Friday, February 20, 2009

Killing the Economy With Good Intentions

The Constitution should require entrance exams for elected public office. Too many Congressmen, for example, do not understand the basics of economics, and yet they throw themselves into "fixing" the economy or using economic policy to remedy what they see as social ills.

One basic principle of economics and of public policy is the so-called law of unintended consequences. Rob Norton, former economics editor at Fortune magazine, explains it this way:

The law of unintended consequences, often cited but rarely defined, is that actions of people—and especially of government—always have effects that are unanticipated or unintended. Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it. …

Most often, however, the law of unintended consequences illuminates the perverse unanticipated effects of legislation and regulation. In 1692 the English philosopher John Locke, a forerunner of modern
economists, urged the defeat of a parliamentary bill designed to cut the maximum permissible rate of interest from 6 percent to 4 percent. Locke argued that instead of benefiting borrowers, as intended, it would hurt them. People would find ways to circumvent the law, with the costs of circumvention borne by borrowers. To the extent the law was obeyed, Locke concluded, the chief results would be less available credit and a redistribution of income away from “widows, orphans and all those who have their estates in money.” (Concise Encyclopedia of Economics)

We have seen this in the current housing/credit/economy crisis. Well meaning Democrats pressured Fannie Mae and Freddie Mac and banks in general to make housing loans to poor people who could not afford houses. Banks developed loan products that in turn attracted people of all sorts to purchase them. What we are now calling "toxic loans" flooded the system. Housing demand shot up, and then home prices followed, creating a price bubble. When the bubble burst, as inevitably it had to, the collapse was systemic and catastrophic. Here we are. Good intentions. Bad policy. Unintended consequences.

Iowahawk's adaptation of Margaret Bourke-White's 1937 original

It's the poor who pay the price for ill-advised government "help"

A "must read" on this subject is The Economist's View of the World by Steven Rhoads (Cambridge, 1985). This University of Virginia professor explains what basic economic concepts people people need to understand in order to be effective public servants in the modern world. He then brings political wisdom to economics, explaining how a fuller, political perspective needs to supplement the economist's understanding of human affairs.

1 comment:

Anonymous said...


What somewhat amazes me in this "mortgage" crisis is that no one, in our out of government, seems interested in canceling out the Community Re-investment Act that started the ball rolling.

I worked in the printing industry for many years. One thing I used to try to teach my young managers/supervisors was that hiring was at best a 50/50 operation. The more important problem wasn't hiring someone who didn't work out, but allowing the problem to continue without prompt corrective action.

The idea that we are trying to concoct all these complex financial band-aids without first cleaning out the original wound, is sophomoric.