Creating jobs is effective political rhetoric. Who would be against creating jobs?
But a job is different than just giving someone money. It’s a subtle difference that few people understand.
Allen Sanderson explains it in this article, Jobs, Jobs, Jobs (via Greg Mankiw’s blog). In this paragraph Sanderson gives the typical economic refrain:
…pay 100,000 people salaries of $50,000 a year to dig holes in the ground every morning and another 100,000 folks $50,000 annually to fill up those holes in the afternoons. That’s also $10 billion in spending—and 200,000 new jobs created. Of course, at the end of the day we will have the same level of output as before to show for our “shovel-ready” efforts.
Most people can clearly see that the effort of digging holes and refilling them produces no benefit.
But, much of government spending does produce visible benefits, like repairing roads or building bridges. So, people view Sanderson’s example as extreme and discount it.
What they don’t consider is whether those visible benefits from government spending was worth the cost or whether there were better alternatives for the spending.
Several years ago in my hometown someone in local government got the idea to spruce up a couple houses in a blighted neighborhood to spur revitalization.
They city spent $1.1 million to renovate two homes in a blighted neighborhood and eventually put the homes on the market for about $160,000 each and they didn’t sell for anywhere near that. That project was not even close to be worth the cost.
I’ve been thinking about how to better differentiate between an activity that produces benefits in excess of costs, like a job, and an activity that doesn’t.
Here are some thoughts:
- A job is something you would willingly spend your own money on to have done.
- If charged with the financial accountability of an organization (which means you get fired if you do a poor job of making decisions that create value for the organization), it’s something you would willingly spend the organization’s money on.
- A job isn’t something that you would spend money on only if you have no direct accountability to it. Most of public spending falls into that category.
When you willingly spend your own money, you consider two criteria:
- Will the benefit exceed the cost? In the business world, this is known as a cost-benefit analysis. In economics this is known as evaluating consumer surplus.
- Are there alternatives that will bring me more bang for my buck, that is, provide more benefits than this option? In economics this is known as opportunity cost.
Private spending is not perfect. Like most things, it is trial and error. In many cases we misjudge potential benefits and later discover that the benefits were not worth the cost. But, we then use that as a learning experience for the future.
We stop spending money on the things where the the benefits did not exceed the cost. We get better at knowing our options and projecting benefits. These simple feedbacks drive private spending to be an effective generator of value in an economy.
Public spending does not often have to satisfy these same two criteria. In the public spending arena many other criteria come into play, and few of those have to do with whether the spending is generates benefits in excess of the cost.
Here are some of these criteria:
- Will this create a multiplier effect to stimulate the economy? How much of a factor is the economic multiplier effect when you spend your own money? Not much.
- Will I [politician] be able to claim that I was hero for spending other people’s money to solve some problem in order to encourage people to vote for me?
- Will this spending of other people’s money please a special interest group enough to garner me campaign donations and other favors (like lobbying jobs in my post elected life) from that special interest group?
- If I vote for this spending of other people’s money that politician B supports, will politician B vote for my ideas on spending of other people’s money so I can claim to be a hero?
So, the next time a politician pushes a big spending project, ask yourself if it would be something that you would be willing to put your own money into.
Who’s accountable to the spending and what happens to them if the spending doesn’t generate enough benefit to offset the cost? If cost-benefit isn’t governing the spending, what is?