Freeman

IT JUST AIN'T SO

Terrorism Is Good for the Economy?

The Broken Window Fallacy Lives

DECEMBER 01, 2001 by ROY CORDATO

Following the disastrous attack on New York, Washington, and our country, the purveyors of economic quackery began spilling gallons of ink in describing how they think the tragedy will affect the U.S. economy. One of the most prominent views to emerge, and also the most wrongheaded, is the idea that the destruction of the World Trade Center (WTC) and all the wealth embodied in it will be good for the economy.

According to Timothy Noah, writing for Slate.com, “[I]n seeking to harm America, terrorists will probably end up making it more prosperous. They can make us die, and they can make us weep, but they can’t make us poor.”1 And in the words of economist Larry Kudlow, “[W]e may lose money and wealth in one way but we gain it back many times over when the rebuilding is done.” Kudlow states that “in economics, it’s called the broken window effect.”2 In fact, Kudlow is not only ignorant of economic theory, he is also ignorant of economic terminology. The “effect” that he describes is actually known as the “broken window fallacy”—from the destruction of wealth comes prosperity. It is the same ignorance of economics that leads some to conclude that wars are good for economies.

The “broken window fallacy” stems from the observation that when wealth is destroyed, through war, natural disaster, or, as told by nineteenth-century French economist Frédéric Bastiat, a hoodlum throwing a brick through a shop window, it is usually replaced. As the story goes, in replacing this destroyed wealth, jobs are “created.” Money is spent on hiring construction workers, plumbers, electricians, glaziers (in Bastiat’s original story), and so on. In turn employment and economic activity are stimulated in all the industries those people do business with, and so on. This is why Kudlow concludes that from the ashes of the WTC we will gain back the lost wealth “many times over” and Noah concludes that we will actually end up being “more prosperous.” In the case of the WTC and Pentagon disasters, the impetus for all this economic growth will not only come from the private sector but from the government as well. According to Noah, “we live in a very wealthy nation that responds to horrible disasters by spending large sums of money. In this case, the spending will come from both the private insurers and from the federal government’s Federal Emergency Management Agency” (FEMA).3

The Fallacy

The problem with this argument is that it ignores what economists call opportunity costs. The entire analysis assumes that all the money and resources which must go into rebuilding the WTC and the Pentagon would, had the terrorists not been so kind as to destroy these buildings, have lain idle. Of course this is a ridiculous assumption. All the money and resources—the lumber, steel, oil, labor, human capital, and more—would have gone elsewhere in the economy.

Consider the massive sums that insurance companies must now pay in claims. Those funds would not have been left in a mattress somewhere. That money would have been invested in the insurance companies’ portfolios of stocks and bonds. This means that it would have been used in productive ways somewhere else: building new homes or financing new business expansion or new research into life-saving drugs. This investment and the resulting improvements in our lives are now lost as a result of the terrorist attacks.

The same is true with any money that is spent by FEMA or other government agencies. Taxpayers, if allowed to keep that money, would be spending it on themselves or their families, or saving and investing it. In either case, the money would be going toward other productive uses that would be stimulating growth in the economy. It is truly goofy economics to assume that if bureaucrats don’t use the money, the people from whom they must first take it would be doing nothing with it.

Indeed, that is the fallacy. It assumes that if people and resources weren’t employed in fixing the broken windows and the blown-up buildings, they would be unemployed. In reality, if the windows didn’t have to be fixed and the buildings rebuilt we could have more buildings, more windows, and more of all of the products that we desire and that make our lives better. The true absurdity of the “broken window fallacy” is that if it were true we could make the entire economy wealthy by constructing buildings, blowing them up, and then rebuilding them.

Discounting Human Productivity

In this particular situation, where many thousands of obviously productive and hard-working people have lost their lives, invoking the broken-window fallacy has implications that are somewhat different from the typical natural disaster. Even if the analysis of those who claim that the destruction of wealth brings more wealth had merit, at the very least it would depend on having the ability to replace what was lost. But what was lost in this terrorist attack was not just physical capital, like tall office buildings, but massive amounts of human capital. Kudlow and Noah, in their assessment of the situation completely discount the future productivity of those whose lives were lost. This is productivity that is gone forever. It is human capital that can never be rebuilt and that would have been productive for many years to come. To say that the economy will be better off because of the terrorist attack is equivalent to saying that the economy will be better off without these thousands of human minds and bodies and their productive output.

The destruction of wealth can never be good for the economy, whether the destruction occurs through natural disasters, terrorists, or hoodlums. And certainly war, which is clearly the most destructive force invoked by man, should never be considered a conduit for economic growth. Resources used to replace destroyed wealth are resources that cannot be used to create additional wealth. To invoke this broken-window fallacy is to ignore both economic and human reality.


Notes

  1. Timothy Noah, “Will Terrorism Resuscitate the U.S. Economy?” at http://slate.msn.com/code/Chatterbox/Chatterbox.asp?Show=9/12/2001&idMessage=8279.
  2. As quoted in David Seifman and Lisa Marsh, “N.Y. Urges Bizmen: Stay!” nypost.com, September 17, at www.nypost.com/business/2229.
  3. Noah.

ASSOCIATED ISSUE

December 2001

ABOUT

ROY CORDATO

Roy Cordato is the Vice President for Research and resident scholar at the John Locke Foundation. He is a member of the Mont Pelerin Society and the former executive board member of The Association of Private Enterprise Education. He holds an M.A. in urban and regional economics from the University of Hartford and a Ph.D. in economics from George Mason University.

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