Scrappage and broken windows

Henry Hazlitt, in his marvellous Economics in One Lesson, cites Frederic Bastiat's exposition of the broken window fallacy. The fallacy is that vandals breaking a shopkeeper's window have benefited the economy, because the glazier will get work and money that he otherwise would not have got, and he will spend that money on goods that also would not have been sold if he had not had this piece of business, and the producers of these goods will likewise spend their money, etc...

What those taken in by this fallacy have failed to notice, observe Bastiat and Hazlitt, is that the shopkeeper is now as much down for the cost of replacing the window as the glazier is up. The money that the shopkeeper spent on the window would otherwise have been spent on other goods (for instance, a suit), whose producers are also therefore disadvantaged by this outcome, and will therefore have less money to spend on other goods, etc...

At one step removed, there are as many losers as winners. But the shopkeeper himself is worse off, because after the vandalism and expenditure he simply has a new window, whereas without the vandalism, he would have had a perfectly serviceable window, and a new suit.

As Hazlitt points out, "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, by professors of economics in our best universities. In their various ways they all dilate upon the advantages of destruction."

Hazlitt was writing in the 1940s, but the observation is more true now than ever.

Usually, the fallacy is quite well-disguised. But we have a blatant example being promoted at the moment: the idea of a car scrappage scheme to pay people to scrap their old cars and buy new. This is not just vandalism, but state-sponsored vandalism.

Would it have reduced the economic harm done by the vandal if the replacement window had been paid for by the shopkeeper's insurers rather than by him directly? No. In fact, the need to put money aside in advance to cover the risk that this might happen has caused the shopkeeper not to spend money on goods that otherwise would have been bought for many years before the incident. Insurance premiums, whether paid in advance or recovered through increases subsequently, and whether paid solely by the shopkeeper (e.g. if he has paid more in premiums than he claims, or if he loses a no-claims bonus) or spread across all the clients of the insurer, are an economic cost necessarily heavier (because of the operating costs of the insurer and the time-difference between provision and claim) than the value of the work to the glazier. Insurance would have increased the economic cost, not reduced it.

The fact that the costs of scrappage are spread amongst all taxpayers is equally irrelevant to the question of the economic cost of the scheme. The additional money that we all pay in tax, so that the Government can encourage people to scrap cars that were sufficiently serviceable that their owners otherwise wouldn't have scrapped them, is money that will not be spent on goods which we value and which the producers would be as keen to sell as the car producers are keen to sell their cars.

Would it have reduced the economic harm if the shopkeeper had replaced his window with an improved model - perhaps one that showed his products better, or that reduced his energy bills? Reduced the harm, yes, but not eliminated it. If the shopkeeper valued the improved window as much as the suit, he could have bought the window anyway without being forced to do so by the vandal. The fact that he was planning to buy the suit tells us that he felt he was getting more benefit from a new suit than from a new window. Making the best of a bad deal does not mean that the deal is not bad, nor that the shopkeeper was as happy to make a virtue of necessity as to spend his money how he preferred.

So it is with the benefits of the scrappage scheme - to the environment and to the participant in the scheme (who has an improved car). There are many things we can do to improve the environment, and many ways to spend our money to that end. A new car is not necessarily the best way of pursuing this objective. If the person with the old car also lives in a home with poor insulation and glazing and an ancient, inefficient boiler, they might have got more bang for their buck (both environmentally and in terms of their quality of life) from improving those other features and hanging on to their old car. The scrappage scheme will have created an incentive to spend money in a way that would disadvantage the supposed beneficiary, the producers of the unsold domestic goods, and the environment, in order to put off temporarily the necessary adjustment to a more economically-sustainable level of production in one particular (and not particularly green) industry.

The scrappage idea can seem quite attractive and relatively painless, at first sight. But it is, in reality, hopelessly and irredeemably wrong. We wait to see whether Chancellor Darling can resist the siren calls, or whether he follows the rest of Europe down this blind alley in his forthcoming budget.



Mark Wadsworth reports results from the German scrappage scheme that were entirely predictable and consistent with the above, very simple, analysis.

He might also have mentioned that the German scheme has been so popular (with the beneficiaries) that the cost to taxpayers has more than tripled from €1.5bn to €5bn. The irony is that the same edition of the FT that carried this report, also reported that "Daimler chief’s words highlight how German industry’s initial attempts to thwart the downturn by reducing working hours and axing temporary workers increasingly look destined to fail" and that "German manufacturers booked fewer orders in February than in January, the sixth month in a row that the global recession hammered Europe’s largest economy". I hope German taxpayers think that their government's latest wheeze to spend their money is worth it.