Opportunity Costs: The Sacrifice of the Road Not Traveled

This week’s “Daily Journal” guest columnist is Jon Sanders (twitter.com/jonpsanders), associate director of research at the John Locke Foundation.

RALEIGH — One of the most fundamental concepts of economics — a key to understanding what economist Paul Heyne liked to call “the economic way of thinking” – is opportunity costs.

The opportunity cost of a good or action is, in Heyne’s terms, the value of sacrificed opportunities. Money (and time and other economic resources) used to obtain that good or take that action is not spent on other goods or actions. You give up those alternative uses when you choose.

Every choice you make has opportunity costs. When poet Robert Frost encountered two diverging roads in a yellow wood, he understood that he “could not travel both / And be one traveler.” He concluded that his choice “has made all the difference,” a famously enigmatic conclusion that underscored the very real risk that the opportunity cost of a choice could be greater than its benefits.

In other words, with a poor choice you could be worse off. What parent hasn’t tried to instill this basic idea in his child? “If you spend your money on candy, you won’t have enough left to buy that toy you want”; “If you spend your afternoon watching TV, you won’t have enough time to study for your test.” It’s an intuitive concept when it comes to personal decision making.

When it’s your own individual choice, the deleterious effects of choosing poorly are limited. But what if you are in a position of power over people? Then the effects of your choices in that capacity concern not only you, but those people as well.

For some reason, whatever intuition people have regarding their own choices seems to get lost in considering political choices that affect them all. Politicians especially tend to seem completely unmindful of the opportunity costs of their pet policies. Perhaps Lord Acton’s famous dictum about power tending to corrupt also works this way: Power tends to obscure opportunity costs, and absolute power obscures them absolutely.

Power is an inescapable feature of the opportunity costs of political choices. A political officeholder committing to a policy doesn’t just reach into his own pocket to pay for it; he reaches into everyone else’s, too. He commits your resources to his choice. He sacrifices your alternative uses for his use.

That being the case, the politician’s choice ought to be of the utmost importance. If he chooses poorly, sacrificing the resources of everyone under his authority, then the negative effects of that choice will resound throughout his realm.

Measuring the Unseen

Ironically, it is the nature of all those forced sacrifices that they are unseen. The sacrifice is always before the fact. No individual in the realm is given the opportunity to imagine what he would like most to spend his money on before it is confiscated. The sum of all those dashed dreams is the opportunity cost of the political decision, but because the dreams never were envisioned, measuring that cost is impossible. But the lack of a gauge doesn’t mean that cost doesn’t exist.

Without the anchor of some tangible measure of the opportunity costs of their choices, political leaders can be tempted toward some exceptionally poor economic decisions. All they see are benefits. Economists, meanwhile, are always trying to find ways to make the intangible tangible, or at least conceivable.

They talk about unforeseen consequences. They warn that there is no such thing as a free lunch. They release forecasts of the effects of policies that try to show how changes in this area will affect other areas. To illustrate this all-important concept, they will even use parables.

One of the most enduring parables in economic literature is Frédéric Bastiat’s parable of the broken window, which comes in an 1850 essay of his titled “What Is Seen and What Is Not Seen.” In it he recounts the misfortune of one James Goodfellow, whose son breaks a pane of glass, which he must replace, and the subsequent good fortune of the glazier, who receives six francs for the repair. He then works to expose the fallacy in the tempting deduction that, since the glazier would not have received a windfall of six francs had the window pane not been broken, “it is good to break windows, that it helps to circulate money, that it results in encouraging industry in general.”

As Bastiat observes, this deduction considers only what is seen, without accounting for what is not seen. What is seen? That the glass industry gets six francs, and James Goodfellow gets a replacement window. What is not seen? That because of the accident, the shoe industry, for example, doesn’t get the six francs, because James Goodfellow doesn’t get a new pair of shoes, and that rather than having a nice window pane and new shoes (or six francs), James Goodfellow just has the pane as before, but not the shoes (or francs).

Bastiat sums it up:

Now, if James Goodfellow is part of society, we must conclude that society, considering its labors and its enjoyments, has lost the value of the broken window.

From which, by generalizing, we arrive at this unexpected conclusion: “Society loses the value of objects unnecessarily destroyed,” and at this aphorism, which will make the hair of the protectionists stand on end: “To break, to destroy, to dissipate is not to encourage national employment,” or more briefly: “Destruction is not profitable.”

This essay was written over 150 years ago, but its relevance to the present day was unwittingly underscored by President Barack Obama in his State of the Union address this week. To praise the economic benefits of his stimulus bill, Obama told Congress:

Talk to the window manufacturer in Philadelphia who said he used to be skeptical about the Recovery Act, until he had to add two more work shifts just because of the business it created.

Two more work shifts for a glazier; that’s what is seen (allegedly). What’s not seen? All the jobs that haven’t been created by all the sacrificed expenditures of the money — in this case, about $826 billion.

While uncreated jobs can’t be seen, unemployment figures can. Obama’s stimulus bill was passed on the promise that it would soften the blow of unemployment. Last January the incoming Obama administration released a report featuring its estimates of the effects of the stimulus bill. A key finding was that without the stimulus, unemployment would peak at 9 percent, but with the stimulus, it would peak only around 8 percent. Here is the widely reported graph from that report:

In other words, the advertised benefit of spending nearly a trillion dollars in “stimulus” funds would be cutting peak unemployment by 1 percentage point. That is what everyone else’s sacrifice was predicted to be worth – looking at only what could be seen.

Actual economic effects include what is not seen, however, because opportunity costs exist even when there is no gauge to measure them. And as they came in, they showed what an exceedingly poor choice the president and Congress made. Here is the graph from January 2009 (courtesy of innocentbystanders.net), updated with actual results.

As was predicted by those who understand opportunity costs, the cost of the government making this choice turned out to be worse than had our leaders decided against it.

Perhaps just as predictable, the president is urging Congress for yet another stimulus bill. In Washington, it would seem, what is not seen includes negative consequences even after the fact. If Obama unwisely chooses that well-traveled path for the nation again, it will make all the difference.