Fiscal Policy

The Broken Window Fallacy: A Rebuttal

The broken window fallacy – first expressed by the French economist Frederic Bastiat – is often employed by critics of Keynesian economic thinking to reject the notion that state fiscal policy can play a role in reviving and stabilising aggregate output and employment.

According to Bastiat’s fallacy, if the window of a shop is broken, the shopkeeper will have to pay to repair or replace it. But, onlookers observe the broken window and conclude that the individual who broke it has done the local community a great service. This is simply because the shopkeeper will now have to pay the glazier (the window repair man) to replace the broken window, who will, in turn, earn an income. The glazier will then spend a proportion of this newly-earned income on other goods and services, in the local economy. Onlookers would then assume that since more money is circulating the economy, and because more goods and services are being purchased, the broken window would have induced a multiplier effect thus stimulating the (local) economy.

In Bastiat’s view, this is a fallacy because there would be no net benefit to the economy. If the shopkeeper had not spent money to fix the broken window, then he could’ve purchased new clothes or new shoes instead, for instance. So, the broken window would’ve helped the glazier – by increasing his income – but at the expense of the shopkeeper – who would’ve experienced a fall in his disposable income.

This parable, at its very essence, is about opportunity cost: if resources must be directed to one activity (in this case, repairing the broken window), then those same resources must be diverted from another productive activity (purchasing goods and services which raise the buyers living standards, for instance).

Now, critics of counter-cyclical fiscal policy apply this to a macroeconomic level. They assert, for example, that any state expenditure financed by borrowing from the public will not lead to a net increase in aggregate demand and economic growth, because the increase in borrowing will only divert resources from the private sector to the public sector. Expansionary fiscal policy, they argue, cannot impact aggregate demand because the money must come from somewhere: if the government increases its borrowing by one pound, then this will correspond to one less pound spent by the private sector. In other words, any government borrowing will crowd out private sector expenditure by an equivalent amount. Thus, leaving aggregate expenditure in the economy unchanged, and rendering expansionary fiscal policy efforts ineffective.

However, a critical assumption underlying the broken window fallacy is the notion that the economy is operating at full employment. If the economy is operating below full capacity – where expansionary fiscal policy is typically advocated – then this proposition is false. If resources are idle and there is (ample) spare capacity, then there will not be any crowding out of private sector activity. Instead, government borrowing would merely offset the fall in private sector spending, and instead utilise the corresponding increased private-sector savings to stimulate aggregate output.

The broken window fallacy may, at first, be a convincing analogy, however further analysis into the bread and butter of the concept suggests that it is not a credible rebuttal of counter-cyclical fiscal policy that many of its critics seemingly believe. Indeed, the broken window fallacy is predicated on a fallacious understanding of the aggregate economy, that aggregate spending in the economy is always equal to the full employment level of output.

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