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Thinking like an Economist Means Thinking about Tradeoffs

by James Broughel on August 16, 2016

in Environment, Infrastructure, Regulation

This week, I’ve written two articles about different types of tradeoffs that economists think about when they evaluate the likely effectiveness of proposed public policies. One type of tradeoff relates to the costs that consumers and businesses incur in exchange for the benefits policies will achieve, while a second type of tradeoff involves countervailing risks that sometimes increase as policies aim to reduce other risks.

An example of the first type of tradeoff, involving benefits and costs, comes from energy efficiency regulations for appliances. These regulations do produce some benefits involving reduced emissions, but entire classes of very important costs are routinely overlooked by regulatory agencies. When an agency doesn’t count what consumers give up in exchange for the good things policies produce, there is a greater chance people will be made worse off by a policy. That’s bad news.

Here is a relevant portion of an op-ed I wrote published in the Washington Times:

The Department of Energy sets energy conservation standards that limit the amount of electricity that can be used by home appliances like refrigerators and air conditioners. These sweeping regulations affect nearly every American consumer. The department claims its rules address an imminent problem — environmental degradation — and argues that its conservation rules produce two main benefits: First, more energy-efficient appliances use less energy, so we all release fewer emissions into the atmosphere. Second, by using less energy, consumers may save money over time on monthly utility bills.

Sounds like a win-win situation, right? Not so fast.

We haven’t considered the costs of these regulations. Consumers care about their utility bills and the environment, but they also care about how well a product works, its appearance, whether the product comes with or without a warranty, the purchase price, and countless other things. When product attributes change as a result of regulations, these are costs to consumers. But the costs are ignored by regulators at the Energy Department. Regulators do consider some costs, like how much more appliance makers will have to pay when they are forced to comply with new rules, but the costs to consumers — whom we should care most about — are systematically overlooked.

In a second article, published in US News and World Report, I show how tradeoffs can involve more than just benefits and costs (which are valued in monetary terms). Tradeoffs can also involve risks. An example of a risk tradeoff comes from proposed legislation in New Jersey that targets distracted driving. The bill would ban drivers from engaging in “any” activity unrelated to driving that might interfere with the safe operation of a vehicle in the state. Some have said the bill’s language is so expansive that drinking a cup of coffee while driving would be banned.

The distracted driving bill has the potential to create what economists call “risk tradeoffs,” which occur when the mitigation of one risk simultaneously increases the risk of another. This bill addresses an all-too-real danger, but any law that prevents people from drinking coffee behind the wheel is going to increase at least one other risk: the risk created by drowsy drivers on the roads.

With fewer people drinking coffee on the roads, that means more sleepy truck drivers hauling sixteen wheelers at 2am. Is that a risk worth bearing in exchange for fewer distracted drivers? That’s a difficult question that will involve careful analysis to answer.

Risk tradeoffs are actually pretty ubiquitous, and involve far more than just Jersey drivers.

One of the most common ways new policies create risk tradeoffs is through “substitution effects.” For example, when a pesticide is banned, farmers usually switch to a different pesticide instead. The new chemical may be safer than the banned one, but it could also be more dangerous. Sometimes risks are simply shifted from one group of people to another. A new pesticide might reduce the risk from eating residue left on fruit in the supermarket, but at the same time, it could create new risks for farmers who work among the sprayed fruit.

Considering these kinds of tradeoffs—benefit/cost and risk/risk—is what rational decision making is all about. Any good economists is trained to think about these things when evaluating proposed policies. If legislators and regulators are going to use the resources we entrust them with wisely, we should all demand they think like economists too.

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