Monday, March 2, 2009

Opportunity Costs and Budgeting

The core principle of economics is a concept called opportunity costs. Basically, opportunity cost is the value of an alternative course of action given the choice to do something else. You give up current income to go to college (the opportunity cost) in the hopes of achieving a higher lifetime income. We live in a world of scarce resources, so choosing one use of those resources necessarily means that we are giving up the opportunity to do something else. Every freshman economics student is taught this concept.

Now that the President's budget "blueprint" has been released, we get a glimpse of how he does opportunity cost calculus (or doesn't). Let's start with a media "darling"...agriculture. Farm subsidies have been a favorite political target of developing countries as well as the Wall Street Journal editorial board, among others. First, a little perspective is in order. The total cost of farm subsidies in current dollars over the last 40 years is somewhere in the neighborhood of $140 billion. Compare this to the TARP and"stimulus" packages of the past several months. But, are there opportunity costs associated with farm subsidies? Of course there are costs. The money could have been used elsewhere in the economy. The subsidies have distorted resource use away from the allocation of resources that would have resulted in the absence of government intervention (how much, of course, is a relevant question).

We have to compare this, though, with what we get in return. In the 1940s, as much as 50% of U.S. household disposable income was spent on food. Today, it's less than 10%. This relative decline means we have had more money to spend on DVD players and cars, thereby fueling economic growth. We have arguably maintained or improved the standard of living in rural areas and promoted a sector that is the only industry that has consistently fed the U.S. population uninterrupted through two world wars and countless other conflicts and economic crises.

Platitudes aside, the question is whether the benefits to society outweigh the opportunity and cash costs of the programs? Well, society, since 1933, has consistently said "yes." Now, we find in the President's budget that for some reason that calculus has changed dramatically. Why? Surely it is not cost. He argued for a $600+ billion "reserve fund" for some future undefined nationalized health care system. What is the opportunity cost of that $600 billion? What is the future economic growth drag of a system like that?

I have never been a proponent of farm programs. But, I recognize that there are social, political, and other non-economic reasons for their existence. I also recognize that our trading partners will continue to subsidize their production even if we do not (and do not be fooled; even developing countries are subsidizing their agriculture). In years past, government budget and deficit spending levels were such that we economists were concerned with the social tradeoffs between agricultural and other government spending. But today, I am not sure the opportunity cost arguments implicit in the President's budget are genuine. If we are to spend $600+ billion per year on health care, what's another $15 billion on food?