By Cassi Ainsworth-Grace
In his 1850 essay, That Which We See, and That Which We Do Not See, French economist Frédéric Bastiat wrote that “to break, to spoil, to waste, is not to encourage natural labour; or; more briefly, ‘destruction is not profit’”.
In what has now become known as the parable of the broken window, Bastiat argued that money spent on net recovery from destruction held significant unintended consequences for the economy in the long-run, despite what we see at first glance. In a global economy racked by the coronavirus outbreak, this 170-year old parable has found itself incredibly relevant to our modern-day news cycle.
Broken Windows and Economic Growth.
If a child breaks a window, could the replacement represent a fundamental benefit to the economy, if we must pay for its repair? This is the fundamental question that Bastiat posed in 1850. From a certain light, breaking windows is beneficial to the local economy – the family pays for the repairs, money circulates, and the local glazier’s business grows.
After posing this dilemma, Bastiat considers what would happen if it was later found that the child who broke the window was hired by the glazier, and paid for every window he broke. With this information, such an activity would be considered corrupt. Yet, in the framework of economics, the glazier benefits from the business, money moves and the economy grows.
Bastiat, however, reminds us that the economic impact goes far beyond the glazier, for the shopkeeper, the shoemaker, the tailor, now have to spend money on new windows. Money that they could have spent on something more productive that would have increased consumption and circulated money with a multiplied effect on economic growth. Known as opportunity cost in contemporary economic jargon, Bastiat cautions us to look beyond the consequences of this destruction on one group, to consider instead society as a whole.
Henry Hazlitt’s 1946 Economics in One Lesson, reiterates Bastiat’s idea “that the wanton destruction of anything of real value is always a net loss, a misfortune, or a disaster and whatever the offsetting considerations in a particular instance, can never be, on net balance, a boon or a blessing.” Economists must look beyond the numbers if they want to reveal the bigger picture.
Are We Stepping on Broken Glass?
This is a lesson that many seem to have forgotten. It becomes a difficult feat, when mainstream economic models on the issue of destruction appear to present contradictory predictions. On one end of the spectrum, models predict that the destruction of physical and human capital will produce lower growth. Others suggest, however, that shocks can serve as a catalyst for reinvestment and improvements in the quality of capital.
The dominant measure of economic growth, the change in the level of gross domestic product (GDP), is also problematic. GDP growth measures the change in the level of economic output, but fails to assign a value to what we already have. While the limitations of GDP are heavily contested in contemporary debates, this inherent flaw has not gone unnoticed in the past. In 1968, Robert F. Kennedy spoke of the shortcomings of GDP which “counts air pollution and cigarette advertising…the destruction of the redwood and the loss of our natural wonder in chaotic sprawl”, but neglects the “health of our children, the quality of their education or the joy of their play.”
With a sort of morbid excitement, disaster seems to inspire a great deal of delight in a number of economists. In response to Hurricane Sandy in 2012, economist and professor at the Smith School of Business, University of Maryland, Peter Morici, emphasised the significant benefits that would follow in the hurricane’s wake. He claimed, in a column published in Yahoo! Finance, factoring in the multiplier effect of $10-15 billion, the spending on rebuilding would yield an overall economic benefit in the range of $10 billion.
In line with the sentiment expressed by John Stuart Mill, “What has often excited wonder [is] the great rapidity with which countries recover from a state of devastation”, the Federal Reserve Bank of St. Louis has proposed that it is far more likely that an economy’s recovery after a disaster will make conditions “as good or better than they were before”, as old capital is replaced with “state-of-the-art capital” that lifts productivity, and people replace personal property, increasing the overall level of consumption.
Reactions to the recent catastrophic bushfires in Australia seem to echo this line of reasoning. Whilst economic growth is anticipated to be weaker than forecasted three months earlier, the recovery from the bushfires is expected to add to growth levels in the second half of 2020, as repair and rebuilding commences in the following months.
The current Covid-19 outbreak presents another interesting case study in the economics of disaster. Last week, S&P 500, America’s main stock market index, reached a record high. Whilst China’s stock market fell by more than 10% after the virus began to spread in late January, last week saw it return to its pre-virus level. This sharp v-shaped rebound occurred not only in China, but Japan as well, as the Nikkei 225 index saw stocks climb. Such bullishness, says The Economist, stems from investors’ expectation that the Chinese government may soon unleash a significant stimulus to boost growth levels, having recently declared their continued ambition to achieve a growth rate of 5.5% in 2020. Although the government has only implemented a targeted support strategy, with state-owned banks extending their loans, support being offered to smaller businesses, and lowering taxes on a temporary basis, markets seemed to be anticipating a future boost from a Beijing stimulus.
Optimism was the defining the mood in countries like Australia for the past fortnight. An economy heavily integrated with China, Australia is acutely exposed to its changing economic conditions. Yet, the country’s central bank, the Reserve Bank of Australia, maintained a reasonable level of optimism. Governor Philip Lowe, acknowledging that while it may be too early to accurately determine the impact on Chinese and Australian growth, likewise reckoned that Beijing may move to increase its stimulus injection, with a positive flow on effect to the Australian export market.
This stance simply could not be sustained. This week saw S&P 500 lose one-eighth of its value, falling by 11.5%, its biggest weekly loss since 2008. Fears that the epidemic will strip corporate profits and disrupt the world’s supply chain have finally sunk in. As the disease has spread across the globe, hitting South Korea and northern Italy, trans-national corporations like Nestlé, Apple and Microsoft are anticipating a slump in their production.
Some forecasts remain positive, despite the stock market correction with shares trading more than 10% below their recent peak in value. Analysts at Morgan Stanley, according to The Economist, see the virus outbreak as a “transitory exogenous shock”, that should be followed by a recovery. However, the bond market remains tight, with the yield on 30-year Treasury Bonds hitting an all time low earlier this week, hinting at disconnection in the market. Recovery may prove a lot more difficult if the virus’ spread continues to escalate. The long term economic consequences of this disaster are yet to be realised.
If the current structure of our economy positively accounts for disasters macroscopically equivalent to a child breaking windows, it is perhaps frightening to consider what this means on a national or even global scale. If an earthquake was said to push Japan out of its economic lull, if a pandemic means a significant government stimulus injected into the economy, and if catastrophic and unstoppable fires mean bigger and better property is to be built, does that mean as economists we are always hoping for a bit of disaster to keep GDP moving upwards?
As Bastiat asks, “What will you say, Moniteur Industriel…who has calculated with so much precision how much trade would gain by the burning of Paris, from the number of houses it would be necessary to rebuild?