Following the Herd

January 11th, 2010 by Potato

In my last post on the CMHC, I said: “Unfortunately it’s one of those things where what’s good for one person is bad when it happens to everyone in society at once.”

I tried to find out what that thing is called. Surely there’s an economic theory of some sort that describes this phenomenon — if not, I will gladly accept a Nobel prize in economics for outlining it here. :)

It’s a concept that’s similar to, but not quite the same as, the tragedy of the commons. In the tragedy of the commons, you have some finite public resource, and even though everyone would be better off if consumption was limited, each individual gains when they take a bit more, whereas the costs are spread out amongst everyone, so overconsumption results unless there is some organization between the players to prevent it.

Here there is no finite resource: the government keeps increasing the CMHC’s budget so everyone can get cheap money. For one person, access to an affordable homes program like that lets them get a house with a lower downpayment (and thanks to the insurance, lower interest cost than would be expected with a low downpayment), so it does make housing more affordable. Of course, as I outlined before, when everyone has the same access to the program, asset prices skyrocket and a bubble forms.

Ignoring the confound of government involvement, the same thing can happen with other behaviours. For example, it’s a good thing for people to save their money for a rainy day. When the economy starts going into upheaval, it makes sense for an individual to start saving more as their perception of the risks of say losing their job increases. However, if everyone suddenly reduced their spending at the same time, that would be bad and would cause or worsen a recession.

So, aside from “congestion” (which doesn’t seem to fit well with every case) what’s the term that describes this negative unintended result of following the herd, where each person is acting individually in their best interest?

One Response to “Following the Herd”

  1. Davie Says:

    I agree. Ultimately, people do what is best for themselves. Most people I know are afraid of losing their jobs so they save more. The government will lower interest rates trying to entice the consumer to come back to the market and make big time purchases. But with people afraid of their job security, who would buy?