Law of Unintended Consequences
One of the hardest things to try to explain to people when discussing various kinds of institutional or governmental policy is the law of unintended consequences. It basically says the policy can have effects that are very different than what one expects. History is full of examples, yet people continue to believe that the idea/policy is smart enough to prevent thousands or millions of people from figuring out a way to mess it up while imaginatively trying to better their lives. It shouldn’t scare someone from trying to change things, but steps need to be taken to measure the change in order to ensure that what was intended to happen is indeed happening.
Glen Whitman, an associate professor of economics at California State University, Northridge, wrote a very nice article on this topic, linked here. It is worth a read, as it explains an idea which can be difficult to explain in a nice, accessible way.
The article is also saved after the break for archival purposes.
from
http://www.econlib.org/library/Columns/y2007/Whitmanincentives.html
Slavery, Snakes, and Switching: The Role of Incentives in Creating Unintended Consequences
by Glen Whitman*
May 7, 2007
| In the developed world, we like to think of slavery as a bad memory. But slavery persists to this day, particularly in some parts of Africa, most notably the Sudan. Raiding parties steal children from their home villages and transport them for sale in slave markets many miles away. In the 1990s, when news of this ongoing tragedy came to the developed world, well-intentioned people formed charitable foundations that raised money for slave redemption—that is, buying people out of slavery. |
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| Did these charitable efforts do any good? Certainly, some people are free now who might otherwise of have lived their whole lives in slavery. But there is strong evidence to suggest that slave redemption made the overall situation worse. As journalist Richard Miniter reported in a 1999 article in the Atlantic Monthly, the high prices offered by relatively rich Americans increased the demand for slaves, turned the slave trade into an even more lucrative business, and thereby gave raiders an incentive to conduct even more slave raids. If not for the activities of Western charitable organizations, many of the redeemed slaves might never have been enslaved in the first place! |
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| How did the slave redeemers err? They focused on just one incentive (to release people already in bonds) while ignoring another (to capture more slaves). The sad result was an incentive scheme gone awry.
With just an iota of economics training, most people catch on to the importance of incentives. “Aha! To get people to do what we want, all we have to do is reward the good stuff and punish the bad stuff!” Alas, the world is not so simple. People don’t always respond to incentives in the ways you might predict. What distinguishes good economic thinking from bad is recognition of the subtle, creative, and often unforeseen ways that people respond to incentives. Ignoring the complex operation of incentives is a recipe for unintended consequences.
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| However, insurance companies have to raise premiums to cover the costs of the addition services—and then some customers choose to go uninsured because they can’t afford the higher premiums. As a result, they end up with less medical care, not more. The lawmakers who have passed mandated benefits laws and the advocates who lobbied for them apparently didn’t realize—or didn’t care—that insurance companies and their customers would not keep creating the same number of policies at the same prices. |
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In short, people often switch from one activity to another in response to changes in their incentives. Policymakers who fail to recognize the possibility of such “switching effects” invite unforeseen, and often unpleasant, results.
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| Abruzzi’s story may be apocryphal, but its mistake is not. Consider the case of gun buy-back programs. These programs aim to reduce the number of guns on the streets by having authorities buy them up. Cities with gun buy-back programs tout their success by announcing the number of guns purchased. It’s possible, however, that people will bring guns to town just for the purpose of selling them—after all, if the city paid less than the market price, gun owners would sell their guns privately. The real question is not how many guns are purchased, but how many guns remain on the street. And this is setting aside the difficult question of whether reducing the number of guns actually reduces violent crime. Since criminals presumably have the greatest need for guns—their livelihoods depend on them—they are probably the least likely to sell them. |
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| It’s easy to make fun of government, but private actors are not immune to using incentives in ineffective ways. Take the famous case of Lincoln Electric, a firm that had experienced great success in using piece-rates (instead of wages per hour) to motivate workers who made arc welders. Incentive pay for the production line employees worked so well, in fact, that the firm extended the policy by compensating secretaries based on their number of keystrokes. Eventually management discovered that a secretary had spent her lunch hour typing one key continuously. Private businesses do make mistakes, but at least they have a bottom line incentive to fix them. Lincoln Electric eventually rescinded the keystroke compensation plan. Gun buyback programs remain popular. |
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| In a classic article, Steven Kerr reflects “On the Folly of Rewarding A, While Hoping for B.” Kerr discusses a wide range of policies that do just that, in areas ranging from government to business to medicine and sports. Improperly targeted rewards and punishments abound. In some cases they are unavoidable, because the things we really want to affect are difficult to observe and measure. But awareness of the problem is the first step toward fixing it—or avoiding it in the first place. |
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| The key insight—which applies to all kinds of goods and services, not merely gasoline—is that people do not only make choices about prices and quantities. There are many, many margins of choice that people can exploit to improve their situations and to evade regulations.
If you stare at a supply-and-demand graph, it’s easy to imagine that the products in question—gallons of gasoline, doctor visits, back massages, or what have you—are easily defined entities with well-known and immutable features. In reality, any good or service consists of a bundle of characteristics. There are gasolines with various octane levels and fuel additives; apartments with various levels of maintenance and amenities; back rubs of various lengths and intensities. All of these margins can be adjusted. Likewise, the prices paid by consumers might appear to be simply defined amounts of dollars and cents. In fact, consumers pay for their purchases with a bundle of sacrifices: money paid directly to sellers, money paid indirectly in the form of agency fees and bribes, effort spent searching, and time spent waiting. These margins, too, can be adjusted in response to changing conditions. As a result, policymakers can find it difficult, if not impossible, to escape market forces. Policies that force down the official price of a good or service trigger responses that push down quality, push up other aspects of the price (such as bribes), or both. The important lesson for policymakers is that regulations will almost always have unintended consequences, because creative people continually find ways to exploit margins of choice that were not considered by the regulators. Take, for instance, the case of rent controls designed to make apartments more affordable. That such controls have led to a shortage of apartment housing in places like New York City is no surprise. More interesting is that the meaning of “apartment housing” has also changed. Landlords have reduced the maintenance level of buildings while cutting back on amenities such as free utilities, parking, and built-in appliances, thereby reducing the cost of providing the units. Meanwhile, customers pay for housing with more than just their rent checks; they also must pay “key fees,” bribes to resident managers, and exorbitant commissions to rental agencies just for the opportunity to view rent-controlled apartments. In short, people have dealt with housing regulations by adjusting the characteristics of both the product provided and the price paid.
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