Wednesday, September 9, 2009

Literally Experiencing the Broken Window Fallacy

In several past posts [1,2,3], I used the parable of the Broken Window to demonstrate why "stimulus" spending can not benefit the economy. In another post [1], I explained how government tax incentives encourage employer sponsored insurance coverage to pay for routine services which when coupled with Medicare and state coverage mandates, creates a system that has the essential attributes of socialized medicine along with the necessary consequences - exploding prices, declining quality, and waiting lines. (Naturally, the dire consequences of government regulation in health care is now being used to justify more government regulation).

A week ago, I experienced both of these issues first hand after my car window was literally broken. Fortunately, the thief did not take anything. All that was in my car was Reisman's Capitalism and Norberg's In Defense of Global Capitalism. I claimed that he broke the window and realized there was nothing of value to them and went away. My wife claims he saw the books first...

Anyway, I called a glass repair shop and they quoted me about $400. If I had paid them, someone like Obama or Paul Krugman, seeing that an economic transaction took place, might conclude that the broken window was "stimulative". In fact, that line of thinking is exactly the basis for the entire trillion dollar stimulus program. The goal of such programs is simply to get economic transactions to take place. After all, according to them, "consumption" is what leads to prosperity.

But, of course, as we saw earlier, although the glass repair shop would have been happy to have received new business, many other businesses would be unhappy since I now will not spend that money at their place. For example, now, my wife and may not go out to dinner or buy a new television. Or, worse yet, since I can not save the money, an entrepreneur or inventor may not benefit by having access to the capital. Far from being "good" for the economy, this act of destruction is simply destructive.

Keep the previous in mind when you read an article making the absurd claim that "cash for clunkers" has somehow been good for the economy. Of course, this transfer of billions of dollars from taxpayers to car buyers was great for the automobile companies. But if we transferred billions of taxpayer dollars to jelly bean companies under "cash for jelly beans" it would be good for jelly bean companies. What's missing is the billions of dollars that will not be spent or invested on anything else in the world.

Worse, cash for clunkers encouraged people that had functioning cars to destroy them in order to go into debt to buy a new one that they wouldn't have otherwise purchased. (In fact, the car dealers had to prove that they literally destroyed the clunkers in order to get reimbursed by the government.) Such subsidies divert production from things people really want to things they only want because they got a subsidy. In summary, some taxpayers have billions of dollars less than otherwise, a bunch of perfectly fine cars have been destroyed, a bunch of people who had perfectly fine cars now have a new car plus debt, and the car companies have billions of dollars more than otherwise with which to produce more cars that no one wants.

Great - let's continue the story. As it turns out, I didn't pay the $400. I called my insurance company and they informed me that the state mandates full coverage of glass breakage so it was covered. Yeah! I called another glass repair place who said they would take care of it and would submit the bill directly to the insurance company. Out of curiosity, I asked her how much they were charging, to which she asked, "why do you care, you are not paying?" But still I asked, "how much?". "$650", she said. Hmmm...

So, if I had shopped around for 2 minutes, it turned out I could have replaced the window for $400 or maybe less since I only called one other place. Since the insurance company most likely has a schedule for how much this costs, the glass repair place just charges them the max, i.e., whatever they can get away with. Of course, I didn't care, since I was not paying for it.

This is exactly the problem with third party payer systems and state mandates. When an individuals pays, he has an incentive to shop around and economize or even defer an unnecessary purchase if it is too much. Such behavior forces businesses to compete and offer the best quality for the lowest price. However, when someone else is footing the bill (such as an insurance company) - who cares - give him the works. This is exactly what has happened in America's health care system as the government has encouraged employer provided health insurance.

It's amazing that such a simple experience can explain economic principles that affect millions of people and trillions of dollars. Of course, several hundred years of economics already had given me the answer, and I really didn't need a broken window to figure it out. The good thing is that my story will supplement my original posts by providing actual data to go along with my theoretical explanation. Such "data" should now be able to even convince the pragmatist who denies knowledge and can only grasp "experience". Naturally, I would not expect them to induce the more general principles involved. They will have to repeatedly experience broken windows and wish that the result differs from every other time. I just hope it's not my windows.

3 comments:

Anthony said...

I just experienced what you're talking about with regard to health care. My family was paying $2000/year for a policy with a $10,000 deductible. But my wife just got a job with a company that offers health insurance, so now we have a policy with 20% coinsurance and a maximum out of pocket of $2000. The cost of the insurance: $13,000/year. But we only pay $2000/year out of that, so we're signed up for it, even though the premium alone is more than our old premium plus our old deductible. We're not paying for it, at least not in any way we can do anything about (in theory we could negotiate to have her salary increased in lieu of them buying the health insurance, but I'm pretty sure that would violate ERISA).

Beth said...

Sorry to hear about your car window--but what an excellent illustration of the problem with 3rd party payers! Thanks!

Doug Reich said...

Anthony,

Thanks for the comment. Exactly. Multiply your story by a hundred million and you get the idea. Insurance is really for catastrophes but is used as a middleman to get around the taxation of wages, i.e., employers rather pay benefits than wages since they are not taxed on benefits. So, insurers dream up policies to effect the transfer. Then the government steps in to mandate coverages and we get the current system.

Beth, thanks for the comment!