The Seen and the Unseen. Part II. The Costly Mistake of Ignoring Opportunity Cost

This is a fair enough way of looking at cost as it appears in a competitive market. Raising a million dollars from the market for a given project will not noticeably hinder further millions being raised for other projects. If we said billions in place of millions, the relation would probably still hold, though perhaps only just. With ever more general "globalisation", the supply of resources is getting so elastic that even pre-empting a significant chunk of them for one purpose may not seriously jeopardise the fulfilment of other purposes. Resource scarcity is correctly measured by the cost of capital. The capacity to cover that cost is the sole test of a project. No concern arises about one project "crowding out" another.

Yet "crowding out" is inevitable, for the same million cannot be spent on two alternative projects, each of which costs a million. The crowded-out alternative is not seen. It is quietly ruled out by the market because it is not judged capable of meeting the test of at least paying for itself. The project that is carried out meets the test, or is believed to do so. Its opportunity cost is the forgone alternative that does not get carried out. It does not meet the test, or is not believed to do so, hence it is worth less than the project that has crowded it out. In the competitive market, the visible accounting cost and the invisible opportunity cost perform the same work of selection.

This happy coincidence abruptly ceases to hold in a non-market environment, where the cost may be raised from the taxpayer, where the expected benefit is most often un-priced, non-traded and intangible, and where resources move from one use to another not in response to profitability, but to legislative and regulatory commands. It is in this environment of public policies that Bastiat's pioneer teachings about opportunity cost1 become strikingly timely again, just as they were during the 1848-49 socialist episode when he wrote them down.

Public expenditure is seldom totally useless; its usefulness, however modest, is "what is seen" and this is one reason why even such expenditure can be so popular. The public tends implicitly to believe that "what is not seen" does not even exist—that when a new opera house or stadium is built, it is all a net gain of national wealth, for nothing else would have been built in their place. In the limiting case, even useless outlay can be "useful" if it provides employment. Bastiat has a tale about the broken window that gives the glazier a job of work: "what would become of the glaziers if nobody ever broke a window?" He also relates that when Napoleon had ditches dug and filled in again, he was convinced of doing good, by causing "wealth spread among the labouring classes." ["What Is Seen And What Is Not Seen", par. 1.6 and par. 1.88.]

The belief that even useless activity is good if it provides work and income for the glazier and the ditch-digger, instead of leaving them idle, and thus by a ripple effect stimulates demand and employment throughout the economy, has been lent intellectual respectability by the good old Keynesian doctrine that the cause of unemployment is lack of effective demand. After the experience of recent decades, this belief is no longer widely held. Bastiat, of course, never held any such belief. Indeed, he seems to have been quite unaware of the possibility that if resources are idle, their opportunity cost may in fact be zero. However, the bitter and stubborn failure of make-work schemes in Western social democracies to lure idle resources out of unemployment into work shows that in practice zero opportunity cost, like Milton Friedman's free lunch, just cannot be had.

Perhaps the most important area where public policy tends to overlook opportunity cost is in the defence of "what is seen". Bastiat takes issue with the poet and revolutionary deputy Lamartine over subsidies to the arts and the theatre. Maintaining these activities by state aid serves a worthy aim, including employment for artists, actors and artisans, but Lamartine sees only what is thus preserved. He does not see the opportunity cost, namely that the resources devoted to the arts would have served other aims that corresponded to what people actually chose rather than to what the state induced them to choose by subsidizing a particular branch of activity. Bastiat does not deal with the idea of "merit goods" that ought to be produced whether the public wants them or not. But he stresses that promoting the fine arts can only be done at the cost of cutting back other things—a loss we do not see. It is, he notes, impossible to promote everything at the expense of everything else. This echoes his famous definition of the state, "the great fictitious entity by which everyone seeks to live at the expense of everyone else" (op. cit., p.144 [online, pars. 1.69-1.73.]).

There is great anxiety today about the migration of jobs from high wage to low wage areas. Western Europe and North America are supposed to lose in this process, and there is great agitation to stop it and preserve the employment "we see". A massive regulatory apparatus, notably in Germany and France, makes it difficult and expensive to dismiss employees. The obvious effect is to frighten employers, for who wants to hire if he may be unable to fire? However, while the opportunity cost of thus defending existing employment is to suppress new job creation, the latter is "not seen".

Migration of work across geographic frontiers obeys the same economic logic as its migration across technological ones. The basic case of the latter is when work is taken from men and given to machines. This classic symptom of rising wealth has long been accepted as such by modern man, whose concern today is with other symptoms of progress in productivity, such as "outsourcing" and "delocalisation" to low-cost areas. However, in the middle of the 19TH century, the machine was regarded as the chief enemy of the working man and of all traditional activity.

In the same tongue-in cheek manner that he adopts when speaking of the broken window, the candlemakers who must be protected from the unfair competition of the sun, and the "negative railway" that, by not being laid, will keep all the carters and their horses in business, Bastiat finds that only "stupid nations" can enjoy wealth and happiness, for only they are incapable of inventing the machines that destroy prosperity.

Much regulation has been inspired by the same kind of reasoning. "Outsourcing", "delocalisation" and other ways in which firms respond to the high cost (aggravated by high social charges) of low-skill labor, are rendered difficult by and sometimes impossible by government action. This is tantamount to suppressing the opportunities for the improved, more profitable use of all resources—including the labor that is released from poor jobs and is induced to move to more skilled, more productive ones. There are clearly industries and occupations that highly industrialized countries should simply not engage in. Defending them by passing legislation in favor of what we have and against what we could have, is not unlike the long forgotten attempts to legislate against machines.

"Good Lord," Bastiat sighs, "what a lot of trouble to prove in political economy that two and two make four; and if you succeed in doing so, people cry: 'It is so clear that it is boring'. Then they vote as if you had never proved anything at all".