Fires and broken windows

Economists starting to assess the impact of this week's fires are pointing out that this kind of event can actually stimulate growth, perverse as that may seem. Keep in mind that the Malibu fire in 1993 destroyed 268 homes and almost all of them have been rebuilt (or the owners have rebuilt nearby). They all had to hire a contractor and buy furniture and maybe even use an interior decorator or landscape architect. All those businesses got extra revenue that they otherwise wouldn’t have gotten, which explains why you often see a jump in economic activity in the months after a fire. That's not some crazy theory - it's just the way things work.

So MarketWatch's Tom Bemis takes that prospect and suggests how the stimulus "could at least act as a brake on the housing crash." That’s probably pushing things, but it's not an altogether crazy idea - rebuilding after the 1994 earthquake provided a crucial jumpstart for an area had been mired in recession. Anyway, Dealbreaker's Joe Weisenthal calls this "one of the more ludicrous things we've ever read in our entire lives" (a ludicrous comment unto itself). He then suggests that reading about the broken window fallacy "would spare anyone from writing articles such as this." Ouch.

The broken window fallacy was the work of a guy named Frédéric Bastiat in the 1800s, and it basically refers to an action that has unintended costs attached to it. (It's used in the first chapter of Henry Hazlitt's 1946 classic, "Economics in One Lesson.") To illustrate his point, Bastiat tells the story of a shopkeeper whose window is broken by a little boy. The window has to be replaced, of course, which means there will be work for the glazier, who in turn will be able to buy bread that will benefit the baker and so on. To make a long story short (I know, too late), the fallacy is that these supposedly positive benefits are offset by the costs faced by the shopkeeper - not only for the price of the window but for lost business.

It's an interesting theory but not everyone agrees with it. And it certainly has questionable relevance in determining the economic impact from the fires. The "shopkeeper" - in this case a homeowner - isn't out the cost of a new house because much, if not all, of the rebuilding is covered by insurance. (I know, I know, he has to pay for that insurance, but he would have had to pay for that even if his house was not damaged.) Homes that were damaged but not destroyed will get a new coat of paint, new flooring or whatever, and be worth more money than before the disaster. All this economic activity won't necessarily shake up the real estate market, but it will provide for more opportunities once the market opens up, as it surely will.