The interstate highway near my house is being resurfaced. As part of the process, large machines have ground off the top layer of asphalt, leaving a rough surface on which to lay down new asphalt. It’s left a lot of loose stone, which gets tossed around by the wheels of vehicles on the road. My car has suffered a small chip in the windshield, and my wife’s car’s windshield now has a more significant crack. In South Carolina, the insurance company will pay for a new windshield with no deductible (by law). I’m sure the windshield makers and installers are doing very well in my area. Their revenues are probably higher, and the installers might be getting overtime pay. The stores the glass installers spend their new money in will probably also benefit from the larger number of broken windshields. Economic prosperity all around! Maybe we should leave the highway in its current state, and watch the economy grow! (The potholes that prompted the resurfacing might have been good enough, by this way of thinking–benefiting wheel alignment shops, auto mechanics who worked on suspensions, and the like.)
But that would be to make a mistake, referred to sometimes as the “broken window fallacy.” Destruction, whether of windshields, auto suspensions, or buildings, ships, and aircraft during wartime, never creates a general improvement in the economy. The destruction requires repair, and those in the business of repair will prosper, but the money that goes to that repair came from some other part of the economy–and that part will be worse off. Because insurance companies have to pay for windshields, they cannot put that money in revenue-generating capital investments, and their profits may decline. The lower level of capital investment means that workers have fewer of the tools that help them earn higher incomes, and the lower profits mean lower returns for those who hold stock in insurance companies–which might be the source of a retiree’s income. The negative effects might be widely dispersed and thus harder to see, but they are no less significant than the positive effects for the glass installers.
In the end, the broken windshields make the economy worse off by… the value of the broken windshields. This is an important lesson to remember, since failure to comprehend it has caused people to adopt policies like the misguided “Cash for Clunkers” policy that used taxpayer dollars to induce the smashing still-useful old cars. Or caused a tragic celebration of the supposedly stimulating economic effects of war, hurricanes, and nuclear disaster (for instance, Nobel laureate Paul Krugman argued after the Fukushima disaster that “the nuclear catastrophe could end up being expansionary, if not for Japan then at least for the world as a whole”).
My windshield may be replaced at no significant cost to me, but it is not good for the economy.