Thursday, October 9, 2008

Financial Side Effects of Election Promises

Canadian Financial DIY gave us a great summary of the Canadian political party platforms. As usual, the NDP have the most entertaining promises. The Green Party are a close second with their promises to raise the GST and legalize marijuana.

Whenever I hear political promises, I tend to think about the side effects that will be caused. Charlie Munger, long-time business partner of Warren Buffett, illustrated the concept of second-order effects nicely in a speech at UCSB (pdf):
"A truck trailer business had a plant in Texas whose workman’s comp costs were 30% of payroll. This means that for every ten people working at the plant, the equivalent of three more were at home getting paid because they were supposedly unable to work. Workman’s comp is important for legitimate health problems, but 30% is ridiculous. When legislators created the workman’s comp rules, did they project costs based on existing sick-day rates, or did they anticipate the secondary effects of soaring numbers of workers taking advantage of an easily-gamed workman’s comp system?"

Credit Card Interest Rate Promise

The NDP promises to limit interest rates on credit cards to 5% over prime. With this policy, many people who currently have credit cards would no longer qualify for them or would only qualify for a drastically reduced spending limit. An interest rate 5% over prime roughly compensates the bank for a 5% chance that you won’t pay back the money you borrow. If the bank judges your odds of default to be above 5%, then you won’t get a credit card.

This may actually be a good thing; I’m no fan of the aggressive tactics used by banks to ensnare the unwary into debt. But, I wonder how many people with below-average credit scores agree with this policy not realizing that they would lose their own credit cards.

Promise to Forgive Doctors’ Student Loans

The NDP promises to forgive doctors’ student loans if they devote the first ten years of their practices to family medicine. I don’t have a strong opinion on whether this is a good idea or not, but I do have a strong opinion about assessing its cost. The wrong way to assess cost would be to use the average student loan size among currently graduating doctors.

Many doctors in training who would otherwise have paid their way without taking student loans would seek student loans under such a policy. People prefer free money to a loan. Without any change in the rules governing qualifying for loans, the average student loan size would increase.

Part of the reason why each party’s estimates of the costs of their promises tends to be too low is that they ignore secondary effects.


  1. Hi Michael, Thanks for the link. Excellent post. I know someone currently in medical school who has described how many students have large loans that banks are only too keen to provide. I could easily see much larger loans amongst those doctors-to-be. Of course, then the government would want to clamp down on abuse, start making all sorts of special rules, limitations and exemptions and presto, a whole bureaucracy would arise - one wonders if that cost is included in estimates too. And accountants would get more work too, figuring out how to extract the maximum.

    The part about the workers' comp reminds me a gy I met on the golf course recently - early fifties. When I asked whether he was retired he said no, he'd had to quit work for health reasons ... 17 years ago. He's a low handicap golfer as he golfs every day!! Cool, huh?

  2. Hi CanadianInvestor: I've been semi-retired myself for about 7 years partly for health reasons. Not that my health was bad, but I wanted it to stay good. I've had the time and energy to work out, take care of minor injuries properly, and play sports. Of course, I've had to fund this myself rather than collect workman's comp.