Apr 24, 2020
Why we fail to prevent unintended consequences
The policies we adopt cause a ripple effect throughout the world. What makes us blind to their unintended consequences?
In 1958, at the beginning of the Great Leap Forward, Mao Zedong introduced the “Four Pests Campaign” directed against rats, flies, mosquitoes, and sparrows. His aim was to limit the spread of pestilence and disease. The entire Chinese population was recruited, and even children could be seen climbing in trees to raid sparrow nests.
Three years later, the near extinction of sparrows left crop-eating insects without predators. This ecological imbalance was a determining cause in the great famine that followed. An estimated 16.5 to 45 million individuals died as a direct consequence of starvation. It remains the deadliest famine in history.
Today Mao’s inability to anticipate the increase in vermin population as a consequence of the extermination of sparrows remains a mystery. How could he not foresee the indirect ecological consequences of his campaign?
Yet still today, policies with unintended consequences are ubiquitous.
Beginning in the 1980’s, new micro-prudential policies were put in place to reduce concentration risk, that is, the risk of default induced by a bank’s large exposure to a single counterparty or a group of connected counterparties. In 2010, Basel III regulations promoted the reduction of concentration risk through diversification. Using models like Value-at-Risk (VaR) and stress-testing, financial institutions built confidence in their stability.
Diversification at the individual bank level results in more interconnections in the banking sector. In 2015, Daron Acemoglu and colleagues published an article in the American Economic Review titled “Systemic Risk and Stability in Financial Networks”. In their paper, they readily demonstrate that dense interconnections serve as a mechanism for the propagation of shocks, leading to a more fragile financial system. Micro level stability comes at the cost of increased systemic risk. The policies designed to reduce risk at the individual bank level may have been a determining factor in the unfolding of the 2008 financial crisis.
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So are we learning from these events to prevent the next crisis?
The current covid-19 pandemic calls for social distancing and accelerated research for a cure and a vaccine. Beyond these immediate solutions, we also need to understand the factors that have favored the spread of the virus. Indeed, covid-19 might just be a warning for an even larger pandemic, as contagious as measles and as virulent as Ebola.
The starting point of covid-19 was an open marketplace in Wuhan where live wild animals — snakes, bats, pangolins — are pressed against each other in wicker crates. These animals are luxury products consumed during the Rat Festival. Animals are skinned by vendors, while they may be stained with urine, covered in ticks, or surrounded by clouds of flies. This creates the ideal conditions for a virus to be passed on from animal to animal within a few days. It remained only a matter of time before the virus was transmitted to humans, perhaps through a worker cutting themselves, or touching their face with dirty hands.
Although animals are at the origin of most sanitary crises, researchers seem indifferent to their starting points. Bats alone carry more than 30 different coronavirus strands. Wild animal trafficking, a business estimated to be as profitable as drug trafficking, has experienced an unprecedented spike. On the 24th of February, China ordered an immediate and total ban on the trafficking and consumption of wild animals, yet a similar policy has been in existence since 2003 without ever being truly enforced by Beijing.
Beyond wild animal trafficking, other human activities may increase the risk of viruses spreading. Indigenous forests are shrinking in many Asian countries as a result of infrastructure development for the new Silk Road. With smaller forests, agricultural zones are developed in close proximity to extremely dangerous virus reservoir areas, as such placing humans in close contact with the natural habitats of bats and other virus carriers. Just as the Black Plague came to Europe in the 15th century from rats brought by merchants travelling on the Silk Road, new commerce routes in the 21st century play a central role in the spread of covid-19.
Boat cruises, international travel, destruction of natural habitat, loss of biodiversity, and the spread of communication networks are all among the long list of factors that have contributed to the emergence and spread of covid-19. The pandemic is also revealing the limitations of our globalized way of life. The just-in-time business model, pioneered by Toyota, now dominates the global economy from grocery stores to hospital beds. This cost-cutting logic is now backfiring as supply chains are failing and transportation networks — a central element in just-in-time production — are backlogged. The spread of deadly viruses is an unintended consequence of globalization forces.
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Understanding the complex mechanisms behind a financial crisis or a pandemic is inherently challenging. Causal chains are difficult to retrace, especially in interdependent systems, yet our lack of preparation for potential catastrophes also stems from limitations in the way we think.
We tend to think that what is true at one level (e.g. that more diversification is beneficial for a bank) is also true at another level (e.g. more diversification benefits the financial system), what behavioral scientists call the Fallacy of Composition. This fallacy is also at play when leaders argue that austerity measures will help in restarting the economy (the Thrift Paradox). Yet each layer in a system answers to its own set of rules and incentives.
Physics Nobel Prize winner P. W. Anderson, who died recently aged 96, made many contributions to our understanding of complex systems. In a short article titled “More is Different” Anderson discusses emerging properties: each layer in a system (atoms, molecules, cells, organs, etc) answers to a unique set of rules. In other words, the force which explains the movement of planets does little to help us understand the movement of particles in an atom.
Emerging phenomena can lead to conflicting incentives between different scales in dynamic systems. These trade-offs abound in biological systems. Cancer is an example of rogue cells defending their own interest by multiplying at the detriment of the organism as a whole. Similarly, the interests of an agricultural biotechnology corporation may clash with the security of the global food system. Finding the right balance between the goal of each layer is a matter of both scientific enquiry and ethics.
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As Mao’s Four Pest Campaign illustrates, another shortcoming in the way we reason is our lack of second order thinking. First order thinking anticipates the direct (and more obvious) consequences of a particular course of action. Second order thinking is the process of looking further into time and space to see the ripples of the decision.
The introduction of Cane Toads in Canada is another example of an attempt to control pests that went wrong. These toads were introduced in eastern Australia in order to control the native can beetles that ate crop leaves. In the 1970s, these poisonous toads with no natural predators multiplied rapidly and eventually became the pests themselves.
Understanding how behavior may change in response to a policy is central to second order thinking. The rebound effect is a known phenomena where environmental gains — such as fuel efficiency standards for vehicles — are often partly if not completely offset by an increase in consumption as individuals drive faster and further.
Another famous example of the importance of anticipating behavior can be found in a study on the deterrence principle. A late-coming fine was introduced for parents who picked up their kids late in several Israeli day care centers. The assumption was that the introduction of a fine would reduce the occurrence of parents being late. Yet, following the introduction of the fine, even more parents arrived late to pick up their children. This unintended consequence was explained by the fact that parents felt that paying a fine excused their behavior.
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What can we do in an interdependent and complex world to prevent catastrophes? One possible answer is to be extremely cautious and ban any technology, exchange, or policy that may lead to unintended consequences. Conservative voices around the world are calling for a radical U-turn away from globalization. Yet turning back would also imply to relinquish the benefits brought by decades of growing interconnectedness.
Another approach would be to carefully review the strengths and weaknesses of our global system. A few organizations are promoting this approach and proposing useful recommendations. The first step may be to introduce decision makers to the new concepts and tools for solving complex challenges.
The covid-19 pandemic has brought about a newfound mutual awareness of our common fate. Will we use this opportunity to overcome simplistic thinking mechanisms and design better policies?
