Public Policy and Its Unintended Effects

Through policymaking, governments may aim to achieve a certain positive outcome. However, examples throughout history demonstrate that laws often fall short of their intended goals or even backfire completely. Policy changes frequently have side effects or unintended consequences that may lead to negative results.

Two lectures by Laureates at the 7^th Lindau Meeting on Economic Sciences highlight instances where economic and social policies based in four different European nations – Denmark, Spain, Italy, and Portugal – did not pan out as planned.

Denmark and other Scandinavian countries are upheld by much of the rest of the world as shining beacons of equality and social mobility. Equality in services offered is mandated in Denmark, which provides its residents with universal healthcare, free daycare, free college, and equal pay for all teachers, among other benefits. Often, the media contrasts its generous policies with those of the U.S., a country notorious for offering none of those perks.

In a lecture titled “How the Welfare State Affects Inequality and Social Mobility: A Comparison of the U.S. and Denmark” on 24 August 2022, James J. Heckman takes a fresh look at the origins of inequality and social mobility by using data from the two seemingly contrasting countries as examples.

“We know [inequality] is a very hot topic, and what I’m going to do is present a comparison of policies and policy environments in two different countries, and then to examine the outcomes, which are frequently discussed – or I would say, in some cases, misinterpreted – in the popular and political press,” said Heckman, who received the 2000 Prize in Economic Sciences “for his development of theory and methods for analyzing selective samples.”

Some of his results are surprising. For example, even in Denmark, advantages from universal access to services are reaped relatively more by the affluent rather than by the disadvantaged, who do not often know how – or find it more difficult – to use these services. Heckman and his colleagues also found very strong evidence of neighbourhood effects.

“Educational intergenerational mobility is remarkably very similar in the U.S. and Denmark, and that staggers a lot of people used to the idea that Denmark, by offering this broad array of social services, is getting this tremendous advantage which U.S. and other countries should emulate,” he said. “There are substantial skill gaps across families by background.”

Lastly, a major takeaway of their work is that purposeful sorting of people into neighbourhoods and the timing of their moves plays a major role in both the U.S. and Denmark. In other words, the choice of neighbourhood of residence to raise children has a powerful impact in explaining intergenerational inequality.

In his lecture on 26 August 2022, titled “When Economic Growth in Spain, Italy, and Portugal Came to a Full Stop!”, Finn E. Kydland described an example in recent history where a change in policy had unintended consequences. For three European nations – Spain, Italy, and Portugal – output per worker had started to slow down in the early 1990s. By 2000, growth rates in all three nations were virtually zero.

Why? One thing that happened was an announcement that ended up impacting their interest rates, which affected capital cost. Interest rates can loosely be thought of as being the sum of three components: an underlying real interest rate, an inflation expectation addition to the real interest rate, and a country risk premium.

“When it was announced that these countries would become members of the eurozone, basically the risk premium in the interest rates of these countries disappeared and went almost to zero,” said Kydland, who received the 2004 Prize in Economic Sciences for “contributions to dynamic macroeconomics.” “As you can see, this did not have a very good effect in part because the effect it had on the allocation across sectors of the economy.”

Essentially, it resulted in increased incentives to engage in projects that were not productive for the economy as a whole, such as building an airport in a virtually even province. Another factor contributing to the stall in growth rate for these three countries was a marked shift from producing tradeable goods (e.g. agriculture, forestry, and fishing) to nontradeable goods (e.g. communications). By 2010, close to two-thirds of activity was in the nontradeable goods sector and only one-third in the tradeable goods sector. The output per worker more than doubled over the time period for the tradeable goods sector, but stagnated for the nontradeable goods sector.