Broken window
View(s):
Remittances from migrant workers (seen in this picture) represent the highest forex earner for the country.
A comedy movie of Charlie Chaplin, an English comic film maker and an actor, called “The Kid” was released in 1921. According to the movie, Charlie Chaplin acts as a tramp, who happens to raise an abandoned child. While they both must find money for their living, the tramp and the kid device a strategy and work collaboratively every day.
After choosing a street to work each day, the kid goes first. He picks up a few stones and breaks the glass windows of the houses along the street by throwing the stones. As the kid runs away, the tramp comes along the same street as a window fixer. The house owners hire him to fix the broken windows – actually, the windows smashed by the kid. The tramp and the kid earn money for their living.
Creating demand
Now, let me ask an economic question, which has been a question to economic writers for centuries. Does the work of the tramp as a window fixer in the comedy movie add anything to the economy?
According to Keynes, “yes, it does”. John Maynard Keynes was an English economist and a financier, who is best known for giving birth to the so-called Keynesian Economics tradition. His profound publication in 1936 titled “The General Theory of Employment, Interest and Money” presents a strong case for the effectiveness of demand-management policies to sustain incomes and jobs.
In order to fix the broken windows, the tramp must buy new glasses creating demand for the glass factory to produce more glasses. The factory runs, and the people working there have work to do and get paid. The tramp also has work to do and he gets paid for that too.
He and the kid would buy their food and other needs for living. They create demand for food and other supplies, which should be produced by creating incomes and jobs in such places. The economy works through multiplier effects as such, all because of the effective demand created by the broken windows.
Keynes and Charlie Chaplin
We don’t know whether Keynes had seen this comedy movie of Charlie Chaplin. Neither does he speak of fixing any broken windows in his publication. But they both were contemporary Englishmen who undoubtedly experienced the economic crisis of the Western world brought about by the Great Depression in the 1930s.
Keynes, however, drew parallels with the work of the window fixer. When people are without work, the government should hire them and pay to dig holes in the ground, and then to fill them up again.
Contextually, there is no difference between the two cases of fixing the windows which were smashed previously and closing the holes on the ground that were dug earlier. But they both are similar in terms of creating incomes and employment.
He termed digging holes in the ground as “gold-mining”. He commented that it looks wasteful, when judged on business principles. But it is the most acceptable among all solutions during an economic downturn.
Keynes elaborated his idea of creating effective demand to sustain incomes and employment in crisis times in a profound way saying even ‘wasteful’ expenditure based on borrowings would enrich a community. According to Keynes, even things like pyramid-building, earthquakes, and even wars may serve to increase wealth in a way.
Broken window fallacy
It is interesting to know that the economics of the idea of a “broken window” had already been presented in 1850 by a French economist, called Frédéric Bastiat. His essay titled “That which we see and that which we do not see” is now popularly known as the “Parable of the Broken Window”.
In Bastiat’s story, which apparently resembles the comedy movie of Charlie Chaplin, a boy breaks a window. The people who saw the incident conclude that the boy has actually, done a service to the wellbeing of the community, because his father should now buy a new glass and replace the broken window.
The glass manufacturer can spend his increased income from glass sales to buy some other stuff which stimulates the local economy with multiplier effects. Bastiat’s story is a parable which is, sometimes, used to rebut the notion that “going to war” is good for a nation’s economy – a notion that even Keynes supported 86 years later.
The broken window theory of Bastiat explains its fallacy that spending money on something that has been destroyed does not lead to a net economic gain. It is just a transfer of money from someone else to another in order to replace something rather than creating anything new – a good or a service. Furthermore, it has an opportunity cost too. The boy’s act has forced the father to spend part of his earning to replace the window which would have eventually reduced his spending for something else – a new thing such as food, or shoes or clothing.
Keynesians in crisis times
However, the Keynesian demand management policies began to receive policy priority in economic recessions and crises since the late 1940s. It is mainly because of the fact that crises which weakened private spending have created adequate space for increased public spending. This was initially seen in the late 1940s, due to the Great Depression and the World Wars that had devastated the Western countries.
As a result, public spending increased, while it stimulated aggregate demand offsetting the adverse impact of subdued private spending. It justified the Keynesian idea that even if it is ‘wasteful’ spending, it performs a vital task in the crisis-ridden economies to maintain aggregate demand.
The problem was, however, increased public spending requires money to finance it, while it demands for increased credit financing including the so-called money printing. Thus, the world initiated demand management policies with both fiscal and monetary expansion, which did not exist in the world prior to the Second World War.
As the economic outcome of the policies, the world economy started growing reporting a golden era of the Western countries. At this point, even if there is some truth in what Keynes recommended, does it justify that fiscal and monetary expansion and credit financing have no limits? By the 1970s, it was clear that apparently there are limits of such policies.
Half a century later
Today, a half a century later, history repeats itself. The world has entered a crisis time which has continued to stretch more than a decade. Keynesian demand management policies returned in the form of fiscal and monetary stimuli packages and the world economy attempted to revive.
Credit expansion has grown too high, with an increase in public debt from US$17 trillion to $92 trillion within the past 22 years of the present century. Public debt with household and corporate debt, exceeds $300 trillion.
Only the countries which have focused more on expanding their productive capacity remain resilient to the global crisis with over-spending from debt. In the years to come, the world needs to cool down unwarranted expansion in aggregate demand and to wipe out the accumulated debt pile. There are no universally valid policy packages which work in the past, the present and the future, while going too far with any policy is too dangerous.
(The writer is a former Professor of Economics at the University of Colombo and can be reached at sirimal@econ.cmb.ac.lk and follow on Twitter @SirimalAshoka).
Hitad.lk has you covered with quality used or brand new cars for sale that are budget friendly yet reliable! Now is the time to sell your old ride for something more attractive to today's modern automotive market demands. Browse through our selection of affordable options now on Hitad.lk before deciding on what will work best for you!