Economics 101

How Do You Limit Unintended Negative Consequences?

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Whether you liked economics class in school or not, if you want to be a good steward of God’s resources, you need to think like an economist.

Maximizing the potential of our resources and not wasting what God has given us—materially, talent-wise, financially—is what we mean when we use the word stewardship. This boils down to making choices, which is the work of economics, too.

Thinking like economists means we must look past our hopes and good feelings when making decisions in the public and private spheres. We need to understand the results of our actions and how they may affect us, others, and our communities.

Consider the Long-Term Consequences

With every decision, we can create long-term consequences. The consequences can be both positive or negative. Negative consequences happen less in our decision-making about our personal property because we know that we usually bear the costs of our actions in this area.

If I decide to buy a house in a certain neighborhood, I will likely spend many hours deliberating the potential long-term effects of that decision. Is new infrastructure planned for the area? What is the quality of the schools? Where’s the nearest grocery store? Is the crime rate on the uptick? These and many more questions would run through my mind. And once the house is mine, I have to bear the consequences—or move.

This is why property rights that are well-defined and protected are so important. If you didn’t purchase or don’t own an item, be it a smartphone, a car, land, or a home, you will not tend to it or care for it in the same way that you would if you owned it.

In the arena of public policy, things are not as simple. Politicians and policymakers are also motivated to make decisions, but unlike my example above, they often do not bear the cost of their decisions because they aren’t personally connected, through ownership, to the item they’re making decisions about. When we aren’t required to be fully accountable for our decisions—to bear the full cost—we lose incentives to make the best decision possible with the information at hand.

Why Price Controls Seem Right

The longest-standing historical example of imposing a decision but not bearing the consequence is in the area of price controls.

Economist Henry Hazlitt, in his article “Can We Keep Free Enterprise?”, tells us:

The record of price controls goes as far back as human history. They were imposed by the Pharaohs of ancient Egypt. They were decreed by Hammurabi, king of Babylon, in the eighteenth century B.C. They were tried in ancient Athens.

price control is a policy that sets a limit on the ability of a price to fluctuate to its natural level. It is often used as a policy to prohibit a price from becoming “too high.” I think it is important here to remember F.A. Hayek and his insight into the knowledge problem, which is why I use quotation marks around the phrase “too high.”

Price controls are often implemented with good intentions. Policymakers and politicians look at the world and say, “I think rent in New York City is too high.” So they implement price controls with the intention of making life easier for people who need to rent apartments in New York City. But the results are anything but good. They actually make life harder, less productive, and less efficient than it would have been.

Let’s unpack this a bit. There are some obvious reasons why rent in New York City is higher than rent in Columbus, Ohio. Mainly, New York City has the highest population density in the U.S. with over 27,000 people per square mile. Columbus has only 3,600 per square mile. Based on this difference, it’s hard to imagine why the rental properties should have similar prices. Scarcity of land is the most pressing issue when it comes to housing, office space, etc.

This is a simple example of demand being great relative to the supply. When this happens, the price rises. The price is the only mechanism the market has to allocate resources, and it’s quite efficient. If we don’t let prices move, we curtail the dynamic market process, and we will inhibit the most efficient allocation of scarce resources.

When policymakers look at this situation and move to impose a maximum price on the rent, they think they are making life better for the people who rent apartments, but are they?

Why Price Controls Get the Incentives Wrong

The most significant consequence of rent controls is that they distort incentives. Think of the person who owns an apartment building. If the natural market price is $2,700 per month and rent control takes that price down to $950, what happens? What would you do as the building owner? Most likely you would not be able to afford to maintain that building. Perhaps you can’t fix the stairs, or keep up with fire and building codes, or you have no one to fix leaking sinks. So, this policy has negatively altered the incentives and the ability of the property owner to serve his customers.

Thomas Sowell, author of Basic Economicswriting on rent control, notes:

In short, a policy intended to make housing affordable for the poor has had the net effect of shifting resources toward the building of housing that is affordable only by the affluent or the rich, since luxury housing is often exempt from rent control, just as office buildings and other commercial properties are. Among other things, this illustrates the crucial importance of making a distinction between intentions and consequences. Economic policies need to be analyzed in terms of the incentives they create, rather than the hopes that inspired them.

God calls us, through stewardship, to fully understand the incentives that will result from policies we support. What sounds good doesn’t always turn out that way. Thinking like an economist can help us better see the unseen consequences, and better align our intentions with actual results.

Editor’s Note: On “Flashback Friday,” we take a look at some of IFWE’s former posts that are worth revisiting. This post was previously published on Nov. 14, 2017.

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