# Physics 3333 / CFB 3333 Local Optimization/Unintended Consequences

## Local Optimization

Local optimization describes a process in which individual entities (people, companies, governments, etc.) attempt to optimize some situation (maximizing profit, reducing costs, maximizing production, etc) in the short term without effective consideration of the global picture.

Such activity can have downsides, or possibilities for losses, but the losses are not thoroughly analyzed or are assumed to fall on someone else. Also - short-term optimization assumes that optimum short-term actions are the same as optimum long-term actions. Furthermore, long-term results are often not even considered, making them a surprise when they finally do occur. These surprises are known as unintended consequences.

## Assumptions

Implicit in this kind of approach to things is the concept of assumptions. A lot of short-term local actions are taken under a set of assumptions about what will happen in the long term. Remember that an assumption is something you take as fact although you have no proof of it.

The problems arising from local optimization result from a few basic assumptions that prove wrong.

1. That you can really understand and describe the world and its interactions.
2. That people will continue to behave as they do now, even as things change.
3. That what is good in the short term is also good in the long term.
4. If something is possible it is a good idea to do it.
There are other assumptions, of course, but these cover a lot.

## Assumption Analysis

Most people are not accustomed to analyzing their assumptions, but doing it could save a lot of misery. Scientists have to detail their assumptions in their scientific papers. Why shouldn't we do something like that?

When planning some action, do the following:

1. Write down everything you are assuming. This is not easy and will take a good bit of practice.
2. Look at each assumption and try to figure out what happens to your results if that assumption turns out to be wrong!
3. If the consequences of a wrong assumption are quite bad, you might benefit from investigating that assumption very carefully.
Failure to analyze assumptions is part of short-term thinking.

## What's Going to Happen

It seems that failure to answer this question is part of short-term thinking. What will happen if...? Answering this is hard. It often requires predicting human behavior, which is usually difficult. Also - the person who should be asking the question is often focused on the near term and cannot imagine what might happen in the future or on a larger scale. It's sort of like looking at the world through a paper towel tube; your view is constrained so you don't see everything.

It means, among other things, that you just think you can control the world around you. Any action to accomplish one limited purpose will likely produce effects you didn't expect. Some of these effects can be quite unfavorable, in some cases worse than the original problem.

Remember that, in the context of this discussion, assumption #1 above is almost always wrong.

### Static Analysis

The term "static analysis" is often applied to government actions. There is a nice economic definition of it, but it really boils to assumption #2 being wrong. It means that, for example, if you change a tax structure in some area and make your revenue projections assuming that the peoples' behavior pattern won't change, your projections can be wildly wrong. Such analysis does not account for how variables may change.

## The Tragedy of the Commons

This concept is traced back to a 19th century English writer on economics, William Forster Lloyd. The theme was later developed in 1968 by ecologist Garrett Hardin. The basic premise is that, given access to a shared depleting resource, individuals will attempt to maximize their own return/wealth in the short term while the long-term result is the destruction of the resource. It is interesting to note that the individual participants may know perfectly well what might happen but go ahead and do it anyway on the grounds that "If I don't do it someone else will." Often a few people reap the benefit of the overuse while every pays for it.

### Examples

• Water Pollution: It is cheaper for a waste generator to simply discharge effluent directly into surface waters rather than processing it first. This optimizes the individual entity's costs at the expense of polluting the surface water for everybody. The cost of processing the effluent is simply shifted onto everybody else. In this case the commons is the surface water environment.

• Overuse of Groundwater: Consider the large areas where groundwater is used to irrigate crops. This water is drawn from underground aquifers, some of which are not recharged by rainfall. Every farmer tries to get enough water to irrigate his crops, which he desires to increase each year. If he were alone this might not be bad. He is not alone - every other farmer is trying to do the same thing. The result is that the aquifer is depleted until there is ultimately not enough water left for irrigation. Everyone optimizing their own situation results in depletion of the water and ruin for everybody.

• Overfishing: Ocean fishing grounds constitute a commons. The supply of fish is large but not infinite. If every fisherman goes out to get as many fish as possible, the total of all fishing can exceed the capacity of the fishery. The result is overfishing and collapse of the fish population. All the fishermen are out of business.

## The Law of Unintended Consequences

These unintended side effects result from the fact that the world, and human behavior, is very complex. It is not possible for any individual to understand all of the possibilities and interactions that can occur. It has been characterized as the result of attempting to regulate a VERY complex system like a society or an economy with a simple system like government. You often get results you didn't anticipate. Rob Norton notes that "Economists and other social scientists have heeded its power for centuries; for just as long, politicians and popular opinion have largely ignored it." This is not good, as the unintended consequences can be quite bad.

When we started researching this we found just how powerful and ever-present the Law of Unintended Consequences really is. It is seen coming into action often enough that one wonders just how deeply policy-makers are thinking about what they are doing. Stephen Dubner and Steven Levitt, in a 20 January 2008 article in the New York Times (see References), say that "... if there is any law more powerful than the ones constructed in a place like Washington, it is the law of unintended consequences."

### Examples

• Staff Cutting at Home Improvement Chain: This relatively recent story involves a large home improvement store chain. Their CEO decided to goose up the bottom line by reducing staff cost. Store managers were rated on how well they held down staff hours. The savings flowed right to the bottom line. Unfortunately however, they also flowed right through to customer service. It became possible for a customer to go into a store for a fast purchase only to find no staff to assist in locating the desired item as well as long checkout lines. Customers left the chain in droves, contributing to a large sales loss. The new CEO (the previous one was fired) faced the task of repairing the damage to the store's customer base. Assumption #2 wrong again.

• Anti-Lock Brakes: This one was interesting. The Insurance Institute for Highway Safety had, back in the 70's, done a lot of research on the benefits of anti-lock brakes on cars. They found that the systems definitely improved controllability of a car in dangerous conditions. By preventing wheel lock-up the systems prevented the loss of traction that results when the wheels slide on slippery surfaces. It seemed that installing anti-lock brakes on new cars would reduce the accident rate; the research results were quite positive. This was done - anti-lock brakes were installed on new cars in the 1970's - and the accident rate did not go down. A 2006 article on Physorg summarizes the results. There was an unintended consequence; assumption #2 was wrong again. Drivers were taking more chances, driving more aggressively, and in doing so negating the benefits of the anti-lock brakes. They'd get into situations where the braking system couldn't save them.

• Beer and corn syrup: Back in the 1970's Prof. Cotton heard a friend make a wisecrack about a certain brand of beer being no good. Not being a beer-drinker, Prof. Cotton didn't understand the remark at the time. Many years later he was visiting a beer-making program operated by another well-known brewer and presented by a retired brewmaster. After the class, Prof. Cotton related the story about his friend's comment many years earlier. The brewmaster immediately knew the answer. That brewer had substituted corn syrup and hops pellets for sugar and natural hops and also raised the process temperature.. This allowed a shorter brewing cycle. Short-term result: lower costs and higher profits. Long-term result: customers tasted the difference - and didn't like it. Also, the brewer began using a new foam-stabilizing ingredient to avoid labeling disclosure requirements. This total result was a beer with a short shelf life; it decomposed and produced an unappealing goop in the bottom of the bottle. Sales plunged and the stock price collapsed. The brand was sold in 1982. The sources indicate that this was not the only bad decision that management made.
• The Complete Guide to Activity-based Costing, Michael C. O'Guin p.219
• The U.S. Brewing Industry, Tremblay & Tremblay p.87-92
• Brewing Battles: A History of American Beer, Amy Mittelman p 165
• Beer Blast: The Inside Story of the Brewing Industry's Bizarre Battles for Your Money, Philip van Munching
• Blogger's take on the situation

• Freeway Improvements: In the movie Field of Dreams, the main character is told that "If you build it, he will come," referring to Shoeless Joe Jackson. In the context of freeways one might alter that to "If you build it, they will drive." In a guest editorial in the Boulder Planet, Al Bartlett addresses issues with the Denver-Boulder Turnpike. Now a freeway, it was originally built as a limited-access toll road connecting Denver with Boulder. There were only three access points: one in Denver, one in Broomfield and the northern end in Boulder. The road succeeded beyond anyone's expectations and paid off its bonds in 15 years (half the planned time). After the tolls were removed, developers and officials in the various communities saw the potential for growth if new access points (interchanges) were added to the Turnpike. Over the ensuing years this was done, and those communities grew as expected. So did the traffic. The new interchanges wiped out the original limited-access concept, with the result that a large percentage of traffic on the road is now short trips.

Australians would like to find anything that might exterminate the toads. They are a serious pest. Locals enjoy running them over with their cars, or playing "Cane Toad Golf."

• Digital Rights Management: This one annoys a lot of people. Producers of music recordings and movies are attempting to "protect" their products against rampant digital copying by wrapping in a Digital Rights Management package. These technologies strictly limit what a buyer of the product can do with it. Music files can be played on a very limited number of computers; if hardware failures and upgrades make you exceed the limit, your music files become unplayable. Compare that to the simple CD (or older vinyl record) which can be played on any player that plays that medium. The customers are not asking for this "feature;" it is being forced on them. Microsoft is a poster child for the problem. They sold music files from MSN Music Service, which was their feeble attempt to compete with Apple's iTunes. It didn't work, and Microsoft shut down MSN Music Service on 14 November 2006. The license servers continued, so you could still play your music files. Second shoe drops: on 31 August 2008 Microsoft shut down the license servers. Microsoft said that "If you attempt to transfer your songs to additional computers after August 31, 2008, those songs will not successfully play." So much for "Plays for Sure."

Another example occurred in 2005, when Sony BMG began including copy-protection software on music CDs. When you played the CD on a Windows PC, some very special software was installed on your computer without your knowledge. When you read the reference, you will see that the software installed a "rootkit" on users' computers and opened up a very serious security hole. The end result for Sony BMG was disastrous - they were sued by the Texas Attorney General and many other plaintiffs as well and ultimately forced (after much resistance and maneuvering) to recall the protected CDs and reimburse customers up to \$150 each for repairing the damage caused by attempts to remove the software (which was very difficult because of poor design). Microsoft classified the Sony BMG protection software as spyware. To say that this was a PR catastrophe for Sony BMG is an understatement.

The result of such debacles is another unintended consequence: music lovers have an even greater incentive to get their music files illegally by downloading them from sources which post unprotected versions of the tunes. That way they avoid all of the hassle of Digital Rights Management.

• Rabbits in Australia: Another, older, story of animals brought into Australia. An Englishman living in Australia wanted to continue his pastime of rabbit hunting. The problem was that Australia had no rabbits. This was easily solved - he had his nephew in England send him some rabbits, hares and other creatures. He released the rabbits into the wild for hunting in 1859. The problem with rabbits is that they... multiply like rabbits. In ten years the rabbit population had exploded. One could kill as many rabbits as desired without having any noticeable effect. At least there were some uses for them - dinner, dog food, poultry food and fur. The supply of rabbits was effectively unlimited. Now you cannot eat wild Australian rabbits because of the two diseases that were introduced to control the rabbits.

• Texas Vanity License Plates: In 1985 the state Legislature decided to increase license plate revenue by raising the fees for vanity plates. The price at the time was something like \$25. A price increase to \$75 was instituted, and then everybody waited for the increased revenue to roll in. Unfortunately, they had made assumption number 2 above. The people did NOT continue to behave the same way; since vanity plates are optional, a large number of buyers decided to forego the vanity plates and buy the normal license plate. So many people did this that the loss of vanity plate sales essentially negated the price increase; the vanity plate revenue increased by only 4%. Before the price increase 160,000 Texans bought the plates; afterwards only 55,000 did. Triple the price and lose almost 2/3 of the sales. The price of vanity plates was reduced to \$40 the next year. The DMN quotes Rep. Bill Ceverha of Richardson as saying "I thought it was a mistake when we did it. We made 100,000 people angry for no reason."
• Legislature Approves \$146 Million Fee increase, Dallas Morning News, 27 May 1985
• Lower Fee OK'd for Vanity Tags, Dallas Morning News, 15 August 1986
• Senate Approves Reducing Fees for Custom License Plates Dallas Morning News, 3 September 1986

• Rent Control: This does sound good. You can outlaw rent increases and hold rents at an "affordable" level. It should provide low-cost housing for those many who need it. This has been tried in several cities including New York City and Santa Monica, California. One might think that it is a boon for renters, but this is not the case. The idea is based on assumption #2 above, which is wrong. It assumes that property owners will continue to provide rent-controlled housing in situations where the fixed rent allowed is below the cost of operating the property. The result has been crushing shortages of rental housing in these cities. Long waiting lists for rent-controlled apartments are the rule. Also - once someone finally gets a rent-controlled apartment they tend to stay in it; if they want to move there is no guarantee of getting another controlled apartment. The effects of rent control are well understood by economists. It seems that one ironclad rule of rent control is that the tighter the rent controls, the worse the housing shortage. Hoarding of rent-controlled apartments results in many people staying put for more than 25 years. Walter Block quotes Swedish economist Assar Lindbleck as saying "In many cases rent control appears to be the most efficient technique presently known to destroy a city - except for bombing." (see reference below)
• Endangered Species Act

The Law of Unintended Consequences has caught up to the Endangered Species Act (ESA). Economists can make a case that, under some conditions, the provisions of the ESA can result in habitat destruction in excess of expectations.

• Luxury tax (1990): This also sounds like a good idea. The very wealthy buy lots of yachts, private airplanes, jewelry, etc. Why not impose a "luxury tax" on these purchases? How about a tax on the price of luxury items above some threshold?
• Automobiles - \$30,000
• Boats - \$100,000
• Aircraft - \$25,000
• Jewelry & Furs - \$10,000
A 10% tax would be levied on the part of the retail sales price above the specified threshold. This ought to make the wealthy pay more of their "fair share" of taxes. It was projected to bring in \$9 billion over the next 5-year period.

Would this work? We don't have to guess or theorize - it has been tried. The Congress added exactly this tax structure to the Omnibus Budget Reconciliation Act of 1990. We can ask how well it actually worked.

This turns out to be a perfect example of the results of static analysis (see above). The tax writers assumed that the buying pattern for boats, expensive cars, jewelry and furs would not change. Surprise! It did change. The unintended consequences were quite serious.

Here's what actually happened.

• By the end of 1990 5,000 boatbuilding jobs lost in Florida alone
• At least 7,600 boat-building jobs lost in first year
• Tax brought in \$3 million from boats in 1991.
• Wealthy buyers bought yachts in Bahamas, etc.
• As many as 30,000 workers lost their jobs.
• Large loss of income tax and FICA revenue
• Government had to pay unemployment benefits to laid-off workers
• Losses probably exceeded revenue raised
• Near destruction of U.S boat-building industry
• Tax finally repealed in 1993

Andrew E. Busch wrote (see reference)

"as many as thirty thousand boat workers lost their jobs from 1991 through mid-1993, so the government not only lost income tax receipts from them but had to pay them unemployment benefits."
He also notes
"Overall, the luxury tax probably cost the government more than it raised."

The Scan-Mar Yacht Co. has something to say about the situation in a short history found on their web site (web site now gone).

"Some of the finest American sailboat manufacturers bit the dust within a year, including Cal, Pearson, Gulfstar, Endeavour, Irwin, Morgan, Cape Dory, Bristol & Tartan. In New Jersey where I grew up, there were some of the oldest and finest powerboat builders in the United States, some of which had been in business since the 19th century; by 1991, most had gone bankrupt."

This debacle was an almost certain result of static analysis; assumption #2 was wrong and they didn't know it.

• Population control (2015): 29 October 2015. The Chinese government announced a relaxation of the 35-year-old one-child-per-family policy, the change to be effective January 1, 2016.. This policy was implemented around 1980 to prevent an expected overpopulation which could impoverish the country. One news outlet reported that some 400 million births had been prevented. In the context of preventing overpopulation the policy apppears to have succeeded. This development has been widely reported.

On the other hand, the policy had some unfortunate side effects. It is possible that some of these were not foreseen.

• Reduced fertility: The fertility (birth) rate is now below the replacement rate of 2.1 births per woman of childbearing age. China is reported to be at a rate of 1.5. A society which continues this will eventually shrink as aging parents are not fully replaced, unless immigration makes up the difference.
• Female infanticide: In rural areas the families depend on their sons to help work the farm. If their one allowed child is a girl they face serious difficulties. The result was a wave of female infanticide - the killing of female babies. THe usual means appears to have been drowning. A Wagington Post report notes: "Our intelligence sources, and Chinese sources who asked not to be named, say a conservative estimate of the babies killed in the last 12 years would be 1 million."
• Large excess of men: The female infanticide described above plus effective gender selection methods have produced a significant excess of male babies. At present there may be 10 million or more Chinese men who will never find a wife. A Washington Post report describes it: "The problem is likely to get worse: It has been estimated that there will be a surplus of 40 million to 50 million bachelors in China throughout the mid- to late 21th century." This could have very serious sociological effects later on.
• Support of aging parents: China has no support system for older people. Historically, the children have supported their elders. If you include grandparents you get what is described as the "4-2-1" problem. The single child might be caring for 2 parents and 4 grandparents. This is not sustainable.
• Aging population: With fewer young people coming to the population, the average age is rising. According to the New York Times, " Now, about 10 percent of the population is 65 or older, and according to earlier estimates, that proportion is likely to reach 15 percent by 2027 and 20 percent by 2035." USA Today reports (27 Dec 15) that about 15% of the population is over 60 now.
• Labor shortage: The reduced fertility rate has resulted, in 2012, in the first labor shortage in China. This could have serious implications for future economic growth.
• Shrinking population: If the population actually starts to shrink, reversing the trend is very difficult. There is a "Fertility Trap" hypothesis which is not fully developed; this suggests that at a fertility rate somewhere under 1.5 (roughly) that population shrinkage becomes essentially certain, barring large immigration to offset the loss. It is called a trap because it is extremely difficult to get out of it. The Chinese Academy of Social Sciences stated that no country that has fallen into this has ever gotten out of it. Economic growth is very difficult.

The news reports suggest that these now-visible effects are the motivation for changing the policy. The concern now is the demographic changes which, along with high living costs in cities, have discouraged large numbers of parents from having more than one child. The fertility rate is well below the replacement rate, and reversing this may be difficult.

## Charles Murray's Laws of Social Programs

For the a good summary, see the full column here. These are about empirical "laws" that affect the results of social programs in spite of the good intentions of those who design them. Assumptions 1 and 2 above prove false.

### The Law of imperfect Selection

Any attempt to craft rules for program eligibility will invariably exclude some people who should be eligible. The world is too complex for rules to work perfectly, yet rules are all we can assemble.

### The Law of Unintended Rewards

"Any social transfer increases the net value of being in the condition that prompted the transfer." (Charles Murray) For example, a program which gives substantial benefits to homeless people immediately increases the value of being homeless; if you are not homeless you cannot get the benefits.

This effect is, as Charles Murray suggests, often seen in social programs. Suppose there is a problem with some social pathology. Your government (or some other body) wants to "solve" the problem. This is often done by offering some benefits to those who have the problem with the intention of helping them improve their condition. The hazard is that, if the benefits are particularly attractive, other people will get themselves into the condition that allows them to get the benefits. You wind up with more of the undesired behavior for the simple reason that you are paying for it.

A good example can be found in programs to assist the homeless. People have been known to move out of a relative's home, live in their car for a while, then apply for housing. The fact that they are "homeless" results in their being kicked to the top of the waiting list, ahead of everybody else who are not "homeless." That is a valuable benefit.

### The Law of Net Harm

"The less likely it is that the unwanted behavior will change voluntarily, the more likely it is that a program to induce change will cause net harm." (Charles Murray) It can take a long time for people to understand the damage that is being done and finally stop the program.

• The War on Drugs: A fine example of this law can be found in the "War on Drugs." If you count up all the people sent to prison for possessing small amounts of marijuana, having property seized, and prosecuted for what some believe are minor problems, the total of people whose lives are adversely affected is significantly larger that the number of people directly damaged by the drugs themselves.
• Prohibition: The period 1919 through 1933 was known as "Prohibition." The Eighteenth Amendment was ratified on January 19, 1919. It banned the manufacture, importation and sale of "intoxicating liquors" in the U.S. Prohibition lasted until December 5, 1933, when the Twenty-First Amendment was ratified; it repealed the Eighteenth Amendment.

The "Noble Experiment" attempted to eliminate the consumption of alcoholic beverages in the United States. The effort was high-minded, but the actual effect was far less wonderful.

• Organized crime syndicates became entrenched.
• Tax revenues from alcohol were lost.
• Court and prison systems became overloaded.
• Many drinkers switched to other drugs, like opium, marijuana, cocaine, etc.
• Corruption of public officials was widespread.
• Covert bars (speakeasies) blossomed everywhere.
• Bootlegging (illegal manufacture or importation of alcohol) spread.
• Serious disrespect of the law appeared.
It would be difficult to find a better example of the Law of Net Harm. Read the references below and/or search for "Prohibition," "Volstead Act," or "Eighteenth Amendment" and follow the leads.

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