall either. Creative destruction can result in a temporary period of higher unemployment. So while, there might be some improvements to overall growth in theory, I don’t think they’d offset the huge losses that have been suffered.

    Wonder if the insurance companies can afford to pay off all the damage?

    As PD indicated, I think most insurance companies will not payout for what is considered an “act of God”–i.e. a hugely destructive event. Of course if you had flood and/or earthquake insurance you would probably get a payout, but many people skip that thinking that the risk is so small they will take their chances.

  18. Steve Verdon says:

    The question posed in this article was whether this natural disaster could, in the end, boost Japan’s economy. The author’s claim is no, because he is pushing a pet theory that government spending is always bad.

    I don’t claim to know how Japan will end up after this. Obviously it’s a horrible tragedy in terms of lives lost and lives disrupted. But if the Japanese take Kibbe’s advice, theyll simply crawl under the rubble to die instead of doing everything they — and their government — can do to rebuild.

    No. No, no, no! This is not the argument. The argument is will, on net the earthquake be a boon for Japan’s economy and the answer is almost surely no. Does that mean nothing should be done in response–i.e. spending on rebuilding? No, of course not. However, if there is spending it is merely resource being diverted from one productive activity to another, that pretty much means it is not going to result in a net gain since it is replacing losses as well.

    So you don’t understand the argument or its implications. And yes, if the implication is that disasters are good for the economy then the BP oil spill was a good thing too…for the economy. Since we don’t go around dumping millions of gallons of oil into the oceans I think we can see that the argument it was a good thing for the economy is suspicious.

  19. Dave Schuler says:

    However, if there is spending it is merely resource being diverted from one productive activity to another, that pretty much means it is not going to result in a net gain since it is replacing losses as well.

    Which returns us to Bastiat’s original parable, The Seen and the Unseen. Certainly from the point of view of the shopkeeper whose window is broken it is always a loss—otherwise he would have made the investment without somebody breaking his window.

    Is it possible that the new investment could result in net growth? Yes, under highly unlikely circumstances.

    Disasters remain disasters and capital loss remains capital loss.

  20. PD Shaw says:

    Part of my amazement about this topic is that I lived in New Orleans a few years before Katrina, and have been back several times since. Yes, I found a lot of new investment, and businesses (on higher ground). Perhaps the hurricane has been good for some, but driving down from the Quarter, I could still find abandoned houses with spray painted messages on them. And driving further, I found the open flood plains that look like a lot of places in Japan today, but with green shoots of some Hollywood designed houses, trying to re-establish the Lower Ninth Ward. Because Brad Pitt wants poor people to die in style.

    The population has dropped, people have left, the size of the economy has shrunk. The cost of living in the city has become more expensive either because people spend more on precautions they didn’t take before or because the law is enforcing them.

  21. PD Shaw says:

    To Dave’s point, I think a Japanese representative (Ambassador to the U.S?) was making it this morning on CNBC. He said the Japense companies are diversified with plants in several countries, such as China, with enough slack that there shouldn’t be any interuption.

    So, yes, there will be winners and losers. I’m assuming China will be better off for this disaster.

  22. michael reynolds says:

    However, if there is spending it is merely resource being diverted from one productive activity to another, that pretty much means it is not going to result in a net gain since it is replacing losses as well.

    That would certainly be true. If people were rational actors who made rational decisions.

    They are not, however. An assumption that people will always spend their money on “productive activity,” is just that: an assumption. And a poor one.

    In fact people spend their money on all sorts of nonsense, along with productive activity. A crisis often forces irrational humans to sober up and make hard decisions. Stress forces prioritization and efficiency.

    So it is quite possible that money that a Japanese person might have been saving for, say, an unlikely wedding, or as an offering at a religious shrine, or on Hello Kitty! merch, will now go to build a nice new power plant. Which may lower the cost of energy and inspire someone to build a nice new factory.

  23. sam says:

    “Legend has it that Japan and Germany recovered more quickly than the victors in World War II precisely because of the level of destruction bombings wreaked on their infrastructure.”

    There isn’t a more profitable undertaking for any country than to declare war on the United States and to be defeated.

    Tulley Bascombe

  24. john personna says:

    michael, shouldn’t a guy who drives an Audi know a little more about their history, and pre-war triumphs? Auto Union cars were turning 199 mph in the 1930s. That was before they were sucked into the war machine.

    Slave labor existed, and was a great evil, but it doesn’t change what I’m saying, that Germany and Japan had great wealth and technical skill before the war. It seems quite reasonable to me that without the war we’d still have great Auto Union cars (perhaps without the necessity of a name change).

  25. john personna says:

    “That would certainly be true. If people were rational actors who made rational decisions.”

    This is why writers require of us suspension of belief. Logic like this doesn’t work outside of fiction. If people are irrational actors, their actions will be irrational with or without national catastrophe. If people are irrational, they can’d get serious after a disaster, just because they want to. If people are irrational, it’s not in them.

    They live at the whim of the gods either way …

  26. Kit says:

    I think the basic misapprehension here revolves around stimulus and wealth. Clearly, destroying and replacing an asset cannot create wealth. Let’s instead consider how wealth destruction might allow the government (typically) to stimulate the economy to increase economic potential.

    When an economy fails to realize its potential, paying the unemployed or under-employed to work will result in increased economic growth. Now if 1) the resulting assets sufficiently spur future economic activity, and/or 2) the temporary increase in employment leads to a permanently higher productivity, then the original stimulus money can be repaid while leaving the economy at a permanently higher rate of growth, and thus eventually wealthier compared the same economy sans stimulus.

    This applies equally to recessions, by the way.

    Just how all this relates to today’s Japan, I cannot say. They certainly enjoy a low level of unemployment, although their lethargic growth over the past twenty years perhaps points to certain structural forces that have throttled growth hitherto; the stimulus of rebuilding might help wring out such problems.

    While no one would wish for such a disaster, one can always hope for some economic benefit. Personally, however, given how advanced and efficient Japan was (and remains) I rather doubt much good will come from rebuilding.

  27. michael reynolds says:

    JP:

    I’m not in any way denying that the Germans and Japanese had serious skills. They did. For example, both were rather good at shipbuilding.

    And yet, somehow, despite having their countries reduced to rubble, and in Germany’s case at least their best scientists bled off to the USSR or the US, and major labor resources decimated, they both managed to spring right back up and at least in Japan’s case become an industrial power far more successful than they were pre-war.

    Logic like this doesn’t work outside of fiction. If people are irrational actors, their actions will be irrational with or without national catastrophe. If people are irrational, they can’d get serious after a disaster, just because they want to. If people are irrational, it’s not in them.

    And the reverse, JP, is to believe that people are rational actors and make the rational choice of smoking meth and eating at the Cheesecake Factory. That’s stretching the definition of rationality past the breaking point.

    If you like, let’s clarify it by saying that people act irrationally. Their buying decisions are based on emotion — need for status, loneliness, compensation for some other unrelated difficulty, and yes, of course, also rational needs.

    But to deny that people make irrational economic choices doesn’t hold up to scrutiny. We’ve just been through a major meltdown caused in part by people who made 30k a year believing they should buy homes valued at a million dollars.

    So if they have 100 dollars today their choices are not, as Steve Verdon said, between one “productive activity,” and another. Their choices run the gamut from highly useful and productive to flat-out suicidal.

    A society (or person) under stress may — emphasis on may — make smarter choices than when they are not under stress. People often do. Then again, they often do something spectacularly stupid. Such as deciding to exterminate the Jews or attack Pearl Harbor.

    Stress, change, destruction, all can be the start of adaptation, improvement and creativity. Or not. The point is that it’s ridiculous to imagine that humans are integers to be plugged into an equation in which their choices can be assumed to be rational ones focusing on productivity.

  28. Kat-Mo says:

    This may be to simple an analysis, but I would agree those who think this may be the possibility of new advancements that spur economic growth out of this disaster.

    Point: After WWII, the US economy was not exactly booming. Returning soldiers created huge unemployment and put a lot of people out of work, people who had new skills, because the course was to give returning veterans preference. There were not enough jobs, people had just been living through ration books.

    What happened to spur the US economy? Was it simply that rebuilding Germany and Japan required materials that had to be manufactured here? That is one aspect, but, as pointed out, the war had advanced many technologies, medicines and even basic materials that eventually led to even greater economic growth.

    Two items, just off the cuff: jet engines and v2 rockets.

    We did get an influx of scientists and other notables into our country after the war. Jet engines being developed for military use became commercially viable. Not only creating commercial passenger flights, but able to move cargo and mail very quickly from one side of the world to the other. If you think about this, one of the reasons that factories could continue running is that, if a factory went down on one side of the country, you could ostensibly send the part on a plane and have the machine back up in less than 24 hours. Logistical ideas that come out of military planning, rebuild of Japan and Germany and the technology of destructive creativity.

    V2 rockets = missiles for defense = satellites = satellite tv, satellite phones, GPS, etc

    I can go through the list. Japan may never be the Japan we think of today, but it and we may be the Japan and the US of the 21st century, the one we imagined we’d be.

    So, when we go through the process of clean up and rebuilding, we will discover some technologies that have been on the periphery may find new and important uses that will spur our own creativity and future economic growth. Technology on the research block may become so common in the next twenty, thirty, fifty years, that we or our children more likely, could not imagine a time without them.

    No, destroying a building and rebuilding it does not create a net positive, but sometimes, the things we create to destroy them and rebuild them, does.

    I would point out even that I am typing this message on my Toshiba computer. A computer that probably would not exist unless Japan had been destroyed and McArthur had not set Japan on a path for a more peaceful focus of their energy. I am watching my Japanese made TV.

    Now, Japan is damaged, but it does not mean that the world, humanity, or the Japanese goes down with the Island.

  29. sam says:

    @Michael

    “And yet, somehow, despite having their countries reduced to rubble, and in Germany’s case at least their best scientists bled off to the USSR or the US, and major labor resources decimated, they both managed to spring right back up and at least in Japan’s case become an industrial power far more successful than they were pre-war.”

    I’m not knocking anybody, but I somewhat amazed that this entire thread could go this far and nobody mention the Marshall Plan.

  30. john personna says:

    And yet, somehow, despite having their countries reduced to rubble, and in Germany’s case at least their best scientists bled off to the USSR or the US, and major labor resources decimated, they both managed to spring right back up and at least in Japan’s case become an industrial power far more successful than they were pre-war.

    First of all, you commit the great sin of historical compression. It is common, when looking at past decades (or even distant centuries) to think of them as a blink of an eye. When did Japan and Germany really rebound into American markets, as top-flight exporters? 1975? 1980?

    The war ended in 1946. 30, 35, years later we worried about Japanese market power.

    Now compare this to a disaster aftermath in the “now.” Are you really telling us that, after suffering and working for 30, 35 years the Japanese will enjoy the benefits? When?

    2050?

    I really don’t know what your rationally/irrationality discussion buys you in this, at all. I don’t see how it relates to widespread wealth destruction and the necessity to pick yourself up, dust yourself off, and start all over again. Why on earth, starting over, would you be a different person than you were?

    FWIW though, after reading half a dozen books on brains and behavioral economics, I think that “rational” and “irrational” are just the wrong words. They imply a false dichotomy. No one lives at the extremes. It is better to talk about “human nature” which we can recognize includes a lot of conflicting goals and impulses. It is human nature to want a new car. It is also human nature to run the finances in your head, beforehand.

  31. john personna says:

    I’m not knocking anybody, but I somewhat amazed that this entire thread could go this far and nobody mention the Marshall Plan.

    Used, and disproved, in Iraq. It is unfortunately not enough to dump money on a society.

  32. Steve Verdon says:

    They are not, however. An assumption that people will always spend their money on “productive activity,” is just that: an assumption. And a poor one.

    Derp…I wasn’t talking about money.

    This is why writers require of us suspension of belief. Logic like this doesn’t work outside of fiction. If people are irrational actors, their actions will be irrational with or without national catastrophe. If people are irrational, they can’d get serious after a disaster, just because they want to. If people are irrational, it’s not in them.

    Exactly right. Rational, doesn’t have to mean that one adheres perfect to Homo economicus. Rational means you’re behavior is largely predictable–i.e. you have a set of clearly defined preferences. Does it mean it allows one to answer all possible questions concerning human behavior? No, but it is a very useful one that provides predictive hypotheses that appear to fit the data in a number of situations.

    The war ended in 1946. 30, 35, years later we worried about Japanese market power.

    Now compare this to a disaster aftermath in the “now.” Are you really telling us that, after suffering and working for 30, 35 years the Japanese will enjoy the benefits? When?

    2050?

    Another good point. Japan is going to be below whatever living standard they might have attained without the earthquake for quite some time, maybe even forever. That doesn’t mean their situation wont improve, but relative to the position absent the earthquake they will be worse off. The rebuilding will take a long time, and will largely be replacing “capital stock” that was destroyed. So maybe in 2050 things will be fully “back to normal”.

    This is why we call these things natural disasters and not natural wins.