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Opportunity Cost

You can’t have your cake and eat it, too.  It’s a silly old saying with a huge dollop of folk wisdom hidden in the middle of it.  But money spent is sometimes more than just money gone – in an integrated world it’s a choice to make one connection when another one might have been a better choice.

Rather than just measure how much money is going in and out, it might be better to understand what we could buy with the same money.  The technical term for this is “Opportunity Cost”, or what we give up by making the choices we do.

The big debate in Washington and on Wall Street is over the proper role of government spending and “stimulus” to the economy.  The traditional way we got out of recessions since WWII has been for the Federal Government to at the very least keep spending the way it has despite a drop in tax revenue or perhaps even increase while the Federal Reserve makes money cheaper by dropping interest rates.  This “pump priming”, pioneered by JM Keynes in the 1920s and 30s, has proven very effective.  The observed value since is every dollar spent by the government stimulates the economy about $1.50.

There is only one problem with this handy li’l tool for keeping the economy moving – it stopped working.  That’s been enough of a head-scratcher that it’s worth looking at from new perspective.  Perhaps it does matter what we buy with our money – even more than just the amount we’re sending out into the world.  When the economy really breaks, rather than simply slows down, perhaps Opportunity Cost really matters.

For example, total spending on defense is very hard to calculate because so much has been thrown “off budget”, but it’s definitely a big number.  The best estimate for 2012 is that it will be around $707 billion for the Department of Defense and something like $1 trillion for all defense related activities.  An argument might be made that this is money we have to spend to be safe. But what if some of those trillion bucks were spent on, say, infrastructure development or any of the other things we can identify for transforming the economy?  The gap of around 8M lost jobs represents, at median income, about $400 billion a year in salaries for comparison.

That is the Opportunity Cost for our defense spending. We spend a lot of money in our Federal budget, but we may not be spending it on the things that we know will  hasten our economic metamorphosis – or even help people keep eating and paying their mortgage until the Free Market™ sorts itself out.

Our political system is adversarial in nature – two or more sides are supposed to argue it out and reach some kind of plan.  It works to the extent that all the good ideas are part of the debate.  Currently, the right is focused on budget cutting and the left seems to be rediscovering Keynes in opposition.  The idea that it might matter more what we spend money on, which is to say that the Opportunity Costs are critical, is not part of the debate.

This becomes more interesting if you look at the whole economy as it transforms.  The Friedmanite or Supply-Side view is that cutting taxes to the wealthiest people frees up money for investment, thus encouraging growth.  This theory completely ignores several things – capital cannot be considered a limiting factor for growth when bank deposits in the Federal Reserve are well over a trillion dollars, it’s indistinguishable from a Keynesian stimulus in practical terms, and it has a lousy track record of ever really working.  So if that money in the hands of wealthier Americans has shown no signs of transforming the economy, is there a better use for it overall?

There’s even an Opportunity Cost for dogmatic political theories.

Before we get to a place where we might decide how much money we can spend – as a government of the people, by the people, for the people – it might do us a lot of good to sit down and think about what we really want to do.  We have vulnerable people to take care of, hurricanes to clean up from, and, yes, defense of our nation to mind.  We also have to get this economy from where it is to better health. How much money we spend is probably a lot less important than spending it well.  Opportunity Cost is really just a concept, but it runs a huge tab when no one is really paying the big up-front cost – attention.

12 thoughts on “Opportunity Cost

  1. Good piece, as always. I think its obvious but I don’t hear people talk about this especially when it comes to defense. Why that isn’t a target I don’t know.

  2. There is a lot more you could say about opportunity cost especially when it comes to creating jobs. Infrastructure is the most obvious way to create jobs with government spending but retraining and education grants would also create jobs while teaching new skills. Simply keeping cities from cutting police and fire would also help a lot. There’s really no limit to what can be done if we really want to. Excellent blog!

  3. Dale: I don’t think most people know how expensive defense has become. The Pentagon has proven unauditable for 20 years now, so it’s not a matter of spending what we must to remain safe – it’s a matter of systemic abuse of a blank check. It simply has to come up, and soon.

    Anna: Thanks! You are right – I use infrastructure all the time but education (I hate the term “retraining”!) would be useful. We could easily design a program that supports universities, community colleges, and trade schools alike and thus allows consumers to make their own choices as to what matters. That would certainly help Structural Unemployment greatly, if nothing else, and as part of the package I’ve described before could be very powerful.

  4. Unfortunately, “Defense” has been a sacred cow throughout the cold war years.
    A vital element in keeping the peace is our military establishment. Our arms must be mighty, ready for instant action, so that no potential aggressor may be tempted to risk his own destruction…
    This conjunction of an immense military establishment and a large arms industry is new in the American experience. The total influence — economic, political, even spiritual — is felt in every city, every statehouse, every office of the federal government. We recognize the imperative need for this development. Yet we must not fail to comprehend its grave implications. Our toil, resources and livelihood are all involved; so is the very structure of our society. In the councils of government, we must guard against the acquisition of unwarranted influence, whether sought or unsought, by the military-industrial complex. The potential for the disastrous rise of misplaced power exists and will persist. We must never let the weight of this combination endanger our liberties or democratic processes. We should take nothing for granted. Only an alert and knowledgeable citizenry can compel the proper meshing of the huge industrial and military machinery of defense with our peaceful methods and goals so that security and liberty may prosper together.” – Dwight Eisenhower Farewell Address to the Nation on January 17, 1961
    Geoffrey Perret, in his biography of Eisenhower, claims that a draft of the speech the phrase was “military-industrial-congressional complex.” Others disagree.
    What IS true is that Republicans & Democrats alike resist termination of defense appropriations involving their district/state as it would cost jobs.
    Still…it is the gorilla in the closet.

  5. Jack: It was fixed! There has to be more than just the military that we can think about, but … fergooshsakes if we can’t start there we’re in serious trouble. We do have to save Medicare and that will mean serious choices and all of that, I understand, but …. none of this is even close to the defense budget.

    Thanks for the whole statement from the man who led us to our greatest victory ever. It’s still relevant, maybe even moreso.

  6. I thinks so. Defense IS important if one believes in “American Exceptionalism,” but still, why pay an exorbitant price for questionable weapons systems? Sometimes ones the military doesn’t want.

  7. I think Obama has done well pointing out some opportunity costs like the corporate jet tax loophole or subsidies for oil companies ( I believe he had specific examples for how to use the $ that could be raised, but I don’t remember them.) I hope he will do more of this when he introduces his jobs plan. Jon Stewart makes the case for increasing revenues in class warfare I think the public would support using the extra $ for worthwhile stimulus spending (without calling it that) rather than deficit reduction. Sorry this is redundant, I am better at linking than writing.

  8. Jack: It is a lot more than defending the nation – it’s about preserving a bygone era at tremendous cost. We just can’t do it anymore.

    Laurie: good clip! Obama has often said the right things, but he doesn’t really sell them. And the left hasn’t done a good job of putting pressure on everyone to even talk about this stuff. Yes, I’m trying to lead into whatever he proposes in a week and get people thinking about how we can – and perhaps have to – afford a serious jobs program. Whatever he proposes it will take some oomph to get through. People have to be more engaged and help push the things that really matter or else we’ll get more of the same.

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