Econ 101
This post comes under the sub-section Econ 101. Under Econ 101, I try to cover some basic economics concepts that will come handy in public policy discussions. We won't cover economic theory exhaustively, there are many textbooks that can do this better. We will be focussed on developing an economic way of looking at the world.
You Can't Do Just One Thing
Growing up, I was very fascinated by the idea of prayer, specifically asking god for favours. If I pray for protection while I'm driving, I'm not just asking god to help me drive well. I'm asking god to help every other driver on the road as well. In fact, I'm asking god to help with the concentration, temperament, and mood of thousands of people on the road. These people on the road, and their mental state is dependent on the people in their lives, whose mental state is in-turn dependent on other people in their lives. When we think about it, this is a large number of people already. If we go on, this might cover an even larger number of people and eventually the entire population of the world. So my simple supplication to god to protect me on a drive is basically asking god to do an infinite number of things for an infinite number of people who are dead, alive, or about to be born. So my desire for protection, if answered, affects a lot of people. Isn't that something?
What I am trying to say is that everything is connected, and you can't just do one thing. Like climate scientists say, when a butterfly flaps its wings in the Amazon forest, it causes rain in some other part of the world.
Policy is a little like prayer. What you intend through your policy may not be the only outcome it produces. When you introduce a policy hoping for a simple outcome, it sets off a chain of events. Not all events in this chain may be favourable for you. Some of them may even be counterproductive. Welcome to the concept of unintended consequences in economics.
Invisible Hand
In economics, the law of unintended consequences says that actions of people—and especially of governments—always have effects that are unanticipated and/or unintended. This is similar to the metaphor of the invisible hand introduced by Adam Smith. According to him, beneficial outcomes for all arise out of the accumulated self-interested actions of dispersed individuals, even though none of them intends to bring about these outcomes. As if they were led by an invisible hand. Adam Smith was referring to positive unintended consequences here. But they are not always positive.
Every policy will have winners and losers; every policy will have intended and unintended consequences, desirable and undesirable outcomes. As economists or policymakers, we can't wish this away. But as Frederic Bastiat said:
Between a good and a bad economist this constitutes the whole difference—the one takes account of the visible effect; the other takes account both of the effects which are seen and also of those which it is necessary to foresee.
But we rarely talk about this. Instead, we are quick to demand new laws from the government. We want the government to solve a multitude of problems. This is because we are plagued with what behavioural scientists call short-termism. We are all wired to ask for and make decisions based on outcomes expected in the near future. If marijuana is bad for your health, ban it. If car emissions are causing pollution, introduce an odd-even scheme. But the consequences, especially the unintended ones, manifest in the long term. The marijuana ban creates a black market for the product where unhealthy versions and amounts of it get bought and sold. Odd-even schemes make people fake their licence plates or buy more cars, worsening emissions. So the government laws we are quick to demand for the problems we see around may end up creating bigger problems than the ones we were trying to solve.
Unintended vs Unanticipated
Every policy, in fact every action, has unintended consequences; this must be common sense for anyone aware of social systems. But the good news is that these consequences can be anticipated and accounted for.
For example, a price cap on a good may be a necessary policy move. But basic economics helps you understand that this will inevitably lead to shortages. Similarly, a price floor leads to surplus. But not all policy scenarios are so straightforward. When it's not straightforward, pilot projects can be run, for example. This is to understand how the project affects a small number of people before scaling it up.
Another way one can trace unintended consequences is to trace the chain of incentives. Every policy has an incentive mechanism wired into it. But it is important to ask questions like: how do these mechanisms manipulate the existing incentives of people directly and indirectly affected by the policy and others who are in some ways connected to them? When we trace these incentive chains, we see some of the ways in which our policy could take some unexpected twists and turns.
India's Tryst with the Unintended
After India's independence in 1947, we followed a strict trade policy with a lot of import bans to protect our homegrown industries. This era made many industries uncompetitive, most products unaffordable for the common man, thriving black markets, over-extended and hence corrupt government institutions and much more - all unintended consequences. When we opened up our markets in 1990s, one might have thought that the policy makers learnt their lesson after decades of bad policy thinking.
But no! Recently, we have come up with a ban on imports of laptops, PCs, and tablets. The stated objective of this policy is to improve domestic production. But the unintended consequences are obvious. For starters, the laptop, PC, or tablet manufacturers in India, without having to compete with international players, will lose out on quality. This would mean that the thriving IT industry in India, for whom quality computers are very important, will have to either settle for less or find a way around this policy. To address this, the government would have to come up with another policy preventing the IT industry from doing whatever they have planned to go around the policy. That, again, will have its own unintended consequences. Are these consequences so hard to anticipate? Not at all, given our history and the lessons we should have learned.
But the common sense that policymakers need to possess to anticipate these unintended consequences is not so common after all. Or maybe it's just public choice theory and it's realities at play here.
Homework:
Read this article to see some examples of unintended consequences.
Read this article to understand the chain of unintended consequences unleashed by policies around minimum support price in the farm sector in India.
A Note for OPW Readers:
To catch up on previous posts that you may have missed, visit OPW archive.
Every week I post some reading links at the OPW page. These posts will not reach your email even if you are a subscriber. If you are interested in getting some policy related readings under your belt, check out the reading links section at OPW.
I would like to hear from you. Write to me at onepolicyconceptaweek@gmail.com.