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In 1850, the French economist Frederic Bastiat designed a famous thought experiment around the tale of a boisterous child who smashes his father’s shop window. The distraught shopkeeper is consoled by a witness who claims that the shattered window would at least provide gainful work for a glazier. So, does that make the destructive act a form of economic stimulus?
Not really. The vendor needs to pay the repairer — there is no net gain. But many succumb to the “broken window fallacy” when looking at the economy today. Most recently, commentators have asserted that Taylor Swift’s concert tours have added hundreds of millions to the US and UK economies. What they fail to consider is the counterfactual: how Swifties would have spent their ticket money otherwise.
The misconception highlights our tendency to value what we see, over what is hidden. Just because we witness or measure certain economic activities does not mean they are net value-creating or productive. Indeed, if Bastiat were alive today, he would probably raise a few quibbles over how we value certain activities in our increasingly complex, financialised and service-driven economies.
First, he would notice that many activities cancel each other out. Defence and prosecution lawyers, regulators and regulatory arbitrageurs, cybercriminals and cyber security experts and much of financial trading — for each winning bet, there is someone on the losing side.
Lord Adair Tuner, the former chair of Britain’s financial watchdog, has described these as “zero sum” activities. They create jobs and income but they net-out. “More skill, effort, and technology,” he wrote, “cannot increase human welfare, given the skill, effort, and technology applied on the other side”.
Likewise, many companies are engaged in “arms races” for our attention. Take a fashion retailer spending millions on hiring branding agencies to convince consumers to buy its products, while its rival does the same. Expenditure snowballs, but it may not be directly enhancing productivity.
Roger Bootle, founder of Capital Economics, has another framing. “Economic activity lies on a spectrum from the distributive to the creative,” he told me. “At one end you have some financial investors, who can generate large gains — but mostly at others’ expense. At the other you might have scientific research.”
Here, Bastiat could take aim at professional services. How much do our vast financial sectors channel savings to productive long-term investments, versus merely shifting funds between market players, he might ask. And if a lawyer raises their hourly rate, say because they have a local monopoly, is that a productivity gain or simply a cash transfer from clients?
Consulting is another case. It recently emerged that New York City paid McKinsey $4mn in 2022 to conduct a feasibility study on how to manage its trash problem. Many on social media felt they could do it far more cheaply — with a single power-point slide entitled: “bins”. Indeed, how much of the industry involves paying for second opinions, against deploying knowledge that the client would not otherwise have access to?
Finally, Bastiat would notice that many activities stem from inefficiencies. One example: healthcare expenditure accounts for 17 per cent of US GDP. That is the highest of any developed country, yet its health outcomes are among the worst. Higher spending on healthcare may boost GDP, but it hides unhealthy citizens — and an ineffective health system.
It would not be difficult to counter Bastiat. Beyond supporting jobs and spending, many of these activities serve important economic functions, notes Diane Coyle, professor of public policy at Cambridge university. “To reckon only in terms of value added is not the only relevant lens on the economy.”
The prize of “zero-sum” or “distributive” activities drives competition. Earnings from “arms races” can be reinvested to boost productivity. Many tasks contain both “distributive” and “creative” elements: a consultant might help one client obtain external validity for a matter they already know the answer to, while assisting another to launch new technology. Even highly distributive activities have a role; hedge funds support liquidity.
But the distinction between economic activity and value added still matters, because in some sense the former tells us how busy we are, and the latter how well our economies can create value. “Summing up the market value of goods and services we produce, which is what GDP does, is not the same as social value creation”, says Coyle. Bastiat reminds us to scrutinise what we see and add up.
tej.parikh@ft.com
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