Rhoads on Opportunity Cost

Good economists use simple principles to transform our decision making in profound ways. Chapter 2 of The Economist's View of the World unpacks what is, perhaps, the key insight of economics: "spending and regulatory decisions that use scarce resources or require their use incur costs in terms of forgone alternatives" (11).  This is the concept economists call "opportunity costs." Every time we allocate a scarce resource in one way, we lose the chance to allocate that resource in other ways. Is that really so insightful? 

If you're about to stop reading because this seems blindingly obvious, Rhoads then shows that few politicians or experts in other fields have properly absorbed this lesson. Rhoads quotes a representative city administrator explaining how his town budgets: "We give primary considerations to the public welfare, but cost considerations are also important" (12). This may sound humane, but to an economist it is nonsense. Costs and benefits are two sides of the same bill, and every cost consideration is a public welfare consideration. 

Imagine that my town considers building a monument in the town square, and my cranky neighbor Ted tells everyone it'd cost too much. This might be pure stinginess, but Ted also might have in mind other potential benefits. The money earmarked for a monument could also give town teachers a raise, repair potholes, etc.. No doubt every taxpayer has considered this when staring down wasteful public spending (the other forgone benefit of public spending, of course, is personal income).

Thus costs are not just constraints that we live and budget within. Rather, costs are a way of quantifying the relative value of scarce resources and options.

(If you're still confused about details of the "opportunity cost" concept, see the bottom of the post for some clarification.)

Opportunity Cost: The Bane of Experts

So why do economists think this insight is such a big deal? Rhoads shows that experts are particularly prone to tunnel vision on projects which blinds them to the true opportunity cost of their work. Engineers, for instance, can be so excited about the prospect of technological advances that they lose sight of the relative value of their projects. Rhoads cites a project developing supersonic transport that received substantial government subsidies despite middling interest from the private sector. He traces the unwarranted subsidy to the enthusiasm of its engineers.

On page 14:

Like engineers, professionals in every area are convinced in the importance of their work. They know less and care less about what other professionals do. As a result, opportunity cost fades from view, and professional standards of need and adequacy are equated with public interest. These standards are almost always based on expenditure levels and other input criteria. It is rare to find any clear link between these inputs and effectiveness or benefits to the public.

Rhoads gives examples of fire marshalls and librarians who (admirably) want the very best for their towns and demand that their budgets be doubled. It is tempting to explain away budget watchdogs as cranks or Scrooges, but they are also protecting other areas of the budget. Would fuller libraries with more copies of Black Panther and top of the line firefighting equipment be good? Of course! But these professionals share the same community budget with other professionals: social workers, teachers, and public defenders to name a few. These experts may suspect public money will otherwise be wasted on graft or returned to the super-rich. This may be true at times, but "there is obviously only so much pure waste and fraud that can be eliminated. Added costs in a program usually mean lost benefits somewhere else" (15).

I often hear an analogous complaint from students: "all of my teachers think their class is the most important at the school!" Since teachers are so focused on their areas of expertise, they can easily lose sight of the other demands on their students' scarce time. As a result, they'll over-assign homework and eventually become disappointed with class effort/interest. (Students also often ignore the opportunity cost of social media or gaming addictions -- but that's another piece entirely).

Rhoads also suggests it is easiest to lose sight of opportunity costs when in a "maximizing" mindset. In a world where we face constant trade-offs and scarce resources, maximizing almost anything is rarely advisable. The Department of Transportation, for instance, stated an objective of "maximizing speed and comfort and minimizing the expense of travel." It is hopefully clear by now that this objective is almost meaningless. Rhoads observes, citing economist John Maher: 

It is impossible to maximize speed and comfort and minimize cost simultaneously ... "to the economist, the phrase 'greatest possible' is almost devoid of meaning because it suggests a violation of the human condition, a devotion of all resources to the achievement of one end; it denies the economic problem of choice and conflict among competing ends" (15).

 Another name for the maximization mindset is "idealism," and Rhoads fears that idealism about good things can overwhelm our sense of their relative value (in the next chapter, he'll also offer a defense of idealism). 

Opportunity Cost in Environmental Policy

Rhoads spends several pages discussing how this maximizing mindset pervades environmental policy. The book is a bit dated here; our discussion surrounding environmental policy is much different than it was in the 1980s when Rhoads wrote. But Rhoads is not questioning climate science or the role of government in protecting the global environment. Instead, he is concerned that scientists often lose sight of the opportunity costs of environmental policy when setting goals and standards. It is tempting to be constantly tough on all pollution as a rule, but sometimes environmental benefits come with painful opportunity costs. 

This is why economists like Rhoads encourage careful, targeted environmental regulation that is mindful of the scarce resources it consumes. More sophisticated criticism of climate change regulation centers on the concept Rhoads unpacks here. Conservative researcher Oren Cass, for instance, argues that the projected costs of climate change are far less than the projected costs of fixing climate change. 

I can imagine several possible responses. For one, are the "costs" of climate change so easily translated to dollars? What is the "cost" of losing the Great Barrier Reef? What is the "cost" of decreased biodiversity? Is it just unrealized profits? Surely not. The costs of climate change also seem unequally distributed, meaning we should consider fairness and not just budgets here. 

Both are fair points. Rhoads indirectly addresses the first in a fascinating section of the chapter I hope to cover in more depth later. Obviously, calculating the "costs" of pollution takes a bit more than a math degree. But in principle, the point should still stand. Sometimes, single-minded regulation obviously ignores the larger picture of public welfare. Rhoads cites a 1970s Occupational Safety and Health Administration standard meant to control benzene that cost companies $100 million per year and saved one life, nationally, every three years. Put another way, the standard cost each worker in affected industries $22,000 (2018 dollars) a year to avoid a 1 in 100,000 chance of death. Data shows that many American workers (like coal miners) are willing to take on much more risk in their occupation for much less money. 

The chapter also observes how unrealistic emissions benchmarks can easily backfire. Say that regulators set an unrealistic emissions standard for automakers which takes effect in 2020. By 2020, automakers will incur much higher costs per vehicle, raising the price of new cars. This will discourage consumers from buying newer eco-friendly vehicles, driving consumers to older cars ... hurting the environment. This is a classic example of an unintended consequence driven by tunnel vision, the type economists fear plagues much public policy. 

 Opportunity Cost and Politics

Rhoads does make peace with the experts and engineers he criticized earlier. "Doctors should worry about diseases, and firefighters should worry about fires," he writes (23). It is excusable to lose sight of the larger budget when lobbying for your passions and field of expertise -- this single-mindedness is clearly part of being an expert in the first place! Instead, it is politicians who deserve blame: 

Politicians will want the electoral support and psychological pleasures that come from standing for something -- being introduced to applause as "Mr. Solar Energy," "someone veterans can always count on," or "a dependable friend of occupational safety." The legislator who keeps opportunity cost in mind may have to forsake much of that. (23)

So we just need to rely on our politicians. What could go wrong?

Rhoads notes that voters are even less cognizant of opportunity cost than politicians or experts are. Most voters, when asked about a social program, think it should be better funded. Most of these voters also want the government to slash its budget.  They "approve of more spending in most areas, but then look in horror at the size of what they have wrought" (22). This voter pressure makes budgeting all the harder, and working media narratives all the more important. As former NYC mayor Ed Koch complains, "being told to do good things, when you can't afford them, is not doing good things" (23). 

--

Technically, the opportunity cost of any action is the best possible alternative use of a scarce resource. 

Two parts of this definition are worth focusing on: First, it is helpful to consider all of the scarce resources at play when making a decision. Most of us are instinctively alert to financial costs but may not grasp how scarce other resources like time, patience, and focus are. I realized this when spending almost an hour recently trying to redeem a deliberately complicated $4 Heineken mail-in rebate. 

Second, the opportunity cost of a decision is the best possible use of a scarce resource, not all alternative uses of a resource. My students are sometimes overwhelmed when they consider all of the ways they could use a 2-hour block of time and are tempted to use the sum of these possibilities to second guess any use of their time. If I spend an hour trying to redeem a $4 rebate, what is the one best alternative use of my time -- and would that use of time be worth $4? If I'd choose to be on social media for that hour (probably not the most redemptive decision), then likely not.

See here for a more thorough explanation of opportunity cost, if interested.