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The Leithner Letter
Issue 38 spacer26 February 2003
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  Bastiat’s Broken
   Window

  Politicians Breaking
   Windows

  War and Bastiat’s
   Window

  What Is Seldom Seen
   in Wartime

  Preserving Unbroken
   Windows

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spacer  The Intelligent Australian Investor–Chris Leithner




 

Allow the President to invade a neighbouring nation whenever he shall deem it necessary ... and you allow him to make war at pleasure. Study to see if you can fix any limit to his power in this respect, after you have given him so much as you propose. If, today, he should choose to say he thinks it necessary to invade Canada, to prevent the British from invading us, how could you stop him? You may say to him, “I see no probability of the British invading us” but he will say to you “be silent; I see it, if you don’t.”

The provision of the Constitution giving the war-making power to Congress, was dictated, as I understand it, by the following reasons. Kings had always been involving and impoverishing their people in wars, pretending generally, if not always, that the good of the people was the object. This, our Convention understood to be the most oppressive of all Kingly oppressions; and they resolved to so frame the Constitution that no one man should hold the power of bringing this oppression upon us. But your view destroys the whole matter, and places our President where kings have always stood.

Congressman Abraham Lincoln (Whig-Illinois)
letter to his law partner, William H. Herndon (1848)

Bastiat’s Broken Window

At last the remedy to what bedevils us is at hand. An excellent way to “resuscitate the economy” is to give each member of a group of youngsters a cricket bat, lead the group to a randomly selected street in a randomly selected suburb, instruct each youth to walk in any direction he chooses and, as he walks, to smash car lamps, windscreens and panels, shopfront windows and displays – anything, in other words (including motorists, pedestrians, merchants and shoppers), that stands in his way.

A likely consequence of this orgy of destruction is clearly that demand and perhaps employment will increase in the auto manufacturing and repair, glass production and glazing, medical and other industries. If someone smashes a shop window, then its owner will probably move quickly to repair it. Ample demand for glass and the labour of glaziers puts people to work and keeps them at work. Surely, then, vandals are actually benefactors, and the more severe and widespread their carnage the better. Would we not all benefit – indeed, would an economic boom not eventuate – if enough hooligans sufficiently frequently rampaged and destroyed everything they encountered?

The vast majority of people – indeed, all except those who espouse mindless destruction – would reject this proposal summarily and contemptuously. And they would be right for the simple and obvious reason that the destruction of valuable property is, under any and all circumstances, an unambiguously bad thing. To destroy such property is always to reduce – and never to maintain or improve – standards of living.

The horrendous bushfires in Canberra and the ACT on 18 January reminded Australians, if only momentarily, of this reality. Yet allegedly well-educated people in surprising positions seem to disagree. A prominent example is the article “Hurricane Floyd May Leave Robust Economy in Its Wake” (The Wall Street Journal 17 September 1999). Its author, Tristan Mabry, reported that this hurricane, which caused severe damage across large swathes of the eastern U.S., “won’t likely damp economic growth and may actually have churned up some extra economic activity.” In the article, Marilyn Schaja, chief economist at Donaldson, Lufkin and Jenrette Securities Corp., said “the storm may actually give the economy a boost.”

Thomas DiLorenzo, professor of economics at Loyola College, Baltimore, writing in the February 2000 edition of Ideas on Liberty, notes that statements such as these exhibit an utter ignorance of the most basic principles of economics. Yes, the cleanup after the storm will generate economic activity and employment, as will the repair of smashed windows; critically, however, the cleaning and repairs will also extinguish development and jobs. This is because the resources used to repair damaged and destroyed property are resources that cannot simultaneously be used to produce other goods and services. The money allocated to cleanups, repairs and reconstruction, in other words, must be diverted from other uses; and because money has been redirected from these other goods and services, demand for them (and thus the labour and materials required to produce them) falls.

Hence the “broken window” fallacy exposed by the French economist Frédéric Bastiat (1801-1850) in his essay What Is Seen and What Is Not Seen (see also Henry Hazlitt, Economics in One Lesson, Laissez Faire Books Fiftieth Anniversary Edition, 1996, ISBN: 0930073207). Bastiat demonstrated brilliantly that what economics can teach (but what, alas, relatively few economists actually do teach) is a comprehension of the principles that underlie the often-mundane details of everyday life (see also David Friedman, Hidden Order: The Economics of Everyday Life, HarperBusiness, 1996, ISBN: 0887307507).

As Bob McTeer of the Federal Reserve Bank of Dallas has recounted (“In Praise of an Economic Revolutionary” The Wall Street Journal 5 July 2001), Bastiat doughtily opposed the mercantilism and socialism of his day, and advocated laissez-faire capitalism and individual liberty. His weapons were wit and satire; and his method was the reductio ad absurdum. More than anyone before or since, he exposed economic fallacies clearly, simply and humorously.

Perhaps the most famous example of Bastiat’s satire was his petition to the French parliament on behalf of that country’s candle makers. He sought relief from “ruinous competition of a foreign rival who works under conditions so far superior to our own for the production of light that he is flooding the domestic market with it at an incredibly low price.” The foreign rival was the sun; and the relief he sought was a law compelling Frenchmen to close all drapes, thereby shutting out all sunlight and “stimulating” the domestic candle industry.

What is seen is the window broken by vandals (or the house, street or suburb devastated by a storm) and the resultant employment of repairmen. What is not seen are the workers and resources in other fields that now cannot be employed because the resources required to do so have been diverted to the repair of the window and the reconstruction of the house. The glass manufacturer’s and glazier’s visible gain is thus the butcher’s, tailor’s or new entrepreneur’s less visible loss; and to compensate the homeowner for damages incurred is to impose costs upon the insurer (or, more likely, taxpayer). In neither scenario is additional production undertaken – indeed, less is produced overall – and as a result people as a whole are poorer. The bread that the baker could have baked with the money used to repair the window is not baked; accordingly, as a result of the vandalism and its repair society has no more glazed windows but less bread than it would have had without the destruction. Clearly, then, what is even further obscured from view is that ends (i.e., goods and services) rather than means (i.e., jobs) ultimately benefit members of a society.

Most of the economists, politicians and businessmen of Bastiat’s day, like their contemporary counterparts, focused only upon the immediate impact of “broken window” (i.e., “problems” that allegedly require a policy “solution”). Bastiat showed that in virtually every instance there are unseen circumstances that must also be examined, and that these unseen circumstances usually impact significantly (and, in the instances he examined, negatively) upon long-term results. In Hazlitt’s words, “we are already suffering the long-run consequences of the policies of the remote or recent past. Today is already the tomorrow which the bad economist yesterday urged us to ignore.” Their admonition, then, is that we may commit major errors of judgement, and thereby incur considerable losses, when we focus exclusively upon short-term effects. In order to make sensible choices we must weigh the immediate and potentially positive for the few (seen) against the eventual and potentially negative for the many (unseen).

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Politicians Breaking Windows

Bastiat’s and Hazlitt’s tale is in some ways simply a silly story – an elementary fallacy that most schoolchildren can quickly recognise. Yet it is also much more. According to Hazlitt, “the broken window fallacy, under a hundred disguises, is the most persistent in the history of economics. It is more rampant now than at any time in the past. It is solemnly reaffirmed every day by great captains of industry by chambers of commerce, by labour union leaders, by editorial writers and newspaper columnists and radio and television commentators, by learned statisticians using the most refined techniques [and] by professors of economics in our best universities.”

Indeed, prominent people occupying powerful positions are presently succumbing to a vastly larger and more disturbing variant of the broken window fallacy. Although they denounce small, localised and individual acts of vandalism with all of the rhetorical ferocity they can muster, they impute rather modest negative consequences – and potentially appreciable benefits – to massive, extensive and state-supported acts of vandalism. War, implied George W. Bush’s former economic advisor (and as the American Secretary of State, Mr Baker, stated explicitly during the expulsion of Iraq from Kuwait in 1991), “creates jobs;” further, it spurs the production of certain high-tech goods and services; and after the cessation of hostilities the world is rendered more prosperous by accumulated or “pent up” demand.

Immediately after 11 September 2001, pundits propounded their views about the impact of the government’s response to the attacks (e.g., reconstruction and the “war on terror”) upon economic activity in the U.S. Among these views: the destruction of the World Trade Centre and all the wealth embodied therein would ultimately augment rather than erode American standards of living. Will Terrorism Resuscitate the U.S. Economy? Timothy Noah answered stoutly in the affirmative: whilst “the destruction of the World Trade Centre, the multiple plane crashes, and the damage to the Pentagon are morally obscene because of the (probably thousands) of deaths and countless injuries they caused, economically the net result of the terrorists’ actions is likely to be beneficial to the United States.”

Noah continues: “OK, so the World Trade Centre disaster won’t harm the economy. Why [do I] think it will benefit the economy? Simple: because we live in a very wealthy nation that responds to horrible disasters by spending large sums of money … In this case, the spending will come both from private insurers and from the federal government’s Federal Emergency Management Agency, which over the past decade has established itself as a politically unstoppable source of federal largesse… In seeking to harm America, terrorists will probably end up making it more prosperous. They can make us die, and they can make us weep, but they can’t make us poor.”

Similarly, according to Larry Kudlow (quoted in The New York Post 17 September 2001), “we may lose money and wealth in one way but we gain it back many times over when the rebuilding is done.” If Noah and Kudlow are correct, then the widespread destruction of valuable property ultimately begets prosperity. From this statement it is but a small step to infer that the greatest destroyer of property, war, creates wealth and increase living standards.

Robert Samuelson’s article The Economic Impact of War (MSNBC 2 December 2002) provides a typical example of this relaxed attitude towards war. It sets out the consequences of three possible scenarios for a second Anglo-American attack against Saddam Hussein (see also The Washington Post 5 January 2003). The second and third scenarios are deemed “less probable.” In the intermediate case fighting lasts up to three months; Iraqi attacks slightly damage oilfields; and the price of oil rises to $42 per barrel.

“In the worst case, Iraq badly damages other oilfields. Production drops by at least 5 million barrels a day, out of a total global consumption of 77 million barrels a day. Oil prices hit $80 a barrel. Intense urban fighting incites the U.S. antiwar movement. Social unrest spreads in the Middle East. In the intermediate case, unemployment (now 5.7 percent) reaches almost 6.5 percent by late 2003. In the worst case, it goes to 7.5 percent.” In sharp contrast, the anticipated “‘benign case’ anticipates rapid victory. Much of Saddam’s army surrenders or defects. Because uncertainty lifts, the economy fares better than under a ‘no war’ scenario. The temporary loss of Iraqi oil is no big deal” (italics added).

Similarly, Business Week (What War Would Do to the Economy 13 September 2002) says “a short and decisive conflict could provide a boost. A long one has the potential to spark a global recession.” It elaborates that although “Mideast war carries many risks for the economy, there is good reason to believe that it won’t be as devastating as it was a dozen years ago. In 1990, the sudden Iraqi ‘annexation’ of Kuwait spooked consumers into curbing spending and drove the economy into recession. This time, a U.S. assault on Iraq has been so well-telegraphed that it shouldn’t be a shock to anyone – consumers, companies, or investors – if and when it occurs.”

A third example of relative buoyancy in the face of incipient conflict appeared in Part I of Barron’s Investment Roundtable (13 January 2003): “in the pages that follow, you’ll get a surprisingly sanguine view of the potential impact of a war with Iraq, a brighter investment outlook than [the participants] have shared in recent years and a passel of tantalizing stock, sector and asset-class recommendations.”

Q: Scott, what’s your view?

Black: Ironically, going to war is going to be fiscally stimulative. A short war is going to cost $100 billion to $150 billion, which will add roughly 1-1.5 percentage points to real growth in this year’s GDP. This will be different from the last Iraqi war. They are not going to meet us on the open battlefield. We will be in downtown Baghdad. After we secure the air space, which is easy to do because the Iraqis don’t have good anti-aircraft defenses, we will put roughly 150,000-200,000 ground troops in Baghdad. It is not necessary to kill Saddam Hussein to have a quick regime change. So I’m optimistic. I don’t think it’s going to spread into a major regional or a global conflict. Oil will come down immediately after the war is over, to about $22 or $23 a barrel. Overall, it’s going to be bullish for the U.S. stock market.

Q: This is quite depressing. Since everyone is bullish, that probably means it will be a long war, and the price of oil will go up. John, what is your view of the economic impact of war?

Neff: Mild.

An honourable exception to this pattern is Gene Epstein’s article “Wartime Economy” (Barron’s 23 September 2002). Epstein traces several possible consequences of a second war against Iraq, and concludes that it “should prove no exception to the rule that war is an economic drag. The extent of that drag depends on how the war goes.” Another is Iraq: The Economic Consequences of War by William Nordhaus. It states that a “worst case” (including a long-term occupation and reconstruction of Iraq) could cost $1.6 trillion over a decade. Imposts upon the federal budget would comprise about half of this total; the rest would reflect higher oil prices and slower economic growth. “It seems likely,” Nordhaus concludes, “that Americans are underestimating the economic commitment involved in a war.”

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War and Bastiat’s Window

War and post-war reconstruction, the conventional wisdom therefore alleges, is unlikely to have significantly negative repercussions and may even have positive consequences. According to Nobel Leaureate Robert Solow, “war is good for the economy in the narrowest sense, but it can be bad for the economy when innovation emphasises military and not civilian needs.” Taking due care that the consumption of four-wheel-drives, winter holidays and McMansions remains unrestricted, should one therefore celebrate the occurrence of natural disasters and promote vandalism, acts of terrorism and the outbreak of war? If so, should one plan now to invest in the Balkans, East Timor and Afghanistan (and, perhaps before long, Iraq)?

Armed with Bastiat’s insight, we see that this conventional wisdom ignores not just the livelihoods and lives of the inhabitants of combat zones: it also discounts opportunity costs. It assumes, in other words, that the resources required to rebuild the WTC and Pentagon, fight the war against terrorism and topple Saddam Hussein would, if they were not used for these purposes, lie idle. In reality, these resources must be diverted to these ends from other uses. Consider the scores of billions that insurers will eventually devote to the payment of WTC-related claims. This money would otherwise have been invested in the insurers’ portfolios of stocks, bonds and other securities. Through these investments, in turn, this money would have been put to myriad productive uses, ranging from the construction of houses to the invention of new and better medicines. These resulting improvements of living standards will be lost as a result of the diversion of capital that followed the attacks.

Most government expenditure has the same effect. Taxpayers, if allowed to keep their earnings, would either buy consumption goods or save and invest (i.e., buy production goods). It is false to posit that if a government does not commandeer this money then people would bury it in the back garden. The ultimate absurdity revealed by the broken window fallacy is that if it were true, then governments could easily create and fructify wealth: they need only (and repeatedly) erect pyramids and monuments, dynamite them and immediately rebuild them. Better yet, if “job creation” were desired, then labour-intensive shovels should replace capital-intensive earthmoving equipment; and if even more “job creation” were sought, substitute the shovels with spoons (Bastiat suggested that the spoon-wielders use only their left hand).

Succumbing to the broken window fallacy has wider and more insidious implications. What was lost in the 11/9 and other attacks was not just physical capital, like tall office buildings, but immeasurable talent and tacit information. Kudlow’s and Noah’s assessment of the situation utterly discounts the creativity and productivity of the lives lost that day and the lives that will be lost in any resultant wars. This “human capital,” which would have produced for many years to come, is completely lost and can never be recovered or rebuilt. To say that humankind will be richer because of the 11 September attack is therefore to assert that we will be more affluent without these thousands of human minds and bodies.

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What Is Seldom Seen In Wartime

In the wake of 11 September, other losses, obscured from view but nonetheless mammoth, have been incurred. Resources are being redirected both to the reconstruction of what has been lost and to the destruction of what will be lost (i.e., to preparations for war). Governments in Washington and Canberra are directing raw materials, manufactured goods, labour and technology away from private pursuits and towards state and military ends. These resources have alternate uses and would not otherwise lie idle; rather, they would be used to produce the myriad quantities and qualities of the goods and services that consumers (rather than politicians) desire. The diversion and destruction of valuable resources – whether it occurs as a consequence of vandals or natural disasters – can never increase and always decreases living standards. Hence war, which is vandalism and murder on a vast scale, can never “stimulate” and always retards (if it does not utterly destroy) prosperity.

Why, then, are politicians attracted to war? Because it is, in the words of the classical liberal Randolph Bourne, “the health of the State.” President Lincoln realised the prophesy uttered by Congressman Lincoln (see Jeffrey Rogers Hummel, Emancipating Slaves, Enslaving Free Men: A History of the American Civil War, Open Court, 1996, ISBN: 0812693124 and Thomas DiLorenzo, The Real Lincoln: A New Look at Abraham Lincoln, His Agenda, and an Unnecessary War, Prima Publishing, 2002, ISBN: 0761536418).

More generally (Murray Rothbard, For a New Liberty: The Libertarian Manifesto, Fox & Wilkes, 3rd. ed., 1989, ISBN: 0930073029), “war has always been the occasion of a great – and usually permanent – acceleration and intensification of State power over society. War is the great excuse for mobilising all the energies and resources of the nation, in the name of patriotic rhetoric, under the aegis and dictation of the State apparatus. It is in war that the State really comes into its own: swelling in power, in number, in pride, in absolute dominion over the economy and the society. Society becomes a herd, seeking to kill its alleged enemies, rooting out and suppressing all dissent from the official war effort, happily betraying truth for the supposed public interest. Society becomes an armed camp, with the values and the morals – as the libertarian Albert Jay Nock once phrased it – of an ‘army on the march’” (see also Rothbard’s The Anti-War, Anti-State Right and The Real Aggressor, and Robert Higgs, Crisis and Leviathan: Critical Episodes in the Growth of American Government, Oxford University Press, 1987, ASIN: 0195049675).

Rothbard continued: “it is no accident that Lord Keynes’s economics have proved to be the economics par excellence of the corporate liberal State. For Keynesian economists place equal approval upon all forms of government spending, whether on pyramids, missiles, or steel plants; by definition all of these expenditures swell the gross national product, regardless of how wasteful they may be. It is only recently that many liberals have begun to awaken to the evils of the waste, inflation, and militarism that Keynesian corporate liberalism has brought to America.” Indeed, in the preface to the first German edition of his The General Theory of Employment, Interest and Money (1936), published after Hitler’s establishment of a totalitarian dictatorship, Keynes wrote approvingly that “the theory of aggregate production that is the goal of the following book can be much more easily applied to the conditions of a totalitarian state than [it can] under the conditions of free competition and a considerable degree of laissez-faire.”

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Preserving Unbroken Windows

After his retirement in 1931, Major General Smedley Darlington Butler, one of only two U.S. Marines who received two Congressional Medals of Honour, spoke vociferously against the use of force in world affairs (War Is a Racket: The Anti-War Classic by America’s Most Decorated General, Feral House, repr. 2003, ISBN: 0922915865; see also Hans Schmidt, Maverick Marine: General Smedley D. Butler and the Contradictions of American Military History, University Press of Kentucky, repr. ed. 1998, ISBN: 0813109574). Echoing Bastiat (who stated that “it is impossible to introduce into society a greater ... evil [than] the conversion of the law into an instrument of plunder”), Butler denounced the power that politicians arrogate to themselves, the profits that some corporations (i.e., those privileged by preferential access to government) generate and the suffering that untold millions experience during wartime.

Unlike the laptop bombardiers of today’s editorial pages and the histrionically bellicose of the airwaves and in the parliaments, Butler experienced real war at first hand; and unlike today’s mainstream, his native common sense also enabled him to see what others do not or will not see – and thereby to avoid the broken window fallacy (see also Veterans for Common Sense). “If you ask me my opinion,” says General Anthony Zinni, U.S. Marine Corps commander and former chief of the Central Command, “[as well as that of] General Scowcroft, General Powell [and] General Schwarzkopf, maybe all see this the same way. It might be interesting to wonder why all the generals see it the same way, and all those that never fired a shot in anger and really hell-bent to go to war see it a different way. That’s usually the way it is in history.” Australian and British military commanders seem to concur (see, for example, Gen. Peter Gration, The Case Against War with Iraq).

For these reasons, investors (who, next only to combatants and civilians in combat zones, have the least to gain and most to lose from hostilities) should consider Smedley Butler’s view: “war is a racket. It always has been. It is possibly the oldest, easily the most profitable, surely the most vicious. It is the only one international in scope. It is the only one in which the profits are reckoned in dollars and the losses in lives. A racket is best described, I believe, as something that is not what is seems to the majority of the people. Only a small ‘inside’ group knows what it is about. It is conducted for the benefit of the very few, at the expense of the very many.” Although they were uttered with another context in mind, Mr Buffett’s words also seem to encapsulate this situation: “if you’re in a poker game for 30 minutes and you don’t know who the patsy is, then you’re the patsy.

Chris Leithner    

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