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If I pay someone €100 to dig a hole, and they pay me €100 to fill it back up, GDP will (seemingly) grow by €200, making this seem good for the economy.

"Aha!" says the economist, "that's a common variation of the broken windows fallacy. If you hadn't spent those €200 on hole-digging, you'd have spent them somewhere else. This economic activity doesn't represent real growth, but actually a loss of wealth!"

This indicates that economists make a distinction - whether by intuition or by some standard, which is part of my question - between useful and wasteful economic activity.

There are many things in this economy that people could argue to be wasteful: pepsi and coca-cola both spending a billion dollars on marketing only to keep their market shares stagnant; bullshit jobs like middle management, accountants writing reports that nobody reads, an endless army of lifestyle coaches and influencers, and psychologists curing ailments caused by all of the above - just to name a few examples. About 25-40% of workers self-report their jobs as being "completely meaningless". Obviously one can also make arguments that this is all useful economic activity.

My question is: If economists intuitively make a distinction between 'real' economic growth and wasteful activity (as indicated by the broken windows argument being called a fallacy), have there been any attempts to formalize this distinction? Apparently digging holes and filling them back up is wasteful, and plumbing or doctoring probably isn't, but where do economists draw the line?

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    $\begingroup$ To answer this you need to provide rigorous and consistent definition of "broken window activity". Your examples in your question are not consistent. 1. You claim marketing is an example of such activity because competitors cancel each other market shares but marketing serves many other purposes than simply increasing market share (e.g. informing customers about new products, brand awareness etc). 2. Next you mention "bullshit jobs" which is itself contentious idea promoted by anthropologist Graeber who does not really support widespread existence of these jobs by any rigorous empirical $\endgroup$
    – 1muflon1
    Commented Jun 4 at 10:13
  • $\begingroup$ analysis and rigorous empirical studies reject his bullshit job theory even on his own terms (e.g. by measuring how many people think their job is useless which is itself a contentious definition of bullshit job because employee can think that they are useless while they are actually adding value on a margin) journals.sagepub.com/doi/10.1177/09500170211015067. For example, the accounting reports that you are mentioning are often required by government so without them firms would face severe penalties, moreover, they are actually being read by professional investors and so on $\endgroup$
    – 1muflon1
    Commented Jun 4 at 10:15
  • $\begingroup$ If a broken window activity is just some activity you personally find useless without any objective metrics this is impossible to answer. $\endgroup$
    – 1muflon1
    Commented Jun 4 at 10:16
  • $\begingroup$ The real issue isn't "broken window" but where profits are shifted to solely for tax purposes. See Ireland and its modified GNI. $\endgroup$
    – user71659
    Commented Jun 4 at 21:41
  • $\begingroup$ @1muflon1 this is precisely why I added the third question. Áre there objective metrics for the 'usefulness' of a job or transaction? I'll edit the question to put more emphasis on that. $\endgroup$
    – Jumboman
    Commented Jun 5 at 11:48

2 Answers 2

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I do not think a distinction between useful and useless jobs is necessary to make a case for the broken window fallacy.

I think this would be clearer if we clarify the causal claim. The initial claim is: you pay someone to dig a hole and then the person pays you to fill it up, this causes the GDP to rise up by 200 euros. This means, that had you two not engaged in this digging and filling of the hole, the GDP would have ended up 200 euros less than what it ended up being after the digging and filling hole.

The argument of the broken window fallacy simply says that this need not be the case. Digging up the hole and filling it up required labour and time, which are resources which could have been used somewhere else. For example, you could have spent your time sewing clothes, or doing pottery. The clothes sewn could have amounted for 100 or 300 or maybe exactly 200 euros. There is no way to tell without further data or assumptions. Alternatively, you could have spent your 100 euros on something else, say, a bottle of coca cola. If the marginal propensity to consume of the coca cola seller is higher than yours, then it is possible that at the end of the day, that might have ended up in a higher GDP compared to what would result from digging and filling up the hole.

But one thing that can surely be said is that we cannot be certain that the digging and filling of the hole has caused the GDP to increase. It may or may not. Therefore, this reasoning is fallacious.

Regarding formalisation, I think the idea of crowding out comes close. This also makes sense because the broken window fallacy is often associated with parables that warn against government spending to raise employment or GDP.

Consider the IS-LM model. $Y$ is the income, $C$ consumption, $I$ investment, $G$ government expenditure, $r$ interest rate. $C$ is an increasing function of $Y$ but the derivative is less than 1 as people save part of additional income and do not consume everything. $M^s$ is money supply and $M^d$ is money demand. Money demand rises with income and falls with interest rate. The equations are

$$Y = C(Y) + I(r) + G$$

$$M^s = M^d(Y, r)$$

If the derivative of $a$ with respect to $b$ is denoted by $a_b$ then we have

$$Y_G = \frac{1}{1 - C_Y + I_r (M^d_Y / M^d_r)}$$

If investment does not respond to interest rate at all and $I_r = 0$ then the total income rises by more than the increase in government expenditure.

But if investment negatively responds to interest rate rise, then the effect is smaller: rising government expenditure leads to rise in interest rate and this makes private investment costlier. So part of private investment is "crowded out".

In the extreme, of investment is infinitely responsive to interest rate, then, the effect of increased government spending will be precisely 0.

Even otherwise, in the long run, as we allow prices to vary, raising $G$ will raise prices so that there might be no real change in the income (as we add the AS curve to the model).

Therefore, simply spending on something doesn't mean it is contributing positively to the GDP. It might lead to less expenditure on other things, overall might cancel out on net terms, which I think is the crux of the broken window argument.

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  • $\begingroup$ Thanks! With the balance sheet of the largest companies eclipsing the gdp of some countries, would this formula apply to them as well? Or is the assumption that extra government spending is paid for by increasing the money supply (printing) which companies can't do? $\endgroup$
    – Jumboman
    Commented Jun 7 at 5:35
  • $\begingroup$ Money printing is not assumed in the IS-LM model, money supply is fixed, in fact. Extra gov spending raises income initially. But this raises money demand. With money supply constant, this forces the interest rate to rise. It is the rise of interest rate that reduces private investment by increasing the cost of funds. It is an aggregate model, so it does not specify which exact companies would bear the brunt, but tells us that someone or the other will. $\endgroup$ Commented Jun 7 at 6:04
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I will split my answer into two parts, I will first address your misconception about the broken window fallacy, and then I will address the question about pointless work.

Broken Window Fallacy

You seem to be misunderstanding the broken window fallacy. Broken window fallacy is not actually about work that is not useful. You mention example of digging and filling hole, but that is actually not the original example, and while the digging and filling hole could be used as an example similar to broken window, it is also genuinely purposeless activity, whereas fixing broken window isn't, which is where you probably get the confusion.

The broken window fallacy comes from Bastiat's (1850) essay "Ce qu'on voit et ce qu'on ne voit pas". The essay was an attack at people who do not employ counterfactual thinking when in comes to economics. I think its relevant to look at the paragraphs that contain the main message of the essay;

Suppose it cost six francs to repair the damage, and you say that the accident brings six francs to the glazier's trade – that it encourages that trade to the amount of six francs – I grant it; I have not a word to say against it; you reason justly. The glazier comes, performs his task, receives his six francs, rubs his hands, and, in his heart, blesses the careless child. All this is that which is seen.

But 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."

It is not seen that as our shopkeeper has spent six francs upon one thing, he cannot spend them upon another. It is not seen that if he had not had a window to replace, he would, perhaps, have replaced his old shoes, or added another book to his library. In short, he would have employed his six francs in some way, which this accident has prevented.

If you read the above, you should clearly see that Bastiat does not consider fixing window useless/bullshit economic activity. Fixing the window is useful economic activity (try breaking your window and lets see if you will be satisfied living without fixing it). The point is that if the window wasn't broken other economic activity would take place and society still would have additional window.

To sum it up, the claim is that the growth rate is the same whether the window is broken or not, but without broken window there are more assets in the society then in the contrafactual with broken window.

This is different from digging up and filling up a hole, because yes the broken window fallacy still applies, other economic activity would take place if this did not occur, but in this case there is additional twist that digging and filling a hole serves no purpose.

Measuring Useless Production

First, the measuring of output is already set up to try to exclude useless production. We measure GDP as output at market prices and not just as an output, precisely because we do not want to count production of goods and services that do not add value to the society.

If someone is paying \$x for a good or service, that generally means that good or service created at least \$x for that individual. If markets would be perfect this would measure added value. The examples you mention like with the advertising that cancels each other out is not a valid example. Clearly, even if this is prisoner dilemma situation that advertising adds value to the company by not lagging behind competition, putting out information about new products and so on. Moreover, value is ultimately subjective, if someone decides to spend money on my little pony dolls you can consider that waste, but clearly for that person having such doll has utility.

A miscalculation occurs when someone spends \$x on something but they do not actually value it at \$x or more. This is typically a result of something 'shady' going on. For example, an actual example of pointless activity would be a middle manager secretly employing their family member by putting them somewhere out of sight where they collect salary but just watch cat videos whole day. In that case clearly the company does not actually values this work at the salary that person is earning yet that salary would still end up in GDP.

The problem is that there isn't really any valid way how you can discover something like this without micro audits of every activity. That is simply not currently feasible. There isn't a single broad category in GDP calculations that could be declared wasteful per se.

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