GOVERNMENT SPENDING & THE BROKEN WINDOW FALLACY

Keynesian economics implies that increased government spending is required for an economy pull out of recession because that would lead to more jobs, more money for the people to spend and therefore more growth, however, critics of Keynesian economics often use the broken window fallacy, advanced in the 19th century by the French economist Frederick Bastiat, to reject the role of government spending in stabilising the economy during recessions.

According to this fallacy, if a troublemaker breaks the window of a bakery, all onlookers would see it as a good thing, because with the money the shopkeeper spends to repair the window, can be used by the repairman to spend on something else, this creates a multiplier effect and there would be more spending hence more growth, but this doesn’t hold true and creates a fallacy because if the baker had not spent his money to fix his broken window, he would have spent it on something else, say, buying a new jacket and would also create a multiplier effect with the person the shopkeeper would have bought the jacket from.

Thus, while it would be true that the fixing of the window would have a positive multiplier effect on the economy, this positive effect would be exactly offset by the negative multiplier effect of foregoing the purchase of the jacket.

The above argument is often used by critics of Keynesian economics to reject any role for government fiscal policy in macroeconomic stabilisation. Just like the above bakery example, critics assert that any money raised by government through taxation to finance its spending would have no net effect on the economy, because taxation on individuals and private sector leaves less money for the individual and private sector to spend. In other words, any government spending would simply “cancel out” an equivalent amount of private spending that could’ve happened instead, leaving total aggregate spending in the economy unchanged.

This argument, is however, not justified because most critics fail to recognise an important assumption underlying the window fallacy, that the economy is fully employed. Under full employment, aggregate spending in the economy is constant and is equal to the full employment level of aggregate output. Furthermore, for full employment to hold, all earnings must be duly spent and none saved. Otherwise, there will be a recession.

Going back to the baker example, it is assumed that if he had not used his money to fix his window, he would have definitely used it to buy a new jacket, but, obviously, we all know that under recessionary conditions, this is not always the case. If the baker had expected harder economic times ahead, he would have most likely saved his money, instead of spending it.

Under these conditions, one can’t say that if the window had not been broken, the baker would have used the extra money (which would have instead been used to fix the window), to buy a jacket, instead there’s a high chance of him saving the money. This means that breaking and fixing the broken window would have actually helped the economy more (by increasing the aggregate level of spending) than not breaking the window.

In conclusion, by assuming full employment in the economy, the broken window fallacy simply negates the problem of pulling the economy out of recession. And that is why, during the periods of high unemployment, and recession, government spending is a much better option than doing nothing at all.