Aftermath. Thomas E. Hall
enterprises Fannie Mae and Freddie Mac were heavily exposed to subprime mortgages, they were especially hard hit.
The combination of falling house prices and falling stock prices resulted in a decline of $13 trillion in U.S. household wealth, which was a major factor in causing the U.S. economy to plunge into the 2007–2009 Great Recession. This economic debacle led to the loss of 8 million jobs and the ruin of several financial institutions, including Fannie Mae and Freddie Mac, which required massive federal bailouts to stay afloat. Not surprisingly, the U.S. homeownership rate dropped, and by 2011 was back to where it had been in the late 1990s. Thus, we are left with the irony of government policies designed to promote homeownership helping cause the worst economic recession since the 1930s’ Great Depression.
The 2000s’ housing boom and bust is an example of the law of unintended consequences. This term refers to situations in which government policies enacted to accomplish one set of goals end up causing another set of outcomes that were unanticipated. In the case of U.S. housing policies, the federal government was attempting to achieve the honorable goal of promoting homeownership but caused an economic catastrophe while doing so. The losses to society far outweighed the gains.
How did this fiasco occur? Did the advocates of policies designed to promote homeownership not foresee the negative consequences? Or did they know there might be harmful effects but believed the benefits would outweigh the costs? Or were they aware that the adverse effects would be large but believed so strongly in their goal of promoting homeownership that they ignored the possible negative consequences?5
In this case, the answer appears to be that housing advocates understood that raising the homeownership rate would involve increased lending to risky borrowers, which would lead to more mortgage defaults. But housing advocates never imagined the enormous number of defaults that would occur, nor the impact that would have on the U.S. economy and financial system.
So Many Examples
There are countless examples of the law of unintended consequences as applied to government policies. One case much in the news during the last several years involves traffic cameras at street intersections. Traffic cameras have two primary purposes: (1) to motivate motorists to drive in a safe manner by not running red lights and (2) to raise revenue for local governments by allowing them to simply mail traffic tickets (along with a photo of the incident) to offending drivers. There is widespread agreement that traffic cameras raise revenue, and they may reduce the number of T-bone collisions. But there is an unintended consequence: drivers who know their actions are being recorded are much more likely to slam on the brakes to avoid running a red light. But slamming on the brakes raises the likelihood of rear-end collisions, and considerable evidence exists of this outcome taking place.6 Since rear-end collisions are usually less injurious than T-bone collisions, traffic cameras seem justified on safety grounds, although there is disagreement on this point.
Another example is China’s one-child policy, which was instituted in 1979. This policy restricts married couples to one child, although there are exceptions, depending on various factors, including the couple’s ethnicity and where they live in China. Couples who violate the policy are subject to severe fines. In addition, some reports mention women enduring forced abortions and sterilizations, as well as government officials seizing babies and selling them on the adoption market. The purpose of the one-child policy is population control; on this score, it has succeeded. The Chinese government claims that the one-child policy has resulted in 400 million fewer births, although most estimates are considerably lower (Nie 2010).
This policy has also caused major unintended consequences. Since Chinese culture places a premium on baby boys, in part because males traditionally care for elderly parents, many couples strongly desire a male child. That preference has led some parents to kill their baby girls so they could try again for a boy. Accounts of widespread infanticide in China began surfacing during the 1980s. In recent years, the availability of modern technology that allows a fetus’s sex to be identified has resulted in huge numbers of abortions of female fetuses. The sex ratio among children has become seriously imbalanced. For example, during 2010 in Guangdong Province, 119 baby boys were born for every 100 baby girls. A decade earlier, the ratio in that province was even worse, 130 to 100.7
A related consequence of the one-child policy is a shortage of marriage-age women in China. Estimates suggest that in 20 years, the ratio of Chinese marriage-age women to Chinese marriage-age men will be four to five. The problem could be solved by polygamy in the form of women with multiple husbands, but that is unlikely to happen. A much more plausible outcome is Chinese men seeking non-Chinese brides. Residents of neighboring countries are understandably nervous.
Four Case Studies
This book contains four studies of the law of unintended consequences. The discussion addresses the following questions: How did the policies come into being? Who were the advocates? What were the underlying political considerations? Why are these policies (with one exception) still in place?
The first case considered is the federal income tax and what has resulted from it. The income tax was originally instituted in 1913 for two reasons: (1) to tax high-income Americans who at the time were largely able to avoid taxes and (2) to reduce the U.S. government’s financial dependence on taxes assessed on alcohol, tobacco, and imported goods, which were burdensome to middle- and low-income Americans. Thus, the establishment of the income tax was about shifting the tax burden away from the lower and middle classes and toward the upper class.
The unintended consequence was a flood of tax revenue that amazed everyone, including the income tax’s creators. These funds allowed politicians, who can rarely resist the temptation to spend every cent of available revenue and then some, to go on a spending spree that has lasted decades. The federal income tax is a major reason why we have the huge federal government we live with today, one that is several orders of magnitude larger than the Founding Fathers ever imagined.
Cigarette taxes are examined next. These taxes are collected by the U.S. federal government, along with all 50 states and the District of Columbia, and some counties and cities. They were originally imposed solely as a revenue source for governments, and they have been very effective in that regard because tobacco is an addictive substance. Since the 1960s when the link between smoking and health problems was documented, an additional justification has been on health grounds: taxing cigarettes discourages smoking, which results in a healthier population. More recently, as governments have increasingly funded health care, cigarette taxes have been rationalized on the grounds that the revenue is needed to help pay the higher health care costs incurred by smokers.
The major unintended consequence of cigarette taxes is the criminal activity they create. Large differences in tax rates across jurisdictions present criminals with a profit opportunity: they can purchase cigarettes in low-tax areas and then illegally transport them to high-tax areas where they are sold. Cigarette smuggling is a huge business in the United States and is largely controlled by organized crime syndicates. Most Americans are aware that it takes place but are unaware of its magnitude. Since many states seem intent on raising cigarette taxes to ever-greater heights, this smuggling problem will not only persist, it will worsen.
The third case is the U.S. minimum wage law. Minimum wage laws first appeared at the state level in the early 1900s and were advocated as a method of raising the cost of employing women and children so that employers would replace them with adult men. Several additional arguments were used to justify these laws, such as ensuring that workers earned enough to afford a decent standard of living (i.e., a “living wage”) and encouraging children to attend school instead of working. The federal minimum wage law was enacted in the 1930s and has existed ever since.
The problem with a minimum wage law is that it can artificially raise the wage rate of marginal workers above the value they create while working for an hour. If that occurs, businesses will employ fewer of these low-skill workers, replacing some of them with machines, or altering business practices to save labor. So at a basic level, the minimum wage is about a choice: (1) a smaller number of workers earning a higher legally mandated minimum wage or (2) a larger number of workers earning a lower market-determined wage. Most economists would argue in favor