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Opportunity Costs

I’m too upset by the prospect of a government shutdown to write anything coherent.  It happens.  So I dug through the last time we had this problem potentially looming in 2011 and found this piece.  It’s not only still relevant, but it ties into our recent piece on the Triple Threat of forces on our economic health that no one is really dealing with.  I hope you enjoy this repeat from 31 August 2011.

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.

How much ya wanna risk on the roll?

How much ya wanna risk on the roll?

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.

F-22s are not cheap

F-22s are not cheap

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.

Milton Friedman.  He always had a wry smile like this.

Milton Friedman. He always had a wry smile like this.

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.

6 thoughts on “Opportunity Costs

  1. It is so frustrating to see these games being played. Yes what we spend money on is probably more important than how much most of the time. Especially if we want a stimulus to the economy. But in a shutdown we spend nothing so what does congress care?

    • I don’t think they thought it through that much. Yes, many of them are really Libertarian anarchists at heart. But most of them are just acting out of impulse, I think.

  2. Excellent blog, we never talk about what we can or should be buying. Isn’t this just a continuing resolution they are fighting over and not an actual budget? When did we last look at our priorities?

    • It’s been since 2010 for a real budget. It’s very sad. No one really knows what is being spent at this point, either. If you want to trim it the first thing to do is to actually LOOK at it.

  3. The budget battle is really a distraction from the top level restricting our economy. We need an geared to full employment and small organizations.

    One thing that liberals in Barataria are afraid to say is that all work should be part-time and all large organizations should be broken down to smaller units.

    A constitutional change would be probably be the best way to mandate part-time work for everyone. It would be a major change to say that no one has a right to 40 hours per week. Everyone would have a right to 20 hours per week. The idea is that there would be more employment and labor force participation if lots of new half-time jobs were needed.

    Left liberal progressives resent big government, big labor and big business and socialized risk. To kick off this segment you would do away with all insurance and spending that helps rich people–whether at the individual or corporate level. Left liberal progressives see the local as holy and pure. (I.e. love for city government and recollection of the days of George Latimer) First, big government. We would devolve all programs to the local level and reduce defense spending by 97%. Second big business. No business could be larger than 7 people. The best scenario would be a country of self employed people who go from gig to gig. Big labor would be broken up. No labor union could encompass more than the city level.

    These are the types of changes that float around in the heads of left liberal progressives.

    I doubt anyone would like these ideas however. They are too radical. Even for the Occupy Wall Street crowd.

    • Off topic, but I’ll respond. And I’ll assume that you are being sarcastic, yet I’ll treat it seriously.
      Yes, “work sharing” is the most obvious way to get through this. If everyone worked 32 hours a week we’d have no unemployment right now.
      The problem, of course, is that we don’t have an industrial society anymore where most people make their wages at a job defined by a big company. It was easy to define “time and a half” at 40 hours as a penalty back in the 1930s, but much more difficult today.
      A truly flexible labor force should be everyone’s goal, IMHO, but there are so many barriers to this. Training is the most obvious, and the way we continue to tie health care to employment doesn’t help one bit. But we can move that direction and free up labor substantially – giving it a bit more of an edge than it has now. I’m all in favor of that.

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