Sunday, September 12, 2010

Opportunity Costs

I've reluctant to write this because I think the way of thinking I'm going to argue for here is depressing. It will make you think that you're having less impact on people's lives--which gets distorted into feeling that you are less important. That is most people's visceral reaction. But the upside is that when you use this method to count costs and benefits you (should) be able to better limit costs and create benefits.

Let me start with a story. Angela held a fundraiser at her high school. She and her friends sold 500 cookies for $1 each after school and then sent the money to an NGO that used it to buy 50 children anti-malaria bed nets. Bill wanted to do more. Fundraisers at his school were never going to generate more than a few hundred dollars. But he noticed that there was a competition for high school students to propose a way to "Do Good" and the winner would get $5,000. Bill wrote a proposal to use the $5,000 to buy 300 nets and use the rest to pay to fly to Ghana and distribute them. He won the grant in a close vote over a proposal to spend the money deworming children in Ghana.

Who did more good?

Bill got 300 people nets. Angela only got 50 people nets. Isn't it obvious? No.

If it seems like the statement about the number of nets is the end of the story then you've fallen for one of the most pervasive problems in debate. That statement just listed the benefits--and completely ignored the costs.

And in this case that makes all the difference. The real cost of something is the value of what would have happened otherwise. If Angela didn't organize the bake sale she might have spent the extra time playing volleyball. She also might have prevented the Girl Scouts from selling cookies that today. Compared with the value of saving a (many?) lives, those costs are negligible so maybe it's safe to ignore them.

Bill, though, caused the proposal for deworming not to get funded. The deworming plan was probably of comparable value (perhaps more, perhaps less) meaning that while Bill "saved" perhaps 2 lives he also caused 2 lives not to be saved. The benefit was 2 lives, the cost was 2 lives, and the net benefit (benefit - cost) was nothing. Bill's plan may have done nothing make the world a better place, while Angela's almost certainly did.

Angela, by construction, did more good.

That story is just meant to be an example. Of course it's fictional. And of course the assumptions matter. But it's illustrative. Whenever you apply for a grant you're causing someone else not to get it. The net benefit is only the good from your proposal minus the good of the one that would have been funded. If you open a Fair Trade store right next to another store, and you decrease the business of your neighbor by $5,000 a month while only doing $7,000 yourself, then you've only netted $2,000 in Fair Trade sales for the world. (Of course the distribution of the money could be important too--maybe your suppliers are more desperate and benefit more.)

Too much of the time we don't think at the margin.

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