Economics 101: Hidden Costs

What with our current government's proclivity to take our hard-earned money, spend it on one politically-motivated project or another, and claim they "stimulated" the economy, I think it is time for a fundamental lesson in economics. This one comes from Frederic Bastiat WAY back in 1850, and is called the "Broken Window Fallacy."

It goes something like this. (All currency amounts in the example have been changed to dollars, though Bastiat, being French, originally used francs.)

A shopkeeper is upset when some nameless youth pitches a rock through his window, shattering the glass and forcing him to pay for it's replacement. So the glass maker comes and replaces the pane of glass, for which he is paid the sum of $200. The glass maker is happy with the situation, and intends to spend the money on food and shoes, thus enriching the baker and the cobbler... who of course will spend the newly earned money elsewhere.

Obviously this incident has benefited the economic well-being of the town, right?


The problem with this conclusion is that it ignores the hidden cost here. Yes, the glass maker earned an additional $200, but that doesn't make the broken pane of glass a good thing. For one thing, the shopkeeper is out the money... instead of having a window and $200, he now has only the window. And he may have been intending to purchase something with that money, such as a new suit. But because he had to pay to replace the glass, now he hasn't the money for the new suit.

I hope you see the point being made, here. Looking only at what is visible, the situation looks to have created economic growth... a growth of $200 PLUS all subsequent expenditures by the glass maker, the baker, the cobbler, and whoever else was ultimately involved. But the new $200 suit is left out of the equation for the simple reason that it never had the chance to be made. To understand economics you must not only look at the visible, but also at the hidden.

To personalize it, I have only the money I earn upon which to live... once that is gone, I'm broke. So if the county increases property taxes that cost me $500 per year, that means that I will spend $500 less in the local economy. The pizza place will deliver fewer pizzas, the movie theaters will sell fewer tickets, the local restaurants will see a small reduction in their sales, and so forth. No matter WHAT government does with the money, what is important is what we DON'T SEE... and that's what would have been done with the money in the first place.

The stimulus bill removed $787 billion from the economy and then "re-inserted" it to fund their "shovel ready" projects: road pavings, scientific studies, even the purchase of boots for workers in one memorable example. PresBo and the Democrats loudly proclaim success, but in doing so they fall victim to the "window fallacy" by ignoring the hidden.

What would that money have been spent on, had government not taken it for their own use?

Keynesian economists claim that $1 in government spending increases GDP by MORE THAN $1. They accomplish this by applying what is called a "Keynesian multiplier" to that original dollar... an often arbitrary number that is used to determine the "real" economic impact of that spending. And even with that multiplier in place, numerous studies have proven that government spending grows GDP at a much slower rate than private-sector expenditures.

If you would like to read this in Bastiat's own words, you may find them here:
http://bastiat.org/en/twisatwins.html

But remember when PresBo takes our money from us and announces that X number of jobs were "created or saved"... how would that money have been otherwise spent? It is an important consideration, and one which the politicians in DC are completely ignoring.