Government and the ‘law of unintended consequences’
From time to time, you may hear of something called the law of unintended consequences as it relates to economic decision-making. To the best of my knowledge, there is no such law in the dismal science. Rather, the “law” is simply based upon a concept called “opportunity costs,” which represents a fundamental issue in economic analysis.
In a nutshell, every time any of us (person, business or government) makes a decision to do something, we are also making a decision to not do some next-best alternative. So, as you decide to spend $20,000 to purchase a new car, an opportunity cost (the next best use of that same $20,000) is incurred. The hope is that when decisions are made, the benefits received from the choice actually made will be greater than the benefits that could have been (but won’t be) produced from the opportunity cost. In that way, our nation’s scarce resources (land, labor, capital and entrepreneurship) will be put to their best possible use in satisfying people’s wants and needs.
The so-called “law of unintended consequences” is the simple recognition that sometimes economic agents — people, businesses or government — may do a poor job of analyzing opportunity costs ‚and decisions may prove questionable, if not out-and-out detrimental. Pro-market economists often feel that government is most likely to make such blunders, as they establish public policy without fully considering the opportunity costs (unintended consequences) of their actions. A couple of issues have arisen recently and brought this “law” back into the spotlight.
The first deals with U.S. energy policy and the mandated use of ethanol in our nation’s gasoline supply. A couple of policy decisions, made at different points in time, require a proper blending of 10 percent ethanol (and in a few states 15 percent has been suggested) relative to the amount of gasoline produced. Another later law establishes actual ethanol production requirements, presumably leading to the minimum 10 percent blending. Either way, the government has dictated ethanol’s use to replace another additive of the past which polluted both the air and ground water.
In the U.S., ethanol is produced primarily through the use of corn, with some analysts estimating up to 40 percent of U.S. corn production must be directed to mandated ethanol production requirements. One potentially favorable outcome of this mandate is that it increases the demand for corn and, other factors held constant, increases the price of corn and aids some in the agricultural sector.
Opportunity costs? Consumers pay the price for the government mandate directly via corn-related products or indirectly through increased feed costs (with lower profits or bigger losses) for cattle and chicken ranchers. As well, at a time when output is depressed (as with this summer’s drought), food supplies suffer and the poor around the world may bear the true costs, so much so that other nations are now urging the U.S. to eliminate ethanol mandates.
Another recent policy suggestion, not yet implemented, is meant to help some underwater homeowners via eminent domain. Under the plan proposed by a for-profit company, local governments would seize (via eminent domain) mortgages of certain underwater homeowners and pay “fair market value” to the owners of the mortgage backed securities (MBSs). Then, with the help of the for-profit company (which obtains a fee), the local governments would arrange for new financing for the homeowners based upon the present (lower) property value. Sounds like a great deal, right?
Well, there’s that pesky notion of unintended consequences. Ignoring possible constitutional issues, who suffers in this scheme? Quite obviously, those who hold the MBSs could take huge losses depending upon just how great the differential is between the underwater value and the fair market value. And realize — knowingly or not — many of us could be those MBS holders via pension funds, 401(k) plans and the like. That could potentially reduce a source of income for impacted Americans and decrease spending. If this happens, employment could be reduced — with lower spending leading to less output and fewer jobs — thereby producing unintended consequences.
As well, if communities are willing to use eminent domain, lenders and purchasers of MBSs might withhold future financing to that area’s housing needs, decreasing demand for housing, driving down housing prices and reintroducing underwater mortgages back into the area.
In all of this, the so-called “law of unintended consequences” demonstrates that a potentially huge chasm can develop between good intentions and good outcomes in the world of economics.
Dr. James Newton serves as chief economic advisor to Commerce National Bank and is an auxiliary faculty member in economics and statistics at OSU-Marion and OSU-Newark. Dr. Newton’s views do not necessarily reflect those of Commerce National Bank or OSU-Marion/Newark.