"On Violence" has linked to my text about the lifesaving argument, and this (together with a recent bout in the comments) gave me the final push to write a bit more in general about the importance of opportunity costs in correct decisionmaking.
Imagine you're a collector of nicely decorated coffee cups. You have an annual budget of 1,000 bucks for this hobby. You meet sellers on fairs and a total of 10,000 cups are on offer, with prices ranging from 0.05 bucks to 50 bucks per piece. Curiously, you like all cups on offer the exact same.Which cups do you buy?Educated guess: I suppose you buy the cheapest cups till your budget is exhausted. You would be stupid if you spent money on some expensive ones while there are exactly as beautiful cups still on offer at a lower price.
This is a very widely usable insight, and one usually utterly neglected. I admit it's tough to use in practice because of imperfect information, but one should at the very least not violate this principle of buying the most cost-efficient stuff first after being alerted.
The Military spending and the lifesaving argument blog post applied this rather basic economics thing on the saving of lives: Save as many as possible with a given budget (maximised effect for a given budget), which means save the lives first which cost the least to save.
Another application relevant to this blog is about benevolent interventionism: In theory, an intervention in a civil war or (believed) genocide may save foreigner's lives. Is this a good idea?
It depends (and not only whether one's expectation of success is good enough).
Let's say a government expects no own troops to be killed and the fiscal expenses per foreign life saved are guesstimated at 1,000 bucks per soul.
The aforementioned principle means that you better not intervene unless you exhausted all methods of saving lives at a lower price tag than 1,000 bucks per soul. Immunisation programs, information campaigns, free condoms, subsidised drugs, subsidised water filtration sets, work safety campaigns etc.
This makes military fanboi interventionists weep, of course. That's because their real interest isn't on the lifesaving part, but on the blow up, maim, kill and boast part of the intervention.
Yet another application; egoistic interventions with economic interests. Does it make sense to spend ten billion bucks more per year on expeditionary military forces? There is the possibility that their existence and/or employment makes purchased resources cheaper (outright robbing is out of fashion), after all.
Let's ignore the difference between a benefit to an oil company shareholder and a benefit to the guy buying gasoline at a gas station for now. Shall the expeditionary forces be beefed up and sustained?
Well, it first needs to outperform all other capital investment options that are left to justify itself.
One such option would be to reduce the government debt instead, and we know the interest rates for this: A few per cent. The current interest rates are extraordinarily low, but typical nominal interest rate for German federal bonds during the 90's were around 7 % p.a., ~ 5 % p.a. real interest rate (without the inflation).
The ten billion bucks would need to yield an economic benefit of 500 million bucks a year to beat this alternative. Next year again. and again. And again. Till eternity (there's financial math to make this more handy). And next year's 10 billion bucks would need to do the same. And the 10 billion the year thereafter as well. Et cetera.
Are federal bonds a strong or a weak alternative? It depends on how well-governed the country is. Federal bonds would be a weak alternative if the country is well-run, and a very strong one if it's poorly run. The existence of a narrowly observed deficit limit would de-couple this and one would need to look at available alternatives directly.
Which is what a government should do anyway. It is actually quite easy to find options for spending public funds for higher benefit returns than 4%. After all, taxes often incur secondary effects (administration costs, distortions) well beyond 10% and are still being levied. Research has yielded up to about 30% such extra costs for especially poorly mutated tax laws, but 10-15% is a fine rule of thumb. So after spending ten billions p.a. for a decade, you better get 10 billions economic benefit out of it p.a..
That is, if you have an all-robotic military. Otherwise there would be troops which could increase economic output directly if they worked as civilians, this effect would be an additional approx. 10 billion p.a.. This is known as opportunity costs as well.
Even more: Four to six billion bucks of that economic activity would become government revenues. And these would create even more benefits. Et cetera.
Interventionists really don't stand a chance once you crunch the numbers unless you buy into wild guesses about alleged and never proven benefits.
I doubt that the people who agitate for military interventions in economic self-interest have crunched the numbers or taken into account the actual poor success of such interventions during the 20th century.
We can use the "artistic" approach of resource allocation and just guess what's a good use for money based on our feelings. Some people are convinced that a certain budget would be fine without even thinking about opportunity costs or total budgets.
The result of such guessing would almost inevitably be utter wastefulness. It would be as handing the government's finances over to a six year old boy. Pet projects everywhere, but also people dying for want of a 10 cent screw or a 20 cent pill.
The competent way of allocating resources requires that you make an effort to expect the cost/benefit ratios somewhat accurately. You should then proceed to pay for the most cost-efficient options first. True "must-have" things can have an infinite value assigned in this method. The budget caps the allocation of resources at some point, and everything not afforded up to that point is simply wrong.