Broken windows and thrown towels: The issue of stimulus

Over at Economists View, Mark Thoma points out and, in my opinion, rightly criticises a piece from the Cato institute on fiscal stimulus.

Now the Cato piece seems to equate a fiscal stimulus strictly with the “broken window fallacy“.  I do not completely agree with this.  As Thoma points out government investment should be counter-cyclical, as by investing this way they get to build public goods (which will not be provided in sufficient quantities by the market) cheaply!

However, some fiscal stimulus does fit into the broken window frame – however it does so in two different ways.  First we have the case where the windows are broken and then we are wondering what to do with policy.  Then we have the case where the government could break windows.  Lets discuss.

Mark Thoma discusses the first type of broken window (the already broken one) himself.  In this case the broken window is a sunk cost – the fact it has been broken should not enter our decision, or prevent us from reinvesting.  If the window maker was previously an unemployed resource, the shop owner is credit constrained, and as the new window adds value the government paying someone to fix the window makes sense.

As a result, the first point is that government using unemployed resources to create value that the market can’t (given that the price mechanism is out of wack or the credit market is in trouble or confidence/animal spirits are a mess).

The question then is – is there a case where the government should go round destroying windows to create work?

On the face of it no – doing this pushes people to work without adding any value.  As work is costly to the employee, this can’t be welfare maximising.

However, if other resources are unemployed, you know the worker will stimulate demand for these resources, and the government cannot target them directly – there could be a case for going around and “breaking windows” to make the window maker busy.

But …

The burden of proof that we are in such a dire situation depends on those making recommendations to break windows!  As is obvious from above, the conditions required for smashing up the neighbourhood to be a welfare maximising government policy move are very restrictive – and if they do not hold, the government would be hurting society.

Sometimes I get the feeling that those pushing for a large stimulus (some of which, by adding no value and increasing the future tax burden is like smashing windows) are doing so only because they believe doing something, anything, is better than nothing.  This appears to be, by itself, an unjustifiable cognitive bias.

Then again – people that are completely against any type of fiscal stimulus better be able to explain why they think the government can’t make any productive (insofar as the value made exceeds the cost) use of a growing pool of unemployed resources.

Note: This is not inconsistent with my belief that potential is being overestimated and that a large scale stimulus could be a bad turn – this critique was mainly against the idea of a “paradox of thrift” situation stemming from very low confidence and incredibly sticky prices.  Personally, I think that any intervention needs to be focused on areas of market failure – broadbased policy just doesn’t seem appropriate in the face of all the recent structural shocks to the economy.

  • John

    Glad you don’t agree with the cato Institute Matt. Keep up the good work.

  • John

    People who talk about “the efficient private sector” ignore the Kate Valley Landfill.

  • Kimble

    Yep, the idea of an efficient private sector falls apart if there is a single private sector participant that is not efficient. Such is the nature of first-level thinking.

  • “Glad you don’t agree with the cato Institute Matt. Keep up the good work.”

    They can say good things – however, at times I would say that the opinions expressed by the institute are on the far side of a given spectrum of opinions …

    “Yep, the idea of an efficient private sector falls apart if there is a single private sector participant that is not efficient. Such is the nature of first-level thinking.”

    Although, the discipline of first-level thinking should not be forgotten. We have to ask “why” the single private participant has failed before we can understand how to improve outcomes – this is a question that individuals at the other extreme of the debate often forget.

    Something failed – the best response is too fix that failure, not to run around “stimulating” everything 😛

  • goonix

    John writing about a Canterbury issue and opposed to the private sector?

    It’s John Minto! (taking an imposed break from his website, which has been apparently hacked by Israeli agents)

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  • John

    What i was thinking is that when we are talking about stimulating the economy the primary reason seems to be to fix a problem such as Japan’s where temps are being laid off and having to line up at soup kitchens. There is still plenty to go around but the problem is that whereas in the past small societies shared in bad times (they were mainly engaged in the same occupation) today the person without has to have a widget or service to entice the person who still has form their dollar, that seems to be the basis of consumerism.

  • Hi John,

    I’m not sure that the history you describe is really the case. Did society used to provide heavily for those who lost their jobs in the face of a downturn. I know that it is common to say that they did – but I fear it is a case of a “rose-tinted” look at history.

    In modern times government actually forces those in work to provide for those who lose their jobs already – so we know that there will be no need for the same “long lines” to soup kitchens.

    The real question is – how can government help to get people who want to be in work at the current wage into work. The market failure we are discussing could stem from skills issues, or from wages being held artificially too high (note that the unemployed and the employed are intrinsically in competition) – in which case the government should aim to solve the failure.

  • John

    Actually I was talking about primitive societies where the occupation was something simple (such as herding goats) and some environmental factor causes poor pasture (for example). In those conditions people are motivated to share and work can be spread around (old women can mind children etc).

  • I would say that to some degree social groupings still do that – your friends will help you when time gets tough, your boss is willing to keep you on at a loss for a little while if he gets to know you.

    I’m not sure a reliance on the altruism of humans is the right way for a society to be run – it is a little bit too much like “free market ideology” for me 😛

  • John

    I suppose the basis of consumerism is firms wanting to maximise profit (combined with a lot of other factors). I’ll pass on that one for now.

  • “I suppose the basis of consumerism is firms wanting to maximise profit (combined with a lot of other factors)”

    Firms want to maximise utility just like individuals. The premise of what I suspect you are terming consumerism is simply that individuals have a better idea of what is in there interest than the government – a fair assumption. However, there are times when people acting in their own interest do not do what is in the social interest – if we can explain why the government may be in a place to improve outcomes.

    I don’t see how prior social structures dealt with this issue any differently – outside of the cases where the interest of individuals was ignored for some arbitrary “greater good”.

    I would be careful looking at the past for examples of when policy was “better”.

  • John

    I recall a women in Tijuanna selling crape paper flowers and I thought “her flowers are (fairly) useless but if she doesn’t sell them she doesn’t make any money” and I thought of japan which is so rich but in a down turn has people starving and i thought of some things i read in a piece about evolutionary psychology (generations growing up together, teamwork, far more divisibility of labour)> I then substituted the crape paper flower for kinship and concluded that this must drive (consumerism or its close relation) the need for continual economic growth.

  • Hi John,

    I am not convinced that our society is based on a “need” of economic growth – I don’t think that social progress is wrapped up in a requirement of a strict increase in the amount of products. Now, I realise that often debate are framed in a way that would seem to indicate this – but I think policy, and the general demands of the public, move past this type of view.

    Now, there may be other societies where the trade-off between social cohesion has been “overplayed” – but that is just not my impression of New Zealand.

    I think that government policy is the result of an implicit social contract – which is why I am not particularly negative on the set of policies we have in NZ. If we were strictly “consumerist” I imagine that the set of policies the government would take on would be significantly different.

    Ultimately, I see the government as a body that evolved to create the social cohesion that you discuss – if we take account of this modern society does not seem as cold or stark

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