In Defense of the Visible Hand, plus: How to Win the Nobel Prize in Economics

Liberalism (European sense) in one sentence? The state should not regulate citizens' behaviour and distort the workings of the free market unless there is a good reason to do so and the foreseeable costs of the intervention does not outweigh its benefits. Usually negative externalities of behaviour, such as damage done to the environment, count as good reasons.

Not everybody agrees, though. Writes Eric Crampton:

It's always dangerous to mess with the price system. Even if there are proven positive or negative externalities from particular types of behaviour, and even if you're careful about how you specify the legislation giving form to the tax or subsidy, there often will be unintended consequences.

He links to an article by Christopher Hayes which describes how US laws apparently meant to reduce the emission of greenhouse gases, 'which subsidize the use of fuel mixtures that combined "alternative fuel" with a "taxable fuel" such as diesel or gasoline' caused the paper industry to add diesel to their previously diesel-free fuel in order to collect government subsidies; the law hence causes the emission of more greenhouse gases by the paper industry.

Minor points first: 1. It does not follow that there is a net negative effect of the legislation; overall, it probably reduces the emission of greenhouse gases. More generally, let's not forget that laws usually have intended consequences! 2. The good news is that unintended consequences can often be observed and regulations can be adjusted accordingly. Here's a bit from the article that Eric Crampton doesn't quote:

If there's a cloud hanging over the elation in the industry, it's the sneaking suspicion that once Congress gets wind of this racket, it will shut it down. "The one comment I do get from people [in the paper industry]," says McClay, "is whether it's going to be rescinded or redrawn before the end game."

Investment analysts echo this concern. "We think there is some question as to whether this tax incentive survives to yr-end," a Deutsche Bank analyst wrote recently. "Most industry leaders would like to keep a low profile on this issue. Unfortunately, we think it is a material enough issue that it will draw attention."

So far, though, to the surprise of McClay and others, there's been not a peep from Capitol Hill. Allen Hershkowitz, a senior scientist at the Natural Resources Defense Council and director of its paper industry reform project, told me the industry wields significant clout in Washington and has benefited from myriad federal subsidies throughout its history, but that "this is really a perverse exploitation at the expense of the environment."

I called up the Senate Finance Committee, and a staffer told me they were "aware of the issue, and are talking with the IRS about the technical details. The committee intended the credit to be primarily for transportation fuel and plans to closely review the situation."

But even in the absence of such opportunities for correction, one should not be too worried about the visible hand's action. There is no rule which says that unintended consequences of note need to occur. And although a cursory look at textbook examples or economics blogs might suggest otherwise, unintended consequences, when they do occur, need not be negative. (Here's one example of a positive unintended consequence.)

There currently is no theory predicting how noteworthy the unintended consequences of a law will be or whether their net effect will be positive, negative or neutral. Devise a useful one and they're going to give you the Nobel Prize in economics. As they should: it would arguably be the most impressive and most relevant thing the social sciences have ever come up with. Don't bother writing about intended consequences, though: They usually show up.

In the absence of such a theory, it's back to the drawing board for opponents of government intervention in the face of negative externalities.