The Law Of Increasing Opportunity Cost And The Problem Of Big Government

Imagine a country that produces two kinds of goods, public goods and private goods.

Public goods are things like national defense. They benefit everyone and it is hard to stop non-payers from getting it (it would be hard to stop a non-payer from getting defended).

Private goods are those that only one person can enjoy and you can keep non-payers from getting it. A Big Mac for example. If you don't pay, you don't get it and if I eat a particular Big Mac, no one else can eat it.

What I am going to show is that as government gets bigger, it will actually get more expensive in terms of what we have to give up in the private sector. The bigger government gets, the more costly it is.

Now also imagine that this country has 5 workers. Some are better at making private goods (their skills are more entrepreneurial) and some are better at making public goods (their skills are more bureaucratic). The table below shows how much of each good each worker can make in a day if they only produced that good.

Notice that worker I is very good at making private goods, but not so good at making public goods (so he is more entrepreneurial and not so bureaucratic). Worker V is the opposite.

These kinds of numbers make sense-we know in the real world people don't all have the same abilities. There is a best plumber, a best doctor, etc. The best doctor is not likely to be a good plumber and vice-versa.

The next table will show all the combinations of private goods and public goods that we can produce if we are at full-employment. That is, if we use all workers.

If we started with all workers making private goods, we make 25 (and 0 public goods). But if we want to make some public goods, we need to move a worker. The best move is to have worker V start making public goods. We give up only 3 private goods and we gain 7 public goods.

If we want more public goods, we would then move worker IV, then worker III and so on.

But each time we do this, we give up a different and increasing number of private goods for each public good gained. The next table shows this.

At first, the cost of each public good is .429 private goods (3/7). We lose the 3 private goods that worker V makes and gain the 7 public goods he can make. But then when we move worker IV, we give up 4 to get 6. So that cost .667.

The more public goods we produce, the more costly they will be in terms of the private goods we have to give up. This is what makes the growing size of government so alarming. We can't see this so easily in the real world. Notice that the last public good costs 2.333 private goods, much more than the first one.

Here are some basic terms that economists use to discuss this issue:

Opportunity Cost-The value of the best foregone alternative. There is no such thing as a free lunch. If we want to build one more skyscraper, we may have to give up one submarine, since there may not be enough steel to go around (steel is scarce!).

The law of increasing opportunity cost-As more of a particular good is produced, the opportunity cost of its production rises. Why is the law of increasing opportunity cost true? Different resources are better suited to different productive activities. This is just about the same as saying people have different abilities, like some are more entrepreneurial and some are more bureaucratic.

Cut government spending to boost economy

This was by me and was printed in the San Antonio Express-News today. Here is the link: Cut government spending to boost economy. Here is the article in case the link does not last very long.

Re: “Laffer Curve a tool to help avoid fiscal cliff,” Other Views, Dec. 10:

Mickey Roth, the president of Intercontinental Asset Management, seems to think we need higher tax rates. I disagree.

He correctly explained the Laffer Curve, which relates tax revenue and tax rates. His reading of the historical record leads him to say the high tax revenue and budget surpluses of the late 1990s were due to raising the top tax rate to 39.6 percent in 1993.

We must realize that maximizing the federal tax revenue is not an official policy goal. The goals are low unemployment, low inflation and high GDP growth. Now if tax revenue is spent wisely on things like education and infrastructure, it can help the economy grow. But this is not always the case.

Higher tax rates hurt economic incentives. Investment decisions are made at the margin, based on after tax income.

As tax rates rise, some investments are no longer viable. Less investment, less growth. A slight change makes a big difference in the long run. For example, in 2010, liberal economist Paul Krugman mentioned that the per capita GDP since 1980 had grown 1.95 percent annually in the U.S. and 1.83 percent in the European Union, hinting that their higher tax rates were not a problem. But, if per capita income was $20,000 in both the U.S. and the E.U. in 1980, the per capita income now would be $1,372 higher in the U.S. at those annual growth rates. After 100 years, the U.S. income level would be 12 percent higher.

The harm taxes do to economic efficiency is called “deadweight loss.” It grows exponentially; more harm is done in raising rates from 35 to 40 percent than in raising rates from 30 to 35 percent. If the Bush tax cuts expire, some Americans in states like New York (which has its own income tax) will pay marginal tax rates of over 50 percent, if you include additional taxes to pay for Obamacare.

Roth says we should take a lesson from the 1990s. But in 1997 President Clinton agreed to cut the capital gains tax to 20 percent It is possible that the high tax revenue of the late 1990s was due to a fast growing economy which in turn was caused by the high tech boom and low oil prices.

Economist Alan Reynolds has said, “The unexpected revenue windfalls in President Bill Clinton's second term were largely a consequence of lower tax rates on capital gains.”

William McBride of the Tax Foundation found in a survey of studies that “lower-tax economies are more productive and that raising taxes has negative dynamic effects on revenue collection.”

Spending may be a bigger issue than tax revenue (Roth did call for less spending). As former World Bank Group president Robert Zoellick recently said, “Federal spending has traditionally been about 18-19 percent of the U.S. economy. It has now surged to 23-24 percent.”

Leszek Balcerowicz, the former central banker of Poland, says that countries grow rapidly out of recessions when they cut spending since this increases confidence in markets. Let's give that a try.

Cyril Morong, Ph.D., is an associated professor of economics at San Antonio College.

Words of wisdom from Bono

From the WSJ

""Bono has learned much about music over more than three decades with U2. But alongside that has been a lifelong lesson in campaigning—the activist for poverty reduction in Africa spoke frankly on Friday about how ...his views about philanthropy had now stretched to include an appreciation for capitalism.

The Irish singer and co-founder of ONE, a campaigning group that fights poverty and disease in Africa, said it had been "a humbling thing for me" to realize the importance of capitalism and entrepreneurialism in philanthropy, particularly as someone who "got into this as a righteous anger activist with all the cliches."

"Job creators and innovators are just the key, and aid is just a bridge," he told an audience of 200 leading technology entrepreneurs and investors at the F.ounders tech conference in Dublin. "We see it as startup money, investment in new countries. A humbling thing was to learn the role of commerce.""

Words of wisdom from George McGovern

From the Wall Street Journal

"McGovern was an honest, good-humored man, and one of our memories involves an op-ed he wrote for the Journal in 1992 on the perils of running a small business. After retiring from the Senate, he fulfilled a lifetime ambition to buy and operate the Stratford Inn in Connecticut. The inn failed, in part due to a recession that was more severe in New England than elsewhere, but also because of the burdens imposed by government.

"My business associates and I also lived with federal, state and local rules that were all passed with the objective of helping employees, protecting the environment, raising tax dollars for schools, protecting our customers from fire hazards, etc.," he wrote.

"While I never have doubted the worthiness of any of these goals, the concept that most often eludes legislators is: 'Can we make consumers pay the higher prices for the increased operating costs that accompany public regulation and government reporting requirements with reams of red tape.'" The entire op-ed is available on OpinionJournal.com.

McGovern conceded that he had come to this wisdom late in life, but it's a wisdom that his liberal party heirs could profit from today."

Joseph Campbell Meets Joseph Schumpeter (The Entrepreneur As Hero)

(Published in The New Leaders: The Business Bulletin for Transformative Leadership, November/December 1992.)

Entrepreneurs are heroes. They are not like heroes, they are heroes. Heroes and entrepreneurs are called to and take part in the greatest and most universal adventure that life has to offer: the simultaneous journey of self-discovery, spiritual growth, and the personal creativity they make possible. In fact, the entrepreneur’s journey closely resembles the journey of the “hero” in mythology, as outlined in the book The Hero With a Thousand Faces, by Joseph Campbell. There is an amazing and profound similarity between not only the journey that entrepreneurs take and the adventure of heroes but also in their personality traits. The comparison is profound because the myths are about universal human desires and conflicts that we see played out in the lives of entrepreneurs. 

But what is the hero's adventure? Campbell writes "The standard path of the mythological adventure of the hero is a magnification of the formula represented in the rites of passage: separation-initiation-return, which might be named the nuclear unit of the monomyth. A hero ventures forth from the world of common day into a region of supernatural wonder; fabulous forces are there encountered and a decisive victory is won; the hero comes back from this mysterious adventure with the power to bestow boons on his fellow man." How is the hero's adventure similar to the entrepreneur's adventure?

The hero's journey begins with a call to adventure. He or she is awakened by some herald which touches his or her unconscious world and creative destiny. The entrepreneur, too, is "called" to the adventure. By chance, he or is discovers a previously unknown product or way to make a profit. The lucky discovery cannot be planned and is itself the herald of the adventure.

The entrepreneur must step out of the ordinary way of producing and into his or her imagination about the way things could be to discover the previously undreamt of technique or product. The "fabulous forces" might be applying the assembly line technique or interchangeable parts to producing automobiles or building microcomputers in a garage. The mysterious adventure is the time spent tinkering in research and development. But once those techniques are discovered or developed, the entrepreneur now has the power to bestow this boon on the rest of humankind. 

Heroes bring change. Campbell refers to the constant change in the universe as "The Cosmogonic Cycle" which "unrolls the great vision of the creation and destruction of the world which is vouchsafed as revelation to the successful hero." This is similar to Joseph Schumpeter's theory of entrepreneurship called “creative destruction.” A successful entrepreneur simultaneously destroys and creates a new world, or at least a new way of life. Henry Ford, for example, destroyed the horse and buggy age while creating the age of the automobile. The hero also finds that the world "suffers from a symbolical deficiency" and "appears on the scene in various forms according to the changing needs of the race." The changing needs and the deficiency correspond to the changing market conditions or the changing desires for products. The entrepreneur is the first person to perceive the changing needs. 

Regarding personality traits, the hero and entrepreneur are risk-takers and creators. But what is the source of their creativity? People become creative when in the words of Campbell, they "follow their bliss." This is the message of mythology. It means you should engage in an activity, pursue a career or entrepreneurial venture because it is what you love to do and it gives you a sense of personal importance and fulfillment, not because the social system dictates that you do so. The drive comes from within. It is this courageous action that opens up doors and creative possibilities that did not previously exist. This is the journey of self-discovery and spiritual growth. Although it may be long, painful, and lonely, it is very rewarding.

Both the entrepreneur and hero are aided by mentors, are humble enough to listen to others in order to learn (and thus become creative), and face a road of trials where they must continually slay the demons and dragons of their own unconscious (such as fear, their egos) in order to discover their creative ability which ultimately comes from giving themselves up to a higher power. 

Ultimately, they become selfless and can see the creative possibilities that the universe offers. They become masters of two worlds, one of imagination and creativity and the other of material things and business. This mastery makes it possible for them to bestow the boon.

Here is a link to a longer, more academic version.

The Creative-Destroyers: Are Entrepreneurs Mythological Heroes?  

A transcript of an interview when Joseph Campbell called entrepreneurs heroes