April 3, 2023
Over at Marginal Revolution, Alex Tabarrok posts a delightful little sketch:
A highly recommended visual for your Econ 101 courses. It’s from the fascinating, Sketchplantations, which “explains the world one sketch at a time.”
As Tabarrok correctly notes, unintended consequences are a, well, consequence of interacting in complex, rather than simple, systems. See here for more on this important distinction.
And more from MR:
Examples abound:
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A policy of suppressing forest fires that goes on to cause even greater fires.
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An attempt in Bogotá to reduce traffic by restricting who could drive each day based on licence plates that led people to circumvent the policy by buying more cars.
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More open workplaces that cause people to behave more privately.
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Elimination of predators that leads to the proliferation of grazing animals and a reduction in diversity.
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The effects of literally any dam built anywhere.
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What happens when you change software.
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Or social distancing policies that results in outdoor natural spaces being crammed with people at weekends.
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And on, and on.
Often, as with some of these, the outcome can be the opposite of what you intended, known as the cobra effect.
Where, exactly, do unintended consequences (Henry Hazlitt calls them “secondary consequences”) come from? Unintended consequences need better microfoundations.
I submit that if we’re talking about markets, public policies might be grouped into two buckets.* In a.) public policies curtail the “gains from trade” and in b.) they create new “gains from trade.”
In the first bucket, people devise workarounds to seize the gains from trade they were enjoying before. A classic case of “a.)” includes all the pathologies we observe under rent control. When rent control reduces the gains from trade that buyers and sellers were seizing, they devise workarounds like under-the-table-bribes. Those are the unintended consequences of which economists ceaselessly warn. Of course, what these workarounds will be, in any given instance, isn’t something that can be known ex ante. Third parties aren’t privy to the knowledge, constraints, and opportunities that market participants face.
In the second bucket, public policy may create new exchange opportunities that don’t have the same welfare consequences that market exchange opportunities have. “Cash-for-clunkers” is an example of public policy creating a new exchange opportunity. In this bucket, we find the Cobra Effect, which is particularly interesting because it goes beyond your garden variety unintended consequence that you typically find in the first bucket. The Cobra Effect emerges when public policy positively encourages the thing it was ostensibly intended to suppress. For more on the Cobra Effect, see these papers by David Lucas, Ennio Piano, and myself.
For more on unintended consequences, see this eminently readable primer by Chris Coyne and Karras Lambert.
As they put it in their introduction:
“The term “unintended consequences” typically carries a negative connotation, but there is no reason unintended consequences cannot be harmless or even recognized as desirable by the actor. Adam Smith famously noted the positive unintended consequences of commercial action in a market setting in his famous passages invoking the “invisible hand.” Smith (1776, p. 456) argues that in a market, an individual often make decisions about what to buy or sell only with self-interest in mind, yet nevertheless these exchanges “promote an end which was no part of his intention.” Far from considering the “unintended” aspect of the mutual betterment following voluntary market exchange as troubling, Smith recognizes that an individual acting out of self-interest, “frequently promotes that of the society more effectually than when he really intends to promote it” (p. 456). After all, as Smith (p. 27) writes, “It is not from the benevolence of the butcher, the brewer, or the baker, that we expect our dinner, but from their regard to their own interest.”
And:
“Although the magnitude and scope of consequences from the private action of an individual will tend to be limited, governmental actions can more easily generate more systemic effects, by intervening in the price system or legal institutions, which more directly affect all individuals in the society in some way. Perhaps for this reason, the academic literature on unintended consequences tends to deal with the negative unintended consequences of government interventions.”
Coyne and Lambert draw on a host of colorful examples. Price ceilings, the minimum wage, the Peltzman Effect, Prohibition, IP, and foreign aid illustrate the “dynamics of interventionism.” In fact, that topic is the primary theme of this survey piece. I highly recommend the paper to anyone teaching public policy or the economic way of thinking more generally.
*I don’t want to rule out unintended consequences stemming from policies, such as three-strike-laws, that don’t concern markets directly.