GDP: The Broken Window Fallacy

There is one fact about the GDP which is often misquoted in the media. I am sure all of us have heard the following statement “XYZ war helped increase the economic output i.e. the Gross Domestic Product of ABC country”.

The name of the wars i.e. XYZ keeps on changing and so does the name of the economy i.e. ABC. However, this fallacy has been alive for many years in economic literature.

The most famous example being USA’s participation in the World War-2 helped its economy come out of the Great Depression. Since World War 2 and the Great Depression are both calamities of epic proportions, this example has remained etched in the minds of many economics students for the past seven decades!

Now, there is one question that arises. Is our economic system as loggerheads with the basic human values? Does violence and mass murder of thousands of human beings reflect as being an achievement on our economic scorecard?

Well, contrary to what economics textbooks may tell you, that is not the case. The larger system of economics that we have is completely at peace with human values and does not regard mass destruction as an achievement. However, when we use the lens of the GDP number to view the workings of the economy that is when this confusion arises.

An economist named Henry Hazzlit has explained this concept in detail. He named this concept, the broken window fallacy. The broken window fallacy, according to him is one of the most misunderstood concepts of economics. Here is how he explains it.

He asks us to imagine a quaint little town in any part of the world. The day is progressing as usual in the market. All of a sudden a mischievous boy decides to break the window glass of a tailor’s shop. He picks up a stone breaks the glass and then runs away giggling. So now, we have a broken window and what many confused economic students would also call, a catalyst to economic growth.

Now, since the window is broken, the tailor will have to replace this window. To do so, he calls on a carpenter. The carpenter then places an order with the glass manufacturer. He then also uses glue, his tools and his labor and then fixes the window. To do so, he receives a sum of money from the tailor.

Since there are so many transactions taking place because of a broken window, many people could argue that breaking windows is actually a good thing and that we must go all across town and break everyone’s windows. Since this would mean more business for the carpenters, the glass manufacturers and the laborers. So an inherent act of vandalism can be portrayed as a social good thanks to this twisted system of thinking.

What is the Fallacy Here?

Now, to pinpoint this exact fallacy, we have to imagine how the world would have been with and without the broken window. The answer is the world would have been the exact same. The market place would have looked the exact same and would have provided the same utility to customers as well as sellers. Nothing additional has been built. All the expense undertaken by the tailor has been done only to restore the past situation.

But then what about all the expense that has been undertaken by the tailor? All that money did change hands, didn’t it? So then why should it not be added to the GDP and why did growth not occur.

Well, if we are adding the new expenses to the GDP, we should also subtract the destruction caused! It is not incorrect to add the new expenses incurred by the tailor to the GDP. After all they were new transactions that were taking place. It is incorrect though, to simply forget to subtract the act of vandalism from the GDP.

A common sense approach to accounting for this transaction would mean that first you subtract lets say $100 from the economy because of the childish act of vandalism by the young boy. Then you add the same $100 back when the carpenter rebuilds the window. It is a personal loss for the tailor and a personal gain for carpenter, glass manufacturer and others. However, the economy as a whole remains unchanged. There have been no gains and losses that have accrued to the economy thanks to vandalism.

Conclusion

Hence, as we can see that the economic principles are indeed in harmony with society. What is not in harmony though is the way we account for them.

The GDP system is all about addition. It simply does not know how to subtract. Hence when wars happen, the GDP system just keeps on adding. It forgets to subtract the destruction that was caused by World War 2. It forgets to subtract all the killed humans, the broken infrastructure and such other instances on destruction.

It just adds all the wasteful production that took place as a result of it and presents a grossly distorted picture of economic growth. According to the GDP system, rebuilding broken roads and ports, excessive spending on healthcare caused by indiscriminate bombing are all good for the economy!

The GDP system is therefore not only an economic evil but also a social evil. This twisted logic has been used by many corrupt politicians to justify conquest and wasteful spending of taxpayers’ money for personal economic gain.

Authorship/Referencing - About the Author(s)

The article is Written and Reviewed by Management Study Guide Content Team. MSG Content Team comprises experienced Faculty Member, Professionals and Subject Matter Experts. We are a ISO 2001:2015 Certified Education Provider. To Know more, click on About Us. The use of this material is free for learning and education purpose. Please reference authorship of content used, including link(s) to ManagementStudyGuide.com and the content page url.