The minimum amount of recovered funds that can earn a reward is $1 million, but the sky’s the limit on the upside. The whistleblower gets to keep 10 to 30 percent of the amount collected, including fines, interest, and disgorgement of ill-gotten gains. We’re talking about big game here, with awards conceivably topping $100 million.

Eric Havian, an attorney with a law firm that represents whistleblowers, noted in an interview with the San Francisco Chronicle’s Kathleen Pender that the securities laws cover a “huge category of bad conduct,” such as illegal insider trading, cooking the books, market manipulation, stock option back-dating, false or misleading disclosures, and the deceptive sales of securities. Almost anything potentially can be illegal, and these vaguely defined offenses leave much room for government mischief. As for insider trading, this is a practice that does little harm and may actually provide benefits to small investors. (See my January/February 2011 Freeman article, “Inside Insider Trading.”)

If corporations felt they needed limits on insider trading or other conduct to attract shareholders, they could write prohibitions into their bylaws so that violations, if not settled internally, could be remedied under civil law.

The mind boggles at the incentives the whistleblower program establishes. Law firms must be gearing up already to coach whistleblowers in the fine art of identifying and documenting actions that can be gussied up into plausible cases. It would make sense for law firms to take cases on a contingency basis because this sort of lawyering could be very lucrative. The SEC staff, concerned primarily with covering its collective rear end, will shy away from dismissing all but the most frivolous cases.

The road to riches will not be short or direct. Many years could elapse, if only because of bureaucratic inertia, between the time of filing and the bestowal of an award. “There will be more people struck by lightning in a given year than will get a check from the SEC in the next five to ten years,” cautioned Tim Mazur of the Ethics and Compliance Officers’ Association. But once the first awards hit the headlines, “a lot of people will start paying attention,” he added (San Francisco Chronicle).

All whistleblowers run the risk of retaliation from their employers, but in today’s climate this risk seems minimal. Besides, complaints may be filed anonymously.

Whistleblowers will lose their incentive to pursue complaints through their companies’ internal review process, an avenue that could correct any genuine wrongdoing relatively quickly. With such a massive potential pot of gold beckoning, why not wait and let the supposed wrongdoing fester for a while?

To be sure, the SEC rulemakers are aware of at least some perverse incentives. The website announcement contains a section headed, “Avoiding Unintended Consequences,” which excludes certain people from eligibility. The SEC also says information presented must be the whistleblower’s independent knowledge or analysis. But these limits seem to leave enough space to drive a truck through, and the truck drivers are revving their engines.

New Uncertainty

Of course corporate officers will be aware of the new incentives for whistle-blowing, which may well make them more cautious about taking on the risks of new or expanded production. Too bad. Investment is exactly what the country needs to get out of its economic funk. New uncertainty will further delay recovery.

Meanwhile, government whistleblowers aren’t doing nearly so well. Thomas Drake, a National Security Agency employee, found hundreds of millions of dollars being squandered on failed programs and tried to expose them. He did not leak any classified information, and he tried informing his bosses, the NSA inspector general, the Defense Department inspector general, and congressional intelligence committees before taking his findings to the Baltimore Sun. Rather than a pile of cash, Drake’s reward was an indictment on ten felony charges that could have gotten him many years in prison. But earlier this month, following a New York Times article on his situation and a judge’s ruling that certain classified information which prosecutors wanted to use against him could not be kept under wraps, all charges were dropped in a deal in which he pleaded guilty to one misdemeanor.

A recent petition signed by 20 noted whistleblowers calls for rescinding a “Transparency Award” given to President Obama recently. The President “has invoked baseless and unconstitutional executive secrecy to quash legal inquiries into secret illegalities more often than any predecessor,” the complaint noted. “Ignoring his campaign promise to protect government whistleblowers, Obama’s presidency has amassed the worst record in U.S. history for persecuting, prosecuting and jailing government whistleblowers and truth-tellers.”

But hey, we should just be glad the feds are protecting us from those nasty corporate insiders.

The Foundation for Economic Education’s Sheldon Richman once said that advocating policies when you don’t understand their unintended consequences is “the intellectual equivalent of drunk driving.”

You can read Richman’s full article here.

But isn’t food safety a pressing concern, a public-health problem we can’t afford to fool around with? Problem is, the problem isn’t. Emotional rants that “thousands die every year!” do not help us grapple with the scope or magnitude of this alleged threat. Let’s try some perspective: According to the Centers for Disease Control, the estimated number of deaths caused by foodborne illness falls between 5,000 and 8,000 a year (down a substantial 35 percent, by the way, from ten years ago). Sounds pretty bad, eh? Time to call in the Salmonella SWAT team? Before you do, consider that the same number of people die by intentionally strangling themselves each year. Or that the same number of people die from Alzheimer’s in California alone each year. Or that four times that number die each year accidentally falling off of things. Moreover, 70 percent of foodborne illness (and presumably deaths) results from poor food-handling procedures during preparation, not from poor food-production practices. The number of people we’re attempting to save with this kind of legislation, in a cosmic feat of irony, is significantly lower than the number of people who die each year from malnutrition (known in the business as “starving”).

Unless you’re also on a crusade to flatten everything, I’d think twice about ceding greater authority over our food system to centralized management.

True to form, Congress has blithely offered its professional problem-solving services to rid us of the menace of deadly food. And, true to form, it’s about to embark on another unarmed expedition into the tortuous territory of unintended consequences.

Adding more regulations to a sector always reduces the number of operators in that sector. It can be dramatic (as in the case of the payday loan industry), or it can be insidious (as in the case of the livestock industry). The food industry is no exception; it’s impossible to envision a wave of enthusiastic newcomers clamoring at the gates to enter the food business now that the FDA has been granted the most sweeping extension of its powers in 70 years. Granted, some of the bad actors need to be pushed out of the industry (as in the Peanut Corp. of America, which apparently intentionally distributed salmonella-laced product). Call me a Pollyanna, but I don’t think the bad actors generally represent the food industry. The people who do represent a large part of the industry are the small, local, independent operators who have been squeaking by for decades. This kind of regulatory barrage is exactly the sort of thing to make them call it quits. BSE (mad cow) regulations pushed my predecessor at the meat-packing operation I own to hang up his hat. The increasing silliness over E. coli testing pushed his predecessor over the brink years ago. Warranted or not, an increasingly difficult regulatory environment will always winnow out the small players, leaving the field more sparse than before.

Fewer Hands

Of course the demand for food hasn’t gone down, so how does the system accommodate a hungry public? Well, that’s where Cargill, Tyson, Monsanto, and the rest of the Big Food set come in. They’re not evil (despite bumper-sticker claims to the contrary); they’re just picking up the slack left when the small guys get pushed out by big government. I know, I know: It’s easier to blame their success on high-priced lobbying and a cozy relationship with regulators. But consider this: The lobbying and cozying can only manipulate government action when government hands are firmly on the wheel of that particular industry.

The unintended consequence in this legislative bid to create safer food is to push more and more production into fewer and fewer hands. As we all know, the more top-heavy a thing gets, the more prone it is to toppling. As Tom Philpott writes, “[T]he real systematic risk of the food system [is] the exponential expansion of hazard that comes from concentrating huge amounts of production in relatively small spaces.”

So is there any solution? If we agree that even one death from foodborne illness is too many (and it is), then how can we aim to squeeze out that lingering menace without artificially exacerbating the very problem we are trying to solve? How can we do to Listeria what we did to malaria in the United States?

I may be waxing heretical, but might I suggest deregulation? Contrary to myth, markets are in fact very good at giving us what we want, even if those things are intangibles like clean air or safe food.

Let me give you an example: As a producer of livestock and owner of a small (very small, according to the USDA) packing house, I know about the raft of bureaucratic “protections” between you and the beef I produce. There is little or no incentive for me to create a remarkably safer production system because my processes are effectively in the hands of our state inspector. The incentive among producers is to win the race toward the bottom, where you can most cheaply and easily meet the minimum standard. Imagine for a moment what the food world would look like if we made food safety a competitive advantage. What if I could demonstrate (through third-party quality assurance, a sophisticated testing regime, or something completely unthought-of as yet) that my beef was quantitatively safer than my competition’s? I suspect that the maligned self-interest of “money-grubbing capitalists” would be instantly harnessed toward the greater public good. I for one would probably behave considerably differently if I were continually striving for the next-higher grade on something like a “Good Housekeeping Seal of Approval” scale instead of aiming simply for the “Inspected—Passed” stamp.

We didn’t regulate malaria out of existence; we simply ensured that millions of empowered individual actors had the information to combat it (that, and some choice applications of DDT). Allowing food processors to compete for customers by marketing their very best possible food-handling practices would have a similar effect.

Regulations are good for imposing minimums, but not for creating excellence. Since our food safety “problem” is clearly in the vanishing margins, excellence is what we need. This can only really be attained when incentives are structured to push our producers (and consumers) to go the extra step to make food as safe as it can possibly be.

Many foodies rightly criticize government meddling in the food sector in the late 1940s for attempting to create cheap food at tremendous ecological and sociological expense. Let us not condone the same mistake under the aegis of “safe food.”

This is particularly true with respect to economic policy and can be illustrated by the world of competitive sports, which often makes a nice analogy to markets given that both involve competition according to rules.

The current discussion about changing the rules for overtime in the NFL, at least for the playoffs, provides a good example. Right now, the rule for overtime is sudden death: The team that scores first wins. Of course this means the coin flip to determine who gets the ball first is crucial—for many people it’s too decisive: The first possessor wins too often. In addition, other changes to the game since overtime was introduced in 1974 have given the team with first possession an easier path to scoring, especially by a field goal. (For example, the kickoff line is five yards farther back and field-goal kickers are stronger and more accurate).

One proposal would allow the loser of the coin flip to have possession of the ball if the team that has it first only scores a field goal. The intent is to reduce the advantage of first possession by reducing the value of the field goal.

As with economic policies, however, we cannot ignore how this change might affect the teams’ choices and strategies.

Fooled by Inflation?

Consider the history of macroeconomics. Early Keynesians believed that inflation could fool workers into accepting lower real wages (thereby increasing employment) because they would not understand its effects. When Milton Friedman, Robert Lucas, and others later pointed out that people eventually learn, it changed how economists viewed loose monetary policy. If people know inflation will reduce their real wages, they will have an incentive to find out the inflation rate and do their best to incorporate it into their wage demands. As a result, inflationary policies will not have the nearly the effects on the average real wage that the early Keynesians thought.

Observe the analogous reasoning about the proposed NFL rule change. If the first possessor only gets a only field goal, the second team would know it has to score to keep the game alive and therefore would never punt on fourth down. It turns out that statistically the second possessor is more likely to score in such circumstances than on a typical NFL drive. So to that extent, it seems the rule change would have its intended effect.

But we don’t want to assume that the first possessor would do the same thing no matter the rules. After all, it would know that if it only scores a field goal, the other team would be more aggressive on fourth down, which would make it somewhat more likely that it would tie or win the game than under sudden-death rules when the first team doesn’t score. This knowledge may well induce the first team, on the margin, to risk a fourth-down play, passing up a field goal, to try for a game-winning touchdown.  Reducing the marginal value of a field goal to the first possessor would encourage more teams, again on the margin, to try to score a touchdown, and thereby counteract some of the intended consequences of the rule change. The change would be less effective than first thought when we consider how the first possessor might react.

In economic policy this point can matter quite a bit. As Friedman and Lucas put it, people’s expectations are not invariant to the policy regime. People form expectations that counter the intended effects of the policy. The sports version is: Game strategies will change when the rules change. In both cases a thorough analysis of the actual effects of a policy or rule change requires that we assume that people learn and react to the change itself. Just changing policies or rules without assuming people learn is a recipe for ineffectiveness and potentially damaging unintended consequences.

Both insights rely on the foundational idea that intentions and results are not the same thing. Thinking we ought to do something does not mean it will have the results that motivate the “ought.” With respect to profits we have to recognize that because someone does something to benefit himself, it does not mean the action doesn’t benefit others too. In both cases the core concept that is often overlooked is unintended consequences. Recognizing that intentions do not equal results and that we must consider the possibility of unintended consequences is what separates good social analysis from bad.

The issue of unintended consequences is interrelated with a more general aspect of human social existence: the pervasiveness of uncertainty. The future is not available to us in the present. We cannot know the course of nature, but neither can we know the course of human choices. We are always acting based on our best guesses about what others will do and how our actions will coordinate with theirs, which we can never know with certainty. This structural uncertainty of the human condition means that we can never know all the consequences of our choices, which implies that some of those consequences will be other than what we intend. Anyone who believes the consequences of his actions will be exactly as intended is blind to the fact that his choices must interact with those of others, creating outcomes that none of the choosers designed.

Unintended consequences come in two flavors: positive and negative. The concept of negative unintended consequences is acknowledged in some social analyses and in morality, but is certainly underdeveloped in the understanding of economic policy. Positive unintended consequences are rarely recognized in “serious” conversations about public policy, even though they are at the core of modern economics.

Consider the two-by-two matrix below.

We have moral language for three of the four possible combinations of intent and outcome. Vice and virtue are easy enough, as they are our common terms for discussing the morality or desirability of our actions when the outcomes match our intentions. But what about when they don’t? We have the category of “negligence” when we cause negative outcomes we did not intend, such as failing to set the brake on a car that rolls down a hill and damages property. But we do not have a word for the unintentional doing of good! That missing box is filled in by economics and good social science as they explain how, under the right institutional framework, the pursuit of self-interest leads to unintended benefits for society as a whole.

Naming the Unintentional Good

From Adam Smith in the eighteenth century to Carl Menger in the nineteenth to Ludwig von Mises and F. A. Hayek in the twentieth, the central mission of economics has been to understand how we can produce beneficial outcomes that were not intended. Smith captured this idea with the “invisible hand” that leads the butcher, baker, and brewer to provide us with our dinner not out of altruism but “self-love.” Smith understood how exchange guided by prices and profits would harmonize (to use a term associated with Frédéric Bastiat in the nineteenth century) the self-interest of producers with the self-interest of consumers. Even if we care not at all about the people we trade with, we will nonetheless be led to satisfy their wants in our attempt to satisfy our own. Looking only at the seller’s profits without tracing out the entire chain of beneficial though unintended consequences that his self-interest produces is to take an “unscientific” approach to understanding society.

Menger put the concept of unintended consequences (and the closely related idea of “spontaneous” or “unintended” order) at the center of his conception of the social sciences. In what is often termed “the Mengerian question,” he asked: “How can it be that institutions which serve the common welfare and are extremely significant for its development come into being without a common will directed toward establishing them?” Menger recognized that many social institutions are not the product of human design, but instead emerge as people seek their own self-interest. Menger’s own classic work on the evolution of money explains how it arose this way from barter.

Mises and Hayek deepened this argument another layer as both recognized, with somewhat different emphases, the role that knowledge plays in understanding the centrality of unintended consequences in social thought. Mises provided what we might call the “microfoundations” of Smith’s invisible hand by carefully explaining how we go from people’s subjective perceptions to market-level outcomes via prices, which facilitate our calculations about the effectiveness of the use of resources. Mises also explored how profit and loss provide further signals that serve as “aids to the mind” in guiding our behavior. Entrepreneurs are led to use resources wisely, profiting for themselves but also improving the well-being of others, thanks to the signals of the marketplace.

Hayek’s work on economics, knowledge, and the problems of socialism allowed us to see the opposite side of Mises’s analysis by exploring how socialist planners would be unable to replicate the workings of entrepreneurs. Hayek argued that without market signals government planners would be unable to marshal the dispersed knowledge available to entrepreneurs through prices and other market institutions. Because of their ignorance, planners would not only be unable to generate beneficial unintended consequences in their own pursuit of self-interest, they would in fact cause harmful ones by being unable to see how their mistakes would lead to further mistakes—not to mention accumulating State power. Both Mises and Hayek saw that regardless of the socialist planners’ good intentions, their inability to make use of the knowledge of the marketplace would lead to consequences very different from those intended—in fact, as history has clearly demonstrated, consequences devastating for millions.

Institutions Against Uncertainty

The Smith-Menger-Mises-Hayek line of thought can be tied back to our earlier discussion of uncertainty. This tradition argues that we use evolved social institutions, including the market, to get more accurate expectations of the behavior of others and push back against the uncertainty that threatens to derail our plans. At the simplest level we see this with prices: The prices of particular goods or services are “aids to the mind” regarding the preferences, knowledge, and expectations of others, enabling us to better anticipate the consequences of our choices and to thereby make better ones. Institutions that emerge as a result of unhampered social evolutionary processes all perform this uncertainty-reducing function.

Consider the institution of ownership. When someone says that he “owns” a particular good, we know that gives him a certain set of rights to it and imposes certain obligations, largely negative ones, on us. Knowing that the good is owned means we can form particular expectations about what the other person might and might not do with that object, and he in turn can have reliable expectations about what we will and will not do.

An irony of social institutions is that by limiting our choices they make us better able to execute our plans and anticipate their likely consequences. However, to perform that coordinative function in complex matters and help us overcome uncertainty, institutions need to emerge from people’s voluntary interactions, usually over a period long enough for them to embody the best ways of doing things. This is why markets are so good at generating positive unintended consequences and why institutions imposed by force from the top down tend to generate negative ones. Just as we are much more productive as a society when entrepreneurs and consumers have access to competitively determined prices, so in general does human action produce beneficial unintended consequences when social institutions generally are the result of unhampered evolutionary processes.

Even in less dramatic ways modern economics remains focused on unintended consequences, particularly in how economists like to make highly counterintuitive arguments. For example, a number of years ago there was a call for government to require very young children to sit in car seats rather than on their parents’ laps when flying on airplanes. This arose out of concern that in some circumstances lap children could be hurt or could hurt others. Critics, particularly economists, quickly responded that such a law would actually kill more children than it saved.

To see why, one has to explore the unintended consequences. Under the law parents would have had to buy tickets for children who formerly flew free in their laps. Faced with the additional charge, some families on the margin would switch from flying to driving. But the odds of being injured or killed in an automobile are much greater per mile than in a plane. Thankfully, that unintended consequence was anticipated before it was too late, saving many children in the process.

The idea of unintended consequences also helps us understand one process by which government has grown over the last century or two. Because even well-intentioned interventions produce consequences that political actors could not foresee and did not intend, every time government acts, it creates a new set of problems that in turn leads to calls for more government solutions.

A final observation: The neglect of unintended consequences and the focus on motives lead us to celebrate the lives and mourn the deaths of politicians, although they may have caused undesirable unintended consequences, while inventors and businesspeople who benefit humanity while pursuing their own ends go unnoticed. As my matrix on the previous page suggests, we simply don’t have a moral category for people who unintentionally benefit others in pursuit of their self-interest. And we also highly overvalue intentions as a measure of moral worth, leading to praise for those whose “hearts were in the right place” even as they have caused incalculable damage to prosperity and freedom.

A better understanding of the idea of unintended consequences will not only give us the tools we need to more accurately analyze social issues, it will also provide us with a different way of making moral judgments. After all, it is results that count, and we all know where the road paved with good intentions leads to.

Start with the Corporate Average Fuel Economy (CAFE) law, which requires each auto producer in the U.S. market to make fleets that average at least 27.5 miles per gallon for cars and at least 20.7 mpg for trucks. (Former President Bush and Congress increased that to 35 mpg by 2020, with no lower standard for light trucks.) That law had the unintended but totally predictable consequence of making cars less safe. The reason is that one relatively cheap way to raise fuel economy is to make cars lighter, and the lighter they are, other things being equal, the more dangerous they are to their occupants. In 1989 two economists, Robert Crandall of the Brookings Institution and John Graham of Harvard University’s John F. Kennedy School, found that, adjusting for the downsizing of cars that would have occurred anyway, the CAFE laws would cause an extra 2,200 to 3,900 deaths over the life of a 1989-model-year car.

But the CAFE law is itself the result of another unintended consequence of government policy, namely price controls on oil and gasoline. President Nixon’s economy-wide wage and price controls, imposed in 1971, did not cause much difficulty at first. But when the Organization of Petroleum Exporting Countries (OPEC) raised the world price of oil from about $3 a barrel to about $11 over a few months in late 1973, Nixon’s price controllers refused to allow refiners to pass on the whole increase in the price of gasoline. The result was a massive shortage of gasoline, with long lines at the pump. Rather than remove the controls, Nixon had government officials start allocating the gasoline by various arbitrary criteria, a process the Ford and Carter administrations continued.

Government officials in the Ford administration and in Congress noticed that American car buyers were not buying as many high-fuel-economy cars as these officials thought they should. In other words, Americans were responding to the artificially low price of gasoline by acting as if the price of gasoline were low! Gee, what a surprise. Of course, instead of removing the price controls, Congress and Ford decided to regulate the fuel economy of new cars—that’s how we got CAFE. Like all regulations, this one bred its own lobby, featuring Ralph Nader and Clarence Ditlow. They had been, until that time, advocates of car safety. But they wanted enforced fuel economy even more.

That’s not the end. One way the companies could meet their CAFE targets was by importing small, high-fuel-economy cars from their foreign production facilities. The United Auto Workers union noticed this and lobbied for—and achieved—separate standards. Auto companies then had to hit the standard with their domestic production and, separately, with their imports. That caused the companies to produce more small cars at home rather than import even successful cars from abroad. According to William Niskanen, the chief economist at Ford in the late 1970s, Ford dropped its Fiesta in the late 1970s not despite, but because of, the car’s potentially large market: Ford feared that its German-made Fiesta would “steal” sales from its U.S.-made Escort, thus lowering its domestic CAFE average.

Moreover, even the increase in the world price of oil engineered by OPEC in late 1973 was in part the unintended consequence of U.S. energy policy. Why? Because OPEC had been formed in response to President Eisenhower’s restrictions on oil imports. As economist Ben Zycher points out, in 1959 the U.S. government established the Mandatory Oil Import Quota Program (MOIP), which restricted the amount of imported crude oil and refined products allowed into the United States. It also gave preferential treatment to oil imports from Canada and Mexico. Two major growing sources of supply at the time were the Middle East and Venezuela. By reducing a major market for Middle Eastern and Venezuelan oil, the import-quota system drove down the demand for that oil, causing its price to fall in February 1959 and again in August 1960.

In September 1960 governments of four Persian Gulf countries—Iran, Iraq, Kuwait, and Saudi Arabia—facing discrimination against their oil, joined with Venezuela to form OPEC. Their goal was to get monopoly power to offset the monopsony power created by the U.S. oil import quota system and thus get higher prices. Although OPEC was at first relatively powerless, by 1973 the governments of eight other countries—Algeria, Ecuador, Gabon, Indonesia, Libya, Nigeria, Qatar, and the United Arab Emirates—had joined. In 1973, OPEC made its move.

From the CAFE to the Mess Tent

CAFE laws and other fuel-economy standards are not the only unintended consequences of U.S. price controls on oil and gasoline. One can even speculate reasonably that these price controls led to two major wars initiated by the U.S. government. The reason is that instead of blaming their government for lines at gas stations, Americans have tended to blame foreign governments—especially the government of Saudi Arabia, the leader of the OPEC cartel and its largest producer. In 1979 President Carter formed the Rapid Deployment Force to train for combat mainly in deserts. President Reagan kept this force and renamed it the U.S. Central Command.

Whatever Carter’s motives or understanding in forming this force, the hardwiring in Americans’ minds led them to associate gas lines with nasty Middle East governments rather than with the nasty U.S. government. That made them more willing than otherwise to support intervention in Middle Eastern affairs to secure the continued flow of oil. Thus when Henry Kissinger claimed in August 1990 that Saddam Hussein’s invasion of Kuwait, if left unopposed, “would cause a world-wide economic crisis,” many Americans believed him. In a Wall Street Journal article that month, I showed that, in fact, the absolute worst harm Hussein could do to the U.S. economy, even if he grabbed Saudi Arabia and the United Arab Emirates, was a loss of less than half of 1 percent of GDP annually. But because so many Americans feared the return of gas lines, they were more open than otherwise to a U.S. attack on Iraq.

Later, in 2003, the U.S. government still had the military capability to invade Iraq. The stated issue this time was Saddam Hussein’s alleged weapons of mass destruction. Still, the fact that the U.S. government had the capability to attack Iraq was due in part to Carter’s buildup of the Rapid Deployment Force.

As poet Robert Burns might say, “Oh what a tangled—and tragic—web government weaves when first it practices to intervene.”

Nassim Nicholas Taleb is famous for introducing us to black swans. Though these rare creatures have long been used among academic philosophers to explain the shortcomings of reasoning by induction (“Every swan I’ve ever seen has been white, therefore all swans are white.”), Taleb uses the black swan as a stark metaphor for the inevitability of highly improbable events. In other words, black swans are rare, but one will swim by eventually.

As far as Wall Street—particularly the people with a large stake in getting things right—is concerned, this financial crisis involved a confluence of events. Some of these black swans were set in motion by government, like flexible lending standards to extend home ownership, Fannie and Freddie, and a mortgage-friendly tax code. Others were set in motion by willfully ignorant bankers, big shot risk-modelers, and people believing they could live beyond their means. It all came together in a fantastic cascade of failure. The trouble is, no one—neither government nor market actors—can predict such a large-scale event. Black swans happen.

The other important thing to remember is that the economy is a chaotic system. Most of the time chaotic systems achieve a sweet spot between order and chaos, which is a good thing if an economy is to be robust. Chaotic systems, though, change constantly and involve dynamics that are highly sensitive to initial conditions.

An Ecosystem, Not a Machine

Sadly, we’re getting a whole lot of precisely the wrong kind of thinking in response to this crisis. Indeed most of the bad thinking arises from viewing the economy through the lens of a false metaphor: economy as machine. We’ve heard pundits accuse the government or banks of being “asleep at the switch.” But in a complex system, there is no switch. We’ve heard people ask how to “fix it,” “run it,” or “regulate it,” suggesting if just the right sort of genius controlled the rheostats, we’d get just the right sort of economy.

The economy is not like a machine at all. It is rather more like an ecosystem that no one can run, fix, or regulate. The hubristic sort of person who thinks he or anyone can run an economy is the victim of what Hayek called the “fatal conceit.” If given power, the planner will end up making the rest of us the victims of his false metaphor.

It is ironic that Alan Greenspan—once adored by the press but now pilloried by it—is being blamed not only for wielding a laissez-faire ideology that supposedly caused the crisis, but also for failing to predict a black swan. Greenspan was a single, powerful government bureaucrat in charge of gathering enough data to determine the “right” interest rate for a multitrillion-dollar economy. Given the size of that task, he did pretty well for many years. But he was one man. He was housed in a government building. He held an unelected office and made decisions in a bureaucracy that has a monopoly on money and influences the price of credit, at least in the short run. One can hardly call that free-market fundamentalism. Whether Greenspan offered artificially cheap credit or not, interest rates were only one factor among many. To have asked him to predict the best of all possible worlds and adjust interest rates accordingly would have been to ask him to be an oracle channeling the knowledge only God would have. Greenspan is not omniscient. Nor is Bernanke. No one is. But to “run” an economy would require not only omniscience, but omnipotence as well—a power that would bend the actions of millions to its singular will.

Whatever your ideological persuasion, the economy is a complex system that cannot be planned, designed, or have its black swans regulated away. Far from the caricatures sketched in the papers, this is precisely what serious free-market types have been saying for years. That’s why it’s a little more than silly to blame free-market ideology for the current mess, and a little more than mendacious to claim that government fingerprints won’t appear all over the crisis when the postmortem is done.

Hunting Black Swans with Shots in the Dark

The timeless nostra of the politician are to prime the pump (machine metaphor) and to regulate. It seems so simple. But that response is deceptively linear. If you could ask FDR, might he now concede his policies stretched the Depression out for a decade beyond what was necessary? He listened to J.M. Keynes and a coven of interventionists. If we agree that our mixed economy is a complex system, then we also have to agree that the benefits the partly free market confers are an emergent property of that system. If we attempt to regulate away the rare, unforeseen black swan event, the costs of our hubris will be terrible, for we will regulate away untold benefits, too.

In the real world the question may come down to whether we should accept a couple of years of painful market adjustments or decades of recession caused by the blunt instrument of politics. Devastating unintended consequences and unseen effects will follow government attempts to clean up a mess made in great measure by its own hand. Why? Because no one possesses a God’s-eye view of the economy. Government intervenes within the system as part of it, not from outside of it. Nor is the economy an instrument to be manipulated to positive effect—at least not over the long term. That is why Keynes got it so terribly wrong and why the economy must heal itself from within in a distributed, holistic way.

People want government, like God, to come down and fix the unfixable, or explain the inexplicable. That’s why they’re finding it easier to blame greed for our current financial crises. But greed is rather more like gravity: When you fall, you can blame either Newton or the banana peel on the ground.

The profit motive is a good thing when it operates in an environment where bad bets are punished with losses and good investments are rewarded. Only government can distort that healthy profit-and-loss system, giving people incentives to make bad decisions. And it’s in this environment that greed is no good to anyone. It turns out, however, that greed—or better, rational self-interest—can help our economy stabilize faster than government ever could. As the lubricant of our economic system, self-interest will cause a million market actors to recalibrate and to direct resources to projects that create value in our society. We the people will temper our irrational urges and mitigate our risks if government restores the rules that let profit and loss bring discipline. But if government continues to change the rules to bias the market in favor of irrational behavior, rent-seeking, and corporatism, the chaotic aspects of the system will continue to wobble out of equilibrium. Black swans will become commonplace.

Take the possible connection between the “public schools” and the current housing and mortgage woes.

Robert Frank, drawing on a 2003 book by Elizabeth Warren and Amelia Warren Tyagi, The Two-Income Trap, suggests that one factor in the housing mess is the government school system. In an April 27 Washington Post op-ed, Frank wrote that since the assignment of children to government schools is determined by geography, the way for parents to get their kids into putatively better schools is to buy homes in the best districts and neighborhoods they can. That system, they claim, encourages families to strain their budgets and to bid up the price of those houses.

Governments have traditionally assigned students to schools by district and neighborhood, regardless of parents’ wishes. District and intra-district boundaries could not be crossed without special permission. In rebellion against this system, parents have been known to lie about their address to get their children into better schools. But parents who didn’t want to lie might have instead bought more house than they could afford.

“Public schooling” is said to be free, but of course it can’t really be free. Parents (and others) pay through their taxes. Frank’s point is that parents also pay through their mortgage. Instead of paying higher tuition for better schools, they take on bigger mortgage payments by buying houses in more expensive neighborhoods with what they believe to be better schools. “[W]hen a family buys a house, it buys much more than shelter from the rain. It also buys a public-school system,” Warren and Tyagi write.

A couple naturally asks, “How are the schools?,” when scouting a prospective home. Government policy thus has made education a key factor when people buy houses.

This has long been true, of course, but the limits on such behavior were once stricter. Frank writes, “In the 1950s, as now, families tried to buy houses in the best school districts they could afford. But strict credit limits held the bidding in check. Lenders typically required down payments of 20 percent or more and would not issue loans for more than three times a borrower’s annual income.”

However the architects of public policy decided there should be no such barriers to the American Dream of home ownership. So a constellation of federal agencies and government-sponsored enterprises proceeded to subsidize ownership by providing mortgage insurance and other ways to avoid stringent income requirements and large down payments. “Down payment requirements fell steadily, and in recent years, many houses were bought with no money down. Adjustable-rate mortgages and balloon payments further boosted families’ ability to bid for housing,” Frank adds.

In other words, the politicians invented ways to weaken the credit market’s natural checks on excessive risk.

If Frank, Warren, and Tyagi are right—the thesis may provide a piece of the housing-bubble puzzle, but it has its critics and empirical work needs to be done—we can say one thing with certainty: the phenomenon couldn’t have occurred in a free market for education. There you wouldn’t have to live in the same neighborhood as your children’s schools because education entrepreneurs would not limit their customers to a given zip code. Thus no direct connection would exist between the size of your mortgage and the quality of the schools your kids attended.

I don’t know how much if anything the state school system contributed to the housing bubble and resulting problems. But it stands to reason that it played some role.

* * *

Dropping housing values, burgeoning mortgage defaults, and the rippling effects in the credit markets have spawned a variety of proposals for government interference with lending and investment. All would make the situation worse, reports Robert Murphy.

Free-market economists agree we live in a world of scarcity. Yet they also optimistically insist we need not run out of resources as living standards rise. Can this paradox be resolved? Yes, it can, says Steven Horwitz.

Advocates of the freedom philosophy often preface their remarks with the words “In a free market . . .” because we don’t have a free market today. Interventionism has been significant throughout even American history. As Kevin Carson writes, that legacy has had lasting and distorting effects.

One of the great tragedies of the second half of the twentieth century was China’s one-child policy to combat alleged overpopulation. Wendy McElroy has the details of the shameful episode that is not over yet.

John Taylor of Caroline trusted freedom and distrusted centralized power. In his second article about Taylor, Joseph Stromberg surveys the early American’s positions on political economy.

Freeman columnists serve up a cornucopia of insights this issue. Richard Ebeling relates the Austrian theory of the business cycle to current economic events.

Donald Boudreaux explores why the statist left is willing to believe every gloomy report about people’s economic circumstances.

Robert Higgs revisits a construction boom and bust from the past. John Stossel goes after lawyers who abuse the tort system.

Charles Baird predicts bad things for universities just getting faculty unions. And Aeon Skoble, pondering the claim that only government can save people from dying for lack of medical insurance, responds, “It Just Ain’t So!”

Our book reviewers have consumed volumes on judicial activism, government planning, eminent domain, and consumer-driven health care.

—Sheldon Richman

Leaving aside for a moment whether the health-care industry is really dominated by the profit motive (given that almost half of U.S. health-care expenditures are paid for by the federal government, it is not clear which motives dominate) and whether Moore knows better than millions of individuals what their health-care needs are, the claim that a “motive” is a root cause of social pathologies is worthy of some critical reflection. The critics seem to suggest that if people and firms were motivated by something besides profit, they would be better able to provide the things that patients really need.

The overarching problem with blaming a “motive” is that it ignores the distinction between intentions and results. That is, it ignores the possibility of unintended consequences, both beneficial and harmful. Since Adam Smith, economists have understood that the self-interest of producers (of which the profit motive is just one example) can lead to social benefits. As Smith famously put it, it is not the “benevolence” of the baker, butcher, and brewer that leads them to provide us with our dinner but their “self-love.” Smith’s insight, which was a core idea of the broader Scottish Enlightenment of which he was a part, puts the focus on the consequences of human action, not their motivation.

What we care about is whether the goods get delivered, not the motives of those who provide them. Smith led economists to think about why it is that, or under what circumstances, self-interest leads to beneficial unintended consequences. It is perhaps human nature to assume that intentions equal results, or that self-interest means an absence of social benefit, as was often the case in the small, simple societies in which humanity evolved. However, in the more complex, anonymous world of what Hayek called “the Great Society,” the simple equation of intentions and results does not hold.

As Smith recognized, what determines whether the profit motive leads to good results are the institutions through which human action is mediated. Institutions, laws, and policies affect which activities are profitable and which are not. A good economic system is one in which those institutions, laws, and policies are such that the self-interested behavior of producers leads to socially beneficial outcomes. In mixed economies like that of the United States, the institutional framework often rewards profit-seeking behavior that does not produce social benefit or, conversely, prevents profit-seeking behavior that could produce such benefits. For example, if agricultural policy pays farmers not to grow, then the profit motive will lead to lower food supplies. If environmental policy confiscates land with endangered species on it, owners of such land who are driven by the profit motive will “shoot, shovel, and shut up” (that is, kill off and bury any endangered species they find on their land).

The same issues can be raised in the health-care industry. Before blaming the profit motive for the problems in the industry, critics might want to look at the ways in which existing government programs like Medicare and Medicaid, the interpretation of tort laws, and regulations such as those that limit who can practice what sorts of medicine might lead firms and professionals to engage in behavior that is profitable but unbeneficial to consumers. Labeling the profit motive as the source of the problem enables the critics to ignore the really difficult questions about how institutions, policies, and laws affect the profit-seeking incentives of producers and how that profit-seeking behavior translates into outcomes. Placing the blame on the profit motive without qualification simply overlooks the Smithian question of whether better institutions would enable the profit motive to generate better results and whether current policies or regulations are the source of the problem because they guide the profit motive in ways that produce the very problems the critics identify.

For example, high medical costs may well be a result of profit-seeking providers’ recognizing that government programs are notoriously bad at pricing services accurately and keeping good track of their expenditures. Ignoring the way institutions might affect what is profitable is often due to a more general blind spot about the possibility of self-interested behavior generating unintended beneficial consequences. Before we attempt to banish the profit motive, shouldn’t we see whether we can make it work better?

Placing blame for social problems on the profit motive is also easy if critics offer no alternative. What should be the basis for determining how resources are allocated if not in terms of profit-seeking behavior under the right set of institutions? How should people be motivated if not by profit? Often this question is just ignored, as critics are merely interested in casting blame. When it is not ignored, the answers can vary, but they mostly invoke a significant role for government. The interesting aspect of such answers is that critics do not suggest that we somehow convince producers to act on the basis of something other than profit, but that instead we replace them with presumably other-motivated bureaucrats or have those bureaucrats severely limit the choices open to producers. The implicit assumption, of course, is that the government personnel will not be motivated by profits or self-interest in the same way as the private-sector producers are.

How realistic this assumption is remains highly questionable. Why should we assume that government officials are any less self-interested than private individuals, especially when the door between the two sectors is constantly revolving? And if government officials do act in their self-interest and are motivated by the political analogs of profits (for example, votes, power, budgets), will they produce results that are any better than the private sector’s? If blaming the profit motive entails giving government a bigger role in solving problems, what assurance can critics of the profit motive provide that political officials will be any less self-interested and that their self-interest will produce any better results?

One will look in vain in Sicko, for example, for any analysis of the failures of state-sponsored health care in Cuba, Canada, Great Britain, or anywhere else. To blame the profit motive without asking whether an alternative will better solve the problems supposedly caused by the profit motive is to bias the case against the private sector.

How Will They Know?

Even this argument, however, does not go far enough. We are still, after all, focused on intentions and motivation. What critics of the profit motive almost never ask is how, in the absence of prices, profits, and other market institutions, producers will be able to know what to produce and how to produce it. The profit motive is a crucial part of a broader system that enables producers and consumers to share knowledge in ways that other systems do not.

Suppose for a moment that we try to take the profit motive out of health care by going to a system in which government pays for and/or directly provides the services. Suppose further that we could, somehow, ensure that the political officials would not be self-interested. For many critics of the profit motive, the problem is solved because public-spirited politicians and bureaucrats have replaced profit-seeking firms.

Well, not so fast. By what method exactly will the officials know how to allocate resources? By what method will they know how much of what kind of health care people want? And more important, by what method will they know how to produce that health care without wasting resources? It’s one thing to say that every adult should, for example, have a checkup every year, but should it be provided by an MD, an LPN, or an RN? What kind of equipment should be used? How thorough should it be? And most crucially, how will political decision-makers know if they’ve answered these questions correctly?

In markets with good institutions, profit-seeking producers can get answers to these questions by observing prices and their own profits and losses in order to determine which uses of resources are more or less valuable to consumers. Rather than having one solution imposed on all producers, based on the best guesses of political officials, an industry populated by profit seekers can try out alternative solutions and learn which ones work most effectively. Competition for profit is a process of learning and discovery. For all the profit-critics’ concern—especially but not only in health care—that allocating resources by profits leads to waste, few if any understand how profits and prices signal the efficiency (or lack thereof) of resource use and allow producers to learn from those signals. The most profound waste of resources in the U.S. health-care industry stems from the incentives and market distortions created by government programs such as Medicare and Medicaid.

Thus the real problem with focusing on the profit motive is that it assumes that the primary role of profits is to motivate (or in contemporary language “incentivize”) producers. If one takes that view, it might seem relatively easy to find other ways to motivate them or to design a new system where production is taken over by the state. However, if the more important role of profits is to communicate knowledge about the efficiency of resource use and enable producers to learn what they are doing well or poorly, the argument becomes much more complicated. Now the critics must explain what in the absence of profits will tell producers what they should and should not do. Eliminating profit-seeking from an industry doesn’t just require that a new incentive be found but that a new way of learning be developed as well. Profit is not just a motive; it is also integral to the irreplaceable social learning process of the market. Critics may consider eliminating the profit motive the equivalent of giving the Tin Man from Oz a heart; in fact it’s much more like Oedipus’ gouging out his own eyes.

As happens so often, the results of the fuel-efficiency program were opposite of the stated objectives. By reducing the per-mile cost of driving, it became economical to drive more. Forget carpooling and public transportation. The significant savings in MPG (114 percent improvement for cars and 56 percent improvement for light trucks) were more than offset by an increase in the per capita miles driven (through more leisure driving and living farther away from the workplace). So instead of seeing a drop in oil consumption, there was a significant increase. In 1975 U.S. consumption of oil was 14.4 million barrels per day. Today, we consume 18.7 million barrels per day. Given this revelation, it should not come as a surprise that oil imports did not decrease as predicted but increased. In 1975, before CAFE, we imported 37 percent of our petroleum requirements. According to the government’s Monthly Energy Review of July 2005, with CAFE we now import 64 percent. CAFE neither reduced America ‘s use of foreign oil nor lowered our consumption of gasoline. 

Even if the masses had done what the elite class wanted (that is, drive less), it is unlikely the results would have been much better. Conventional wisdom assumes that most of a barrel of petroleum becomes gasoline for automobiles. Actually, gasoline accounts for less than half (44 percent) of the petroleum end-products. Some of the other end-products include: petrochemicals (such as plastics), jet fuel, diesel fuel, kerosene, propane, and home heating oil. 

When the CAFE standards took effect in 1978, the initial impact was benign. Because of the high gas prices, consumers already strongly preferred high-mileage cars. There was no need for a mandate because consumers and the auto industry were responding to market conditions. In 1981 prices peaked at an inflation-adjusted $3.07 a gallon. After that, real gas prices started to plummet. By 1986 they had fallen to the lowest levels in 30 years. As a result, American consumers were abandoning the small cars for their true love: Big Cars. Unfortunately, Phase II of CAFE was just kicking in. The federal government was now pulling the auto industry and the consumer in opposite directions. By law the auto industry would be punished if it provided products that the consumer wanted. The industry had no choice but to pursue the following suicidal strategy: Overcharge for the big cars consumers demanded in order to restrict sales, and give away the small cars that consumers didn’t want in order to encourage sales. 

Unfortunately, consumers responded to this shell game in a way that neither the government nor the auto industry wanted. They stopped buying cars. The large-car market has effectively been replaced by pickup trucks, SUVs, and minivans. The light-truck market, which is not subject to the same CAFE restrictions as cars, has gone from 28 percent of the market in 1987 to over 55 percent today. This consumer rebellion also resulted in the following CAFE irony: The fuel-economy average for all vehicles dropped from 26.2 MPG in 1987 to the 24.4 MPG today. 

It would be hard to find a more anti-consumer, anti-business, anti-jobs, or anti-American piece of legislation. The CAFE laws forced the Big Three auto industry to unilaterally surrender its strong suit, the large-car market, and go head to head against the small-car strong suit of the Japanese manufacturers. This was no contest. In 2004 the top four selling cars were are all Japanese: Toyota Camry, Honda Accord, Toyota Corolla, and Honda Civic. 

To make compliance even more difficult, each of the Big Three American automobile companies actually have to meet two sets of CAFE standards, one for domestically produced cars and one for foreign-made cars. In other words, the U.S. companies could not use their high-MPG foreign-produced cars to offset  low-MPG domestic cars. Since the large cars were more likely to be produced in the United States , the domestic-fleet target of 27.5 MPG was all but unreachable. To avoid fines for producing cars that the consumer wanted, the auto industry had four options: 1) downsize the large cars, 2) stop production of large cars, 3) move large-car production overseas, or 4) make the domestic large cars “foreign” by outsourcing at least 25 percent of the parts. If all this seems insane, that’s because it is. 

Besides being ignorant of economics, our elite class does not know much about engineering. They assume that the auto manufacturers are deliberately hiding the technological silver bullet that will enable cars to get phenomenal gas mileage. While a few known engineering changes could make marginal improvements, the only proven way to make substantial gains in miles-per-gallon efficiency is to reduce the weight of cars. This is accomplished by both making the cars smaller and by replacing steel parts with plastic parts. The average weight of new cars has dropped by an average of 1,000 pounds since CAFE became law. While lighter cars get significantly better gas mileage than heavier cars do, this comes with a price. There is an unavoidable tradeoff between better mileage and safety. The following is not rocket science, just Physics 101: Lightweight cars are less able than heavyweight cars to absorb the impact associated with a crash. In the late ’90s the Geo Metro was able to get 44 MPG. According to the EPA, this was one of the most fuel-efficient cars in America . The Geo Metro was also ranked by the Insurance Institute for Highway Safety as one of the most dangerous cars in America . It had a death rate double that of the overall car average. 

Deadly Standards 

As Robert Crandall of the Brookings Institution and John Graham of the Harvard School of Public Health wrote in the Journal of Law and Economics in 1989: “CAFE will be responsible for several thousand additional fatalities over the life of each model-year’s cars. We conclude that the real social cost of government-mandated fuel economy is much greater than is commonly believed.” They went on to state: “We estimate that these 1989 model year cars will be responsible for 2,200-3,900 additional fatalities over the next ten years because of CAFE.” While Crandall and Graham looked only at the 1989 model cars, CAFE-induced fatalities apply to every model year car since 1978. 

Echoing a similar conclusion, in 2002 the National Academy of Science estimated that CAFE was responsible for between 1,300 and 2,600 fatalities and 13,000 to 26,000 incapacitating injuries in 1993. Based on data from the National Highway Traffic Safety Administration and the Insurance Institute for Highway Safety (IIHS), USA Today reported on July 2, 1999 (based on data through 1998) that 46,000 people had died needlessly since the CAFE legislation became law. The article also stated: “Small cars comprise 18 percent of the vehicles on the road. . . . Yet they accounted for 37 percent of the vehicle deaths in 1997.” Given that the congressionally mandated killing and maiming has been going on another seven years, it is probably time to revise the total carnage figure to around 60,000 fatalities. 

It has been 28 years since CAFE became law. A case could be made that this was (and continues to be) the worst piece of legislation ever passed by Congress. Contrary to grandiose predictions, it did not reduce oil consumption and it did not decrease our dependency on uncertain foreign sources of oil. It did, however, result in 60,000 deaths and hundreds of thousands of serious injuries. And it has all but destroyed America ‘s Big Three auto companies. Given the damage done, CAFE should be scrapped. Any pending CAFE legislation should be permanently tabled as well. 

Micromanaging the automobile industry through government centralized planning has been a colossal failure. It is time to let the marketplace create jobs, save lives, and efficiently allocate resources. The automakers should no longer be punished for producing products that consumers want. Consumers are fully capable of making rational decisions about cost, safety, fuel efficiency (hybrid and non-hybrid), comfort, appearance, and size without government mandates. They need no help from politicians, bureaucrats, consumer advocates, environmentalists, or media pundits. If a family wants to buy a safe vehicle big enough to transport grandma and all the kids, why is this controversial? It is time to restore freedom of choice in the automobile market.