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.
We’re looking at Henry Hazlitt’s Economics in One lesson. You can access the Table of Content of this series here.
The broken window is an elementary lesson in economic fallacies, and yet it still exists under a hundred disguises. CEOs, chambers of commerce, labor union leaders, editorial writers, and professors of economics all believe one version of it or another.
Although most would agree that vandalism isn’t really a good thing, they see endless benefits in major disasters. The economy will be better off during a war, they claim, because wartime creates “miracles of production” that can be easily absorbed by “accumulated” or “backed up” demand after the war. In 1946, the economists were almost gleefully counting the houses and cities that had been leveled and would now need to be replaced. In the US, they pointed to all the consumer goods that had been unaffordable … or unavailable … during the war.
This is merely our old friend, the broken window fallacy, in new clothing, and grown fat beyond recognition. … It confuses need with demand.
How? Well, war improverishes as it destroys, creating postwar need, which isn’t the same as demand.
Effective economic demand requires not merely need, but corresponding purchasing power.
There is a half-truth in the “back up” demand fallacy. Just as the broken window did provide business for the glazier, the destruction by war creates more business for producers of certain things. The construction industry is benefited when homes are pulverized into toothpicks. To most people, the cry for replacement homes seems like an increase in total demand, but what is really happening is a diversion of demand to replacement homes from something else. Demand for new houses will shrink once the need is filled and the economy can then redistribute to provide for wants.
Hazlitt explained that demand and supply are two sides of the same coin. They are the same thing looked at from different perspectives. Supply creates demand because it is demand. What people make is what they have to offer in exchange for the things they want. They supply goods to others in hopes of being able to buy goods from others. A farmer grows wheat and sells it so that he can purchase a new car, for example. The car maker sells cars so he can afford to buy wheat. Yes, we have an intermediate symbol of this system of exchange that we call “money”, but it really comes down to that simple cycle.
Money, which can be printed without anything backing it, can be manipulated to distort the economy – creating higher wages and prices — and seem to create more demand, but that doesn’t really account for any real demand.
A fall in postwar demand may be concealed from many people by the illusions caused by higher money wages that are more than offset by higher prices.
Hazlitt used the example of England. Instead of being damaged by her participation in the war, what if she’d had all her great cities, foctories and consumer goods destroyed so that she was reduced to a third-world status.
Few people would be talking about the great accumulated and backed-up demand caused by the war. It would be obvious that buying power would be wiped out to the same extent that productive power had been wiped out.
Runaway monetary inflation might lift prices so high as to make income figures higher than before the war, but it would be clear that you could buy less.
Hazlitt acknowledged that sometimes war provides technological innovations, but this is probably not worth the destruction it causes.
Therefore, the belief that a genuine prosperity can be brought about by “replacement demand” is a fallacy.
This is Part 4 of a series. To read the entire series, click here to access the table of contents.