Government interventions and the Cobra effect

Source: Photo by Paul Fiedler on Unsplash

Almost two decades ago, German economist Horst Siebert coined the term the “Cobra effect” to describe the real-world consequences of “well-intentioned” government interventions that go awry and produce the exact opposite results from what they aim for. The term was inspired by an incident that took place in India during the British rule, when the authorities tried to reduce the number of deadly cobras in Delhi by offering a cash reward to citizens for every dead snake. As one might expect, it didn’t take too long for entrepreneurial Indians to start breeding cobras to increase their income. And when the authorities realized the folly of their scheme and put an end to it, the now-worthless reptiles were released, causing the number of cobras to skyrocket to levels much higher than when the plan was first implemented.

This incident itself might be almost a century old, but the mechanism behind it is basically timeless. It always comes down to the hubris of central planners, who believe they can tame, micro-manage and control the economy, a living organism, with countless participants, forces and moving parts. Instead of allowing the free market to function as it naturally does, they naively try to tinker with it, restrict it and manipulate it, and the results are always the same: Either their efforts produce no results, usually at a great cost, or more often, they simply backfire and make the problem they were supposed to solve much worse. Or as Mark Twain aptly put it, “The best way to increase wolves in America, rabbits in Australia, and snakes in India, is to pay a bounty on their scalps.”

We’ve seen this play out time and time again, throughout history and in all kinds of different countries, periods and circumstances. Back in the 1860s, as the US was trying to complete its first transcontinental railway system financed by both state and US government subsidy bonds, Congress thought it would be a good idea to pay the contractors for each mile of track they delivered. Consequently, Union Pacific Railroad went on to lay tracks in the shape of a bow to maximize their profit.

A much less amusing example can be found a little later in Canada. In the middle of the last century, the government conceived of an inspired social welfare scheme to help the weakest and most vulnerable members in any society: orphans and mentally ill people. It paid institutions 70 cents per day per orphan and $2.25 per patient per day. An estimated 20,000 orphans were purposefully misdiagnosed and falsely certified as mentally ill and forcefully confined in state facilities until they reached adulthood and were rendered unprofitable.

Much more recently, we find similar results stemming from the “Endangered Species Act of 1973” in the US, a statute that still stands. Signed by President Nixon, the law imposed severe building and development restrictions upon landowners that find endangered species on their property. Clearly meant to preserve and protect those species and their habitats, the law had the exact opposite effect: The fear of losing the right to develop and use their property incentivized many landowners to preemptively destroy areas that might be able to serve as an attractive home to such species, while it even caused some to deliberately eradicate endangered animals found on their land.

It is clear to any sane reader that behaviors like that, being entirely unnatural, irrational and senseless, could never have come about without the interventions of central planners. There are no such incentives presented in a truly free market and if anyone witnessed their neighbor engaging in similar activities, without knowing the full context and the artificial economic forces invented and laid down by state actors, they would surely think them lunatic or psychopathic.

And while it is obvious that creating such perverse incentives can directly cause real and often irreversible harm to large groups of people, to the natural environment and to entire economic sectors, the ripple effects of these policies should also not be underestimated. Although less clearly identifiable, at least at first sight, there are long-term and far-reaching consequences that stem from the vanity of a few men who believe they know what is best for millions of others.

Unsound money, unsound society

Of course, one of the most important and consequential parts of the incredibly complex organism that is the economy is money itself. It is its lifeblood and as the song goes, “it makes the world go round”. Therefore, manipulating the currency itself is one the most dangerous and hubristic things a central planner can do, which probably explains why it’s their favorite pastime. Ever since the gold standard was officially abandoned, the floodgates opened and governments and their central bankers had a field day. They’ve tried all kinds of schemes and strategies to render money just another tool in the hands of whomever happens to be in power at the time: they tried diluting it, printing tons more of it on a whim, assigning arbitrary and imaginary value to it, restricting its free use and punishing its accumulation.

Students of monetary history know well that is no shortage of examples clearly demonstrating how all these efforts backfired and how short-sighted and self-defeating these policy initiatives have been. Most recently, we saw this play out over the last decade, with the wide adoption of QE and ultra low interest rates. These extreme measures were supposed to “save the economy” and the political justification for them, as it always is, was focused on “helping those most in need”. A decade later, we can plainly see what these policies actually delivered and it certainly wasn’t what was promised.

They created and inflated an unprecedented asset bubble, with stock prices of worthless companies at record highs. They incentivized large corporations to go on acquisition sprees with borrowed money, snuffing out smaller competitors, and to engage in reckless stock buybacks, artificially inflating their own “value”. They penalized responsible savers, pensioners and long-term, prudent investors, and they instead rewarded mindless speculation, excessive borrowing and senseless risk-taking.

However, most importantly, these policies also had a devastating, long-term and truly deleterious impact on society itself. They widened the inequality gap, one of the most severe problems of our time and one that can trigger much deeper crises, as we well know from history. As the “haves” profited, seemingly endlessly, from the inflated asset prices, the “have-nots”, the average worker and those with no access to the markets, saw that next step on the ladder get further and further away from them. The gap between the two groups in society widened and for those stuck on the wrong side, crossing over to where the grass is greener eventually became all but impossible.

Soon enough, as the money printing went on and accelerated, it wasn’t only “red-hot” stocks they couldn’t afford, but houses too. By now, “those most in need” that the central planners promised to save, can’t afford a new car, or used one, for that matter. They also can’t afford to heat their homes, as electricity and fuel prices are skyrocketing. Buying basic, everyday necessities is becoming an increasingly heavy burden on the finances of countless low income households and even food and essential groceries are straining many budgets.

Instead of directing their anger at the people who were actually responsible for this situation, those that feel cheated and clearly see that the game is rigged, many turn their ire against their fellow citizens. The politicians and the central bankers of course fan these flames with toxic and divisive rhetoric, as they see an opportunity to deflect blame and avoid accountability. Therefore, as these financial pressures continue to build up, the danger increases drastically that the way the tension will be released might create a permanent and irreversible tear in the social fabric.

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