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In 1850, French economist Frédéric Bastiat devised a famous thought experiment based on a story of a rowdy child who smashes a window in his father’s shop. The distraught shopkeeper is consoled by witnesses who insist that the broken window will at least bring in some income for the glaziers. So is this act of vandalism a form of economic stimulus?
Not really. There’s no net gain, since the seller still needs to pay the repairman. But when we look at today’s economy, many people fall victim to the “broken windows fallacy.” Recently, critics have argued that Taylor Swift’s concert tours have brought hundreds of millions of dollars into the US and UK economies. What they fail to consider is the counterfactual: how Swift’s fans would have spent their ticket money otherwise.
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This misconception highlights our tendency to value what we see over what we hide. Just because we witness or measure a particular economic activity does not mean that it creates net value or is productive. Indeed, if Bastiat were alive today, he would probably have some objections to how we value certain activities in an increasingly complex, financialized, and service-driven economy.
First, he will find that there are many cancelling activities: defense and prosecution lawyers, regulators and regulatory adjudicators, cybercriminals and cybersecurity experts, and many financial transactions – some win and others lose.
Sir Adair Turner, a former chairman of the UK financial regulator, described these as “zero-sum” activities: they generate jobs and incomes, but only offset each other: “Increasing skill, effort and technology does not improve human welfare, given the skill, effort and technology applied at the other end,” he wrote.
Similarly, many companies are in an “arms race” to get our attention. While fashion retailers spend millions on hiring branding firms to persuade consumers to buy their products, their competitors do the same. The spending snowballs, but it may not directly increase productivity.
Roger Bootle, founder of Capital Economics, sees it differently. “Economic activity exists on a spectrum from distributive to creative,” he told me. “At one end, you have financial investors who can generate big profits, but mostly at the expense of others. At the other end, you might have scientific research.”
Here Bastiat might take aim at professional services: How many savings does our vast financial sector channel into productive long-term investments, rather than just moving money between market participants? And when lawyers raise their hourly rates because of, say, a local monopoly, is that a productivity gain or simply a cash transfer from clients?
Consulting is another example. It was recently revealed that New York City was paying McKinsey $4 million in 2022 to conduct a feasibility study on how to manage its trash problem. Many on social media felt it could be done for less: with a single PowerPoint slide titled “Trash Cans.” Indeed, how often does this industry pay for a second opinion in exchange for deploying knowledge that clients would not otherwise have access to?
Finally, Bastiat will note that many activities stem from inefficiencies. To take one example, health care costs account for 17% of the US GDP, the highest among developed countries, yet our health outcomes are the worst. Higher health care spending may boost GDP, but it masks an unhealthy population and an inefficient health care system.
Countering Bastiat wouldn’t be hard. Diane Coyle, a professor of public policy at Cambridge University, points out that much of this activity serves important economic functions beyond supporting jobs and spending. “Judging value added alone is not the only appropriate way to look at the economy.”
The benefits of “zero-sum” or “distributive” activities drive competition. Profits from an “arms race” can be reinvested to increase productivity. Many tasks contain both “distributive” and “creative” elements. A consultant might help one client launch a new technology while helping another client gain external validity for a problem they already know the answer to. There is a role for highly distributive activities as well. Hedge funds support liquidity.
But the distinction between economic activity and value added remains important, because in some ways the former tells us how busy we are, while the latter tells us how well our economies create value. “Adding up the market value of the goods and services we produce, which is what GDP is about, is not the same as creating social value,” says Coyle. Bastiat reminds us to examine and add up what we see:
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An earlier version of this article incorrectly stated Sir Adair Turner’s name.
