The Opportunity Cost of the Bailouts

by Will Wilkinson on March 18, 2009

Richard Florida offers some insight: 

The bailouts and stimulus, while they may help at the margins, also pose an enormous opportunity costs.  One the one hand, they impede necessary and long-deferred economic adjustments. The auto and auto-related industries suffer from massive over-capacity and must shrink.  The housing bubble not only helped spur the financial crisis, it also produced an enormous mis-allocation of resources. Housing prices must come a lot further down before we can reset the economy – and consumer demand – for a new round of growth. The financial and banking sector grew massively bloated – in terms of employment, share of GDP and wages, as the detailed research of NYU’s Thomas Phillipon has shown – and likewise have to come back to earth.

On the other hand,  there is the classic question: What better and more effective things might have been done with these trillions?  That’s for historians to ponder and decide. But the combination of the massively misallocated resources produced by the bubble (plus the costs of military adventures)  combined with humongous bailout spending puts the US behind the economic eight-ball in a way it has not been in more than the century. Having hold on the reserve currency helps, but it cannot absolve all these compounded sins.  Sooner or later the money will run out; bills will come due.

That creates a wide open structural opportunity to accelerate what Fareed Zakaria has dubbed the “rise of the rest” to accelerate.  Crises are periods where the relative position of nations and regions can and do  change dramatically.   (Do I think the US will lose its hegemonic position: Of course not.  My hunch is that the US is in the same position structurally as England at the onset of the Long Depression of 1873.  It was not until the next major crisis – the Great Depression of 1929 and the onset of WWII that it lost its position  [to] the United States. So worst case: The US has one more long-cycle at the top of the heap).   But, just think of all the ways the trillions of bailout money could be used to build the economy of the future. And while you’re doing that imagine that some other places … that have been patiently building and conserving their resources may start to figure out how to do just that.

I don’t give a fig about the U.S.’s relative position, but I do care about the absolute level of welfare and thus the absolute level of innovation and it is here that I worry about the costs of American decline.

  • lyca
    Well, it depends how heavily you weight the importance of the present welfare over future welfare. If you have a zero pure rate of time preference then (I think) you would always prefer to focus on long term growth because it's exponential & will eventually outweigh any present suffering, even if it's very great. If the importance you attach to future welfare decays faster than the "small cost in long term economic growth," then you'd be willing to take the dip in growth to prevent a depression now.

    I know that doesn't answer your question, but it seems to be a useful way to think about this.

    Funny thing is, if you wanted to be consistent, you ought to prefer both aggressively limiting climate change AND pro-growth policies if you have a low rate of time preference, or prefer both cushioning recessions AND not spending too much on climate change if you have a high rate of time preference. Of course, that's not how the usual left-right divisions work out.
  • LarryM
    I think that is a helpful, though somewhat flawed way to look at it (for reasons I'll get to in a minute). I would say that I personally don't have a zero pure rate of time preference, which is one reason why I would favor some level of amelioration of current suffering over long term growth. The flaw, though: basically the assumption that increased economic growth maps onto increased welfare on a one to one basis. I think it doesn't (though obviously there is some correlation), though the reasons for my conclusion (most of which I am sure you have heard before) won't really fit into a blog comment.

    As for your final paragraph, I think the reason that you don't see those preferences correlated to a greater extent is that "aggressively limiting climate change" and "pro-growth policies" are not independent variables - that is, they are to a large extent not compatible. I would certainly agree that, in choosing policies that "aggressively limit climate change" one should choose those policies which tend to have the least impact on growth, but that's easier said than done and not, I think, terribly controversial.
  • lyca
    Me too -- I think we should ameliorate recessions, if we can, and if it's worth it. Florida's point is that we shouldn't be indifferent to the effect on growth, but yes, I'd be willing to sacrifice a sufficiently small amount of growth to prevent a painful recession today.

    Not sure which reasons you have in mind for growth \= welfare. Do you mean the "money can't buy happiness" sort of arguments or the "high growth can still leave people in poverty" arguments? Or something else I haven't thought of?

    And, yes, you're right about climate mitigation and growth going in opposite directions, at least for a while.
  • LarryM
    And to further elaborate upon the banality of the Florida quote, while many blog commenters may not understand the concept of opportunity costs, I would suspect that our policy makers do. Now, they may not be properly weighing such costs, but if one wants to make the argument that they aren't ... one should make the argument, rather than just asserting it (or, in Florida's case, implying it).

    (And did I say England rather than Florida in my prior comment? Ugh, I need to do a better job of editing my comments.)
  • uknowbetter
    Most politicians have never taken an economics course in their lives.

    It would be a good question to ask them if they could define 'opportunity cost'. I doubt many members of Congress could and I doubt Obama could.
  • LarryM
    Re Florida, my beef with him is not that his observation is wrong, but that it is banal, and that he punts the hard questions. I mean, not to beat a dead horse, but saying that history will determine "[w]hat better and more effective things might have been done with these trillions" is a cop out of major proportions.

    Re growth and welfare, it's a little of both, though I'd frame the issues differently. For the former, I'd say "while money and happiness are highly corrolated, they aren't corrolated on a one to one basis," for the second, I'd say that "economic growth tends, all else being equal, to benefit some people disproportionately; whatever one thinks about the justice of this, it is a reason why maximizing economic growth does not maximize welfare." Of course, that leads to a whole host of additional questions and issues, but as I said, serious engagment of them is beyond the scope of a blog comment.
  • LarryM
    Regarding growth and welfare, there is an additional argument. Even without adopting the more extreme doom and gloom predictions of environmental catastrophe, there is, at least, an open question as to whether high high rates of growth are sustainable indefinitely. It's certainly possible that there will be technological fixes to various environmental/resource issues, but it seems somewhat dangerous to just assume such fixes. That's part of what I meant in a previous comment when I mentioned the magical thinking that soem libertarians seem to have regarding the benefits of the free market. One can have a healthy respect for the power of free markets (especially relative to governmental solutions) without fetishizing the free market.

    Or, to put it another way, assuming that enviromental and resource problems will have a technological fix is as big an error (and the same kind of error) as ignoring the possibility of such fixes.
  • LarryM
    To kind of elaborate upon one particular point in my last post. (Note that I am assuming arguendo our host's underlying philosophical justification for libertarianism; a more "property rights" approach would consider the following questions irrelevant):

    Let's assume that a governmental intervention during a recession can cushion the recession - prevent a lot of suffering during the recession, maybe even prevent it from becoming a depression - but at a small cost in long term economic growth. How do we weigh that? Does it make any sense to say that maximization of long term economic growth is our only priority?
  • LarryM
    Couple of points. Firstly, "That’s for historians to ponder and decide." is a cop out of major proportions, and frankly by itself entirely undermines a significant proportion of the critique. I raise it because it mirrors what I see as a rather scattershot critique coming from this blog, a gathering of disparate and sometimes contradictory critiques of the administratins performance, without a coherent set of alternatives.

    Now, I realize that one coherent alternative, given the libertarian outlook of this blog, would be the "do nothing" approach - let the market sort it out. There are times when I indeed think that this might be the best approach. But what's lacking here is any real examination and defense of this approach.

    Set aside the stimulus for a moment (and the auto industry bailout, which is IMO particularly indefensible but ultimately small potatoes). What about the financial crisis? As much as I distrust the government to solve the problem, there seems to be a consensus that without such intervention there is a substantial chance of a complete collapse of the banking and financial sector that will lead to catastophic consequences. Now, I for one don't simply accept this consensus as a given. But entirely absent from the discussions on this blog, it seems to me, are answers to these & other fundemental questions:

    (1) Is the consensus right?
    (2) If not, why not?
    (3) If so, are the governmental interventions to date reducing the risk of a catastrophic collapse?
    (4) If not, are there alternative government interventions which would reduce that risk? If so, what are they?
    (5) How do you weigh the risk of a deep depression versus some long term reduction in the growth rate?

    I don't pretend to know the answers to these questions. But it would be nice to see a coherent presentation and defense of an alternative approach to the financial cris specificaly - even if that alternative is the "do nothing" approach which may, in fact, be the best approach.
  • Haha, knb,

    On a scale of 1 to 10 (10 being, say, Ghandi), exactly how "influential and widely respected" would you say Richard Florida is?
  • knb
    With 1 being blog commenters (having zero influence and no respect) and 10 being Ghandi (maximum respect)? I would say Florida is probably a 7-8.

    In case you actually are unfamiliar with Florida, he did popularize the notion of the "creative class", and written several well received books. Honestly, how high are your standards for being blog-post worthy. If Tucker Carlson is worthy of a blog post (and I think hes is), then Richard Florida is as well.
  • So Florida hits 80% of Gandhi's respect and influence just because he came up with a pop economics "theory" along the lines of Dow 36,000 or the Laffer curve?

    I agree if Tucker Carlson deserves a blog post then Florida's opinions on the economy do, too, but it just shows how low the bar is to be considered an "intellectual" these days.

    Nice to think us lowly blog commenter rate a 1. I would have thought on that scale we are the poster children for the 0 rating.
  • "The auto and auto-related industries suffer from massive over-capacity and must shrink.
    "The auto and auto-related industries suffer from massive over-capacity and must shrink.
    The housing bubble not only helped spur the financial crisis, it also produced an enormous mis-allocation of resources. Housing prices must come a lot further down before we can reset the economy - and consumer demand - for a new round of growth."

    Florida doesn't have a very good understanding of how markets work, does he?

    The next new model from Detroit could touch off a buying frenzy for it worldwide.

    Will, where do you dredge up these loons?
  • uknowbetter
    alphie, have you ever taken an economics class or read an economics text in your life?

    Do you even know what 'opportunity cost' is?

    Do you think 'how markets work' is that a company should never go out of business and instead should get money from the government to continue running a crappy company?

    Do you realize how many people get screwed over because the government is propping up housing prices?
  • Emperor Joseph II: My dear young man, don't take it too hard. Your work is ingenious. It's quality work. And there are simply too many notes, that's all. Just cut a few and it will be perfect.

    Mozart: Which few did you have in mind, Majesty?

    uknow, please name an American industry that doesn't get money or technological discoveries from government.

    And please don't bring up insane wingnut talking points and then try to pretend you want a serious discussion about economics.

    On second thought, go ahead.

    I still get a kick when I hear the lame propaganda that has cost the Republicans two elections now being repeated.

    I particularly enjoyed your leader Rush's attempt to label the Republican's recession "Obama's fault."
  • uknowbetter
    All sorts of businesses do without government help and many of them succeed in spite of the government getting in the way. Nearly every business in America does not get government money.

    Republicans are stupid (mostly because they act like democrats on economic matters, social freedoms are expanding in spite of them), but the democrats are retarded.

    It would be pointless to have a serious discussion with you. You didn't even attempt to answer any of my questions because you can't. You believe in all-government-all-the-time-in-every-orifice. People like you are the enablers of statists and that goes as far as Hitler, Stalin, and Mao.

    Keep apologizing for incompetence and inefficiency.
  • LarryM
    This is a perfect example of the pro-business “libertarian” approach which I find rather amusing (in fairness, our host doesn’t seem to share it). The fact is that the United States government benefits most businesses – big business, certainly - in a myriad of ways beyond direct subsidies (of which there are plenty). Of course, at the most basic level, the government benefits incorporated businesses by creating and enforcing laws protecting the existence of limited liability corporations. Now, there are plenty of grounds to defend that concept; they just don’t happen to be particularly libertarian grounds. Moreover, government regulation, as heavily as it falls upon many small businesses, in most cases privileges larger enterprises (see regulatory capture). I could go on all day.

    Now, one can derive different conclusions from these basic facts, but unless one starts from the basic premise that, on the whole, big business (at least) gains far more from our system of government than it gives up (a conclusion that is almost inevitable if one consistently applies libertarian principles regarding how governments work – see, e.g., rent seeking), one will go seriously astray.
  • uknowbetter
    I don't disagree with much of that. Many libertarians don't have a problem with the government creating and enforcing some simple laws dealing with the existence of companies.

    Big business does tend to benefit more from government interference because they hire the better hookers (ahem, 'lobbyists') to get the government to write anti-competitive regulation or give them subsidies and tax-breaks.
  • LarryM
    Obviously at this point we aren't much in diagreement - about this, anyway - but I'd hardly call the artificial creation of a fictional entity that shields its owners from liability a "simple law dealing with the existance of companies." One can argue that it ultimatley is only a small distortion of the free market, and defend it on utilitarian grounds, but it is pretty hard to justify on any kind of big L libertarian gounds.
  • uknowbetter
    I'll have to look into that more. Though it's not as if people are completely shielded; they still put time, money, resources into a company they form and stand to lose those.
  • knb
    Right or wrong, someone as influential and widely respected as Richard Florida certainly does not need to be "dredged up".
  • huadpe
    The point which doesn't seem to be addressed here is that the stimulus doesn't seek to just increase growth ex-ante, but to prevent there from being a massive and sudden crash of the economy which pushes people into very bad situations.

    There are massive economic costs associated with rapid changes. You can both say "housing prices should be 20% lower" and "if housing prices were 20% lower tomorrow, it would screw alot of stuff up."

    I think there is a rational argument here given that Florida's analysis is correct, that we should use stimulus to provide a more gentle path to the reset point where we can start to see growth again.
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