Nominee for MR post of the decade

Alex is the quiet half of the MR blog, but he usually makes up for his low quantity with high quality. His most recent post, The Law of Unintended Consequences, is in response to this post at the Freakonomics. Alex comes up with this definition for the Law:

The law of unintended consequences is what happens when a simple system tries to regulate a complex system. The political system is simple, it operates with limited information (rational ignorance), short time horizons, low feedback, and poor and misaligned incentives. Society in contrast is a complex, evolving, high-feedback, incentive-driven system. When a simple system tries to regulate a complex system you often get unintended consequences.

The Law should make us hesitate to invoke the so-called Precautionary Principle that I wrote about a couple years ago. The Principle would have us do “something” about climate change because even though there’s great uncertainty about the science of climate change, there’s a substantial chance of great harm if we do nothing. The Law, though, pushes back on the idea of doing “something” by suggesting that “something” will have unintended side effects.

The NYT piece also got this reaction from Andrew Gelman and someone over at his place has this great take on the Law:

I usually think of the law as a normative one: if you propose a policy to do X and use only the direct consequences of X to motivate your decision, you will have overestimated the effect of X by ignoring indirect effects. The reason the expected effect is always counter to the direct effect is that the economic incentives must work in the other direction — otherwise you wouldn’t have needed to impose X in the first place. Thus, the ingenuity of people attempting to follow the economic incentives underlying the problem will always frustrate, to some extent, the direct effect of what you’re trying to do.

The Law suggests anything we do can have significant negative side effects. For whatever reason, incentives are aligned in the economy towards emitting lots of green house gases. Unless we address all of those incentives directly, Andrew’s commenter suggests we expose ourselves to the potential for negative unintended side effects.

How to address incentives directly? Balance policy towards pricing green house gas emissions (e.g. CO2 tax) and away from regulations (e.g. CAFE standards).

3 thoughts on “Nominee for MR post of the decade”

  1. You’d still run into unintended consequences, though I doubt they would cause problems as big as the ones you could fix with this.

    Fuel ethanol is a decent example. It’s closer to CO2 neutral as fuels go, but there are major social and environmental consequences attached to diverting food crops to fuel production.
    (Then again… the market for the stuff would probably collapse without federal support…)

  2. That’s why subsidizing ethanol fits more on the regulation side of the scales. I’m for going to the source of the problem and the source is the fact that emitting CO2 is too cheap. By directly making it more expensive (with a tax or a cap and trade setup) people will be incentivized to stop using it as much.

    But I realized this doesn’t release from the law of unintended consequences… someone has to decide what the “right” price for CO2 is. Prices aren’t usually set by fiat (except for money) and there’s opportunity for someone to muck it up when they set the price. Interestingly, I think cap and trade programs suffer less from this problem than carbon taxes. Taxes, by standard economic theory, are more efficient than the cap and trade program because they’re less distortionary. This makes me think the standard theory may to reconsider unintended consequences.

  3. I agree – it’s almost impossible to reach consensus on the effects of a given kiloton of CO2 in the atmosphere. The feedback you expect a market to provide comes decades in the future.

    “there’s opportunity for someone to muck it up when they set the price.” – doesn’t this hold true for all taxes?

    You’re looking to nudge economic activity onto different, cleaner tracks. Figure out a taxation plan that will encourage this in a workable time frame. The rate that accomplishes this for you is the “right” price.

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