In Part I of this two part post, I laid out a specific example pulled from the headlines that highlights the opportunity cost of an act of compassion. In this post, I will try to generalize a little to see what we can learn from this.
When you hear the term "social safety net," what comes to mind? I tend to think of Social Security, unemployment insurance, or welfare programs. A social safety net is there to catch you if you fall through the cracks in your own support system. A social safety net is the government following the "Golden Rule" (Do unto others...) on our collective behalf. My ideal social safety net is part of the social contract I would design from behind Rawls' "Veil of Ignorance." These are some things that come to my mind.
But the social safety net is not free. As a concrete example, consider Social Security--part retirement plan, part safety net. Your benefits when you retire are related to your contributions, but are less than what those contributions might have received if invested in other assets. The reason is that Social Security also pays disability and survivors benefits. That knocks a couple points off your implied rate of return. That, my friends, is opportunity cost.
So it is with other things that governments do to protect us. Consider the example of fire protection I raised in the previous post. Fire protection is usually thought of as a public good rather than a social safety net, but the notion of opportunity cost is the same. And because it is closely tied to the concept of insurance, it is certainly a relevant comparison. Fire protection is very costly, and modern firefighters do much more than their ancestors, the fire insurance companies of a couple hundred years ago. Modern fire departments protect us against more than the loss of our home or business. They protect us from hazardous material spills and come to our aid in medical emergencies. A hazmat team is expensive, and if modern fire companies were financed only by homeowners insurance, I doubt that hazmat teams would exist, at least not in their present form. Government stepped in. We collectively choose to pay for a higher level of protection. Again, this has an opportunity cost. When a city needs to hire more firefighters, taxes must go up or something else must be cut.
But just as there is a cost, there are also benefits--in some cases benefits that extend beyond the individual. And many people would argue that it is part of the social contract that we have a responsibility to pay a share of the cost even when we do not enjoy a direct private benefit.
Measuring the private benefit of this blanket of protection is to ask the question of how much you would need to be compensated in order to voluntarily waive your right to that protection. But that does not measure the social benefit. It does not measure how much you are willing to pay to ensure that protection is there for your neighbor.
Of course caring for your neighbor is not the usual picture of the rational, utility maximizing, self-interested homo economicus (Adam Smith's Theory of Moral Sentiments notwithstanding), but consider the following scenario.
Suppose that your city is building a "free" public health clinic. You could measure individual private benefit by asking people how many times per year they would expect to visit the clinic. The number of visits per year times the average cost per visit is the total private benefit.
For some individuals, the private benefit would be zero. People with insurance would probably reveal a preference for seeing their private doctor rather than going to the county health department. Yet do they share in the social benefit from the clinic? To find out, you might ask someone who gets zero private benefit which they would prefer: 1) a guarantee that the clinic will remain open serving the community or 2) the clinic closes tomorrow, but the person gets a crisp, new $10 bill.
Would I be "irrational" if I turned down the $10? I don't think so. The reason markets fail in the presence of a positive externality is that people do not take into account the benefit of an action to others because their contribution to the total social benefit is so small. But if you asked people to reveal how much benefit they get from the collective action of others, you can get a rough estimate of the social value that would be lost due to the market failure.
I say, "rough estimate" because even this method is not without its pitfalls. If you survey people who obtain private benefit, they may give an inflated answer. Nonetheless, such studies can be done, if interpreted with caution. From the Minneapolis Fed (fedgazette):
Sports teams, for example, create a public good by virtue of the fact that they often engender community pride, interest and enjoyment outside of ticket-buying customers (what economists call externalities). "The magnitude of this benefit is unknown, and is not shared by everyone; nevertheless, it exists," wrote Roger Noll of the Brookings Institution.
In some cases, it might be hard to say more than "it exists," but even that does say something. In the case discussed in the separate articles by Landsburg and Frank, I would argue that a social benefit exists. But Roger Noll's comment above on a totally different issue would apply just as well here. I don't know the magnitude, and properly measured, it's probably smaller than most of us would initially think. Yet it must be put on the table for discussion.
Economic analysis, particularly through focusing on opportunity cost and the notion of "willingness to pay" can shed much light on everyday subjects like these. We dissect cases like this to separate out the social benefits/costs from the private benefits/costs. We prioritize elements of the social safety net based on their opportunity cost. We justify or criticize government intervention on the basis of costs and benefits that are seen as well as those that are unseen. Economists may not always agree, but we can usually identify the root source of our disagreements. We do all this because, as Frank says,
We cannot think intelligently about these decisions without weighing the relevant costs and benefits.
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