Nineteenth-century political economist Frederic Bastiat in his 1850 essay wrote a parable that changed the thinking of how we look at economics. It's a parable about the seen and the unseen. It's also known as the fallacy of the broken window. It goes something like this:

Suppose a small boy picks up a stone and throws it through a shop window. The many bystanders gather around and soon several workmen show up to replace the window. The townspeople remark at the swiftness of the workmen and their competency to install the new window. Soon painters show up to touch up the frame and in all the hustle and bustle the townsfolk conclude that the broken window is actually a blessing in disguise.

What is seen is the activity of new employment, the repairing of an eyesore into a bright new shiny window. However what is not seen is what would have occurred had the window never been broken. What is not seen is if the workmen's time were spent on installing a new window elsewhere. The town would then have had two windows instead of one and the towns GDP would have grown.

Instead, the town ends up with one window, a window that added nothing except to replace what was already there. The town's GDP is the same -- stagnant -- no new growth occurred. In fact, since the shopkeeper had to spend his daily profits on replacing the window, he could not make a desired purchase of flowers for his wife or a pie for his kids for after dinner that night.

What is seen is the new wealth that goes to employed workers. What is unseen is a redundancy of work at the expense of the potential would-be new wealth of the florist and the pie maker.

Bastiat is not addressing the issue of production here - he concedes that replacing the broken window is a good thing; he is addressing the wealth and progress of society. He is not merely looking at the immediate but at the longer term effects of the broken window.

Bastiat does not only take into account the consequences of the broken window for one group, but for society as a whole. On the one hand we have a window - which is what we had at the beginning. On the other hand, we have lost time and a second window. We have expended energy but for no net gain.
 

The lesson? What is good or bad for one person, a company, or an industry, is not necessarily good or bad for an economy as a whole.

A good example of the fallacy of the broken window can be applied to outsourcing and free trade. Everyone "knows" that outsourcing jobs is bad. What is seen is the closing of a local manufacturing plant, or a store. What is seen is the tragedy of people losing their jobs. What is not seen is the benefit of reproducing those products at lower prices which show up on the shelves throughout America.

A very small percentage of Americans are workers that lose their jobs, but we are all consumers and benefit if the prices we pay fall. Outsourcing occurs when a company moves to another country to lower costs, compete with its competitors, and lowers prices. There is no way to see the benefits of lower prices and trace the money saved to all of us who benefited from the extra cash in our pockets.

We don't see directly the extra hamburgers sold, and the additional help needed to supply those hamburgers as people have more money in their pockets. We don't see the extra seats filled in movie theaters and sports events. We don't see the extra shirt or blouse being bought, or the decorative piece for your home or apartment that would not exist except for additional savings elsewhere.

We also don't see the increase in innovation that leads to higher quality and new products in our lives. They appear "magically" over time, as the businesses that cut costs were able to invest and eventually increase profits, then hire more and better workers, expand, and produce better products for us all.

All of this happens on the subliminal level. It is difficult to measure going from small bulky TVs to flat screen TVs; or from land lines to cell phones. How do you measure the use of computers available to almost everyone in society? Progress is hard to measure because unlike a plant in the middle of a town that closes and is featured on the nightly news, progress is widely diverse and pervasive reaching hundreds of millions of people in small ways over time.

And the reverse is also true. It is estimated that 80% of new businesses fail. Everyday there is the tragedy of dozens of businesses going broke. But we don't see that. It is a natural result of risk taking, but those involved bear it quietly and move on.
 

Such is not the case when a plant goes out of business or is moved and is widely covered by the media. The forces of political action are mobilized and new policies by the government are advocated and many times enacted. The amount of business people that lose their jobs daily is far greater than a single plant, but the market absorbs the shock quietly and a transition begins.

This is not true when government intervenes to impose an economic policy on the nation. Government intervention disrupts this natural transition and leads to unforeseen consequences. The result almost always from this disruption is less growth.

Whether well-intended or not, government-induced stagnation is the result of the undermining of freedom and free markets. It is not obvious. It is the "unseen" in Bastiat's parable. You can look in vain for the cause of a nation slowly stagnating. You don't see it at first. You don't recognize that your wages are not keeping pace with your expenditures. That the quality of things is getting worse; that lines are growing longer, and that opportunities are getting scarcer, and that things are breaking down quicker.

Adam Smith tried to explain it by describing free trade and free markets being like an "invisible hand". The interaction of free people to act in their own self-interest acts as a governor on supply and demand which all together makes a market more efficient. Prices are the result of millions of decisions and values of free acting individuals in society. They represent information. Jointly they lead to market-based wages and the distribution of goods and services based on market-induced supply and demand. The free flow of new ideas, informative pricing, and the distribution of goods and services that result, leads to the optimum conditions for prosperity. It is what gives rise to the wealth of nations.

It is only when governments intervene and decide these things for individuals that the information system of markets breaks down. Then comes stagnation.
 

When free markets are allowed, it has always led to prosperity. Nothing had ever been seen like the burst of prosperity, the rising standards of living of people, and the wealth creation that we saw during the Industrial Revolution that began in Europe in the 18th and19th Century.

The "miracle" continued with the birth of America. Free market capitalism, a philosophy of individualism, and the court protection of contracts, individual rights, and property rights, all converged to create the greatest economy in the world. The lives, health, and longevity of citizens throughout the world increased during this period more than in the entire history of mankind.

Today, the world is mired in stagnation.

The task of political economists is to follow in the tradition of Bastiat and Adam Smith, and look behind what is immediately seen and rediscover the unseen causes of our economic malaise. We need to rediscover the virtues of the free market and the folly of government intervention.

Given the economic deterioration and stagnation of the world's economies today, now would be a good time to take one long hard look at present day government economic policies.

Chances are they will find a lot of broken windows.

Paul Nathan

Paulnathan.biz