Unintended Consequences Impact Everything
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Welcome to Money for the Rest of Us. This is a personal finance show on money, how it works, how to invest it, and how to live without worrying about it. I'm your host, David Stein. Today's episode 399. It's titled, Unintended Consequences Are Inevitable and What to Do About Them.

A couple of weeks ago, LaPro and I stopped in Phoenix on our way from Idaho back to Tucson. While I was walking that next morning, I saw a woman in the distance. She was walking very erect, pushing a wheelchair. Later, when I went into a convenience store and came out, she walked in. She was wearing a mask. She was homeless.

But she looked like she hadn't been homeless for very long. Her clothes were still very clean. She was very well-dressed. But she clearly had been pushing a wheelchair with her things in it, as you often see the homeless do. In Phoenix, rents have increased 30% in the past year. The vacancy rate for apartments is 3%. The average is 6%.

I didn't speak to the woman. I wanted to, but I just didn't. And she was coming in as I was going out. I was curious about her story because with rents increasing by that amount, logic dictates that the number of homeless is increasing because they can't afford those higher rents. In Metro Phoenix, overall rents have increased 80% between 2016 and 2021.

In episode 388, we looked at the massive increase in the money supply in the U.S. from a combination of

the Federal Reserve's Quantitative Easing Program, and government stimulus, the government, the U.S. government, running huge federal budget deficits during the pandemic with many of those funds going to help those that are down and out. An unintended consequence of all of that stimulus and money creation appears to be a rise in homelessness because rents have increased so much.

Why have rents increased? Low interest rates combined with stimulus led to more people being willing to purchase houses and to pay more for those houses. And as housing prices have gone up, the rent on those houses have gone up, and the value of apartments have increased, as has the rents on apartments. Higher home prices, higher rents, more homelessness.

Now, there isn't an official number of homelessness in the U.S. to confirm that the actual number has increased. The U.S. government does a point-in-time count every January counting the sheltered and unsheltered homeless. The most recent count was in January 2022, 2022.

But those numbers haven't been released yet. The count in 2021 only counted sheltered homeless as opposed to those that were out on the streets. And that was due to safety concerns with COVID. So we don't actually know, but anecdotal evidence suggests that a rise in rents is leading to an increase in homelessness. And those rents have risen because of QVC.

QE, low interest rates combined with large federal budget deficits. Unintended consequences are outcomes that were not expected when a particular course of action was pursued. When the federal government initiated stimulus payments, cash payments to citizens, the idea was not to increase homelessness. Unintended consequences can be both positive and negative.

Sociologist Robert Merton published one of the first comprehensive looks at unintended consequences in a 1936 paper titled The Unanticipated Consequences of Purposive Social Action. He suggested there were three major factors that led to unintended consequences. The first was just a lack of knowledge.

taking action and not realizing what some of the consequences would be. A second factor is error, just not really understanding the current situation or selecting a course of action that just isn't the right one. Or maybe it was the right action, but it wasn't executed properly. And a third factor that can lead to unintended consequences is

is an over-fixation on a particular outcome while ignoring potentially other consequences. An example of unintended consequences is price controls.

This is from an example that economist Ludwig von Mises would often give, and he was looking at price controls of milk. In Argentina, in the 50s, the government instituted price controls on milk to allow poor parents to be able to buy milk for their children.

By setting that maximum price for milk, there were some milk producers on the margin who previously could operate profitably at the higher price. But at that new price, there are some that just aren't able to make a profit at that price. And so they stop making or they stop producing milk. They dedicate those resources, cows, to something else, perhaps to beef, maybe cheese.

Within those lower prices or cap prices for milk, there's clearly more demand from parents who want milk for the children, but the supply is less. And as a result, not as many children can get milk because it's just not available at that set price. The government then might initiate price controls on other factors on the inputs that go into milk production. Maybe they put price controls on grain. There's further repercussions.

Economist Sanford Aikida discussed this when it comes to unintended consequences. There's often the first intervention, the action that's taken, and then there's a realization, well, we didn't want that to happen, an unintended consequence. And so then there are further interventions in order to correct what led to the undesired consequences.

Per Byland, in his book, The Seen, the Unseen, and the Unrealized, gives the analogy of a single change can cause a ripple effect in production, just like the waves around a stone thrown into a pond. There's just ripples. If they're unintended, we just don't know what they are, but it does cascade through the system. An example I saw this year is in Norway.

In Norway, there have been for numerous years incentives to purchase electric vehicles. The tax rate for electric cars is 50% less compared to a similar diesel car or one that runs on gasoline.

And in some places, you don't have to pay a toll if you're driving an electric car or the parking fee might be lower. In April this year, 74% of all new automobile registrations in Norway were electric vehicles. In March, it was 86%. Now, the government is thinking about adjusting those incentives because there's lower tax revenues for infrastructure projects, for the roads.

Transport Minister John Ivor Nygaard said, It's great that people use electric cars, but it's not good if people get into their cars and drive to busy urban areas instead of walking, cycling, or using public transportation. Any government action, be it a subsidy, tax relief, leads to incentives.

businesses and households, individuals choose to do things based on those incentives, and sometimes it leads to consequences that were not anticipated. Another study I saw was on guns, where the authors looked at 47 major U.S. cities that had instigated the right to carry a concealed handgun. The idea is that if more people have hidden handguns, that will reduce crime because there will be an incentive

for criminals not to act, not knowing if they'll get shot or not. What they found in this sample of 47 was the unintended consequence that firearm violence and firearm robbery increased about 30% in those cities. And the reason why is there was a 35% increase in gun theft.

With more people having guns, even if they're hidden, more guns got stolen. We also found that the police just weren't as effective in prosecuting crime. So here then we have an unintended consequence of legislation put in place to reduce gun violence actually led to increased gun violence. Another example was a study I saw by Sarah Papich.

titled Marijuana Legalization and Fertility. Many states around the U.S. have made it legal to use marijuana for recreational uses as well as for health uses. Legalizing drugs leads to more production, and so there was the anticipated consequence that the price of marijuana would fall, and it has, from about $2,000 a pound in 2016 to $1,025 a pound today.

Now, that has hurt some of the smaller growers of marijuana because it's been a more efficient market, but that's an anticipated consequence. What wasn't necessarily anticipated, according to this study, is that the higher use of marijuana has led to lower fertility rates, fewer births, because marijuana use lowers the likelihood of pregnancy.

through health effects on both women and men. It's just less likely to conceive. On the other hand, greater use of marijuana leads to more sexual activity. There are two forces there. There's more sex, but less conception. And overall, then, the birth rate has gone down about 3% on average. Not an anticipated consequence of marijuana liberalization.

Economists Karis Lambert and Christopher Coyne write that unintended consequences result from human action in complex and open-ended systems. The world is a complex adaptive system. So many different linkages, many which are unknown. And as actions are taken, as it cascades through the system, it leads to both positive and negative consequences.

They're inevitable. It's just the nature of complex adaptive systems and making choices.

There's incentives to make choices, and those incentives can be changed by the government, or it can even be changed by algorithms. I've been amused over the last year or so in looking at the algorithm for Instagram. The algorithm started favoring video content. So there's friends that we have that run a retail store that for years have posted pictures of models modeling clothing.

Now those photographs aren't getting the type of traction that they used to have. Now they have to do reels. In fact, the owner of the store is having to dance in front of the camera and do all kinds of different unique content, different than anything they ever did, in order to get engagement on social media, which is a big driver of their business. We're seeing this with YouTube.

On YouTube, it used to be if you subscribe to a channel, you saw their videos when they produced new videos. Not anymore. The algorithm won't necessarily show a video of someone you follow on YouTube. And that has led YouTubers to use more clickbait-like titles, more extreme titles in the personal finance space. A lot of titles of videos about catastrophes that are happening or could happen.

One of the things that leads to unintended consequences when we take an action is just not knowing what Jacob Viner, economist, calls negative knowledge. It's an awareness of the range and depth of what he describes as unconquered ignorance, just what we don't know. So then we take an action and then something happens that just wasn't expected, or governments take an action. Or here's the...

Pretty funny example in Japan. Their tax agency in Japan is asking people age 20 to 39 to come up with business ideas to revitalize the sake industry. Due to demographic changes, shrinking population, the pandemic, and just lack of interest, there's been a downward trend in alcohol usage.

The campaign is called Sake Viva. And the idea is, what can the government do to stimulate more drinking by the young? Because the government gets tax revenue from alcohol tax. And as a percent of the overall tax revenue, it's gone from 3% down to 2%. That's the action. Campaign to get more drinking. Will there be unintended consequences of that? The Japan Health Ministry says it

It isn't cooperating with the tax agency on its contest, but they're in regular close contact and they trust that the campaign will be mindful of what they say is the appropriate amount of alcohol consumption. But here the taxes are a disincentive to drink alcohol and then there's other demographic trends and now they're trying to fix that. Before we continue, let me pause and share some words from this week's sponsors.

Because of unintended consequences, just not knowing what the impact will be, a helpful approach is just to make small changes rather than making super huge changes. This is what philosopher Karl Popper suggested in his book, Poverty of Historicism. He describes it as a piecemeal engineer, and that piecemeal engineer knows, like Socrates, how little he knows.

that he can only learn from his mistakes. So he'll proceed step by step, carefully comparing the results expected with the results achieved, and always on the lookout for unavoidable, unwanted consequences of reform.

But that's not easy to do. Sometimes legislation, for example, has to be large. One of the most successful pieces of legislation in the U.S. was the Clean Air Act of 1970 that was again modified in 1990 to combat urban smog and acid rain. Most people would suggest the Clean Air Act has been successful when you look at the just

the lack of smog and particulates in the air. The air is just cleaner now than it was in the 70s. But that act didn't directly regulate greenhouse gases. And the Supreme Court ruled last year that the EPA didn't have authority to regulate greenhouse gases that can contribute to climate change. This year, just recently, this

This month, President Biden signed the Inflation Reductions Act.

which had very little to do with reducing inflation. It passed on party-line votes. Not one Republican voted for it. This legislation not only regulates carbon dioxide, but basically consists of subsidies to promote clean energy. It offers tax credits for renewable energy, assistance to keep nuclear plants operating, incentives to purchase electric vehicles, make home energy more efficient.

but it's subsidies. And there's some tax incentives, and there's actually some tax increases, including a 15% minimum corporate tax, excise tax on buybacks. They were going to adjust how carried interest was taxed for private equity managers. This was a topic that we looked at a couple of weeks ago on a Plus episode. But what was interesting is that

this legislation, it's a huge piece of legislation. There was no carbon tax. Where just three years ago, 3,600 economists signed a pledge that included 15 former chairs of the Council of Economic Advisors, more than half of whom served under Republican presidents.

and in that January 2019 pledge, they recommended carbon tax, which they described as the most cost-effective lever to reduce carbon emissions at the scale and speed that is necessary. By correcting a well-known market failure, the market was able to reduce carbon emissions

the market failure being the excess production of carbon dioxide that leads to climate change, a carbon tax will send a powerful price signal that harnesses the invisible hand of the marketplace to steer economic actors toward a low-carbon future. The idea was that carbon tax would increase every year and could lead to technological innovation.

and large-scale infrastructure development that would lead to an array of carbon-efficient goods and services. We've discussed carbon tax in the past when discussing climate change, and the benefit of a carbon tax is it is a tax at the business level, household level, and it provides disincentives.

It's very much a bottom-up adjustment and ideally would lead to more innovation. But again, this new legislation, it focuses more on other types of incentives, subsidies, for example, or other encouragement, which tend to be more specific, whereas a carbon tax is more general and then everybody just sort of figures out how to go about that.

Some that have argued against the carbon tax suggest by providing subsidies it can encourage innovation in areas that there just aren't adequate solutions yet, whereas a carbon tax was better if there's already existing solutions. I don't know.

Lambert and Coyne in their piece, this is actually a chapter from a book that I'll link to, individuals pursuing their own interest must coordinate with others. In doing so, they contribute to a broader order that is beyond the ability of human reason to design or fully grasp. This is the concept of emergence. And the idea then is if incentives are put in place at the

the individual, the household, or the business level, from that interaction will have an emerging order, what they describe as a broader order. It's very much bottom-up innovation as people adapt to incentives or penalties, that that can lead to a new order of things. But it could also lead to unintended consequences. Nothing is done without something unexpected happening.

happen. That's just the nature of complex adaptive systems. And so we have to decide, we have to take action and recognize unexpected things will happen. More unexpected things will happen, more unattended consequences, the bigger the action taken, which is why there's generally a temptation to act in a piecemeal manner and an incremental approach.

Take an action, see what happens, compare it to what we expected that would happen. This is what's sometimes known as a lean startup approach or just a lean approach.

that existing managers or companies have been doing for decades. Incremental changes focused in the manufacturing sector on waste reduction, quality management, continuous product improvement, learning, and that is a very effective strategy that Japanese manufacturers and other manufacturers have employed.

Some startups try to use that same methodology. They create minimal viable products. And the idea is to get interaction with the customer as soon as possible. It can be very effective, except that an incremental approach, either on the startup side or in just running an existing business, often doesn't lead to radical innovations. And I'll link to a paper that

that discusses that. But for something incredibly different and unique, sometimes you can't just do an incremental approach. You actually have to try something more revolutionary. Your customers won't necessarily tell you what they want because they don't know. Steve Jobs was very much a proponent of that. He says customers don't know what they want, so we're going to create something based on our own knowledge that we think they will like, but we're going to create it first and then we'll see.

Sometimes a startup's founders have a vision and they just have a better sense for what they think customers will want. Now, there can still be iteration, but sometimes it just isn't a steady improvement because the initial thing hasn't been created. In conclusion, then, unintended consequences are inevitable as individual actors make bottom-up decisions based on incentives, and those decisions cast through the complex adaptive systems.

Legislation and other changes that foster bottom-up action are often better in order to monitor for unintended consequences.

and to allow for positive unintended consequences to emerge as a new order emerges. People collectively acting individually lead to a greater order. This is what Adam Smith talked about way back in the 1700s in The Wealth of the Nation, The Invisible Hand. Individuals making decisions in their own best interest often leads to unexpected order and innovations and developments.

Sometimes those small changes aren't sufficient, particularly if you're trying to come up with something new, to come up with a radical innovation. In that case, things can be tried to see how they work out, always maintaining some type of buffer or margin of safety just in case they don't work out. We need to recognize, though, that unintended consequences aren't always negative.

Sometimes they're positive. We have to have the requisite humility to recognize that we just don't always know. And we do our best to try to make choices that minimize negative unintended consequences and try not to make things worse by constantly intervening. Admittedly, it's a delicate balance.

But it makes for some fascinating observation as we see things happen constantly that weren't expected, that were a surprise. And that's just part of living. It's part of investing, constant surprises, which is why we, stay humble, build up reserves and margin of safety for the ongoing stream of unintended consequences, both positive and negative, that we will see every single day. That's episode 399. Thanks for listening.

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