I don’t think the British had cobras roaming the street. Wild guess, I know, but it probably explains why they were so surprised to find them in Delhi during the colonial period. One can hardly blame them for wanting to remove them.
So they came up with a simple plan [1]. Have the citizens kill the cobras, show them the skin of the cobras as proof of the kill, and they would be given a payout for their work. It sounds ingenious. You don’t have to hire a lot of people to hunt cobras – imagine how much you’d have to pay them – you’d have more eyes on the problem, and you have the community involved.
Just one problem. The population of cobras went up.
What happened was that a part of Delhi’s population started to farm cobras. As smart as the bounty scheme sounded, Delhi’s population was even smarter. The citizens of Delhi figured out that the cobras had a dollar sign attached to them, so why not make more of them? So, a portion of Delhi’s population started breeding cobras. Of course, the British panicked and ended the bounty scheme. And in response the population released the cobras, because if they no longer have dollar signs attached to them, what use are cobras?
There is an important lesson to be learned from this anecdote: public policy is hard. What the British did not realize is that they weren’t playing a game against the cobras, they were playing against the entire population of Delhi when they initiated this scheme. A game that is much harder to win. This is not an argument against all public policy, but it is important to remember that when you are fighting against the self-interest of many other people, you better be ready for unintended consequences.
Consider the case of the UN trying to mitigate a coolant gas [2]. The structure was – again – simple. Companies could earn one credit if they reduced the amount of carbon burned by one ton. But if they reduced the use of this coolant gas by one ton, the companies would get 11,000 credits. The credits could then be sold for millions of dollars a year. The reason the coolant gas was worth so much more was because it was much worse for the environment. So what do the companies do? They use more of the coolant gas. This way, they could start reducing their use of the coolant in exchange for carbon credits, which turned into money for them. A colossal waste of money for the UN, and the environment suffered, even though the UN was actively trying to do the opposite.
A different version of the unintended consequences problem [3] occurred after the Exxon Valdez oil spill of 1989. In order to prevent such spills from happening, states introduced legislation that placed unlimited liability on such operations. This meant that big companies with the most modern technology no longer performed services there, leaving these tasks to be completed by smaller, less safe operations who would more readily accept that risk.
Of course, we all remember the problems of price control from Economics 101. If a certain good starts becoming very expensive, then the public complains, politicians promise to control the prices, and the supply of that product goes down, since there is no longer any incentive to produce it. The government tries to create a policy to make a good more readily available, but it actually becomes harder to obtain, because fewer people are offering it.
This phenomenon exists in more popular government policies as well. Take social security in the US for example: because everyone is guaranteed a cheque issuing a basic standard of living, people started to save less privately [4]. This means there are less savings available as a whole, which in turn reduces investment, slowing the economy and growth of wages.
Of course, this doesn’t mean that all public policy is a lost cause, or even that we shouldn’t keep these policies, but all of these examples should remind us of one of the fundamental parts of economics: people respond to incentives. It is probably going to be impossible to avoid all of the unintended consequences in a free-market, but when enacting or arguing for certain policies, it is important to remember incentives and it is probably best to keep things simple. Unless you want cobras roaming the street.
[1] – http://freakonomics.com/podcast/the-cobra-effect-a-new-freakonomics-radio-podcast/
[2] – http://www.nytimes.com/2012/08/09/world/asia/incentive-to-slow-climate-change-drives-output-of-harmful-gases.html?pagewanted=1&_r=2&hp
[3] – http://www.econlib.org/library/Enc/UnintendedConsequences.html
[4] – https://www.cbo.gov/sites/default/files/105th-congress-1997-1998/reports/ssprisav.pdf