Ask 'And Then What?': Thinking Beyond the First Stage

Intro: Beyond the First Stage

Hi everyone, welcome to Cold-Knowledge Blind Box. When was the last time you asked "and then what?" Three simple words, yet they are a super prompt that can spark your thinking.

Today we're talking about a book called Then What? The Ripple Effects of Economic Policy, by the famous economist and thinker Thomas Sowell. That's the Chinese title. The English original, translated literally, is Applied Economics: Thinking Beyond Stage One. Sowell is also the author of A Conflict of Visions, which we covered on this channel before.

Sowell's book walks through what may be the most important habit in economics, and that's the idea in the subtitle: "thinking beyond stage one."

So what does "beyond stage one" mean? Take any public policy or regulation. Say the government introduces price controls so rent can't go up. Or it provides free healthcare for everyone. Or it passes a law to protect the employment of people with disabilities. At the moment such a policy is announced, which is the "first stage," it usually looks wonderful. It seems reasonable, and everybody cheers.

Rent isn't going up. Everyone can see a doctor. People with disabilities have the law on their side. Who wouldn't welcome a policy like that?

But if you follow the chain forward and look at the knock-on effects, the second stage and the third stage, you often find the outcome is the opposite of what was intended. The people who end up hurt the most are frequently the very people the policy was meant to protect.

Here's a classic example. The cities where it's hardest in the world to rent an apartment are New York, San Francisco and Paris. Housing is scarce, buildings are old and falling apart, landlords can't be bothered to make repairs, and many people have to slip the landlord an envelope of cash just to get on a waiting list. The irony is that all three cities have had strict rent control laws for a long time.

Sowell's Moment of Clarity

Sowell's habit of thinking beyond the first stage came from a moment of clarity when he was young.

When he was an undergraduate at Harvard, in an economics class, his professor, Arthur Smithies, asked him what he thought of a certain policy. Sowell immediately launched into a passionate speech about how much good the policy would do. The professor neither praised him nor argued with him. He simply asked, very calmly, three words: And then what?

Sowell was stumped. He started to work through the "and then what," and discovered that the policy he had been so confident about reversed its conclusion entirely once you followed it into the second and third stages.

"And then what?" is the most concise summary of thinking beyond the first stage, and it is the important habit of thought this book wants to pass on to readers.

I've grouped the policies in the book that only look at the first stage into three typical patterns: price controls, protection that turns into harm, and risk shifting.

Pattern One: Price Controls

The Ripple Effects of Rent Control

Whenever something gets more expensive, from politicians to ordinary people, the first answer that comes to mind is to control the price, stop it from rising, freeze it. Wouldn't that make everyone happy? But that's only the first-stage effect.

Let's use the most classic example, rent control, and keep asking "and then what?"

First stage: The government says rent may not exceed a certain figure. Tenants who already live in the apartments are of course happy, and so are those who haven't found a place yet, at least at first.

Second stage: Developers stop building new housing. They do the math: at the controlled rent, they can't recover their costs, so why build? After World War II, Melbourne, Australia, had very strict rent controls, and for a full nine years not a single new apartment building was completed. More landlords left the rental market than entered it, so the number of units available to rent kept shrinking. Prices didn't rise, but renting became harder, and the apartments people could rent got older. A survey in San Francisco found that more than three-quarters of rent-controlled apartments were over 50 years old, and 44% were more than 70 years old.

Third stage: People already living in these apartments start to waste the space. If you live alone and the rent is at market price, you'll probably choose a small apartment. But when the rent has been artificially pushed down, living alone in a big apartment doesn't cost much, so why move? A 2001 survey in San Francisco found that nearly half of the rent-controlled apartments surveyed were occupied by just one person. This is the most basic principle in economics: when the price falls, people consume more. Each person takes up more housing space, which leaves less for everyone else, so the scarcity gets worse.

Fourth stage: The chain reaction reaches the landlords. They find that repairing buildings no longer pays. In an open market with plenty of supply, a broken boiler gets fixed quickly, or the tenant moves out. But now supply is short, tenants are queuing for a place, and whether you repair or not, someone will rent it. So maintenance declines, and the buildings get more and more rundown and dilapidated. Some landlords can't even afford to keep up the minimum, because maintenance costs have long exceeded the income from controlled rents. Every calculation shows a loss, so they simply abandon the buildings. The New York City government ended up taking over thousands of abandoned buildings, many of which were boarded up with plywood. In some New York neighborhoods, this has become a familiar street sight. The number of abandoned housing units in New York far exceeded the number of homeless people sleeping on its streets.

Fifth stage: A black market appears. Housing is scarce, but there is always someone willing to pay a high price, so money starts flowing under the table. People slip landlords cash, bribe building superintendents, and do all sorts of gray deals. The New York rental market is full of this kind of thing.

Sixth stage (the most ironic step): Developers realize that ordinary apartments don't make money, so they build only luxury apartments, because luxury apartments aren't subject to controls. And so a city that claimed to be protecting the housing of the poor ends up with streets full of housing the poor can't afford. New York has the strictest rent control law in the United States, and it also has the highest rents in the country. That's no coincidence.

In sharp contrast is Massachusetts, not far from New York. After the state repealed local rent controls, some communities started building new housing for the first time in decades. Prices were freed, and they actually fell.

The logic of price controls runs like this: lower prices lead to shortages and declining quality, which leads to a thriving black market and misallocated resources, and in the end prices are actually higher. Every step requires no advanced economic theory at all, just the simple question "and then what?"

Nixon's Wage and Price Controls

In 1971, inflation in the United States was severe. Nixon ignored the objections of economists and announced a full freeze on wages and prices. The first-stage effect was very good. The media applauded, and ordinary people felt the president had finally acted to deal with those greedy bosses and profiteers. Nixon rode this wave of popularity to win reelection in 1972 by an overwhelming margin.

But then what? Herbert Stein, one of Nixon's economic advisers, later recalled: "We found out later that cows were being held back on farms and wouldn't be sold, chickens were drowned, and store shelves were emptied. Controls led suppliers to refuse to ship goods at prices below cost, so shortages set in." It was the classic script again. Only these were second-stage consequences, which slowly showed up after Nixon had already been reelected.

Drug Pricing

Developing a new drug usually takes more than ten years and costs hundreds of millions of dollars, and most research projects fail. A pharmaceutical company may synthesize thousands of compounds a year, and only a handful, maybe one or two, will ever get through approval and onto the market. The few successful drugs have to earn back the full cost of all that research, or no one would bother developing new drugs at all.

But what politicians see is this: the raw materials for this pill cost 25 cents, and you sell it for two dollars. That's pure profiteering, and we can't let these greedy drug companies get away with it. Canada's public health system buys large quantities of American-made drugs at very low prices, pricing them solely on manufacturing cost, without covering any share of research and development.

If nobody pays for that enormous research bill, drug companies have no incentive to develop the next generation of medicines. But the consequences don't show up right away, because a new drug usually takes more than ten years to develop. Ten years later, people notice there are still no new drugs for Alzheimer's, cancer or AIDS, and by then the politicians who pushed for price controls have long since left office and are happily writing their memoirs. Nobody has to answer for this second-stage consequence.

Sowell says: For politicians, killing the goose that lays the golden eggs is a perfectly feasible and perfectly rational political strategy, as long as the goose doesn't die before my next election.

In 1990, European and American drug companies each held one-third of the global pharmaceutical market. By the time Sowell wrote this book, Europe's share had fallen to 21% while America's had risen to 50%. European drug companies moved their research centers to the United States, because only American prices let them recover their research costs.

The Second Pattern: Protection That Turns into Harm

Disability Laws

In 1992, the United States passed the Americans with Disabilities Act, which requires employers to provide various reasonable accommodations for disabled employees, such as making sure wheelchairs can get into the office. The first-stage effect looked good. People with disabilities had legal protection, and many companies did improve their working conditions because of the law.

But then what? An economic study found that after the act was passed, employment among people with disabilities actually fell. The reason is simple: faced with the extra compliance costs and the risk of lawsuits, employers decided not to hire disabled people in the first place. The law protected disabled people's right not to be discriminated against, but it took away their chance to be hired.

This case also reveals a deeper economic principle: people's behavior tends to follow costs, not intentions. Change the cost structure, and you change the behavior.

How the Free Market Erodes Discrimination

Turn that around. If the cost of discrimination goes up, does discrimination simply decline? Something naturally raises the cost of discrimination, and that's free-market competition.

In apartheid-era South Africa, the government passed many laws to systematically discriminate against Black people. For example, many respectable jobs could not legally be given to Black workers. But even under this notorious system, the cost mechanism of the free market quietly eroded the foundations of apartheid. White builders, to save money and meet deadlines, secretly hired Black workers on a large scale. That broke the apartheid laws, but these businessmen weren't going to lose money over their principles. The government ended up having to fine several hundred construction companies.

On Broadway in New York in the 1920s, there were already Black stars. But in the same decade, Black people couldn't even join the U.S. Navy, and Black women couldn't even work as telephone operators for the phone company. Why was discrimination so different within the same era and the same country? Because Broadway was a fiercely competitive industry where you could win big or lose big, and a producer who turned away a Black performer who could fill a whole theater would pay a steep price. The telephone company, on the other hand, was a government-licensed monopoly. Its discrimination costs could be passed on to all its customers, so management could act on its racial preferences without paying anything for it.

California's Land Conservation Policies and Soaring Housing Prices

California is one of the places with the highest housing prices in the United States, but that isn't because California homes are especially luxurious. The problem isn't the construction cost of the houses themselves. It's the price of the land.

Starting in the 1970s, the California coast implemented a wide range of land restrictions: open-space laws, historic preservation laws, farmland protection laws, building permit approvals and more. The motives varied. Some were about protecting the environment, some about preserving the look of the city, and some simply because longtime residents wanted their houses to appreciate in value. But the effect was the same: a large part of a city was declared off-limits for building.

In San Mateo County, next to San Francisco, more than two-thirds of the land was designated as so-called open space, where the law forbids building anything. Doesn't the remaining third's price skyrocket?

In 1969, the median home price in San Jose, the heart of Silicon Valley, was 2.2 times the local median household income. A family could pay off a mortgage in 12 years by spending a quarter of its income. By 1979, the ratio had risen to 4 times, meaning 40% of income for 30 years. By 2005, the ratio had reached an astonishing 7.5 times.

These policies protected the space of the city and the longtime residents who already lived there, because their houses did appreciate. But for the young people, the poor, the teachers, nurses and police officers who wanted to move in, sorry, you can't afford it, please get out. In the Palo Alto area, only 7% of police officers could afford to buy a home in the city they worked in, and nearly a quarter of police officers lived on the other side of San Francisco Bay.

California real estate agents have a saying: "Drive until you can afford it." It means you drive inland on the highway, all the way out to the place where you can finally afford a house, and that's where you live.

From 1990 to 2006, the Black population of San Francisco fell by 35%, and in neighboring San Mateo County it fell by 33%. This wasn't because of racism. It was because they simply couldn't afford to live there. People talk about needing diversity and affordable housing, but their land conservation policies push poor people and minorities out to 100 miles away.

The most interesting contrast with the California coast is Las Vegas. Over the last two decades of the 20th century, the population of Las Vegas nearly tripled, yet the median home price, adjusted for inflation, didn't change. Because there were almost no land conservation policies there, the supply of new housing kept up with demand. Later, some environmental groups succeeded in blocking the sale of federal land to developers, and only then did Las Vegas's home prices take off. Same script again.

FDA Approval Incentives

The U.S. Food and Drug Administration (FDA) is responsible for approving new drugs in the United States. Its primary mission is to protect the public from dangerous drugs. The intention is certainly not a problem, but Sowell says this is only the first stage.

The trouble is that the officials who approve new drugs face wildly asymmetric incentives:

If an official approves a new drug, and it later turns out to have side effects that kill 1,000 people, those 1,000 people all have names. Their families will appear on television in tears, Congress will hold hearings, and that official's career is over, perhaps even with prison time.
But if the official doesn't approve the drug, 10,000 people might die because they can't get treatment. Those people, however, are often just a number in a mortality statistics table.

A former FDA commissioner sighed: "Congress has held so many hearings on FDA approvals that went wrong that we ourselves have lost count. But in all of history, we have never once been called to a hearing because we failed to approve a new drug."

The most classic example may be aspirin. Medical research had long shown that taking a low dose of aspirin every day could cut the risk of a heart attack in middle-aged men by nearly 50%. But at a 1988 meeting, the FDA clearly told all aspirin manufacturers: you may not advertise this use, or we will sue you. One study estimated that this ban led to tens of thousands of people each year who could have avoided heart attacks by taking aspirin, but didn't.

Medical Malpractice Lawsuits

The purpose of medical malpractice lawsuits is to let victims of medical errors receive compensation and to make doctors more careful, which protects patients to the greatest possible extent.

But then what? In some U.S. states, obstetricians pay nearly $40,000 a year in malpractice insurance premiums (and of course, that cost ends up being passed on to the patients). As many as 76% of American obstetricians have been sued at least once, so more and more obstetricians choose to leave places where lawsuits are easy to file.

The book describes a pregnant woman in Nevada, 13 weeks along, who called 28 obstetricians and not one would see her. The litigation risk in that area was so high that nearly all the obstetricians had left.

Even when doctors did accept patients, they practiced so-called "defensive medicine," meaning that whenever they could over-treat, they never played it safe. Among Pennsylvania obstetricians, 54% frequently ordered tests they themselves considered unnecessary, and 38% performed invasive procedures that weren't needed. None of this was because medicine required it. Doctors were protecting themselves from being sued.

A law meant to protect patients ended up loading them with extra risk and cost, and in some cases made it impossible for them to find a doctor at all.

The Third Pattern: Risk Shifting

Insurance for Hurricane Country

Some coastal areas of the United States get hit by hurricanes regularly. If you want to build a house in such a place, private insurers will demand very high premiums or simply refuse to cover you. The market is telling the truth. It's warning you: living here is dangerous and expensive, so think it over.

But politicians step in and say this is too cold-hearted. So they pass laws that forbid insurers from pricing according to the real risk, and even have the government act as the insurer of last resort, using taxpayers' money as a backstop.

The first-stage effect is certainly good. Coastal residents keep their homes, premiums become "affordable," and politicians win votes.

But then what? Because the cost of living in these dangerous zones has been artificially lowered, even more people build houses in hurricane country. When the next hurricane arrives, whole neighborhoods of houses are blown down again, and the government launches disaster relief, using taxpayers' money to help the victims rebuild. But many people rebuild on the very same spot, in the same place that keeps getting hit, because they know that next time the government will come to help again.

A small number of people keep up their high-risk behavior, politicians win hearts, and taxpayers pick up the bill.

Universal Free Healthcare

The government promises that everyone can afford to see a doctor. The first-stage effect looks wonderful: when you get sick, you don't pay out of pocket, the state covers the cost, and personal financial risk is shifted to all taxpayers.

But once seeing a doctor no longer hurts your wallet, what happens? There's an old French saying: every healthy French person has a patient inside them, longing to be diagnosed. If medical care is free, then a headache you could have beaten with a painkiller can now become a trip to the clinic. A minor ailment not worth a special trip to the hospital suddenly seems worth checking out, because it doesn't cost anything anyway. Why not?

It's not just patients whose behavior changes. Doctors change too. Since the bill is guaranteed by the government, doctors have no qualms about prescribing expensive drugs and ordering all kinds of tedious tests. Some even have an incentive to split a shot that could be given in one go into two, so they can bill two visits.

So a huge number of minor problems pour into the healthcare system, and doctors have no incentive to hold back. The truly urgent medical needs are completely swamped by a flood of non-urgent ones. And since price can no longer be used to screen patients, something else has to do the screening, and that thing is time: long waiting lines.

In countries that run universal free healthcare, such as Britain and Canada, patients often wait more than half a year for life-saving elective surgery such as heart bypass or joint replacement. The same operations in the United States involve almost no wait. Many seriously ill patients have let their conditions deteriorate beyond saving while they waited.

A better healthcare system would let patients feel the sting of paying for minor illnesses while being protected against major ones. That might create more sensible incentives.

Conclusion: Politics Is Where First-Stage Thinking Loves to Hide

The three patterns are not identical in mechanism, but in the first chapter of the book, Sowell points out that they share a structural cause: politicians' terms are too short, and the policy consequences take too long to appear.

The benefits of a policy show up before the politician's next election. Its costs erupt many years after the vote. That is the fundamental reason first-stage thinking can keep succeeding in democratic societies.

Nixon himself wrote in his memoirs that he knew wage and price controls were wrong in the long run, but that they were politically necessary and very popular in the short run. His economic adviser Herbert Stein also confirmed that from the start, the White House never expected these controls to actually curb inflation.

So in many cases, politicians aren't unaware that some policies have consequences beyond the first stage. Politics itself is a game played only at the first stage.

Sowell says that economics has an old nickname: "the dismal science." It sounds gloomy, not sunny enough, not positive enough. Sowell thinks the nickname is quite accurate, because economics really doesn't offer feel-good answers. What it offers is trade-offs. It tells you that nothing in this world is free, every choice has a cost, and every cost is borne by someone, though that someone may not be you, and may not even be born yet.

Politics, on the other hand, excels at offering the illusion of costless solutions. A politician can tell you without any burden: we can shut down every coal power plant and lower electricity prices at the same time. So politics is where first-stage thinking loves to hide.

Well, that's where we'll stop for this episode of Cold-Knowledge Blind Box. See you next time!