DRI-224 for week of 11-24-13: The ‘Cost’ of the Government Shutdown: Another Myth Bites the Dust

An Access Advertising EconBrief:

The ‘Cost’ of the Government Shutdown: Another Myth Bites the Dust

The sixteen-day federal-government shutdown that occurred in early October is gradually shaping up as a watershed event. That is what the mainstream news media and the political left, not to mention the Obama Administration, expected to happen. They believed a government shutdown would bring life as we know it to a grinding halt. But the actual experience of shutdown was dramatically different; no such thing happened. To free-market devotees, the myth of all-purpose government is undergoing exposure.

Is there any way to reconcile two such divergent views?  Seemingly, they should be readily distinguishable in reality. People approach these matters in two ways. Sometimes they consult fact. Other times they try logic. To be thorough, we’ll try both.

Uncertainty Over the Shutdown? None Visible in the 3rd Quarter Economic Data

Prior to the shutdown, the news media agonized over the prospect of government shutdown. The attendant uncertainty was not merely an annoyance for government employees whose income and work schedules were at risk of disruption. No, this was a threat to the economic lifeblood of the nation, whose circulation depended on the full-bore operation of the federal government. Even a temporary interruption in day-to-day activities would deal a severe blow to real incomes of Americans – or so went the party line.

Were this really true, we would certainly expect to see advance indication. One of many purposes of markets is to discount the future. The prospect of a measurable economic setback would be reflected in various indices prior to the actual occurrence of the shutdown. Among these would be the stock market, interest rates, short-term investment and futures markets. And adverse changes in these indicators would have immediate adverse effects on markets and real incomes prior to the shutdown.

None of this actually happened. In the third quarter (July-September) 2013, GDP grew at an annual rate of 2.8%, exceeding the 2.5% growth recorded in the second quarter. This result caused considerable surprise, not to say consternation, in media quarters.

This is not to say that uncertainty does not affect the pace of economic activity. All evidence and logic says that it does. And uncertainty has never bulked larger in the minds of Americans than in the last few years. We are uncertain about the general status of the economy; GDP reports suggest that we are in recovery while labor-market data suggests the serious recession. We are uncertain about the course of interest rates in the short-, medium- and long-term. The level of government debt is the subject of pervasive uncertainty.

All these factors were present in the third quarter. But they were no more or less troubling than previously. If the government shutdown were truly a fundamental threat to our well-being, we would have expected markets to register it in advance of the event. And they didn’t.

Did the Government Shutdown Devastate the Economy? October Economic Data Say Otherwise

When the federal government did actually shut down – albeit only partially – we would certainly expect this event to make its mark on contemporary economic statistics. Economists and business forecasters awaited the October jobs report from the Labor Department with trepidation.

The result dealt a knockout blow to devotees of big government. Economists had forecast an anemic employment gain of 120,000 jobs. The actual gain was 204,000, one of the largest totals of the year. Not only that, both August and September jobs totals were revised upward, by 46,000 and 15,000, respectively. While October saw continuing decline in government employment (by 12,000), net employment increased in the retail, hospitality, health-care, manufacturing and technical services sectors.

The Cost of the Government Shutdown, As Viewed By Various Sources

The federal government’s Office of Management and Budget (OMB) compiled a document purporting to list various costs of the federal-government shutdown. The document consisted of various monetary amounts estimated on a daily basis. Various other entities, notably Standard & Poor’s and Moody’s, compiled what they called an aggregate or sum of these costs, using the OMB components and multiplying them by sixteen (the length of the shutdown in days). Curiously, OMB itself disclaimed any pretensions to completeness for its document, despite the fact that it served as the basis for other aggregate estimates. (Possibly this is because the figures come mostly from independent sources rather than from OMB’s own internal research.) Both S&P and Moody’s ended with a total roughly equaling $24 billion. This figure was very widely distributed and quoted throughout the mainstream news media, as were several of OMB’s component estimates.

Since the OMB document was the apparent source of the components used by S&P and Moody’s, we will treat it as the source of the relevant information even though the government agency disowns the aggregate results obtained by the rating agencies.

Economics is the study of human choice. The essence of choice is the estimation and evaluation of cost, which is the highest-valued alternative foregone in any situation of choice. Although the OMB’s document purports to list the costs of shutdown, we cannot take this claim for granted. Instead, we must evaluate the line items on the OMB document by relevant economic criteria.

The OMB estimates that some $217 million per day in federal and contractor wages were lost as a result of the shutdown. Since the shutdown lasted 16 days, the aggregate value of these lost wages adds up to $3,472,000,000. The U.S. Travel Association estimates that some $152 million per day was lost in travel expenditures thanks to the shutdown; OMB accepts this figure and multiplies it by 16 to add $2,432,000,000 to the cost total. Closure of national parks adds $76 million per day to the kitty, according to the Parks Service, which translates into an aggregate addition of $1,216,000,000. The noted consulting firm IHS Global Insight estimates a loss of approximately $3.1 billion in government services that weren’t provided because of the shutdown, which OMB throws into the pot as well.

So far, the total adds up to $10 billion and change. OMB continues in this vein to accumulate its $24 billion total. But we need to pause long enough to ask ourselves if what we are adding up constitutes valid economic costs – or something else. Accuracy of computation is not the issue. Rather, the point is that OMB has engaged in the sort of “kitchen sink” type of pseudo-economic exercise common to state and local “economic development” programs. The idea behind the exercise is to build up an impressive-looking monetary total. To that end, the compilers throw everything but the kitchen sink into their list of numbers. In this connection, we need to remember that, while the figures were not dug up by OMB, that agency compiled them within a single document and thus bears liability for its lack of discrimination.

How to Rig a Cost-Benefit Analysis: Count the Costs as Benefits

In principle, the costs of the government shutdown are the benefits that citizens have to forego because our elected representatives chose to shut the government down instead of keeping it open. That is, the costs are the “benefits foregone” or the “road(s) not taken.” If the OMB’s portrayal of costs is correct we should know how large the benefits of shutdown would need to be in order to justify it.

When businesses produce output in the private economy, they incur costs in order to provide benefits to consumers. The benefits to consumers come from the output produced by the business, which provides utility or satisfaction to consumers. The costs are incurred by the business in order to get the output produced. Although accountants tote up costs in monetary form, economists know that the costs are really foregone alternatives; they are incurred because inputs are used in producing output rather than in their next-best alternative use, whatever that might be. In principle, that next-best alternative use is reflected in the market price paid by the firm for each input.

So, the delineation between costs and benefits is pretty clear: Benefits are what consumers get from consuming the goods they buy; costs are what firms pay for the inputs used to produce the goods.

When government produces goods and services and provides them to citizens, the process should work the same way. Citizens derive benefits from the goods and services the government provides, such as (say) weather forecasts provided by the National Weather Service. The costs are what citizens pay the meteorologists and other government employees, as well as the costs of using the various capital goods necessary to produce the forecasts. Then there is the bureaucratic overhead to consider as well.

It can sometimes be tough to estimate costs in practice because not all inputs are traded in markets. But the problem is vastly magnified when studying government since so many government goods and services do not command a unit price and are not sold to citizens. Alas, this does not mean that they are “free;” it simply means consumers don’t know what they are paying and can’t compare that to the value they place on the output they receive. And it also means that economists at OMB have no way to place a dollar value on government output either.

Now we have the basic knowledge necessary to evaluate the cost computation done by OMB. Here is our verdict: OMB’s so-called compilation of government shutdown costs is utter gibberish, a meaningless aggregation of numbers. If its authors were put on a witness stand and asked under oath whether they could honestly claim that it constituted the true costs of the government shutdown, an affirmative response would make them guilty of perjury.

Consider the line item of $3,472,000,000 for “lost wages.” Wages are paid for labor costs. Labor is used to produce output. It is a cost of production, not a benefit of consuming output.Since it is not a benefit of consuming the output produced by government, it cannot be an alternative foregone by citizens because of the shutdown. The OMB has counted a cost as a benefit.

If we call the OMB to account for this obvious mistake, this is what they will say. “We often have to value government output ‘at cost’ because government output is usually not sold in a marketplace the way private goods and services are. For example, economists study the research and development services provided by government. They have no choice but to substitute the costs of providing the service for the value of the service because R&D is not sold in the market. What we’re doing here is the same thing.”

But it isn’t the same thing. When economists study R&D, they include all the costs (or try to), not just wages. Their justification for this is that long-run equilibrium in a perfectly competitive industry occurs at a zero-profit level of output, in which the price is just sufficient to cover all costs (including the opportunity cost of the firm’s capital). So by adding up all costs and counting them as benefits, they are “assuming” a condition equivalent to long-run competitive equilibrium. In this case, however, OMB is counting only wages – just one of the costs of producing output.

That’s not the worst of it. Consider further that OMB is also adding in benefits of government output of travel services ($2,432,000,000) and National Park tourism services ($1,216,000,000). Some of the lost wages just referred to undoubtedly were incurred in producing these services. So what OMB is doing, at least to some extent, is adding together the costs and benefits of producing the same services – and calling the resulting total “benefits.” (Remember: The costs of shutdown are the benefits derived from output of government goods and services. And also keep in mind that, while three separate sources compiled the figures for lost wages, foregone travel services and foregone Park services, OMB is the agency that put them together for cost-calculation purposes.)

For several decades, state-level “economic development” programs throughout the U.S. have operated in exactly this manner. They have bankrolled investment by politically favored individuals but, in order to present this crass activity in a favorable light to voters, they have pretended to validate the investments through the use of “economic impact” statements using “cost/benefit analysis.” Early on, practitioners of pseudo-economic development learned that the best way to inflate the benefits in a cost/benefit analysis was to call the costs “benefits” and include them together to generate one, huge staggering total. In effect, that is what OMB has done here; the structure of economic theory makes it confusing to penetrate this fallacy because economic costs are really foregone benefits.

What about the $3,100,000,000 in lost government services? Since this represents foregone benefits in the form of lost services, this is a valid line item, right? As a practical matter, the answer is “no.” We’ve already alluded to the problem; because government doesn’t usually charge a price for its services, we cannot assume that people really value those services “at cost.” (In a competitive market, we could, since the price of the produce would reflect the unit cost of its inputs.) The real value that citizens place on that foregone $3,100,000,000 might well be much lower. When we consider the periodic revelations about the inflated wages paid to government workers relative to private-sector workers, this becomes downright likely.

There is no getting around it. The OMB estimate of government shut-down costs is a mess. It is bureaucratic toadyism at its most craven. The professionals at OMB are forced to inflate the importance of government in order to preserve their own bureaucratic standing.

Having roasted OMB, we should at least sear the rating agencies on a hot grill for intellectual opportunism. By taking OMB’s mélange of figures to their extreme of absurdity and calculating aggregate totals of shutdown costs, S&P and Moody’s remind us why some people wanted to generously award them the lion’s share of blame for the Great Financial Crisis of 2008.

A Necessary Caveat

It is only fair to note that OMB’s list of cost components contained at least two reasonable entries. One of those assigned roughly $2 billion for “lost productivity” to the fact that furloughed employees received payment for work they never performed. In this case, the foregone benefit was the $2 billion worth of benefits that could have been provided had work actually been performed. Another $4 billion entry was made for tax refunds the IRS couldn’t make because of the shutdown. Since these refunds were presumably only delayed rather than cancelled, this entry seems mysterious. Moreover, it illustrates still another distasteful facet of the shutdown-cost calculation business. The income tax is bad government and tax refunds are sub-optimal behavior by citizens; blaming the shutdown for disturbing this system is like blaming America’s Founding Fathers for spoiling the beverage consumption of dedicated tea drinkers among the colonists.

The poor excuse for analysis offered by OMB and the parasitic commentators who tried to inflate its half-baked conclusions into an apologetic soufflé doesn’t really address the underlying issues of cost created by big government. On a purely short-term basis, it is possible to identify legitimate benefits foregone by shutting down government simply because government has a hand in practically every human activity. The real economic issue, though, is to outline the optimal parameters of government involvement in daily life. On that long-term basis, it is clear that most of what government does today should be shut down. The things that are worth doing can be done much better by the private sector, either for profit or by what the late Richard Cornuelle called the independent sector.

Government has morphed into an unhealthy wish-fulfillment mechanism for a sizable political majority encompassing the political left and most of the political right. Everybody sees it as a deus ex machina for realizing their cherished dreams and everybody suspends their disbelief of its motives and capabilities when their own interests are at stake. Meanwhile, the reality of government is that it operates for the advantage of politicians, bureaucrats and government employees, not for the citizenry at large. There is no private-sector analogue to this, but if there were it would entail private business being run entirely for the benefit of CEOs, middle managers and their employees, while the interests of shareholders and consumers were completely ignored.

Viewed in this light, the failure of the Keynesian economic paradigm – government spending as a supercharged elixir injecting vitality into the economy with its multiplier benefits – no longer seems inexplicable. It seems inevitable.

The Index of Leading Economic Indicators Makes It Unanimous

Just to confirm the unanimous verdict of the objective indices, the Index of Leading Economic Indicators rose in November for the sixth time in the last seven months. Leading up to this announcement, economic forecasters had been vying to predict the precise magnitude of decline in the fourth quarter. Whoops! Between gritted teeth, news commentators reported this development as a sign that business and consumers apparently “shrugged off the recent 16-day government shutdown.” For years, the political right has been accused of “wanting America to fail” because of its opposition to the Obama Administration’s policies. Now it is the political left’s turn. Never has good economic news been greeted with more chagrin and forced cheer by the Establishment.

Valediction for a Myth

The White House jumped on the bandwagon for bad economics with a resounding endorsement of the shutdown-cost estimates promulgated by OMB, et al. The Obama Administration has cemented its status as the realm where economic myths go to die. The best valediction for this myth of irreplaceable government was delivered, appropriately enough, by the venerable Keynesian economist John Kenneth Galbraith. “The ultimate enemy of myth,” Galbraith declared gravely, “is circumstance.”

It was “Mr. Keynesian Economist” himself, James Tobin, who sounded the keynote for Keynesian theory when he once asserted that “it doesn’t matter what you [in government] spend the money on; spending is spending.” Tobin intended to assert that even wasteful government spending will raise incomes and employment in a time of recession. If true, that would imply that cessation of government spending would curtail economic activity.

Wrong. We are now in the gruesome position of having to disprove each and every Keynesian nostrum, one by one, before we can regain some semblance of normality. The federal-government shutdown has not only failed to produce political disaster for Republicans, it has crossed off one more Keynesian fallacy on the road back from serfdom. Thanks to the Tea Party, another myth bites the dust.

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