Obama's Broken Window Fallacy

July 26, 2013

At a general level, employment created as a result of a government policy is a cost rather than a benefit for the economy as a whole, unless the policy improves resource allocation by, say, correcting for some sort of market inefficiency, says Benjamin Zycher, a visiting scholar at the American Enterprise Institute.

As counterintuitive as that may seem, imagine that a federal policy had the effect of increasing the demand for high-quality steel.

  • That clearly would be a benefit for steel producers, or more broadly, for owners of inputs in steel production, including steel workers.
  • But for the economy as a whole, the need for additional high-quality steel in, say, an expanding wind-power sector would be an economic cost, as that steel (or the resources used to produce it) would not be available for use in other sectors.
  • More generally, the creation of "green" jobs as a side effect of environmental (or carbon) policies is a benefit for the workers hired (or for those whose wages rise with increased market competition for their services).
  • But for the economy as whole, that use of scarce labor is a cost because those workers no longer would be available for productive activity elsewhere.

Wind power and solar power are more costly than conventional generation policies. Driving a shift toward heavier reliance upon the former would increase aggregate electricity costs, and thus reduce electricity use below levels that would prevail otherwise.

There are no free lunches is an eternal truth. The Obama version of this is simple: we can have a stronger economy and more employment if we discard part of the power-generating capital stock. That is a blatant example of the old broken window fallacy: if a window is broken, output and employment will rise because someone has to hire someone else to replace the window. For the economy as a whole, the broken window (or the electric generating capital forced into retirement) is a net loss. We cannot become richer over time by making ourselves poorer in the here and now.

Source: Benjamin Zycher, "The President's Broken Window Fallacy: Carbon Policies and Jobs," The American, July 10, 2013.


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