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Posted by Tim Harford

https://timharford.com/2025/08/the-law-of-unintended-consequences-strikes-again/

https://timharford.com/?p=9432

Economists love to tell each other stories about perverse incentives. The “cobra effect” is a favourite. It describes an attempt by the British Raj to rid Delhi of its cobras by paying a bounty for each cobra skin, thus encouraging a thriving cobra-farming industry. The cobra story is probably an urban myth — or a policy wonk’s version of one — but there is more evidence of a very similar scheme for Hanoi’s rats in the early 1900s. Rat tails brought a bounty from the colonial government, and soon enough the city was crawling with tailless rats who had had their valuable tails clipped before being released to breed.

It’s easy to dismiss such policy blunders as a thing of the past, but the Straits Times and Climate Home News recently reported on a striking scheme in Melaka, Malaysia, where locals were selling cooking oil that would eventually be used to supply European producers of aviation fuel. The underlying idea of turning a waste product, used cooking oil, into something that can be blended into aviation fuel seems as appealing as getting the cobras out of Delhi. Cooking oil starts tasting bad after being used for frying three to five times, but as an input to aviation fuel, used oil is perfectly good.

At this point two intriguing forces intersect: European governments are demanding that airlines use more biofuels from sustainable sources — used cooking oil being one — while the Malaysian government subsidises cooking oil. This means that in Malaysia buying fresh oil is cheap and selling used oil is lucrative. If you run a food stall or restaurant in Malaysia, you can buy subsidised fresh oil, fry food a few times, then sell the waste oil at a profit. It’s a nice side-hustle.

The trouble is, writes financial journalist Matt Levine, “If you don’t run a restaurant, you can buy fresh cooking oil for $0.60, not use it to fry food any times, and then say, ‘Oh, yeah we totally used this oil,’ and sell it to a refiner for $1.” That seems a simpler and more scalable way to proceed. It certainly cuts out the precarious, time-consuming hassle of actually running a restaurant. It is hard to know how much fresh oil is being resold this way, but fraudsters have both the motive and the opportunity. Climate Home news notes that Malaysia collects an astonishing volume of “used” cooking oil: more per person than anywhere else, and two and a half times as much as second-placed Singapore.

Sitting in the UK, we shouldn’t be too smug about the unintended consequences of environmental legislation. The Northern Ireland Executive collapsed in 2017 in the wake of the Renewable Heat Incentive scandal — popularly known as “cash for ash” — in which residents were paid generous subsidies for using heating from renewable sources such as wood pellets. Rather than merely encouraging people to switch from fossil fuels to biomass, the subsidy effectively set a negative price on biomass heating: the more things you could find to heat, the more money you made. The result was a vast waste of valuable energy at taxpayer expense.

But perhaps the real scandal is not this long list of backfiring policy wheezes, but what is accepted as perfectly reasonable environmental policy. The Institute for Fiscal Studies (IFS) recently reported a chaotic patchwork of inconsistent tax incentives to reduce emissions. While these inconsistencies lack the anecdotal appeal of Hanoi’s rat tails, Melaka’s cooking oil shuffle or turning Northern Ireland’s empty agricultural sheds into saunas, the policy jumble is making the push towards net zero emissions more expensive than it needs to be.

For example, power station operators that burn gas to generate electricity need to buy emissions permits under the UK’s emissions trading scheme (ETS). The ETS functions very much like a tax on carbon dioxide emissions, and until the grid is completely zero carbon, it will mean electricity is more expensive. As far as it goes, that’s fine — a good incentive to save energy and to switch to greener sources of power. The problem is the contrast with what happens if instead that same gas is sold to retail customers to burn at home for cooking, hot water or central heating. No ETS costs there, and in fact domestic gas attracts a discounted rate of VAT. Taking the standard rate of VAT as the baseline, gas central heating is effectively being subsidised to the tune of £55 per tonne of CO₂ emitted. Domestic electricity use faces a tax, not a subsidy, of about £120 per tonne of CO₂. The gap — of £175 per tonne — is yawning wide and hard to justify.

While this mismatch is unlikely to produce any spectacular scandals, it does exert a constant pressure to burn gas instead of using electricity. If the government is wondering why it is having such trouble persuading the British to scrap their gas boilers in favour of highly efficient electric heat pumps, perhaps it should have a look at the IFS’s numbers.

Three rules of thumb: first, it’s generally better to tax the bad stuff rather than subsidise what seems to be the good stuff, whether that is biomass heating in Northern Ireland, rat tails in Hanoi or cooking oil in Malaysia. In an economics textbook the effects might look similar; in the real world, a subsidy is often exploited.

Second, it’s a good idea to tax similar things similarly. If the goal is to discourage carbon dioxide emissions — as it should be — then it is strange to levy a heavy tax on some, while giving others a tax break.

Third, beware the overlaps. Two policies that seem sensible in isolation may interact in strange ways — such as the Malaysian cooking oil arbitrage. Too many governments find themselves performing the policy equivalent of a driver simultaneously hitting the accelerator and the brake.

We need good environmental policies, but they need to be designed with care, and the political process does not always favour careful design.

Written for and first published in the Financial Times on 10 July 2025.

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https://timharford.com/2025/08/the-law-of-unintended-consequences-strikes-again/

https://timharford.com/?p=9432