UNINTENTED CONSEQUENCES: From Invisible Hands to Kudzu

Sooner or later everyone sits down to a banquet of consequences. ~ Robert Louis Stevenson 

Disregard the Laws of Supply and Demand. The most powerful principal of economics is the Law of Unintended Consequences, which states that any purposeful action will always produce some inadvertent outcomes. As Harvard economist Gregory Mankiw stated last year, “Unintended consequences are the norm” for economic policy-making. This is not just a recent thought.

Social scientists and political economists have long recognized the importance of unintended consequences. John Locke argued in 1691 for the defeat of a British Parliamentary bill designed to cut the maximum permissible rate of interest from 6% to 4%. He believed that instead of benefiting borrowers, as intended, it would hurt them. To the extent the law was obeyed, Locke concluded, the chief results would be less available credit and a redistribution of income away from “widows, orphans and all those who have their estates in money.” Sen. Bernie Sanders and Hillary Clinton should take note of Locke’s Enlightenment Age concerns about unintended consequences when they espouse reducing allowable interest rates for student loans.

Another early example of unintended consequences is Adam Smith’s notion of the “invisible hand,” discussed in his 1776 foundational treatise The Wealth of Nations. Smith declared a person earning money by their own labor not only benefits themselves, but unknowingly, also benefits society. This was expressed with his enduring, covert image, “By directing that industry in such a manner as its produce may be of greatest value, he intends only his own gain, and he is in this, as in many other cases, led by an invisible hand to promote an end which was no part of his intention.”

Here are 4 modern examples of unintended consequences.

Ethanol.  First, a current and timely example is US biofuel policy. Timely because the geographic kernel of this 40-year old issue is where corn farmers and other Iowans will decide their 2016 presidential preference in a mere 7 days. Although we’ve been besieged seemingly forever by constant media balderdash about the Feb 1 Iowa caucuses (see below), Iowa’s “Big Corn” agricultural-industrial complex has played a keystone role in formulating our national, subsidy-based biofuel policy long before corn ethanol was first mandated by Congress in 1988. An ethanol-based supplement, MTBE, was added to gasoline when lead was removed in the 1970s, until MTBE was found to harm the environment. In 2011, the US produced 13.9 billion gallons of ethanol fuel. By 2010 over 90% of all gasoline sold in the US was blended with 10% corn-based ethanol.

Iowa corn farmers (and other mainly rectangular-states’ corn farmers) love the Renewable Fuels Standard (RFS) that was established by Congress in 2005. It mandated that a minimum of 4 billion gallons of biofuels (principally corn-based ethanol) be used in 2006, rising to 15 billion gallons by 2022. The cumulative corn ethanol subsidies between 1995 and 2012 have been estimated to be $15 billion.

Does the RFS make the environment as green as the fatter wallets of corn farmers? No. Federal biofuel policy, mainly based on corn ethanol, has been shown to actually harm the environment, increase CO2 emissions, raise the price of gasoline, increase corn’s price and reduce the availability of other food grains. These harmful unintended consequences are not limited to the US. In 2007, US government corn-ethanol subsidies contributed to riots in Mexico due to the ensuing increased cost of corn and tortillas. A World Bank report stated that large increases in biofuels production in the US and Europe were the main reason behind the steep rise in global food prices.

Services.  Second, over the past 4 decades the composition of the US economy has steadily changed from producing goods to providing services. This shift has produced unintended macro consequences. The services sector accounts for 77.8% of our GDP. This sector is more labor intensive than either the extractive (mining, drilling and agriculture) or goods-producing sectors. Thus the share of service jobs has steadily grown; from 76% of all private-sector jobs in the mid-1990s to 86% of our labor force in 2015. About 73% of all new private businesses are service companies; it’s where our renowned entrepreneurial spirit is most energetic. Think Airbnb, Google and Uber. However, almost 50% of all low-wage workers in the US are employed in just 2 service industries, retail and leisure/hospitality.

One of the foundations of sustained economic growth is improved productivity. But the shift to being a service economy is one factor that has unexpectedly reduced our prospects for historic-level economic growth. Our average real GDP growth from 2010 through 2014 increased a meager 2% per year, less than half the rate between 1974 and 2014. A leading reason for this significant reduction in GDP growth is that productivity in the services sector has dawdled compared with other sectors. The Brookings Institution determined that the growth of multifactor productivity (MFP), which measures the changes in output per unit of combined inputs (not just labor, but also capital, energy and materials), was only 20% as high for services as MFP for manufacturing between 1987 and 1997. I found that from 1997 to 2013 (the latest available year) the services’ sector multifactor productivity growth “deficit” was 8.2%, compared with MFP for manufacturing.

How can our macroeconomic growth increase as much as it used to, given the predominance of services? No one knows how to reinstate such higher growth rates for an $18.1 trillion economy like ours. Or maybe Nobel-laureate Prof. Robert Gordon may be correct in the thesis of his new book, The Rise and Fall of American Growth. His thesis is the internet revolution has been hyped and the “golden age” of American growth may be over. Nevertheless, that hasn’t stopped Republican candidates from fecklessly promising to restore 4% growth if they are elected. However it might happen, this unintended consequence won’t be easy, quick or inexpensive to remedy.

Election polls.  Third, the media has become more poll-focused during our incessantly-covered presidential election season. This focus has unpredictably produced more inconsistent (and probably unreliable) poll results. Have you received a call from some pollster? If not, consider yourself lucky.

A recent count showed that during the last 30 days, there were 11 pre-election polls in the 3-million strong Hawkeye state and 10 polls in the 1.3 million person Granite state, as well as 9 national polls. All this attention for the 30th and 42nd most populous states? Amazing. The polling firms are circling like moths ever-closer around the media spotlights. Because the attention given to the first 2 primaries is no surprise, such firms have been more than happy to call corn farmers and Yankees virtually 24/7 to satisfy the media’s interest in “real information.” But the polls rarely offer meaningful, consistent evidence about actual voters’ preferences and intentions.

On January 24 Real Clear Politics listed 16 polls’ results for Iowa and New Hampshire conducted during the past 4 days! The results for Iowa included margins of +11 points, +1 pt, +14 pts and +15 pts that Donald Trump will allegedly beat Ted Cruz. On the Democratic side, margins for Hillary Clinton beating Bernie Sanders include +9 pts, +29 pts, and +9 pts, and one poll has Bernie Sanders beating Hillary Clinton by +18 pts. The bywords seem to be “pick a number you like, almost any number, and you’ll likely find a poll that has it.”

The increased dependence on polls comes despite a very mixed performance record. Polls of the 2014 congressional and gubernatorial elections miscalculated the margins in assorted races. Most prominently, the Real Clear Politics average of polls predicting the Kentucky governor’s election had the Democrat winning by 5 points. He lost by almost 9. Oops. One unspoken key fact about any of these poll results is that most voters have not yet decided who they’ll vote for. For example, in a New Hampshire poll conducted last week only one-third of Republicans stated they have chosen a candidate to definitely vote for. In other words, notwithstanding the fancy graphics and earnest words declared by talking heads at CNN, NBC, Fox, or in the New York Times or the Wall Street Journal, poll results are likely just imaginary numbers. At this point, any and all poll results mean   next   to  nothing.  

Kudzu.  A final example involves a natural item with widespread unintended consequences – Japanese arrowroot, aka kudzu. This plant was imported to the US from its native eastern Asia via the Philadelphia Continental Exposition in 1876 as an ornamental shrub. By the 1940s Southern farmers had been paid by the US Soil Conservation Service to plant more than one million acres with this invasive vine to control erosion. Kudzu was all too happy to inhibit soil erosion and overwhelm many native plant species as it spread throughout (and beyond) the South. It is reputed to grow one foot per day. Recently it was estimated to have spread to 7.4 million acres. In 1997 kudzu was placed on the Agriculture Department’s “Federal Noxious Weed List.” Take that, kudzu! 

THE TIME OF TWO

Time is the longest distance between two places. ~ Tennessee Williams     

The only two things that scare me are God and the IRS. ~ Dr. Dre     

It’s now the time of 2. The numerical system that we all use was developed by Hindus in India between the 1st and 5th centuries. Later, the Persians and Arabs adopted it and spread it to the West during the Middle Ages via trade and commerce. Thus, we have been using the number 2 for many centuries as part of the Hindu-Arabic numeral system.

Number 2 is important in a variety of ways: our brains have 2 hemispheres; Cartesian geometry (as you remember from high school, with its 2-phase (x,y) coordinates) has played a large role since the early 17th century in learning about how the world works; the binary (base-2) numeral system is the core of all electronic operations (how smartphones and computers do their stuff); when using it as a divisor, it neatly produces the fundamental dichotomy of odd and even integers; it’s the first even number; it’s the smallest and only even prime number; and it’s the first “magic number” in physics.

The number 2 has recently become unexpectedly present in many diverse policy discussions. A numerical conundrum? Hardly, it’s no longer just Tea for Two or the number needed for tango-ing. It’s our economy and global policies adhering to the power of 2 in several interesting, hopefully not too tumultuous ways. Here are four (4) examples of the seeming primacy of number 2; that’s two-squared and 2x2 examples.

The first 2: GDP growth.  The Bureau of Economic Analysis recently determined that during the 3rd quarter of 2015 our real GDP grew at a meager 2%. And, between 2010 through 2014 the real US GDP grew at a miserly 2% per year. This 5-year period spans our not-so-great expansion following the Great Recession. Although better than 1.9% growth, 2% yearly growth is hardly heady. Regrettably it’s a lot less than the 4.1% average annual growth rate the US economy enjoyed from 1995 to 2000. I’ve talked before about several of the reasons for this frail growth.

The second 2: target inflation rate.  The Federal Reserve has an almost fixed-in-concrete 2% target for national inflation (the annual rate of change of prices for all goods and services). It turns out the Reserve Bank of New Zealand, its central bank, pioneered inflation targeting in 1990. In 1997, the Kiwis’ central bank was the first to adopt a 2% target inflation rate. The Federal Reserve announced its inflation target 13 years later, in Aug. 2003. In Jan. 2012, the Fed set its inflation target at 2%, where it remains. Actual inflation this past year in our country through Nov. was 0.5%. The 2% inflation target is internationally contagious. There are now at least 13 nations that have stated their target inflation rate is 2%.

The third 2: government bond rates.  On Dec 18 the interest rate on a 10-year US Treasury note closed at 2.2%. They have hovered around 2.2% since Dec. 1. For some international perspective, on Dec. 30 other nations’ 10-year notes’ interest rates ranged from -0.062% for Swiss bonds to 16.27% for Brazilian bonds. Yes, this Swiss interest rate is negative, indicating that purchasers actually pay money to buy the bond. Euro-bonds’ interest rates are also negative to defend their economies from slipping into deflation. Brazil is in the midst of a significant crisis of confidence with the government, has growing public debt, falling GDP and 2-digit inflation. It’s not at all a good economic place to be, as reflected in that 16.27% interest rate, which is over 8% higher than even Greek bonds. BTW, before last year Brazil’s economy had grown at 2.2%. It’s hard to get away from 2s.

The fourth 2: global warming threshold.  2^o Celsius is the declared upper limit of global warming. The earth’s temperature needs to not increase beyond 2^o C more than its pre-industrial average in order to prevent ruinous environmental damage. Since 1880, the earth’s average temperature apparently has increased 0.82^o C. An ever-expanding number of people accept this number 2 and are establishing public policies that recognize our collective responsibility to halt the climb in global temperatures. For example, see the Dec. 12 environmental accord reached in Paris by over 190 nations. This agreement is a necessary but insufficient step for curtailing environmental calamity. The sufficient step – and a tall order – is instituting a uniform, meaningful carbon consumption tax. Some scientists suspect this accord unfortunately offers 1-degree of separation from the 2-degree ceiling. These pessimista scientists expect the Paris agreement will allow a 3-degree rise in temperature. Given the sizeable uncertainties about the agreement’s policies, and the future, it’s hard to agree or disagree with this criticism.

It’s an altogether different issue to have reservations about the accuracy of the now thoroughly-institutionalized 2-dgree limit itself, which is based on intricate, very long-range weather/climate models. I’ve previously mentioned these reservations. Nevertheless, the 2-degree goal is a worthy one. As Thomas Friedman mentioned in a recent column, “Dinosaurs didn’t believe in climate change either.”

So these four 2s provide a fine foundation for economic and environmental policies in the US and beyond. Four 2s is an impressive poker hand, only beaten by a straight flush or holding four 3s through aces; a probability of 0.196%. Moreover, in terms of macroeconomic indicators GDP growth, inflation and bond rates carry significant authority for any modern nation. When each of these formidable gauges rolls a 2, it’s both odd and an extraordinary numerological event. Should we consider these four 2s two-timers? Not at all, so enjoy it while it lasts. Happy New Year!