Charles Wheelan, Ph.D. The Naked Economist

One of the most important lessons for making good public policy can be encapsulated in three short points (with some amusing examples following):

• People are smart, creative, wily, and persistent.
  
  
• Public policy usually requires getting those very same people to do something that they don't want to do (or to stop doing something that they do want to do).
  

  Why? Because if everyone were voluntarily behaving exactly as we would like, we wouldn't need the policy, would we? If suspected terrorists sequestered themselves at Guantanamo, then we wouldn't have to lock them up.
  

  Even if we were all to agree on some public course of action, such as building a park or running a public school, there's still an element of coercion involved since it has to be paid for. Call me a cynic, but I don't think voluntary taxes would work very well.
  

• If you tell smart people that they can't get to the other side of a wall -- and that's where they would prefer to be -- they'll come up with clever ways to get over, under, around, or through it.

The punch line is simple: If you're going to change policy, you should be darn certain how rational people are going to react. Because they will react. And if you don't anticipate it, your bright idea will be the next victim of what economists call the Law of Unintended Consequences.

Looking for Loopholes

Sometimes such consequences are comical. For example, India bans alcohol advertising. Obviously, brewers would prefer to get their message out to consumers if given the chance. (Have you watched a football game on U.S. television lately?)

So the makers of Haywards 5000 beer came up with a shockingly clever idea: They introduced a soda with exactly the same name. Thus, they can now advertise on television for Haywards 5000 -- the soda, of course.

And yet beer drinkers must have found the message persuasive. According to the Wall Street Journal, sales of Haywards 5000 beer tripled after the "soda" advertisements began.

Then there's the strip club owner in Idaho. When the city of Boise banned full public nudity, the law left a loophole for art schools, drama performances, and anything with "serious artistic merit."

Facing a serious loss of business, the owner of Erotic City sought instead to squeeze through the loophole. He gave his patrons sketch pads and pencils and declared that the dancers would be fully nude on special "art nights." Alas, it didn't work; the police and city officials weren't convinced that art was the real focus.

A License to Pollute

Still, it's a beautiful example of the larger lesson: Smart people don't give up easily when it comes to their own self-interest.

Officials in Mexico City missed that point when they were trying to fight serious air pollution problems. Since automobiles were responsible for much of the pollution, the seemingly obvious remedy was to ration the road. Cars with certain license plate numbers were restricted from driving on certain days.

Certainly that would reduce driving and air pollution, right? Well, not exactly. One rational response among the affluent was to simply buy a second car (or keep an old one rather than trading it in when purchasing a new one), making the policy worse than ineffective.

Older cars pollute much more than new cars; the net effect of the policy was to keep such autos on the road longer, making air pollution worse, not better.

Of course, my students from Mexico have since told me that there was also a cheaper way to evade the driving ban: Buy a second license plate!

Plugging Policy Holes

So what does all this mean? Policymakers who don't anticipate these kinds of rational responses -- or choose to ignore them -- are going to end up with policies that don't work, or worse.

Since I'm annoyed by politicians on both ends of the political spectrum who promise simple solutions to complex problems, let's take a pet project from each side.

Wouldn't it be great if everyone in America earned at least $12 to $15 an hour? I think it would be. The fact that America's poverty rate still hovers in double-digits is a national disgrace. But requiring employers to pay double or triple the hourly wage they're currently paying wouldn't necessarily do any great favor to many of America's working poor.

Why? Because every business forced to pay the higher wage will behave exactly like the beer company in India, the strip club owner in Idaho, and drivers in Mexico City. Firms won't simply write bigger paychecks to the same workers doing the same jobs.

They'll look for more cost-effective alternatives, such as moving work overseas (e.g., China or India), substituting technology for labor (e.g., automated assembly lines), and using fewer workers with higher skills (e.g., college graduates). Rational firms don't like to pay $15 an hour for $6 worth of labor, which is basically what the law would require.

The better answer here is twofold:

1. Upgrade the skills of workers so that what they can offer to employers is actually worth $15 (or even $20) an hour. Why is the minimum wage (or any living wage) irrelevant for most college graduates? Because they can sell their skills in the market for much, much more.
   
   
2. Use the Earned Income Tax Credit (EITC), a feature of the federal income tax, to supplement the incomes of the working poor. The EITC raises the incomes of low-skill workers without making them too expensive for employers relative to what they can offer.

I'm not real keen on any war where every "victory" virtually ensures a subsequent defeat. Markets -- including the market for illegal drugs -- are very powerful things, and that's really the enemy that we've taken on here, at least as long as the U.S. continues to fight drugs on the supply side.

After all, what happens when we make a huge cocaine bust, or wipe out a huge coca producer in Colombia? The street price of cocaine goes up.

And what happens when the street price of cocaine goes up? There are new profits to be made, for everybody from the Colombian mules willing to swallow condoms full of the stuff for transport to the street gangs looking to sell it.

Drug smugglers may be nasty, but they're not stupid. Rational people respond to profits -- and every "victory" in the war on drugs simply creates new opportunities for profit.

You're not persuaded by this theory? How about the data: The New York Times reported in August that a six-year, $4.7 billion effort to eradicate Colombia's coca crop "has left the price, quality and availability of cocaine on American streets virtually unchanged."

According to the report, coca production has shifted to smaller, more remote plots that are harder to wipe out -- which is really just a more depressing version of the strip club owner passing out sketchpads.

The economic logic here says we ought to devote far more resources to the demand side of the problem. Only when fewer people want to buy cocaine will fewer people want to produce and sell it.

The Bottom Line

Obviously, I'm not defending drug dealers or strip club owners. But I will tell you that they're not idiots. Nor are most people affected by public policy.

And if we forget that, we'll continue to end up with policies that cost a lot of money and accomplish little -- or worse.