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

Summary:
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 .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

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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.

John Quiggin
He is an Australian economist, a Professor and an Australian Research Council Laureate Fellow at the University of Queensland, and a former member of the Board of the Climate Change Authority of the Australian Government.

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