It takes a crisis, such as the financial meltdown in 2008, to rally support for a Keynesian style fiscal stimulus.
It takes another kind of crisis, specifically the earthquake and tsunami that devastated the northeastern coast of Japan last week, to expose the Keynesian fallacy that the government can spend its way to prosperity.
For that reason, Acts of God provide a teaching moment. They make the distinction between spending and wealth so blatantly obvious that even the most dyed-in-the-wool believer in the value of digging holes and filling them up will be hard pressed to deny it.
The flawed thinking emerges right on cue after every earthquake, flood or other natural disaster when economists put pen to paper, or input into model, to calculate the effect.
First comes the hit to output, or gross domestic product. Some of Japan’s productive capacity was destroyed. Power disruptions forced other companies, including the country’s auto manufacturers and chipmakers, to halt production, creating a ripple effect through the entire supply chain, in Japan and abroad.
Small businesses destroyed by the earthquake may not be able to make payroll or pay their creditors, in some cases causing them to default on their bank lines. Most companies will feel the effect of the damage to the national infrastructure, including roads, railways and the power grid.
The list goes on. You get the idea that what happened is a big negative for the Japanese economy, which never regained its position in the global hierarchy following the bursting of the real estate and stock-market bubbles in 1989.
Yet some economists still see a silver lining for Japan’s economy in the wake of the disaster, claiming reconstruction efforts will create jobs and stimulate growth.
They’re not optimists; they’re just misinformed.
Larry Summers managed to put his foot in his mouth last week when asked about the effect of the earthquake. The former top economic adviser to President Barack Obama, former Harvard University president, former Treasury secretary and now ordinary professor at Harvard’s Kennedy School of Government, told CNBC the earthquake and its aftermath “may lead to some temporary increments, ironically, to GDP as a process of rebuilding takes place. In the wake of the earlier Kobe earthquake, Japan actually gained some economic strength.”
Too bad Japan had to wait 16 years for another opportunity.
The blogosphere was quick to pounce. At Cafe Hayek, George Mason University economics professor Russell Roberts provided a translation of Summers’s comments for readers who responded to his initial post.
“He wasn’t saying the tsunami was a good thing,” Roberts said. He was saying that “rebuilding would be good for the economy, that spending creates prosperity.”
For John Maynard Keynes, building pyramids in the 20th century made sense, too. And two “masses to the dead” were better than one, he wrote in “The General Theory of Employment, Interest and Money.” “Pyramid-building, earthquakes, even wars may serve to increase wealth” and cure involuntary unemployment.
Eight-five years before Keynes penned the “General Theory,” French political economist Frederic Bastiat pointed out the fallacy in his thinking.
“Destruction is not profit,” Bastiat wrote in his 1850 essay, “That Which Is Seen and That Which Is Unseen.”
I’m glad to see that Bastiat is enjoying something of a revival, judging from the numerous post-earthquake commentaries that reference his parable of the broken window. Bastiat used the analogy of the broken window, and the spending that flows from it (that which is seen) to point out that which is unseen: How the money used to repair the window ― government spending on fiscal stimulus ― could have been spent more efficiently if the window hadn’t been broken.
Japan won’t be better off ― richer, as a nation ― as a result of the rebuilding effort. Housing starts will increase, but the housing stock won’t. The same goes for factories and office buildings.
A nation isn’t richer when it has to allocate scarce resources to rebuilding. Just think how the money could have been used, in ways only entrepreneurs can envision, rather than rebuild what was destroyed.
Here’s Bastiat again:
“If, on the other hand, you come to the conclusion, as is too often the case, that it is a good thing to break windows, that it causes money to circulate, and that the encouragement of industry in general will be the result of it, you will oblige me to call out, ‘Stop there! your theory is confined to that which is seen; it takes no account of that which is not seen.’”
One hundred and fifty years later, Keynesians are still flying blind.
By Caroline Baum
Caroline Baum, author of “Just What I Said,” is a Bloomberg News columnist. The opinions expressed are her own. ― Ed.