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.