Economic efficiency
In last week’s column I concluded the series of columns commemorating the 30th anniversary of the Third World Debt Crisis (TWDC) and addressing the performance of Guyana’s public indebtedness since then. The focus has been on the period since 2006, for the reasons previously given. I also took the opportunity last week to introduce the test for economic efficiency that should be used when evaluating the soundness of government policies, programmes, or investments (projects). The example I used to illustrate this was the Delta Airlines’ pull-out from the Guyana market, and the authorities’ public response to it. I urged for efficiency’s sake that the standard of the best possible alternate use of Guyana’s resources ought to underline all government spending.
Surprisingly that column has evoked numerous requests for me to amplify. Readers have frankly admitted that the government/authorities had bamboozled them when referring to all the plausible benefits which could flow from the economic activities “opposition critics” were unfairly tearing down. In exchanges with these persons, I soon recognized that their being fobbed-off by government/authorities was basically due to the consideration that the “critics” of the government projects had failed to establish what standard of economic efficiency they were using. This omission is not deliberate, but reflects a wider lack of public appreciation about the impact of scarcity on choice, in situations where everything is not possible.
As a prelude to the presentation of the 2013 annual Budget I shall discuss in coming columns how readers might best engage issues of public investment management in Guyana. Hopefully, this would serve to reduce both the noise and nonsense prevalent in ongoing public discussion of various state investments, including those in sugar, Amaila Falls, and the Marriott Hotel.
First principles
For this purpose, it is important to start with a basic understanding of those first principles that underline best-practice assessments of government spending and economic efficiency. The first of these is that Guyana (like all other countries) does not possess unlimited resources. Indeed, if this were the case the country would be positioned to satisfy every need of every citizen! Unemployment, poverty, homelessness, hunger and squalor would be banished from our midst. Unfortunately, not only do we have limited resources, but because of our relatively small size on a global scale (whether in terms of population, geographic area or endowment of natural resources) Guyana faces greater resource constraints and limitations than the vast majority of nations. Our limited resource base therefore operates as a constraint (economists call it a ‘budget constraint’) on what we can do. Alongside this constraint (or scarcity), however, the country as a whole (its citizens and leaders), have goals and desires that can never all be met, as these are unlimited. Further some of these take time to implement as with building a new school, health clinic, or farm.
The result, therefore, of limited resources (scarcity) juxtaposed to unlimited desires means that choices have to be made in order to determine 1) what desires should or should not be met, and 2) in what order or sequence these are to be satisfied.
Opportunity cost
The implication of this situation is that the choice of every purposeful economic activity undertaken by the government has to be situated in the relation of scarcity (constrained or limited resources) and unlimited desires. In this relation, the true or real economic cost of every choice of purposeful activity undertaken by government is the next best activity the country has to forgo in order to be able to implement a chosen activity. Economists refer to this as the ‘social opportunity cost’ of government spending. This concept must be distinguished from the financial accounting costs that are routinely given by prices in private markets for private businesses.
The subtlety of the notion introduced here is revealed in the costing of labour. To a private business the cost of labour is its payment in the market (wages/salaries and benefits) for its employees. However, in an economy like Guyana, with structural long-term unemployment, some economists might well argue that, the true economic (opportunity) cost of labour for a government project, should be zero or close to it. Why is this the case? Simply put, it is because the next best thing available to employed workers is unemployment. If this is the case, then from the social standpoint (Guyana’s) it costs the country nothing to employ labour if the alternative labour faces is joblessness.
To sum up, from a country standpoint the social opportunity cost of government spending is the loss occasioned from being unable to pursue the next best available government spending option. To be very, very clear the next best alternative might well yield a positive social return on the investment. It does not have to make a loss. However, to be rational and efficient the chosen public investment (project) must perform better than the next best choice of investment (project) the government foregoes.
Conclusion
Next week I shall introduce the second fundamental principle readers should grasp. There I shall note that, while it is normal for private investors to seek to maximize benefit through obtaining the highest possible private profit, this is not by any means the case for public investments. In seeking to assess the merits or otherwise of a proposed public investment (project) the criterion used to determine this is not the same as for private businesses. Furthermore, while in private markets investments are normally evaluated against their private profitability (based on the costs and revenues of the business based on market prices), for public investments this is inadequate. Society as a whole would put a different valuation on benefits than that obtained from prices in private markets. Worse yet, some of society’s benefits are not even traded in private markets; for example, noise reduction, reduced traffic congestion, accountability, and empowerment.
Next week I shall continue from this observation.
