Bad Economics Makes Bad Policy

As I watch the Trump administration tear up existing contracts relating to infrastructure spending, green energy initiatives, and research projects affecting science and medical discovery, I can’t help but think about how antithetical these actions are to the objective of rooting out waste. What could be more wasteful than abandoning projects mid-stream, thereby bearing costs for which no benefits will be forthcoming?

Presumably, if a government truly wanted to cut waste, some measure of this loss from abandonment would have to be part of the calculus. Alas, not so. It should be patently obvious that this consideration is being ignored by Musk and Trump as they indiscriminately cut government spending and slash the bureaucracies charged with overseeing these projects.

In evaluating any candidate for termination, economists rely on the concept of present value. Present value is the worth in current dollars of a stream of future cash flows — i.e., what you’d have to pay today to get a prospective stream of benefits in the future. When you buy a bond, the price you pay for the bond reflects the current dollar value of the stream of future cash flows that that bond delivers while it is outstanding. The same applies to virtually any item that generates future benefits.

In the context of projects funded by taxpayers’ dollars, conceptually, we should be able to assess the present value of the future benefits and compare that present value to the present value of the projected costs. The project would be viable and attractive if the net present value (i.e., the present value of the benefits less the present value of the costs) were positive. Otherwise, the project wouldn’t be justified.

I’d expect most programs to require preliminary spending for planning, development, and infrastructure before the expected benefits can be realized. Thus, in the general case, it’s reasonable to expect costs to be front-loaded, while benefits might likely tend to be more evenly spread out over extended time periods. In any case, assuming a positive net present value at its inception, as time passes and a larger share of costs relative to benefits are realized in the early stages of the project, the net present value of remaining costs and benefits should normally be expected to be rising. Put another way, as sunk costs are expended, the project becomes increasingly attractive — not less attractive.

This concept of net present value is fundamental to virtually any economic decision, and it’s taught in introductory courses in business schools throughout the nation. It applies equally to public and private projects, and yet the Trump administration seems to be oblivious to it. The kind of net present value assessments that are appropriate are neither trivial nor easy to perform, and they’re complicated by the fact that they require placing values on prospective outcomes that may not be easily measurable. Nonetheless, if the objective is to cut waste, this kind of analysis is essential. The fact that it has been so blatantly lacking is testament to the fact that those making these decisions are ill-equipped to the task at hand and that they are way over their heads. Those of us who live here are sure to suffer from their ineptitude.

Given Trump’s demonstrated ignorance of the consequences of tariffs, his disregard for present value analysis doesn’t surprise me. I’m just disappointed that those in his inner circle — supposedly those with some measure of financial acumen — are willing to endorse his misguided economic policies despite the faulty economic logic underlying them. It’s hard to believe they don’t know better.