The Broken Window Fallacy — Again
One of the most popular and hotly debated ideas of modern economics is the broken window fallacy, which posits that money spent to recover from a destructive event is not actually a benefit to society. While storms might spur spending which looks like economic growth and activity, the broken window fallacy would say that this is just an illusion, and the opportunity cost renders a zero or negative net benefit of the cost spent on fixing a broken window.
The idea has its critics, who point out that sometimes being forced to replace a broken window can produce a net benefit. For example, a window that was in bad condition and outdated could replaced with a brand new window made of better technology, which may provide better insulation, greater light, and other marginal benefits that would offset the opportunity cost of the replacement. Others point out that things like broken windows reduce excessive savings–meaning that it might encourage hoarders of cash to convert that cash into goods and services that will have a residual effect of creating higher demand and production throughout the economy.
How will market participants react to Hurricane Sandy is largely dependent on how they see the Broken Window Fallacy and its knock-off effects. Those who think this gives New York City and the northeast an opportunity to replace outdated infrastructure–as well as those who think the destruction was less than anticipated–will most likely be in a bullish mode on Wednesday.