The world is changing at an unprecedented pace. The change we are facing is complex, non-linear and systemic. How can governments design public policy under such extreme uncertainty? A deeper appreciation of a few fundamental, but profound, economic principles can help you make the best decisions when the time comes. I want to highlight three powerful economic concepts that can provide a framework that facilitates problem-solving under uncertainty, while allowing flexibility and adaptation.
Public policy is fundamentally about making trade-offs
To get something we have to give up something else. Resources are scarce. That means we have to make decisions. The alternative we give up is our opportunity cost. Public policy aims to assign scare resources to its most valuable use. This means that there will always be winners and losers. How we manage those that feel loss is crucial to achieving broad support for a reform or program.
People respond to incentives
People inherentlymake decisions based on a cost-benefit analysis. Certain actions incentivize us to do something, or not. This concept is useful at the individual level but also from a macro perspective. Development is a political process. Effective policy making requires an understanding of how power and resources are distributed and contested. To know the incentives of key players.
Institutions have a major role in development
Institutions are the formal and informal ‘rules of the game’ that shape the social, economic and political interactions. These institutions shape incentives, impact the allocation of resources and the distribution of power in a society.
Let’s think about lockdowns for a moment
Minimizing COVID-19 transmission is a key public policy objective designed to save lives. One way to achieve that is to impose a lockdown on the population. The opportunity cost of minimizing the health impact is the increase in the economic impact. The way in which this trade-off between health and economic impact has played out has varied depending on the context and objectives of different countries and governments.
Australia and New Zealand are examples of countries that have been successful with their lockdown policies. While similar in many aspects, each country valued their opportunity cost differently. New Zealand was more risk averse and went into a stricter lockdown than Australia. However, both countries have a functional government and strong institutions with adequate social protection systems that were key to their success in controlling the spread of the virus.
Countries with weaker health systems and more vulnerable populations, like the Pacific island countries for example, have made different choices when dealing with similar trade-offs between the health and economic impact. The low capacity of the state to respond in the case of an emergency means that they have pursued extreme measures to protect their populations from the potentially devastating health impacts. They have been prepared to accept a much greater economic cost to avoid dealing with a health crisis they couldn’t handle. In their case, given that they haven’t had local infections, their incentives are set to minimize risk by closing their borders.
In Latin America strict lockdowns have been unsuccessful. The adopted measures have responded to the same macro-level trade-offs as countries like Australia and New Zealand. However, there are two key differences. Low institutional capacity to respond to the crisis, including in the health and social protection systems, meant the region generally failed to adequately change the incentives for people to stay home rather than go out. As a result, these countries failed to control the spread of the virus. Moreover, the incentives at the household level are completely different to what the lockdown policies anticipated at the macro level. In Peru, for example, 70% of the population works in the informal sector. In the absence of a strong social protection system that can cover their basic needs, staying at home is not an option for these households. To stop work means no income and no food.
Final Thoughts
Economics is essential for a comprehensive view of public policies. To allocate resources efficiently and effectively requires an understanding of trade-offs and opportunity costs. Knowing how people respond to incentives improves policy design. Furthermore, public policies don’t happen in a vacuum. Institutions shape resource allocation, incentives and the power of economic agents that will impact public policies. As Otto von Bismarck said, public policy is the art of the possible, the attainable… The art of the next best.
Photo by Ambrose Chua on Unsplash
