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The law of unintended consequences

Spring / Summer 2010 GB Geo-Blog

The law of unintended consequences

Peter Hodson, the Chair of Sprott Asset Management, wrote an article about the “law of unintended consequences” in this past Saturday’s Financial Post. He provided four examples. I will look at three of them to show that the consequences in each case should be obvious. There is no law of unintended consequences in these and most other cases. There is only short-sightedness, and a lack of understanding of basic economics.

One example dealt with the austerity programs being foisted upon many members of the EU by the so-called “bond vigilantes” – the traders in the major financial institutions. Hodson points out, correctly, that the austerity programs are leading to social unrest and prolonged recessions. In turn, tax revenues will continue to decline and even deeper spending cuts will be required leading to more social unrest.

Of course these are the outcomes. No one should have expected otherwise. Indeed, I have been writing about the absurdity of tough austerity programs when economic recovery is still in its early stages in most countries.

Unfortunately no one has bothered to do a cost-benefit analysis regarding the timing of a fiscal austerity program. It would be very difficult to do such an analysis, but at least the exercise would shed light on the key issues and alternatives. The bond vigilantes by and large are not good economists, nor do they care about the welfare of others. They only care about their next bonus checks.

In another example, Hodson again correctly points out that in the wake of the BP fiasco in the Gulf of Mexico, many countries have implemented bans on offshore drilling, and that these bans will in turn negatively impact oil exploration and the supply of oil in the future. He then goes on to predict sharply higher oil prices on the horizon.

Yes, oil prices might surge, but only as long as politicians do not act to further reduce demand. While there are many shortcomings with the simple supply-demand model in economic theory, this model is useful for showing that there are two sides to this issue. Are policy makers willing to supplement their bans on drilling with more difficult measures to curtail demand? Is there any politician worldwide who has the courage and foresight to introduce a real carbon tax?

The problem in this case is not unintended consequences, but the absence of political will.

In a third example, he cites a hypothetical case of a company deciding to cancel its takeover of a rapidly growing rival because of a downturn in the economy. In this example, the takeover target continues to to do well and becomes a serious competitive threat to the company that decided not to follow through with the acquisition.

In this case, short-sightedness and risk aversion are the causes of the company’s decision and future problems. An acquisition should have a long-term horizon and a strategic goal. A dip in the economy should only influence the price of the takeover, not its rationale. Here it is not the lack of political will; rather it is the absence of good management and sound corporate governance that creates the problem.

Most people have a decision-making horizon that barely extends beyond their noses. In the case of the bond vigilantes, their time horizons are measured in seconds, just like their attention spans.

The opinions expressed in this blog are personal and do not reflect the views of either Global Brief or the Glendon School of Public and International Affairs.


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