Broken window fallacy and economic illiteracy.

post by Desrtopa · 2010-12-01T04:48:12.618Z · score: 7 (8 votes) · LW · GW · Legacy · 13 comments

Some time ago, I had a talk with my father where I explained to him the concept of the broken window fallacy. The idea was completely novel to him, and while it didn't take long for him to grasp the principles, he still needed my help in coming up with examples of ways that it applies to the market in the real world.

My father has an MBA from Columbia University and has held VP positions at multiple marketing firms.

I am not remotely expert on economics; I do not even consider myself an aficionado. But it has frequently been my observation that not just average citizens, but people whose positions have given them every reason to learn and use the information, are critically ignorant of basic economic principles. It feels like watching engineers try to produce functional designs based on Aristotelian physics. You cannot rationally pursue self interest when your map does not correspond to the territory.

I suppose the worst thing for me to hear at this point is that there is some reason with which I am not yet familiar which prevents this from having grand scale detrimental effects on the economy, since it would imply that businesses cannot be made more sane by the increased dissemination of basic economic information. Otherwise, this seems like a fairly important avenue to address, since the basic standards for economic education, in educated businesspeople and the general public, are so low that I doubt the educational system has even begun to climb the slope of diminishing returns on effort invested into it.

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comment by jsalvatier · 2010-12-01T05:30:24.614Z · score: 5 (5 votes) · LW · GW

I think that though your father may not have been familiar with the phrase and the abstract concept of the broken window fallacy, he and most people grasp reasonably well this and many such economic concepts at least in domains where they have decent experience. For example, I doubt very much your father would break some windows on his house to give his friend who happens to be a window installer some work. There are no doubt some domains where more abstract understanding of economic concepts could do quite a bit of good (for example, investing where many more people need to understand why market timing is not a good idea and where people need to learn to invest in index funds rather than actively managed funds), but I don't think they are as broadly needed as you suggest. I say this as someone who would describe himself as an economics aficionado.

comment by SilasBarta · 2010-12-02T04:25:37.122Z · score: 4 (4 votes) · LW · GW

Understanding the broken window fallacy doesn't just mean recognizing that you shouldn't break stuff just to give your resources more to do; it means recognizing that a social policy of breaking stuff is stupid, even if it benefits specific people.

Considering how many people support policies isomorphic to breaking windows, with isomorphic justifications, I think it's fair to say must people do commit this fallacy, even if they wouldn't commit a different version of it in a different domain.

Also, there's serious debate at the academic level (that I don't take seriously) about whether it even is a fallacy. Some Keynesians believe (according to Wiki) that breaking windows can alleviate a recession.

(I think this is similar to our earlier debate about whether it's a failing of an economic theory that it regards obviously-stupid policy A as "better than nothing", if it also regards not-obviously-stupid policy A' as "better than A".)

comment by jsalvatier · 2010-12-02T16:31:03.874Z · score: 0 (0 votes) · LW · GW

Yes, I agree.

This is why I specified "domains where they have decent experience". My point is that I don't think there's a gigantic need to learn these concepts to improve business practices etc. . I do think there's a gigantic need to learn these concepts to improve public policy and charity (for the reasons given in The Myth of The Rational Voter).

People do a decent job of knowing these things on near topics, but not far topics.

comment by Swimmy · 2010-12-03T01:53:33.537Z · score: 1 (1 votes) · LW · GW

I suppose the worst thing for me to hear at this point is that there is some reason with which I am not yet familiar which prevents this from having grand scale detrimental effects on the economy, since it would imply that businesses cannot be made more sane by the increased dissemination of basic economic information.

The question is whether businesses can be made more profitable with employee economics training, which is costly. I'd wager that they can't; otherwise, there's a $20 bill lying on the ground and nobody's picking it up. Not saying those aren't around, but they're rare.

Economists usually presume that people max utility subject to constraints whether or not they can explain it in terms of opportunity cost or broken windows. The Caplan thesis is that people only do so when there's some positive cost to acting irrationally. I expect most businesses can't be made more sane with econ training because they're profit-seekers, but policy can be made more sane because voters are not.

comment by FormallyknownasRoko · 2010-12-01T22:11:39.562Z · score: 1 (1 votes) · LW · GW

"The myth of the rational voter", Bryan caplan, has a lot more to say on econ illiteracy.

comment by jsalvatier · 2010-12-02T02:52:12.270Z · score: 2 (2 votes) · LW · GW

The myth of the rational voter is an excellent book, and I think someone should write an article on the basics for the wiki at some point.

I would like to point out that Caplan's reasoning applies specifically to people's economic illiteracy about policy, rather than econ as it applies to their own lives.

comment by Jayson_Virissimo · 2010-12-01T05:53:53.601Z · score: 0 (0 votes) · LW · GW

1.) Some economists do not necessarily consider the reasoning of the onlookers in the parable of the broken window to be a fallacy (although, I believe that they are mistaken).

2.) If you apply the concept of opportunity cost correctly, you will not commit the broken window fallacy and it is unlikely that your father didn't learn about opportunity cost in his MBA program.

comment by Desrtopa · 2010-12-01T14:12:53.537Z · score: 3 (3 votes) · LW · GW

Given that he needed me to help him come up with any examples of how it applies to the market, I'm doubtful that he had learned about the idea of opportunity costs in a sufficiently general way, or in a manner that caused him to internalize that understanding. If I had prompted him to consider the problem in terms of labor opportunity costs, he might have come up with something, but the idea that GDP positive economic transactions can actually create reductions in material wealth was completely new to him.

comment by Aurini · 2010-12-01T18:00:10.897Z · score: -3 (7 votes) · LW · GW

"I suppose the worst thing for me to hear at this point is that there is some reason with which I am not yet familiar which prevents this from having grand scale detrimental effects on the economy,"

You know, I'm pretty sure they do.

I completely fail to comprehend why people actually listen to the talking heads on TV - or for that matter why heads of state listen to them - economics is not a particularly hard concept to wrap one's head around (certainly no more complex than QM), and it seems that the profession is almost entirely dedictated to making up BS to justify the worst economic policies possible. Herp Derp, Production Good, Bailouts Bad, those are the basics. And yet these jokers who couldn't predict the housing market collapse, who can't even explain it, are still paid to mouth off on Fox and CNN.

No wonder he didn't understand it - it's like trying to make sense of Physics, when all you've ever heard is Star Trek technobabble.

Within the next year the US is going to see inflation coming back, and that ass Bernanke is actually going to think it's a good thing!

The problem with educating the public - and you're bang on about being nowhere near 'diminishing returns' - is two-fold. First of all, most Economists are absolute morons, who practice a faith more than a discipline. The second is that there are vested interests who want to maintain the status quo. Keynesianism has probably hurt millions over the years, but it sure as hell benefits the Keynesians, while promising the Voting Public bread and circuses.

Edit: I'm just going to link to this guy: http://gonzalolira.blogspot.com/ He's a lot smarter than me on economics. I can't take credit for all of my ideas.

comment by CronoDAS · 2010-12-01T18:28:20.309Z · score: 0 (2 votes) · LW · GW

Within the next year the US is going to see inflation coming back

Based on what I've been reading, I disagree with this. Want to make a bet? ;)

"What I've been reading", incidentally, is the blog of that arch-Keynesian Paul Krugman, who did, in fact, see the housing market collapse coming. And you disagree with Paul Krugman at your peril.

and that ass Bernanke is actually going to think it's a good thing!

It would be, considering that we're in a liquidity trap right now: the Federal Reserve can't lower nominal interest rates any more because they're basically zero. The only way they can lower real interest rates is to push them negative by promising that there will be more inflation in the future.

(And yes, hyperinflation is bad, but we're in no danger of that.)

comment by knb · 2010-12-02T08:00:12.726Z · score: 1 (3 votes) · LW · GW

"What I've been reading", incidentally, is the blog of that arch-Keynesian Paul Krugman, who did, in fact, see the housing market collapse coming.

He didn't just see it coming, he spent the years of 2001-2003 calling for the record low interest rates with the goal of causing the housing bubble!

To fight this recession the Fed needs more than a snapback; it needs soaring household spending to offset moribund business investment. And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

God willing, our intrepid macroeconomists will soon create another bubble to save us from the last bubble (which they created to save us from the bubble before that, etc.

That's how a sane economy works.

comment by CronoDAS · 2010-12-02T20:57:20.181Z · score: 1 (3 votes) · LW · GW

And to do that, as Paul McCulley of Pimco put it, Alan Greenspan needs to create a housing bubble to replace the Nasdaq bubble.

Krugman's comments on the quote

comment by Aurini · 2010-12-01T20:28:37.706Z · score: 1 (5 votes) · LW · GW

I would love to make a bet, but all I can offer up is a pint of blood. Nonetheless, thanks for the link.