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.

Posted by Jim Newton on Aug 21 2012. You can follow any responses to this entry through the RSS Feed. Comments can be made below.