Basic Tenets Part 6 — Beware of Secondary Effects!

Source: 4-block world (h/t Mark Perry)

As you know, I’m writing brief blog posts on these 8 guideposts for economic thinking.

1. The use of scarce resources is costly; trade-offs must always be made.
2. Individuals choose purposefully —
 they try to get the most from their limited resources.
3. Incentives matter — choice is influenced in a predictable way by changes in incentives.
4. Individuals make decisions at the margin.
5. Although information can help us make better choices, its acquisition is costly.
6. Beware of secondary effects: economic actions often generate indirect as well as direct effects.
7. The value of a good or service is subjective.
8. The test of a theory is its ability to predict.

Source: Economics: Private and Public Choice, | Gwartney, Stroup, Sobel, Macpherson

This is probably one of my favorite aspects of economics because people rarely consider the unintended consequences of certain policies. Especially politicians, political hacks, and worst of all: hacktivists.

Thomas Sowell put it this way in his book Basic Economics:

“One of the big differences between economics and politics is that politicians are not forced to pay attention to future consequences that lie beyond the next election. An elected official whose policies keep the public happy up through election day stands a good chance of being voted another term in office, even if those policies will have ruinous consequences in later years. There is no “present value” to make political decision-makers today take future consequences into account, when those consequences will come after election day.

Although the general public may not have sufficient knowledge or training to realize the long-run implications of today’s policies, financial specialists who deal in government bonds do.”

Bastiat put it a little more bluntly:

“There is only one difference between a bad economist and a good one: the bad economist confines himself to the visible effect; the good economist takes into account both the effect that can be seen and those effects that must be foreseen.”

It doesn’t matter the political party, listen closely to the rhetoric of folks and you’ll see that they promote economic policies that their constituents or supporters favor, but they won’t often delve into the weeds of the nitty gritty unintended consequences of what they’re proposing.

First, some definitions: direct effects result directly from the policy. More often than not, they are the focus of the policy (make type of energy X “cheaper”, or make socially frowned upon behavior Y more expensive.) Indirect effects result indirectly from the consequences of pursuing a policy. Indirect effects can be the intended goal of a policy, but that is not often the case.

A few examples:

Steel Tariffs, Import Quotas, and Buy American

Coming from Cleveland, steel is a sensitive topic for many of my friends. I’ve written about it in the past on this blog. President Bush pushed for (and imposed) tariffs on foreign made steel. Many Presidents and Congresses did so before Bush. Senator Brown (OH) is pushing for “Buy American” policies to require our military to use American steel in our military armor.

Both have unintended consequences that are rarely brought up in the debate.

First, import quotas and tariffs serve to make imported steel more expensive, thus making American-made steel more competitive or in some cases, cheaper by comparison. However, the overall price for domestically available steel increases as a result of that distortion. It also can cost jobs in other industries.

From my earlier post:

“President George W. Bush’s trade policies on steel would protect between 4,375 and 8,900 jobs — but at the expense of an estimated 35,000 to 71,200 jobs. Now, if you were one of those 35,000+ workers who lost their jobs, you might not realize the connection between tariffs or import quotas and why you lost your job.”

Similarly, Sen. Brown (who supports far more zealous action than President Bush) pushing for the DoD to buy American steel for its armor has unintended consequences. The first is it will increase the demand (artificially) for U.S. steel, which will likely drive prices higher. People wishing to use American-made steel (let’s say because it’s part of their made in America marketing campaign) now have to compete for that steel at higher prices, or buy imports.

Ironically, the result of making the military “Buy American” might be that it is more expensive for Americans to buy American-made steel goods, or it might lead to them buying more imported goods.

Of course, this is simplifying things — we aren’t taking into account our environmental regulations, tax rates, the effect of unions on wages, OSHA and other factors on the domestic steel industry, but you get the point.

Using food/feed as a fuel source:

There is nothing wrong with the idea of using alternate sources of fuel. My first landlord here in Virginia used to power his old Mercedes Station Wagon with frying oil. Sure, it led to flies being attracted to the door to my English basement, but it saved him money.

Agriculture is an area where there are tons of government-imposed distortions, from price controls, trade restrictions to subsidies. Name a type of food, and there’s probably some law that benefits domestic producers.

When it comes to using tax policies to provide benefits for ethanol production, there are unintended consequences. Corn is a scarce good (although we plant a lot more of it because of our ethanol policies) with alternate uses. Now, not all corn is the same, but corn is used in our food and it is used in the food of animals — from livestock to feeding your hamster. (Special note: since land is also scarce, increasing acreage for corn leaves less land for other crops.)

We also mandate that our unleaded gasoline use a blend of ethanol, in addition to providing lots of subsidies. Ethanol, like steel tariffs, import quotas, and “Buy American” mandates, is bad policy.

It doesn’t take a genius to recognize that our ethanol policies keep corn prices artificially high. Of course, people who use corn for more normal things — like feeding animals — dislike the policy very much because it imposes higher costs on them, and eventually, higher costs on you when you buy their products.

Ethanol (outside of the Midwest) is pretty well recognized as a bad policy decision by our government. This is because we’ve kept at this bad policy for so long we’ve seen the long-term effects.

Yet, Congress and the White House makes decisions every day that can have similar long-term effects, without having a debate on serious thoughts like these: “Hey, doesn’t this sound kinda similar to that whole ethanol thing we did?”  Sadly, our bad ethanol policies are not dead.

Conclusion:

It would be better for us to stop picking winners and losers. I have no reason to believe that bad trade policy and bad agricultural/energy policy actually lead to increased U.S. employment. Rather, the policies keep more people employed in favored industries, but with costs — lower employment in other areas and higher prices for some others.

Keeping goods and services at market prices, rather than artificial/distorted prices, is (in my opinion) better for the long-run. We cannot (and should not) make everything. Whether it’s fuel, steel, corn, cotton or sugar, our policies should be neutral. Similarly, we cannot subsidize everything, and it would be better to subsidize nothing.

Remember, whenever we try and keep out those “evil” foreigners trying to sell us goods at lower prices (the horror!), we reduce the purchasing power of others. This means they have less of an ability (and willingness) to buy our exports. You can imagine what that does to U.S. employment.

In short, the secondary effects of well-intentioned policies often retard, not grow, the economic pie of our country and the world.

Further Reading:

Econlib: Unintended consequences

Sowell: The Housing Boom and Bust

Cato: The Meaning of Hayek

Hayek: The Road to Serfdom

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