There have been a lot of bad economic policies being enacted recently. In fact, there have been a lot of bad economic policies enacted throughout this country’s history. Most of these policies can be revealed to be bad by understanding two economic terms: Opportunity Cost and Moral Hazard. These terms are not in and of themselves complicated. In fact, they are quite simple. But, correctly reasoning about them is very hard.
Opportunity Cost is the economic cost of a decision in forgoing the best alternative use for the resources used in an economic decision. For many economic decisions, one such alternative is to simply “do nothing.” For example, the opportunity cost of buying a car is the interest earned on the money spent on the car. But all alternatives need to be considered, and the best alternative is the true opportunity cost. This is very important when it comes to government spending, as the opportunity cost might either be putting money towards other, more deserving, government projects, or it might be leaving the money in the hands of the taxpayers (who can then spend the money in the way they choose).
Moral Hazard is the idea that if the consequences of taking bad risks are not born by the risk-taker, that the risk-taker will engage in riskier behavior than if the consequences directly impacted the risk-taker. For a trivial example, if you are willing to reimburse the purchase value of a lottery ticket if I don’t win, I am more likely to buy a lottery ticket. When examining economic policy, all government bailouts reek of moral hazard. Businesses that made poor economic decisions (even if they were only poor in hindsight) have been saved from bankruptcy because “the alternative was worse.” Of course, one bailout typically is followed by another, and another, and another.
A new book coming out, Bailout Nation, argues that the bailout of Chrysler in 1979 is one of the root causes of the terrible state of the auto industry today. The moral hazard argument is obvious: Chrysler engaged in poor business practices that caused it to lose its competitive edge against foreign auto manufacturers. But the opportunity cost is less obvious because it was an alternate history that wasn’t allowed to happen. Imagine a world where Chrysler went bankrupt, and Chrysler’s factories were bought by small and nimble car companies (like the present day Tesla Motors). Perhaps 20 such car companies could have been created. Perhaps 5 of them could have survived. Today we might have the big two and little five competing for your car needs instead of needing to debate between Toyota, Honda, or a Ford. It might be worthwhile pointing out that the labor that went into the Ford was subsidized by the American taxpayer (the amount of dollars that has continued to flow from the government to the auto industry is staggering).
In closing, it is important to consider not just what message you are sending when you propose a bailout (moral hazard), but also all alternatives (opportunity cost). Our “leaders” seem to fail to understand these two economic concepts.
