Opportunity cost, MMT and public spending (crosspost from Crooked Timber)

I’ve been busy for the last week doing events for Economics in Two Lessons, so I didn’t have time to take part in the discussion arising from Harry’s post on alternatives to Sanders’ proposal to wipe out college debt.

In one way, that’s a pity because the key point of the book is the idea of opportunity cost – the true cost of anything, for us as individuals, and for society as a whole, is what you must give up to get it. More precisely, it’s the best alternative available to us.

Harry’s post was all about opportunity cost – what would be the best use of $1.6 trillion in public funds. However, the discussion was inevitably enmeshed in the complexities and inequities of US education, while comments making broader arguments about opportunity cost reasoning weren’t discussed in detail.

One of those broader arguments is the idea that, thanks to Modern Monetary Theory, there’s no need to worry about such questions. In the “chartalist” reasoning underlyng MMT, the fact that governments can issue their own sovereign currency means that there is no need to “finance” public spending by taxation; rather taxation is a tool used to manage aggregate demand so as to keep the economy fully employed but not at a point where excess demand creates inflation. That (essentially correct) position can easily slide into the (only subtly different, but radically mistaken) view that governments can spend money on anything they like with no need for any increases in taxes or cuts in other spending.

As I will argue over the fold, a correct version of MMT makes no such claim. Unfortunately, while avoiding the error themselves, a lot of MMT theorists have not shown much willingness to set their more naive followers straight.

To begin with, I’ll ignore imports and exports look at the case where workers (and capital) fully employed and expected to remain so, thanks to a Job Guarantee (a standard part of the MMT package). And, consistent with MMT, I won’t worry about whether the government budget is in balance, deficit or surplus.

Now consider a policy (such as debt cancellation) which improves the financial position of a large number of people. Naturally, the beneficiaries will want to consume at least some of their increased wealth. But since the economy is already at full employment, that can’t happen without reducing some other area of consumption or investment.

In the MMT framework, the role of taxes is precisely to reduce aggregate demand to a level consistent with the productive capacity of the economy. So taxes must increase sufficiently to reduce the consumption of those who don’t benefit from the policy. That reduction in consumption for some is the opportunity cost of the increased consumption made possible by the policy.

If the taxes were levied on the very well off, the result would presumably be socially benefical on balance. But again, we need to look at the best alternative. Assuming it becomes politically feasible to tax the rich more, an obvious option (I’ll assume its the best one) is to tax the poor less. So, the true opportunity cost of introducing the policy is forgoing tax cuts for the poor.

That’s not the only option available to government. An alternative is to match the increased expenditure under the new policy with a reduction in some other area of policy, such as military expenditure. (I discuss the opportunity cost of military spending at length in this extract from Economics in Two Lessons. As an example, for the cost of keeping 35 soldiers in the field in Afghanistan, the US could provide education for a million children there, or in other poor countries).

But to repeat, opportunity cost is the next best alternative. If we could cut military spending by $1.6 trillion, we would still be faced with Harry’s question “what could you (or a progressive US government) do with $1.6 trillion?

I’ve said more than enough on MMT, so I probably won’t engage much with comments that don’t focus fairly directly with the analysis I’ve proposed here.

10 thoughts on “Opportunity cost, MMT and public spending (crosspost from Crooked Timber)

  1. “A theory that explains everything, explains nothing” – Karl Popper.

    It seems to me that opportunity cost is precisely this kind of theory, at least when it is spread too thin in an attempt to explain everything in economics. Opportunity cost functions well enough as a theory when specific and limited genuine alternatives are clear and when the costs are real not nominal. Opportunity cost functions poorly as a general theory when alternatives are multifarious or unclear or unknowable (at least until after the event of choice) and when the costs are measured nominally (via money).

  2. I assume that a $1.5T student abolition of debt is like a 5% increase in the US public debt mountain. Does the MMT theory suggest this is irrelevant and that all that matters are the positive wealth effects from the lucky students?

  3. I see the MMT as pretty sinister characters. They have two major economists broadly onside. The brilliant Michael Hudson and our own innovative Professor Keen. But I think these two have been lulled in to give the movement credibility that it does not deserve. Actually Michael Hudson is my favourite economist right now because of his excellent knowledge of the British Classical School and the late 19th Century German Economists whose success was manifest.

    However the rest of the MMT crowd are not monetary sophisticates. Rather they are bait and switch merchants who are covertly against monetary reform and instead want a lot of red ink everywhere. I like Moslers welfare orientated programs but you need to pay for them with department mergers and closures and pulling back from running around the world killing people. The MMT crowd has to be seen as the financial system running an operation to get in the way of monetary reform.

    There is so much that could be done with the 1.5 trillion. Debt reduction for one thing. Getting rid of sole trader taxes on retained earnings. Getting rid of the regressive payroll tax that poor working Americans have to pay. Zero interest loans for small business to retool. Infrastructure. Tunnels everywhere. Zero interest loans for famers to convert from big agriculture to permaculture if they will sell off chunks of land. Swaling all the hillsides and putting in ponds, dams, terraces, or zero interest loans to do so. Programs to produce four metres of dark black soil everywhere which is the ultimate carbon internment strategy.

    The possibilities never end. The Americans have 800 bases. Thats not sane defence thats big corporate exploitation and the intimidation of people everywhere. They need forward defence but that would amount to 20 unassailable bases. Not 800 crappy ones. Its time for them to retire this empire which has gotten too ugly and mad for a human tongue to describe.

  4. Graeme Bird,

    I don’t see any MMT advocates who are sinister characters. I see some naive lay advocates of MMT who don’t even understand MMT correctly. However, Bill Mitchell, Steve Keen and Micheal Hudson are all very clever and thoughtful economists who don’t toe the orthodox line of neoclassicism, monetarism and neoliberalism). Mitchell is an avowed MMT theorist. Keen is a critic of equilibrium models and homo economicus style microeconomics. Hudson is a hard-nosed realist who knows what business really does and what government really does (especially when they are in cahoots with each other) and also knows that much of academic economics is unrealistic, unempirical theory not related to what really happens in the halls of money and power. All three, I think, would be advocates of increasing public spending on the needy and on infrastructure, and decreasing public spending on assisting the rich, the oligopoly corporations and the military-industrial complex.

    On the geostrategic front I agree with you. Less money should be spent on endless and pointless wars against 4th order opponents half a world away from the US. In fact, the US fell for Bin Laden’s “rope a dope” strategy. Bin Laden wanted the US stuck in a quagmire (or a sand-trap) in the Middle East. He knew a few thousand or at best ten thousand insurgents could tie down whole armies (up to thirty times larger as it turned out) and cost the US immense wasted blood and treasure.

    John Mearsheimer, developer of offensive neorealism theory, would agree with you on the forward bases issue. They need to be rationalised (at great savings) and the US returned to a hemisphere hegemon stance rather than an attempted global hegemon stance which is no longer sustainable in economic or strategic terms.

  5. If Mitchell is an avowed MMT advocate he’s a monetary crank. But yes I’m a big admirer of Hudson and Keen. The economics profession and the lay people are full of what we call monetary cranks. Its a sort of magical thinking you get that takes over a person. The quest for something for nothing. I know that Keen and Hudson aren’t like that but they’ve thrown their lot in with these guys for some reason.

    One of the hallmarks of monetary crankery is not wanting to re-establish the reserve asset ratio. They see some sort of alchemy in the way that private banks create money. They confuse the creation of money with the creation of wealth. Although there is a scintilla of truth to the whole thing in that if the economy is full of debt junkies there is some temporary relief when the new lot of spending power rolls around.

    If you think that Bin Laden had anything to do with what the Americans are up to I would encourage you to revisit the crime scene and I won’t explore that topic any further.

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