Better late than never, I’ve got round to the next in the series based on Hazlitt’s book, Economics in One Lesson. In the previous post, I looked at the broken window fallacy, which underpins the whole book. Today, I’ll focus in more detail on ideas on “the blessings of destruction”, the title of the third chapter.
It might seem rather obvious the war is bad for the economy (as well as life obviously!) – destroying cities, and diverting production from what consumers demand to more tanks and battleships. However, it remains a persistent idea that destruction has a silver lining, as it will create employment and perhaps increase GDP during reconstruction. As I noted in my last blog post on this book, some argued the Japanese tsumani would bring economic benefits:
But if one can look past the devastation, there is a silver lining. The need to rebuild a large swath of Japan will create huge opportunities for domestic economic growth, particularly in energy-efficient technologies, while also stimulating global demand and hastening the integration of East Asia.
Of course, there is no economic growth here – the nation will be rebuilding what it lost. How is it benefiting the family who lost their house? Before the tsunami hit, they had a house and their life savings. Now all they have is their savings. Some growth!
As Hazlitt says,
It is merely our old friend, the broken-window fallacy, in new
clothing, and grown fat beyond recognition.
If it takes 10 years to rebuild the areas affected by the tsunami, then that region has effectively lost 10 years of economic growth. Just imagine how much better off the inhabitants could have been in 10 years – now they are back to square one.
There is no doubt that construction firms will benefit from the rebuilding – but this will be negated by the countless lost jobs and destroyed factories that will take years to come back on-line. As before with the broken window, we can easily count the money spent on rebuilding and the people employed in the process. What is less noticed is the diversion of resources and labour from other industries for the rebuilding, and the consequences of this.
Hazlitt explains this diversion of demand that takes place following a war (or a natural disaster), but also how the total demand is likely to fall also:
This is inevitable when we consider that demand and supply are
merely two sides of the same coin. They are the same thing looked at from different directions. Supply creates demand because at bottom it is demand.
This is effectively a restatement of Say’s Law – that we pay for what we demand using the things we supply. In the modern world, we trade our increasingly specialised labour for the things we want. In my case, I “supply” my IT skills so that I can demand goods and services. Say’s Law is even more obvious if we picture a barter economy. Say’s Law has been disputed by Keynes (amongst others) – something I’ll discuss more in a later post.
The point Hazlitt is making here is since overall supply has fallen (imagine the destroyed factories), there are less products we can sell to buy what we demand. Hence there is no increase in demand that will stimulate the economy – rather there is actually a fall in demand.
If anyone is still convinced war really is good for the economy, then let’s try this. Friendly nations agree to build huge navys. They then sail them into the Atlantic and evacuate the sailors. From a safe vantage point, the red button is pressed and all is destroyed! The world leaders then congratulate themselves on increasing GDP and prepare for the next round.
Such a facetious example would employ many thousands of people, but it would destroy wealth, and not create economic growth. By employing people in such a pointless endeavour, we waste their time (and taxpayers money) that could have been spent to produce goods and service consumers actually demand – thereby making everyone wealthier.
But what happens when the economy is in a recession? What if there are millions of people unemployed? Surely any job is better than no job in those circumstances. It is often argued that the broken window fallacy does not apply when there is a recession, or if we are in a “liquidity trap”. So did WWII therefore help to end the Great Depression, by reducing unemployment and increasing spending? I look at these ideas, which are very relevant to what we do about our current recession, in a future post.
For those who can’t wait, Steve Davis argues otherwise: