Friday, December 02, 2005

Unintended consequences

Economics makes a useful contribution to policy in demonstrating that when you start interfering in markets (if they’re working), you can not only get nasty side effects, you also often get the opposite of what you were intending to do. For example, putting price caps on products makes investing in producing those products unprofitable, cutting off the innovation that could bring down the prices of the products in the long run.

However, as we saw in the previous post (below), that is only the case if markets are working (and they often don’t). So – for example - economists say that we should remove the minimum wage, which would encourage firms to hire people, bringing down unemployment, boosting productivity, increasing profits and making products cheaper for everyone. Yay! In theory that might work, but because there’s so many other gremlins in the labour market, it’s unlikely to work that way in practice. One example: because of the way the tax and welfare systems are structured (essentially the working poor pay more tax than they should), if you reduce the minimum wage in Australia any further, people will earn less – after tax – than they would on the dole. So cutting the minimum wage would only make these people poorer and discourage people from working. So the real outcome is likely to be more poverty, more unemployment and more stress on the public purse.

A nasty example of this in an environmental context was reported in the last issue of New Scientist and it concerns using ‘biofuels’, renewable fuels made from such things as sugar (ethanol), palm oil or soybean (oil) that can replace diesel. According to the article:

THE drive for "green energy" in the developed world is having the perverse effect of encouraging the destruction of tropical rainforests. From the orang-utan reserves of Borneo to the Brazilian Amazon, virgin forest is being razed to grow palm oil and soybeans to fuel cars and power stations in Europe and North America. And surging prices are likely to accelerate the destruction.
The rush to make energy from vegetable oils is being driven in part by European Union laws requiring conventional fuels to be blended with biofuels, and by subsidies equivalent to 20 pence a litre. Last week, the British government announced a target for biofuels to make up 5 per cent of transport fuels by 2010. The aim is to help meet Kyoto protocol targets for reducing greenhouse-gas emissions.

Rising demand for green energy has led to a surge in the international price of palm oil, with potentially damaging consequences. "The expansion of palm oil production is one of the leading causes of rainforest destruction in south-east Asia. It is one of the most environmentally damaging commodities on the planet," says Simon Counsell, director of the UK-based Rainforest Foundation. "Once again it appears we are trying to solve our environmental problems by dumping them in developing countries, where they have devastating effects on local people."

Pretty depressing, considering the good intentions behind these laws. I guess the message is that in a world with globalised markets, you need to be even more careful when you use economic measures to help solve environmental problems. Economic measures can be powerful things.


Veggie Friendly said...

That's a really interesting post. My other environmental economist friend once told me that another side effect of some biofuels is that the eamount of enrgy it takes to produce them negates the positive effects from using them.

Is it called "the theory of second best" becauswe sometimes the optimal solution overall is the second best one, or because 'fixing' a problem can create these accidental side effects that you leave you with a second best outcome.

I think it's a cool idea, too. Also like the dots.

David Jeffery said...

I like to think that the 'second best' tag comes from Plato's Laws, where he talks about ideas for a 'second best' city. Wikipedia says this:

"The Laws is similar to and yet in opposition to the Republic. It is similar in that both dialogues concern the making of a city in speech, but different in that the one city is ideal, and the other a real, practical city. The city of the laws is described as "second best," whereas the beautiful city of the Republic is the best possible city."

The idea would seem to be that the one in the Republic is philosophically ideal but not the best once you take human nature into account, so the 'second-best' is actually a better idea.

Veggie Friendly said...

That is a great idea. I like that the practical city (second best) is still described in positive terms. Thanks!

David Jeffery said...

If you're interested, the Guardian (UK) has an article about the dangers of biofuels:,,1659037,00.html