In theory, national economic management is formulated to achieve what’s known as ‘allocative efficiency’ – that is, producing the best mix of goods and services with the most efficient combination of resources with the least waste and with resources as fully employed as possible.
Like anyone knows we “can’t have it all”, there are trade-offs with any choice we make, and we also know that you can’t “please all the people, all the time”.
The real or opportunity cost of a choice is the value of the best alternative forgone, it’s true on a national level and a personal one.
We face constraints, both with our time and money.
How often do we hear or say, “there’s just not enough time in the day?”
Prioritizing our workday and choosing to do A rather B is a choice we make. Choosing to study for several years means forgoing potential full-time income in that period. Watching TV when we could be exercising, is also a choice and has its costs!
If we work more hours, we sacrifice leisure time.
Budget constraints force us to make choices about how we spend the limited income we have at our disposal. After we have paid taxes, we allocate our income and either spend it or save it.
If we can save (refraining from current consumption) we can then choose what to do with the savings.
Constraints also exist for the economy as a whole and those who are tasked with managing it.
Opportunity cost, the alternative foregone is never more obvious than when looking at the competing claims on the budget. Every decision to spend means that some other wish must be crossed off the list or at best, trimmed back. There are also the unintended trade-offs that come with policy decisions.
The Federal Budget can allocate more funds to reducing public hospital waiting lists at the expense of increasing our military capabilities or it may increase both and cut back on welfare, by increasing the age eligibility criteria for a pension.
Up until now we have not acknowledged that there is a distinction between what nations, governments and consumers should do and what they actually choose to spend funds on.
Positive economics is based on facts and assumes rational behaviour while normative economics is based on value judgments and opinions, it’s what decisions we consider “should” be made.
It is worthwhile keeping in mind that any policy decision involves opportunity costs and, unintended costs.
An example is the imposition of lockout laws in inner Sydney’s entertainment district. Not many would argue the social benefit of a policy to curb both the human and financial costs (policing, hospital admissions, legal system etc) of alcohol fueled violence.
However, the trade-off has been the closure of a large number of venues due to lower demand – resulting in higher unemployment and therefore pressure on the welfare budget, loss of rent for venue owners, less work for taxi and uber drivers, and kebab shops!
The decision to trade off the welfare of a small group of business owners against the well-being of the public generally is a subjective decision and therefore in the realm of ‘normative economics. Not all economic decisions, rational as they may be, are socially desirable and vice versa.
(Interestingly, these lockout laws have been modified just recently in NSW in recognition of the inequitable burden it placed local business and the tourism industry)
Positive economics is objective while normative is subjective.
Likewise, an individual’s evaluation of the allocation of budget funds will also depend on their perspective and attitudes in life.
Take the now defunct carbon tax as an example. Observing the debate it seemed to me that politicians typically lack sufficient skills to convince any kid they need to eat their greens, let alone the voting public that it needs to pay more for the things they buy!
Pollution is a negative externality; an undesirable by product of another productive activity and is an example of market failure. Everyone accepts that the cost of an item on the shelf is determined by the factors of production that go into producing it. What most people are not conscious of is the hidden costs, those that aren’t obvious, the costs that we all bear whether we buy the product or not. The most obvious example being pollution.
Price is a rationing device and the only way to make consumers bear the true cost of a product, and perhaps change their consumption patterns, is to internalize or price the hidden costs, in other words, make them pay for it. For those who have teenage children, how many times have you caught yourself saying things like, “wait til you’re paying the bills, then you’ll switch off the lights”! True? That’s because they don’t yet bear the cost, their usage of your electricity is not priced; it’s not internalized.
But at the same time I do feel sorry for policy makers because there are no easy answers. Opportunity cost, the alternative foregone is never more obvious than when looking at the competing claims on the budget. Every decision to spend means that some other wish has to be crossed off the list or at best trimmed back. There are also the unintended trade offs that come with policy decisions.
Ever been to a dinner party or BBQ where someone pronounces with the enormous certainty that ignorance allows, “the government should just….”?
Similarly, those that claim housing affordability will be magically fixed by changing the tax rules around negative gearing don’t seem to have any inkling (or alternative suggestions for that matter) about how the public sector would provide all that rental accommodation in the absence of investor activity and have even less appreciation of the private vs public efficiency trade off or the likely effect on rent of an investor exodus from the housing market. One politician recently responded to the suggestion by saying “oh, it’s complicated”. Really?! They should be able to do better than that.
Explain that tax breaks for investors encourages the supply of housing in an already constrained market more cost effectively than the public sector could ever do and that it encourages a rapidly aging population to invest for the future and reduce the burden on the future public purse.
Explain that housing starts are a leading indicator of economic activity and therefore jobs and the multiplier effect of house construction is huge. Building new properties has a ripple effect on consumption that is hard to replicate.
Explain that the new driver of growth and therefore jobs is population growth and the houses and infrastructure and services they will demand, all 32,000,000 of us by 2033. That’s less than 15 years from now! Incentivizing the simple ‘changing of hands’ in the property investment market may be a lot less socially beneficial than encouraging new construction.
But then things are never that simple….