On the money

Beware the snakebite of economic strategy

In Delhi, back in the spring of 1898, there was an explosion in the population of cobras. Suddenly, the deadly beasts were everywhere. The British governor devised a cunning plan: he offered a cash reward to anyone bringing a cobra skin into the colonial offices. That, he thought, would turn the citizens into an army of snake killers. Brilliant! Or was it? It didn’t take long for enterprising citizens to start breeding cobras; after all, they represented a guaranteed income. So, rather than turning Delhi into a city of cobra killers, the policy created a city of cobra farmers.

This is “the cobra effect”. It’s usually treated as an example of a “perverse incentive”, but I think it’s more interesting than that. The governor’s policy failed because he forgot to ask the question that sits, or at least should sit, at the heart of economics: “What happens after that?”

“What happens after that?” is an extraordinarily powerful question; the essential component in avoiding the greatest of all strategic errors… namely, to lose sight of the fact that when we change our strategy, other people will respond by changing their strategies. It’s astonishingly easy to fall into the trap of adopting plans which depend upon everyone else just carrying on as before.

This oversight is the main reason why so many government policies fail; why countless strategic moves by companies don’t increase profits; why military campaigns don’t go according to plan; and even why tactical changes made by football managers so often don’t win games.

Want some current examples? Well, at the moment, there seems to be genuine bafflement in Brussels that Russia is retaliating against EU sanctions. In London, it looks like the Treasury failed properly to take into account the effect on the future plans of oil giants when devising the “windfall tax”. For example, the Norwegian company, Equinor, is now reconsidering its planned £4bn drill near the Shetland Islands. Because of that, the windfall tax may actually end up reducing tax revenue. In Sweden, the rent control policy, designed to solve the housing shortage, has led to a reduction in the supply of dwellings… rent control policies always do that, by the way. In Canberra, the Australians clamped down on various Chinese investments and engaged in general anti-China rhetoric and were then utterly dumbfounded when the Chinese slapped a massive import duty on Australian wines… so far sales are down by 26%.

There may well be a lot wrong with economics, but I come to praise economics not to bury it

As I said, “What happens after that?” sits at the heart of economics. Of course, economics has had a bit of a bad press in recent times. Some say it’s a pointless exercise, or that while it may pose as a science, in reality, it’s nothing more than a mechanism for generating plausible narratives; stories that can be used by the powerful to justify self-serving behaviour.

Now, there may well be a lot wrong with economics, but I come to praise economics not to bury it, and the vast majority of attacks on the subject are akin, in Prof. Terry Eagleton’s superb phrase, to “someone holding forth on biology whose only knowledge of the subject is the Book of British Birds.

No, those who claim economics is pointless are wrong. The point of economics is to place “What happens after that?” firmly at the forefront of all policy discussions and to provide tools with which to answer that question.
Does that mean using economics will mean we always get it right?

Absolutely not.

The idea that a discipline doesn’t count as science unless it… somehow… produces only correct answers, is based upon a serious misconception. Personally, I blame Descartes, a man whose ideas sit at the foundation of modern science. He sought infallible certainty. Unfortunately, he was hunting a chimaera; infallibility isn’t achievable.

Instead of asking “What can I know with certainty?” it would have been a lot better if Descartes had asked: “What do I have to do to guard against error?” This is the question that led to the development of today’s scientific norms.

Gradually, it was realised that certain methods of reaching a conclusion were prone to systematic error, and therefore must be banished from scientific practice. I mean such things as superstition, Argument from Authority, wishful thinking, ad hominem etc. Infallibility isn’t available and the avoidance of systematic error is the best we can hope for.

Of course, there are always going to be scientists who don’t play by the rules. Those who cherry-pick data, or defend conclusions they secretly believe to be wrong. However, when that sort of thing happens, these people may be called “scientists”, but they aren’t doing science.

The raison d’être of economics, just like every other science, is to help us identify and steer clear of avoidable, systematic errors and, in the sphere of human conduct, the essential first step is to ask: “What happens after that?” and when the question isn’t asked, watch out for the cobras.

Peter Lawlor is a trustee of the John Hicks Foundation in Oxford. He was formerly the Principal Economic Advisor to the German Stock Exchange (Deutsche Börse), and continues to act as an adviser to senior Wall St figures and political leaders. These are his own views and should not be imputed to any organisations with which he is, or has been, affiliated

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