Thursday, June 12, 2014

The importance of opportunity cost

John Allison, the wise and experienced banker who now heads the Cato Institute, has some thoughts on opportunity cost in the current issue of Cato's Policy Report. Here are some excerpts:

While opportunity cost is an easily understood idea, in many decisions individuals choose to ignore it. The current economic recovery is a classic example. It is very difficult for most people to understand the radical difference in economic well-being between 2 percent growth and 5 percent growth compounded even over just five years. Many people assume the stimulus package, increased regulations, and the Federal Reserve’s quantitative easing are critical to a recovery. They do not understand that a normal recovery is 5 percent growth and not 2 percent, and that these government interventions radically slowed growth.  
It is difficult for individuals to understand the damage the FDA does when it delays or stops drug development. It is easy to see when someone dies from the misuse of a medicine, but many cannot visualize the loss of life from bureaucratic delays. It is hard to grasp that the market would develop a rational quality control alternative (like Underwriters Laboratories, in electrical products) if the FDA did not exist. People have an emotional reaction to a single death from an unexpected effect of a drug, while it takes a conceptual leap — or an economics class — to see all the lives that could be saved without the FDA. 
Good teachers in government schools support their unions’ efforts to stop school competition. They fail to grasp the opportunity cost to them from the lack of competition. In a competitive education market, good teachers would be in strong demand and would be paid more. Public school unions protect mediocre and poor teachers. 
People see the benefits paid from Social Security. They have a hard time understanding that a like amount of savings properly invested would have created dramatically more income and more capital, driving faster economic growth. The opportunity cost of incentivizing government spending through governmental Social Security instead of incentivizing private savings is tremendous. 
People often see the world through the lens of the status quo. They cannot grasp how much better things could be if different opportunities were pursued. Fortunately, in private markets, entrepreneurs who do see the opportunities make them visible to the rest of us — Steve Jobs, Sam Walton, and Bill Gates are examples. This is one reason free markets radically outperform statism. 

I would also highly recommend John's book The Financial Crisis and the Free Market Cure: Why Pure Capitalism is the World Economy's Only Hope. His is the best explanation of what caused the 2008 financial crisis that I have read. He takes you inside the crisis, viewing it from the perspective of a seasoned banking executive who has a deep grasp of how free markets work and how government regulations only make things worse.


Benjamin Cole said...

QE? Do not conflate QE with wasteful federal civilian and military outlays.
BTW John Cochrane says the Fed should have a permanent and gigantic balance sheet...see his presentation at Hoover...

Anonymous said...

Purchasing this book was a lesson in economics itself. Kindle $15. Hardback $19. Paperback $42.

I bought the hardback so I could pass the book around.

Having the government do things for us is a lazy way out. Food safety? You will definitely have to take more time and effort to ensure its safety. I actually like that and there would be local orgs that you could pay to handle that.

Now we have The Protection Bureau. It will be a disaster for the average person who it is purportedly supposed to protect. What people should do is take a lot more time and work with people they trust. Some of the trusted ones will fail them. But The Protection Bureau will fail them and it will be a big failure.

Sil Sanders said...

I enjoyed J Housman 1-star review of this book, particularly:

"There are two novels that can change a bookish fourteen-year-old's life: The Lord of the Rings and Atlas Shrugged. One is a childish fantasy that often engenders a lifelong obsession with its unbelievable heroes, leading to an emotionally stunted, socially crippled adulthood, unable to deal with the real world. The other, of course, involves orcs."

theyenguy said...

There can be no popular action as perceived by Liberal economists such as Mark Thoma who weeps Synthesis Lost. “I am coming around to the idea the intervention may also be needed to redistribute income as an offset for those who reap where they never sowed”.

There will ever be never be any human action, as presented by the Austrian economists such as Cato Institute's, John Allison, an Objectivist, who advocates Free Markets.

There is only the divine action of the Son of God, specifically the stewardship of Jesus Christ for the completion of every age, epoch, and time period, as presented by the Apostle Paul in Ephesians 1:10, who has produced peak wealth. He prompted the ECB Chairman Mario Draghi to announce the NIRP and TLTRO Mandate of June 5, 2014, and in response the Euro traded lower causing investors to derisk out of debt trade investments in European Grocer, DEG, and deleverage out of currency carry trades in European Financials, EUFN, Eurozone Stocks, EZU, European Small Cap Dividends, DFE, and EU Nations, such as Portugal, PGAL, Italy, EWI, Ireland, EIRL, Greece, GREK, and Spain, EWP.

Having completed the paradigm and age of liberalism, meaning freedom from the state, where the investor was the centerpiece of economic action; He is now developing that of authoritarianism, where the debt serf is the centerpiece of economic activity.

Having completed peak moral hazard, He is going to apply all the debts, public and private, to all the peoples of the world.

randy said...

Sil: Now that was a funny quote! Thanks for sharing.